Columbia Property Trust's (CXP) CEO Nelson Mills on Q4 2015 Results - Earnings Call Transcript

| About: Columbia Property (CXP)

Columbia Property Trust, Inc. (NYSE:CXP)

Q4 2015 Earnings Conference Call

February 12, 2016 10:00 AM ET

Executives

Tripp Sullivan - IR

Nelson Mills - President and CEO

Jim Fleming - EVP and CFO

Analysts

John Kim - BMO Capital Markets

Brad Burke - Goldman Sachs

Sheila McGrath - Evercore ISI

Mitch Germain - JMP Securities LLC

Sumit Sharma - Morgan Stanley

Operator

Good day and welcome to the Columbia Property Trust Fourth Quarter 2015 Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded.

I would now like to turn the conference over to Mr. Tripp Sullivan, Investor Relations. Please go ahead, sir.

Tripp Sullivan

Thank you, Laura. Good morning. Welcome to the Columbia Property Trust conference call to review the company's results for the fourth quarter of 2015 and its outlook for 2016. On the call today will be Nelson Mills, President and Chief Executive Officer; and Jim Fleming, Executive Vice President and Chief Financial Officer.

Our results were released yesterday afternoon in our earning press release and filed with the SEC on Form 8-K. We have also posted a quarterly supplemental package with additional detail in the Investor Relations section of our website.

Statements made on this call regarding expected operating results and other future events are forward-looking statements that involve risks and uncertainties. A number of factors could cause actual results to differ materially from those anticipated including those discussed in the Risk Factor section of our 2015 Form 10-K.

Forward-looking statements are made based on current expectations, assumptions and beliefs, as well as information available to us at this time. Columbia undertakes no obligation to update any information discussed on this conference call.

During this call, we will discuss certain non-GAAP financial measures. Reconciliations to comparable GAAP financial measures can be found in our earnings release and supplemental financial data.

I’ll now turn the call over to Nelson Mills. Please go ahead.

Nelson Mills

Good morning, everyone. Thank you for joining our call. There is a much anxiety over the past few months regarding where the office sector is headed. Even for some of the strongest rental markets in the country. As New York seen its best days, how will San Francisco be impacted by questionable private tech company valuations, will Washington DC’s office recovery be spurred or stymied by the looming election, and can Houston ever recover from the collapse in the price of oil?

Apprehension about some of these markets like New York City has intensified as recently as this earning season. For other markets we’ve been weighing concerns for some time. This trepidation is understandable given the broad economic uncertainty we all face. But we are still seeing opportunities and maintaining leasing momentum across these markets. We’ll give you our read on each of our focus markets and explain how our properties are faring within them.

While market conditions are always important, real estate performance and valuation is also largely dependent on specific location, fiscal quality and other attributes of individual assets relative to their competitive set. We’ve assembled a portfolio of well-located and attractive assets predominantly in high-barrier CBD locations with healthy tenant demand. The portfolio is also quite diverse in terms of tenant industry. Over the last few years we’ve sold properties in suburban and secondary markets and diligently reinvested those proceeds in assets and markets that we believe best equip us to preserve value during downturns and to grow value during up cycles.

While we’re not immune to potentially softening margin conditions our transition, which is nearing completion should serve us well in this uncertain economic environment. We now have a portfolio after completing dispositions currently in process among the best of high-barrier REITs in the office sector. We have 22 properties in 12 markets, 82% of our annualized lease revenues are sourced from CBD locations and strong urban infill submarkets. 76% of our revenues are from multi-tenant properties, 60% of revenues come from high-barrier markets, and we have net rents of over $27 per square foot today compared that with a little over $18 per square foot when we began the transition in 2011. No one is declaring mission accomplished just yet, but we’ve now assembled a very attractive and stable portfolio, which is geared for long-term growth. Now we just continue to execute.

