Duke Realty's (DRE) CEO Dennis Oklak on Q2 2014 Results - Earnings Call Transcript

Jul.31.14 | About: Duke Realty (DRE)

Duke Realty Corporation (NYSE:DRE)

Q2 2014 Earnings Conference Call

July 31, 2014, 03:00 PM ET

Executives

Ronald Hubbard - President, Investor Relations

Dennis Oklak - Chairman and Chief Executive Officer

James Connor - Senior Executive Vice President and Chief Operating Officer

Mark Denien - Executive Vice President and Chief Financial Officer

Analysts

Jamie Feldman - Bank of America Merrill Lynch

Kevin Varin - Citigroup

Vance Edelson - Morgan Stanley

Brendan Maiorana - Wells Fargo

Dave Rodgers - Robert W. Baird

Eric Frankel - Green Street Advisors

Neil Malkin - RBC Capital Markets

Michael Bilerman - Citigroup

Ki Bin Kim - SunTrust Robinson Humphrey

Operator

Welcome to the Duke Realty's second quarter earnings conference call. (Operator Instructions) I would now like to turn the conference over to our host Mr. Ron Hubbard. Please go ahead, sir.

Ronald Hubbard

Thank you. Good afternoon, everyone. And welcome to our second quarter earnings call. Joining me today are Denny Oklak, Chairman and CEO; Jim Connor, Chief Operating Officer; and Mark Denien, Chief Financial Officer.

Before we make our prepared remarks, let me remind you that statements we make today are subject to certain risks and uncertainties that could cause actual results to differ materially from expectations. For more information about those risk factors, we would refer you to our December 31, 2013, 10-K that we have on file with the SEC.

Now, for our prepared statement, I'll turn it over to Denny Oklak.

Dennis Oklak

Thank you, Ron. Good afternoon, everyone. Today I will highlight some of our key accomplishments for the quarter, and then Jim Connor will give you an update on our leasing activity and development activity. I'll review our asset recycling transactions, and Mark will then address our second quarter financial performance and balance sheet.

By all account, the second quarter was a great success for Duke Realty, and I am very proud of our team for their accomplishments. We signed 9 million square feet of leases and finished the quarter at 94.5% in-service occupancy rate, our highest level since 1999.

Rent on renewal leases for the quarter grew by 7.6%, a level consistent with the first quarter and reflective of strong supply demand fundamentals and solid pricing power. We started a $213 million of new development projects at solid yields, and we made significant progress on the disposition front with nearly $300 million closed in the second quarter, both exceeding our expectations as of mid-year.

We also opportunistically issued common stock on our ATM program. We used the disposition and the ATM proceeds to redeem our Series J preferred shares into fund our increased development expectations for the full year. Mark will touch more on this later.

Now, I'll turn it over to Jim Connor, to give a little more color on our leasing activity and development pipeline.

James Connor

Thanks, Denny, and good afternoon, everyone. From an operational standpoint, we had a very strong quarter with leasing of 9 million square feet, as Denny noted. Our total in-service occupancy ended up at 94.5%, that's up 50 basis points from the previous quarter.

Our tenant retention was solid at about 68% and rental rate growth on renewals continues to improve across the portfolio with growth of 7.6%. We continue to be very focused on pushing rents throughout our portfolio and in particular on the industrial side.

Now, let me touch on some of the key activity within each of our product types. With respect to our industrial portfolio, we continue to see fundamentals improve with completion of 7.8 million square feet of total leasing, including 1.9 million square feet of build-to-suit development, 680,000 square feet of leasing in our recently completed spec projects.

In-service occupancy in the bulk industrial portfolio at the end of the quarter was 95.6%, that's 120 basis points higher than a year ago and a 15-year high for us. Compared to general market vacancy in our 22 markets, our in-service occupancy has outperformed in the competition by almost 250 basis points.

As I noted, we signed two deals totaling nearly 680,000 square feet that fill the remaining space in two of our speculative projects. One in Chino, California and one in Indianapolis, Indiana that were both placed in service in 2013. Also contributing to growth in our industrial occupancy was a new 300,000 square foot lease that we signed with Amazon in the Atlanta market. And on the renewals side, we executed three notable industrial leases between 200,000 and 430,000 square feet with Georgia-Pacific, Home Depot and Coca-Cola in our Atlanta, Indianapolis and Dallas markets respectively.

With the tightening of conditions across most of our markets and high occupancies in our own portfolio, we've been highly focused on capturing rent growth, as we've been saying now for the last few quarters. I am proud to note that our industrial rent growth accelerated to 9% during the second quarter, bringing our year-to-date average to 8.7%.

