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Digital Realty Trust, Inc. (NYSE:DLR)

Q2 2014 Earnings Conference Call

July 29, 2014 5:30 PM ET

Executives

John J. Stewart – SVP-Investor Relations

A. William Stein – Interim CEO, and CFO

Scott E. Peterson – Chief Investment Officer

Matt Miszewski – SVP-Sales and Marketing

Matt Mercier – VP-Finance

Analysts

Vance H. Edelson – Morgan Stanley

Tayo T. Okusanya – Jefferies LLC

Ross Nussbaum – UBS Securities LLC

Vincent Chao – Deutsche Bank Securities Inc.

Steve T. Sakwa – International Strategy & Investment Group LLC

John Bejjani – Green Street Advisors, Inc.

Jonathan Petersen – MLV & Co

Jordan Sadler – KeyBanc Capital Markets Inc.

Michael Jason Bilerman – Citigroup Global Markets Inc.

Emmanuel Korchman – Citigroup Global Markets Inc.

Operator

Good afternoon, and welcome to the Digital Realty 2014 Second Quarter Earnings Conference Call. All participants will be in a listen-only mode. (Operator Instructions) After today’s presentation, there will be an opportunity to ask questions. (Operator Instructions) Please note this event is being recorded.

I would now like to turn the conference over to John Stewart, Senior Vice President of Investor Relations. Please go ahead, sir.

John J. Stewart

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

In addition to our press release and supplemental, we’ve also posted a presentation to the Investors 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 do not – that involve risks and uncertainties that could cause actual results to differ materially.

Such forward-looking statements include the 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.

Additionally, this call will 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. Questions will be strictly limited to one plus a follow-up and if you have additional questions, please feel free to jump back into the queue.

And now, I’d like to turn the call over to Bill Stein.

A. William Stein

Thank you, John. Good afternoon, and thank you all for joining us. Last quarter, we outlined our strategic vision for the company and the initiatives that we’re pursuing to advance that vision. Today, I’d like to provide an update on the progress that we’ve made over the last 120 days, beginning here on Page 2 of our presentation.

We’ve stated that driving improved return on invested capital through the lease-up of existing inventory is our top priority. I am pleased to announce that we leased 9 megawatts of existing inventory during the second quarter. We’ve reduced our finished inventory balance by over 25% since Investor Day last November. This enhanced asset utilization has boosted our ROIC by over 20 basis points so far this year.

We’re also well underway on a rigorous evaluation of the entire portfolio. This process is designed to identify non-strategic and underperforming assets that can be harvested to narrow our focus on the core. We expect our capital recycling initiative will likewise have a meaningfully positive impact on overall return on invested capital. We expect to conclude this exercise over the summer and bring the first set of properties to market immediately after Labor Day.

Scott Peterson will have more to say about our efforts on this front during his remarks.

In early June, we announced our global cloud marketplace, a solution that makes our customers public, private and hybrid cloud services, easily accessible to our entire global customer base. We believe that partnering with our customers is the best way to provide our enterprise customers with a differentiated offering and to create value. The global cloud marketplace will enable Digital Realty clients to instantly provision on demand, burstable cloud services from trusted cloud providers such as IBM SoftLayer, Internap, Interoute, GoGrid, and SingleHop. And program is still on its infancy, but demand for the offering has been strong and we expect to see healthy adoption as awareness grows.

I’d like to pause here for a moment and explain why the concept behind the cloud marketplace is so important for our future direction. A year and a half ago, at the Citi Conference in Florida, Michael Bilerman stepped out of character for a moment and served me up a softball. He asked what aspect of our story was most underappreciated by investors? I responded that it was our global footprint and our enterprise customer base. That was true then, but it’s even more applicable today. Modern cloud providers cater to small and medium-size businesses, but they all aspire to penetrate the enterprise marketplace.

The enterprise segment is our bread and butter customer base. They already populate our data centers around the world. Our recent leasing activity has been heavily skewed to cloud service providers, in part because they want access to our enterprise customer base. Enterprise customers in turn are attracted by the ability to easily and securely connect to multiple areas of their hybrid cloud. Both sets of customers choose to grow on our platform, in part because of the presence of other.

The final catalyst connecting our incredible enterprise customer base to the cloud service providers they now need to grow is the deployment of our global network ecosystem. This mutual attraction and our interconnected global portfolio essentially act as a wide mode that is extremely difficult for competitors to replicate. No one else has the footprint and the cost structure to effectively service the enterprise customer on a global basis.

The competitive advantage of this network effect is analogous to a network-dense data center but on a global portfolio scale rather than a single building. This premise will be borne out over time by the ability to attract new enterprise logos, as well as new cloud service providers, the ability to retain these customers and the growth of their existing footprints within our portfolio.

Back to current results. Our mid-market segment turned in another solid performance this quarter. The investments we’ve made in upgrading connectivity and expanding the amenities that we offer are enhancing RPO to retail customers.

As you can see from our press release, we’ve raised guidance for our capital spending plans over the balance of the year. Over 90% of this additional capital commitment is due to incremental leasing activity. This match between leasing and funding is exactly what we aim to achieve with the build-to-order inventory management strategy that we outlined last quarter.

