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Executives

Jeanne Leonard - IR

Bill Hankowsky - Chairman, President and CEO

George Alburger - EVP and CFO

Mike Hagan - SVP and CIO

Rob Fenza - EVP and COO

Analysts

Mitch Germain - JMP Securities

Alexander Goldfarb - Sandler O'Neill

Jordan Sadler - KeyBanc Capital Markets

Michael Bilerman - Citi

Ki Bin Kim - Macquarie

Sheila McGrath - KBW

Sloan Bohlen - Goldman Sachs

Brendan Maiorana - Wells Fargo

John Stewart - Green Street Advisors

Presentation

Liberty Property Trust (LRY) Q2 2010 Earnings Call July 27, 2010 1:00 PM ET

Operator

Good afternoon. My name is Darla and I will be your conference operator today. At this time I would like to welcome everyone to the Liberty Property Trust second quarter earnings call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. (Operator Instructions). Thank you. Ms. Leonard, you may begin your conference.

Jeanne Leonard

Thank you, Darla, thanks, everyone for tuning in today. 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 this call, management will be referring to our quarterly supplemental information package and 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 in the press release, you will also find the reconciliation of non-GAAP financial measures we referenced 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 Laws. Although Liberty believes that the expectations reflected in such forward-looking statements are based on reasonable assumptions, we can give no assurance that these expectations will be achieved.

As forward-looking statements, these statements involve risks, uncertainties and other factors that could cause actual results to differ materially from the expected results, risks that were detailed in the issued press release and from time-to-time in the company's filings with the Securities and Exchange Commission. The company assumes no obligation to update or supplement forward-looking statements that become untrue because of subsequent events.

Bill would you like to begin?

Bill Hankowsky

Thank you, Jeanne and good afternoon, everyone. Liberty had another strong performance this quarter particularly in light of the tepid economic environment we are in. FFO for the quarter with $0.67. We leased over 4.1 million square feet and our renewal rate was over 58%.

In combination, these factors raised occupancy by 50 basis points to 88.7%. The occupancy gain was led by our industrial portfolio, but we saw gains across all three property tax. As we have been saying for the last couple of quarters, we believe market rental rates have hit bottom. But as we have also said, they are staying there. So we continue to see rentals down as our new leasing meets these market rents, this quarter being the 2.4% decline. This decline, however, is less severe than we saw last year, which is a hopeful sign.

I am also pleased that last week we closed on our first value-add acquisition of the year, 228,000 square feet of industrial space in Houston. So this was a very solid quarter by Liberty in an unsettled economy. George, Mike and Rob will provide some additional color in a moment.

Let me spend a minute giving you our observations and perspective on the economy and the real estate markets. There is no question that economic metrics and perhaps more importantly people's perceptions are the things that are less positive today than they were in the first quarter.

Inventory build up and the playing out of the government stimulus efforts were the major drivers of the fourth quarter '09 and first quarter '10 GDP growth. These factors will not be available to influence GDP growth in future quarters. On the sentiment side, people all felt better in late '09 and early they are year.

The financial markets meltdown was averted, and these markets have reestablished themselves. The monthly negative economic reports were tempering. So everybody thought, the worst is over, 2010 will be a positive year. And now it's not as great as we expected, so people are disappointed and caution and concern are back.

Our sense is that people should not have felt as good as they did earlier this year and they shouldn't feel as bad as they do now, but we have said over the last several quarters, this is going to be a long and slow path up, and that's how it is playing out.

For real estate markets, this recent renewed caution has manifested itself with a decline in prospect activity in June from where it was in April and May, as well as another dose of delayed decision making. Nationally, we saw office and industrial vacancy each increase 10 basis points.

Absorption turned positive in office markets for the first time in six quarters and the majority of it was in the suburban markets. Industrial absorption is at an inflection point, with very national reports having absorption at plus or minus several million square feet. We still see industrial doing better than office in terms of deal flow and prospects in the markets.

To sum up, it will be a slow, long road back but we are on it and as this quarter showed, with Liberty gaining occupancy, while the national markets have modest declines, we think Liberty will be the leader in our markets on the road back.

We still expect to see our occupancy increase further between now and year end, but given the recent rise in tenant uncertainty and the decreased deal flow, we anticipate that this increase will be less than we had projected at the beginning of the year.

This sentiment change has also slowed decision making on the build to suit front, where we remain in active discussions but we have yet to ink a deal.

And with that, let me turn it over to George.

George Alburger

Thanks, Bill. FFO for the second quarter of 2010 was $0.67 per share. The operating results for the quarter include $1.5 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.

During the quarter, we pre-paid $119 million of mortgage loans. The interest rate on these loans was 7.3%. The pre-payment penalty and the deferred financing costs that were written-off because of the prepayment totaled $2.1 million. The interest savings we realized during the quarter from preparing these loans were approximately $1.4 million.

The operating results for the quarter also include a $1.4 million net of tax gain from the sale of land in the UK. During the quarter, two development properties were brought into service, one was a wholly owned office building which is essentially 100% leased. The investment in this building is $46 million and the yield on this investment is 8%.

The second property which was brought into service was a 464,000 square foot warehouse, which is owned by joint venture in which the company has a 25% interest. This property is vacant. There are prospects for approximately half of this space.

We didn't start any development properties this quarter. As of June 30, the committed investment in development properties is $146 million. For wholly owned properties, it's only $12 million. We didn't have any acquisitions this quarter, but we sold two properties and 12 acres of land for $10 million.

