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Parkway Properties Inc. (NYSE:PKY)

Q3 2010 Earnings Call

November 2, 2010 11:00 am ET

Executives

Steve Rogers - President and CEO

Richard Hickson - CFO

Will Flatt - EVP and COO

Mandy Pope - Chief Accounting Officer

Jim Ingram - Chief Investment Officer

Thomas Blalock - Director of IR

Analysts

Rich Anderson - BMO Capital Markets

Josh Attie - Citi

Brendan Maiorana - Wells Fargo

Jordan Sadler - KeyBanc Capital Markets

Ross Nussbaum - UBS

Sri Nagarajan - FBR Capital Markets

Dave Aubuchon - Robert Baird

Mitch Germain - JMP Securities

Operator

Good day and welcome to the Parkway Properties third quarter earnings conference call. With us today are the Chief Executive Officer, Mr. Steve Rogers; Chief Financial Officer, Mr. Richard Hickson; Chief Operating Officer, Mr. Will Flatt; Chief Accounting Officer, Ms. Mandy Pope; Chief Investment Officer, Mr. Jim Ingram; and Director of Investor Relations, Mr. Thomas Blalock.

At this time, I'd like to turn the conference over to Mr. Blalock.

Thomas Blalock

Good morning, everyone, and welcome to Parkway's 2010 third quarter conference call. Before we get started with this morning's presentation, I would like to direct you to our website at pky.com where you can find a printable version of today's presentation.

On our website, you will also find copies of the earnings press release from November 1 and a supplemental information package for the third quarter, both of which include a reconciliation of non-GAAP measures that will be discussed today to their most directly comparable GAAP financial measures.

Certain statements contained in this presentation that are not in the present tense or that discuss the company's expectations are forward-looking statements within the meaning of the federal securities laws. Although the company believes that the expectations reflected in such forward-looking statements are based upon reasonable assumptions, it can give no assurance that its expectations will be achieved. Please see the forward-looking statement disclaimer in Parkway's press release for factors that could cause material differences between forward-looking statements and actual results.

I would now like to turn the call over to Steve.

Steve Rogers

Good morning and thank you for joining us today. We accomplished since our last call, so I'll be brief in my comments on the overall economy this quarter. Let's start with some economic commentary from Dr. Barton Smith, our good friend and noticed economist.

PRS sponsors and distributes a quarterly research report by Dr. Smith known as Ahead of the Curve. We've provided an overview of his report as well as a link to the latest edition on Page 2 of our web presentation.

Dr. Smith notes that all recessions have a purpose, and this one is not finished yet. Purpose of this recession is to reset the arrows that created the real estate bubble. To correct these flaws, several adjustments are needed. The most important of which is change in expectations that quick and easy wealth can be obtained through asset speculation.

Until we finish the job of reducing our nation's debt and increasing our savings rate, we will continue to have a low growth recovery similar to Japan in the early '90s. We are optimistic that our country will be successful in correcting these problems and we'll have a strong or better economy long term.

In the meantime, job growth continues to be stagnant. Another 218,000 jobs were lost during the third quarter as the temporary jobs from the 2010 census expired as shown in spaghetti chart on Page 3. The private sector created small amount of jobs in September, but in total only 600,000 of jobs lost have been recovered thus far.

As expected, minimal job growth continues to put pressure on market fundamentals. Our strategy is aligned with the expectation that jobs will not recover quickly and that a new normal or slow economy growth with low to no job growth is possible.

Under this assumption, we believe that our focus should continue to be on financial flexibility which means more liquidity and less overall debt, which we've identified as the C in our now FOCUS plan and reported herein.

A more liquid company during this economic environment should result in more free cash flow to take advantage of accretive investment opportunities that typically exist at the tail end of prolonged recessions.

Toward that end and since our last conference call, we've taken three major steps to improve Parkway's balance sheet. First, we raised $45 million through the reopening of our Series D Preferred Stock. Several great investors participated in the offering and interests far exceeded our needs. This offering was timed in close proximity to our $33 million purchase of our deeply discounted first mortgage notes secured by RubiconPark I assets and proceeds were used primarily to reduce our line of credit.

Second, we completed the foreclosure of RubiconPark I assets and subsequently made our first investment by the Texas Teachers Fund II by selling two of the assets to the Fund and have a third asset under contract for selling to the Fund. This sale to the Fund not only represents a great opportunity to produce attractive returns, but it also represents a $23 million cash inflow to Parkway. The total amount of net cash proceeds from Parkway after the loan purchase, the Preferred Stock offering and the asset contribution to Fund II is around $34 million to $35 million.

To put this amount of cash flow into perspective, $35 million is equal to Partkway's equity requirement to purchase $230 million in total assets in the Fund II. Completing our first investment in Fund II is a big step and we're very active in our other offerings at this time.

The third major step we've taken toward an improved balance sheet is progress made on the company's revolving credit facility renewal. As announced last week, we obtained commitments from eight lenders for a total of $320 million. The company is carrying through with previously communicated plan of structuring a more efficient credit facility that better meets our borrowing needs and company strategy. It is important to note that a very high-quality group of bank line participants led by Wells Fargo and JPMorgan are involved in the credit facility renewal.

Our performance during the third quarter was in line with our expectations, and we're in good shape to meet our operational and financial goals for the year. We signed over 1 million square feet of leases during the third quarter, which represents the single largest quarterly volume of record. Additionally, we made substantial progress on our lease rollover exposure which Will intends to cover in a moment.

FFO for the quarter was $0.63 per share, and we've increased the low end of our guidance range by $0.02 per share. Our FAD for the quarter was $0.24 per share, bringing us to a total FAD of $1.02 per share year-to-date. While this was much better than we expected at this point of the year, the timing of the capital projects related to several of the large long-term leases we signed this summer are expected to occur during the fourth quarter. We ended the quarter at 95.7% occupancy, 87.4% leased and have a 75% customer retention rate during the quarter.

I am very pleased to report to you that in September, Parkway was again selected as one of the best small and medium workplaces by Great Place to Work Institute. This is our fourth time overall and third consecutive year to be chosen for this award. It's a testament to the high level of trust and mutual respect we have at Parkway, which models our strong culture.

With that, I'll now turn the call over to Will for an update on operations.

