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DuPont Fabros Technology (NYSE:DFT)

Q4 2011 Earnings Call

February 08, 2012 10:00 am ET

Executives

Christopher Warnke - Manager of Investor Relations

Hossein Fateh - Co-Founder, Chief Executive Officer, President and Director

Mark L. Wetzel - Chief Financial Officer, Executive Vice President and Treasurer

Analysts

Jordan Sadler - KeyBanc Capital Markets Inc., Research Division

Srikanth Nagarajan - Cantor Fitzgerald & Co., Research Division

Jonathan Atkin - RBC Capital Markets, LLC, Research Division

Brendan Maiorana - Wells Fargo Securities, LLC, Research Division

Michael Bilerman - Citigroup Inc, Research Division

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

Ross T. Nussbaum - UBS Investment Bank, Research Division

Omotayo T. Okusanya - Jefferies & Company, Inc., Research Division

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

Robert Stevenson - Macquarie Research

David Rodgers - RBC Capital Markets, LLC, Research Division

Romeo A. Reyes - Jefferies & Company, Inc., Research Division

Christopher R. Lucas - Robert W. Baird & Co. Incorporated, Research Division

Unknown Analyst

Emmanuel Korchman

Operator

Welcome to DuPont Fabros Technology's Fourth Quarter 2011 Earnings Conference Call. Today's call is being recorded. At this time, I'd like to turn the conference over to Chris Warnke, Investor Relations Manager for the company. Mr. Warnke, you may begin your conference.

Christopher Warnke

Thank you. Good morning, everyone, and thank you for joining us today for DuPont Fabros Technology's fourth quarter 2011 results conference call. Our speakers today are Hossein Fateh, the company's President and Chief Executive Officer; and Mark Wetzel, the company's Chief Financial Officer and Treasurer.

Certain matters discussed during this conference call may constitute forward-looking statements within the meaning of federal securities laws. These forward-looking statements are subject to certain risks and uncertainties. The company assumes no obligation to update or supplement these statements that become untrue because of subsequent events. Additionally, this call contains non-GAAP financial information, of which explanations and reconciliations to net income are contained in the company's earnings release issued last night, which is available in PDF format in the Investor Relations section of the company's corporate website at www.dft.com.

To manage the call in a timely manner, questions will be limited to 2 per caller. If you have additional questions, please feel free to return to the queue. I will now turn the call over to Hossein.

Hossein Fateh

Thank you, Chris, and good morning, everyone. Thank you for joining us on our fourth quarter 2011 earnings call. As noted in last night's press release, we again delivered solid quarterly and full year financial results for 2011, which Mark will discuss later in the call. 2011 was our fourth year as a public company. We are proud of our accomplishments, none of which could have been achieved without the hard work of our excellent team of employees. I thank each one of you for your valued contributions.

Leasing is our primary focus, so I would like to begin with an update. We placed into service 86-megawatts of critical load within the last 15 months. We have leased just over half of it. We are confident that we'll be successful in leasing the other half. For the full year 2011, we signed 14 new leases, totaling 25 megawatts of available critical load, with a contract value of over $425 million. This compares to 23 megawatts in 2010 and 37 megawatts in 2009. During the fourth quarter, we signed 3 leases, totaling 3 megawatts of available critical load. Two leases were in New Jersey, which were previously discussed on the last call. The third lease is a new lease in Chicago, with a new health care tenant. So far in the first quarter, we signed 1 lease in Santa Clara for 2.28 megawatts. This lease commenced in the first quarter. This building is now 25% leased.

On a macro level, we remain comfortable with the fundamentals and industry trends for future data center space. The amount of data stored and processed worldwide continues to double every few years. We are well-positioned to capitalize on this trend. The challenge in the short term is executing new leases. Traffic remains good. However, sometimes decision-making for larger blocks of space we offer is unpredictable and can take longer to execute.

As I have stated many times, leasing wholesale space is a lumpy business. We remain confident that we will lease the vacant space in our buildings. Nevertheless, we have pushed out the lease commencement start date by a couple of quarters. This means that the majority of the 2012 leases not executed as of today will commence in the second half of the year. This covers the vacant space in Santa Clara, Ashburn and New Jersey. The timing delay affects our original expectations and your expectations for the 2012 guidance, which Mark will walk you through. This does not affect the margins or NAV we expect to create once the buildings are leased. Returns on our invested capital remain in the 10% to 15% range.

One important point to remember is that we do not require raising new capital. Now that all new construction have finished, our challenge is to lease the remaining buildings we opened in the last 15 months. The timing and pricing of the new leases will impact our NOI, FFO and taxable income significantly over the next 2 years.

I will now give you an update by market. Chicago Phase II opened last week. This phase is 79% leased and remains a top market for us. Phase II has 1 new tenant compared to Phase I. This reconfirms our strategy of building in 2 phases. In new markets, we experience the greatest leasing risk in the first phase. Once Phase I is leased, our risk is reduced significantly because our Phase I tenants will typically grow with us. There is no secured debt on this facility and we continue to expect a 12% unlevered return once fully leased. Leasing at CH1 has done better than expected.

New Jersey has competition but we represent the majority of the available built-out inventory. Financial institutions have been and continue to be a large percentage of the demand in this market. They, however, have been thoughtful in making decisions based on overall economic environment. There is no secured debt on this property and we remain at 34% leased at NJ1 as of today. Leasing in this market has been slower than expected. On January 12, the NYSE placed in service the Safety Access Center at NJ1. This access center offers full safety network services and support and offer tenants more direct connections to the financial market and market information. We believe this will attract new financial tenants to the building.

Northern Virginia remains a solid market for us. This is where we have the greatest concentration of tenants and critical load. As our tenant requirements increase, we like our chances to capture this embedded growth. Power remains cheap and fibers abundant. Although leasing has been slower than expected, we are still experiencing good traffic. In the long term, we are not concerned about this market. We remain at 8% leased at ACC6 as of today.

Santa Clara opened on October 1. This is an excellent, well-positioned asset. We have competition in the valley, but we have the majority of the available space in this market. Demand within this market can surface quickly. An application or a business can suddenly take off, creating unexpected demand. It is hard to predict this type of event, but we are well-positioned to capture the opportunities. There is no secured debt on this property and we continue to expect unlevered returns of 10% to 12%. As of today, SC1 is 25% leased. The leasing pace in this market has been what we expected.