For the core portfolio, during the quarter we executed 3.5 million square feet of renewal and replacement leases. For these leases, rents decreased by 2.4%. One of the leases that was executed this quarter was a 615,000 square foot lease in the Lehigh Valley. The cost for this lease were approximately $10 million. This one lease accounts for 45% of the $23 million in leasing cost this quarter.

This lease is for 10 years. It's with an excellent credit tenant, and is for a very good rent. Its one of the reasons the decrease in rents this quarter was only 2.4%. Excluding this lease, the decrease in rents for the remaining 2.9 million square feet of renewal and replacement leases executed this quarter was 7.7%. This decrease and the 9.2% decrease in rents for the first quarter are both less than our guidance for the year, which was that rents would decrease by 10% to 15%.

So the same store group of properties, operating income decreased by 3.2% on a straight line basis and decreased by 1.8% on a cash basis for second quarter 2010, compared to the second quarter of 2009. These decreases are primarily due to a decrease in office occupancy.

Finally, one matter we are working on is replacing our existing credit facility, which is due to expire in January. Our present facility is a $600 million facility. We anticipate that the new facility will be a $500 million facility, and we hope to have it finalized in August.

Now with that, I'll turn it over to Mike.

Mike Hagan

Thanks, George. I would like to give you our views on the investment sales market. Clearly, activity has picked up, especially on the industrial side. We have tracked several transactions in the market, where well leased property in top tier markets is trading in the seven to eight cap rate range. Some transactions may even break 7%.

It is not as active on the office side, but again well leased class A properties are trading in the 8.5 to 9.5 cap rate range for suburban offers. We attract a few metro office transactions in South Florida and Washington DC, where cap rates are below 7%.

Liberty continues to look for value-added opportunities, and subsequent to quarter-end, closed on two multi-tenant industrial buildings, totaling 228,000 square feet in the Houston market. These building had institutional ownership, with a local operating partner. We approached the ownership directly, and were successful in coming to terms before the buildings were taken to market.

The purchase price for these buildings was $51 per square foot. The buildings are new construction, and have never been leased. We have included in our investment an additional $13 per square foot for closing, due diligence, cost, carry, and first generation tenant improvements.

We have underwritten it on an 18 month lease up period. This is greater than we normally would do, but given the current marketing conditions, we felt the extra time was warranted. We anticipate an approximate 8.25 return upon stabilized occupancy.

Houston has been a strong market for us, with our current portfolio 93% leased, and we will continue to look to invest there. We will continue to look for value-add opportunities, although this does not seem to be many of these opportunities in the market at this time.

To give a sense of where we will end up for the year, on acquisitions, we are comfortable with the ranges we gave earlier, which was zero to 100 million at stabilized deals in the 8% to 10% range.

On the disposition side, year-to-date, we have sold $16.5 million in four transactions mostly to users. Our game plan at the beginning of the year was to sell 75 million to 125 million. We continue to explore sales that are consistent with the company's overall strategy of decreasing our investment in suburban office. And if opportunities arise that meet our pricing expectations, we will sell.

Given what we have completed to date, as well as what is in our disposition pipeline, we expect to be below the low end of the guidance range of $75 million.

With that, I'll turn it over to Rob.

Rob Fenza

Thanks, Mike. Good afternoon. I'm going to spend a few minutes, discussing operations and market conditions. As Bill mentioned, Q2 was another solid quarter on the leasing front. 213 new and renewal leases were executed for 4.1 million square feet. This performance is consistent with our budgeted projections, and moved the occupancy higher in office, flex and particularly industrial, to June 30th combined occupancy of 88.7%, a 50 basis point increase over Q1.

We continue to outperform our competitors and our occupancy is outperforming the national averages by 440 basis points. The current leasing environment, although better than last year, continues to be rugged.

Second quarter prospect activity compared to the first quarter has remained flat in most of our markets, and has trended lower in some. On one of our recent leasing calls with our city managers and our leasing terms, the description of market activity was that the summer dull drums that usually occur in July and August started in June this year.

This feeling is [worn] out in our prospect tracking numbers, where Q1 and the early part of Q2 were very similar with the number of prospects, number of showings, proposals and the number of leases out for signature. But for June and now more significantly in July prospects and showings have begun to trend down.

Uncertainty over the economy, and government actions or inactions coupled with a general drop in consumer sentiment, has contributed to cautiousness and a lack of confidence among corporate customers, and smaller local companies alike. The only positive from all of this is that companies are more likely to renew in place.

Our renewal rate for the second quarter increased to 58% on a reporting basis, where we don't remove the impact of bankruptcy, move outs and shutdowns, i.e. the items that are out of our control and increased from 72.2% to 77.4% on a full-view basis.

Let me now highlight a few specifics from our second quarter activity. As you may recall last quarter, we reported a slight increase in industrial demand. For Q2, we continue to see industrial demand trending higher, supported by continued increases in US container traffic, which has been trending higher since January, and is up to 20% year-over-year. And an increase in the industrial job creation of a 152,000 new jobs created since January of this year.

While we remained cautiously optimistic about this improvement, the industrial markets remain a long way from equilibrium. We did however have tremendous success in the Lehigh Valley in Industrial leasing during the second quarter, especially in Lehigh Valley in Phoenix.

Lehigh Valley Pennsylvania, it's a prime distribution hub for the entire northeast. We signed over 1.4 million square feet of new leases in four separate transactions. This leasing moved our industrial occupancy in the Lehigh Valley from 83.4% to 90.1% and overall Lehigh Valley occupancy from 84.5% to 90.4%, which is nearly a 600 basis point improvement. And in Phoenix, we leased all of our remaining industrial vacancy, improving our overall occupancy in this market to 93.9% leased.