Will Flatt

Thank you, Steve. The national office vacancy at the end of the third quarter was 17.5% and was slightly better than last quarter. The vacancy rate in Parkway's market was 19% compared to Parkway's vacancy rate of 14%. Construction levels continue to remain at historically low levels, which should help support growth and occupancy as the job market recovers. According to CoStar, it had a second consecutive quarter of positive net absorption and a total of 7 million square feet of positive absorption year-to-date.

We have provided a brief over of the market fundamentals by our three largest markets, Chicago, Houston, Atlanta, on pages 9 through 11 of our company presentation, and I would like to highlight a few of these items for you.

Chicago's vacancy decreased to 20% compared to Parkway's vacancy in Chicago of 9.8%. As we discussed last quarter, the main driver of Parkway's increase in occupancy in Chicago was the commencement of combined insurances 99,000 square foot lease. We have also signed an additional 29,000 square feet of leases in Chicago, but have not commenced yet, including AOL's 19,000 square foot lease at 233 North Michigan, which brings Parkway Chicago lease percentage up to 91.2%.

The Chicago office market had negative net absorption of 1.8 million square feet for the first three quarters of 2010, but there are currently no new office developments under construction today.

Houston's market vacancy remains flat at 18.5%, whereas Parkway's vacancy in Houston increased slightly to 7.6%. As we announced earlier this month, we signed two major new leases at 1401 Enclave with Chemical Market Associates and Callon Petroleum for a total of 38,000 square feet. These new leases combined with our other leasing activity bring our Houston portfolio to 95% leased.

We also signed a major renewal with Nabors for 205,000 square feet which removes a significant amount of lease rollover exposure in Houston for 2011. Overall, the Houston market had negative net absorption of 416,000 square feet so far in 2010 with 2 million square feet or 1.1% of total stock under construction today, most of which is in the CBD where Parkway is not located.

Atlanta's market vacancy took a small step backward this quarter with an increase of 23.3% and negative 165,000 square feet of net absorption year-to-date. Parkway's vacancy in Atlanta followed this trend and increased to 14.3% during this year. Atlanta currently has no new developments under construction today, which should help mitigate continued losses in occupancy in the area.

For our entire portfolio, we had over 1 million square feet of leasing activity during the third quarter, and our customer retention rate was up to 75%. We signed a total of 50 renewals totaling 711,000 square feet and the average rent per square foot of $19.51. While the average rental rates of our renewals have increased over the past two quarters, they're still well below the expiring rates with a negative 15% spread on leasing activity during the third quarter.

This is continued evidence of an extremely competitive leasing environment with the majority of the negotiating power remaining with the customer.

When evaluating a lease, the company considers the overall economics of the lease through a net present value analysis. For example, the Nabors renewal which is our largest renewal during the third quarter at 205,000 square feet was a four-year lease of acquired no-tenant improvements. Total rental rate decline on this lease was approximately 4%. We were able to maintain a relatively high net present value of the lease due to minimal upfront capital cost.

One of the main drivers of the large negative spread in lease renewals this quarter is related to U.S. Cellular's long-term lease at the U.S. Cellular Plaza in Chicago. Since the renewal was signed during the quarter, the effective renewal spread related to this lease is included in the 15.3% average reported. However, U.S. Cellular's lease prior to our renewal does not expire until December 2011.

The structure of renewal keeps U.S. Cellular brand at approximately the same level until January 2012, which is when the effect of a negative rent spread will occur. Our rent spread excluding U.S. Cellular renewal is negative 7.6%, which is in line with our expected rent declines during 2010. We have provided an updated embedded growth chart on Page 13 of the presentation, which also shows that our current estimated market rents are 7.3% below our current inflation rents.

Page 14 of the presentation shows year-to-date average terms leasing cost of our leasing activity compared to our averages over the past five years. Our average lease terms are slightly above average, yet well below late 2009 levels. I mean we've been able to keep our leasing costs at historically low levels on a cost per square foot per year basis.

Our average in-place rents increased for the second consecutive quarter, and our year-to-date average rent is slightly high than our average rent during the first three quarters of 2009. We ended the quarter at 85.7% occupied and increased on lease percentage to 87.4%. The lease percentage includes 121,000 square feet, which will take occupancy in the fourth quarter of 2010. Our year-to-date average occupancy is 85.9%.

Page 15 of the presentation shows an updated schedule of major lease expirations. We have reduced our 2011 expirations to 1.6 million square feet or 11.8% with AutoTrader, Motorola and Alta Mesa Holdings remaining as the only long leases greater than 50,000 square feet that expired during the year.

As we've announced before, we know AutoTrader will vacate upon their expiration date in February 2011. We currently have over 200,000 square feet of prospects for this space, and we are negotiating a lease for approximately 50,000 square feet. However, our customer retention will be lower than normal during the first quarter, and we expect our occupancy to drop in early 2011 until we're able to backfill this space.

Blue Cross Blue Shield at 111 East Wacker in Chicago officially exercised their early termination option as expected and will vacate approximately 230,000 square feet in March of 2012. They will be relocating to the regional expanded headquarters building (inaudible) within the East Loop submarket. With over 17 months of advance notice, we feel confident in our ability to back that significant portion of this space with minimal downtime.

The Blue Cross Blue Shield space shows well and is in good condition, and it is possible that we could receive early buyout dollars during the 17-month period which could help on TI leasing cost needed to re-lease the space.

Looking even further into the future, we have a very manageable expiration schedules show on Page 16 of the presentation with less than 12% expiring each year for the next five years.

With that, I'd now like to turn to Richard for an update on our financial results.

Richard Hickson

Thanks, Will. Our reported FFO for the third quarter was $0.63 per share and our recurring FFO for the quarter was $0.61 per share. We have provided a reconciliation of FFO to recurring FFO on Page 18 of the presentation.

In light of year-to-date performance and our expectations for the fourth quarter, we are revising our 2010 guidance range for reported FFO from $2.72 to $2.92 per share to $2.82 to $2.92 per share and recurring FFO from $2.40 to $2.60 per share to $2.47 to $2.57 per share.

We have provided a list of the major assumptions for our 2010 outlook on Page 20 of the company presentation. The main drivers of the adjustment for guidance are the net effect of higher lease termination fee income than expected and lower interest and G&A expenses, offset by lower NOI, the impact from the sale of One Park Ten and additional dividends from our preferred stock offering.