Now, I'd like to turn to the medical office portfolio. We continue to have positive trajectory with our in-service occupancy increasing to 93.9%. That's a 120 basis points above a year ago and with weighted average remaining lease term of over 10 years.

The suburban office market continues to show slight improvement across most of our markets. Rent growth is still relatively flat in most market, but concessions are on a downward trend. Our in-service office portfolio ended the quarter at 87.7% leased, which is down 40 basis points from the first quarter. This decrease is entirely attributable to our second quarter dispositions, which had an average occupancy of 93%.

Now, I'll turn to the development side, where we had $213 million of starts across 10 projects in the second quarter that totaled 3.6 million square feet and expect to generate a 7.2% weighted average initial stabilized yield. We commenced three speculative projects this quarter, as we had alluded on previous calls regarding support coming speculative projects in 2014.

With our recent signing, our 2.4 million square feet of speculative projects that we've started since 2009 and are now in service are 97% leased. We've done a great job covering all of our spec bets across all of our markets.

The projects, in particular, we started a 144,000 square foot speculative project in Northern New Jersey in our Legacy Commerce Center. We started a 324,000 square foot speculative facility in Chicago down in the I-55 Corridor, which was a redevelopment site we acquired in late 2013. You should also note that Chicago industrial market has been 95%-plus leased for close to five years, and we've got a great leasing momentum down in the I-55 Corridor.

The third project we started was a 937,000 square foot development within an existing joint venture at our AllPoints Midwest park in the Indianapolis Airport submarket. We are currently 99.3% leased on our entire 19.5 million square foot bulk industrial portfolio in Indianapolis.

In addition to these three spec developments, we commenced construction on a 270,000 square foot facility that's 47% pre-leased in Dallas Airport submarket. Our Dallas portfolio is over 97% leased and our team has been generating excellent rent growth in renewals over the last year.

We also executed six 100% pre-leased build-to-suit development projects in the second quarter. Four of these were bulk industrial as follows: one is 486,000 square feet on our own land in Minneapolis in the northwest submarket; a 305,000 square foot development in Columbus, Ohio, on our land at the Rickenbacker Global Logistics Park; a 757,000 square foot building in the northwest submarket of Chicago; and lastly a 240,000 square foot development in Houston, down near the Port of Houston. These industrial build-to-suit projects have terms ranging from 10 to 15 years.

And lastly, the fifth build-to-suit project was a 54,000 square foot medical office expansion with TriHealth in Cincinnati. This represents the fifth development completed with TriHealth in the last seven years, which is really a reflection of our reputation as a trusted provider and advisor a facility needs in healthcare industry.

Lastly, the sixth build-to-suit we started in the second quarter was a 112,000 square foot Class A office project for Interactive Intelligence on our land in the Woodland Corporate Park in Indianapolis. We simultaneously negotiated expansions and extensions of our leases with Interactive on two existing leases that totaled 272,000 square feet within that same park.

From an overall development pipeline perspective, at quarter end we have 31 projects under construction, totaling 10.8 million square feet and a projected $722 million of stabilized cost at our share that is 76% pre-leased in aggregate. These projects have an initial cash stabilized yield of 7.4% and GAAP yield of 8.1%, again highlighting the tremendous value creation being executed by our teams and our strategic land holdings.

Thank you. And now, I'll turn it back over to Denny to cover our recycling activities.

Dennis Oklak

Thanks, Jim. With respect to investment activity, we had $278 million of building dispositions during the quarter, consisting of five transactions. The two largest transactions were the sale of the 3630 Peachtree, our office building in Buckhead and an office portfolio in Cincinnati.

We closed on the 3630 Peachtree Tower in Atlanta's Buckhead submarket, a deal that most of you probably saw in the news late last month. The deal sold for a Buckhead record $390 per square foot and our share of the proceeds was about $100 million. The project was 86% leased at closing.

While this project went through some rough times during the downturn, including a large impairment charge, it ended up with a great result, as we fully recouped all of our invested capital and made a nice profit. The portfolio in Cincinnati was sold for $150 million or roughly $144 per square foot.

The six office buildings making up this portfolio were on average 16 years old. The portfolio was 96% leased, but I will qualify that, saying that nearly 75% of the leases rolled in the next three-and-a-half years.

On the land side, we sold $18 million of non-strategic parcels during the quarter. In addition, I'll note that combining land sales with development projects on our land year-to-date remonetized 350 acres or about $69 million of land.

On the acquisition side, this quarter we closed on a 980,000 square foot modern bulk facility, located in Lehigh Valley region of Pennsylvania, and which was just completed for a purchase price of $73 million. We actually went under contract on a facility in a full commitment structure in the third quarter of 2013, just after the project commenced construction and after a pre-lease for 100% of this space was signed.