In Houston, which is another of our prime industrial markets, Liberty's occupancy remains at 93.3% leased. We mentioned last quarter that with the stable activity in this market and our high occupancy rate, we would be well served to having additional product.

Subsequent to quarter's end, as Mike mentioned, we closed on two new Class A industrial buildings, providing us with 228,000 square feet of available product to lease right away, in the Northwest submarket. Prospect activity in Houston continues to be relatively strong.

Shifting now to office. Market conditions continued to be rugged. Prospect activity is spotty, while rents remained pressured. Is it getting worse? No, not really. But markets continue to bounce along the bottom and demand remains sluggish.

Nationally, office markets eked out 3.3 million square feet of positive net absorption during Q2. This is the first time office absorption was positive in the United States, since the fourth quarter of 2008.

And with that, I'll turn the call back to Bill.

Bill Hankowsky

Thanks, Rob, Mike and George. Before opening up for questions, let me provide one additional comment. Given where we are at mid-year and reviewing our forecast for the remainder of year, we are comfortable affirming our guidance of $2.60 to $2.80 a share. But given recent developments, we would have it biased to the low end of that range.

With that, let us open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Mitch Germain with JMP Securities.

Mitch Germain - JMP Securities

Can I get some more information on the build-to-suits? I know you said that discussions have slowed a bit. But can you talk about possibly how many discussions you are having maybe regionally where they are located?

Bill Hankowsky

I am going to answer even lighter than your question. Let me talk a little bit from first quarter to second quarter, because we talked a little bit about sort of change of behavior. There were probably like 10 active deals that we were talking to people about in the first quarter. That's probably down to eight right now. But candidly sort of four have dropped out, two have gotten added, to go from ten to eight, they are predominantly office. They represent customers who have very particular needs in a particular geography, but simply can't get that by what's available in the existing stock.

The people that have sort of fallen off the list generally represent people who have just decided we are not going to do this right now. The people that are still on the list, are people we have had conversations with most of them it's sort of passed the proposal stage they've got a proposal. They know what the economics are. So they are kind of past the fact that the rents are going to be greater than market rent. But they are still in the midst of evaluating, thinking about it and probably in every instance there is least a significant decision point that has yet to be crossed, going to a board, going to a CEO. So we still again may or may not happen.

Our stance at the moment, when we kind of vent them, is that we'll probably land a couple of them this year, I don't think there is any way we've got a 1000 to get them all, but I think a couple might land. Geography, they tend to be predominantly in the northeast with one or two scattered in the south and west.

Mitch Germain - JMP Securities

And just with regards to your comments on the acquisition a buyer may particularly value add, are you guys looking across the spectrum of value add from debt deals and tenanting, new deals with tenanting issues or mostly just tenanting issues right now?

Bill Hankowsky

I would tend to say we are not in the business of going on and starting to buy a bunch of debt. Okay. Now, having said that there clearly could be a scenario where the way to get to ownership would be by buying the debt.

But that would probably be a situation where the borrower and the lender and Liberty all are having a conversation about how to get some place and a step in that process might involve buying the debt.

I don't think we would buy debt, I don't mean speculatively in the sense, but where we would assume its long elongated process. It's kind of not the business we are in.

We would look at in terms of value-add, I think we would look at any opportunities. So it could be vacant. It could be under leased. It could be with an exploration coming up in a year. I think the sweet spot, maybe I'll put it another way, that the stock that's selling at these very low cap rates is product that is well leased, with term, credit, in historically liquid markets, fundamentally product that can get life company mortgage.

We are probably going to do better in the spot where you can't get a mortgage. Because that's going to knock out a bunch of potential buyers who need to put leverage on assets. So to some extent, that's almost the dividing line. Mike, you want to…

Mike Hagan

I think that's right.

Operator

Your next question comes from the line of Alexander Goldfarb of Sandler O'Neill.

Alexander Goldfarb - Sandler O'Neill

Bill just want to go back to some of your opening comments on what's going on in the economy and tenants. If you think about what's going on from some of the transport names that are reported, it seems like demand is slowly recovering, so what's your sense that's going on, it sounds like some of your customers have pulled back decision making but the shipping companies, real companies etcetera are saying they are seeing some demand start to improve. So what do you think is going on in as far as decision makers and is there sort of an effect where certain areas are benefiting but other, industries or parts of the country aren't? Like what's your take?

Bill Hankowsky

I think that's a good question because I think that question is exactly the phenomenon we are trying to describe. I think what's happened is that people came into this year, we had a 3% GDP number, 3.5 or something then they've revised it down.

People thinking that this economy was going to begin to take off. Presuming housing markets would get better etcetera. And recently over the last 30 - 60 days, we had a number today like consumer confidence number where people [upset about] where it came in. So these numbers have begun coming in, not necessarily going down, although in some instances they are. But clearly not going up with any kind of robustness.

So in conversations with tenants, with customers, with business people, I think there is this pervasive sense of, it doesn't feel that good right now. Because they thought it was going to feel better. It's not as if we are getting bad news. It's just we are not getting enough good news. And so I think it creates this sense of uncertainty, concern then you get the double gets into the vocabulary and it becomes a little bit of, the perception becomes the reality, because I am where you are. I think the facts aren't that bad. Things are better than they were a year ago. We have shut down, I think fundamentally job losses, the last number wasn't good, but the ones before that were.

And I think we are in a better place than people think we are. I think some businesses are picking up. But I think the negative is, it doesn't feel that good, that can tend to permeate decision making, make people not wanting to make longer term commitments, so you see use the three PLs versus signing a ten year deal on a distribution space.