Parkway's share of recurring same-store GAAP NOI for the quarter was down 7.4% from the same period last year and is down 5.9% year-to-date. We anticipate ending the year with a slightly larger decline in Parkway's share of same-store GAAP NOI relative to our original guidance range, primarily due to straight-line rent associated with new leasing activity and large early renewals. Parkway's share of recurring same store cash NOI was down 4.3% compared to the same period last year and was down 5.8% year-to-date.

FAD is better than expected at this point in year at $0.24 per share for the third quarter and $1.02 per share year-to-date. However, we are expecting a significant amount of capital to be spent during the fourth quarter. We are forecasting negative FAD for the fourth quarter, but our project FAD amount for the year is still in line with our expectations.

On August 9, the company priced an offering of approximately 2 million additional shares of its 8% Series D Cumulative Redeemable Preferred Stock at an offer price of $23.76 per share and an offer yield of 8.5%. We believe an issuance of our Series D Preferred Stock represented favorable pricing for long-term equity capital, while at the same time reducing dilution relative to common equity.

The company used a portion of the $45 million in net proceeds to reduce borrowings under its revolving credit facility with the remainder being used for general corporate purposes. It is important to note that this was a reopening of this Preferred Series, which provides the company the flexibility to call the issuance at any time at Park.

Last week, we announced that we received aggregate commitments from eight lenders totaling $320 million for a new unsecured revolving credit facility. The amount of commitments we received far exceeded our goal of the $190 million, which is the anticipated final size of the credit facility.

As we have reported to you in the past, the company is proactively reducing the size of its credit facility in order to have a more efficient facility that better matches our actual borrowing capacity and funding strategy and should also serve to minimize the amount of unused fees potentially paid by the company over the term of the facility.

In addition to the $190 million credit facility is a $10 million commitment for a separate working capital revolving credit facility, which brings the anticipated combined size of the two facilities to $200 million. The pricing on the new facility will vary between 275 basis points to 350 basis points over a 30-day LIBOR depending upon the company's total debt to total assets ratio. This pricing compared to a spread of 130 basis points on our current credit facility.

It is important to note that the company's $100 million interest rate swap, which fixes LIBOR at 3.64%, will remain in place until its expiration on March 31, 2011. As a result, the company's effective interest rate on its borrowings under the new credit facility will be initially higher than the company currently pays, but should be reduced materially once the rate lock expires assuming LIBOR remains at current levels.

The valuation cap rate used for our property net operating income will remain at 8.25%, and the cap rate used for the company's fee income will decline to 15% from 20%.

We would like to thank Wells Fargo and JPMorgan as lead arrangers and all the other lenders that have provided important commitments to this new credit facility. We plan to have the new credit facility closed during the forth quarter, which is subject to customary documentation and closing conditions, and we will discuss the comprehensive final turns of the new credit facility once it is closed.

On October 8, the company used its credit facility to pay off a $7.6 million mortgage loan secured by One Jackson Place and Jackson Mississippi. This loan had a 7.9% interest rate.

Parkway's only remaining debt maturity in 2010 is a $31 million first mortgage loan secured by Squaw Peak Corporate Center in Phoenix, Arizona, with a fixed interest rate of 4.9%. The company plans to utilize available cash balances and its credit facility to repay this upcoming debt maturity.

Beyond revolving credit facility, our only major debt maturity in 2011 is the mortgage loan secured by 233, North Michigan in Chicago, Illinois. As previously stated, we still anticipate having an ability to achieve a refinancing of this mortgage loan at favorable new terms and pursuit levels.

We made progress this quarter towards reducing the company's debt. Our net debt to EBITDA multiple dropped to six times below our target of 6.5 times or less. Our net debt to gross asset value also dropped to 50.4%, slightly above our goal of 50% or less. Despite this quarter's metrics, maintaining these debt metric levels may prove challenging as our NOI and EBITDA are expected to remain under pressure in these current market conditions.

We also recognize that even though our primary leverage metrics improved this quarter, our increased preferred equity dividends had a negative impact on our fix charge covered ratio. The fixed charge coverage ratio of 1.7 times is lower than we prefer, and we intend to look for opportunities to improve it over time, such as through the reduction of debt and refinancing the secured debt at a lower cost.

On the capital investment side of the business, we announced last week that we completed the first investment by Texas Fund II with the Fund's acquisition of Falls Pointe, Lakewood II and the pending acquisition of Carmel Crossing. We issued a detailed press release on October 29 which provided information on these assets and the history of Parkway's ownership in them. We've also provided a synopsis of the investment on Page 24 of the company presentation.

The sale price of the assets will be a total of $33 million or $59 per square foot. The initial capitalization rate based on projected year one cash NOI at 6.1%. There is currently over $1.4 million of contractual free rent during the first year of ownership of these properties. And adding back this free rent to the cash NOI results in adjusted cap rate of over 10%.

We are projecting a property level leverage internal rate to return of 12% over the whole period and a leverage internal rate of return of 23.5% to Parkway. Parkway expects to receive a total of approximately $22.5 million in cash proceeds in connection with this sale, and Parkway's resulting ownership in the properties will be 30% or $9.9 million.

With that, I'll turn the call back over to Steve.

Steve Rogers

In summary, we had another good quarter with increased leasing activities, steady FFO and cash flow, lower debt and our first investment by Texas Fund II. We also made good progress on the renewal of our revolving credit facility.

You may have noticed that Sarah Clark is not on the call this morning. Sarah is facing some health issues and was used for work hours at Parkway while she deals with those issues. She is on demand and with us today. And I'd like to add that Many Pope and Thomas Blalock have many years of Investor Relations experience between them. And as always, any member of the management team would be happy to answer any investor-related questions you may have about Parkway.

With that, we will be happy to answer any questions you may have at this time.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Rich Anderson with BMO Capital Markets.

Rich Anderson - BMO Capital Markets

Thanks and good morning, everyone. Could you just walk me through the math on the lower GAAP level NOI? I know there was a straight-line rent issue, and I just want to get the math down if you could please.

Mandy Pope

Sure, certainly. You'll notice that we did revise our range for recurring same-store GAAP NOI to negative 5% to negative 8%. The primary reason is due to straight-line rent adjustments associated with some new leasing and large early renewals. The straight-line rent just happened to be less than what we had originally anticipated in our original earnings outlook. Therefore, you notice that GAAP and cash are pretty much the same range now. It had no impact to our cash range; it was more of a GAAP adjustment.