Unleashing intellectual capital is something of a soft initiative. So let me give you some tangible examples. For starters, our General Counsel, Josh Mills’ responsibilities had been expanded to include environmental fairs and corporate real estate.

Sustainability has been important issue for data centers, given the sector’s energy footprint and Josh will be sphere hitting our efforts on this front. John Sarcus who many of you met at various conferences and investor events has recently been named Colocation general manager, in addition to his responsibilities leading our connectivity initiative.

Scott Peterson’s promotion to Chief Investment Officer has arguably had the most immediate impact. He and his team are restructuring the investment review process to ensure consistency across disciplines and regions. Essentially, any deal that requires commitment of incremental capital is now brought before the investment committee. This process is imposing tighter discipline on capital allocation decisions and promoting appropriate behavior from the sales team, as well as the broker channels.

It also delayed two quarter end leasing transactions, which has traditionally been the window when customers were able to extract the most favorable terms. One of these deals has come back to us and appears likely to close on terms that we proposed. This underwriting discipline may impact leasing velocity in future periods, particularly, as we continue to riddle down our stockpile of available inventory. However, we are confident that this approach is translating to improved net effective leasing economics and better returns for our shareholders.

Looking forward and turning now to page 3 of the presentation, we see robust demand for the premium data center solutions we offer, providing peace of mind to our customers and enabling them to focus on their core business. The macro backdrop appears relatively benign despite the reason rise in geopolitical uncertainty.

Data center fundamentals are gradually improving, as excess supply is being consistently absorbed. We are taking a much more disciplined approach to inventory management. And we see more rationale behavior for many other industry participants as well.

Consequently, we are cautiously optimistic that data center fundamentals will continue to improve underpinning acceptable risk-adjusted returns, as well as the stability of our cash flows.

And now, I’d like to turn the floor over to Scott to provide an update on our capital recycling initiatives.

Scott E. Peterson

Thank you, Bill. As mentioned in the last quarter, the investment team is undertaking a wholesale analysis of every single property in our portfolio. This analysis is well underway and should be complete later this year. The first phase of the project targeted a group of high priority properties consisting primarily of non-core assets, data center properties in non-core markets, underperformers and at-risk properties.

As a result of this analysis, we expect to prune the bottom 5% to 10% of our portfolio in order to refine our strategic focus, fund future capital requirements and improve return on invested capital. As Bill mentioned, we plan to start bringing these properties to market after Labor Day.

During the second quarter, we closed on the previously announced sale of a small single tenant building to the user for approximately $42 million, generating a gain on sale of approximately $16 million and realizing a levered IRR in the low teens.

While the cap rate was at the high end of our expected disposition range, it is not a very relevant metric in this instance as there are only 18 months left on the lease term. We did explore several options for the property and determined we could generate a better return on our capital elsewhere.

I’d now like to turn the call over to Matt Miszewski to discuss our recent leasing activity.

Matthew J. Miszewski

Thank you, Scott. As shown page 5 of our presentation, we signed new leases totaling over $35 million of annualized GAAP rent during the second quarter. The first half of the year tends to be seasonally slow. The consistency of our recent leasing momentum is readily apparent from a comparison of our year-to-date leasing activity, relative to the first half of any previous year. Keep in mind that the $47 million we reported in the first quarter included a $12 million direct lease with the former subtenant at a Powered-Base Building in Santa Clara.

Excluding this lease, our second quarter leasing velocity was right on top of the first quarter and both quarters progressed according to plan. This positive momentum has carried through to the month of July and the third quarter is off to a strong start as well.

Colocation revenue accounted for over 15% of our second quarter leasing activity. This is the fourth consecutive quarter that our mid-market segment has delivered a contribution within a range for $4 million to $8 million. The purchase in context, is helpful to realize that prior to the third quarter of 2013, this segment typically generated between $1 million and $2 million per quarter.

Cloud, content and social media were the drivers once again accounting for over three-forth of our second quarter leasing activity. Existing customers represented more than 80% of our second quarter lease signings, but the new team has also added 60 new logos year-to-date. Cash rents on renewal leases rolled out by mid-single digits as shown on page six. The large lease with the financial services tenant in Northern Virginia that was signed at Pageant and that we highlighted on the last call was finally renewed in July.

The rent roll down 11% on a cash basis, a bit better than the 15% to 20% roll down we guided towards previously. This renewal was not reflected in our second quarter leasing statistics, but will obviously leave a mark in the third quarter although it has been fully baked into our guidance. It’s important to note that this transaction was also expanded to include one part in Dallas, as well as the fourth part in Ashburn. Base rates on Turn-Key Flex leases signed were lower than last quarter entirely due to market mix, reflecting a concentration of activity in lower cost, lower rent in North American markets including Dallas, Ashburn and Phoenix.

On a like-for-like basis, base rents were flat to up slightly. More importantly, concessions are abating. This improvement reflects our retool sales compensation program, and the revamped investment review process, as well as gradually improving data center fundamentals. Turn-Key leasing costs were elevated in the second quarter driven primarily by one large 15-year lease. Adjusting for term on a per square foot per year of lease turn basis, the second quarter leasing cost terms are significantly diverged from the norm.

