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Piedmont Office Realty Trust, Inc. (NYSE:PDM)

Q4 2011 Earnings Conference Call

February 10, 2012 10:00 ET

Executives

Don Miller – Chief Executive Officer

Robert Bowers – Chief Financial Officer

Ray Owens – Executive Vice President

Laura Moon – Chief Accounting Officer

Bo Reddic – EVP of Real Estate Operations

Eddie Guilbert – VP of Finance and Strategic Planning

Analysts

Michael Knott – Green Street Advisors

Dave Rodgers – RBC Capital Markets

Anthony Paolone – JPMorgan

Brendan Maiorana – Wells Fargo

Chris Caton - Morgan Stanley

Paul Adornato – BMO Capital Market

John Guinee – Stifel Nicolaus

Michael Harmon – Midwest

Operator

Greetings, and welcome to the Piedmont Office Realty Trust Fourth Quarter 2011 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instruction) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Robert Bowers, Chief Financial Officer for Piedmont Office Realty Trust. Thank you, Mr. Bowers, you may begin.

Robert Bowers – Chief Financial Officer

Thank you, operator. Good morning. Welcome to Piedmont’s fourth quarter 2011 conference call. Last night, in addition to posting our earnings release, we also filed our Form 8-K, which included our unaudited quarterly and annual supplemental information. This information is available for your review on our website at www.piedmontreit.com under the Investor Relations section. On today’s call, the company’s prepared remarks and answers to your questions will contain forward-looking statements, as defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements address matters, which are subject to risks and uncertainties that may cause actual results to differ from those discussed today.

Examples of forward-looking statements include those related to Piedmont Office Realty Trust future revenues, operating income, and financial guidance as well as future leasing and acquisition activity. You should not place any undue reliance on any of these forward-looking statements, and these statements speak only as of the date they are made. We encourage all of our listeners to review the more detailed discussion related to risk associated with forward-looking statements contained in the company’s filings with the SEC. In addition, during this call, we will refer to non-GAAP financial measures such as funds from operations, core FFO, AFFO, and EBITDA. The definitions and reconciliations of our non-GAAP measures are contained in the supplemental financial information available on the company’s website.

I will review our financial results after Don Miller, our CEO discuses some of this quarter’s activities including progress towards our strategic operating objectives. In addition, we are also joined today by Ray Owens, our EVP of Capital Markets; Laura Moon, our Chief Accounting Officer; Bo Reddic, our EVP of Real Estate Operations; and Eddie Guilbert, our VP of Finance and Strategic Planning. All of whom can provide additional perspective during the question-and-answer portion of the call.

I will now turn the call over to Don Miller.

Don Miller – Chief Executive Officer

Good morning, and thanks for joining us as we review our fourth quarter 2011 results. Before I get started I wanted to remind everyone that today is our second anniversary as a publicly traded company and we want to say thank you for your support over the last two years. We are pleased to report the company’s financial and operational results this quarter and we are prepared to update you on our transactional activity as well.

As we begin we want to reinforce that one of our primary operating focus has been on the continued strategic repositioning of our portfolio, into a handful of major markets, while dealing with the releasing of the substantial portion of our properties is approximately 44% of the portfolio was facing lease expirations between 2010 and early 2013. We believe that our disciplined low leverage investment strategy coupled with an aggressive yet prudent leasing approach of creditworthy tenants has served our shareholders particularly well.

Regarding our recent leasing efforts we have been very pleased with the leasing accomplishments in the portfolio. We executed just under 4 million square feet of leases during 2011 with 900,000 square feet taking place during the fourth quarter including 581,000 square feet of new tenant leases. The 4 million square feet leasing transactions represent almost 19% of our office portfolio and outpaces any single previous year in Piedmont’s operating history, although rent continued to bump along the bottom in most markets.

We have continued to be disciplined in our negotiations and have achieved these leasing accomplishments without compromising our effective rent objectives to reach property. Importantly we believe this allow us to continue to maintain enterprise value at the highest level possible given the leasing environment.

Our same store office portfolio was 88.3% leased at December 31, 2011 as compared to 89.1% leased at beginning of the year. The total portfolio including several value-added properties acquired during this year was 86.5% lease at December 31, 2011. And our weighted average lease remaining lease term was 6.4 years.

I will highlight just a few of the more significant leases that were executed in the fourth quarter. Our single largest deal during the quarter was the previously announced 15 year renewal on expansion for up to 400,000 square feet with GE at our 500 West Monroe building in Downtown Chicago. If you’ll recall this is the building that we acquired through the conversation of our mezzanine debt position in first quarter of 2011 in which we inherited significant nearly near–term leasing exposure.

So we’re very fortunate to not only retain but also to expand a high credit anchor tenant for a lengthy term with only a slight roll back in current rents. CBD Chicago it is one of the markets and where we’re seeing positive absorption over the past year, if it whether relatively few large blocks of space remaining effective should go well for not only our remaining space in 500 West Monroe, but also at Aon Center.

The southwestern U.S. has also been an encouraging area for us during the quarter we signed a new 12-year full building lease with U.S. Foods at our River Corporate Center property in the Phoenix market as well as a new 12-year on 105,000 square foot lease with Schlumberger Technology Corporation at our newly acquired 1200 Enclave property in Houston. Both of these leases bring high quality tenants and when combined will provide incremental rental revenue once they commence.

The Schlumberger lease in particular highlights the value that we added by acquiring well positioned properties with some vacancy in select markets as we just acquired 1200 Enclave during the first quarter of 2011 and this single transaction will take down the majority of the vacancy in that building.

Year-to-date for the 3.2 million square feet of executed leases for spaces that have not been vacant, rents were up 3.6% on a GAAP basis and down 1.7% on a cash basis. It’s worth noting our average capital commitment per year of lease term of $5.11 for renewal leases signed in 2011 was above our historical average. Two major long–term transactions during the year drove up our average capital cost renewals those two being NASA and GE. If we’d remove the cost associated with those two leases our average capital commitment would have been $2.80 per square foot per year.

We’ve also made visible progress toward our portfolio repositioning strategy during 2011 with several disciplined investment transactions. We sold five assets including two joint venture properties while exiting two different markets all at a gain of $122.8 million or about $0.71 a share. The largest of the disposition is the sale of 35 West Wacker Drive in Downtown Chicago closed during the fourth quarter generating an approximately $96 million gain or $0.56 per share which is included in our 2011 results of operations.