In a few markets, we are seeing an emergence of a super wholesale category of tenants. These are tenants which have requirements of 8 megawatts or more who would normally build their own. If we agree to a return of around 10%, they would likely lease with us instead of building their own. Our biggest competition has always been tenants doing it themselves. In this range of returns, we're seeing even the very large tenants interested in outsourcing. We continue to explore all of these opportunities.

In summary, we believe that there is and will be sufficient demand in all 4 markets to absorb our available inventory. When market vacancy is discussed, it may be viewed, there is considerably supply. However, it's important to note in Northern Virginia, New Jersey and Santa Clara, we are the majority of the market vacancy. We have a proven leasing track record and remain confident in our ability to lease.

The positive signs for our industry remain in place. Less than 20% of enterprises outsource their data center requirements. We believe there is a potential for considerable growth as companies realize the benefits of outsourcing. Additionally, we believe that cloud computing, gaming, data retention and processing will continue to grow significantly year-over-year. This growth will also increase the need for data center space. Leasing our available inventory is everyone's primary goal for 2012. We are focused on the long-term value creation of the company.

Now, I will turn the call over to Mark, who will take you through our financial results.

Mark L. Wetzel

Thank you, Hossein. Good morning, everyone, and thank you for joining us. I want to cover 5 main topics today: a fourth quarter and full 2011 results, a capital markets update, a walk through our 2012 guidance, a summary of the 2012 expected sources and uses of cash, and a 2012 dividends update.

For the fourth quarter of 2011, the company's FFO was $0.37 per share, compared to $0.33 per share in the fourth quarter of 2010, an increase of 12%. For the year, FFO was $1.61 per share, compared to $1.33 per share for the prior year, an increase of 21%. The overall increase for both reporting periods is due to new leases commencing. AFFO was $0.32 per share for the fourth quarter, compared to $0.25 per share quarter-over-quarter, an increase of 28%. For the year, for the year ended, AFFO was $1.23 per share, compared to $0.92 per share for the prior year, an increase of 34%. These overall increases for both reporting periods are primarily the result of increased cash rents collected from tenants.

Quarterly revenues were $74.4 million, our highest ever. This increase was $8.4 million or 13% quarter-over-quarter. For the year ended, revenues were $287.4 million, compared to $242.5 million for 2010, an increase of 19%. As to a capital markets update, in January of 2012, we sold 2.6 million shares of perpetual preferred stock, raising approximately $63 million. The proceeds from this raise were used to pay off $35 million that was outstanding on our line, with the remaining amount for dry powder. Cash on hand today stands at $50 million and our unsecured $100 million line remains available.

As of today, the interest rate on 80% of our debt is now fixed. Based on our 2011 results, we are very confident in our ability to continue to meet the financial covenants of our loan agreements. We do not have any bullet debt maturities until December of 2014. Our balance sheet is in great shape and we plan to keep our leverage low.

I now would like to discuss our 2012 guidance. Our 2012 FFO guidance range is $1.31 to $1.51 per share. Let me walk you through this reduction as compared to our 2011 actual results of $1.61 per share. Interest expense, preferred dividends and non-recurring G&A will have a negative impact on FFO of $0.40 per share year-over-year. As we stated on our third quarter call, we do not expect to commence any new developments in 2012. We continue to believe this is prudent. The effect is a year-over-year negative impact to the interest we expense on the P&L as compared to what we capitalized to our developments and balance sheet. For 2011, we capitalized $28.4 million. In 2012, we expect to capitalize only $1.4 million. We do, however, have savings of $2 million cash on lower interest rates year-over-year. This net difference represents a $0.31 per share negative FFO impact. To be clear, this difference is expensed to the P&L and does not affect any covenant ratios, fixed charge ratios or our ability to pay. We fully expect to pay all interest payments on time as scheduled.

As to preferred dividends, we accrued $21 million in 2011 and expect to accrue $27 million in 2012. This includes the $65 million of additional Series B just raised, which we discussed on the third quarter call. This difference represents a $0.07 per share negative FFO impact. We fully expect to pay all preferred dividends on time as scheduled.

2012 G&A is up $0.05 per share year-over-year. This increase includes $2 million of compensation related to the development personnel. We will expense this rather than capitalize it during the year as no development starts are planned. 2011 G&A includes zero cost for the development team. This difference represents a $0.02 per share negative FFO impact. We currently believe that the commencement of new leases for space in our non-stabilized facilities is more likely to begin after the first quarter of 2012 and through early 2013. This timing directly impacts the timing of recognizing additional revenue and net income from new lease commencements at these facilities.

As Hossein mentioned, the lease-up of the available space is critical. As of today, we see the pace of executed leases that can be signed and commenced in 2012 to be slower than what we'd previously thought. The decision process simply is something we cannot control, which is why we have tempered our 2012 lease commencement starting dates. On occasion, demand does come out of nowhere. Having available inventory will enable us to sign and commence a lease quickly which, in the long run, we believe is a competitive advantage.

The operating costs of opened buildings not leased represents a negative impact to our 2012 earnings as we have not -- as we are not reimbursed for the operating costs on the vacant inventory and do not receive a management fee. Year-over-year, excluding base rent, we expect this negative impact to be $10 million or a reduction of $0.12 per share of FFO in 2012. During lease-up, this implies lower overall margins. Once leased, the margins return to our historical norms under the triple net lease structure. As a reminder, on an individual building basis, once a building reaches 25% to 30% leased, it breaks even when we include the base rent and all expenses.

Our 2012 guidance expectations include the following. Base rent for new leases already executed with commencements in 2012, net of Yahoo!'s termination on April 30th, total approximately $18 million or $0.22 per share. Base rent on new leases we expect to sign and commence in 2012 total approximately $11 million or $0.13 per share. Both of these assumptions place our revenues at the midpoint of our guidance range. These projected new lease commencements are primarily spread over the second half of 2012. This places our non-stabilized portfolio at about 70% stabilized, up from 39% today as of the end of 2012.

