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Digital Realty Trust (NYSE:DLR)

Q1 2014 Earnings Call

May 06, 2014 5:30 pm ET

Executives

John J. Stewart - Senior Vice President of Investor Relations

Arthur William Stein - Interim Chief Executive Officer, Chief Financial Officer and Secretary

Scott E. Peterson - Chief Acquisitions Officer of Digital Realty Trust Inc

Matthew J. Miszewski - Senior Vice President of Sales and Marketing

Matt Mercier - Vice President of Corporate Finance

Analysts

David Toti - Cantor Fitzgerald & Co., Research Division

Vance H. Edelson - Morgan Stanley, Research Division

Jonathan A. Schildkraut - Evercore Partners Inc., Research Division

Charles Croson - Barclays Capital, Research Division

Stephen W. Douglas - BofA Merrill Lynch, Research Division

Vincent Chao - Deutsche Bank AG, Research Division

William A. Crow - Raymond James & Associates, Inc., Research Division

Omotayo T. Okusanya - Jefferies LLC, Research Division

Michael Knott - Green Street Advisors, Inc., Research Division

Jordan Sadler - KeyBanc Capital Markets Inc., Research Division

Michael Bilerman - Citigroup Inc, Research Division

Gabriel Hilmoe - UBS Investment Bank, Research Division

George D. Auerbach - ISI Group Inc., Research Division

Jonathan Atkin - RBC Capital Markets, LLC, Research Division

Operator

Good afternoon, and welcome to the Digital Realty First Quarter 2014 Earnings Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to John Stewart with Investor Relations. Please go ahead.

John J. Stewart

Thank you, and welcome. The speakers on today's call will be Interim CEO, Bill Stein; Chief Investment Officer, Scott Peterson; SVP of Sales & Marketing, Matt Miszewski; and Vice President of Finance, Matt Mercier.

In addition to our press release and supplemental disclosure package, we've also posted a presentation to the Investor section of our website to accompany management's prepared remarks. You're welcome to download the presentation and follow along throughout the call.

Before we begin, I'd like to remind everyone that management may make forward-looking statements on this call. Forward-looking statements are based on current expectations, forecasts and assumptions that involve risks and uncertainties that could cause actual results to differ materially. Such forward-looking statements include statements related to the company's future financial and other results, including 2014 guidance and the underlying assumptions. For a further discussion of the risks and uncertainties related to our business, see the company's Form 10-K for the year ended December 31, 2013, and subsequent filings with the SEC.

This call will also contain non-GAAP financial information. Explanations of such non-GAAP items and reconciliations to net income are contained in the company's supplemental package furnished to the SEC and available on the website at digitalrealty.com.

Management's prepared remarks will be followed by a Q&A session. [Operator Instructions] And now, I'd like to turn the call over to Bill Stein.

Arthur William Stein

Thank you, John. Good afternoon, and thank you, all of those who are joining us. I'd like to begin today by outlining our strategic vision for the company. We strive to enable our customers to build their future growth here, Digital Realty data centers around the world. We see IT as rapidly evolving from a cost center to a revenue generator. Corporate executives are widely coming to view data as a strategic asset. Data storage is a less critical function than the traffic and exchange of information. Against this backdrop, we believe proximity to major metropolitan areas such as London, New York, San Francisco and Singapore will take on renewed importance, not just for ultra-low latency applications, but for delivery of all matter of content to the broadest population bases with the deepest penetration of smartphones and connected devices. We are building a vibrant ecosystem that will enable our customers to exchange and transmit their data to myriad ultimate destinations as quickly and as efficiently as possible.

If we are successful at facilitating our customer's future growth, we will also be successful at maximizing the value of our 4-data-center portfolio, and creating meaningful value for shareholders in the process. Our global footprint is a key differentiating factor. Over 90% of the business that we signed in the first quarter was with existing customers. And no one in the industry can match our ability to facilitate customer growth on a global scale. We produce high-quality data center solutions, and our cloud and network-based partnerships are nurturing an ecosystem that will likewise lead to product differentiation.

This vision dovetails perfectly with our #1 objective of optimizing the return on our portfolio for driving improved return on invested capital through the lease-up of existing inventory. Matt Miszewski will have more to say regarding our progress on this front in his commentary.

We are also undertaking a review of precisely which properties constitute our core portfolio. We believe capital recycling represents prudent real estate portfolio management. You can reasonably expect to see us cull the bottom 5% to 10% of our portfolio over the next several years. We expect to prune legacy, non-data-center assets, non-core markets and a handful of underperforming assets. Subject to our board's approval, proceeds will be used to shrink our capital structure on a leverage-neutral basis, which is to say, a portion of the proceeds will be used to pay down debt and a portion may be used to buy back stock, so long as we believe that the public market value of our portfolio is trading at a meaningful discount to its private market value.

We will also continue to explore additional joint venture opportunities, which may serve to provide greater transparency on the private market value of our Turn-Key properties, in addition to the Powered Base Buildings that seeded the joint venture with Prudential Real Estate Investors last September.