Rich Anderson - BMO Capital Markets

Okay. What should we be assuming for straight-line rent on a go-forward basis? Is this a good run rate now?

Mandy Pope

If you look on Page 2 of our press release, we note Parkway's share of straight-line rent for the quarter at $324,000. Right now, we are anticipating for the year straight-line rent of $4 million to $5 million, but that is factored into our revised same-store recurring GAAP NOI range.

Rich Anderson - BMO Capital Markets

A question on the Rubicon transaction. I mean it was noted ad nauseum I guess that the $59 per square foot was an extremely low basis. And I think we can all agree with that. That was a big part of the conversation last quarter. And yet, now you're selling it to the Fund at that very same level. I'm curious if you can walk me through the logistics of that transaction. If you believe that $59 a foot was low, how was it that this got sold to the Fund at that level?

And forgive me if there is a tone of ignorance in this question, but are there other bondholders involved? Can you just talk about how that whole deal went down at the level it did?

Richard Hickson

First of all, it took a very long time, and unless you're sort of new, all the machinations that took place behind the scenes are probably difficult for one press release or a conference call to capture it all. So I'll try not to be too worried in this.

It started actually in December of 2009. When one of our customers in the building couldn't make it, another customer reduced their size dramatically and it basically put the partnership into a negative cash flow situation.

About that same time, Rubicon U.S. REIT, our partner, filed bankruptcy at the REIT level, not the partnership level. And so we have an 80% partner that is really not able to take care of their obligations.

You'll recall that in our February conference call, we noted that and actually took a write-down on asset impairment on that asset generally due to the reduced cash flow from the partnership driving that assessment.

So there is kind of a bad news, if you will, and from that, we approached the special servicer and said, "Okay. Look our partner is having trouble. We've got some cash flow issues at the building level. We have a balance sheet that would allow us to write a check on a discounted low purchase, and would you allow us to do that."

And from that, Jim Ingram in our office negotiated successfully a very large discount in both from $51 million down to $33 million. And I think it was a very good piece of business for our company.

We offered that opportunity to our partner. Now it's important to note this was our partner, Rubicon, clearly in bankruptcy, they were unable to make such a contribution and refused formally to do so. The bondholders said we make this investment with you, which we honored and said yes we can. And after structuring with them a while, it was determined that for tax reasons it was very inefficient for them to participate in this. And they elected to pass sometime in the summer.

Parkway went ahead and approached Texas just in the spirit of good faith and asked if you would be willing to undertake this investment and purchase the note with us at $33 million. They initially said it looked great, but felt like it was in their best interest to allow us to take title of the property and then go ahead and transfer it to them straight that way.

And that's what happened. We bought at July 30. We went through a foreclosure process. And now we are really giving to them the assets at $33 million, which would have been the same price the note purchase would have been at. We really added no value since July 30 to the note purchase.

It's also important to note that there are a lot of TI capital expenditures associated with this building. And while $59 per square foot we've articulated as we the principal purchase price, we've also right below that line item added there were $7 million plus for first two years' capital expenditure. So when you add those CapEx into it, then of course the price is higher. And in the spirit of having a good partner that showed good faith to come into the note purchase and then just simply allowed us some time in their best interest and ours to foreclose on it, we felt like that conveying the assets at our strike price on the note was the correct course of action. And all things being equal, that's what we did.

Rich Anderson - BMO Capital Markets

Do you think that the market value of the three assets is roughly equal to 59 plus the CapEx?

Steve Rogers

I think the best way to probably look at is we have appraised values that give a pretty wide range on this. But if you take the $33 million, add $7 million to it, add some carrying cost that you have to have because there is free rent as noted in the press release and all of that, you come up into the, say $40 million would a fair value of the asset today. But all of that is accounted for in the $33 million purchase price, because they coughed up 70% of the price, 70% of the improvements and eat the 70% of the free rent.

Rich Anderson - BMO Capital Markets

And then are the Rubicon notes still outstanding? Have they been paid down? I don't know if I got that detail anywhere.

Steve Rogers

The Rubicon notes are now gone. They're extinguished. They're illegal foreclosure process in accounting in which they were foreclosed. We had these simple titles to the two buildings in Atlanta which had been conveyed to Parkway Properties office fund too. And we these simple titled through foreclosure of the item in Charlotte, the Carmel Crossing, but North Carolina has kind of a quirky 10-day waiting period which will expire on November 9. On that day, that last asset will be converted and sold is the correct word to the partnership for the price.

What our press release really indicates is the pro forma completion of all of those activities.

Operator

Our next question comes from Michael Bilerman with Citi.

Josh Attie - Citi

It's Josh Attie with Michael. Can you talk about the strategy for I guess paying down the remaining balance on the line of credit? And also in terms of acquisition for the fund, do you see yourself selling any of your existing assets into the fund as a way to grow it and also as a way to generate proceeds to pay down the revolver?

Steve Rogers

I'll take the sales component of it and then I'll transfer over to Richard for the line of credit component of it, if I don't answer that component first. In our focused plan, we have $100 million of sales. I think that is a modest amount of sales for a three year period. This company has demonstrated that the ability to sell assets of about $65 million a year for the past seven years.

Now, this year is a little anemic in that area, we've only sold $16 million, one asset. But if you'll evaluate us on a longer time period and look back over history, our ability to sell $33 million of assets a year is de minimis. So at a minimum, what I'll say to you, Josh, is that we plan to sell $100 million of assets over the next three years. And those are unencumbered assets, and have already been identified as non-core assets in the program. Now these would not be contributions to the Texas Teachers Fund, please understand. These would just be straight sales that would be simple. In the third party marketplace using brokerage firms to fetch the best price on a fair market value sale.

If we want to step on the accelerator a little bit, just for the sake of argument, then we have other assets on our balance sheet that are also non-core assets. And in completing that, I could say that it is doable to do another $100 million. But our announced plan right now is $100 million of unencumbered assets to be sold in the open marketplace.

And so if you just did that alone, that would either allow you $100 million to fund the balance with our equity required for Texas which is now down to $107 million or reduce our line of credit down to zero pending such investments. That's counter from a sales perspective how we are looking at it.

