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Gramercy Property Trust Inc. (NYSE:GPT)

Q2 2014 Earnings Conference Call

August 8, 2014 11:40 AM ET

Executives

Gordon F. DuGan – Chief Executive Officer

Jon W. Clark – Chief Financial Officer

Benjamin P. Harris – President

Analysts

Jason M. Ursaner – CJS Securities, Inc.

Peter Anthony Hunt – JMP Securities LLC

Daniel P. Donlan – Ladenburg Thalmann & Co. Inc.

Wilkes Jackson Graham – Compass Point Research & Trading, LLC

Operator

Thank you, everybody, for joining us and welcome to Gramercy Property Trust Second Quarter 2014 Financial Results Conference Call. A reminder, presentation materials and a supplemental for the call are posted on the Company’s website at gptreit.com in Investor Relations Section under Events and Presentations. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please note that this conference is being recorded.

The Company would like to remind listeners that during the call management may make forward-looking statements. Actual results may differ from the predictions that management may make today. Additional information regarding the factors that could cause such differences appear in the MD&A section of the Company’s Form 10-K and other reports filed with the Securities and Exchange Commission.

Also during today’s conference call, the Company may discuss non-GAAP financial measures as defined by the SEC regulation G. The GAAP financial measures most directly comparable to each non-GAAP financial measure discussed and a reconciliation of differences between each non-GAAP financial measure and the comparable GAAP financial measure can be found in the Company’s press release announcing second quarter earnings, a copy of which can be found on the Company’s website.

Before turning the call over to Gordon DuGan, Chief Executive Officer of Gramercy Property Trust, we would like to ask those of you participating in the Q&A portion of the call to please limit your questions to two per person.

Thank you. And please go ahead, Mr. DuGan.

Gordon F. DuGan

Thank you very much and thank you all for joining us on a beautiful Thursday afternoon in August. For those in the New York area it looks awfully nice out there. So anyone on this phone we appreciate your time and attention.

The second quarter for Gramercy was truly a transformational quarter for us. There are two themes that I want to talk about on today’s call. I will be referencing our second quarter 2014 investor update that’s available on our website. So, if you don’t have a copy, and you’re in front of a screen I would encourage you to pull that up so when I hit a couple of slides in there you’ll know what I’m referencing. But the two themes that we’ve been stressing and I think become clear in the second quarter, one is growth and the second is the cost of capital, lowering our cost of capital and increasing our financial flexibility. I think it’s fair to say that the second quarter was transformational on both of those fronts.

For those who remember at the very beginning of this year, in January at a call, I’d laid out how I thought the activity and pace of growth for Gramercy would increase. And then in Q1 I think we closed one deal for like $15 million and a couple of investors called up and wanted to know if that was our definition of increased activity. But clearly in Q2 we saw the benefit of all the work that we’ve started laying the groundwork for in Q1 in terms of growth and cost of capital. So I’ll get into that as we go through the investor update. John Clark will walk through a more detailed discussion on the financial figures and earnings figures. For Q2 I have some high level slides on those as well. I will skip over 2014 highlights.

In general, other than to say it was obviously an extremely active quarter, raising capital with over $200 million of equity raise and deploying it into a series of investments. What I think is most telling about that is we were really able to, with all of the hard work of the team here, to sort of hit all of our dates in terms of when we thought we could accomplish the closing of the buyout of our JV partner, raising equity, raising debt. All of the things that we set out to do in Q2 we did and all of that activity level sets us up. We’re really in an inflection point for growth going forward with Gramercy. And in addition, I’ll talk a little bit about the OP Unit deal that we did. We love those types of deals and I’ll talk about why we like it so much when we get to that slide.

Page 6, if we just take a snapshot, this is a slide you’ve seen in the past. We believe we have built and are building the highest quality net lease portfolio of a public company. We view high quality both in terms of average lease term, tenancy, but also in terms of contract rent versus market rent. We’re really sticklers for underwriting rents that in our contracts are hopefully at or below market. And so the NOI and some of the other statistics you see here is the high level, but below that every asset has been underwritten in its very great detail on a contract rent versus market rent et cetera. So 99% occupancy, greater than 10-year average lease term, over 50% investment grades. This is a very, very high quality cash flow stream.

Page 7, the ability to underwrite asset by asset also means that we are focused on major markets in the U.S. 84% of what we own are in major markets. That’s our focus going forward and, as you look at the top 10 tenant list, one of our goals for the remainder of this year and going into next year is to work down the percentage of top ten tenants. In terms of our overall revenue, it’s today 70%. Our metric is to get that under 40% and Bank of America is a very large percentage today. While it’s a single a credit, we at the bank operating company, which is our lessee, we do want to get that worked down over time, even though again it’s a very fine credit.

Page 9 is a quick snapshot of the transactions we have under contract. You’ll see their industrial property, primarily where we say specialty in the San Francisco Bay Area specialty. It’s a parking facility for a national major rental car company. So that fits within our specialty category, but most of the transactions that we are buying are industrial on a one-by-one basis. And so you’ll also see the percentage of office start to wind down. One other comment on that, the office that we own that we showed in the earlier slide on Page 6, the 48% office, the Bank of America portfolio as it overall are below market rents. So we have contract rents below market.

We did add to that in the second quarter, an investment in Malvern, Pennsylvania outside of Philly. It’s an R&D facility with market rents, recently renewed lease. So it’s been tested in the market. And then we’ve also bought a property in Nashville. Nashville has got one of the stronger suburban office markets in the country and that’s also a market rent. So where we do have office we’re extremely focused on market rent versus contract rent. We’re only buying, especially on the office side where we’re at or below market.