Our private capital initiative may also serve to demonstrate the significant value our development platform has created. Going forward, however, we are adopting a very disciplined approach in terms of taking on speculative development risk. For example, we now have the ability to deliver a data center pod in 12 to 16 weeks. So we no longer see the need to stockpile finished inventory, and we plan to transition to a build-to-order inventory program. Having a lease in hand before we build will enable us to reduce our risk profile, commit capital only for projects that meet our return thresholds, know our returns with certainty, and avoid accepting subpar returns under pressure. We offer a premium product and our ideal customer fully appreciates the value proposition that Digital Realty provides.

This discipline will likely cause us to pass on some deals. But we believe it will lead to a healthier industry dynamic, better returns for our shareholders and a better match between the product that we offer and the customer base that appropriately values our offering. In addition to discipline, however, we must be vigilant about meeting our customer's needs. We cannot just offer them any color Model T they want so long as it's black. We must pay careful attention to the market's evolving product configuration requirements and be sure that we are equipped to provide the product that our customers [indiscernible].

Finally, we aim to implement some subtle shifts in our corporate culture. First and foremost, we will place renewed emphasis on serving customers in addition to managing properties. In our business, customer focus and value creation cannot be separated. Increased attention to our customers' business needs and technological evolution will enable us to anticipate changes, market dynamics, as well as technological shifts, and allow us to continue to match our product to market requirements, ultimately increasing the value of our portfolio. We've also entered a new era of candid dialogue with all constituents, including shareholders, as evidenced by the recent steps we've taken towards improving our disclosure. We have assembled an incredibly talented team of professionals.

It is my mission to unleash the intellectual capital and creative energies of this reservoir of talent. One recent announcement that exemplifies both our efforts to unleash intellectual capital as well as our commitment to driving improved return on invested capital was Scott Peterson's promotion to Chief Investment Officer. Having closed some $6 billion in data center acquisitions, Scott is clearly one of the sector's most accomplished investors. But more importantly, he is also, in my opinion, one of the most astute. I could not be more pleased by Scott's well-deserved promotion.

And now, I would like to turn the floor over to him to provide further detail on our capital allocation strategy going forward.

Scott E. Peterson

Thank you, Bill. Over the past several weeks, we have begun to evaluate every single property in our portfolio as the initial step in an assessment of our long-term performance potential. The results of this analysis will help prioritize capital allocations, decisions -- capital allocation decisions, focus individual asset strategies, and will also help identify potential disposition candidates. The preliminary conclusions of this analysis are that we have a substantial portfolio and it isn't going to turn on a dime. Improving our return on invested capital will be measured in basis points and it will be achieved over time.

The only investment activity we closed during the first quarter was the contribution of a fully-leased data center for our existing joint venture with the fund managed by Prudential Real Estate Investor. This property is located in New Jersey and is fully-leased to a AA-rated financial services tenant with over 9 years of remaining lease term. It was contributed to the joint venture at a 7.1% cap rate, fully loaded for all closing costs and debt prepayment penalties.

In early April, we sold a small single-tenant building to the user for approximately $42 million. We expect to book a gain on the sale of approximately $16 million in the second quarter. The only notable third-party transaction during the first quarter was Amerimar's acquisition of 401 North Broad, an Internet gateway in downtown Philadelphia. This property reportedly traded at a high 7s going-in cap rate, which does not include an estimated $70 million of projected CapEx, which would put the cap rate solidly in the 5% range. This transaction was fairly complicated to underwrite given its age, prior use and ownership structure, and we believe it will be a fair comp for these types of assets. The common theme among each of these transactions is that data centers continue to become more widely accepted as a mainstream asset class and a liquid private market is developing for these properties.

I would now like to turn the call over to Matt Miszewski to shed some light on the demand curve and growth prospects data center investors are currently underwriting.

Matthew J. Miszewski

Thank you, Scott. As shown on Page 4 of our presentation, we signed leases totaling nearly $47 million of annualized GAAP rent during the first quarter, including a $12 million direct lease with a former subtenant of a Powered Base Building in Santa Clara. The first quarter is typically the seasonally slowest quarter of the year, and the fact that we were able to generate a third consecutive quarter of robust leasing velocity suggests that the business is gathering momentum.

We signed over $4 million of co-location revenue on the heels of a $7.7 million contribution in the fourth quarter of last year. And I am becoming increasingly optimistic that our mid-market segment should be able to deliver results within this range on a consistent basis. Cloud applications have been a major driver of our recent leasing activity, and the first quarter was no exception.

In addition, we also saw healthy demand from mobile, content and social media. We leased 5 megawatts of finished inventories during the quarter, but the ending balance was essentially unchanged from year end due to new inventory coming online and a Turn-Key tenant move-out in Los Angeles. We had another strong month in April, however, and have several committed deals that should enable us to make a further dent in our finished inventory balance during the second quarter.

The polar vortex did not have a pronounced effect on our operation, but we did have one large cloud requirement in Toronto that was touch-and-go to close by March 31 due to weather-related local government office closures. Neither rain, nor sleet, nor snow was able to stop the Digital sales team. And we closed that deal in the quarter. And I'm very proud of what the entire team has been able to accomplish together.

As you can see from the numbers at the bottom of Page 5, base rates for Turn-Key Flex leases signed were higher than they have been for some time. We do see pricing as generally stable to slightly improving, but the big number in the first quarter was primarily a function of market mix, reflecting higher rates at Asia Pac, which represented fully 30% of our leasing activity this quarter.