Richard Hickson

The only thing I'd add is, if you look at page 25 of our company presentation, there is a slide that you are all used to seeing. And it outlines the other areas of funding sources if you will for the company and beyond the second portrait that flushes out what Steve just spoke about. We always do have the ability to opportunistically issue any various forms of equity whether it be for our ATM program or others as we see appropriate to the extent the company is creating free cash flow such as in 2010.

That certainly can be used to pay down the line of credit. And then also the refinancing of any secured debt to the extent we can pull proceeds out and contribute that toward paying down the line. Those are the primary areas we can use beyond the asset sales.

Josh Attie - Citi

Have you started marketing any of those non-core assets for sale yet?

Steve Rogers

We are starting right now. Meaning, we actually decided today to go out with an asset into the marketplace today. We have a Board meeting next week where we routinely review those matter with our Board and we're going to be recommending two or three other assets to go to sale with in our late fourth quarter 2010 or early 2011. And the only reason we're really waiting, Josh, was to get occupancy up on a couple of them.

You can see on two or three of the assets, we feel like that timing is right. If you think about it, we pushed the occupancy accelerator in Columbia and in Chesapeake. And both of those areas are now at least available to discuss going to market with which would fetch a higher fair market value price than under occupied assets would in the marketplace.

Josh Attie - Citi

On the mark-to-market, I know you gave what the portfolio was mark-to-market. But when you look at what's rolling next year in your auto trader space, in particular where are those rents compared to where you think you could release them at tin Atlanta?

Will Flatt

Well, on the global portfolio, if you go to page 27 of our supplemental package, you'll see mark-to-market current in place rent is 2375 and weighted average of 2121 is what we're projecting for 2011. If you look at Atlanta, in place rent today at 2359 and a mark-to-market of 1960, specifically toward the auto trader space, most of that in 2011 is going to be auto trader. So you should see a similar mark down expectation.

Operator

Your next question come from Brendan Maiorana with Wells Fargo.

Brendan Maiorana - Wells Fargo

Will, I thought may be we could continue with you for a little bit. If I look at your leasing activity in the quarter and the past couple of months, its been good in terms of the amount of volume. I think over a 1 million square feet is the most you've ever done in any single quarter. And a lot of that was renewal activity, but there was also a fair bit of new activity over the past couple of quarter. So I think the average has been around 200,000 square feet of new activity and your long term average is a little less that 150,000 square feet.

But if I compare that, it hasn't really moved significantly since the beginning part of the year. And on a relative basis relative to your markets, that relative market shares also remained at around 500 basis points better than your markets overall. So if leasing activity drops back to normalized levels, should we expect to see occupancy move back down or can you help me fill the gap?

Will Flatt

Well, what we show as our long term average is about 200,000 square feet, so may be offline I'll try to reconcile to you the 150 number you're using. We were higher than that this quarter. I would say there's been a lot of churn in the portfolio. I would answer that is, we've had some significant move outs that we have replaced. And so while we have inched forward some in occupancy, a lot of it has been, we've backed up space in Columbia, South Carolina, we had a move out there.

And so, we still have customers come up for renewal. There is still downward pressure of coming forward to get back space. And then if you look at just the timing of commencement for some of that leasing, and these are matriculated into the portfolio. So if you look at our percentage leased number, it is higher. And so you should see that matriculated with portfolio, and the only caveat out place on that forward looking as we've said is, we are under pressure in early 2011.

So even at our historical rate, we are going to see occupancy pressure in early 2011.

Brendan Maiorana - Wells Fargo

Yes, I understood that you got some of these move outs in early '11, but if we look beyond that, what do you think it takes for you to gain more market share than you currently have relative to your peers or your competitors in the market?

Will Flatt

We have looked forward and we haven't given our 2011 number yet, in our focus plan, we have a look forward through 2013 and forecast and increase in occupancy using our historical average of 200,000. Again, we've got a lot of roll in 2011, but as we set forth in the presentation, we have managed (inaudible). If you look at page 15, if you look at sort of the total leasing that we've done, to throw a phrase out there, 'chop a lot of wood' in terms of leasing volume and mitigating some of the larger roll.

So if you look at what we got in 2011 and the '12 and '13, we really have sort of manageable expirations going forward. And I think page 16 shows the chart. So how I'd characterize it is what we've really done is, mitigated the risk of the portfolio. There's a major lease on in Chicago and an auto trader in Atlanta. And that is really where our focus for backfilling is. And if we continue just on a normal pace, again, we do show occupancy increase through the end of the focus plan.

Steve Rogers

And on Page 15, I agree with everything Will says. If you look up at the top part of that page, there is 1.9 million square feet that has been gone since '09. We looked at this schedule in the first quarter of 2009, this same schedule. None of these were in the completed category. In fact, every single one of these leases falls in '09, '10, '11, '12 and '13 timeframe.

And in most cases, we looked forward and said we are going to go ahead and knock the lease out either through a blend and extend, early renewal, trade-off some square footage for an early renewal, whatever the term you want to use, and knocked out close to 2 million square feet. And that's what's generated Page 16, very measured, very flat, very vanilla, boring lease expiration schedule, which is where we want to be where we are now.

Brendan Maiorana - Wells Fargo

Okay, that's helpful. And then in terms of the CapEx, I think the implied guidance for Q4 on TI's leasing commissions, building improvements CapEx is around $10 million and $15 million to get you to that $38 million to $43 million range for the year. The past couple of quarters, that amount has been around $10 million or $11 million. And I think you mentioned that you've got most of the CapEx from the large deals that were signed at the beginning of this year with the combined insurance kind of coming in Q4. So is $10 million a quarter sort of the new normal if we're in this tough leasing environment?

Steve Rogers

To give you our new normal on the CapEx right now, I would say that's kind of what we are doing this year. So it wouldn't be fair a game to make such an assumption. We've really not even finished our 2011 budget. So even internally, I can't tell you right now sitting here today what 2011 looks like. So I can't opine on a new normal type commentary there.

I think the best thing to do, Brendan, is let us finish up the year, see where we are. This is lumpy metric. I think CapEx is best measured over a year another quarter and is best measured ruling out the highs and the lows.

We look at fourth quarter last year, for example. I mean it was just way off the charts. There were some 11-year leases, big deals, and have we "annualized" that, and I think it was a huge mistake for our company.

Likewise, we have had some very low quarters that I would not annualize either on that side of the equation. So if you allow us, let us finish the year, give some commentary on it. And I think that would be the best course of action for us.