Turning now to lease duration on page eight, lease terms are admittedly shorter on core location leasing and as Bill mentioned, last quarter we are comparable going a bit shorter in a rising rental rate environment. The average turn on leases signed during the second quarter was over seven years. This is true whether the second quarter leasing activity is weighted by square feet or by rent. The weighted average remaining lease term across the entire portfolio is half year shorter, we did by rent rather than square feet, but it’s still well over six years.

The duration of our average lease term supports the stability of our cash flow stream and strengthens our cost of capital advantage. In addition to signings lease commencements were also respectable. As you can see from the chart at the bottom right of page nine, the weighted average lag between signing and commencement and stuff from six to seven months. This lag is entirely due to future delivery of committed space and is not indicative of either free rents or an elongation of the sales cycle. The team reached a total of 17 megawatts during the second quarter of which 9 or a little more than half came from our finished inventory balance. To put this in contact, the historical average mix of existing inventory as a present of total leasing has been one-third of the total. We started new clouds in Ashburn and in Hong Kong this quarter and the net absorption of finished inventory was 4.5 megawatts.

As Bill mentioned during his remarks, and as you can see here on page 10, we have reduced our finished inventory balance by over 25%, since the Investor Day last November. The positive net absorption in Phoenix over that timeframe is particularly encouraging. It was also encouraging to see this positive net absorption translate to a 70 basis point improvement in overall portfolio occupancy. Following several quarters of declines, due to the move out of various non-data center tenants along with the delivery of the inventory that we are now absorbing.

We did have one tenant occupying 2 megawatts in Phoenix, that was in whole over started as of June 30 and is expected to move out in the third quarter. We have a very healthy demand funnel in Phoenix however, and we expect overall portfolio occupancy to continue to improve in the second half.

Turning now to supply on pages 11 and 12, the available inventory in Northern Virginia has actually come down by a few megawatts over the past 90 days. While new construction is underway in Texas. I’d like to point out, that these charts reflect total market supply and do not differentiate between shared back plain facilities and our dedicated infrastructure product. We believe that much of this available supply is not directly competitive with our offering.

As a case in point, we have a very healthy demand funnel in both Northern Virginia and Dallas, and we can scarcely keep any inventory on the shelf in either market. The uptick in sublease space in Santa Clara resides within our portfolio. We received notice from an internet enterprise that represents approximately 1% of NOI that they intend submit approximately 10 megawatts they occupy in Santa Clara. Their leases expired in 2016 and 2019 and the in place rent is well below market. We are working with the client on it solution, and do have interest in the space from multiple perspective customers.

With that, I’d now like to turn the call over to Matt Mercier, to talk you through our financial results. Matt?

Matthew Mercier

Thank you, Matt. Most of the balance sheet activity occurred prior through our last earnings call, but several significant events took place during the second quarter. In mid-April, our exchangeable debentures are exchanged for common equity, which improved debt to EBITDA by 0.3 turns. We also raised an additional $63.5 million in April under reopening of the 7 and 3H Series H preferred and partial exercise of the underwriters over allotment option, including the sterling bond offering and the original Series H issuance that closed in the first quarter.

This brings our year-to-date total of long-term capital ratio approximately $900 million. Subsequent to the end of the quarter S&P revised its outlook from negative to stable reflecting our improved operating performance As shown here on page 14 of the presentation, the bond market has taken note and our credit spreads have tightened considerably over the past several months, and have also our performed the re-BBB benchmark, most notably since S&P revised its outlook.

Turning now to operating performance, as Matt alluded to in his remarks, portfolio occupancy ticked up 70 basis points. The first sequential occupancy gain in the past six quarters. We’ve also raised guidance for the year-end portfolio occupancy by 75 basis points at the mid-point on the strength of the second quarter rebound. As Matt indicated in his presentation, cash releasing spreads were positive across product types in the second quarter.

Although, the large roll down in Northern Virginia was signed in July, it will have an impact on our third quarter leasing statistics. Same capital cash NOI growth was 5.8% for the second quarter, above the high end of our forecast. The year-to-date number is squarely within the 4% to 5% guidance range. I’d also like to address our guidance for incremental revenues remaining to be recognized in 2014 from speculative leasing, which shows the reduction from $10 million to $15 million last quarter to $5 million to $10 million this quarter.

As of mid-July, we have already achieved the full speculative leasing target that was embedded in our prior guidance. We are not resting on laurels for the rest of the year, however, we’ve raised the bar by an additional $5 million to $10 million of current year revenue we expect to recognize from leases that have not yet been signed. We’ve also raised CapEx guidance for development spending and capitalize leasing cost by approximately 15% at the mid-point.

However, as Bill mentioned in his remarks, over 90% of this additional capital commitment is related to incremental leasing activity. We expect to fund near term capital requirements with proceeds from asset sale and joint ventures. We currently have no plans to revisit the equity market any time soon. At the bottom line, we’ve raised core FFO per share guidance by $0.05. Our improved outlook is entirely organic. We’ve actually reduced our acquisitions guidance by half. We’ve also introduced disposition guidance for the first time and we do expect a couple of pennies per share of dilution on a combination of assets sales and joint venture contributions in the second half of the year.