The disposition price for Piedmont’s 96.5% interest in the building was approximately $387 million, a price that equates to a value of a little over $400 million or $359 a foot or 100% of the property. Although the sale this fully leased properties are expected to decrease our reported FFO short term, it reflects the strategic disposition of a low FFO growth asset and attractive pricing.

Additionally Piedmont has been signed to manage the building for the next five years. For the year we recycled nearly $390 million of capital into seven buildings located within one of our designated core or opportunistic markets. Our approach is been consistent and disciplined often acquiring value-added properties at attractive basis with intrinsic earnings growth and compelling risk adjusted return profiles generating value for our shareholders through the leasing up of those properties.

During the fourth quarter the company purchased 400 TownPark, a 176,000 square foot five-story Class A office building in the Orlando submarket of Lake Mary Florida were about $23.9 million. We believe this high quality property is located in one of the most desirable Orlando submarket and we are confident in our ability to increase rental revenue by leasing up this building which is only 19% leased at acquisition.

In fact we’ve already executed and commenced the 19,000 square foot lease with Farmers Insurance with a 5.5 year term. As we continue to execute on this strategy repositioning the portfolio we remain focused on building value for our shareholders and we will not lose site of basis of the property. As we have indicated previously we intend to be patient to transition the portfolio, transacted market conditions allow and not give up real value for a speedy shift to the portfolio.

I will add that while we purchase several suburban assets during this year that choice and it was a choice was driven more by a particular set of circumstances and where we saw the best value in the market. We remain committed to being a CBD and Urban Infill owner and operator with two-thirds of our current ALR and nearly 70% of 2011’s NOI, coming from our CBD and Urban Infill assets, which is disclosed on Page 30 of our quarterly supplement. Over time, we expect that contribution to remain in that range or even growth further.

Lastly, in our corporate governance note I wanted to mention the addition of a new member to our Board of Directors that we announced in December. Mr. Ray Milnes who many of you already know from his association with the Board of Governors of NAREIT was national were also real estate industry sector leader for KPMG joint the Piedmont board in late December. We are very pleased to have benefited of his experience and expertise as we move forward.

With that, I'll now turn the call over to Bob you will discuss the financial performance and financing activities.

Robert Bowers – Chief Financial Officer

Thank you Don. While, I'll briefly discuss our financial performance over the quarter and our guidance for 2012, I encourage each of our listeners to review the earnings release, the supplemental information, and the financial results filed last night for further details. Rental revenues for the quarter were up 5% to $107.4 million, as compared to the same quarter in 2010. This increase was driven largely by new properties acquired in 2011 and is partially offset by roll down in some lease renewals and in 80 basis point increase in year-over-year vacancy in our same-store portfolio.

This change in vacancy is primarily due to the 300,000 square foot Zurich lease that expired at Windy Point II in suburban Chicago. Total revenues for the quarter were up slightly, compared to the fourth quarter of 2010 and this increase is despite the inclusion in 2010's results of $1.5 million termination fee income which did not recur during the fourth quarter of 2011. On the expense side, property operating costs, depreciation, and amortization all increased year-over-year due to the acquisition activity. While corporate, general and administrative expenses decline primarily due to lower expenses associated with our change in transfer agents at the beginning of the year.

The comparative change in interest income on a quarter-over-quarter basis as well as on a year-over-year basis reflects the acquisition of the 500 West Monroe building. During the first quarter of 2011 and the result in termination of the mezzanine loan receivable held buyers on the property. On an annual basis AFFO was $1.17 per share in 2011 versus $1.34 per share for 2010. This reduction in AFFO was primarily due to capital requirements associated with the large amount of leasing activity that occurred in the portfolio during 2011.

Non-incremental capital expenditures increased $15 million on a year-over-year basis. As discussed in previous calls this anticipated increase in capital expenditures and the resulting decline in AFFO were expected and expected to result in our cash flow being institution to fully cover are current annual dividend. Our board will undertake its annual review of our dividend policy and its next regularly schedule quarterly meeting to be held later this month. As we previously disclosed, we anticipate that our current annual dividend of $1.26 per share will be reduced in the first quarter of 2012 to approximately $0.80 per share which is closer to our taxable income level.

We also had some changes in our capital commitments during the quarter that I would like to draw to your attention. The sharing of the future tenant improvement commitments at 35 West Wacker was largely offset by the addition of $32 million in commitments associated with the 15 year GE lease signed during the fourth quarter. Our total outstanding capital commitments that we report to you each quarter end remained relatively stable at approximately $143.8 million at December 31, 2011. I will point out that of this amount of approximately $53 million will be incremental capital when spend..

From the financing side, Don mentioned the sale of 35 West Wacker, that transaction resulted in the buyer assuming the $120 million secured note on the property. In addition to the transfer of the 35 West Wacker debt, we also repaid the $45 million mezzanine loan on the 500 West Monroe building during the fourth quarter. The West Monroe mezzanine instrument was settled at discount resulting in a $1 million gain on the early extinguishment of debt, which is reflected in our fourth quarter operations.

Subsequent to year end we also paid off in early January $140 million first mortgage on the 500 West Monroe building. Since mid-year 2000, we reduced the total amount of secured debt on our books by over $300 million. Further as previously announced, we obtained a new $300 million unsecured term loan during the fourth quarter of 2011, and we effectively fixed the interest rate on the loan at 2.69% for the entire five-year term of the loan. The proceeds of this term loan as well as the proceeds from 35 West Wacker sale.

We use to pay off the debt I just mentioned as well as pay off the balance outstanding on our 500 million revolver. As of yearend, which includes the $140 million West Monroe mortgage paid off in January, we had a net debt to core EBITDA ratio of four times, a fixed charge coverage ratio of 4.7 times, a debt-to-gross assets ratio of 27.5% and approximately $614 million in combined cash and borrowing capacity heading into 2012.

Please refer to your supplemental information for a detail of all of our debt and the associated maturities. Additionally as an update to our stock repurchase plan announced during the fourth quarter of 2011, in December before the REIT markets rallied, we repurchased about 200,000 shares of our common stock at an average price of $16.24 per share.