Given the cap rate compression in this market, over the last nine months, we believe our acquisition cap rate was approximately 50 basis points below to date levels. As noted on the last few calls the acquisition market continues to be intensely competitive and given our very strong development pipeline and opportunities, we expect the acquisition activity for the remainder of this year to be low.

I'll now turn over to Mark, to discuss the financial results and our capital plans.

Mark Denien

Thanks, Denny. Good afternoon, everyone. As Denny mentioned, I would like to provide an update on our financial performance as well as an overview of our capital transactions.

Core FFO for the second quarter of 2014 was $0.30 per share compared to $0.28 per share in the first quarter of 2014, and $0.27 per share in the second quarter of 2013. Core FFO was up $0.02 per share from the first quarter of 2014, as a result of improved occupancy and the negative impact of the extreme winter weather conditions had on first quarter operating results.

Carrying a higher base of operating properties through the second quarter also contributed to the improvement, as our Cincinnati office portfolio disposition did not close until the end of the quarter.

Same property NOI growth for the 12 and three months ended June 30 was 3.5% and 4.6%, respectively. The 12 month number is reflective of current annual run rate, driven by increased occupancy and rental rates in all product types. The quarterly number is higher, primarily because of timing of certain items.

As Jim noted, our growth in average net effective rental renewals was 7.6% and we are happy to say that this is the third consecutive quarter that we've been able to report increased quarter-over-quarter rental rate growth on renewals across all three product types. We are optimistic about our ability to continue to push rental rates.

We generated $0.25 per share in AFFO, which equates to a dividend payout ratio of 68%. Although core FFO increased $0.02 per share from the first quarter, the increased capital expenditures that coincided with the second quarter's increased leasing volume, resulted in AFFO per share being equal to the $0.25 per share reported for the first quarter of 2014.

On the balance sheet side. We finished the quarter with $60 million outstanding on our $850 million line of credit as compared to a $180 million outstanding at March 31. Building and land sales generated $297 million of proceeds during the quarter, which allowed us to reduced line of credit borrowings and overall leverage.

We anticipate continued strong disposition activity for the last half of the year, which will allow us to fund development and minimize use of our line of credit. We also repaid four secured loans totaling $64 million during the second quarter. In the process, we unencumbered about $155 million of properties to enhance our financial flexibility and credit profile.

During the second quarter and in early July, we issued 12.7 million common shares from net proceeds of $222 million. We are using the proceeds from ATM issuances as well as proceeds from property dispositions to fund our increased development pipeline in the recently announced redemption of our $96 million in Series J preferred shares that carry a coupon of 6.625%. The redemption of these preferred shares will result in over $6 million of the annualized reduction in preferred dividends.

Our ATM shelf that we filed in the first part of 2013 has now been fully utilized. All of these capital transactions coupled with our operational performance resulted in noteworthy improvements for key financial metrics during the quarter.

We reported a fixed charge coverage ratio of 2.3x for the rolling 12 months ended June 30 compared to 2.2x we reported last quarter, and 1.9x that we reported one year ago. For just the second quarter fixed charge coverage is now up to 2.4x.

Net debt plus preferred EBITDA for the rolling 12 months ended June 30, 2014, was 7.4x compared to the 7.8x we reported last quarter, and 8.2x we reported for the rolling 12 months ended June 30, 2013. When looking at this metric for just the current quarter, it improved to 7.1x.

We expect to see continued improvement in these financial metrics, as development projects continue to come online and as we realize the benefit of the redemption from the Series J preferred shares. We are in an excellent liquidity position and have no significant debt maturities until February of 2015.

I will conclude by saying that we're very happy to have reported another strong quarter. And with that, I'll turn it back over to Denny.

Dennis Oklak

Thanks Mark. Yesterday, we raised and narrowed our guidance for FFO for 2014 to a range of $1.15 to $1.19 per share. This change is reflective of our overall strong start to the year across all aspects of our operations, and includes increased anticipated development starts, dispositions and overall leasing activity for the year, which are expected to be better than what was originally anticipated.

As noted in yesterday's earnings release, additional detail on revisions to certain guidance factors can be found on the Investor Relations section of our website. In closing, we're pleased with our teams outstanding operation performance and allocation of capital year-to-date, which should set the stage for solid future growth and benefit our stakeholders.

So we'll now open up the lines to the audience, and we ask participants to keep the dialogue to one question or perhaps two very short questions. You are of course welcome to get back into the queue. Thank you. With that, we'll open it up.

Question-and-Answer Session

Operator

(Operator Instructions) And we'll go to the line of Jamie Feldman.