To recap the highlights for the quarter, as advertised here on page 16, we signed over $35 million of new leasing during the second quarter, including a $5.7 million mid-market contribution. Released 9 megawatts of existing inventory with 4.5 megawatts of positive net absorption. We achieved our full-year speculative leasing target. We’ve registered an uptick in occupancy for the first time in a year and half. We generated positive cash releasing spreads across the product types.

We delivered 5.8% same capital cash NOI growth. S&P revised its outlook from negative to stable. Our second quarter core FFO per share consensus by a $1. And finally, we raised 2014 core FFO per share guidance by $0.05 at the mid-point. We are quite pleased with our second quarter financial results. And as most people here at Digital know I am fairly hard to please.

And now, we’ll be pleased to open up the call and take your question. Operator?

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. (Operator Instructions) The first will come from Vance Edelson of Morgan Stanley. Please go ahead.

Vance H. Edelson – Morgan Stanley

Great. Thank a lot. So as you look to bring the first set of properties to market after Labor Day, maybe if you could just provide an update on the money flows in the data center world. Who the potential buyers might be? I think in the recent past, you've mentioned seeing pension and other money looking to invest. Any updates there on demand or even cap rates? Will it be more users looking to buy? And any appearance of sovereign wealth money yet?

Scott E. Peterson

Yes. Vance it’s Scott Peterson here. It’s a little soon to say, but as far as the buyers we’re seeing a lot of – we’re seeing demand on the buy side to be pretty robust in the private markets. I think we’ll find on the non-core assets, I think we’ll find traditional buyers for those types for assets that will be interested in them, the data center buyers will be a mix and the non-core markets will be a mix of maybe value add as well as traditional stabilized asset buyers, and then for some of the underperformers I think we’ll see probably more the value add type buyers there, there might be private equity backed, but that’s kind of really speculation at this point, what I can say is we’re getting numerous phone calls from potential buyers out there that are very interested in looking at anything that we’re interested in selling.

Vance H. Edelson – Morgan Stanley

Okay, that’s helpful. And then as my follow-up, you mentioned geopolitical risk. Could you expand on that a bit? Where you think there might be potential risk? And perhaps while you’re at it, just walk us through Europe – do Germany, France, and the UK remain strong? Any updates on demand in Asia? Do the inventory shortages continue there? Just kind of walk us around the globe in terms of strength and weaknesses?

A. William Stein

So London is very strong for us Vance, in fact we’re in the process of running out of inventory there. We’re bringing a project online in Dublin and we would expect the demand there to come mostly from this side of the pond. We have very little inventory in Paris I think less than half a plot and we’re considering Amsterdam, but we’re not going to – we have a site in Amsterdam, a land site but we won’t be building there unless we have a pre-lease situation. Asia-Pac is also a very strong; Singapore, we could be out of inventory in Singapore by the end of next quarter. And I think in Hong Kong it’s a good possibility we’ll be out at the end of this year. So we’re looking for additional sites both in Singapore and Hong Kong and leasing in Australia has been steady both in Melbourne and Sydney.

Matt Miszewski

Vance, this is Matt Miszewski and given my political background apparently I get to answer the geopolitical risk questions. I don’t see any impact to us on the geopolitical conflicts in the Middle East, or in Central, and Eastern Europe. It is important though to understand that privacy concerns of the European Union and the non-Union countries that are inside Europe does have a bit of an impact on operations of datacenters through continental Europe as well as the islands. That actually ends up being a demand driver for some of our key customers including some very large cloud providers who are taking a deployment strategy to eliminate the data sovereignty risk that other providers have. So we’re happy to see folks adjust for data sovereignty requirements within EMEA. As Bill said, we see the Asia demand on the demand side extremely strong and we don’t see any geopolitical risk throughout our Asia-Pac portfolio.

Operator

And our next question will come from Jonathan Schildkraut of Evercore. Please go ahead.

Unidentified Analyst

Hi this is Rob for Jonathan. I was wondering if you guys could talk a little bit about the increasingly solutions based sales approach under match guidance and how the strategies evolving in terms of the sales team and the recession by customers. And secondly regarding the launch of the global market place can you talk a little bit about take rates or how those services have been adopted with new customers or with new leasing and the impact on pricing.

Matt Miszewski

Happy to Rob, your first question is about the solution based sales approach and we continue to see this evolve in the best of possible situations where we are getting closer to our customers and really starting to approach the customer base from their point of view as opposed to from our point of view. We did need to make some fundamental adjustments to the sales force including the compensation plan adjustments that we made this past year before we went after the more advanced selling process in terms of solution selling, but now we see solution architecture as part of what we do inside the sales force as well as inside the small marketing team that I have on my team. If you think about the basics of this instead of us simply providing fantastic technical solutions for customers that we create here in San Francisco or in London or in Singapore, now we do this in partnership with our customers by sitting down with them talking to them about what their needs are and then making sure that our products and our solutions sit and meet their needs. One of the things we found out when we started this solution based process was that we did need things like the global cloud marketplace. And so the conversation that we are having with our customers are leading us to do things that make them more sticky inside all of our properties.