The chart on Page 6 is likewise indicative of stable to slightly improving pricing. Cash rents on renewal leases were positive, albeit just fairly, for Turn-Key as well as PBB, and GAAP re-leasing spreads were up by double digits across the board.

In addition to signings, lease commencements were also quite healthy. And as you can see from the chart at the bottom right of Page 7, the weighted average GAAP between signing and commencement remains reasonable at just over 6 months.

I'd like to pause here to highlight 2 data points related to the desired behavior incentivized by the new sales compensation program we rolled out at the start of this year. First, the book-to-bill cycle has stabilized at 6 months, with over 90% of the deals we've signed so far this fiscal year commencing within 12 months. Second, we have already seen market reduction in tenant improvement allowances, as well as rent grants and abatements, without any increase in comparable commissions. Now one quarter does not a trend make, but early indications are encouraging that the revamped sales compensation plan is already beginning to have its intended effect.

Moving on to Page 8. The key takeaway here is that the big blue bar called 4Q '14 contractual NOI is up by over $20 million since just last quarter, entirely due to leases signed in the first 90 days of the year. At a cap rate with a 7% handle, that represents around $2 per share of NAV.

Turning now to supply. The biggest change in the last 90 days is that all 24 megawatts of the shadow sublease space in Northern Virginia has been confirmed as available, up from 13 megawatts reflected on this chart last quarter. They have a very healthy demand funnel in Northern Virginia and very limited exposure. But the large block of sublease space, in addition to several recently announced competitive starts, could potentially pressure pricing in this market.

We believe our solutions should be somewhat insulated, hence, most of the available inventory is shared infrastructure product in contrast to our dedicated infrastructure offering. But we will be keeping a watchful eye on the supply-and-demand dynamics in Ashburn. I should point out that we do have a large lease in Northern Virginia with a financial services tenant that was signed at peak rent and is expected to roll down in the second quarter, which will clearly have an impact on our leasings, but has been fully baked into our guidance.

With that, I would now like to turn the call over to Matt Mercier, to take us through the rest of the variables affecting our financial results. Matt?

Matt Mercier

Thank you, Matt. We had quite an active start to the year on the capital-raising front. During the first quarter, we tapped the preferred equity market for the first time in almost a year. The issuance was met with solid demand and we were able to upsize the offerings and ultimately raise gross proceeds of $365 million. We were also able to price at 7 3/8%, well below the range we had guided to previously. We also executed our second sterling bond offering, which closed in early April, raising gross proceeds of $500 million, 9.5-year paper at 4.75%, at the bottom end of the pricing range in our prior guidance.

Interest rate environment remains benign for the time being, and we are pleased to have turned out the substantial majority of our short-term floating rate exposure at what we perceive to be very favorable economics. Matching with the redemption of our exchangeable debentures, $261 million of the debentures were exchanged to common equity mid-April, which had the effect of reducing debt-to-EBITDA by 0.3 turns.

Credit metrics, shown here on Page 11, are pro forma for the following: first, the redemption and exchange of the exchangeable debentures; second, the sterling bond offering; third, asset sale that Scott mentioned; finally, the additional $65 million of preferred equity we raised under the reopening partial exercise with the greenshoe on the Series H, all of which closed subsequent to the end of the quarter.

You can see here, pro forma for those adjustments, net debt to adjusted EBITDA dropped 5x. Fixed charge coverage remains above 3x. With annualized adjusted EBITDA of over $900 million, we have more than $450 million of borrowing capacity while maintaining leverage below 5.5x. We do not expect to raise common equity on this year's remaining capital [indiscernible]. Asset sales may also be a potential source of capital.

Our guidance contemplates an additional dollar-denominated debt issuance, which could be either a dollar bond offering or a term loan. However, the timing has likely been pushed back from mid-year towards the year end, given the larger-than-expected preferred equity offerings, as well as the prospects of potential proceeds from asset sales.

Turning now to earnings. We reported first quarter core FFO per share of $1.28, or $0.10 above consensus. Roughly half of the analyst estimates and consensus appeared to reflect the severance charge for a former CEO and the other half do not. On an apples-to-apples basis, core FFO per share would likely have been $0.05 above consensus. As Bill indicated on our last earnings call, the timing and execution of our financing activities, as well as the incremental revenue expected from speculative leasing represented the primary wildcard in our 2014 forecast.

We are pleased to report we have made considerable progress on both fronts, having raised $865 million of capital previously discussed, and having reduced volumes of speculative leasings contemplated in our guidance by 50%. As a result, we have raised core FFO per share guidance to $4.80 to $4.90 a share. Solid leasing activity to date has largely derisked the low end of the range, but potential future asset sales and joint ventures represent additional wildcards.

But I'd also like to point out a few items to begin to bridge your own forecasts from our 1Q annualized core FFO per share to the 2Q through 4Q quarterly run rate applied at the midpoint of our range. First, as shown on Page 12, 5.9% blended coupons on the $865 million long-term capital we raised year-to-date is almost exactly 425 basis points higher than the all-in cost of our line of credit. 425 basis points on $865 million equals $37 million, or just about $0.07 a share per quarter, as shown on the chart. Second, joint venture contributions, the asset sale and the effect of 1Q expirations will be dilutive to the tune of $0.02 per quarter. Finally, operating expenses and overhead are both expected to pick up over the course of the year, which will reduce the run rate by another $0.01 per quarter. The upshot is that the core quarterly run rate is roughly $1.18 to $1.19 per share, essentially in line with the midpoint of the revised core FFO per share guidance range of $4.80 to $4.90 we've provided in the press release.