Finally, I also want to point out that we added a note in our earnings release regarding outstanding litigation. During the fourth quarter, our trial date was set in late March of this year for a suit filed in 2007 related to the internalization of various management functions provided by our former advisor. We cannot predict the possible outcome of the trial. However we do intend to continue to vigorously defend against this action.

Turning to our guidance for 2012, as we have mentioned in our last quarterly call, the sale of 35 West Wacker causes a $0.13 per share decline in FFO for 2012 versus the prior year. When we combined this strategic event with modest rent roll downs and downtimes before major leases come out we expect a decline in 2012 FFO to a mid point range of $1.40 per share or about $0.04 per share less than 2011 results without 35 West Wacker.

This translates into a core FFO in the range of $234 million to $250 million or $1.35 to $1.45 per diluted share. This annual guidance includes assumptions of approximately $200 million in dispositions and acquisitions totaling $300 million during 2012. Depending on what the market conditions dictate in 2012 particularly with our U.S. government lease exposures over the next 18 months, we’re anticipating growth in our earnings over the next few years as the number of annual lease expirations decreased.

That concludes our prepared comments. Therefore I’ll now ask the operator to provide the listeners with instructions on how they can ask questions to management. We will endeavor to answer all of your questions now and make appropriate later public disclosure if necessary. We do ask, however, that you limit your questions to one follow-on question, so that we can address as many of you as possible. Thank you. Operator?

Question-and-Answer Session

Operator

Thank you. We will now be conducting the question-and-answer session. (Operator Instructions) Thank you. Our first question is coming from Michael Knott from Green Street Advisors. Please proceed with your question.

Michael Knott – Green Street Advisors

Hey guys good morning. Hey Don or Bobby, could you just give a little more color on your expectations for same store NOI for 2012?

Robert Bowers

It is Bobby, Michael. We think it's on the same store basis with the Downtown that we’ve got associated there at Aon with PerkinElmer is moving out for KPMG moves in and USC moves in and that Bridgewater, Downtown after Santa Fe of Venice moves out and Synchronous and Savient moves in probably about 2% down on the same store basis this year.

Michael Knott – Green Street Advisors

Okay, thanks that’s helpful. And then for my second question, Don, we’ve heard some of your peers talk about seeing more opportunities are expecting to see on more opportunities on the acquisition side in 2012. What’s your expectation for the outlook on in terms of acquisitions this year and what can you just remind us what if any is included in your guidance?

Don Miller

Yeah, I would say we’re continuing to see prices particularly in the better markets moving up or at least staying very strong and obviously that hasn’t been a great environment for us to be as a value player to be finding lot of great value. We are getting more creative on some of things that we’ve done in the past like what we did with 500 West Monroe for example in the past where we are looking at some debt positions and things like that to try to see if we can’t find ways to get access of the kind of products that we would like to have and still feel like we’re getting good basis.

So I would say I think the opportunities that’s going be greater I don’t know that the opportunities set where we find good value is any better right now and so I think we’re going to have to continue to be as creative as we can to find new investment activity. Bobby mentioned I think in the call that we had budgeted $300 million of acquisitions, Ray remind us we are probably say $300 million of investments because that could be some acquisitions it could be some debt positions with underlying collateral that would be consistent with what we would like to do.

Michael Knott – Green Street Advisors

Okay so your $1.40 includes $300 million of investment activity?

Don Miller

And $200 million of disposition activity and admittedly the acquisition activities waited towards later in the year the disposition activity is waited sort of equally across the year.

Michael Knott – Green Street Advisors

Okay. So net to net there is not a big amount of earnings expected from investment activity for 2012?

Don Miller

Very little.

Michael Knott – Green Street Advisors

Okay.

Robert Bowers

Firstly, as you recycle Michael from these secondary markets into the core markets where you got lower yielding at least on a short term basis from an income standpoint.

Don Miller

And Bobby want to clarify earlier the negative two number he gave you that was an accrual number, not a cash number.

Michael Knott – Green Street Advisors

What’s the cash number?

Don Miller

What was the cash number be, do we have that?

Robert Bowers

Yes, I think around 5% or so.

Don Miller

Okay closer to 5.

Michael Knott – Green Street Advisors

Okay. Thanks.

Operator

Thank you. Our next question is coming from Dave Rodgers from RBC Capital Markets. Please proceed with your question.

Dave Rodgers – RBC Capital Markets

Hey, good morning guys. I guess when you look at leasing spreads coming up this year, I didn’t hear it in your comments. But can you talk about the big leases that you’re looking at that are still coming up and in aggregate for this year what do you expect to see on the leasing spread side?

Don Miller

Let’s – Dave may be the best thing to do is if you got the supplemental in front of you just look at the leasing the big leases and we’ll just go through the update. Kirkland & Ellis obviously we mentioned previously before that the leases we are doing in that space are roll-ups, fairly substantial roll-ups because Kirkland was at a very low number in that building.

So although those leases don’t start until August and September once they commence on a accrual basis there will be pretty nice roll-ups. Marsh was paying a fairly strong rent obviously we only got a portion of that space re-leased at this point in time. So unless we get some leasing done there even – well I can say even if we get some leasing done there quickly which obviously is not going to be real simple to do that would be probably a small roll-down.

The Santa Fe deal we talked about for a long time we’re getting good rents in that project, but Santa Fe was on the back end of a build-to-suit lease. And so that’s one of the big roll-downs that we had in our portfolio over the last couple of years. Park Service which comes up in the third quarter of this year and because it’s a GSA lease its hard to know what’s going to happen there but they obviously haven’t made any move to do anything yet which bodes well from at least a short-term renewal standpoint. But they are at below market rents and they’re building by a fairly meaningful amount. GE of course has renewed and control the currency today because they did a short-term deal would now be at certainly above market rent as we took them from below-market to above market when they did their short-term renewal.

Dave Rodgers – RBC Capital Markets

So I guess aggregate for the year continued to improve from what we’ve seen in the last couple of quarters but still down?

Don Miller

If I had to guess I would say it’s somewhere between, we were basically flat last year and we were down substantially the year before, I’d say it’s somewhere between the two.

Dave Rodgers – RBC Capital Markets

All right, okay. And I guess the packages that are coming out today – you kind of addressed it in Michael’s question. But just to give it a little more sense out there, you talked first about – I guess the guidance not being necessarily that accretive in terms of investments. I assume there is some dilution actually built into the guidance from these numbers. Can you quantify maybe how much of that might be if there is any and then I guess more on the package side, what are you inclined to do if the returns aren’t there in value added core. Are you happy to kind of stay where you are today and just wait for better opportunities down the road?