The global cloud marketplace is one of this; the global network ecosystem is another one. And this has been successful we started as you know we started in Europe; we finished the North America rollout and the Asia Pacific rollout is scheduled to be completed by the end of the year. When we finish that rollout, our network ecosystem will feature connectivity to over 1,000 available networks across the world.

The last piece I will talk about in terms of this solution approach is our Open-IX initiative, not our Open-IX initiative, but the communities Open-IX initiative, is really starting to take off. We’ve of course landed at the Amsterdam internet exchange inside our New York – one of our New York facilities as well as landed them into one of our Western Coast facilities and we are talking to four more providers right now.

As you can see as we’ve taken this approach and we’ve led this approach in terms of solution based selling, you can start to see the data center industry itself start to transform from storage to a more affordable way for our customers to exchange data, which is truly the value that they see inside data centers today.

Unidentified Analyst

Okay. Anything about take rates? Or any sort of – can you quantify any of that related to new leasing activity or anything?

Matt Miszewski

Yes. So when we announced the global cloud marketplace in June, we announced it early and we’re in the early innings of the consideration of the GCM, what we’ve also noticed is that there is an awful lot, we’re learning more than we thought we would learn initially. And that learning is that there is an awful lot of demand for global cloud marketplace that we didn’t anticipate. So we’re starting to see not just cloud marketplace that we’ve launched, but individual cloud marketplaces that are starting to come up in the conversation that we have with both our partners, as well as our customers.

So I think the take rate question is a little bit too soon right now. We’ve just operationally launched the facility and we’re filling it up with partners today. and once we start to see, I mean we start to actively market that solution, I think you’re going to start to see the uptake increase. And so we should be able to give some updates on that on next call.

Operator

And our next question will come from Tayo Okusanya of Jefferies. Please go ahead.

Tayo T. Okusanya – Jefferies LLC

Yes. Good afternoon. Just a quick question on just the economics around some of the deals that were signed this quarter, specifically Page 17 of the supplemental. If you just kind of take a look at leasing costs of square foot, it’s gone up quite a bit that many leverage lease term is filled roughly about the same for a lot of your new leasing activities. So I’m just a little bit curious about why the higher leasing costs and what may be going on and we got to higher negotiating with tenants that’s resulting in this?

A. William Stein

Tayo, that was one long-term deal in the quarter that drove an external commission that was quite substantially. So the leasing costs were based on that land commission, not TIs. And we don’t see this as a trend. I think importantly, we’re still seeing ROICs including TIs and LCs hitting our target range of 10% to 12%. And the comp plan that we put in place at the beginning of the year as we think is proving these leasing economics.

Matt Miszewski

Yes. Tayo, this is Matt when we start to look at the total leasing costs across the quarter of course, we dug in a little bit deeper as the guys who launched the new comp plan, I wanted to make sure we’re having the demonstrative effects that we anticipated we would. And as I said in my opening statements, we’ve seen the rent abatements go away and lease ramps shorten, we’ve also seen TIs in our world start to decrease when we do quarter-to-quarter comparisons, it is a significant decrease especially across the GKF products.

Tayo T. Okusanya – Jefferies LLC

I think we took up that large tenant what would be you know what the number would have been for the quarter in regards to leasing cost per square foot on that when tenant?

A. William Stein

I don’t know that I have that data immediately in front of me, but I’d be happy to provide that right after the call.

Operator

Our next question will come from Ross Nussbaum of UBS. Please go ahead.

Ross Nussbaum – UBS Securities LLC

Thanks. Good afternoon. Can you guys talk a little bit about the lease expirations for the remainder of the year I see you got 5.4% of your rent roll expiring at about 190 bucks per foot can you just give us a little bit of color on what you think the retention rate is going to be on that? I know you talk about that one I think was that one leasing in Phoenix but beyond that what you expect the retention to be?

Matt Miszewski

Yes, this is Matt. We actually showed in terms of rent what we expect to expire over the balance of the year. It's on the NOI, NOI step up chart as part of the presentation is a $5 million that's included so of what expire we expect about $5 million and annual base rent not to renew as of today.

Ross Nussbaum – UBS Securities LLC

Okay, that’s helpful. And then Bill, can you give us an update on where things stand with the CEO search overall in the timing thereof? Thanks.

A. William Stein

Ross, we are happy to. I mean as I said on the last call the board, our board is comfortable with the leadership that’s in place. I think that comfort has been validated by what I would say has improved employee, customer and investor confidence both on the equity side and the fixed income side. I think it’s interesting to note that since the change in leadership we’ve recovered almost $2 billion of market cap for our shareholders. So the board continues to be focused on sourcing the right candidate for the job, but nevertheless the timing is still expected to be this year and meanwhile this team is focused on executing the strategic vision, which we played out to be optimizing the return on portfolio recycling capital and unleashing the intellectual capital of the firm.

Operator

Our next question will come from Vincent Chao of Deutsche Bank. Please go ahead.

Vincent Chao – Deutsche Bank Securities Inc.