You can see a customer saying you know what, I'll sign for the space I have, but I am not going to take more space. People say I am not going to hire until I see the orders. So that's what we are starting to describe here and it really manifested itself as Rob said in his comments, when we look at prospect activity, in June, it began to slow up sooner than it should have, just slows up in the summer anyhow. We think that's about people just pulling back a bit at the moment looking for more clarity.

Alexander Goldfarb - Sandler O'Neill

Do you think that people are going to be [impause] until the midterm election? Or you think this is something else that they are looking to provide them greater comfort to move forward?

Bill Hankowsky

I'm not sure everybody is driven by worrying about what's happening at Washington from a political perspective. But I will tell you, I think Washington, this is not political comment. But I think all of the activity in Washington is adding to the uncertainty. So we have health care reform and now we have to publish a whole set of regulations that haven't come out yet. We've just done financial regulation, and we have to send out a whole bunch of regulations that haven't happened yet.

You see in the banking industry, where people are really wondering about how all of the implementation will affect the [bags]. So I think that just adds to the uncertainty, aspect of it as these things aren't fully flushed out.

And you know, what's going to happen with tax rates, are we going to do cap and trade? So there's a lot of issues on the table, and people aren't quite sure where it goes, it just adds to the environment. I don't think it is even now itself the pivot point, but I think it's a contributing factor.

Alexander Goldfarb - Sandler O'Neill

And just a final question, is on TIs and the dividend, certainly I am sure that the Lehigh Valley and now it kind of appreciates the large TI spend. But, want to get a sense for what your budget for TIs and LCs are for the year, and then also on the dividend, let's assume that this is a trough year and next year is better and things improve from there. How long is the board comfortable with an uncovered dividend and what would cause it to reconsider that?

Bill Hankowsky

Let me do the two questions. I think that the budget for the year roughly in TI was around 70 million to 75 million for the year as a spend. So we are kind of at 21 and 23 in the first two quarters, kind of on track for that kind of a number. This one deal happens to be a kind of a bigger pops so to speak. So, something like that is sort of the run rate at the moment.

In terms of the dividend, as you know we are big believers in the REIT model, we believe the dividend is an important ingredient in that as part of the total return we provide to our shareholders. So we think about, it's a great deal. The board thinks about it, a great deal. You are right that the two ingredients that occurring in the non-coverage, one is the decline in revenue. So to agree we could get occupancy up, and as I said earlier we still think that's what's going to happen, we don't think it's going to get up as much as we had hoped by the year-end, because we think this decision making uncertainties is kind of dampening some of the decisions.

But we still think we'll be somewhat better than where we are today. And to a degree that carries its momentum into '11 and we can see revenues beginning to go the other way, number one. Number two is, next year at the moment, I think we have got about seven million square feet expiring. We when came into this year were about nine million square feet expiring.

As the occupancy gets higher, we'll have a little bit less to rent. So conceivably the overall TI costs in 2011 could be less than the TI costs in 2010. So we have both lines going in the right directions. One cost going down, revenue going up. And I think the board if they felt that those lines were going to cross sometime in '11, would consider their decision that it's worth waiting for those lines to cross. If those lines don't look like they are going to cross, I think that's something you have to think about hard.

Operator

Your next question comes from the line of Jordan Sadler with KeyBanc Capital Markets.

Jordan Sadler - KeyBanc Capital Markets

Had a question regarding the guidance. I know now you are more comfortable at the low-end of the range. And I am just wanting to frame that in the context of, interest savings that you'll have that weren't baked in previously, I guess in to my expectations or perhaps the guidance related to this prepayment of the 107 million to 118 million less disposition activity that was expected to be somewhat dilutive, I think given the cap rates you were anticipating. And then it seems like a smaller roll down in rents largely as a result of this deal, but pretty much almost across the board. I know we still have six months to go. But given sort of those three positive items, and I know you touched on occupancy a little bit, but what's driving the comfort range or the comfort at the low-end of the range?

Bill Hankowsky

I think I got to add into this. We are going to renew the line in a much higher expense. So we are going to have interest go the other way on short term borrowing.

Jordan Sadler - KeyBanc Capital Markets

You don't have anything outstanding on that. We [should] have known about that.

Bill Hankowsky

Well, I have 160 million expiring in August of unsecured. And we'll put that on the line. So the line will be used over the course of the year. But I think the most fundamental thing driving it, is that our expectations about where occupancy will be, is definitely muted by the behavior we are seeing in the last 30 - 45 days, and probably the most important part of that it doesn't show up in what, in the quarter, because the quarter we are announcing commence leases the deals we did three or four months ago and are now commencing. Is what we think is going to happen for the remainder of the year, and then our reforecast for the second half, we think occupancy as I said is going to be better than where we are today, but not where we thought it was going to be when we started this year.

And in particular, where that can be most impactful and given that is what's happening is on the office side where the rents have the greatest impact. So it's great to have the industrial move and we feel terrific about it. But the industrial rents are one-third of the office rents on kind of average basis. So unless we start seeing those office, occupancies move, which as I said we think they are going to be more [tempered] than we had hoped earlier in the year. That's kind of where we are loosing it..

George Alburger

That was the primary reason for the decrease in same store performance in the second quarter 2010, compared to second quarter 2009, decrease in office occupancy.

Jordan Sadler - KeyBanc Capital Markets

Do you have an updated sort of same store expectation or rent roll down expectation for the full year, George?

George Alburger

I think that our original number was probably 2% to 3% decline. We are probably on the higher side of that decline.

Jordan Sadler - KeyBanc Capital Markets

Okay. And then, in terms of this unsecured that you've got coming in August due maturing, how would you look to replace that? Would you look to be opportunistic with the curve here, and maybe tap the longer end or what? And then just maybe talk about size and pricing?