Jamie Feldman - Bank of America Merrill Lynch

I just want to get your latest thoughts on just supply in the warehouse market. How are you guys feeling this quarter? What are your thoughts on the markets that are the greatest risk and concern? And looks like you are ramping up your development pipeline even more. So how should we be thinking about that?

James Connor

I would tell you, much like last quarter, when we talked about some of the specific markets, there are really only a couple around the country that look a little uncertain at this point in time. Dallas has unfortunately got a lot of questions. Dallas had a huge year last year of net absorption between 16 million and 17 million square feet. They're off to a great first quarter, north of 6 million square feet of absorption. That slowed down a little bit in the second quarter. So I think there is a little bit of uncertainty there in the Dallas market.

All of the other major industrial markets, Chicago, Pennsylvania, New Jersey, Atlanta, even the Inland Empire has largest development pipeline areas. There is just a great deal of leasing and a great deal of positive absorption. So I wouldn't tell you outside of Dallas, we've got our eyes on any particular market right now.

Jamie Feldman - Bank of America Merrill Lynch

And then I guess as a follow-up to that on the demand side. What did you guys see in the quarter? Did you see continuation at the same level of demand? Is it picking up? I mean we certainly saw better GDP announced yesterday. What are you seeing recently?

James Connor

I would tell you that across the board, demand is up. We're just compiling our own internal study of all of the spec products in all of the different markets. But the spec that's out there in the second quarter, we're tracking about 18 million square feet of that absorbed. That's not true net absorption of the market. That's just of the spec base that was complete or under construction.

Leading that would be the Inland Empire, north of 9 million square feet of absorption, so a big quarter. But a lot of good numbers across the board, so we still think the vast majority of the markets are in very good health and very much in balance.

Dennis Oklak

Well, Jamie, our 9 million square feet of leases that we saw in the second quarter was really our second highest quarter for the last two years. So momentum is certainly still out there, with wind at our back right now.

Operator

Next we'll go to the line of Michael Bilerman.

Kevin Varin - Citigroup

This is Kevin Varin with Michael. How should we think about development spreads going forward, just based on the new starts and guidance? You mentioned in your opening remarks that yields on the new projects were 7.1% which is down from the overall pipeline. So are the spreads starting to tighten to acquisition cap rates, given either increased development competition or maybe higher construction costs?

James Connor

I would tell you that it is a competitive market out there. And there is a lot of local developers that are in the markets. There is no shortage of capital. So that's one piece of it. We've seen construction price still up. I think we covered this on the last call.

We have not seen significant increases that some of our peers had pointed out, which we think is probably because we have our own construction company, so we have a little bit better handle on managing the cost there. So while we've seen a little bit of compression on the yields. As long as we're doing stabilized yields north of 7 with overall yields north of 8, given where cap rates are, there is just huge value creation.

Mark Denien

I would add to that too. The product mix has a little bit to do with the decrease in our yields this quarter, because a higher percentage of our development starts this quarter was on the industrial side, whereas in the prior couple of quarters we had a little bit more office and medical office in that number. So I agree with what Jim said. The overall quality of the yields is still really there holding up.

James Connor

Yes. I think if you were to look at where yields have come down slightly, I have seen substantially more cap rate compression in last two quarters. So I can make a compelling case in spreads that that probably increased slightly as opposed to going down.

Kevin Varin - Citigroup

And then just one follow-up question is, I just wanted to see if you had more clarity on what the new incremental sales are in terms of what asset types you're looking in the market out there? And then also how we should think about timing as well?

James Connor

Well, Kevin, it really hasn't changed much for us. We're still focused on selling, primarily again the Midwest suburban office assets with a couple of selective suburban office assets in the Southeast, like we did with 3630, we think there is just some very opportunistic sales we can do right now. And then in the second half of the year, I mean you'll also see us selling couple of, I mean, just a little bit of remaining retail that we have left, which is something we've been planning on teeing up here for a while.

The only other thing I would add is, you might see a bit of selective pruning of the industrial portfolio also in the second half of the year. And this will mainly be, I would say, the older, smaller, lower, clear height type product that we have in a few of our markets. The pricing on that out there seems very good right now. So I think we'll selectively prune some of that.

As far as timing goes, we closed quite a bit right near the end of June, things that we've been working on for a while, including those two office dispositions. So the pipeline, I will tell you, is sort of getting geared back up right now. So I would tell you likely the dispositions will be later in the third quarter and then throughout the fourth quarter.

Operator

Next we'll go to the line of Vance Edelson.