In summary, our 2012 FFO midpoint is $1.41 per share. We project revenues of $325 million, up 13% year-over-year. We project operating income, excluding depreciation or EBITDA, of $200 million, up 9% year-over-year. Given the current environment, we think it's appropriate to look at the business as it is now. Once we are able to lease the current non-stabilized portfolio, we expect approximately $60 million of incremental annualized NOI from new leases not yet executed or commenced without a new capital raise. We have conservatively budgeted approximately $11 million of new lease commencements of this NOI in the 2012 guidance, with the remainder in 2013. This equates to approximately $0.60 of 2013 FFO based on the current share count.

Cash flow remains a priority, so let me quickly walk you through our expected sources and uses for the calendar year 2012. Our 2012 sources total approximately $137 million. We started the year with $14 million in cash, the net proceeds from the January preferred raise was $63 million, and we expect free cash flow from operations after dividends to be $60 million. Our 2012 uses total approximately $64 million. The cash spend to complete the existing developments is $35 million, the $20 million line of credit outstanding at year-end is paid off, $4 million of recurring portfolio level CapEx and $5 million on the principal loan amortization paydown.

Page 15 of our release details out other assumptions related to our 2012 guidance. The 2012 guidance also assumes no development starts, no debt or equity raises unless leasing exceeds our expectations.

As to a dividend update, we expect to continue to pay a $0.12 per share cash quarterly common dividend. We will reevaluate any change as the year progresses. An increase is contingent on new lease commencements. Our policy remains consistent to pay at least 100% taxable income. Any future changes to our common dividend will be approved by our Board of Directors. We believe our current balance sheet and financial condition gives us a solid foundation. With that, let me turn it back over to Hossein.

Hossein Fateh

Thanks, Mark. Before we open it up for questions, let me offer 2 final comments. First, leasing is the key to increasing shareholder value, and we're confident in our ability to do it. Secondly, Jonathan Heiliger joined the company's Board of Directors in November. Previously, he served as Vice President of Technical Operations for Facebook. His addition provides the board with the perspective of a designer and a user of innovative data center solutions. We are happy to have him with us. With that, I will open up the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question will come from Kreg Milliman [ph] of KeyBanc Capital Markets.

Jordan Sadler - KeyBanc Capital Markets Inc., Research Division

It's Jordan Sadler here with Kreg. First question is I'm curious about your comments regarding the super wholesale tenants you're seeing in the market. And it sounded as if you talked about lower potential returns on certain projects as a result of maybe potential leases with these types of tenants. Can you maybe just give us a little bit more color around the number of tenants like this in the market, the markets they're showing up in? And then sort of the genesis for the lower returns versus your historical underwriting.

Hossein Fateh

It's only, again, 8 to 15-megawatt type tenants that we're talking about. And that size tenants, there are only like less than a handful that we're talking to, primarily in 2 markets. And we're not prepared to discuss which markets because there are only a few of them. There are only a handful of tenants that can take that much space. Now, the comment was just to give not necessarily that we'll have lower returns, no. But what the comment was meant to give you more color on, a positive tone of what we're seeing is where before, a year ago, it was, look, you get to 10 megawatts, after you get to 10 megawatts, you can do your own. Here we're saying that, look, if you get to 10 megawatts, you could now do your own or, in a lot of ways, some tenants are realizing outsourcing makes more sense because they are able to go into a bigger building than an 8-megawatt building, a 36-megawatt has significantly lower operating expenses and have the savings there, and also, with that savings, they're able to really -- it'll be similar to owning their own, which in this current economic environment, we're seeing deals that otherwise would be built-to-suits that maybe some of our other competitors are even talking about, saying look, but we'll also consider an outsourced data center that's 36 megawatts, what if we take 10 megawatts of it? We have not executed any of those but we're seeing those deals in the market. But typically, if the entire data center was at those type of rates that those very large tenants were looking for, it would be approximately a 10% return. But we're never going to have the entire data center with 1 36 megawatt tenant. It just doesn't exist.

Jordan Sadler - KeyBanc Capital Markets Inc., Research Division

Okay, but you're saying essentially those leases are being underwritten at 10% returns?

Hossein Fateh

Yes, approximately. I mean, the same as doing a built-to-suit, right? Built-to-suits that are out in the market are essentially around those rates. But what they get in going into a very large building is that they'll have the operating expense savings as well.

Jordan Sadler - KeyBanc Capital Markets Inc., Research Division

Should we also expect that the lease term would be similar to a built-to-suit type transaction in terms of the overall term?

Hossein Fateh

Yes, that's correct. I would agree with that. It will be longer than what we typically see.

Jordan Sadler - KeyBanc Capital Markets Inc., Research Division

10-plus years?

Hossein Fateh

Much more than that, yes.

Jordan Sadler - KeyBanc Capital Markets Inc., Research Division

Okay. Last question is, I mean is this -- it seems the guidance obviously is catching everyone by surprise. And I understand some of the drivers here, one of which, which you've obviously gone through, the capitalized interest, which we all really should've had in our numbers. But separately, the leasing. Is this super wholesale strategy a piece of that lowered guidance? And how much of guidance is you setting the bar so that there's no possible way you could miss this?

Hossein Fateh

No, this super wholesale strategy is absolutely not in the guidance. That was just a comment on what we're seeing out in the market.

Mark L. Wetzel

I think with specific to guidance for this year compared to what maybe consensus was, that we -- we obviously look at where leasing is each and every quarter. Sitting here today, what we think will sign this quarter and potentially in the next quarter is still up in the air. And it's really a function of just putting it out there, this is where we're at, and that low-end is obviously no leasing, the midpoint, the high-end is we'll be upside if we lease.

Hossein Fateh

Yes, on the low-end, basically we're being so conservative we could even not show up.

Jordan Sadler - KeyBanc Capital Markets Inc., Research Division

Yes, it seems that way. Okay, no that's helpful. Were you saying, though, if you were -- let's say you were to sign one of these super wholesale type tenants, there could be some downside relative to the $60 million of incremental NOI upside, Mark?

Mark L. Wetzel

Yes, I think the $60 million was in that midpoint, if you recall from some investor presentations last quarter, with I think Santa Clara was $11 million. Chicago was pretty well leased, so that one, $12 million is good. Ashburn and New Jersey were in that $10 million, $11 million or $12 million range. So maybe a point or 2 shaved off of that $60 million but not materially different.