Don Miller

We are all furling or brewing your first question Dave. So I’m not sure I understood the aspect of the dilution question. Would you restate that one?

Dave Rodgers – RBC Capital Markets

I guess what cap rates do you expect to sell, what cap rates do you expect to buy at in the model related to the guidance this year?

Don Miller

I see, although we don’t do broad cap rate conclusions because everything is so specific in the individual assets that we expect to sell. And given that we’re going to be selling, what we hope are lower quality assets in lower quality markets. By definition, there should be some dilution spread.

Having said that, if we do some debt positions or something like that on an income basis we might actually do as well are better on those positions because of the nature of what they are. So it’s really hard to forecast but I think on my answer to Michael and Michael’s conclusion from that earlier was that there is probably not a lot of either accretive or dilutive activity from our transactional work this year. It’s just going to be continuing progress what we hope that progress towards the strategic longer term strategic goal.

Dave Rodgers – RBC Capital Markets

Okay, fair enough.

Don Miller

And then the second question I’m sorry I now forgot what it was.

Dave Rodgers – RBC Capital Markets

I mean I asked you if you address it in a way its just that how longer you’re willing to be patient what are the next steps in either the credit markets that you’re looking for or you expect to see opportunities coming your way if in fact you are not seeing a lot of those today?

Don Miller

Yeah, I mean we’re not seeing a ton of activity right now that’s really interesting to us. But I will tell you we’re going to continue to plug away and try to find value. And I think we would – we’ll follow our error on the side of being disciplined and conservative rather than go out and make some mistakes and utilize what is the utilize the balance sheet that otherwise would be is in great position. So we’re protecting that we’re going to protect that balance sheet at all cost but we’ll make some – we’ll make some bets where we think they’re we’re seeing good value. So that – that’s not a great answer to satisfy your question but it’s just how we look at it we’re going to be pretty ardent disciplined.

Dave Rodgers – RBC Capital Markets

Okay. Thank you.

Operator

(Operator Instructions) Our next question is coming from Anthony Paolone from JPMorgan. Please proceed with your question.

Anthony Paolone – JPMorgan

Thanks, good morning. For 500 West Monroe can you just walk through what you think you’re basis will ultimately be once you get that leased up in kind of where net rents are shaking out?

Don Miller

Yes Tony, I obviously like a lot of downtown towers net rents are function of where you are in the building if you will. So I’ll try to give you a sense of where we are if our basis initially started out at 230ish bucks of foot keep in mind that includes on the parking deck which we have somewhere assumed it somewhere between if 1300 plus parking space. We think it’s assumed somewhere between $35 and $50 of square foot to the building value given the NOI that’s coming out of the parking deck.

So lets try to make the basis of simpler calculation it’s something slightly under $200 of foot going in if we have to lease the vast majorities of building which is say 70% to 80% of building over the next few years and your apply sort of normalized CapEx you probably are adding $70, $60 depending on whether you’re doing 10 or 15 year deals 70 to 75 bucks of foot and basis to the assets overall in total. So maybe you’re at 275 a foot and your rents are in the lower part of the building starting 1920 to top of the building is sort of 25, 26.

Anthony Paolone – JPMorgan

Okay, so something in that I guess low 20s I guess?

Don Miller

I would say low to mid 20s average I think it’s probably a pretty good estimate yeah.

Anthony Paolone – JPMorgan

Okay.

Don Miller

And then obviously the parking deck itself has its own sort of return and cost separately from that.

Anthony Paolone – JPMorgan

Okay, so rough numbers that it seems like upon this getting always step it would be somewhere in the pricing of digit then I guess coming out just rough math where I can that 8% range it’s seems like?

Don Miller

Yeah I think we would we think its little more than that but yeah I think your –your not too far off. So you see here a nice spread of what we think long term value would be particularly for doing these GE type leases on a 15 year basis. You can see what that can drive in terms of cap rate.

Anthony Paolone – JPMorgan

Okay. And then my other question is just on the two big DC expirations. Can you talk about just how you’re going about approaching OCC, how your market space, prospects for that, just give us an update there?

Don Miller

Sure. And obviously the big leases particularly the GSA leases have been few and far between lightly. There are – there is some activity out there in the large lease space arena, but basically what we’ve got is a really good quality building in the Southwest market, it’s going to have to compete both with other government buildings but also we’re going to try to pull private sector tenants now into that area. We’ve actually a couple of the prospects we look at so far have been private sector prospects, which have been encouraging to us. And I think it’s just because it’s a slightly more value-oriented alternative to being in the CBD for a larger tenant, somebody you might need a couple of 100 plus thousand square feet.

So, obviously we’ve got a full marketing team on the project. They’re going at full bore. We have a pretty good sense from OCC of the timing of their departure. So it's not a typical GSA deal where we kind of don’t know when they’re going to leave and so it's going to be hard to think how to communicate to the marketplace when this space may become available. And so we feel like we’ve got a pretty good handle on that. And so now just a matter of trolling for everybody who is out there, but we probably wouldn’t open the building for anything less than say 50 or 1000 feet or more just for all the obvious reasons.

Anthony Paolone – JPMorgan

Any sense on just what you think the TI package might be to get to private sector tenant in there?

Don Miller

I don’t because there is some decent existing conditions in the building today. So, it really depends on the kind of tenant it shows up. So if I was to quote you a number it would be sort of middle of the road who knows kind of number, and if you go a lot higher or lot lower depending on the type of tenant and the renter willing to pay.

Anthony Paolone – JPMorgan

Okay. Thank you.

Don Miller

You’re welcome.

Operator

Thank you. Our next question is coming from Brendan Maiorana from Wells Fargo. Please proceed with your question.

Brendan Maiorana – Wells Fargo

Thanks, good morning guys.

Don Miller

Hey Brendan.