Will Flatt

I'll make a qualitative comment, which is I don't think of special packages getting any higher. I think we have seen market rents declining flat now. And I think there has been some pushback across the country from either landlords or banks that says we only give so much TIs, so much for your rent. I don't see them invest any lower in the short term, but it is still very competitive marketplace.

Brendan Maiorana - Wells Fargo

Sure. And then just a quick clarification for Richard. The 15% cap rate on the fee income that the lenders are using, is that on the net fee income or the gross fee income?

Richard Hickson

That is gross fee income.

Operator

Our next question comes from Jordan Sadler of KeyBanc Capital Markets.

Jordan Sadler - KeyBanc Capital Markets

I'm just looking at the recurring guidance and the change. The new midpoint is $2.52, which I think compares to your year-to-date of $1.93. So you're suggesting $0.59 for the fourth quarter, which is a couple of pennies down from where you were this quarter. I'm just trying to put the pieces together and figure out what's causing the drag?

Is it the preferred issuance that's doing it at this point? It's not being offset enough by the fund investments and the debt repayment. Or is there another factor on sort of the fundamental front that I'm missing eventually?

Mandy Pope

Jordan, this is Mandy. In our recurring guidance outlook, there is a lot of moving parts that make up the changes within our earnings guidance. And we certainly aren't curative to guide anyone to the midpoint on that (inaudible). But what is included in our total outlook for the year are a lot of moving parts.

There is sales of building One Park Ten. There is the series D preferred offering which you alluded to that has some negative impact associated with the occurred dividend. There are some additional lease terminations fees in the fourth quarter that doesn't affect recurring FFO, but it's reported. And we have the Texas fund investment in the fourth quarter, which again is a small item, but due to the lightness in the year of that item.

But over the year, we have had some G&A savings as well as some operating expense savings, and some declines do, primarily as we discussed earlier, the straight-line rent difference than what we had anticipated originally. So there is a lot of moving parts that get us to our range.

Jordan Sadler - KeyBanc Capital Markets

I am just curious if there is a significant factor driving continued downward trend. And where I'm going with this I'm struck by the chart on the bottom of Page 17 that recurring FFO for the quarter were better than 3Q '09, $0.74, now on $0.61. You're modeling $0.59. I remember I was going for $1 not very long ago frankly. How low is this going to go? At what point, do you guys think this will bottom and start to move in the opposite direction?

Richard Hickson

I'll take that and resolve as best as I can, so kind of calling for prediction of the economy. And I think we'll get some jobs coming back and we'll probably start seeing some of the result of this terrible trend that you're stating very clearly on Page 17 that nobody in Parkway has missed.

You're right. I remember modeling this for $1 also. In April 2009, we issued equity and that marked our FFO per share downward during 2Q of 2009 and I felt right for at the time while it's dilutive, it is for a good purpose, and then we just simply have been working through lease economics which are worse in each quarter prior to yet.

And so that is kind of what we've consistently communicated, and I'll continue to communicate that message until I see this kind of new normalish type economy start turning into an old normal with sort of a cyclical sign way type recovery that I'm used to seeing in the prior sessions I've personally managed through. We just aren't there yet.

Jordan Sadler - KeyBanc Capital Markets

Is it safe to assume that this trend sequentially may just continue?

Steve Rogers

I think it is safe to assume that the lease economics on office buildings, unless we see some job growth, will continue the downward decline movement.

Jordan Sadler - KeyBanc Capital Markets

And that will not be trumped by sort of new investment activity through Texas Teachers?

Steve Rogers

Well, we really haven't performed at that. And so you give new investment activity as a counterbalancing effect. But again, most of our guidance to the Street these days has been more of a non-capital activity type guidance.

So as such, we haven't had a single investment in any of these quarters that you're looking at on the bottom of Page 17. We never made a new investment since the first quarter of 2008. So in other words, it's been our time period categorized by no new investments, a declining rental market. And therefore, the FFO per share has been declining.

Jordan Sadler - KeyBanc Capital Markets

Despite the fact that we're running through this, I'm asking these questions, I don't hear you pounding the table where (inaudible) opportunities despite the fact that you had your first investment consensus? I don't hear a lot of people asking questions about the pipeline anymore. So is there still hope for attractive features in the near term? What's the pace of that activity?

Steve Rogers

Absolutely. No one has asked the question yet. So thank you. I'll take that lead and answer. Despite that we haven't talked about it doesn't mean that it isn't out there. It's just that again our activity doesn't call for in the three-quarter review. The only thing we've done was subsequent to third quarter. We got our first investment in Texas.

We are in the best in final for two to three good Class A assets totaling between $80 million and $100 million in three core Parkway/finest cities. We have a pipeline that's close to 3 million square feet, which would amount of hundreds of millions of dollars. And our pipeline is always a big number relative to what we get, certainly as evidenced by recent activity. But even in the old days when we were buying pretty routinely, we only ran about a 10% hit rate in the pipeline. So if you're looking at $1 billion, you'd probably get about $100 million, something like that.

And so it's been tougher. There is no doubt about it. There is not a conference call you'll listen to or even on the private side of the business which is 90% of the commercial state office space, I think my contemporaries that I talk to have the same issue, which is while the banks are blending and pretending and there really has been not that much distress yet, there is really very low incentive for someone to take Class A buildings in the marketplace where the lenders are not friendly.

In other words, if the lenders are being friendly, just let it roll and run it out the door. The lenders have started getting people a little harder, and you're starting to see a few more deals hit the marketplace.

In fact, we're working on one large now, which is probably more of a lender driven issue than a decision by the owner. And I would expect to see quite a bit more. We're kind of looking at this one quite frankly as a thin point of how we can do this in the future. But we're just getting booked first before I articulate too much about something that has been done by knocking it.

Jordan Sadler - KeyBanc Capital Markets

Are these next three come to ahead before the end of the year?

Steve Rogers

We will. The best and final rounds will take place over the course of the next two to three weeks. So yes, we will know this before the end of 4Q.

Richard Hickson

And of course if we do land one, then we will give a press release similar to what you saw on Friday on the PPOF Fund and what we've done historically in Parkway. So we won't make anybody wait until February of 2011 to discuss it.

Operator

(Operator Instructions) We'll now get our next question from Rob Salisbury with UBS.