Page 10, just a quick snapshot of our acquisition activity. Our target for 2014 is $600 million. We’ve closed $370 million. That leaves us $230 million to go. We have under contract $75 million, that leaves us $155 million, which we’re halfway through Q2, Q3 and Q4, although August isn’t the busy time. Usually Q3, Q4 are quite active in our space. So we expect to come in really right on top of this number of $600 million. It won’t be exactly $600 million as you well know. It will either be slightly below or slightly above. But we don’t expect to be considerably above it and we don’t expect to be considerably below it.

So in terms of both acquisition volume and the need for capital, we’re sort of are right on with where we expect it to be. We continue to find these one-off deals one-by-one deals that are made up on the prior page where we’re getting higher returns. And we’re really staying away from the most competitive segment of the net lease or really the commercial real estate sector, which are larger transactions, especially larger portfolios. And we have a great team internally that’s able to take these one-by-one deals. We’ve clearly built up a track record of taking them and closing them. We have a great closing and legal team in-house and we’re able to really crank these things out with the existing G&A that we have in the Company.

Page 12, flashing ahead, I’ll let John go through the Q2 results in greater detail. I did want to highlight on page 13. You’ll see a highlight in the presentation of some of the one-time charges that flow through. Property acquisition costs were quite high in part because of the BofA JV buyout as well as just a number of costs that flowed through there. Almost all of those costs are costs that were incurred in connection with deals that we closed.

So, in my view those are really – they’re expense but they’re one-time cost to gather NOI for the future. And then we also have a loss on extinguishment of debt. That’s the refi of the credit facility and then the derivative instrument, which was the re-pricing of the convert note at the time that we obtained the shareholder vote to be able to convert the entire convertible note into equity. Jon will explain that in greater detail.

Page 14, I guess describe as a normalized FFO for Q2. This is our first bullet point in the press release. Just adding back the variety of one-time charges that flowed through, we got to $0.05 a share which is right where we expected to be.

And then Page 15, I thought an important slide is our run rate results. These are basically adjusting for the Company as we ended the quarter and giving us a full quarter of earnings power for all the assets that were on our books as of June 30, as well as all of the expenses that were associated with those assets as of June 30 and very significantly as well, including all of the shares that have been issued as of June 30.

So this diluted share outstanding isn’t the weighted average but it’s the full amount of any shares issued during that quarter as of June 30. So it’s a true run rate, all of the assets, all of the liabilities and then all of the shares outstanding. That number, of course, does not include the earnings power on roughly a $100 million of cash that we have sitting on our balance sheet as of that date. So it’s a deleveraged balance sheet with a ton of cash and it was still able to provide a run rate FFO of $0.07 as of the end of the quarter. So we feel like we’re right on track to our earlier guidance that we continue to guide to for Gramercy.

Page 16 is another great snapshot of really the two things on the right side of our balance sheet, reduction in our cost of capital as well as increased flexibility on our balance sheet. In terms of reduction in our cost of capital, two quick data points. Our (indiscernible) loan re-fied an existing floating rate mortgage. That mortgage had a floating rate of around 4.3%. The term loan has, as of September, will be fixed through the end of its term, roughly five years, at 3.42%. So almost 100 basis point decrease from a floating to a fixed rate instrument and of course going to unsecured, so much greater flexibility, much lower cost and a fixed rate instrument.

Our unsecured revolver which we have zero drawn on. The old revolver was 225 over LIBOR. This revolver is 165 over LIBOR on the current borrowing. And, so, again a significant decrease in our cost of capital. And as of June 30, I think it’s significant to point out all of our debt is fixed rate through the term of maturity that you see on the right hand side. We have no debt that’s floating-rate debt. At some point we’ll probably draw on the revolver and that would be our only floating rate debt in the capital structure. Everything else has been fixed out. So we’re operating off a fixed balance sheet with a very flexible financial structure.

On the upper right hand side you’ll see the liquidity of roughly $300 million. That’s our cash plus our revolver capacity. In addition, you may have seen in the press release we’ve collected roughly $7.5 million of our servicing advances post the end of the quarter. Those are servicing advances that were slow in coming in and we had guided to getting those in the second half of this year and we’ve now collected the vast majority of those. So we’ll be able to put those servicing advances to work into real property and increase NOI based on that. So we’re very, very happy with the progress that we have made on the balance sheet side.

Page 17, this is – we’re reaffirming our previous FFO guidance. This is our run-rate FFO. We think that’s the most appropriate for Gramercy because the timing of acquisitions and the related expenses will obviously have an impact. We ended up issuing more stock than analysts’ models had modeled, as well as I think that some of general expectations but because we have been able to get the money to work, we’re able to maintain the guidance that we have outstanding, even after a share issuance that was greater than, I think, any of the analyst’s models that I have seen.

Back to the strategy of growth, if we flip ahead to Page 19, there’s Gramercy has achieved a significant growth in total market cap. This is as of the date we took over the old Gramercy, 6/30/2012, obviously, a very significant increase in total market cap. The underlying engine for that is on Page 20. And this is real estate NOI growth for GPT. This is as significant as or more significant than any other public REIT that I know of. We continue to drive significant real estate NOI growth and that’s the engine of growth for total market cap share price. Everything flows from our ability to continue to drive real estate NOI growth. So that’s our primary focus through the second half of 2014 going into 2015.