George Alburger

We have a lot of capacity on the line. We paid off $119 million worth of mortgages and we did that primarily with available cash. So we have, what is 50 million outstanding on the line, and it's a little bit more today.

We would the maturity that's happening in August, we will put on the line. Yes, we are looking at what's going on in interest rates. Historically we have done mostly 10 year financings. We haven't done any secured financings for awhile. We did some mortgage financings last year and the year before that we did the financings for the Comcast center.

So, and have become somewhat of infrequent issuer of late. So I think an issuance by us would be well received. But we have plenty of capacity on our line to carry a couple of hundred million of outstandings on our line, but we would continue to look at what's going on out there in the yield curve, and be attentive to it and try and be opportunistic.

In terms of size, transaction, senior notes issuances that we've had have all been index eligible, so they've all been plus 250 million, $300 million range. So I can't imagine us doing something less than that. Could we do something under 6% perhaps for a 10 year? But, no, that's color for now.

Jordan Sadler - KeyBanc Capital Markets

And we have, what next year?

George Alburger

We have around 235 million maturing I think it is in March.

Bill Hankowsky

Yeah. Right. So I would point that out only when you sort of look at the timing of various events.

George Alburger

245 million maturing in March.

Jordan Sadler - KeyBanc Capital Markets

You might look to take care of those.

Bill Hankowsky

We have already past August and just look right over the next several months.

George Alburger

We wouldn't do something in August and then do another something in March. You have to consider, kind of clustering some of those maturities.

Operator

Your next question comes from the line of Michael Bilerman with Citi.

Michael Bilerman - Citi

Josh Attie is on the phone with me as well. I just want to continue along the guidance front. The bonds that are maturing in August are at 8.5%. I know you don't know about where your line pricing is, but I can pretty much put a good piece on it, that it ain't going to be north of 8.5% for your line. Your 2017 bond…

Your 2017 bonds outstanding are trading in the 5.25 to 5.50 range, so it would seem to me that if you float these bonds there is significant accretion, if you just do a 10 year deal, even if you do it in 6%, you still got accretion at the back half of the year; right. And so you think about the trajectory of FFO that you are on about let's call it $0.67, when you include the a penny of lease term in the quarter. If you just run rate that to the back half of the year, you got 2.65 without the financing benefit that you are going to get, unless you have cost that are in your numbers that we don't know about.

And so I guess, I'm having a harder time also trying to understand what's changed relative to your mind set on guidance, because I think you're already at the lower end because of the acquisition volumes weren't coming in to a level you thought they were. So I guess I'm also a little bit perplexed.

Bill Hankowsky

We are not trying to perplex you. I'm not trying to say 67 is a run rate. I mean if you go through all the one timers, we have the UK land gain, the interest savings, offsetting the debt cost you are probably more like a 65 - 66 run rate than a 67 run rate.

Michael Bilerman - Citi

Does the charges offset the gain and then the lease term deal was a penny which is exactly in line with $0.04 to $0.06 for the year?

Bill Hankowsky

It's primarily the UK.

Michael Bilerman - Citi

So you back that up in and the charges that you had and then that's the zero. So, 66 to 67, we're splitting here.

Bill Hankowsky

I think the simplest thing is that when we reforecast the year, on the operating side, on the fundamentals, not on the financing side, and we look at where we thought we were going to be at the end of the year and versus where we will be as best we can calibrate or write down.

We think the occupancy is going to be lower than where we had projected, and we think that's going to be mostly on the office side. And we think that therefore the core same store, however you want to characterize it is going to provide us less than we had anticipated even if we factor in sort of where we are in the financial side. You can sort of move this around a little bit depending on how you decide when you are going to do, what deal, at what time. We're going to have to take a look at that in terms of capital activity over the course of the rest of year. We are assuming as Mike said that acquisitions will be in the range of zero to 100.

We think dispositions are not going to be where we quite really thought they would be at this rate. We are again looking for the second half. I mean we are just trying to give you as much clarity as we can. But that's sort of how it all adds up when we put it all together.

Michael Bilerman - Citi

Is there any specific cost in terms of the line renewal that are in guidance?

George Alburger

Well, the good…

Michael Bilerman - Citi

I mean what sort of costs are there…

George Alburger

There is going to be couple of hundred. I think it's like 350,000 or something in cost that will be written off in connection with the line…

Bill Hankowsky

Plus the cost of new line, Gorge.

George Alburger

Are you talking about the cost of the new line or what's…

Bill Hankowsky

The new line is significant.

George Alburger

The cost is going up. I mean you've seen lines that are being done out there. I mean we will have a market line and it will be consistent with what's out there for market lines. We will be writing off the unamortized costs for the old line. It's something that close to a penny. The old line matures in January, those costs will be written off, that’ll be close to a penny.

Michael Bilerman - Citi

But nothing else, there's no other sort of charges that are in the numbers that we should be aware of.

Bill Hankowsky

Well, I mean, no.

Michael Bilerman - Citi

And are you able to, some people have been able to get rid of the LIBOR floor and the new lines. What sort of initial discussions that you are having?

Bill Hankowsky

Well, I hesitate to put out all of the initial discussions we are having until its finalized, but I do not expect to have a LIBOR floor.

Michael Bilerman - Citi

Market deals that they don't have them. Is that fair to…

Bill Hankowsky

Yeah. It's fair to say. Market deals, if we had done it eight months ago, maybe we would have had a, have a LIBOR floor.

Michael Bilerman - Citi

And then just in terms of the acquisitions on the Houston deal, is that effectively going, you are capitalizing interest on that right away. So that you are not, because I thought that may be a dilutive event if you weren't?