Shifting gears to operational performance. Our tenant retention was uncharacteristically low this quarter due primarily to a PBB move-out in Minneapolis, and occupancy slipped again as a result. However, we expect occupancy to begin to improve going forward. I would like to highlight 2 new variables with the assumptions underlying guidance that speak to our view of internal growth prospects going forward. The first is we are projecting portfolio occupancy at year end of 92% to 93%. Second, same-capital cash NOI growth of 4% to 5%.

This concludes today's prepared remarks. I would like -- I would now like to turn the call back over to the operator. We are pleased to take your questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is from David Toti of Cantor Fitzgerald.

David Toti - Cantor Fitzgerald & Co., Research Division

My first question has to do with -- obviously, you touched on the retention rate and the occupancy as being connected. A question I have relative to the leasing statistics was across the board on both new and renewal leases, the terms or the lease length appear to be significantly shorter. Can you give us a little bit of background on maybe the composition that drove the shorter terms?

Arthur William Stein

So we think that we are living in an improving fundamental environment. So we're actually quite comfortable living with shorter lease terms. In the first quarter, we did have a number of leases with lower-than-average lease terms. But it really varies. So the current pipeline has leases that are also quite a bit longer than what you saw on the first quarter. And our mid-market initiative is designed to even out some of that lumpiness. I just want to remind you that the first quarter is our third consecutive quarter of strong leasing volume. And we saw very stable pricing in the quarter. And in addition, we saw very encouraging results from mid-market initiative, which as Matt said, we're expecting $4 million to $7 million a quarter of mid-market revenues. So to sum up, we think the first quarter demonstrates the continued strength of the overall demand environment.

David Toti - Cantor Fitzgerald & Co., Research Division

Great. And then, my follow-up question, Bill, is just relative to your comment on increasingly looking at future joint ventures. Does the company have any outline as to the scope and the nature of those joint ventures? Or is it early days still?

Arthur William Stein

Well, it's still early days. We do have a potential joint venture on Turn-Key assets. We're evaluating that right now in the context of the larger capital recycling initiative. And we are looking at potentially using joint venture capital to fund our growth initiatives in Asia Pac.

Operator

Our next question is from Vance Edelson of Morgan Stanley.

Vance H. Edelson - Morgan Stanley, Research Division

Terrific. So the press release refers to pricing being, I think, it said generally stable to slightly improving, and you mentioned the strength in Asia Pac. But if you could provide us more pricing color by region, including around the U.S., are there any particular standout markets, good or bad, right now?

Matthew J. Miszewski

Yes. Thanks for the question. The pricing differential, and we did talk about sort of the standout piece and with the good deal of the Q1 leasing being in Asia Pac, and certainly is significant that the pricing in Asia Pac remains strong. We do see relatively stable pricing throughout the U.S. with some small pockets of potential increased pricing power in areas like New York metro, and I would say stabilized pricing power in the places where most of our new deals are landing, including Ashburn, Dallas and Chicago.

Vance H. Edelson - Morgan Stanley, Research Division

Okay. And then, for my follow-up, which is related, just regarding the supply by region that you provided back at the Investor Day. Are you prepared with any stats? Could you update on -- us on that in terms of excess supply? The number of quarters of supply by region? Or can you just give us a feel directionally for how much that's improved?

Matthew J. Miszewski

So certainly, I'd be happy to refer to some of the trends that we've seen in the first quarter, as well as sort of an update to where we are in -- from Investor Day. And I did make mention during my prepared remarks about Northern Virginia certainly as a standout area that has got some reported strength in terms of the supply that's out there. And I do want to make sure that we color this the correct way. The supply announcements that happened in Northern Virginia were primarily what we refer to as shared infrastructure supply as opposed to our dedicated infrastructure supply that we have in that same market. So the industry does need to mature to the point that it takes into account some of these product differentiations. But across the board, we certainly did see an increase in supply. As I just mentioned, in terms of pricing, we are not seeing the macroeconomic event that would suggest there would be pricing pressure in that market for us, as our pricing ability in Northern Virginia remains relatively strong. I believe, at Investor Day, we discussed a little bit about Silicon Valley supply as well. And all of these things need to be taken as a whole. Supply, of course, exists in Silicon Valley. And there were some announcements that would suggest additional supply. But we have seen, on our side, in my team, a demand curve that's actually shifting up and to the right. And so, that demand characteristic matches up with the supply that we currently have in that particular environment, which by the end of this half will be small to nonexistent.

Operator

Our next question is from Jonathan Schildkraut of Evercore.

Jonathan A. Schildkraut - Evercore Partners Inc., Research Division

Great. Yes. Just, first of all, it's another great quarter of leasing. And I was wondering if you can give us a little bit more color in terms of either verticals or applications that you're seeing the demand come out of? And I guess, as a sub-question to that, just wondering how much of your leasing comes through an RFP process versus sort of an outgoing calling effort?