Ross Nussbaum - UBS

Steve, it's Ross Nussbaum here with Rob. A couple of questions for you. Can you discuss the decision to repay the loans on One Jackson Place and at Squaw Peak? Why repay them, why not refinance?

Steve Rogers

We've not given up the opportunity to refinance them. It's pretty much of a short-term decision.

Richard Hickson

I think the primary thing that we would look at is just what the cash flows are coming off the properties and the status the property is in and what they can yield on the secured debt market. That's always going to be the primary driver of whether to refinance with secured debt versus putting on the line of credit and contributing to another (company forwards) into the day's occupancy.

So that's the primary consideration. Beyond that, I think it's a good thing to contribute good-quality assets to the unencumbered pool and increase the diversity and quality of that pool. So that was one other area that influenced that decision.

Ross Nussbaum - UBS

I'm looking at your website. Are those assets somewhere in the 80% occupied ballpark?

Steve Rogers

One Jackson Place would be a little less than that with a planned move-out. There is a customer here which I think is going to be early '11. And so with that roll, we can place it on the line of credit and at an 8.25% cap rate value where if we took it to the first mortgage marketplace today, you would not get whole proceeds credit. So the better course of action in our opinion is to temporarily place it on the line at a decent cap rate and then move into the first mortgage market when you jack the occupancy back up.

Ross Nussbaum - UBS

(inaudible) unwilling to extend?

Steve Rogers

We didn't talk to them. The New York Life was the lender on it, and (Dan Mcmillan) had made this loan. And I think they originated this loan in 1987. Yes, probably could have pushed the loan out with a small mortgage balance.

Richard Hickson

At $7.6 million, it's very undervalued.

Steve Rogers

We built the building in 1986 with 22 floors, and the first mortgage that we placed on this building, just to put it into historical context, was $22.5 million in 1987. So it's just as underleveraged. And a lot has changed in the past 25 years, but I think the better course of action, Ross, is just letting lease go back to the mortgage market. It'll easily finance. There is no issue there. It's just proceeds.

Ross Nussbaum - UBS

If I could turn over to your lease roll, when I look at 2011, the three biggest leases, you got the GSA at a little over 100,000 feet, Alta Mesa at 78,000 and Motorola at 68,000, have you began discussions with each of those and where are you in terms of your likelihood to renew?

Steve Rogers

We are in discussions with Motorola. They liked the building. I think that our indications are they may downsize a little bit, but they will stay. Alta Mesa at this point is uncertain. They were purchased by another company. They have existing space in Huston. So it's unclear. We are actively working to try to back fill that space early.

AutoTrader, I think you didn't mention, but we've talked about it. And then the GSA, you're referring to leases here in Jackson, Mississippi, that we expect to vacate if I'm correct. (inaudible) GSA leases, but we have some holding in Jackson, Mississippi, that are spread out.

Richard Hickson

GSA is our largest customer with 15 leases. There's no one lease that's driving that.

Steve Rogers

There are a couple of leases that are under our threshold that shows up on Page 15 of 50,000 or greater. But we have a U.S. attorney and a bankruptcy court that we expect to move into the new federal building here in Jackson, Mississippi, which I think would be a big part of that.

Ross Nussbaum - UBS

And then finally, Steve, can you help me on the dividend a little bit in this context? You're starting to put money out the door with your new fund. So you're starting to move in a positive direction on the external growth front. And I am trying to reconcile that decision with the decision to keep the dividend suppressed. And I am just wondering in an environment where leasing is stuff, office economics are tough, why not get the dividend back up?

You are only saving $10 million-$15 million a year in free cash flow? I mean it's not moving the needle drastically for the company. Why not put that money back in shareholders' hands through dividend?

Steve Rogers

I guess sometimes I just go back to kind of corporate finance 101 and really get it away from the REIT space that in periods of good opportunity, we retain cash; and in periods of lower opportunity, you distribute the cash.

Right now, I've seen two opportunities and I'll articulate this in February, although it was an awkward time to be articulating it. It might be that we may not remember the message in February, but we cut the dividend $1 and created $22 million of additional funds flow.

It was a two-fold purpose. A, there are opportunities being formed out there; and B, the conditions under which we were working are not improving. So in other words, to pay for TI leasing commission is just simply more expensive today. And we feel like that paying for TI and leasing commission is job one. The best investment we can make is back into the properties that we currently own, to lease them back up with the best and immediate pickup in value once we actually start getting the leasing pick back up.

And then two, the accretive acquisitions and the fund which are really yet to materialize, other than Rubicon, would mean there are two reasons, opportunity and defensive. So there is no one in the room that would like to raise the dividend more than me, I promise you. And I think it's a fair game to talk about it going forward.

It just that right now the fact set has not changed since February of 2010. And so I would be able to mindset to just stay to course right now, not jack up the dividend until the cash flow of the company is in a better condition. And we think we're out of this old fashion great recession.

Operator

Your next question comes from Sri Nagarajan with FBR Capital Markets.

Sri Nagarajan - FBR Capital Markets

You've highlighted a lot of large leases and the questions earlier have been to do with large leases. Yet a large portion of the portfolio is small leases. Could you comment on the strength and recovery of the small tenants from 2009-2010?

Will Flatt

Anecdotally, I would say that I think it's in our bad debt expense as we're not seeing that the small customers are not evaporating the way they were in 2009 where you come in on Monday and you'd have a note left at the management office that said, "I'm sorry, but we're not in business anymore." Those seem to have slowed down.

I would say that we're still not seeing marked expansion. There are some pockets of hope that sometimes I feel like there were signs of recovery. But we are still not seeing marked expansion from small customers. And so my ending comment would be the pace of contraction has slowed and the pace of bankruptcy has slowed, but we're not seeing meaningful expansion.

Sri Nagarajan - FBR Capital Markets

So at least from a retention perspective, it seems to be getting better?

Will Flatt

I think so. The question of shadow space is still out there, and it's not something that I initially got my complete hands around is that I think folks when they're rolling their market, they still have more space than they need. And so there is still downward pressure.

Said differently, if we're going to get positive absorption, there is still space to be had internally. And our customer retention is going to be on the pressure because of the larger rolls we've got in 2011.

Sri Nagarajan - FBR Capital Markets

Parkway Moore LLC, there's some occupancy issues of the building there. What is the strategy as you look forward? Is this one that again the Texas Teachers Fund may be interested in?