Operator

Our next question will come from Sri Nagarajan of Cantor Fitzgerald.

Srikanth Nagarajan - Cantor Fitzgerald & Co., Research Division

A question just to follow up on what Jordan was asking there, in terms of perhaps rent impacts as you lease the space. I know that for guidance, you've pushed out the leasing but obviously, and you're talking about super tenant sizes as well in terms of tracking that as a demand. I was wondering how much of a tenant or rent sacrifice are you assuming in your guidance, number one? And would you have -- are you turning down tenants because of lower rents that are being asked in the market?

Hossein Fateh

The answer is we will not lose any tenants. We believe our rents are very competitive. If anything, we're told our rents are too low in some of our markets. So -- and the guidance we're giving is assuming the returns that we stated, that we feel comfortable in getting, which in Santa Clara has been 10% to 12%. In New Jersey, we're still at 34% leased, we're still comfortable with a 12% return. And Ashburn has been 12% to 15%. And in Chicago, that is we're almost fully leased, we're feeling comfortable at 12%.

Srikanth Nagarajan - Cantor Fitzgerald & Co., Research Division

Okay, fair enough on the development yields there. Second question, I mean just curious as to your remarks, Hossein, on you're saying that the big tenant leasing is taking time to sign out here. Obviously, from a peer perspective, I believe other peers may not be seeing the same type of things that you're seeing because of the big tenant decision-making that's probably slow here. My question has to do with product strategies. Are you planning to change that or in any way trying to alter the leasing situation here?

Hossein Fateh

Well, I have no comments regarding our competitors. We feel very comfortable with our market. We feel very comfortable with our product. Our customers tell us that we have the best product in every market. So that's where we are.

Operator

Our next question will come from Jonathan Atkin of RBC Capital Markets.

Jonathan Atkin - RBC Capital Markets, LLC, Research Division

I have a couple of questions. I was wondering, the leases that you signed in Santa Clara and elsewhere, were those existing customers upsizing their relationship or were those new logos that you signed? And then with respect to built-to-suits, is there any opportunity that you would consider that would maybe take you into a new market that you don't currently operate in?

Hossein Fateh

With respect the Santa Clara, all of our tenants, we have very, very strict NDAs in place. So we cannot comment in any shape or form in relation to who we signed and where. So I'm sorry about that. It just would be a violation of our NDA. With relation to built-to-suits, yes, we have looked at them. And we continue to look at built-to-suits. Again, typically what we're seeing is the 10% range in the built-to-suits and the leases being 15 to 20 years long. And we're looking at those type of built-to-suits.

Jonathan Atkin - RBC Capital Markets, LLC, Research Division

And then on the power side, I'm interested in any commentary you would have on what portion of the critical load that the customer actually takes and has the customers' ability to kind of gauge their actual usage, has that changed over the last several quarters?

Hossein Fateh

No. I think we're seeing different industries use different type of critical loads. We encourage our customers, as opposed to some data center operators, to use as much of the load that we make available, and we consult with them regularly in how they can use up the space more efficiently. So we haven't seen any change in the path. But it really depends by industry. Financial tenants are on the lower side, the West companies are much -- are really on the higher side.

Jonathan Atkin - RBC Capital Markets, LLC, Research Division

And then finally, just the leasing decision cycles kind of being elongated. So how much of that is due to internal budgeting on the part of the customer versus any kind of competitive part of that?

Hossein Fateh

Like I said, I don't want to say delayed because delayed means it's an industry trend. I just think it's lumpy. Sometimes you get it within the quarter, sometimes you don't. And our businesses is in the business of, we have less than 30 tenants and we only sign a handful of deals every quarter. So the subset is that -- the sample subset we're taking from is so small that I can't really give you a general market generalization.

Jonathan Atkin - RBC Capital Markets, LLC, Research Division

But those are driven by the customers' own internal considerations, it's not competitive supply? It's mainly the former or the competitive factors here as well that are playing into your outlook?

Hossein Fateh

I think at Santa Clara, we were very clear we see some competition and there was a market distortion. In other markets, no, it's been a internal decisions of shall we do it, shall we not, what shall we do, and considering all their options.

Operator

Our next question will come from Brendan Maiorana of Wells Fargo.

Brendan Maiorana - Wells Fargo Securities, LLC, Research Division

so I guess, Mark, it sounded like you were saying that your lease-up properties expected to get to 70%, I think per your guidance by the end of the year, up from 39%. If I do the math on that, I think it works out to be about 20 or 21 megawatts of leasing over the year. It doesn't sound like you really have anything that you expect to do in the first half of the year outside of maybe the lease that was signed in Santa Clara. And you've been running the last 3 quarters at around 4 megawatts of leasing. So is that -- as we think about 2013, how comfortable are you that you can get to that 70% level given that leasing over the past 3 or 4 quarters has been pretty sluggish?

Mark L. Wetzel

The first -- you're right, Q4 and Q1 to date have been low in terms of megawatts signed as compared to the last probably 8 quarters. There's a lot of deals that are on the table. There's traffic. So it's just a function of -- there's some in Q2 that we expect to close and then it's weighted in Q3 and Q4. But you're right, that 20-plus megawatts is our goal. We've accomplished that the last 3 years. I think you say in reference 37, 1 year, 23, 25 the other 2 years. So we're in that ballpark.

Hossein Fateh

And also, Brendan, when you look at it in Santa Clara and in New Jersey, we're really dealing with Phase Is. The Phase I of a building, it typically takes longer than the Phase IIs because we have those embedded, organic growth on the Phase IIs. And we are just in a time in our lifetime that we have gone out to these 4 other markets and we're dealing with Phase I in 2 new markets. And that typically, because we're dealing every customer is a new customer, is more challenging than the Phase IIs.

Brendan Maiorana - Wells Fargo Securities, LLC, Research Division

Yes, understood. Okay. And then, Hossein, maybe you can clear up kind of your comments with respect to returns and some of the commentary that's kind of been coming out of the market, where I think you guys have been willing to be more aggressive on rate. It sounds like you're suggesting that your return expectations, notwithstanding the super wholesale customers, are in line with what you've communicated previously. But there's been, I think, discussion that you guys would look to do deals at lower rates in New Jersey and maybe a couple of other markets and that you're willing to drive broker commissions a little bit higher too. So how do you kind of match up those comments with your earlier comments that your return expectations are still unchanged?