Bill Hankowsky

No, we are. That's the difference between the 51 bucks to bag and the 64 bucks the all-in costs. It's the 18 months of carry and as Mike said, that's more than we usually do, Mike, as you know we historically do a year of lease up. Just given the environment, we are doing a year and a half. Plus it's the TIs and these were, these were never occupied. So there is kind of a shell TI to do the initial improvements to the buildings. But once they are leased.

Michael Bilerman - Citi

But you are not carrying these up for dilution, upfront. You are capitalizing your costs, the interest associated with it?

Bill Hankowsky

During the standard lease up period, yes.

Michael Bilerman - Citi

Because I just thought if you are buying vacant and you are not putting them into production right away, then maybe, that would have been a drag on your FFO.

Bill Hankowsky

But it is not.

Michael Bilerman - Citi

But it's not. So I am just trying to find if there was anything else out there that's causing, I guess, the projections. Just maybe last one is on tenant activity you talked a little bit about the build to suite and the prospect levels. If you go back and if you talked about June or July being weaker than last year, clearly last year was pretty weak even coming up with the trough in the second quarter. If you go back a little bit longer term, how do these months stack up?

Bill Hankowsky

How does it feel this July compared to two or three years ago?

Michael Bilerman - Citi

Yeah, just on a longer term basis? Because I got to imagine…

Bill Hankowsky

Yeah. No, Mike. Just I don't want to confuse anybody. Let me do it kind of chronologically. If you go back to 2006, 2005, 2007, before it all hit the fan. What was in a descent economic environment deal flow? We are nowhere near that kind of deal flow today. We weren't there at the beginning of the year. So when we talk about activity being better in the first four months of 2010 versus '09, it's because '09 was on its back, and things have picked up.

But they have not picked up to what I would have anyway characterize as normal deal flow, and now we've got somewhat of a decline from that so it was tepid, now its kind of mediocre, whatever words you want to use being June into July, from where it was earlier this year. But all of that is left on any kind of normalized environment.

Michael Bilerman

And is there anything on the renewal side recently. The good news was more tenants staying in their own space. Are they contracting in that renewal space?

Bill Hankowsky

Yes, I mean generally what's happening and Mike I am going to apologize, but we probably need to let some other folks.

Michael Bilerman

Okay.

Bill Hankowsky

That's okay, Michael, but here is what's generally happening. People are either staying in place as is or they are contracting, and so what happened was as you know, in this cycle we did not have a big sublet phenomenon. We didn't see the markets get flooded, because I think fundamentally companies didn't have either the energy, the focus or the wherewithal to try to sublet space and make their space efficient.

So what they are doing is when that lease expires, they are saying I was in 20, I am only using 50 and I only want 15. So they are either staying in the same space or somewhat getting smaller, and I think that is the behavior we're seeing. Now the good news is that it's kind of flushing out underutilized space out of the inventory, but that is generally the behavior.

Operator

Your next question comes from line of Ki Bin Kim with Macquarie.

Ki Bin Kim - Macquarie

Most of my questions have been answered, but I just want a couple of quick follow-ups. I guess falling on the previous question, if you had to just index the first four months activity and kind of gauge where we are today, would you say product activity was down just putting a number around it 10% in the first four months or 5%?

Bill Hankowsky

I would say that, if on a monthly run rate, because if you ever watch it, sometimes I feel like I am watching this everyday, but we really watch it kind of every week, kind of roll out for the company. I would say that when we got into late June, now July, you are probably down 10% to 15% in terms of prospect flow, does feel right, Rob?

Rob Fenza

But remember you would be down anyhow because it's the summer.

Ki Bin Kim - Macquarie

Okay.

Rob Fenza

So what we're more focused on is the fact that it seemed to happen earlier and in talking to people it's not just I am on vacation, its I am not sure I want to make a decision right now. So we could find that it is simply early summer doldrums and come Labor Day, things get a little bit better and it feels like where we were in April and May or we could find that in fact the beginning of the year was a little bit better and that things settled out, it kind a of somewhat more anemic rate.

So I think it's something to watch. We're not calling it as an inflection point, it's just something to be observant of and given what's happened, we don't see the line up of prospects that we just had a showing for this week, who may turn into our signed lease at the end of this quarter who turned into an occupied tenant in the fourth quarter. We're seeing that pipeline kind of fade out a little bit and that's what's giving us a little bit of pause.

Ki Bin Kim - Macquarie

The more the companies wait, is it safe to say that the industrial utilization rate would be increasing throughout the full time or the capacity utilization rate for your properties?

Rob Fenza

Well, I mean…

Ki Bin Kim - Macquarie

So eventually you would have to sign leases…

Rob Fenza

I think I understand the question. The utilization of industrial space, I would say is very high, has been high for the last several months, nothing new is happening there. Industrial tenants move fairly quickly. So they don't tend to sit on empty space.

The leases are shorter, you can move in and out of industrial space very quickly, you're not laying people off. Candidly moving stuff off of racks, pallets, whatever. So the utilization is higher on the industrial side than it is on the office side just generally and I think more so in this kind of an environment.

So, to the earlier question by the prior person, Michael about, are people shrinking. I was mainly focused on the office side there, not as much on the industrial side that when that lease expires, its shrinking. On the industrial side, that most of that's already kind of through the system.

Ki Bin Kim - Macquarie

And next question, the negative 2% mark-to-market, would that be on a cash basis?

Rob Fenza

It was 8.4.

Ki Bin Kim - Macquarie

Okay. The rent increases in your leases, the way you've built that in, has that changed at all in the past couple of quarters or is it still a typical 1.5%?