But in addition to that, there are some opportunities we think that exist outside of our continuing to buy these one-off properties. I think we’re doing a better job than anybody I know. We have other opportunities to grow Gramercy as we look to 2015 and beyond. Portfolio acquisitions, this Cardinal acquisition is just a great example of a deal where Gramercy was able to differentiate ourselves. We issued $3.8 million OP Units at $6.19; it’s a very accretive transaction to issue shares at market with no dilution as part of an acquisition of real estate assets. We hope to do more of them. They’re very complicated so there are a lot of reasons I could give you that they’re very hard to do but we are actively looking for those types of opportunities.

In addition, in investment management our background is from W.P. Carey. We have a lot of background in investment management. It was a big driver of our earnings growth while we were at W.P. Carey. We like that model very much. We see opportunities in Europe where in Europe there’s significant capital for trophy assets and distressed assets but less capital for what I describe as medium return cash flow assets. I started the European business at W.P. Carey. The first office was in Paris in 1998, reported directly to me as did our first London office. And we think there’s some interesting opportunity there.

Institutional JVs, we – through our asset management business as well as our own investment platform, we see a lot of interesting opportunity. And to the extent we have an opportunity that isn’t a perfect fit on our balance sheet, either it doesn’t have very high cash flow or high cash flow, or has something else to it that we think would be better as an off-balance sheet investment, we think there are opportunities to JV with large institutional investors. And then the non-traded REIT market has been very hot. We have a lot of background in that marketplace. We have nothing that we have to announce or are in the works at the moment, but we are exploring whether there’s an opportunity to create a differentiated non-traded REIT product again given many years of background in that space from the W.P. Carey days.

And then lately, there’s just enormous opportunity in net lease through the consolidation that’s occurring. It’s that opportunity comes because net lease has been described as the most fragmented major real estate sector in the publicly traded markets. It’s the least owned in the publicly traded market. Only 3% to 5% of all net lease assets, according to Green Street estimates are owned in public companies. And so that consolidation, however it plays out, and we don’t have a crystal ball to say we know how it plays out, but consolidation in that type of fragmentation always prevents – presents opportunities.

It doesn’t prevent it but it presents opportunities if you’re nimble and intelligent about it. So on 22 I just want to leave by saying we really think we’ve achieved an inflection point in terms of our ability to grow the business. There are continued significant opportunities for Gramercy to grow. The most important will be, of course, to continue to execute on our plan of buying assets with attractive ROAs in our target markets. And we’ve set ourselves up for the future, for this future growth, with a significantly lower cost to capital and increased balance sheet flexibility.

We will continue to focus, both on lowering our cost of capital and maintaining flexibility as we go forward. With that, I’ll turn it over to John to talk about the details of Q2.

Jon W. Clark

Thank you, Gordon. I’ll just hit on a few highlights and then I’m going to talk about some of the effects of our acquisitions and capital market activities that affected our income statement during the quarter which I thought may be some further explanation would be helpful.

We generated AFFO during the second quarter of $5.6 million or $0.06 per diluted share. That compares to $3.6 million or $0.05 in the prior quarter. Excluding acquisition costs, discontinued operations and a few one-time things that I’ll take about more in a moment, FFO was $4.8 million, or $0.05 per share, as compared to $3.2 million or $0.05 per diluted share in the prior quarter. The per share measures, the weighted average basic and diluted share count includes the effect of the public equity raise of 46 million shares, which was outstanding for 39 days during the quarter.

Turning to income statement, we recorded total revenues of approximately $20.6 million as compared to $15.6 million recorded in the prior quarter. That’s an increase of 32%. Rental revenues increased to $10.3 million from $7.5 million recorded in the last quarter and that’s primarily due to the growth in the real estate portfolio and the significant addition of the Bank of America portfolio in June. Management fees were essentially flat as compared to the prior quarter. We did receive incremental fees of about $250,000 attributable to a one-time project for a client. This was offset by a reduction in fees from our BoA joint venture subsequent to the acquisition of our partner’s interests.

On a quarterly basis, asset management fees from our joint venture were approximately $250,000. So annualized we expect a decline in the contribution of asset management to net operating income of about $1 million not taking into account the potential to earn incentive fees from our KBS arrangement and things like that.

I will just point out that on the income statement going forward; on the face the income statement is just going to look a little different. Your fee revenue from third parties is actually going to decline by more than that but that will be offset by additional tenant reimbursements, so essentially a management fees instead of showing as coming in from a third party will be showing as coming from tenants.

As compared to the prior year, management fees declined by about $6.5 million and that’s primarily attributable to the recognition of $5.4 million of incentive fees in the second quarter of 2013. That was related to the prior contract with KBS. At that time last year based on the valuation of the portfolio that we managed, the Company had achieved the maximum value under that prior agreement. In addition, the old KBS fee provided for a slightly higher base fee than the current contract and that accounts for the remainder of the difference year-over-year.

The new contract with KBS was put into effect in December of last year. It has a new incentive-fee structure that allows for incentive fees to basically be earned over time. To date under the new contract we’ve recorded about $620,000 of incentive fees. No incentive fees, however, were recorded in the second quarter of 2014.

Just a reminder about the fee structure from our asset management business, our fee revenue is comprised of an asset management fee that’s fixed, incentive and distribution fees that are not and a property management fee that’s variable and based on rent collections.

So accordingly, there’s a certain amount of volatility period-over-period that we expect with our fee revenue on the asset management business. Conversely, the expenses on the asset management business are less volatile.