Matthew J. Miszewski

Happy to talk a little bit more about the leasing success and the vertical orientation, some of the leasing. We saw significant movement in terms of social media, the cloud being sort of a dominant part of the last 3 quarters of our progress, as well as some movement and some positive movements in terms of mobile applications, as well as content delivery. We believe that the progress in each of those areas in Q1 is indicative of the health of our ecosystem as we move forward. Each one of those has been identified as drivers of data center demand. But as we see us landing and capturing that demand, we think that bodes well for us.

Jonathan A. Schildkraut - Evercore Partners Inc., Research Division

Great. And in terms of the RFPs?

Matthew J. Miszewski

So, yes, it's very interesting. I think we commented that 90% of our Q1 deals came from repeat customers of ours. And when we see repeat customers of ours, oftentimes, more than likely, we see those deals before they go out officially to RFP. So we see a good mixture of RFP-related demand, but we also, because of the relationships and the long-term relationships that we've had with our customers and the performance of our operational staff, we actually have a tendency to get some first looks prior to RFPs being released, then we have the ability to capture that demand pretty well.

Jonathan A. Schildkraut - Evercore Partners Inc., Research Division

Great. I don't know if I'm going to break some rules here, but I was wondering if you guys might tell us a little bit about how you're interconnected data center effort is going. And what kind of demand you saw for the bandwidth between your facilities?

Matthew J. Miszewski

Yes. As you know, we are a big advocate of the digital ecosystem and that was -- the respect that I had for that process was based upon the promise of the digital ecosystem. During the first quarter, I got to see -- I was lucky enough to see the promise of that ecosystem now start to deliver itself in terms of actual results. And so -- and this was maybe a little less obvious in the prepared remarks that we had earlier. But we do believe that there's a shift happening in the data center market that used to focus on data storage as the highest-placed value, and now really focuses on the exchange of information as part of that value. When we started the digital ecosystem -- network ecosystem process, we had done it as a way to increase deal liquidity and to increase the size of those deals as they come out. We did see in Q1 some direct revenues that actually came out of that effort as well. So we're pretty happy to see the outcome be both direct and indirect to our bottom line.

Operator

Our next question is from Charles Croson in Barclays.

Charles Croson - Barclays Capital, Research Division

This is Charles, standing in for Ross. So in terms of this retail push and taking that into context with the shifting to a more build-to-suit model, how does that work? Because I imagine that you're not building out an entire data center anymore for a few retail-based tenants. Can you kind of tease out how that all works?

Arthur William Stein

So the buy-to-order, if you will, is really more targeted at the enterprise market. And the middle market would still require that inventory be available. So that tends to be absorbed very quickly after signing.

Charles Croson - Barclays Capital, Research Division

Okay. That's helpful. And, Bill, I apologize if you had mentioned this at the start of the call. I got on a little late. Do you have any updates in terms of the CEO search in terms of timeline, a potential short list of candidates?

Arthur William Stein

Sure. Well, the update is that the search has started. So a recruiting firm has been retained and the expectation is that the process will be concluded some time in 2014. But in the meantime, the board and the Chairman of the Board, in particular, has indicated that he's confident with the current leadership that's in place. And the board is really focused on finding the right candidate versus rushing to find the candidate in an arbitrary period of time.

Operator

Our next question is from Stephen Douglas of Bank of America Merrill Lynch.

Stephen W. Douglas - BofA Merrill Lynch, Research Division

Great. Bill, maybe a follow-up on the last question. For the CEO search process, I mean, can you maybe talk about what criteria, if any, have been identified for that "right candidate?" And then, second question, maybe one for Scott. Just wondering if you can comment on where your visibility is on some of the asset sales as part of the capital recycling program. And maybe, what the potential magnitude of that could be this year?

Arthur William Stein

Stephen, the criteria is really what you would expect for the CEO of any public company, and particularly one that's in the data center space. So it's an individual that is experienced in data centers, ideally, specifically, real estate, as a subset, technology and finance. But let me -- I want to reiterate here though that the company is really focused right now on pursuing its strategic vision during this interim period. And that represents optimizing our return on portfolio, recycling our capital, as Scott will speak to, and unleashing the intellectual capital of the organization.

Scott E. Peterson

Part of the visibility on the asset sales, it's a little early in the process to speak to specifics on that. So we probably will have a better idea of some of the order of magnitude maybe in the next call. The general plan, though, is that we will sell the non-data center assets, the non-core markets, underperforming assets and evaluate the potential underperforming assets. And as Bill stated earlier, we'd expect to cull the bottom 5% to 10% of our portfolio over the next few years.

Operator

Our next question is from Vincent Chao of Deutsche Bank.

Vincent Chao - Deutsche Bank AG, Research Division

Just want to go back to the comments regarding sort of the more customer-centric focus today, which I think is definitely the right direction. In the past, the focus has been more on sort of standardization of processes and some of the scale benefits through the development program when you were -- was a bigger part of the story. I was just curious how you guys balance the benefits of that scale and standardization versus sort of more customized -- custom service-oriented solutions and maybe possibly more customized data centers.