Hello good afternoon everyone. Just want to go back to the new lease pricing in the US which dropped down to 130 per square foot I know a lot of that was attributed to the particular markets in the U.S., which are lower-priced in general. Just curious those three markets what percentage of within those three was all of it?

A. William Stein

So Vin, The drop as you said, the drop in rates is all market. North America, I think from North America perspective quarter-to-quarter in the first quarter 44% I think of our TKF GAAP rents came from Toronto while in second quarter 48% came from Dallas and Phoenix. It’s actually give you an idea of a rough makeup in the North America since globally in Q1, we had some very large deals in APAC and EMEA about 62% of rents coming in across APAC and EMEA in the first quarter and again that comes back to North America in the second quarter about 75% of the rents.

Vincent Chao – Deutsche Bank Securities Inc.

Great, okay. And then, I’m sorry, you also mentioned, I think Northern Virginia being a fairly big part of the mix this quarter, what was that percentage of leases?

A. William Stein

Yes, so in Northern Virginia was – there was sizable lease in the quarter and I’m just going to back into that number I’ve got to get that number for you. And I don’t have in front of me.

Vincent Chao – Deutsche Bank Securities Inc.

You mentioned the quarterly same capital growth NOI growth was 5.8% was exceeded expectations. Can you just talk a little bit about what the upside was relative to the expectations and the implied guidance at the midpoint suggests some slowing from the 5.8% that we saw here in the second quarter just curious if that's really what you're expecting us to see or maybe your trending towards the higher end of that range?

A. William Stein

Yes, I mean it’s obviously that’s just one quarter comparison. I think that’s why we also stated with the year-to-date growth was which is clearly in the middle of where we’re guiding and right now we are comfortable that with the year-to-date it reflects clearly accurately where we expect to be coming end of the year.

Scott E. Peterson

And Vin, just to get back to you on Northern Virginia Q2 it’s about 10%.

Operator

Our next question will come from Steve Sakwa of ISI Group. Please go ahead.

Steve T. Sakwa – International Strategy & Investment Group LLC

Thanks, I guess good evening at this point or good afternoon. Just two questions, I guess on the Turn-Key joint venture Bill, what exactly or the goals if you want to get out of that. Is it too kind of established pricing and kind of core markets for yourself? Is it to eliminate some of the smaller markets that your end or markets really have one or two assets, I guess what’s the immediate goal of that joint venture?

A. William Stein

There are two goals, Steve. The first is I think it’s prudent for any company to diversify its capital sources. And so we clearly have access to public and private debt and access to public common debt and preferred this we believe will give us access to reliable source of private capital. In addition, we expect this will provide some transparency on private market valuations from a sophisticated investor for our Turn-Key product. And we think that’s important as well particularly for the any devaluation of the analyst community and our investors.

Steve T. Sakwa – International Strategy & Investment Group LLC

But I guess from a market perspective where you looking to kind of proven in the Northern Virginia, Silicon Valley, Chicago are you looking the kind of sell maybe in the Boston, and in the St. Louis where you have one, two assets and maybe those markets on quite a score.

Scott E. Peterson

At this point the BOEs when we proven the non-core markets that will be throughout right sale. The joint venture would be in core markets really want to retain an interest and retain management of the asset. And each joint venture – this joint venture is being structured in the similar way to the prudential joint venture with retained 20% interest as management and property management fees as well as promote on cash flow in back end.

Operator

The next question will come from John Bejjani of Green Street Advisors. Please go ahead.

John Bejjani – Green Street Advisors, Inc.

Hey, guys is that kind of $20 million or so quarterly G&A run rate is that fully incorporating the mid market sale teams up or how much further do you see this growing?

Matt Miszewski

Yes, the G&A numbers do have baked into them, the entire mid market sales additions, so we’ve completed that process from a mid market perspectives, across G&A in total we do anticipate that we’ll see a mild increase this year that also important to remember that this is already baked into guidance. And I would like to point out as the head of sales and marketing that additional cost in my area always result in higher revenue. So we continue to see great steady progress on our strategic plan.

John Bejjani – Green Street Advisors, Inc.

Great, thanks and just one quick follow-up on the Turn-Key JV, you guys have been talking about this for a better part of the year at this points, is there anything you can show on the status there and what’s the delay, let’s call delay at this point.

A. William Stein

John I’m not sure that I’d say there is a delay, we’ve taken out multiple counter parties, we have identified one counter party, terms have been negotiated, and now that you have the process of sourcing debt as well and all the conditions that are associated with the debt arrangement. So I think we’re making good progress and I think perhaps there was a bit of delay earlier in the year, as we were looking at generating capital from asset sales. But now, we’ve more or less side the asset sale program and have a sense for the sequence there. And we have a view as to how the joint venture would fit into that program.

Operator

The next question will come from Jon Peterson of MLV & Company. Please go ahead.

Jonathan Petersen – MLV & Co

Great. Thank you. Just a quick question on the guidance (indiscernible), but in terms of dispositions obviously that have pretty wide range I know you said you are going to give more details after Labor Day, but on the cap rate the ranges from 0% to 12%. I was hoping you guys kind of elaborate on what to expect, obviously 0% assets to negative cash flow. I’m just curious what percent of 0 to 400 would kind of fall in that bucket. I guess how do I think about that really wide range and what you guys see it realistically following now that?