Hossein Fateh

Well, I think let me put Santa Clara aside because we adjusted our return expectations in Santa Clara. So when you put that market aside, so we look at our other markets, there are -- in New Jersey, in Virginia, we're very comfortable with our return expectations. In Chicago, we're almost there, right, at 79% leased. So we're very comfortable with that return expectations. And so it's really only New Jersey that you're talking about. And in New Jersey, we're about 1/3 leased. On 1/3 leased, the demand we're seeing, yes, we've quoted some rents lower because we really want that particular tenant. We've closed at some rents that are higher. At where we are today, at the 1/3 leased, we are comfortable with that 12% unlevered return. Now, how -- if we really want the particular tenant, yes, we'll fight for it. If -- some other tenants, we may want to stick to our rents. So I think there is a lot of broker talk, and especially in Jersey. Now, obviously, one of our biggest competitors raised their brokerage commissions and I wrote them an e-mail and said, okay, fine, we're matching it. And we would match that all the time. We're not going to lose deals based on a commission. And so that's how that came about.

Brendan Maiorana - Wells Fargo Securities, LLC, Research Division

Yes, understood. And how much, kind of for sensitivity, how much do increased commissions, like, does that impact your returns?

Hossein Fateh

Not significantly at all.

Operator

Our next question will come from Michael Bilerman of Citi.

Michael Bilerman - Citigroup Inc, Research Division

Hossein, I wanted to talk a little bit as to how you think about returns. You've talked a lot about the stabilized sort of returns and maybe a little bit lighter on Santa Clara but that you're holding firm on the other markets. But how do you think sort of from an IRR perspective? And I say that just because you obviously build big. You obviously have the cap interest for when you're building, but there's a certain amount of idle capital as you lease up these buildings and it takes 18 to 24 months to get them leased. You have the operating expenses that are obviously flowing through the P&L and higher costs, time, all these things that sort of impact over a long term sort of the return of a project, not necessarily your stabilized yield. But if you were to think from day one where you buy the land and you put your shovel in the ground and the all-in cost. You're not capitalizing interest but you certainly have spent all that money, it's idle. How do you sort of think about IRR?

Hossein Fateh

Well, I think the way I'm quoting a return is the GAAP rent over the total development cost. That's the 12%.

Michael Bilerman - Citigroup Inc, Research Division

But that development cost doesn't include the idle -- I mean you're not capitalizing any more debt to the projects but, arguably, you've spent all this money and you're not earning a return, so . . .

Hossein Fateh

Just to take the definition we're using, and you should use the same definition on your model, so we're apple-to-apples, is once the project is fully built and stop capitalizing, that's the amount, that's the denominator. And the numerator is all the GAAP rents.

Michael Bilerman - Citigroup Inc, Research Division

No, and I understand. My question goes more so, I mean do you not think about it from the perspective of if you were to build a -- let's say, a 10-year discounted cash flow analysis, obviously the early years of a project, you are obviously carrying a lot more of the capital with no rent. And if we were to think about it from an IRR, that IRR would inherently be less. So when you talk about that your returns haven't changed, the fact that the leasing is a little bit slower, the fact that you're holding more capital in the project with no return, that would affect your sort of IRR on the project.

Hossein Fateh

Oh yes, I agree. The longer the math works -- I mean, all of us went to business school, right? The longer it takes to lease, the lower the IRR. You can't argue with that.

Michael Bilerman - Citigroup Inc, Research Division

Right, and has that -- I mean as you think about the business model and where you're going, does that -- I guess do these projects change your thinking about how you build and how you want to approach it?

Hossein Fateh

Well I think we do -- we're not stubborn. We do believe that long term, as a landlord, these are the buildings that I certainly want to own. Because once you lease up a 36-megawatt building, our operating costs are a fraction of a 10-megawatt building. And the buildings are extremely high quality. Long term, if you're going to own these assets, this is what you want to own. Now, you're right, what we are looking at in some of the Phase IIs is, as we look at the Phase IIs, I'm glad you asked this question, we had looked at breaking up the Phase IIs into 9-megawatt and 4.55-megawatt increment builds. And we are now comfortable, even with the isoparallel design, of breaking down the build of the second half to those increments.

Michael Bilerman - Citigroup Inc, Research Division

So it allows you to phase it in a little bit better.

Hossein Fateh

Exactly.

Michael Bilerman - Citigroup Inc, Research Division

Mark, just a question on the -- sort of the NOI and the phasing through the year. And I think obviously you talked about this negative FFO two-fer, effectively; right? Where you're not getting any rent and you're having to take all of the operating expenses of the building, which you talked about being a $0.12 or about a $10 million hit for the entire year. I assume that abates during the year. So I'm wondering, if you look at where you are today, you are 33% leased and 39% -- 39% leased but 33% commenced in the 4 effective development projects. Assuming your stabilized yields and applying it to that, you would get to about $30 million of annualized NOI, but I assume you have a lot of operating expenses that will reduce that. So your effective yield is not sort of call it 4%, it's something much lower today. And as you move to the fourth quarter, you start to lease up to 70%, you get to that sort of $60 million of NOI based on your yields. But I'm just not sure sort of where you are in the first quarter in terms of NOI contribution from the 4 developments versus what you're expecting in the fourth quarter of the year to make sure that we have the ramp going the right way.

Mark L. Wetzel

Yes, I mean it's obviously a challenge because the ramp does affect it. And as you think of Santa Clara, we're sitting at 25%, and we walk through the year, how that leasing will go, it's sort of back end-loaded. But the OpEx team, the operating team is paying attention to their spend in the first couple of quarters here. And as we go, we obviously have tenants in the building, so we're obviously taking care of the building. But I think the spend -- on spend side, you think of it somewhat even over the course of the year because the building's open and running, we're paying the taxes, we're paying insurance. But at the maintenance level, some of the buildings still have burn-off with regards to warranty work on some of the equipment. So it does ramp up as the year progresses.

Michael Bilerman - Citigroup Inc, Research Division

But you don't have the NOI contribution from developments each quarter so that -- how it matches up to your guidance? So that...