Brendan Maiorana – Wells Fargo

I just wanted to follow up on Tony’s question about 500 West Monroe, so kind of going through the math and I guess Tony’s math would sort of call it on eight cap maybe it’s a little bit better than that and that’s a cash number, that’s a GAAP number, GE did they have sizable bumps throughout because I’m just trying to compare where you guys maybe on 500 West Monroe relative to 35 West Wacker, which was sold in a low cash cap rate, but the GAAP cap rate just given the long duration of at least it's there I think was around 7.5 on a GAAP basis. So just kind of…

Don Miller

Yeah I think I understand your question, Brendan. This situation should be quite a bit different and let me see if I can explain why. The number I was just giving you a sense of would have been a cash cap rate not a GAAP cap rate and would have been sort of a going in yield if you will. In this case the thing it was different about 35 West Wacker is what happened when we restructured that lease back in 2006 was one of the tenants had a large rent continuing through I think it was 2012 if I remember correctly.

And then when we extended that lease and roll back down fairly substantially so, even though the going in cap rate was 6.4, the rent stayed pretty flat for quite a while on that deal and as a result I didn’t – I don’t have a way to validate the 7.5, you just quoted but that’s probably not far off, what a GAAP cap rate would have been on that deal because there was a roll down in the rents of one of the big tenants initially. That won’t be the case on 500 West Monroe it really shouldn’t be because all the leases will be new, all will have 10 to 15 year steps in them and so the GAAP cap rate will be much higher than what we’re recording on a cash basis.

Brendan Maiorana – Wells Fargo

Okay, all right that’s helpful. And do you guys think that the relative return that you get for taking the amount of risk on those value-added deals is appropriate to spread of 150, 200 basis or so?

Don Miller

Well, we certainly have and we think so far it seems to be bearing out pretty nicely. Obviously the activity we had at the Houston Building this quarter, we outperformed our pro forma pretty dramatically on the lease up of the building. And so we feel really good about how that’s coming together. We are making small incremental progress on some of the other deals and then obviously getting the GE lease renewed. So, we feel like we had a really nice quarter from the value-added portfolio standpoint. And so, yeah we think we’ve really, executing really well on that front these days.

Brendan Maiorana – Wells Fargo

And then Don, you mentioned the balance sheet and I’m trying to make sure that you’re a good steward on the balance sheet. And we’ve talked in the past about how you’ve got a lot of balance sheet capacities so you can do net acquisitions that will be fairly sizable. But it’s being relatively conservative with the outlook for this year. So, net acquisitions would be $100 million, its part of that driven by the amount of lease of capital debt. It can be required given the value-add strategy that you guys have. So, even if we kind of look at net acquisition activity, that might be positive by a couple of hundred million dollars over the next few years, when you layer on all the CapEx to get those assets up to stabilize it becomes a number much bigger than that and therefore may be just looking at net acquisitions we got to dial those expectations back over the next few years?

Don Miller

That’s an interesting point, Brendan. I guess my first reaction to it is that, if there is – I don’t think you’re implying that there was some limitation on our new investment activity because of the amount of capital we’ve got to spend, but if there was that’s clearly not the case obviously the balance sheet allows us to have a lot of flexibility in that ground. But obviously everyone has CapEx coming, we’re no different than anyone else, but we do have some lumpier if you will lease expirations and leases to be done and so our capital will be fairly substantial over the next couple of years and we’ve been pretty consistent with talking about that. And so I don’t think there is a correlation between the two if that’s what you’re trying to figure out at all, but at the same time maybe I’m misunderstanding your question.

Brendan Maiorana – Wells Fargo

I’m just trying to think if lets say you guys do acquisitions that like if we’re thinking about the model and you guys put in just draw a number out there lets say you do $100 million of acquisition. And we think you’ve got $500 million $600 million of net acquisition capacity on your balance sheet. But that 100 maybe that number is really 150 when we layer in the amount of CapEx that is going to take to stabilize that asset. So just thinking about longer term as we kind of built out our model over several years. Do we have to sort of budget that in whereas if you guys just announced a $100 million of acquisitions maybe we say you’ve got $500 million more of capacity and maybe we’re sort of understating that future or overstating that future capacity?

Don Miller

I don’t think I just agree with you Brendan. I’m trying to - I made if I’m misunderstanding the question we can always take later but I think the real point is that you’re right if we’re buying a $100 million of acquisitions and lets say half of those are value-added in nature and I don’t know if that will be the case for now, but lets say they are and we’ve got to spend another 50% of the purchase price to get them lease stop or whatever I’m just making a number up now. And then yeah I think your point is well taken we’ve that’s going into the capital bucket its not coming out of AFFO, if you will because it’s new basis-oriented capital. And so I think that if you’re trying to model those things in your AFFO models a lot of that capital won’t go into AFFO that will go into basis if you will. And so I think you’re right in the way you’re thinking about it, I just may not fully understand exactly what you’re trying to get at.

Brendan Maiorana – Wells Fargo

Yeah, okay. We can follow-up off-line. Thanks for the color.

Don Miller

Okay. Alright, you’re welcome.

Operator

Thank you. Our next question is coming from Chris Caton from Morgan Stanley. Please proceed with your question.

Chris Caton – Morgan Stanley

Thanks. Good morning. I guess I’ll ask a follow-up, one is when you discussed the purchase price you include some kind of near-term you anticipated capital either for short-term leasing or base building improvements? And then specific to guidance, can you talk a little bit about what the capital budget is and if you could may be split it into three buckets I know you have incremental or non-incremental. But within the incremental how much of that is allocated to your recent value-added acquisitions and how much of that is related to the existing portfolio?

Don Miller

I’m going to talk real slow Chris and answer your first one while Bobby and Eddie is picking out to answer your second one. I think if you remind what the first question was.

Chris Caton – Morgan Stanley

It was a follow-up, was a follow-up but it was on the – when you disclosed the purchase price especially on the value-added side, do you include any kind of allocated near-term capital in that purchase price?

Don Miller

We don’t, that would typically be the contracted purchase price in almost all cases that we’ve been talking about.

Chris Caton – Morgan Stanley

Okay.

Don Miller

And then Bob and Eddie, you’re working on, let me see if they have got the answer yet.

Robert Bowers

Yeah, you’re asking me the write-down relative to the capital expenditures maybe between non-incremental and incremental, Chris.

Chris Caton – Morgan Stanley

Exactly.

Don Miller

Things you just break it out between value-added and space it was down for a year, I am not sure we have that readily available we could probably get it, Chris.

Robert Bowers

The non-incremental capital is probably about $88 million to $90 million next year, there maybe as much as $70 million of incremental capital. So when Brendan was talking a little while ago, almost try to mature when you add those two together it’s 150 which was the number that he said But I don’t have the breakdown right now and I apologize for the point.