Scott E. Peterson

Yes. I apologies for the wide range as you can imagine it's kind of tough to try to ballpark that it's a little early in the process to nail it down. But I think it's reasonable to expect that the average cap rates for the dispositions will be below our employee portfolio cap rate. Is that helps.

Jonathan Petersen – MLV & Co

Okay. All right, that’s fair. And then go ahead.

A. William Stein

No, that’s okay.

Jonathan Petersen – MLV & Co

Okay. And then in terms of debt maturity is just hoping for an update you got about $130 million of secured debt maturing I think alone in November of this year and $375 million of unsecured notes in July of next year. Just what can we kind of expect in terms of how you guys plan to refinance that debt?

Matt Miszewski

Yes, sure. This is Matt. Over the balance of this year, our thinking is we’ll effectively repay most of the secured debt that's maturing through our revolver. We do have in our guidance and additional capital raise and additional U.S. bond late in the year that you can say effectively would be part of that refinancing.

And then in terms of next year, we are still putting together our capital plan, but I would think we given our rates are today in terms of the large the first bond maturing we have mid-next year that we should be able to refinance that on the longer-term at effectively the same cost. So basically take out of five-year paper with ten-year money. So we feel very confident about our ability to fund the business through 2015 at this point.

Scott E. Peterson

We’ll be generating a liquidity through asset sales as well as the joint venture we talked about, which will not only – it’ll pay down debt as well as keep leverage in line.

Operator

The next question will come from Jordan Sadler of KeyBanc. Please go ahead.

Jordan Sadler – KeyBanc Capital Markets Inc.

Thanks. Just wanted to comeback to demand that’s driving sort of the optimism for data center fundamentals that Bill I think you’re referenced in your prepared remarks. Sequentially supply seems to be up a little bit overall with Dallas and Houston up to Silicon Valley up really offset by little bit of decline in Northern Virginia. What can you tell us about what you’re seeing in the demand side particularly, domestically?

A. William Stein

I’m sure Jordan, well first of all we are constricting our supply and we see supply constricting from others as well. And demand is remained strong impact that might even be stronger than it was six to twelve months ago. So based on that I think, we think market rates will inflect. And then within our own portfolio we’re seeing a positive cash market-to-market in 2015. Well I think it’s important to note here, but there is definite difference between product offerings Matt mentioned that in his prepared remarks.

And by that I’m referring to share versus dedicated and we are seeing significant demand for our dedicated to end product and what would call national markets as well as the other markets while we have finished inventory. And that really lead to start conclusion that fundamentals are improving at least for our product.

Matt Miszewski

And Jordan as you think about the shared back claim versus the dedicated infrastructure. You do not have to search long for approved points, right, largely reported over supply in Northern Virginia but I can't keep the two and dedicated solution that we have there on the shelf same situation in Dallas. So you don’t need to search long and hard to find the approved points that dedicated offering that we have is different and therefore that supply is constricted.

Jordan Sadler – KeyBanc Capital Markets Inc.

Okay, and then just maybe as a follow-up given sort of the increase in the development spending guidance surrounding sort of this optimism around demand of fundamentals and the significant recovery in the share price that we talked about. How do you feel about raising equity here given sort of where you are in the leverage spectrum positioning the balance sheet for 2015.

Matt Miszewski

Yes, this is Matt, Jordan I think we said in our prepared remarks with some of the capital recycling initiatives that we have in our way. We don’t currently have any plans to sell equity, we've got a plan for the year that fully funds all of the capital needs that we have keep it inline with the covenants and relevant leverage ratio’s that we like to operate within particular in light of our upward revised stability outlook from S&P. So as of today, we don’t have any plans in guidance to issue any equity.

A. William Stein

And let me Jordan, I mean while the stock has done well, we still think it’s trading on a discount NAV. and we also are looking at significant what we think is a significant growth in NAV due to improving fundamentals, inventory absorption and that’s a value accretion through our development program. So we don’t think it makes sense to sell equity at this level.

Operator

The next question will come from Emmanuel Korchman of Citi. Please go ahead.

Michael Jason Bilerman – Citigroup Global Markets Inc.

Yes. It’s actually Michael Bilerman with Manny in. Bill, you got a pretty good memory from a year and a half ago. I’m curious on the distribution program, the 0 to 400. Is that all encompassing for this review that you did, I think Scott talked about 5% to 10% of the portfolio, which I think would be greater than 0 to 400 in this, they’re are really low valued assets. So I’m just curious sort of how big that portfolio is and whether you want to – you’re instead after Labor Day, assuming not all the stuff will come in at that point. So can you just sort of give a little bit more color surrounding it?

A. William Stein

Yes, sure. I think the first part of the question. I kind of lost track here for a minute there, but we planned to initiate the program after Labor Day. So obviously, assets will bring it out. from that point, we’re not going to hit the market with every asset that we intend to – that we have slated for dispositions at that point. And then I think the question was about the size…

Michael Jason Bilerman – Citigroup Global Markets Inc.