Mike Hagan

Well, they tend to be more like two to three.

George Alburger

It is more like 2 to 3 and maybe we get it in 70% of the leases maybe higher than that.

Bill Hankowsky

I don't think, no we still try very much to make that happen. We are still trying to do that the same way we have historically. I think the one thing to keep in mind though is you are talking about particularly replacement leases; you're probably looking at a month's free rent per year of term as concessions in the market. That's the nature of the market today.

Operator

The next question comes from the line of Sheila McGrath with KBW.

Sheila McGrath - KBW

We do hear a lot about well capitalized landlords having the advantage to capture occupancies from market share gains, clearly your occupancy is much better than the markets here and so I was just wondering do you continue to capture market share from more capital constrained landlords and is this driven by your ability to offer higher TI packages?

Bill Hankowsky

The answer to the first question is yes and the answer to the second is not necessarily. In other words, there is no question that there are landlords who remain under stress, who are spending more of their time talking to other banks than they're able to kind of go out market their properties.

There's no question even as recently as the past month, where somebody can't deliver a TI package, go to the lender on a deal that they got okay on and the lender says I'm not approving it and they can't make the deal.

So that still is market behavior. And you're absolutely right, one of the things we look at is for the quarter, out of all of the leases signed in our markets, what percent of those leases did we do. And that number is higher this quarter than it was last quarter. So we're getting more than our fair share and it's a function of being well capitalized. Can't believe it's a function of being able to operate your properties well. I mean we're not skipping; you're not skipping on CapEx. It's a function of the network and relationships we have with brokers, etcetera and tenants and all that comes to bear.

So that's all true. To your second part though, it's not like we're buying deals with TI. It's not as if we're going to run out there and offer $5 more to TI because we can do it and therefore we get the deal. That's sort of not what the real market behavior. The market behavior basically is, we meet the market.

So it's a combination of where the rents are, where the concessions are, generally free rent, and what people are looking for TI packages. And I still don't think this is a market that is generally in anyway characterized by people using TI to buy deals.

Sheila McGrath

Okay. One quick follow-up, the joint venture portfolio, we did notice that the occupancy moved sequentially down quite a bit and I was just wondering if you could give us some more specifics on that?

Bill Hankowsky

I can be very specific. In Chicago, we brought into service an entirely vacant building. So that's now in the core, and that knocked down the Chicago number which is the Illinois joint venture, and in Southern New Jersey which is Liberty Venture 1. Two things happened, one was an exploration we knew about which simply expired and it renewed, and the second was a company that basically went out of business, so it was a distress situation. Our team has done a great job getting that space released, but it hasn't commenced. So South Jersey will stay in the 70s for the rest of the year and it will be looking much better for the first quarter of next year.

Operator

The next question comes from Sloan Bohlen with Goldman Sachs.

Sloan Bohlen - Goldman Sachs

Good afternoon. I just got one question for Bill and Mike. Just on the comments on the lower sales number or lower dispositions for the year, is that more of a kind of a reflection on where pricing is that you're hearing? Or is that that you are not happy with the pricing or is that more a reflection of I guess less demand for the products that you would be marketing?

Mike Hagan

We started out at the beginning of the year trying to figure out where this market would be and did not take a lot of property to the market. We have spent the last quarter fielding a lot of phone calls from folks looking to acquire property and we have been trying to sell some of our suburban office and I would tell you that if we have a situation where we have a well leased stabilized asset, we can trade that and some things where there is a short-term rollover or some vacancy, we're were having a pricing gap. We'll continue to explore those opportunities and see how it plays out the rest of the six months, but that's been the game plan.

Sloan Bohlen - Goldman Sachs

Mike, how wide would you say that pricing gap is on anything with any lease roll?

Mike Hagan

You know, maybe it's 5% to 10%.

Operator

Your next question comes from line of Brendan Maiorana of Wells Fargo.

Brendan Maiorana - Wells Fargo

Just a quick follow up on the guidance question. Where specifically was your year-end occupancy target? And what has that been revised to? I think the overall year number was plus or minus 100 basis points, but I don't recall what the year-end figure was?

Rob Fenza

I don't think we put a year-end number out there.

Mike Hagan

It was plus or minus a present, is what we said would be for occupancy.

Rob Fenza

On average.

Mike Hagan

On average.

Rob Fenza

So remembering what we also said, right, so we went down in the first quarter, kind of just picked up a tad here, but we have went down 100. So I guess the way to think about it is if we said plus or minus 1%, we no longer probably look at the plus 1% looking at the other way.

Brendan Maiorana - Wells Fargo

Okay.

George Alburger

Yes, I think that's fair to say. But I mean I would again stress that other footnote which is that was a blended percentage that we gave and maybe we're doing a little bit better in industrial than we are in office and officers are higher rent paying portion of the portfolio. So when Bill says…

Bill Hankowsky

The mix is going to be different.

George Alburger

Yes, the mix will be different.

Brendan Maiorana - Wells Fargo

Understood. So, if I then think back to your comments about moving the occupancy number up as you kind of go into '11 to cover the dividend, how much are further do you think you need to push the occupancy level to get to a level where you're covering the dividend with reasonable comfort?

Bill Hankowsky

Again, I am talking about how the lines are going to cross. So we can look a little bit today, even past the end of 2010, because we can look at what signed, but not commenced. So its not just about where do I end 2010, its where do I end 2010 not so much on a commenced basis which is what we are going to report to you, but on a signed basis so I know where I am going to be first, second and third quarter of '11. And put it this way, given where we are right now, I am comfortable saying that, it is still something where we could see the lines cross in '11 and therefore be comfortable leaving the dividend where it is. We watched that every month as more information comes to us, but we're comfortable where we are today.