Don Miller

We maybe, I’ll get that by the end of the call, so keep listening. You don’t think so.

Robert Bowers

No

Don Miller

No all right...

Chris Caton – Morgan Stanley

I’ll keep listening anyway.

Don Miller

Okay, alright.

Chris Caton – Morgan Stanley

And then my follow up Don, is trying to write-down a comment you made earlier on in the call you talked about the leasing environment and being patient for the right deals for your buildings. Can you talk a little bit about, more about the types of deals you’re seeing that either you’re passing on or pushing out to re-negotiate and if you have any specific comments to Chicago, that will be helpful?

Don Miller

Sorry, I may have misunderstood. The question I was addressing earlier was around acquisition activity, not leasing activity.

Chris Caton – Morgan Stanley

It was in your prepared remarks.

Don Miller

Oh, in the prepared remarks. No, actually we’ve seen and to begin, if I misspoke I apologize. We’ve actually seen a nice pick up of leasing activity again here after the first of the year. I’m not sure we’ll see this same level of total leasing activity in 2012 that we saw in ’11 just because we obviously had so much renewal activity and otherwise going on last year. But I think we’re going to see a pretty productive year this year as well and like I said even although in the last quarterly call I was telling you I thought the leasing environment was slowing down. We are now seeing a pick back up again.

The place that we’ve seen the most activity and have seen the strongest activity is in the Texas markets and in Downtown Chicago. And then there as been some odd places where we have seen just some improved activity. We have seen some great activity, the Bridgewater assets as we’ve talked about in New Jersey. We have seen some more renewed smaller tenant activity in, for example suburban Chicago. I don’t know that’s a huge trend or we’ve just seen some good activity just in the last couple of months in some of suburban assets there.

And we’ve seen a little bit of a pickup in the LA Basin recently. So and the only place we’re seeing a slowdown if you will is probably Washington DC at this point. Atlanta remains slow, Phoenix is probably a little slow but by and large nowhere else its slowing down other than may be Washington DC.

Chris Caton – Morgan Stanley

Thank you.

Don Miller

Okay.

Operator

Thank you. (Operator Instructions) Our next question is coming from Paul Adornato from BMO Capital Markets. Please proceed with your question.

Paul Adornato – BMO Capital Markets

Hi, good morning. Don, I was wondering if you could talk a little bit about the appetite in the market for large space versus small space and what’s your outlook for having large blocks versus smaller blocks available, are you agnostic and how does the math kind of work on a per square foot basis?

Don Miller

Well I say we sort of pride ourselves or build a business model around serving large corporates and governments as you guys know. And as a result we think that’s always wise to try to maintain a big block strategy that does make our income stream a little bit lumpy although what our size level some of that diversification sort of diversifies that away. But we do have and worked pretty hard to maintain full blocks of space on floors. For example, we might whereas some of our competitors might block breakup a 25,000 floor by swapping to 45 pre-build units on it and throw some bunch of 4000 and 5000 footers on there.

And I don’t necessarily say that’s a wrong strategy, we’ve always worked to try to maintain that full floor availability so that we can deliver blocks of space. And as a result when times are good I think we pickup very quickly and when times are tough which I think is the environment we’ve been in that’s been a little harder on this. But as a result right now I think we’ve got let me see if I can count the first seven, nine or eleven, thirteen, fifteen about seventeen or eighteen blocks of space that would be 50,000 square feet or more contiguous available in our portfolio and I’m not suggesting don’t take this wrong way I’m not suggesting this is the immediate benefit of debt, that translates into growth potential ran of about $60 million in just those 18 spaces.

So you can see the impact of a pickup in activity in the marketplace from a big block standpoint, when that when the market starts to get that point with the quality of spaces that we have available. And so we’ve been protecting those spaces as much as we can because the minute your start curving goes up or dividing them up you really takeaway your potential to get a premium rent out of someone who needs a bigger block of space. So that’s always been our theory and that’s why you see such a big contiguous block for example the top of Aon center, while you see a big contiguous block of top of 500 West Monroe. And we think we are now in position to take advantage of that given there is no other really good Class A blocks of spaces available on Downtown Chicago and there are few tenants floating around other. So, we hope we can convert one or more of those.

Paul Adornato – BMO Capital Markets

Okay. And can you point to any examples where you made the determination that the large block is just this just not going be too much activity and you did decide to break it up?

Don Miller

There are few buildings in our portfolio because of the way they’re configured or where they are in a market then we see as more smaller tenant buildings. Great example of that is the Matlacha here in Atlanta that some of you guys toured recently were you just not going to get very often the 50,000 big block to come along, but you got a lot of really good local regional firms at 10,000 to 15,000 that fit really well into that building, we are looking for at higher image.

And so that’s a good example when we don’t have a lot of those, the few others would probably be largely concentrated in Washington, DC or like our 1201-1225 High Buildings, 400 Virginia would be a good one and the stuff like 4250 North Fairfax in the RBC quarter. So I would say that’s really where we’re concentrated in the spaces that work for small units because otherwise, we pretty well protect the larger blocks in our portfolio.

Paul Adornato – BMO Capital Markets

Thank you.

Operator

Thank you. Our next question is coming from John Guinee from Stifel Nicolaus. Please proceed with your question.

John Guinee – Stifel Nicolaus

Guys, thank you. Aaron is with me and pointed out this. You’ve got to let’s say about over 775,000 square feet leased to a BP, majority is subleased to Aon. I think Aon just signed a letter of intent in that building. Of the 776, the BP leases, how much of that subleased to Aon and then how much do you expect them to keep?

Don Miller

Yeah, John I can’t comment on the Aon situation because we have not announced anything on that. It has been in Chicago newspapers the LOI was signed. So, I’ll just leave it at that, but let’s say we renew Aon and the reported information in the paper was that, well that would be about half of the space that the BP originally leased. And then all, but three floors of the entire rest of that block of space is already leased on a long-term basis to other tenants including Integris you may remember, we signed a corporate headquarters lease with Integris earlier this year.

About two or three years ago, we signed a multiple floor lease with the Federal Home Loan Bank of Chicago. We also signed a two floor lease with ThoughtWorks, a computer consulting company in the building. I know I think there is one other if I’m saying many way that all but three floors if we did sign the Aon lease would be completely taken care of it at this point already.