Arthur William Stein

Sure, Vincent. So we think that it's possible to do both. So we basically build in blocks or modules. I think you've probably seen our presentations where you see how we build electrical rooms in Dallas, and it's been trucked up to our data center sites. So really, I think the issue is the level of redundancy that a particular customer might need. And we can adjust that through the assembly process, still maintain the cost efficiencies that we've achieved.

Vincent Chao - Deutsche Bank AG, Research Division

Okay. And maybe just a follow-on to that question. I mean, as the industry continues to evolve and change, you guys talked about the supply in Northern Virginia being mostly shared infrastructure versus dedicated. I mean, are you seeing that sentiment change at all in terms of is there -- is the pool of folks that really just want dedicated versus shared as big as it has ever been? Or are you starting to see some of that barrier come down as people get more comfortable with the overall outsourced model?

Matthew J. Miszewski

Yes, that's a great question. And I would say that I certainly came in as a newcomer to the industry this last year with some of those same types of questions. I'd say that the past 3 quarters of very solid, dedicated infrastructure revenue that we produced is a pretty good testament to a strong and growing market out there for that particular type of product. But as Bill said, we can't keep our eyes closed to particularly new customer demands that are out there. We need to be open to that. And I think that the secret sauce moving forward is truly sort of getting the pieces that we have traditionally provided, that our customers have paid us for over the years. And coupling that together with what some of our partners provide to provide solutions that they're seeking in a new environment. And when we can do that, we find that the value that they're seeking matches well the value that we provide. And that's what we're going to try to do moving forward.

Operator

Our next question is from Bill Crow of Raymond James & Associates.

William A. Crow - Raymond James & Associates, Inc., Research Division

Bill, in order to avoid maybe a surprise next quarter, you already alluded to a lease with a financial services tenant that was going to roll down. Maybe, you could give us the magnitude of that roll-down. And how many more such leases that would be material we might see over the next year or so?

Arthur William Stein

Sure. Firstly, I want to emphasize, Bill, that rolldown is in our guidance. So there shouldn't be any surprise from that standpoint. And the -- we expect that rents could roll down in the 15% to 20% range for that lease.

William A. Crow - Raymond James & Associates, Inc., Research Division

Anything more over the course of the year that you think is going to pop up of that magnitude?

Arthur William Stein

No.

Operator

Our next question is from Omotayo Okusanya of Jefferies.

Omotayo T. Okusanya - Jefferies LLC, Research Division

Yes. I just have 2 questions. The first one being the 4% same-store cash NOI growth that you're projecting for the year. I'm just -- if you give a little bit more color on how you roll up to that number, because your occupancy, you're going to gain somewhere between 50 to 100 basis points. The mark-to-markets are probably going to be flat to modestly positive. I'm just kind of struggling a little bit how to kind of roll on that up to a 4% kind of same-store cash NOI growth number.

Matt Mercier

Yes, Tayo, this is Matt. Good question. So we've got 2.5% to 3% basically coming from -- we're talking about cash NOI growth. So we got 2.5% to 3% coming from just embedded rent bumps. And we've got probably 60 to 80 basis points from some of the expirations that we've talked about. And then, we also have another 2.5% to 3% coming from free rents of ramps that are burning off from the embedded portfolio, as well with some additional staggered lease commencements that were part of leasing we've done over the last year.

Omotayo T. Okusanya - Jefferies LLC, Research Division

Got it, okay. That is helpful. And then, the second question is, one of your peers mentioned that they were actively working through the Facebook sublease in Santa Clara. Just kind of wondering, at this point, if you guys are doing anything with Facebook and where kind of things stand?

Arthur William Stein

Scott?

Scott E. Peterson

We don't make comments about individual customers, but we've enjoyed a great deal of success with Facebook, both as it started out a company and grew inside Digital's data centers. And we continue to see that progress moving forward.

Operator

Our next question is from Michael Knott of Green Street Advisors.

Michael Knott - Green Street Advisors, Inc., Research Division

I think you may have addressed this earlier, but the decline in guidance for spec revenue for this year that's just -- is that related to a longer-than-expected commencement lag?

Matt Mercier

No. I mean, this is a positive thing. It's actually -- the spec revenue we've cut in half. So meaning, we've signed up and expect to commence $15 million to $20 million of what we had in the prior quarter. So that leaves a -- or $10 million to $15 million, I'm sorry. And now, we have another $10 million to $15 million left for the year. But it's a positive.

Michael Knott - Green Street Advisors, Inc., Research Division

It's not a cumulative number?

Matt Mercier

It's not a cumulative number.

Michael Knott - Green Street Advisors, Inc., Research Division

Okay. I was a little bit confused on that. Okay. But that helps. And then, I guess, a question for Bill or Scott, just on the guidance on cap rates. I guess, your max contribution could be $400 million, if I read that correctly. And your average cap rate that you're projecting is about a 7%, and I seem to recall that you guys have said that Turn-Key would be a big component of that, or potentially a meaningful component. And so, I'm just curious if that's the right inference that you guys think that a JV partner is going to pay basically a 7% cap for Turn-Key. And if that's not really much of a spread in cap rate over Powered Base, I'm just wondering if you can help us with the right conclusions to draw from what we're seeing in your guidance?