Our asset management business generates most of its fee revenue from an agreement with KBS and currently because of the significance of the fee revenue in comparison to our total revenues, as a REIT we conduct most of these asset management activities in a taxable subsidiary and substantially all of our tax expense is related to this business.

Our effective tax rate in 2Q is about 37%. That compares to 41% in the prior year and we continue to look at other means of trying to lower our tax rate. I would point out that we would require substantially more scale in order to conduct our asset management fully inside the REIT and otherwise eliminate the tax expense.

Increases in property operating expenses are just driven entirely by the increase in the portfolio. The increase in property management expenses also corresponds to an increase in operating expense reimbursement from tenants. Summary of management general administrative expenses by business is provided in our press release. Total MG&A for a comparison though is $4.4 million this quarter versus $4.3 million in the prior quarter.

Okay, so let me summarize some accounting effects of the acquisition activity of the Bank of America portfolio and capital markets activity that contributed to some one-time things on our income statement. First, I’ll draw attention to the loss on the derivatives of $3.4 million that Gordon mentioned earlier. This is entirely related to the equity component of the exchangeable notes.

The accounting for convertible debt is probably some of the most complex there is. The convert when it was issued and appeared on our first quarter financial statements, it appeared in two places on the liability section of our balance sheet. First, the notes appeared in long-term debt and that represented the basically the debt characteristics of the instrument. Then the conversion feature and all the other equity type features were bifurcated and appeared on the balance sheet as a derivative.

The preferred treatment for equity components of a convert is to have this live in shareholders’ equity, not as a derivative liability. However, for us the conversion feature was required to be presented as a derivative because of a New York Stock Exchange restriction that applied to all listed companies and, based on the number of shares of stock we had outstanding when the convert was issued. We could not issue enough shares to fully satisfy the conversion option without a shareholder vote.

At our Shareholder’s Meeting in June, a proposal to allow us to issue those shares to satisfy the convert if and when the time came was approved by our shareholders; and once approval was obtained that derivative portion of the convert was mark-to-market and it toggled out of the liability section and became a component of shareholders’ equity and that’s where it’s going to reside permanently.

So, although there are many components that make up the fair value of the bifurcated equity portion of the note, the most significant factor contributing to the derivative loss was that the Company’s stock price increased about 14% in a very short period of time. And this is what generated what is a non-cash charge. We excluded the non-cash charge from our AFFO calculations. The derivative loss had no impact on the Company’s net asset value. It’s primarily an accounting exercise to move what was a liability into equity and for us it was just a two-step process whereby a portion ran through the income statement and a portion ran through the balance sheet.

Now, on to the gain that was recorded for the BoA portfolio acquisition; as part of our acquisition of our partner’s interest in the portfolio, we consolidated the assets on our books. Accounting rules require the assets to be consolidated at fair value, which we determined to be $395.2 million for the consolidated position. Although the acquisition of our partner’s interest was at fair value, the existing interest that was on our books was not. Previously our interest was accounted for on the equity method, which basically starts with our acquisition price, increases it by earnings from the portfolio or decreases it by losses and then further decreases the carrying value by cash distributions.

So in order to consolidate the assets at fair value, it’s necessary to re-measure our existing interest. And as part of that we recorded a gain on re-measurement of $72.3 million or, as a per share measure, that’s $0.76 per diluted share. And basically the gain is comprised of three things. First, the overall value of the portfolio increased since we originally acquired it. Next, we received a $5.3 million incentive profit credit from our partner against the purchase price at closing pursuant to the original JV agreement. And then finally, when the portfolio was held as a joint venture, it distributed a significant amount of cash. Those cash distributions reduced our basis as we got them and this actually increased the amount of gain that we recorded when we consolidated all the assets.

Just to talk about the cash distributions for a moment. For the quarter, we received yet another additional $3.1 million before the acquisition was completed from the JV and over the life of the JV we received cash distributions of about $36.6 million. The gain is excluded from our calculations of FFO and it’s excluded from AFFO. This gain is also unique to GAAP accounting. It does not affect our taxable income.

Finally, through loss on extinguishment of debt, this is actually somewhat simple. We replaced our $150 million secured credit facility with a $200 million unsecured revolving credit facility. So when we extinguished the secured facility we had approximately $1.9 million of unamortized deferred costs on our balance sheet. And those costs were written off and the write off represents 100% of the loss that appears on the income statement as extinguishment of debt

Just finishing up on the income statement, there continues to be a small amount of cost classified as discontinued operations. Substantially all of this is accrued interest on the 2 Herald transfer tax matter with the City and State of New York. The transfer tax is fully accrued for, but we continue to record a charge for interest up until the matter is resolved. I will say that for the quarter there was no substantial progress on resolving that matter.

Just turning really quickly to the balance sheet, just a couple things I’ll highlight, although most of the fluctuation you see on the balance sheet is attributable to acquisition activity and the consolidation of the Bank of America portfolio. At quarter end we maintained $298.7 million of liquidity. That’s $98.7 million of cash and full availability under the unsecured revolving credit facility of $200 million.

As Gordon mentioned, servicing advances remain substantially unchanged from the prior quarter, but right after quarter end we received $7.5 million of these. This represented basically the resolution of one of the largest assets underlying the CDOs. This will leave about $1.3 million of servicing advances to collect.

The retained CDO bonds increased slightly. This just reflects the basic accretion earned on those securities. The expected cash flows this quarter were pretty much in line with our expectations for last quarter. So no impairments, no write offs, no write downs on those interests.

Gordon, that’s enough of the technicals, back to you.