John Guinee – Stifel Nicolaus

Okay, great. And then the second question is you guys have done a great job of on acquisitions and dispositions of it. To some extent repositioning the portfolio in 2011 you acquired about $390 million of assets and in 2011 you sold about $500 million of assets. But in reality, if you carve out 35 West Wacker and 500 West Monroe which essentially you just traded positions in Chicago by about a mile as the growth wise, I think, the rest of it is may be $150 million, $100 million to $150 million. And then I think you’ve got $200 million of dispositions in acquisitions this next year. Given this kind of volume how long it take you to get where you want to be?

Don Miller

John, I think we said for a while now we think that we largely completed our strategic plan by the end of 2015. And at that pace we would do that. Could we be more aggressive and get some more done and get it done sooner yeah, but I think that obviously that would require the capital markets to fit our strategy pretty well. But now, I think if you look at our longer term models of what we sell and when we sell them and then how much volume we have to do to get there, it’s a fairly modest – we’ll always say in 2015 it only takes a fairly modest amount of activity to get there by 2015. So, we hope will exceed your expectations, but we don’t want to promise more than we think we can be fairly certainly deliver.

John Guinee – Stifel Nicolaus

Got it, okay. Thank you.

Don Miller

You’re welcome.

Operator

Thank you. Our next question is coming from Michael Harmon from Midwest. Please proceed with your question.

Michael Harmon – Midwest

Greetings and I’m calling primarily as a retail investor. You’ve talked about additional revenue that can come in from leasing up and you’ve talked about profit and buildings that you sold and on comparing those numbers to the potential liability that the plaintiff is climbing of a $159 million certainly a significant number. I know you’re saying that the odds that, how you feel that they’re going to prevail is low, but then you’re also saying on the other hand that, when you’re dealing with the court system as a wild card. So, obviously the probability, possibility issue is significant, when you are talking about $159 million. So, could you shed a little bit of light on that, I look that your 10-Q from ‘11, 3 I’m not sure if that’s the one that really details the litigation because I really didn’t pickup a lot of information there. But if you could give some insight on that $15 million of insurance certainly isn’t going to do a lot to cover potential $159 million liability. So, are you reserving any funds or perhaps you’re going to come to negotiate settlement?

Don Miller

Well, obviously it would probably inappropriate for us to address litigation strategy on a broad public call. I think the reason we want to just point out that risking exists as we’re getting closer to the date of trial. Now we’ve had some Judges pretrial rulings that didn’t go exactly the way we wanted, I mean, so we felt like there was a greater chance of risk then there was previously and so we up the profile on our risk assessment at this point, because we just felt like that it was prudent to do so, when we want do it as soon as we follows it was the right time to do it. But to get into any sort of litigations strategy or be to quantify anything any further will be very, first of all it will be extremely difficult to do and second it could pre-compromise our position in the case.

Michael Harmon – Midwest

Yeah I understand, but can you discuss if it was adversely found against the company. How you would deal with that? How would that affect the dividend payments?

Don Miller

Well, I don’t know that if there was a material adverse effect that it would affect dividend payments going forward. Obviously we’ve made a comment on what we think we’re going to be doing with the dividend, already going forward. But obviously it would impact the value of the business in our capacity, in our line of credit. But we have $600 million of liquidity as a company and the plaintiff top ask is nowhere near that. That’s before you even sort of take into account, whether they would even get their ask and whether that would be a sign liability to the company or not and that kind of things. So, it’s not always prudent to comment much further on the math.

Michael Harmon – Midwest

One of your last comments there was very comforting. So I appreciate that. Thank you.

Don Miller

Okay. Thank you.

Operator

Thank you. Our next question is coming from Michael Knott from Green Street Advisors. Please proceed with your question.

Michael Knott – Green Street Advisors

Don, just coming back to the minus 5 on cash, same-store NOI for 2012, can you just talk about the sources of that and maybe not that you’ve given guidance on 13, but it is looking 13. There is a big chunk of the minus 5 for ’12 caused by some of these downtimes that you’re talking about and so maybe the outlook for ‘13 actually is much better, maybe not much better, but has to start improving as you get some of those leases taking care of etcetera. So, can you just talk about, maybe your expectation for the art maybe average occupancy for the year for ’12 compared to maybe what might be appropriate to think about for 2013?

Robert Bowers

Michael, this is Bob here. I’m going to take a shot at this, but you asked about five questions and one question that is so long. So, bear with me, so I’ll try to get through it. We talked about on the GAAP basis that we thought to do about a 2% roll down. Obviously as leases began, that’s the front end part usually is where any concession and abatements are. So, that’s why you see a further decrease on a cash basis for 2012 on a NOI basis.

As you start talking about 2013 there is still just a large number of unknown. If you follow the model, we’ve got it, where we think it will be very positive in terms of lease potential. We are sitting at 86% today or a little over at 86.5% maybe going to 88% by the end of the year. The unknowns going into 2013 that really largely lag with, what we’ve talked about already was going to happen on the governmental side National Park and with OCC about 13% of our revenues come from the governmental side.

Don Miller

Yeah, Michael I would add one thing, I think Bob has said this was, as we look at it a lot of our lease expirations were ‘11 early ’12. The later half of ‘12 we don’t have a ton of lease expirations as a couple way at the end the year and then we have the two or three big government deals coming up that we just don’t know what’s going happen with those other than OCC at this point we don’t know what’s going happen with those yet. And so the two government leases in early ‘13 well the one government lease OCC that we know is leaving is going to affect us in early ’13 we don’t yet know what’s going happen with national park obviously and how long they may extent and then there is always other impacts from the government downsize it could had hit us in ’13 as well and so if you looked it all that at it’s gets really hard to predict what ’13 looks like over ’12 but if you starting looking at fourth quarter and in the first quarter of ’13 I think the NOI numbers start to getting a lot better because we’re burning off some of the free rent of all this big leasing chunk we had going on here and you’re starting to also pickup occupancies, assuming our occupancy or our leasing activity to stay as strong as it’s been so far. And so we think we will pick up occupancy that will offset other roll downs.

Michael Knott – Green Street Advisors

Okay, thanks. It’s helpful. And then just in terms of the upcoming dividend cut, any updated sense from retail investors in terms of whether you’re worried about sort of – wholesale flooding of stock in the market or not?