Mark L. Wetzel

Yes, I don't have that at my fingertips in terms of what that -- in terms of disclosing that by development. It is back-end loaded. There's more of a negative hit obviously in the beginning and then, as it leases, then it obviously goes away.

Operator

And our next question will come from Bill Crow of Raymond James.

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

Hossein, how long do you anticipate keeping the development team in place if conditions kind of muddle along as they are?

Hossein Fateh

That's a good question. Our development team is -- the majority of it is outsourced. So we're very comfortable with them. There are -- this year, we don't anticipate -- unless we get a very large free lease, we do not anticipate starting -- actually I can just tell you, we will not start a new development unless there's a huge prelease. Having said that, our small team that we have in place, we will keep, because they are now working on our next-generation design for the future years. And it takes -- to finalize and to really get these things to the perfection that we'd like to build them, on a normal schedule, it takes like 9 months to get to our next-generation design.

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

How different do you think that -- I know I'm asking you to look into the future, but the next generation design will be from the current design? Are you going to build smaller or how will you change the design, do you think?

Hossein Fateh

The design will change in the electrical infrastructure and mechanical infrastructure. From a size perspective, it will not change. We'll be -- we're working on having it built more in smaller phases but still do an isoparallel ring bus. It's from an efficiency standpoint, we believe will drive material efficiencies in operating costs and in construction costs.

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

Okay. And finally for me, I know we've beaten the yields to death here, but we've seen yields on development go from 12% to 15% to 10% to 12%, let's call it right now. And at $1,000 a foot back development, it's high risk. At what point -- if you'd go sub-10%, if that's the way the market turns, does that change the model? If you and Lammot were building privately, what sort of yields would you require before you put that risk out there?

Hossein Fateh

I think you make a very good point, but also our cost of capital has changed significantly. Where we ended up raising our bonds, they were at 8.5%, if you remember. Now, they're trading in the low 6s. So we didn't have access to perpetual preferred. Now we have access to perpetual preferred. We just raised our last round at 7 5/8%. Compared to normal real estate, we have -- before the private company, Lammot and I were using very high octane Lehman money. So I would say our overall returns have remained pretty much consistent with what we've been doing because our cost of capital has come down significantly. So we still see a big amount of a gap between our returns and our cost of capital.

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

But your unlevered returns have come down. And I guess if you went sub-10% on an unlevered basis, how would that impact your appetite for future development?

Hossein Fateh

Well, I think we'd look at everything and, if that did happen -- but again, I think the difference is not just the return. The difference is between our cost of capital and return. That delta is what makes the difference. So say, for example, if our return came to sub-10% but our cost of capital was at 5%, that's still a very good deal.

Operator

Our next question will come from Ross Nussbaum of UBS.

Ross T. Nussbaum - UBS Investment Bank, Research Division

A couple of questions. First, can you give me a ballpark of what the actual operating expenses are on your lease-up projects? Should we be assuming somewhere between $4 million and, call it, $6 million a property on an annual basis?

Mark L. Wetzel

I think for New Jersey and Santa Clara, it's roughly around $7 million, $7.5 million, those 18.2-megawatt phases. Obviously for ACC6, it's a smaller build, it's probably in the $4 million, $4.5 million range.

Ross T. Nussbaum - UBS Investment Bank, Research Division

That's helpful. With respect to the lease-up, one of your other competitors recently had a slide which basically commented that the Northern Virginia market is currently experiencing an oversupply situation. And basic economics usually suggest that when supply exceeds demand, it can put pressure on pricing. Do you have any expectation that rents, overall, in the Northern Virginia market are going to be coming down over the next 12 or 18 months?

Hossein Fateh

We haven't seen it and I think our other competitor, we all know who it is, we are the supply. We're the ones with 12-megawatts of space available right there, in their backyard. So I think if the supply was everywhere in the market, it's a little bit different in that we are 80% of the supply.

Ross T. Nussbaum - UBS Investment Bank, Research Division

Last question, just a clarification. When you talk about the GAAP yields, if we were to translate those over into cash yields, just given the rent bump that are inherent in your leases, would you say that your cash stabilized yields are, give or take, initial cash stabilized yields let's call it, are they under 200 bps lower?

Hossein Fateh

No, I don't have the number in my head but typically, last time I looked at it, the difference between -- the GAAP number and the cash number, there are 2 factors in there. One is the ramp, which takes given 6 months to 18 months to fill up, that's part of -- that's about 75%, 80% of the difference. The balance is the escalator. So once the -- do you see what I'm saying? That's how it breaks down between GAAP and . . .

Ross T. Nussbaum - UBS Investment Bank, Research Division

A follow-up on that, if I can. Do you have any situations where you've got tenants with signed leases where they've commenced their lease, but you thought they were going to be ramping up the rent payment over 6 months and now they're telling you, we don't need that much power, we don't need that much space, let's ramp it over 12 to 18 months, and you modify that lease?

Hossein Fateh

No, because in every case is a hard commitment. And in fact, Mark said it in his prepared remarks, that we have signed leases in 2012 with commitments that, if those leases started at the beginning of 2012 rather than the end of 2012, we would have an additional $0.11 of FFO.

Operator

Our next question will come from Omotayo Okusanya of Jefferies.

Omotayo T. Okusanya - Jefferies & Company, Inc., Research Division

Just following up with Ross's question and, Hossein, your comment about the signed leases in '12 where the commencement is later in '12. Is that the Rackspace situation at CH1 you're talking about?

Hossein Fateh

We cannot comment specifically on tenants.

Omotayo T. Okusanya - Jefferies & Company, Inc., Research Division

In your last quarter, you did talk about the phase-in of the Rackspace lease.

Mark L. Wetzel

The 79% leased in Chicago, 57% of that has already started, Tayo. And that remaining 21% is commencing in equal installments over 3 different quarters. They're kind of hard dates, Q3, Q4 and Q1 of '13.

Omotayo T. Okusanya - Jefferies & Company, Inc., Research Division

And it's that phase-in that's creating that $11 million difference that you talked about?

Hossein Fateh

Yes, it's $0.11, that's correct, not $11 million.