Steve Rogers

I don't think we probably talked about contributing to Parkway Moore. For those listeners that are not familiar with that, that is what we refer to as the Toyota Center in Memphis Tennessee, a building we renovated 10 years ago, and we had a partner in that. We just recently took out our partner, and so it became over to the balance sheet as owned asset versus a partnership.

A very de minimis purchase. We hadn't articulated it much. We just took out the partner for a few thousand dollars. They filed bankruptcy and just really didn't want to be partner anymore. So we let it go with that.

And so now it's just a pretty simple owned asset. It's a good building. We've got leases through 2015. Probably a building that would be a good sale (inaudible) one day, but for the moment it would be the Texas Teachers contribution to this.

Sri Nagarajan - FBR Capital Markets

Last one on litigation expenses/reserves, I mean perhaps in more details on what's to come in the future on this.

Mandy Pope

I would say third quarter has any kind of run rate, any increase in fees were just due to some cash expenses that were of an uninsured nature. So we would not anticipate any kind of run rate there.

Operator

Our next question is from Dave Aubuchon with Robert Baird.

Dave Aubuchon - Robert Baird

I'm assuming there is a little probability, but not impossible, if there is another offer made on Carmel Crossing. What sort of the process to have that to come to a resolution?

Steve Rogers

We are in total control of the process, Dave. So that's why we were willing to make a press release. And just from your edification on it, in North Carolina, an interloper has an opportunity for 10 days after the foreclosure to make an offer of cash of 5% greater than the bid made by our company. We bid $28 million at the foreclosure sale at the courthouse steps. So therefore the $29.4 million cash someone would have to pay and then we'd have the right to bid on which gives us all the power and we can bid on. Or at some point, if somebody just wants to offer enough, they'll be the proud owner.

Dave Aubuchon - Robert Baird

Okay. And if that scenario happens, it wouldn't preclude the Falls Pointe and the Lakewood II sales to Texas Teachers?

Steve Rogers

No.

Dave Aubuchon - Robert Baird

Okay. The Blue Cross Blue Shield, I believe there's $1.4 million of lease termination in Q4. There are additional lease terminations close to this calendar year, correct? Related to that lease specifically?

Mandy Pope

That is correct. Under GAAP we are required to recognize that termination fee of about $7.3 million total ratably from the notice date of September 14 through through the lease termination of March 2012. Right now we anticipate 4Q to have $1.2 million of that lease term fee, 4Q '10.

3Q '10 includes about $200,000 of that lease term fee. And then you can do the math ratably going forward in 2011. You could anticipate $1.2 million per quarter in connection with that lease term fee, with it ending in March 2012. I would like to stress that this termination fee is in addition to contractual rent that they will continue to pay. They are occupying the space through March 2012; they'll continue to pay this contractual rent, the lease termination fee is in addition to that contractual rent.

Dave Aubuchon - Robert Baird

Okay. Richard, on the paydown at Squaw Peak and One Jackson Place, looking at your cash balance at the end of third quarter and assuming $22 million of cash from the Carmel Crossing coming into the (DTRS), it looks like you will have like $12 million net cash gain. Sort of, is that the ballpark after the debt paydown?

Richard Hickson

That sounds right.

Dave Aubuchon - Robert Baird

Okay. And then that primarily obviously is going to be used to fund TIs in Q4?

Richard Hickson

Yes I mean, it's all fungible obviously, but I mean, that's a safe assumption. So part of it will be based on the timing used to reduce or payoff Squaw Peak including a line of credit as a portion and then excess cash will be used to fund operations and capital.

Dave Aubuchon - Robert Baird

Last question, Steve, how would you characterize the investment interest in the markets that you're looking at selling out of?

Steve Rogers

In many cases these are not in core markets to Parkway, which just by its very nature reflect a less liquid city. In other words, some of the smaller cities have less liquidity. But there is a market. I've always been surprised by cities that we have sold out off, like Little Rock, Arkansas; Birmingham, Alabama; Knoxville, Tennessee, Winston-Salem, North Carolina, all of those were small markets that partly was the end at one point of time. And although a different time and a different place, we found them to be very robust sales activity. And so I would expect there to be good interest with multiple offers, probably resulting in a couple of decent offers, and best and final, of which we'll pick one and go to closing.

Dave Aubuchon - Robert Baird

And those are generally unencumbered?

Steve Rogers

That's correct. We had taken time, and as part of the older plan, we had prior to FOCUS and (gear up), we de-leveraged substantially all the non-core assets as part of a very systematic program to allow for these assets to go to the marketplace unencumbered.

Jim Ingram

I'll add to that that we have been approached by groups over the course of the past four to six months about buying these assets directly. But as Steve mentioned, we're trying to improve the occupancy, increase the NOI before going to market. And the best way to find the best offer, is simply to go through a fully marketed effort, which is what we intend to do.

Dave Aubuchon - Robert Baird

Do you feel like you'll have to seller finance these? Or let me put it this way, if you want to sell the assets badly enough that you'll seller finance to get it done?

Jim Ingram

I mean, we don't anticipate seller financing when we go into a fully marketed sale. What you do is, you end up just looking at the offers, and if somebody says, I'll pay you a lot more than the next guy and there is some seller financing attached it to it, then we just evaluate that note (inaudible) as any other investment and the opportunity that if we had to foreclose on it, are willing just to re-own the asset. Since we owned it doesn't really bother me too much. But we're not planning on seller financing anyhow.

Operator

Our next question is from Mitch Germain with JMP Securities.

Mitch Germain - JMP Securities

Steve, did you guys make any other bids during the quarter besides the two to three that you referenced earlier?

Steve Rogers

Yes, we've made a ton of bids during the quarter. All I'm really distilling it down to is the bids that we've made it into the best and final on. There have been many, many circumstances where the bids just were rejected because we didn't make it into the best and final.

Mitch Germain - JMP Securities

Do you know from a percentage standpoint, how much you might have been below?

Steve Rogers

I'm thinking of one particular very high profile asset that we were probably 6% off on, a very high profile asset in South Florida that we were 6% off on the sale price. And so, I'd say that's been a about a delta.

Operator

That concludes the question and answer session today. At this time, Mr. Steve Rogers, I will turn the conference back over to you for any additional or closing remarks.

Steve Rogers

Thank you very much for your interest in Parkway. And with that, we'll conclude today's call.

Operator

This does conclude today's conference call. Thank you for your participation.

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