You said 5% to 10%, which to me like greater than zero to 400 million. So I didn’t know whether the basket of assets is identified to eventually look what it was in excess of 400 million.

A. William Stein

Yes. So the basket of the high priority assets is in excess of that, and we’re still finalizing which ones that we’re actually going to be taken the market right after Labor Day.

Scott E. Peterson

Hey, Michael. let me follow up though, the zero to 400 million are assets that will be sold this year that does not represent 5% to 10% of the portfolio that is slated per sale, that’s just – that sequencing and timing, that’s what would be sold this year.

Michael Jason Bilerman – Citigroup Global Markets Inc.

Right. So what I’m trying to get a picture of is, how I assume you’re going to continue this program to next year, as you said, you want to sell 5% to 10%. how big of a disposition plan to envision happening over the next 12 months to 18 months? We will be talking that 1.5 billion of assets – 2 billion of assets.

Scott E. Peterson

I mean what I’ve seen Michael, would say 600 million of proceeds roughly.

A. William Stein

Yes. That’s pretty close and that’s probably over the course of the next eight or nine months.

Michael Jason Bilerman – Citigroup Global Markets Inc.

Okay, thank you.

Operator

Our next question will be a follow-up from Tayo Okusanya of Jefferies. Please go ahead.

Tayo T. Okusanya – Jefferies LLC

Just a quick follow-up Page 16 when I take a look at the same-store results, just kind of curious from an OpEx perspective, fairly large increases in utilities and other property operating expenses repair the maintenance and things like that, just kind of curious on why the big year-over-year bond is number one and what we should expect kind of going forward in regards to our run rate?

Matt Miszewski

Yes. Tayo, this is Matt. There’s a couple of things, I mean some of the – some of that was as we expected in sort of including guidances, as part of our guidance we gave on margin, some of that is seasonal initiatives for preventative maintenance, to mainly just as a matter of timing. and additionally, as we’ve been rolling out some of the data center services and the ecosystem features that’s what’s driving some of that increase, which again, is all baked into the guidance that we provided. and we expect to be within the margins that we laid out as part of that guidance come in the end of the year.

Tayo T. Okusanya – Jefferies LLC

Okay, all right.

Matt Miszewski

Thank you.

Operator

And the next question will be a follow-up from Steve Sakwa of ISI Group. Please go ahead.

Steve T. Sakwa – International Strategy & Investment Group LLC

Thanks guys. I think that’s my second question, I guess maybe for Matt, as you guys have thought about kind of the lease-up potential that it takes for an asset to get from kind of starting point to stabilization. I know that number had kind of got extended out almost 12 quarters and just given the leasing environment that you’re seeing today and that seven months I guess number that you’ve talked about from a tenant signing to sort of taking occupancy. Do you think that 12-quarter stabilization period has shrunk, or is in the process of shrinking and so what do you think the right number is today?

Matt Miszewski

Yes. great question, Steve, I do think that the number is shrinking and what I’m looking for in the data is a pattern I can sort of solidify myself to give you some guidance as to what I think the new number is. There’s a number of things that go into that equation, the gap from signing to deployment is certainly one of those pieces, but the other correction that we made in the sales process helps to speed some of that up as well.

So I would anticipate that we would be able to get to a more crisp number, as to what it takes for us to get fully stabilize on a building over the next few quarters. but it is improving, if I can give you a trend guidance, it’s certainly improving.

A. William Stein

Steve, that might vary market by market though. So Northern Virginia is pretty brisk at this point and Dallas is brisk, Richardson. As Matt said, we can keep the inventory on the shelf. We built the shelf. we finished the data center and it will be fully leased within 12 months.

Matt Miszewski

And Steve, with the focus of new discipline that we have here you can expect that our focus will remain on increasing that ROIC by leasing existing inventory, but also leasing into the markets that are similarly hot that Bill just described. So you should see, like I said, I think you should see market-to-market differentiation, but you should see a constriction of that time to stabilization.

Steve T. Sakwa – International Strategy & Investment Group LLC

Okay, thank you.

Operator

And our next question will be a follow-up from Michael Bilerman of Citi. Please go ahead.

Emmanuel Korchman – Citigroup Global Markets Inc.

Hey, we just are confusing. it’s Manny here with Michael. I had a quick follow-up on the dispositions. Would you ever consider selling some of those pre-stabilized assets to both help the ROIC, maybe bringing some incremental proceeds and just sort of move that along especially ones that have been on that schedule for a while now?

Matt Miszewski

Yes, absolutely. As a matter of fact, I think that you’ll see that some of that’s around the – are in the list of high priority candidates.

Emmanuel Korchman – Citigroup Global Markets Inc.

And then when you said Matt, earlier $600 million of proceeds, did you mean $600 million gross or net?

Matt Miszewski

There are gross proceeds. I think maybe, in this probably net of sales expenses on that, but pretty close.

Emmanuel Korchman – Citigroup Global Markets Inc.

Got it. thank you.

Operator

And ladies and gentlemen, at this time, this will conclude our question-and-answer session. The Digital Realty 2014 second quarter earnings conference call has now concluded. We thank you for attending today’s presentation. You may now disconnect.

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