Omotayo T. Okusanya - Jefferies & Company, Inc., Research Division

Okay, $0.11. Now the other question I have is when I look at your other assets on Page 9, where you have the leased amount and the commenced amounts are pretty much the same. And even some other leases like SC1, you signed it this quarter, it's commencing this quarter. I'm just curious why you expect to see more of this kind of phased-in approach when some of the more recent leases you signed, you've kind of signed them and you've kind of commenced almost in the same quarter?

Hossein Fateh

We typically have ramped in all of our buildings in our lifetime and I think will continue to happen. It happens.

Omotayo T. Okusanya - Jefferies & Company, Inc., Research Division

Yes, but I think you're talking about much longer ramps now versus historically what we've seen in the past.

Hossein Fateh

No, I don't think so.

Mark L. Wetzel

I think it's just a function of when we sign the leases. If we sign leases this quarter and next and the tenant has immediate demand, we're going to start them. But I think it's just the focus of what the tenant wants, how fast do they want in. The ramp is maybe a function of the cash, what they pay us in terms of base rent. But typically, on the reimbursement of tenant cost, it typically starts day one.

Omotayo T. Okusanya - Jefferies & Company, Inc., Research Division

And then last year, you guys kind of gave us what your targeted occupancy was for ACC6, New Jersey 1 and Santa Clara. Are you going to be giving us that kind of number again for 2012? And where you kind of expect to be at the end of the year?

Hossein Fateh

Well, I gave a blended rate of around 70% for the non-stabilized portfolio. Obviously, we gave out 25% for California. We hit that. 50% in Jersey, obviously, we're light on that, and 30% in Ashburn. So pushing out things a couple of quarters, blended 70%, I'd like to leave it at that.

Omotayo T. Okusanya - Jefferies & Company, Inc., Research Division

Okay. And that 70% number you're talking about, is that just leases that have been signed or is that actually 70%, all of that would've commenced?

Mark L. Wetzel

That would be everything that commences by 12/31.

Omotayo T. Okusanya - Jefferies & Company, Inc., Research Division

Commences by 12/31, okay.

Mark L. Wetzel

'12.

Operator

Our next question will come from Jonathan Schildkraut of Evercore Partners.

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

A lot of questions have been asked and answered here, but maybe if we can do 2 strategic questions. The first is, in terms of looking at benchmarks and kind of thinking about what your business might do longer term, because I think obviously, at some point, you're going to return to developing new properties, what should we look for that would give us a sense that you might return to that activity when we look at your numbers?

Hossein Fateh

I think we need to be significantly leased up on this current portfolio. What we're hearing from many of our investors is, and when looking at where we're trading, is we're not getting any credit or very little credit for our development portfolio. So we would want to be more leased up or significantly leased up in our development portfolio, and be paid for that, before we start a new development.

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

All right, great. You mentioned the super wholesale strategy. I think you acknowledge it, that could take you potentially to new markets. Of course, this would have to come with a significant prelease. And you also have talked about looking at some new data center designs. Would you guys be willing to consider something like the open compute designs by Facebook, incorporating outside air handlers in that, because you've been very consistent with the way that you've deployed your assets.

Hossein Fateh

Well, I think it's a very good question. On the new markets and doing those types of deals where we stated the returns are 10%, obviously that 10% incorporates a long-term prelease execution. And when you have a long-term lease, say 20 years, you're not that concerned about the design of a building if the entire building is occupied by one tenant. Because what does it matter? They're taking the risk. If the building is significantly multi-tenanted and -- at that time, we would need to compromise on some of the designs because we want to make sure that other tenants will also like some of the features in there. We still have many tenants that want to follow the ASHRAE guidelines more so than running their computers at 90 degrees. So then, we need to then build a design that the majority of the market wants, not just the Facebooks of the world.

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

Great. Just one last question. One of the things that we're hearing about, from a demand perspective, is a desire to get, call it, hybrid architecture inside the data center. We've seen Amazon deliver fast pipes to a number of different facilities, Amazon Web services, to kind of match up their public cloud with maybe some private deployments. You guys would seem to be fairly well-positioned to go after this opportunity, having one of your larger tenants, Rackspace, run a public cloud. Is that something that you're currently exploring?

Hossein Fateh

We explore all of these opportunities with networks all the time. Yes, we explore any and all those opportunities with network.

Operator

Our next question will come from Robert Stevenson of Macquarie.

Robert Stevenson - Macquarie Research

Just 2 quick here. Mark, the $11 million of incremental revenue that you're expecting to commence in 2012, that puts you at the midpoint of the guidance range?

Mark L. Wetzel

Yes, roughly.

Robert Stevenson - Macquarie Research

And does that correspond with the 20 megawatts of leasing? Does that also put you at the midpoint of the guidance range?

Mark L. Wetzel

Yes, it does. But the commencement dates are obviously second-half loaded. So that's why the pickup. It's not an annualized run rate for this 20 megawatts.

Robert Stevenson - Macquarie Research

No, no. I just want to be able to do the math on that as to what that sort of implies going forward as we roll into fourth quarter and 2013. And then the other quick question is, on your lease expiration schedule, there's a footnotes, 4, that talks about I believe the Yahoo! lease, the 5.7 megawatts that they've notified you about vacating. There's also a thing there about the other lease that's expiring this year that has an option to terminate for, I guess it's a little over 1.1 megawatts. Have they given you any termination notice as of yet?

Mark L. Wetzel

No, they have not. And that's kind of a rolling 6 months lease with that particular tenant.

Hossein Fateh

That was a very unusual tenant that had a tied -- we almost never do this -- that's tied to a government contract. And they matched their option to the government contract that that system integrator had. So as long as they continue getting their government contract, I guess they'll continue.

Robert Stevenson - Macquarie Research

So they get an option twice a year to renew?

Hossein Fateh

It's ongoing.

Mark L. Wetzel

Yes, it's an ongoing. So it kind of rolls every day.

Robert Stevenson - Macquarie Research

So they could give you notice now or never?

Mark L. Wetzel

Exactly.

Hossein Fateh

And we're happy to say we have not received a notice now.

Operator

Our next question will come from Dave Rodgers of RBC Capital Markets.