Robert Bowers

Michael, from where we were two years ago when we had our IPO, over 50% of retail shareholders have moved out of the stock, institutional holdings exceed that. On February 15, we should get updated data. Certainly what we have attempted to do was to get this information out there. Do we anticipate a large flow back? No, it could have happened maybe, but are certainly – we’ve been talking about this for two years and it hasn’t happened yet.

Don Miller

Yeah. Michael, I fully expected you to ask the question, why didn’t you buy more stock back in the fourth quarter? I’m sort of disappointed with you, but obviously we’ve been pretty cautious in our thought process on how we use our share redemption program that’s always been a piece of what we thought about as just to make sure we feel like we’ve got plenty of liquidity for that, if that eventuality came around. But frankly we are kicking ourselves for not having done more share buyback in the fourth quarter.

Michael Knott – Green Street Advisors

Thanks and you talk about it, so I didn’t have to ask.

Don Miller

Okay.

Operator

Thank you. Our next question is coming from (indiscernible) from JRL. Please proceed with your question.

Unidentified Analyst

Yeah, good morning. Going to specifically, the Bridgewater and the Solar Array, can you add some color on the grade ability or scalability of that project or is that a one-off or is that something that you’re looking at going across the portfolio?

Don Miller

Tom thanks for bringing it up and I appreciate your participating in the call. It was interesting there was a unique opportunity we thought last year to start to multiple benefits of obviously putting a Solar Array on one of our properties one was just demonstrate our further commitment to sort of green behavior in activities obviously in New Jersey may be you were aware of this may be you aren’t there is been programs that have been very beneficial to users to install solar rays so we now only got a federal tax credit or ineffective federal rebate for purchase of the solar, but we but they also have program were are in credit.

So required to be purchased by the utilities up there and pricing in that market has been fairly strong. And so we are able to especially once solar panel pricing fell later in the year last year. We’re able to generate a reasonable return on investment by putting those in and then send the message to the marketplace that we’re more active in this arena. Having said that some of the federal tax rebates have gone away, pricing on the extra carbon products in New Jersey and other places have fallen quite a bit lately due to all the new solar projects have been build and so our sense is although this is an intended to be a one off project it may be one up for a while until we find new better economics on future projects.

Unidentified Analyst

Okay. So just the follow–up though that would potentially add to the rent a bull square footage of the building yeah actually if there was 100% rented and you’ve got the roof rented that just touched to bottom line?

Don Miller

Good question. We actually own the solar panels ourselves and it doesn’t add anything to the rentable they way it works. I’m sorry to give you a prime around this but the way it works is effect we generate the power, we send it to utility company they pay us forward in effect and then we are able to bill the power through to the tenants on a more favorable cost structure than they would otherwise get from just buying power from the utility company. And so we get, if you want a spread on that investment plus the ability to sell the carbon credit expect the utility company. So that’s how we generate our return. So it doesn’t actually increase the net rentable area, it just in effect lowers operating expenses and allows us to generate profit from the carbon credits.

Unidentified Analyst

Okay, very good. Thank you.

Don Miller

All right. You’re welcome.

Operator

Thank you. Our final question is coming from Chris Caton from Morgan Stanley. Please proceed with your question.

Chris Caton – Morgan Stanley

Hey Don, just had a quick follow-up on dispositions, $200 million in guidance, can you talk a little bit about market pricing and potentially barbelling with core versus opportunistic markets? And as you look over your portfolio, kind of what are the best kind of sales candidates from here, is it kind of a middle – is it, are you able to sell some of those that you really want to exit? Can you just shed a little color and if you can provide yields that will also be interesting?

Don Miller

Yeah. I’d tell you that the vast majority of what we’ve budgeted, the $200 million we’ve budgeted for this year would be exceeding non-strategic assets. So it would be either markets were trying to get out of other product types or trying to get out of not to be too (indiscernible) there or some of the joint ventures, those more joint ventures we saw have left over. So disproportionately it would be in that arena, there are one or two what we would call some of our lower quality projects and concentration markets that are also sprinkled in there because we feel like now it’s the time to reap what we’ve sawn our those. And so, I’m not sure I could give you a good sense of blended cap rate and all that because it is again – I hate talking about cap rates because they’re just so point in time but I know you’re trying to build out models. But to me it would be cash, I’ll hit him throw a number out because I’m not sure I’m calculated.

Chris Caton – Morgan Stanley

That’s all right. And then the follow-up in is if you had any conversations in, I guess in discussions with brokers about financing markets for some of these assets are you in added to New Year are you seeing lenders interested in providing capital as you disclosed these assets?

Don Miller

I would say marginally the financing market improving again may just be because everyone’s got new allocations in insurance companies and banks of new allocations we are also seeing the CMBS market creep back a little not much, but a little and so we are not getting to the point where the four or five year leased assets is got strong financing and you can drive good pricing on it. But if you got 7, 8, 9 years of the average lease term in a property or something like that you can probably get some pretty good financing and move something like that if it’s right decision for the business.

Chris Caton – Morgan Stanley

Thank you.

Robert Bowers

And Chris, this is Bobby, I want to try to follow-up with your question when you asked about the $70 million that we’ve got included in the incremental capital and was that primarily value add related properties. On page 33 of our supplemental schedule you got a list of the value added properties and when you look to that, I can tell you I don’t have the detail I was just giving sum aside were you’ve GE listed that certainly is a large portion of the expenditures for incremental, you've got located the unpaid property will be purchased this year and you got the Schlumberger lease there, that’s a significant portion of our incremental expenses. So without being more precise I’m just trying to get back to your timely and do this publically as the vast majority of that’s related to the value add properties.

Chris Caton – Morgan Stanley

Thank you.

Operator

Thank you. At this time there are no further questions, I’d like to turn the call back over to Mr. Miller for concluding remarks. Thank you.

Don Miller – Chief Executive Officer

Thank you again everyone who is held on. So I think this is our longest call since we’ve been public and we appreciate all the questions and a lot of good questions this quarter and a lot of good feedback. So thank you very much and if anybody here wants a follow-up on anything else, obviously within the bounds of public information we’d be glad to do that. Thank you very much.

Operator

Thank you. This does conclude today’s teleconference. You may disconnect your lines at this time. We thank you for your participation today.

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