Brendan Maiorana - Wells Fargo

Yeah, understood. I was trying to I guess project into '11 and want to cause you to give any guidance or anything, but…

Bill Hankowsky

We'll give you all that on the next call, when we give the guidance back there.

Brendan Maiorana - Wells Fargo

Sure. It's fair to say though as you kind of look towards the year-end '10 you would expect that to cover the dividend the occupancy level would need to move up from there?

Bill Hankowsky

Yes, I think that's fair, yes.

Brendan Maiorana - Wells Fargo

Okay.

Bill Hankowsky

From where we end '10 commence, we'll need to be at a different number in '11.

Brendan Maiorana - Wells Fargo

Sure. Okay. And then, just lastly the $10 million of TIs and LCs for the Lehigh Valley deal. Was all of that spent, so it would hit the AFFO reconciliation in Q2 or is some of that to come in Q3?

George Alburger

It's all reflected in $23 million number that we put in the package and the ratio page.

Operator

Your next question comes from the line of John Guinee with Stifel.

John Guinee - Stifel

I'm sorry, Bill. We got to take another call, but next time. Thanks.

Bill Hankowsky

Got it, John. Hello?

Operator

Your next question comes from the line of John Stewart with Green Street Advisors.

John Stewart - Green Street Advisors

Thank you. Bill, understandably a lot of the focus has been on industrial. I was wondering if you could give us a bit of color specifically on the Philadelphia office market.

Bill Hankowsky

Sure. I think what we're seeing, John is, Philadelphia Metropolitan area let me divide it into sort of three component pieces. So downtown, CBD, candidly we are not that active in the market since we're 100% leased. So we're not seeing that much deal flow.

I think it's, there's some amount, fair amount of sublet space downtown, either in place or about to come into market as a couple of named tenants have indicated that they are going to be putting their space into the markets; Sunoco being one and I am forgetting the other company, a foreign company being another.

So I'd say it's probably a little flattish, South Jersey has been, we've done relatively okay over there, but I think it's still a market that in a down cycle tends to suffer both sort of a step shot a little bit of fully, and a little bit other steps now in North Jersey and Jersey itself having it's own issues. So I'd still say activity over there is relatively soft, it's really suburbs. I think we're seeing decent deal flow, it is having the same phenomenon that we described kind of generally earlier this call, which is to say it's off from where it was lets say for the first, four or five months of the year a bit.

But I think that is the summer, but as you know, and when I look at our portfolio, there's a fair number of significant corporate kind of users that are on our portfolio, and they're willing to make decisions and so we're seeing okay activity, I wish I saw some more new prospects in the market, but we're feeling okay, with the suburbs.

John Stewart - Green Street Advisors

Just wanted to touch on development, striking if you look at the supplemental schedule over time, it's obviously ratcheted down as projects have been placed in service, and you haven't started anything new, and of course you've touched on the build-to-suit activity which sounds like it's been slowing.

I guess, the question is are there any markets where you feel tight enough that you might consider adding to inventory at this stage. Are you still entirely gun shy in terms of development without significant releasing?

Bill Hankowsky

I think generally, John, you are right that our first priority is build-to-suit, and again I just want to be clear, there still is a real prospects out there, having a real discussions and as I said a couple of them could happen. So we're still hopeful there. But they are taking definitely longer than we would have thought six months ago.

On the last call, we talked a little bit about Houston as a market that we feel good about from the standpoint of where we are in terms of our own portfolio. Where our team is, where that market is. Now to some extent we've used the term sold, the need for inventory in Houston (inaudible) the buildings. So…

John Stewart - Green Street Advisors

Short term.

Bill Hankowsky

Short term, but if our team down there is very successful in getting those leased up, and we can't find other vacancy would we consider it? I'd say, that is a market where it could get on the radar. It's not on the radar today but it could. I think the Lehigh Valley, Rob talked about the activity we've had up there, if these guys keep working the way they are, we are going to run out of product, that's not in and of itself, sufficient reason to build inventory, but it is as you know in our model, it's sort of the condition perceived, it could be able to raise the question.

So I would put that on a would consider, but not necessarily go, and I think the other place whether we do a full inventory, maybe do some thing with some pre-leasing might be the Philadelphia Navy yard where again we're out of product, and we still are seeing some deal flow. So we're looking at the situation there. I think those are the only three that can come to mind, kind of in near-term being the next several quarters.

John Stewart - Green Street Advisors

And then lastly one for Mike, I realized it was a small deal, but Mike can you give us any color in terms of market, property type and cap rate on the disposition during the quarter?

Mike Hagan

What we sold were bout two buildings to users, and let me just take a look at the information. One we had, was one within the Philadelphia service is more (inaudible) building and the other was an office building in Southern New Jersey. And of course the land sale in the UK.

John Stewart - Green Street Advisors

And cap rates on the income producing deal?

Mike Hagan

We are in the 9.5 range.

Operator

Your next question is a follow up from Jordan Sadler with Keybanc Capital Markets.

Bill Hankowsky

Jordan?

Operator

Jordan, your line is open. Do you have your phone muted on your end?

Bill Hankowsky

He may have gone. Is there anyone else in queue?

Operator

(Operator Instructions).

Bill Hankowsky

We may have gotten everybody. Let me thank everybody for calling in and as I said, we're very happy with the quarter. And we'll be happy to talk to you next time, not just about the quarter, but we'll talk to you a little bit about 2011. So, thanks everybody.

Operator

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

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Source: Liberty Property Trust (LRY) Q2 2010 Earnings Call Transcript

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