Let’s talk about this execution. The progress we’ve made thus far and our expectations for what’s ahead. We’ll start with dispositions. With the sale of 1881 Campus Commons in Reston, Virginia during the fourth quarter for $65 million we’ve now sold 47 properties since 2011 for $2.1 billion. We’ve projected a total of $700 million to $800 million of further dispositions in 2016. The bulk of these proceeds will come from 100 East Pratt in Baltimore, Key Tower in Cleveland and 80 Park Plaza in Newark, New Jersey. We are in active negotiations with awarded buyers on all three at pricing consistent with our original expected range. We anticipate that these sales will close within the next couple of months and at that time, we’ll be able to provide more color on the process and results.

We also have two other smaller assets on the box 263 Shuman Boulevard, the former OfficeMax headquarter in suburban Chicago is secured by $49 million non-recourse reinvest loan. We are entitle to the net cash flow through November 2016 at which time we’ll either have a plan for a new user or possibly return this property to the lender and reduce our debt by $49 million. At 800 North Fredrick in Suburban Maryland we continue to work with the developer on an alternative use. The 390,000 foot lease with IBM for this building expires next month and is reflected in our gardens.

Entitlement issues has slowed the disposition process down a bit from our original timing, but ultimately we believe it will generate approximately $45 million in proceeds when it’s sold this year.

Now let’s turn to leasing. We completed 723,000 square of leasing during the fourth quarter of 2015, including the long-term renewal of CH2M for 370,000 square feet in suburban Denver, a 125,000 square foot lease renewal with Thomson Hine at Key Tower, and a 45,000 square foot new lease with Equinox at 315, Park Avenue South in mid-town South Manhattan. In total we leased 1.26 million square feet during 2015 and resolved several of our largest near-term expirations.

We do have few milestone leasing opportunities ahead of us in 2016, which will give us the opportunity to demonstrate our value creation capabilities as well as establish a clear direction for our FFO and AFFO trajectory. I’ll walk through this briefly. Let’s talk with 222 East 41st. The John’s Dale lease expires on October and we still anticipate having much of that space committed by then. This is by far our largest expiration for the next few years. We are trading Piper with three perspective tenants on the lower floors at rates that meet expectations and we’ve been pleased with the demand for this space thus far.

Our best news here is that we’re also working with the perspective tenant to take the entire space under a long-term lease. We are under a confidentiality agreement and can’t say much more about that right now, but we hope to have some news to report in the next few months. This leasing opportunity at 222 East 41st more than any other action item ahead of us will have a significant impact on our ability to finally trend FFO upwards following the planned and very necessary earnings solution that resulted from our successful portfolio transition and of course AFFO will eventually follow soon.

Next, 650 California Street with Littler Mendelson, a 109,000 square feet expiring at the end of March this is more than more exciting leasing opportunities we have on our portfolios, we expect to achieve a substantial roll-up in rents very similar to the success we enjoyed at 221 Main in San Francisco South Financial District.

We are in discussions with the tenant that would take all the space and a bit more across the lower floors. We hope to have something definite to announce in a not too distant future. A year ago, we acquired 315 Park Avenue South in Mid-Town, Manhattan now holding company manages and leases this property on our behalf and we have established a lot of traction with new signings such as Equinox, Oracle and Fullscreen totaling 78,000 square feet in our early days of ownership. We’ve launched a capital improvement project that will include a new entrance for Equinox and enhancements to the lobby and other common areas.

With a net 150,000 square feet currently occupied by Credit Suisse expiring in late 2016 and early 2017 and with promise space currently available at the top of that building we’re set to take advantage of a continuing healthy leasing market in the Midtown South.

Also a year ago we acquired 116 Huntington in the Back Bay of Boston. We have only 60,000 square feet of space available there including the most desirable space in the top two floors that feature dramatic [indiscernible] and sweeping views of the Back Bay and the Charles River and we’re getting a lot of traffic at this time.

The top floors the 14 and 15 floors are in the process of being white box and will feature temporary marketing center. Lobby, entry way and other common area renovations are also underway. Market square Washington DC is our largest asset by value. We completed the property renovations to the entrances, lobby, elevator cabs, restroom and common area corridors during the fourth quarter and will soon deliver a state of the art fitness center.