Gordon F. DuGan

Thanks, Jon. We’ll now turn it over to Q&A and look forward to your questions.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. (Operator Instructions) And our first question comes from Jason Ursaner from CJS Securities. Jason, please go ahead.

Jason M. Ursaner – CJS Securities, Inc.

Good afternoon. Congratulations on nice quarter.

Gordon F. DuGan

Thanks, Jason.

Jason M. Ursaner – CJS Securities, Inc.

Beyond the properties you have under contract, when you look at and think about the pipeline going forward, do you see any risk of the competitiveness you talked about in the larger process type deals spilling over into the negotiated single-asset market, not from bidders but more just seller’s expectations in terms of reading the papers and hearing about cap rates crossing on some of the larger deals?

Gordon F. DuGan

It’s a good question. I think what we’re finding today is as the tenure has dropped from roughly 3% to roughly 2.5% over the course of this year, borrowing spreads have tightened. We’ve definitely seen an impact on cap rates. We’ve seen cap rates probably come down even on the stuff we’re looking at on average about 25 basis points. But because borrowing rates and interest rates have come down, I’d say generally speaking equity returns have stayed pretty stable.

Clearly a concern going forward is how competitive an environment it will be. I think that as a general matter it has become more competitive and we’ve seen some pressure on cap rates, but I would also say that I think that our segment of the marketplace, smaller industrial and office deals, that that segment has held in there pretty well, better than everything else we’re looking at.

Trophy type assets, even in the net lease space, are getting very, very aggressive bids and so we feel pretty good about how we’re positioned in it, but I would say that in general we are seeing some pressure on cap rates, but remember that that pressure that we’ve seen on cap rates corresponds to changes in interest rates. So equity returns have held relatively steady, although if we had a crystal ball looking forward, clearly a risk is that there’s increased pressure on cap rates going forward, even in our stuff. So far we’re very comfortable with where that is, but that’s in the category of unknown.

Jason M. Ursaner – CJS Securities, Inc.

Okay. And on the cost of capital side, obviously you mentioned the transformation this past quarter led by the BofA, which sort of leapfrogged the goal becoming an unsecured borrower. When you talk about continuing to lower your cost of capital, how tied in do you see that with the next goal of investment grade credit and is that goal still really needed at this point to de-risk the investment strategy, just given that raising capital obviously is always a key risk, but it hasn’t posed much of a challenge so far with plenty of capital and the deals you’ve done?

Gordon F. DuGan

I think there’s just an incremental savings to get into that next level of investment. Our goal is still to be an investment grade unsecured borrower in 2015. There are two benefits to it, flexibility and cost of capital. The other benefit is that I think the companies that have done that well and thoughtfully have benefitted from the equity multiple as investors look at companies with better and more flexible and more termed out balance sheets as deserving of higher multiples. So we see it as a cost of capital and a structural benefit, but we think ultimately its greatest benefit resides in getting a better equity multiple.

Jason M. Ursaner – CJS Securities, Inc.

Okay, great. I’ve a few more but I’ll jump back in queue in for follow-up if there’s time.

Benjamin P. Harris

Jason, just one other thing to add to that that the cost savings of becoming investment grade in and of itself is somewhat de minimis. The savings come about when you become a seasoned well-known bond issuer. So if we’re to just go and get a rating tomorrow and then go to issue bonds, our bond pricing would probably be a lot wider than sort of a similarly rated seasoned issuer. So it’s not as driven by sort of a cliff achievement of investment grade as much as it’s becoming a known entity in the bond market and then becoming a seasoned issuer. And then if you look at – realty income is a great example of that. They’re a very well-known seasoned issuer and achieved very efficient executions on their bond deals.

If you look at some of the smaller net lease REITs with comparable ratings, but without as much fixed income activity and without as much bond market activity you’ll see their bond spreads at higher.

Jason M. Ursaner – CJS Securities, Inc.

Got it. Appreciate that, Ben, and thanks for all the other details, Gordon.

Operator

And our next question comes from Mitch Germain from JMP Securities. Mitch please go ahead.

Peter Anthony Hunt – JMP Securities LLC

Hey guys it’s Peter on for Mitch. Thanks for taking the question.

Gordon F. DuGan

Hi Peter.

Peter Anthony Hunt – JMP Securities LLC

Hi. Would say the 25 bps in compression that you mentioned in your last, in the previous question, is reflected in the 2Q deal pricing.

Benjamin P. Harris

Yes I think it’s been a gradual – it’s almost like a weighted average concept. It’s been a gradual impact. I think it’s we’ve seen some of it in Q2. I think we’ll see some of it in Q3. And I think that we’ll see it through – we’re seeing it probably through the remainder of the remainder of this year. It is not a – I want to be very clear, we’re not seeing pricing pressure the way we have in the past cycles. It’s not 2007. It’s not frankly May of 2013 where the tenure bottomed our around 160 and there was very fierce cap rate compression at that time and so it’s a more gradual and a softer compression, I think reflecting the fact that rates have stayed low and have actually gone down substantially since the beginning of the year.

Peter Anthony Hunt – JMP Securities LLC

Okay and other types…

Gordon F. DuGan

One other thing to add to that, I think, especially through our managed asset business, we’re seeing pretty healthy fundamental activity in the real estate markets, very strong absorption in markets that frankly we were less optimistic about six months ago.

Benjamin P. Harris

Market like Charlotte.

Gordon F. DuGan

So I think some of that return that you’re losing in cap rate you’re going to see sort of [may] (ph) through fundamental asset performance in real markets with rent growth.