Vance Edelson - Morgan Stanley

On the industrial side, the development projects range in size from under 100,000 to more than 1 million square feet and just about every size in between. So presumably you get a good feel for where the build-to-suit and other demand is coming from. So can you share with us your thoughts on which size category you're seeing the most active demand? And how that shapes your speculative build plans going forward or is it pretty much across the board regardless of size?

James Connor

Well, I would tell you that build-to-suit activity as leasing activity is pretty strong across all segments. The one probable clarification I would make, there are fewer large buildings available in the inventory, either spec, second generation, out there today. So the tenants that need 500,000 square foot or greater, more of those have to consider build-to-suit and perhaps say a 100,000 foot prospect that was in the market. But as you stated in the question, we're seeing activity all over the board.

Vance Edelson - Morgan Stanley

And then, as my quick follow-up. On the industrial leases expiring say over the next 12 to 18 months, could you give us an updated feel for the portion that were signed during the recession and what the potential price roles might look like on those?

Dennis Oklak

Vance, it's quite similar to what's been rolling in the last couple of quarters. We look out about 18 months. And of all of our industrial leases expiring over the next 18 months, right out about 50% of those were signed between 2009 and 2011, and then the other 50% split fairly even between deals signed before '09 and after '11.

So the way we look at it, the deals before '09 and after '11, probably fairly modest rent growth on those deals, the deals signed in that '09 to '11 timeframe. We're getting deals up into the high teens on some of those. So we think when you average it out, it's pretty close to the run rate we've been at for the last couple of quarters, which is close to high-single digits, I would call lit.

Operator

Next we'll go to the line of Brendan Maiorana.

Brendan Maiorana - Wells Fargo

Mark, if I look at sources and uses as it relates to the guidance for the back half of the year, it seems like you've gotten -- as I think maybe you or Denny mentioned in the script, you've gotten more aggressive in terms of where the dispositions are coming out, more conservative in terms of acquisitions. Seems like a portion of that is related to the Series J redemption. But is there a portion of it that you're using opportunistically to delever a little bit more? It seems like maybe, relative to what you have coming in the door, there's a little bit less in terms of what you need to spend it on.

Dennis Oklak

Brandon, I would say that if you just kind of look at the midpoint of our guidance from acquisitions and development dispositions, where we have to go. When your factor in the two large office dispositions that we had that closed late in the second quarter, we probably have about a net, I would call, a $100 million of excess capital coming in the door.

So you're probably right. I mean absent an even further increase in the development pipeline, the way we've seen it, we've really pre-funded a little bit of that the development pipeline, as we look forward over the next six to nine months. So that's really kind of what we've got it earmarked for right now is development. And as that fix up or decreases that will drive how much additional capital we need. But as we sit here today, we don't really see any needs for capital for the next six months to speak of, with any significance.

Brendan Maiorana - Wells Fargo

And just as a follow-up. So the guidance, there were a couple of sort of changes all around and you guys moved the range up a little bit. I saw the same-store range didn't change and you're kind of tracking ahead. You've got nice rent spreads and it seems like you feel pretty good about occupancy. If you're 3.5% in year-to-date and you add a little bit of a tough Q1 with some weather issues, is it fair to think that you're likely to be towards the upper-end of the 2% to 4% same-store range this year?

Dennis Oklak

Yes, I think we can get to the upper end. I think the first quarter was a little deceivingly low like you said for to weather reasons, and then the second quarter is a little bit higher than our run rate for some other small reasons. So you average it out that 3.5% on the 12 month is pretty close to what we believe our current run rate can be for the foreseeable future.

Now, I'll caveat that a little bit with saying that we have had significant occupancy increases over this period of time. And we're getting closer and closer to full occupancy. Although, we do still think we have some room to go on the occupancy, we just don't know that it will be at pace that we've been increasing the occupancy by. So we'll have to come down to the rental rate growth side.

James Connor

And Brendan, the other reason we didn't really change it is, because that number can fluctuate so much based on our dispositions. And we've got pretty good plan in place for dispositions, but you never know the timing of closings in those type things. So as we look at that, we just select not to change it.

Operator

Next, we go to the line of Dave Rodgers.

Dave Rodgers - Robert W. Baird

Jim, maybe a question for you on the spec developments that you're doing and the spec developments you're tracking in the market. It might be easier, I guess, if you address your own. But I guess, I'm wondering how much market rents are being pushed at the high-end by these spec developments.

I guess another way of asking that is when you're going to an area, putting in a new spec building, what's your premium rent that you're seeking or are you really targeting markets that maybe have already gotten replacement cost rents back from the recovery? Just a little more color on that would be helpful

James Connor

I would tell you without any specifics, probably half of the markets across the U.S. are there. Deals are being done in existing space, first and second generation to support the rents and the yields we need on spec development. The remaining half is probably within $0.05 to $0.10. And for the right users, for the right timing, for the right location, that's not too big a premium. That's why you're seeing as much build-to-suit activities you're seeing around the country.