David Rodgers - RBC Capital Markets, LLC, Research Division

Just one question for me. You talked about, with the super wholesale tenants, is that you'd be willing to accept returns maybe down as low as 10%, which would be comparable to built-to-suits. Generally where I think we've seen some of these super wholesale tenants end up are in cheaper power markets. So I think while the 10% certainly makes sense for you, do you know what type of premium they might be willing to pay to stay in the markets that you're in currently to be involved with DFT, again, based upon power incentives in some of these other markets where [indiscernible].

Hossein Fateh

I think I've also mentioned that, base, this would be typically, if we did a super wholesale deal, it could be a prelease. If it's a prelease, it could be in one of the most attractive markets we're talking about, the power markets we're talking about, specifically perhaps the Pacific Northwest or some of those very cheap power markets. Having said that, I do think Virginia is in the cheaper range of markets as far as power, and it has other things it offers like very good networks and decent cost of construction and employees. So it's not unforeseen to do something in that market as well.

David Rodgers - RBC Capital Markets, LLC, Research Division

What type of premium do you think tenants would be willing to pay to stay there versus, say, the Carolinas or the Pacific Northwest?

Hossein Fateh

Well, the Carolinas is not that much cheaper or the Pacific Northwest. I mean the -- some of the places that we've toured in Oregon, the prices are comparable in power to Virginia's expense. So we've seen some numbers around $0.045 to where it is in some Carolinas or in the Pacific Northwest or the $0.06 were in Virginia. So that $0.015 may answer your question of if it's worthwhile or not, but it's not a huge difference in power cost. That's how I answer your question.

Operator

Our next question will be from Romeo Reyes of Jefferies.

Romeo A. Reyes - Jefferies & Company, Inc., Research Division

Two very quick ones. Just to clarify, on the additional 3 watts that you added in Q4 and the 2.28 that you added in Q1, that adds an incremental $11 million of revenue on an annualized basis? Is that correct, Mark?

Mark L. Wetzel

I don't think that $11 million was tied to those leases executed. That $11 million was base rent on new leases we expect to sign and commence in '12.

Romeo A. Reyes - Jefferies & Company, Inc., Research Division

Okay, so I guess you did not have the 3.01 for the full fourth quarter, I would assume, or did you?

Mark L. Wetzel

I think those were signed during the quarter. So it might not have been -- you can't take Q4 and annualize, if that's what you're trying to do.

Romeo A. Reyes - Jefferies & Company, Inc., Research Division

If we were to add the 3.01 for the 3 months and then add the 2.28 for the 3 months, I guess right now, even without that, you'd be at around $300 million of revenue run rate. If we were to kind of normalize, assuming that whatever you call it, 5.29 megawatts were in the numbers in Q4, how much of a lift would you have in revenues?

Mark L. Wetzel

Maybe -- I'll walk through that after the call with you, Romeo. I'm not sure I follow exactly what you're chasing.

Romeo A. Reyes - Jefferies & Company, Inc., Research Division

Okay. Then the second question is regarding RP capacity and free cash flow. As your CapEx comes down this year, it seems like you're going to have some RP capacity. Would you contemplate buying back stock?

Mark L. Wetzel

That's always on the table. We'd have to discuss that with the board at this point. But I think that's always an option for a lot of companies.

Operator

Our next question will come from Chris Lucas of Robert W. Baird.

Christopher R. Lucas - Robert W. Baird & Co. Incorporated, Research Division

Just a quick question, Mark, on getting to the high-end of guidance. Is that simply a lease commencement exercise?

Mark L. Wetzel

Simple as that, Chris.

Christopher R. Lucas - Robert W. Baird & Co. Incorporated, Research Division

And then in terms of the Yahoo! lease, I know you mentioned it briefly as you were going through your remarks, what is your expected impact this year as it relates to that lease?

Mark L. Wetzel

Well it's roughly half of that building. That building costs us about $4 million a year to run, but maybe closer to $5 million from an OpEx perspective. The lease-up expectations are spread over the course of the rest of '12 and '13. So there's obviously a couple of pennies reduction with regards to the OpEx of that building until we lease it up.

Christopher R. Lucas - Robert W. Baird & Co. Incorporated, Research Division

Do you have access to that space right now or is that still being occupied?

Hossein Fateh

It's still being occupied.

Christopher R. Lucas - Robert W. Baird & Co. Incorporated, Research Division

And then real quick, last question for me. You've cleaned up the balance on the line. When do you start the renegotiation process for your credit facility?

Mark L. Wetzel

That's soon.

Operator

Our next question will come from Lucas Hartwich of Green Street Advisors.

Unknown Analyst

Hossein, I was just wondering, how competitive do you feel DuPont's typical data center is when it comes to attracting traditional corporate tenants or co-location operators? Would you consider a DuPont facility, is it too over-improved, too robust for those types of tenants?

Hossein Fateh

I think it depends on the type of corporate data center. We do believe that we are the highest quality as far as asset quality. Do I think that for some tenants they don't need all the robustness that we have? Yes, I agree with you. For some tenants, they don't need all of the robustness we have. But we're in the business of being the landlord for many years to come. We want a building that is of the highest quality, will have more endurance against time and changes. And I think it's the right assets for the long-term, to own.

Operator

Our next question will be a follow-up from Michael Bilerman from Citi.

Emmanuel Korchman

It's Manny here with Michael. The 70% number that you said that you'd be getting to, I believe that was both for leased up and also commenced. So I was just wondering, are you assuming that any new leases that you sign will have time to commence by 12/31?

Mark L. Wetzel

I'm sorry. Repeat that, Manny?

Emmanuel Korchman

So you said that by the end of the year, you expect to be, in the new developments, 70% leased, correct?

Mark L. Wetzel

On average, on nonstabilized group, that's correct.

Emmanuel Korchman

Where do you expect to be commenced within that same group of assets?

Mark L. Wetzel

That's -- I guess -- I don't know if I misspoke but it is 70% commenced for that group of assets.

Emmanuel Korchman

So the lease and the commenced will be at the same rate?

Mark L. Wetzel

Yes. Just to keep it simple at this point, leased and commenced will be the same. Again, but back-half loaded, so there's not a lot of run rate for the year. So the pickup is really in '13.

Operator

And, gentlemen, I'm showing no further questions in the queue.

Hossein Fateh

Thank you for joining us today. We look forward to providing future leasing updates and showing continued growth in 2012 and 2013.

Operator

This concludes today's conference call. At this time, you may disconnect.

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