Peter Anthony Hunt – JMP Securities LLC

Okay and would you say there’s still a number of portfolios in the pipeline and would you say the pricing delta between these and one-off is shrinking or what’s an accurate description of the dynamic there?

Benjamin P. Harris

That’s a very good point. I’d say that there are always a – the reason I keep quoting that 3% to 5% of net lease assets that are owned in public company form just shows, and shows and net lease companies are now 7%, 7.5% of the [RMC] (ph). It shows just how big the sector is and how fragmented it is and so we expect to continue to see portfolio activity and we also while I would say that we’ve seen some cap rate compression on the one-off deals, we’re probably going to see portfolio returns drift upward.

The most active acquirer, ARCP, has said that they’re on the sidelines for the remainder of the year for any large scale portfolio. There have been a lot of portfolios come to market based upon recent activity in the net lease space so I wouldn’t be surprised if we saw a closer, less of a portfolio premium for portfolios for the coming six to 12 months because I think portfolio returns are actually going to be more attractive going forward with a less frenzied M&A market.

Peter Anthony Hunt – JMP Securities LLC

Okay, great, that’s really helpful. And the last question, I know you mentioned some of the smaller industrial stuff but are you guys seeing any more specialized assets such as cold storage truck terminals, stuff that you’ve historically done in the past? Thanks.

Benjamin P. Harris

Yes it’s still an area of focus for us, cold storage being one of our favorites. Cold storage in major markets is an asset class that we like very much, cold storage. And when I say major markets, a very limited number of major markets. Cold storage in secondary and tertiary locations is of much less interest to us so we’re seeing the specialized deals, the specialty assets that we have that we’ve bought or have under contract we think are great examples of high ROA real estate assets, in part because they don’t fit neatly into any other easy category. Truck terminal, cold storage, car rental facilities things like that.

Peter Anthony Hunt – JMP Securities LLC

Great thanks guys.

Operator

And our next question comes from Dan Donlan from Ladenburg Thalmann. Dan please go ahead.

Daniel P. Donlan – Ladenburg Thalmann & Co. Inc.

Thank you and good afternoon.

Gordon F. DuGan

Hi, Dan.

Daniel P. Donlan – Ladenburg Thalmann & Co. Inc.

Hey just two real rapid fire quick questions here, the incentive fee in promotes, you know, your guidance I think as of last quarter was $16 million to $22 million through 2016. Are you guys holding to that or given that you bought in Bank of America, does that maybe bring that down a little bit?

Gordon F. DuGan

Yes the $16 million to $22 million included $5 million of BofA but I would say that so on a just adjusting for that that would bring us to $11 million to $17 million. I would say the upper end of that has been pushed up as commercial real estate prices have come up. So while it’s a wider range, I would say $11 million to in excess of $20 million is the expected range at this point. As commercial real estate values have recovered and the team that manages those have done a great job, there’s a lot more upside in that number than we had – that number continues to have more upside as time goes by.

Daniel P. Donlan – Ladenburg Thalmann & Co. Inc.

Okay.

Jon W. Clark

Dan, those returns are really being driven by primarily value add plays so as leasing activity has picked up, that’s improved the prospects of certain assets and probably shortened some of the time lines on some of the promotes associated with those assets, as well.

Gordon F. DuGan

And it’s we’ll know more. We have a lot of activity in that area that that area I could go on for 20 minutes about how active and positive the momentum has been but we’ll have an update on that as we get into Q3 and we start to get – we have leases out in some cases, we have leases signed in some cases so we’ll want to update that. But we probably have more upside on that or they’ll probably – we definitely have more upside on that number than we did before and that’s just having a finger. It’s the tail of the whip, having a finger on the pulse of the commercial real estate market.

Operator

And our next question comes from Wilkes Graham from Compass Point. Please go ahead.

Wilkes Jackson Graham – Compass Point Research & Trading, LLC

Hi good morning guys, or good afternoon.

Jon W. Clark

Hi Wilkes.

Wilkes Jackson Graham – Compass Point Research & Trading, LLC

Hi. So just a couple of questions, one on the cost of capital front, looking on Page 16, can you talk about what the latest mortgage rates look like out there for industrial? And then if you have any plans or interests on replacing the [8 and 8th] (ph) preferred?

Gordon F. DuGan

I’ll let Ben hit the mortgage piece of it.

Benjamin P. Harris

Sure. Spreads have come in I would say the conduits are competing more with structure and with terms and we’ve seen LTVs come up more than spreads have come in but spreads have definitely moved. A 10-year fixed rate conduit loans are pricing anywhere sort of low to mid 4% range today and 60% to 65% was sort of full leverage 12 months ago now that’s 65% to 70%.

Gordon F. DuGan

Yes borrowing spreads are great. On the preferred side we don’t have anything that we’ve announced. What I would say about that is look the thing is callable if market conditions allow us to lower the cost of capital on that piece of our capital structure. At some point in the future we would look at that possibility and that’s where we are today.

Wilkes Jackson Graham – Compass Point Research & Trading, LLC

Okay and then sort of a wide ranging question here but as I look at the FFO run rate on Page 15 of $0.07, I look at your guidance for $0.09 to $0.10 for the latter part of this year, there’s always been a path certainly in our mind to you guys maxing out your long-term incentive comp plan and getting to stock plus dividend of $9 by mid 2016 and in my mind if you can get your whatever metric you use to determine your dividend up to maybe $0.12 a share next year which I think going from $0.09 to $0.10 this year to $0.12 next year quarterly is not that difficult assuming the market holds.