Dave Rodgers - Robert W. Baird

And I think that's consistent with your portfolio as well? And you've been a little late to the spec game, but I think that's probably been why there's a little bit more conservatism?

James Connor

We have try to exercise a little conservatism. We can still remember 2007, 2008. But we had so many really good build-to-suit opportunities across the spectrum that it just hasn't really paid for us to take on much spec risk. Now, that so many of our portfolio, industrial portfolios, in particular, are north of 95%.

There is some opportunities there that we need to take advantage of just to handle the growth of our existing clients in some of these markets. So that's why you'll continue to see us selectively pick some markets that we feel comfortable, where our portfolio is, where rents are, where absorptions are. And we'll continue do a modest number going forward.

Dave Rodgers - Robert W. Baird

Mark, maybe one for you. I think we've talked about this before, but I'll ask it again. Given your comfort just more recently, issuing equity on the ATM and given, maybe some comfort going a little bit lower into your preferreds, breaking that 6%, 7% barrier in terms of the yield and buying back that Series J.

As you look at the rest of the preferreds, I don't know if you commented on this already, but if you would, what stops you at this point, given where the equity is, given where some of these 15-year bonds are pricing out in terms of getting rid of the rest of those preferreds?

Mark Denien

Dave, the biggest thing is development pipeline and the deposition. We want to make sure like we'd said before that we've got all of our bets covered on the development side first. And if we've got some excess capital and our stock's trading at a nice price, then we'll look to opportunistically take some more preferreds down over time, but with the disposition pipeline that we have in front of us, we may have the opportunity to do some of that through dispositions. We just need to see how that plays out first.

Operator

Next, we'll go to line of Eric Frankel.

Eric Frankel - Green Street Advisors

I'm curious, if your development pipeline increases further for whatever reason, how would you likely fund it?

Dennis Oklak

It would be through some combination of disputation proceeds or the ATM. Like we said at the beginning of the year, Eric, our plan all along was to fund our net growth 60-40, 60% equity/disposition proceeds, 40% debt. We've been able to fund everything thus far for the most part through the disposition program, but to the extent, that we still have attracted development out there and we don't have the dispositions to pay for it, we will look to fund it through the ATM.

Mark Denien

And I would also say, Eric, I don't think you're going to see that pipeline get much bigger than it is right now. We kind of keep our eye on that under regular basis and know about where we want to keep it. It's been running more in the $600 million to $700 million. We're a bit over $700 million this quarter. But I don't see or think you'll ever see it ramp up significant above that?

Eric Frankel - Green Street Advisors

It's just interesting that this quarter, obviously, as you've stated yourself, you essentially pre-funded your increased development with almost all equity, I thought that was an interesting move. I think the only other question I have is regarding the leasing of some of the spec developments that came online in the last year or two. Did those leases come in at or above pro forma in terms of rental rates?

Mark Denien

No, they came in above pro forma. The only differential is some times you underwrite five year leases and you end up doing 10 year leases. But if you look at the net res across the term of the yields, we're above the across the board.

Operator

Next we'll go to the line of Neil Malkin.

Neil Malkin - RBC Capital Markets

I just had a question. The Cincinnati portfolio you sold, can you give us a cap rate on that, from I guess, GAAP or EBITDA perspective? And then what it would be from an AFFO or economic standpoint, like what's the spread there? And then also, can you at all quantify how much, around how much TIs per total CapEx you could probably take out of your portfolio once the majority of the suburban office dispositions are completed?

Dennis Oklak

Well, I guess, the answer of the first question is we really don't disclose GAAP rates on specific transactions, obviously, for competitive reasons. That that is blended in with our overall cap rate or in-place yield as we call it, that we disclosed.

But on the second question, the difference between sort of the in-place with NOI cap rate and what we would believe is kind of a normal after CapEx. Really as we look at our net portfolio, it's about 150 basis points lower on a cash basis than on an NOI basis, on a pretty consistent basis. And that's probably about average or maybe even a bit low on the low side for some of office, probably goes between a 150 basis points to 200 basis points from cash to NOI.

And I'm sorry the last question was?

Neil Malkin - RBC Capital Markets

Well, I mean, I'm not exactly sure. I guess maybe if you can quantify the amount that you could possibly sell and you have left to sell of the suburban office assets and then, I guess we could actually figure out how much spend you could possibly be saving, right? Because those are obviously CapEx-intensive assets you're selling?