The renovations continue to generate strong traffic for the space we have available from the recent expiration of the Fulbright & Jaworski and Shearman & Sterling law firms. Rental rates continue to remain somewhat stagnant in DC overall, but we are achieving rent rollups on average of 5% to 10% at Market Square. We’ve been breaking up full force to achieve accelerated deal velocity and higher net effective rents.

We have used our concentration of top German Affairs office to create a sense of gravity for similar tenants and it recently attracted Ford Motor Credit and CBS Media as new tenants. We’ve also had success in renewing tenants like Advance Medical Technology Associates that thrive of the proximately to both the Capital and White House. Today we have leased up approximately 39% of Shearman and Fulbright's former space.

Now, I’d like to spend a little time on what appears to be some of the hardest topics in earnings season so far. Our read on what’s going on in San Francisco, New York and Washington DC. As I said earlier, there are some valid concerns for each of these markets, but our views on the current San Francisco and New York office markets are more positive than some.

This is based partly on our recent leasing success and partly on our analysis of the submarkets in which we operate. In San Francisco, we have intentionally struck a balance between technology and traditional Financial District tenants and between southern market and northern submarkets. We’ve also benefited from scale as one of the larger office landlords in Downtown, San Francisco.

First, we’ve purchased 333 Market Street a 657,000 square foot building leased entirely to Wells Fargo that acquisition was in the fall of 2012. Two years ago, we acquired the 378,000 square foot 221 Main Street in the South Financial District. As discussed earlier this asset has performed well about our underwriting.

Finally, in September 2014, we bought 650 California Street, a 477,000 square foot building, which lies squarely in the North Financial District. We believe that this balance of locations serves us well to fill all types of tenants.

Our San Francisco portfolio is currently 97% leased and we purchased 221 Main Street and 650 California we did so with the intention of driving NOI growth by marking up the spaces within the first two to three years of our ownership and that is exactly how it’s laid out for us so far. The long-term Wells Fargo lease at 333 Market and the diverse tenant demand for space at University Circle in Palo Alto provides stable balance for our exposure to the San Francisco area market.

If we look at our breakdown of Northern California revenues by top tenants our largest exposure is to Wells Fargo at 27%. No other tenant produces a greater than 8% of our San Francisco area revenues. Turning to New York our presence in New York is currently comprised of three assets located in three distinct submarkets. We’ve just discussed 315 Park Avenue South and 222 East 41st both of which have substantial near-term leasing opportunity.

Our latest acquisition 229 West 43rd on the other hand is a very stable well leased core investment. As we look at our exposure to the New York City market it’s important to keep in mind, our specific and unique opportunities. We under rose the 315 Park Avenue South acquisition with rents well below peak and have the ability to get to that expiring space very quickly. We’ve had significant early leasing momentum and strong market traction as we approach the expiration of the next block of Credit Suisse space.

229 West 43rd a fully leased property with substantial average lease term provide the balance to our two value-add properties so we’re replicating when it’s worked with such success in San Francisco by simply a mix of stabilized properties with near-term lease up opportunities. Prior to this point we did not have a senior leader in team in this market. Of course we have property management teams, very capable property management teams on the ground in New York, but we’re proud to announce and I’m sure you saw last week that Adam Popper is joining us at the end of this month to be our SVP of the Eastern United States.

Having spent virtually his entire carrier with many of the top office owners in Manhattan we will greatly benefit from his experience, market knowledge, and leadership in this very important market. New York City’s economy continues to be one of the healthiest in the nation it has added over 400,000 jobs since recession, 105,000 jobs in the past year alone. Office using employment grew by 2.6% in 2015 and then unemployment rate dropped by 170 basis points 4.8%. Job growth has been recently fueled in large part by health services, professional services and tourism even though the New York City economy is now less dependent on the financial services sector it too expanded by 3.1% to 463,000 jobs.