Arthur William Stein

Yes. I think that is a fair inference. And by the way, I want to go back to your question on leasing. The guidance was cut in half because of the leasing we did, not because we don't think we're going to do anymore leasing. I just want to make that clear. But we do think that -- I mean, I think, your analysis is correct that the 7-ish is probably the accurate cap rate to use on the Turn-Key for joint ventures. Scott, do you have anything you want to add?

Scott E. Peterson

I think that's probably it. Yes.

Operator

Our next question is from Jordan Sadler of KeyBanc Capital.

Jordan Sadler - KeyBanc Capital Markets Inc., Research Division

First, I wanted to take a stab at the run rate that you ran through, Matt, on the guidance, starting out at $1.28, and then walking us down to $1.18 to $1.19. I guess what I didn't hear in there was any incremental contribution from the core growth that you're anticipating, as well as the impact of any new leasing in the speculative revenue. And I was wondering if there are offsets to those drivers.

Matt Mercier

Yes. Well, clearly, we have a backlog of NOIs we've shown. But the run rate's meant to project where we expect to be starting as of the second quarter. I think there's a couple of other things to keep in mind. First, as we've shown, we did have dispositions, but that's bringing down the run rate. And in addition, we have contemplated an additional capital raise in the year. So that provides some additional headwind that we could be facing, as well as our development program runs down. I think we've talked about in the past that there's capitalized interest that will be coming down. So again, this is just meant to project where we'll be starting as we enter the second quarter.

Jordan Sadler - KeyBanc Capital Markets Inc., Research Division

Okay. That's helpful. Just a follow-up, I think, Matt Miszewski, you mentioned in your commentary that the inventory remained relatively flat sequentially, as you brought on a little bit more inventory and you had a move-out in LA of a Turn-Key customer. So if you could -- so one, I'm curious about the nature of the move-out. But separately, can you just speak to the amount of inventory you would like to have available ideally going forward?

Matthew J. Miszewski

Yes. So I don't think that -- to the question, I don't -- we always sort of bandy about the conversation about what the optimal amount of ready inventory is. But given Bill's comments about the just-in-time inventory adjustment that we're going to make, given that we can deliver within [indiscernible], it becomes a little less of a pressing issue for us. We simply don't see the need for us to hold on to a significant amount of inventory because we're able to satisfy the customer's needs relatively quickly. And I think I may have talked about this at Investor Day, as well. So you may want to refer back to that. The move-out is an interesting story. It was about a 300-kilowatt move-out. And in order for us to do that -- really the organization that did that was consolidating their operations, and they did that out [ph].

Operator

Our next question is from Emmanuel Korchman of Citi.

Michael Bilerman - Citigroup Inc, Research Division

It's Michael Bilerman, here, with Manny. So Bill, just had a question. As you think about when the board made the decision to make a change with Mike and let him go, you've titled this whole presentation in the supplemental, "Turning A New Path Forward." I'm just curious, is this your new path forward that you've presented to the board? Or is Chairman of the Board and transition committee putting forth a new path forward?

Arthur William Stein

This is a new path forward that both I and the senior leadership team have created. And we presented it to the board, and we're presenting it to shareholders clearly, and we're going to be rolling it out to the employees as well.

Michael Bilerman - Citigroup Inc, Research Division

And so, how should we think about -- I assume, the board is thinking about a search process, both internal and external. And I'm not sure if you're raising your hand, or you have raised your hand. But I would assume, and if it is, if you're not the guy, and the new CEO comes in, they may have their own ideas about what path that they want to take, and their ideas about where they want to go. And isn't the board pigeonholing themselves a little bit? Or are you opening up investors to a secondary path forward when a new CEO comes into place, if you're not the person?

Arthur William Stein

Mike, well, I mean, I think these are pretty basic and fundamental in terms of a strategic vision. So optimizing a return on the portfolio, recycling capital, unleashing the intellectual capital of our workforce, is motherhood and apple pie? And I can't really see anyone else disagreeing with those initiatives.

Operator

Our next question is from Gabriel Hilmoe of UBS.

Gabriel Hilmoe - UBS Investment Bank, Research Division

Just going back to the spec revenue number for a minute, and what's been derisked so far. Are there any other moving parts in that number where you've added some additional spec relative to the $20 million to $30 million that you had in there before? Is that clearly here [ph], or has it truly been derisked, I guess, by 50%.

Matt Mercier

Can you repeat that? The first half was kind of lost.

Gabriel Hilmoe - UBS Investment Bank, Research Division

I guess, just on the spec revenue number, is it -- is the $20 million to $30 million, and I guess, now it's $10 million to $15 million, is that truly an apples-to-apples comparison? Or has anything been added on a go forward basis that's new spec revenue I guess?

Matt Mercier

I mean, that isn't apples-to-apples. I mean, just to be clear, it reflects what we expect to recognize from -- on a revenue basis from new leasing. It doesn't include re-leasing or renewal-type activity. So this is new incremental leasing. And at the start of the year, as we've noted, we had $20 million to $30 million expected from -- we expected to sign and commence from new leasing. And as a result of the strong first quarter results, we've cut that in half.

Gabriel Hilmoe - UBS Investment Bank, Research Division

Okay. And then, I apologize if you mentioned this before, but how much of the leasing in the quarter was related to, I guess, the mid-market strategy? I'm just trying to get a sense of how much that played out in the numbers?

Matthew J. Miszewski

I think, it's in there. But $4.1 million was related to colocation mid-market strategy.