Mark Denien

That's right. And I think we, if you look back probably over the last couple of years, I think we disclosed every quarter, pretty much how much CapEx we're spending by product types. So you can see that. And clearly the suburban office is where the higher number is as well as drop to the higher percentage. And so that's coming down. Again, if you look at our remaining dispositions for the rest of year in our guidance, which is probably $300 million, $400 million, at least 50% of that I would say is going to be in the suburban office, probably a little bit more than 50% of it.

Operator

And we'll have a follow-up question from the line of Jamie Feldman.

Jamie Feldman - Bank of America Merrill Lynch

I was hoping you guys could spend a little bit more time on your comments on the office business. It sounds like rents aren't necessarily moving, concessions are coming in. Can you give a little bit more color in terms of what you're seeing on both the demand side and rent growth and maybe a little more granularity on the different markets?

James Connor

Sure, Jamie. I think as we outlined in the script, there's not a great deal of rent growth in the suburban market yet, but where we are making you some ground is concessions are trending down, less free rent, less TIs in particular going into the deals. Better term is probably a big factor that doesn't get talked about a lot. Office tenants in the last years have been a little nervous to make commitments beyond that three to five year period. Now we're starting to see tenants making longer-term commitments, which improves the economics of a lot of our deals.

Dennis Oklak

Just adding to what Jim said, I would say, the Midwest rents are still pretty flat, but I think we've actually seen some decent rent growth in a couple of the Southeast markets and we're not in all of that many office markets anymore, but Raleigh's held up extremely well in both from a volume and a very stable and growing rental rate stream.

South Florida, the activity has been pretty good across the board and rents continue to creep up down there. So the suburban office market is coming back slowly, slowly and even in the Midwest, I think I would say, I think our activity is probably up a little bit but rental rates probably are not.

Jamie Feldman - Bank of America Merrill Lynch

Do you get the sense that maybe three quarters or a year from now we'll be talking about a much more robust office market or it just feels like we're stuck in neutral here in your markets, outside the Southeast, I guess?

James Connor

Well, we love to be talking about that Jamie. But realistically, I don't think so. I don't think -- we're not seeing the trends where you're going to see a real significant turnaround, where you've got some substantial rent growth in the next 12 months. I don't think we're that bullish on the suburban office market.

I think we'll continue to make modest increases in occupancy like we have over the last 18 months. In some of the better markets, as Denny alluded, Raleigh, South Florida, even Texas, those markets rents have gotten back to where they're supporting new construction. I think the Midwest still lags behind and is a little bit softer.

Operator

And we do have a follow-up from Michael Bilerman.

Michael Bilerman - Citigroup

Denny, just on the Lehigh Valley industrial asset, that was a build-to-suit that you had committed to take out from the tenant or from another developer?

Dennis Oklak

That was from another developer.

Michael Bilerman - Citigroup

And what was the, I guess, this is just you were attracted by the asset or what was it? What drove you to.

Dennis Oklak

Michael, the Pennsylvania area and New Jersey are the geographic area we're trying to grow in. And this was good opportunity for us from a group that we have our relationships with and like the price propound and it's an excellent building in excellent location. So it's always good for certain private developers to be able to have it take out and they get that upfront. A lot of times you get a bit better deal on it when if it's fully complete. So we believe we did on that one.

Dennis Oklak

Michael, the only thing I would add is we have a long-standing relationship with the tenant. We have that tenant in four or five other buildings around the country. So we have a very high-level of comfort with them, strong relationship. So we think there is actually an opportunity to grow.

Michael Bilerman - Citigroup

And what's that lease length like?

Mark Denien

10 years I think. Yes. Annual rent growth.

Michael Bilerman - Citigroup

So what is that? And what was your sort of going in versus the GAAP rate, cap rate on it?

Mark Denien

Well, I don't remember exactly, but the going in is 6. And then I think its 1.5% to 2% bumps for sure. But I think closer to 2% on that deal.

Michael Bilerman - Citigroup

On the medical office, do you have any desire as you think about the acquisition market being pricey and you're continuing to sell assets and raising that guidance? Are you thinking about capping the medical office assets at all for proceeds?

Mark Denien

No. As you recall, we did about -- we sold and improved net portfolio at the end of last year about $250 million, couple of those closed, I think early this year. And we've said at the time that that really -- we took advantage of the market, what we thought was good pricing, sold some assets that weren't as strategic to us as the ones we retained for hospital relationships or geographical purposes. So we're very comfortable with where that portfolio is now and quite honestly there is really none of that in our disposition guidance.