Then I think there’s a path to getting there if you can -- obviously if you raise your payout ratio to a level more in line with peers and more suitable for you when you’re perhaps not in such a high growth phase. Having said all of that, my question is if you find yourself a year from now and spread, cap rates have come in and equity returns have come down, do you go to Europe or do you have other things that you can do from a strategic perspective to still try to get to that hurdle?

Gordon F. DuGan

Yes so I would say a couple things, Wilkes. One of the things that we look at is we’re more than halfway through 2014. If you look at 2015 based on your estimates or others’ estimates, Gramercy is not a very expensive stock. It’s arguably pretty cheap on an estimate, on estimates for next year at whatever levels people have. It’s trading at a very comfortable level so one of the things we think that will happen that really hasn’t happened is as we get toward the latter part of this year, we’ll now be guiding toward 2015 numbers and if things continue to progress and we have a continued tailwind and all of the things that have to happen, we think that the stock will start to look very attractive from just an FFO multiple which is nearer term and much less risky than we all started looking, talking about Gramercy.

We’re so much further down that road so over the next couple of quarters I think that will clarify. The second thing is we’ve intentionally kept smallest dividend payout ratio in our sector. Our institutional investors that I talked to are very comfortable with that. I do believe there’s room for significant dividend increase and increases coming up but from our standpoint even though the retained capital isn’t all that great, we like some retained capital. We like maintaining a low FFO, AFFO payout ratio so I think the dividends will not be a driver of stock performance for quite some time, even if we are able to increase it significantly as we continue to grow earnings because I think we want to keep a low payout ratio. And our, again the institutional investors that are supporting us are very comfortable with that.

And then the last thing I would say is this investment management initiative that we outlined in our presentation, the reason we like this so much off balance sheet equity is a great way to grow the value of the business. W.P. Carey has done it well, North Star has taken a very different model, but has done it very well, particularly a shareholder value. So we think that in this value. So we think that in this scenario you just painted of continued competition, continued capital flows, we think that if we can execute on creating some traction on the investment management side, we have the ability to create significant value for shareholders and for us in terms of our incentive plan.

So the investment management piece is a very leveraged way of growing value per share in a company like this and I would say that I think most public REITs probably haven’t done enough of on the investment management side an there’s a couple arguments for it. In many cases it creates a more complicated story. We’re going to be very focused on not complicating the story but I do think the investment management piece, which I’ve said repeatedly, don’t expect anything to contribute to 2014, if we can make some progress could be in a year from now could be a real difference maker.

Wilkes Jackson Graham – Compass Point Research & Trading, LLC

Thank for that Gordon, I appreciate it.

Operator

And our next question comes from Jason Ursaner from CJS Securities. Jason please go ahead.

Jason M. Ursaner – CJS Securities, Inc.

Thanks for taking the follow-up question. Just back on the Q2 run rate FFO slide, I want to make sure I am following it. It doesn’t look like it’s including all of the normal adjustments to get from FFO to AFFO, so is this just a snapshot of run rate FFO exiting the quarter basically to show full consolidation of the BofA?

Gordon F. DuGan

That’s exactly what it is, Jason. It’s not an AFFO run rate. I think we did an AFFO run rate for Q1. We may – maybe we’ll add an AFFO run rate for Q2 as well but this is just an FFO run rate and all of the adjustments down below of taking out the BofA JV revenues, obviously then up above we have an increase in pro forma NOI assuming we owned all of the Bank of America JV for Q2 as well as any other assets that were bought in the quarter. We take a full quarter’s revenue and a full quarter’s expenses against it. And really the big impact, the big negative impact is taking the full amount of diluted shares outstanding when we have $100 million plus of cash on our balance sheet.

Jon W. Clark

Jason there’s no magic to why we did FFO versus AFFO, we had given guidance at the beginning of this year in FFO so we’ve stuck with that but if it would be helpful we’re happy to provide both numbers, both run rate numbers.

Jason M. Ursaner – CJS Securities, Inc.

Got it. I’m just also trying to figure out, the pro forma NOI, I understand it’s all the things you bought. Is it also a full quarter run rate for the Hialeah build-to-suit?

Jon W. Clark

That’s right. It’s including the Hialeah build-to-suit went into production or into service during Q2 so that’s accounting for that full contribution.

Jason M. Ursaner – CJS Securities, Inc.

Oaky. And then also following-up on the question before about guidance, not asking you to commit to anything numbers wise or from a structural perspective, in terms of handling guidance going forward you alluded to guiding 2015 coming up. Will you just be continuing to give expectations for run rate FFO exiting a couple quarters out or are you giving anymore thought long-term AFFO guidance?

Gordon F. DuGan

Jason, I’d say you’re a step ahead of us. The answer is we really haven’t figured that out. I think we’ll do that in consultation with the analyst community investors to make sure we’re providing people what they want. I think that there’s a – one other things in going through Q2 is there’s probably some benefit to doing both an FFO and an AFFO going forward because there are different adjustments for each and we’re – that still being formed as to what sort of appropriate post that’s Q3, Q4 and whether frankly Q3 or Q4 we got anything more to Q3 or Q4.

Jon W. Clark

We aspire to be a Company that gets very normal, conventional guidance. At the current stage the business is so dynamic that it’s – and the timing of transactions has such a big impact that we felt that run rate was an easier and clearer way to communicate the earnings power of the business. As the portfolio gets more mature and as the business gets more mature.