Operator

Our next question is from George Auerbach of ISI Group.

George D. Auerbach - ISI Group Inc., Research Division

Matt, you mentioned the pre-stabilized bucket has some assets moving in and out. Do you have a number for what the lease percentage would have been quarter-over-quarter had that bucket remained static?

Matt Mercier

I'm sorry, can you repeat that?

George D. Auerbach - ISI Group Inc., Research Division

Yes. The pre-stabilized bucket, the $500 million of assets that's now 10% leased and was 17%. I know there's things moving in and out. Just trying to figure out what -- at year end, it was 17% leased, where would that have been today had you not sort of moved some assets in and out of that portfolio?

Matt Mercier

I don't have the ins and outs in front of me. I'm sure that's something we can follow up on.

Arthur William Stein

But, Steve (sic) [George], just to be clear, one of the reasons that percentage went down is that we took some properties out of that bucket that were signed and shown as leased last quarter, and were moved out because the lease has commenced. So that caused the percentage to -- percentage lease decline. And in addition, we delivered some new pods to the bucket as well. Those are pods at Melbourne and St. Louis. So in Phoenix, we commenced leases that have already been signed. They moved out of the bucket. We also -- I mentioned some leases in New York and, again, that bucket percentage will go down. But at the end of the day, this is going to represent our finished inventory. It has to be leased. So I think you would expect, but for properties that are signed but not commenced, that lease percentage should be relatively low until the lease has commenced.

George D. Auerbach - ISI Group Inc., Research Division

Right. I guess I was just trying to think of some sort of measure, how you're doing leasing up that finished inventory? So I was just trying to figure out, as you went from Q4 into Q1, how much was done? And I guess, maybe, the question is, of the $500 million that's in the pipeline today, at 10% or 11% leased, on a same-store basis, where do you think that portfolio is on a lease percentage -- occupied percentage by year end '14?

Matthew J. Miszewski

So I don't know if I've got that exact number. But I think what you're going for, between Q4 and Q1, I'm always careful about the word I use, but we did burn about 5 megawatts of that inventory. And moving forward, we feel like we've got a target on burning even more of that inventory in Q2. I think that gets towards your question.

Matt Mercier

And just to follow-up. Most of that space is not in the pre -- is not going to be in the same capital pool. It's going to be in -- it's new space. And I think that I would refer you back to the 92% to 93% overall total portfolio occupancy that we're guiding to. We're at 92.1% to date. So clearly, that suggests that we expect to lease a decent amount of that pool in the remainder of the year.

Operator

Our next question is from Jonathan Atkin of RBC Capital Markets.

Jonathan Atkin - RBC Capital Markets, LLC, Research Division

Yes. I was interested in the comments about one-size-fits-all. And I don't know if you answered it earlier or not. But you talked about, Bill, all Model Ts and being black, and so forth. And are you -- is there something different in terms of the technical specifications or parameters of the product around density or size that you were alluding to that's going to be different going forward? And then, my second question is, if you could speak to kind of the European market, London, Amsterdam, Paris, and so forth, and where you're seeing strength? And what kind of a competitive environment it is?

Matthew J. Miszewski

Yes. So great question about the product development that may be needed as we continue our customer focus moving forward. And you get right to the heart of what this senior leadership team over the past few weeks had struggled with and come to some conclusions about. We don't believe that there is a significant departure in terms of density and size, and what I call the building blocks of the solutions that our customers are seeking. The building blocks from our perspective will remain, space and power that we have delivered over time. They will also leverage our digital ecosystem in terms of the network deployments that we have made and that we have been able to leverage from some of our partners. And then, they will take some pieces from our partner ecosystem in the new Digital partner network, including items like managed services, cloud service provision, and the like, and they will be coupled together into solutions that our customers want. So in terms of what we need to provide from Digital's perspective, it remains in our wheelhouse. The density and size doesn't even change a whole lot. There may be a few things that we need to provide an individual market that maybe a little more dense or a little less dense, or a little larger, a little smaller. But the general facilities that we provide will continue to be the facilities we'll provide in the future for our customers. But the solutions will be different and will be tailored to their needs.

Operator

Our next question is from Jonathan -- a follow-up from Jonathan Schildkraut of Evercore.

Jonathan A. Schildkraut - Evercore Partners Inc., Research Division

Reading a lot about data centers being built with no resiliency, no redundancies, so I guess, N, and obviously, the cost structure around that is a lot less. You guys have flexibility in terms of the redundancy that you can deliver to your customers. I'm just wondering if you're seeing any demand around that.

Matthew J. Miszewski

Yes. So great question, Jonathan. We see a lot of demand. And it really, from a resiliency perspective, plays the gamut. But the greatness of sort of our POD 3.0 architecture is we can deliver the components that our customers are asking for within the same time frame from market-to-market. So we had an example in 2013, where someone did come to us with a solid N requirement and we were able to deploy a data center solution whose cost profile met their price profile and met exactly what they were looking for in terms of resiliency. So I think that if there is anything changing, folks are moving more towards our incremental process so that they can actually address differing needs without addressing -- without significantly augmenting the cost to deploy.

Operator

And this concludes our question-and-answer session and conference call. Thank you for attending today's presentation. You may now disconnect.

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