Michael Bilerman - Citigroup

And then as you think about just, Mark, on the balance sheet, sort of the target ratios in terms of funding from here and definitely raising the equity, certainly was a big positive in terms of funding and making sure you have the capacity. I am just curious, and obviously buying back the preferreds is going to help fixed charge as well. How should we think about where you want your ratios to be going forward? From a debt-to-EBITDA, debt-to-gross assets and the fixed charge perspective?

Dennis Oklak

Michael, we haven't really set any targets in the sand like we did back in '09, but what I would tell you is this, a couple of things. As we look out towards the end of the year, we fully expect our debt-to-EBITDA to be under 6.5% by the end of the year. Our debt plus preferred to EBITDA to be well under 7% by the end of the year, and our fixed charge closer up to 2.5%.

And then from that point on, what I would say, our plan is to grow the company, to grow mainly through development and to fund that growth at a better leverage profile that we set here today. More in that 60%, 40% range. And if we do that all those ratios naturally will just continue to improve.

Michael Bilerman - Citigroup

And how much do you have left on the ATM right now?

Mark Denien

We are out of our ATM.

Michael Bilerman - Citigroup

That actually you're going to reload then?

Mark Denien

I'm sorry.

Michael Bilerman - Citigroup

Are you going to reload it?

Mark Denien

Yes, I think it's prudent to always have it out there, just if we need it to have it. So you'll probably see us reload that some time in the not too distant future.

Operator

Let's go to the line of Ki Bin Kim.

Ki Bin Kim - SunTrust Robinson Humphrey

Sorry, if someone has already asked this question or not. But you have had been a pretty much a net disposer, shorter developments, just on buying and selling for a couple years now. How should we think about that next year? How does that dynamic change a little bit next year?

Mark Denien

Well, I think, Ki Bin, we're now at the point, I guess I'd say couple of things here. When you look from here on out for the next six months, to say, 12 months, we're still targeting some of the Midwest suburban office assets, which are just not long-term holds for us. And we obviously did some of that in the first half of this year, and we've got some more, that you'll see us do in the second half of the year.

And then, we also are targeting just these couple of retail assets that we still own or own a partial interest in, because those are pretty much stabilize now. And I think the pricing will be pretty good on those. So we're going to be get rid of those. I think looking forward, when you look around the rest of our portfolio, including industrial, suburban office, medical office, it's going to be properties that we really like. And so I think you'll see as the more opportunistic and strategic on the dispositions, once we get through a little bit of those targeted assets again.

And the dispositions will really depend on a lot of different things. First of all, what the cap rates are? If we think it's a really good time to sell, we'll look at selling. What our development pipeline might be, if we've got a development pipeline and we can sell some older assets and redeploy the proceeds back into great new development assets, we'll do that. So I think sitting here today we don't really have any specific targets for a dollar volume of what it might be after this year. I think it will be more strategic, it's really based on market conditions.

Ki Bin Kim - SunTrust

I guess are you ruling out any kind of sizable dispositions or is that still kind of possible?

Dennis Oklak

Well, I don't think it's very likely, because our office portfolio is getting down to the point now where it isn't that sizeable. So I don't think you're going to see any particularly sizeable transactions, but I suppose something should come along, but I don't think it's likely.

Ki Bin Kim - SunTrust

And just one last one. Your service operations income, I know we've talked about it in the past, and there is other reasons why it's there and not just to make the $18 million a year. Any change in terms of the right staff level, especially as it relates to that part of the business?

Mark Denien

Well, the staffing in that piece of the business is just part of our -- there is no separate staffing for that piece of the business. We get that business really primarily, I would say, through our land positions.

And as you know, since we've been around for a long, long time, and definitely since we've been a public company, if we can make some money by selling some land and doing a third-party construction project for a customer who wants to own their building, we're happy to do that. And those are the same people that would develop a build-to-suit that we owned on that land or developed a spec building on that land. So it's all part of the same group.

And I would say the earnings are probably up a bit this year, because we had a couple larger projects that were exactly like that, where we sold the land and entered to a third-party construction contract that have proved pretty profitable for us. But again, we've had this discussion over the years. Our service operations are all there, been very consistent, higher obviously in the years, we were working on the BRAC project in D.C., because that was such a large project, and has consistently stayed above 5% of our overall FFO, and that's it.

Operator

Thank you. There are no further questions in queue at this time, please continue.

Ronald Hubbard

I'd like to thank everyone for joining the call today. And we look forward to reconvening during our third quarter call, tentatively scheduled for October 30. Thank you again.

Operator

Thank you. And ladies and gentlemen, that does conclude our conference for today. Thanks again for your participation and for using AT&T Executive Teleconference services. You may now disconnect.

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