Benjamin P. Harris

(indiscernible)

Jon W. Clark

It will become easier to just look at through the quarter-to-quarter numbers without it and then the run rate will become less relevant.

Benjamin P. Harris

Yes ran rate basically falls right on top of actual at that point.

Jason M. Ursaner – CJS Securities, Inc.

Just trying to get all the help we can get. I appreciate all that.

Benjamin P. Harris

Yes don’t mention.

Jason M. Ursaner – CJS Securities, Inc.

Thank you.

Jon W. Clark

Thanks Jason we appreciate it.

Operator

And our last question comes from Dan Donlan from Ladenburg Thalmann. Dan please go ahead.

Daniel P. Donlan – Ladenburg Thalmann & Co.

Thank you. Gordon, I appreciate the comments on the JVs and the insulated programs in terms of the impact that it sounds like there could be a potential impact to 2015 kind of in the back half of the year. If all goes as planned, is that kind of your idea? I mean obviously I am not going to be probably included in anything but just kind of curious on and make sure I heard that correctly.

Gordon F. DuGan

It’s a good question Dan. How would I say it? You know, when I had lunch with David Hamamoto talking about North Star, I remember one of his lines. He’ll probably hate me quoting him but was in getting into the non-traded REIT business it took him five years and $25 million or whatever it was. So I view the initiative as creating – as a way to create long-term value per share and I would expect something to impact. I mean I can’t – we’re - either there’s no impact in 2015 or there’s impact in 2015.

But we’re thinking of it less from a – that’s why I wanted to show ` the NOI growth per quarter. I thought that’s the primary driver of growth in the foreseeable future. But by beginning some of these other initiatives we have a chance to really impact the value per share of what the fundamental franchise of Gramercy is worth.

If you look at W.P. Carey, if you look at some of the other companies that have done that well, North Star they’ve really created massive shareholder value in these areas and in many cases it took a long time for them to do it. I will say we’re too small to take a long time and put a lot of money into it so our approach to this is to do things that are accretive and not dilutive and so hopefully we’ll be able to do that and impact the Company in 2015.

It’s a long winded way of saying yes I think there will be an impact in 2015, but I wouldn’t expect much of a P&L impact, but rather the ability to see traction on some of these initiatives will – there will be that type of traction and visibility in 2015.

Daniel P. Donlan – Ladenburg Thalmann & Co.

Okay hear you loud and clear on that. And then just Slide 9 and I feel like you maybe have mentioned this at some point in time in the past but you’ve got 30 acres of specialty in Miami under contract. I appreciate if you can talk about it since it’s under contract. But just kind of curious if you could give us any more details there if that was just a sale leaseback on the land or is there some type of build-to-suit opportunity or if you just don’t want to comment I understand as well.

Gordon F. DuGan

What I’ll say is this is a great specialty asset I alluded to the San Francisco Bay area as a rental car parking facility. This is a – we’ve been trying to come up with a better term for this but it is what it is. It’s a salvage yard in essence. There are pieces of land in the best part of the industrial area of Miami where they’re currently operated as salvage yards under a long-term lease. Of all the amazing things in the world, I’ve learned this year one of them is that there is a very large publicly traded salvage yard operator, which is a tremendous credit and so we’re pursuing that acquisition of – you know, this is a great example of land that has enormous upside eventually but will likely be utilized by the current user for the foreseeable future for their existing use. They are all Main and Main locations in Miami industrial.

Jon W. Clark

I have a friend who runs an opportunity fund and he calls these covered land plays and I think it’s a great term for them. This is, as Gordon said, 30 acres in a great location in an – or great infill location in Miami. It’s all being redeveloped into Class A industrial all around us. And we get to get paid a very high yield for sitting on this property. We’re buying it on a per acre basis at pretty close to cycle low cost. It doesn’t attract as much attention from the traditional industrial developers because they don’t know when they’re going to be able to access it. We believe this will be a salvage yard for an extended period of time but at the end of that term we have a very interesting redevelopment asset that could be worth significantly more than what we’re paying for it paying for it.

And that’s really what we’re trying to accomplish with a lot of these assets. It’s very similar to what we were trying to do with the bus depot in Chicago. It’s very similar to what we’ve – the Enterprise Rental Car Center that we purchased at Chicago O’Hare, the rental terminal in the San Francisco Bay area but really trying to take a creative approach and some intrinsic real estate work to really understand assets and frankly uncover value that is maybe not appreciated by the overall network and we can acquire these assets at very high returns and this is one of the assets I’m probably most excited about in our entire pipeline.

My wife thinks I am nuts, wishes we bought shiny buildings but…

Gordon F. DuGan

We have some of those in the pipeline too, we have some shiny buildings.

Daniel P. Donlan – Ladenburg Thalmann & Co.

Well I look forward to a property tour down there.

Jon W. Clark

Yes.

Daniel P. Donlan – Ladenburg Thalmann & Co.

All right thanks guys.

Gordon F. DuGan

All right thanks Dan.

Jon W. Clark

Thanks Dan.

Operator

And this occludes the question-and-answer session. I will now turn the call back over to Gordon.

Gordon F. DuGan

Well I just want to close by saying thanks again for joining us on August, Thursday afternoon. We really appreciate your support, we’re working very hard to continue to create value for all of our shareholders, as we’ve done over the last two years, and we’re very excited about the opportunities ahead of us. Thank you.

Operator

Thank you. Ladies and gentlemen this does conclude today’s conference. Thank you for participating. You may now disconnect.

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