Who knows what the future will hold in the financial sector, but our current exposure there is limited to the Credit Suisse space at 315 Park Avenue South, which is at least at a lease rate well below the current market rates. New York City also continues to be one of leading sources of intellectual capital in the United States and continue to be one of the leading magnets for entrepreneurs and venture capital activity. Overall New York City experienced 28.2 million square feet of leasing activity in 2015, the third highest in the past decade.

Although down by comparison to 2014 activity Manhattan’s overall vacancy rate dropped 90 basis points to 8.5%. All three major submarkets experienced a decrease in vacancy with Midtown falling 100 basis points to 8.8% and Midtown South falling 90 basis points to 9.4%. So while things may appear to be softening there a bit in current days that’s to be determined. We underwrote our projects at well looking rates and we have plenty of room relative to current market conditions to execute our strategy and beyond.

Turning to DC, while the Washington DC leasing market continues to be quite sluggish we’re bullish on this market longer-term, Market Square has held its own with a significant number of leases, favorable leases and improving lease traffic. Late last year, we brought on Blackstone as a 49% partner. We have very high performance expectations for this asset going forward and we’ll continue to look for other opportunities in this market. We believe DC will eventually make a strong return and we’re hopeful that post-election it will begin to ship back to doing what the city does best driving off the demand created by new laws and a new changing government.

While tenant concession packages remain elevated we continue to see strong signs of improvement with supply being significantly observed. Again we are in the midst of a volatile and uncertain market environment. There is no question about that. Like most everyone we are being more measured and conservative in the execution of our strategy until we have more clarity about the broader economy in the office market more specifically. But we’ve made great strides in building a stable high priority portfolio predominantly situated in some of the best office markets in the country. And we’re taking steps to further strengthen what is already one of the strongest and most flexible balance sheets in our industry. We believe this will enable us to sustain and to grow our net asset value through the market cycle.

With that Jim why don’t you walk through the results and our 2016 guidance and I’ll come back at the end with a couple of comments.

Jim Fleming

Thanks, Nelson and good morning, everyone. The markets have become very unsettled over the past several weeks and this has had an effect on our stock price as it has on most real estate stocks. The debt markets too have seen a great deal of turbulence and even though our primary debt sources investment grade bonds and bank financing have been less affected. We understand that broader market conditions can have a meaningful effect on asset pricing and fundamentals. So far we haven’t seen any measurable deterioration and fundamentals in our primary office markets, but we’re working hard to complete leasing and asset sales to stay ahead of any shift in the markets.

Ultimately once we’re able to complete the asset sales and major leases as Nelson mentioned. We should be in a great position to take advantage of opportunities that may arise as a result of dislocation in the capital markets.

With that I’d like to go through the results for the fourth quarter and then turn to our 2016 guidance. The fourth quarter was very similar to the third quarter with $0.48 of normalized FFO bringing us to a $1.99 for the year slightly above the high-end of our guidance. Good performance in the portfolio as well as contributions from the New York acquisitions in August. G&A savings and the timing of our New York team build out and the timing of the 1881 Campus Commons disposition were the primary drivers.

We were also able to achieve some property tax savings that reduced our operating expenses a bit. Leasing activity was strong during the quarter with 723,000 square feet completed including several strategic signings. The first was one we talked about on the last call the CH2M lease in Denver, which took care of our largest 2017 exploration. The second was the renewal of Thompson Hine in Key Tower in Cleveland that was expiring in 2017 and solidified the tenant roster for a major disposition on the market.

CH2M was a significant roll down on a cash basis and up slightly on a GAAP basis while Thompson was flat on a cash basis and a significant rollup on a GAAP basis. The other one of note, of Equinox at 315 Park Avenue South, which was a substantial rollup on both a cash and GAAP basis. Overall, we reported a 7% decrease on a cash basis and an 11% increase on GAAP basis.

For the full year we had substantial rollups overall 9.6% on a cash basis and 27.4% on a GAAP basis. these roll ups are a result of the strategy we’ve been following over the past several year, buying properties in good markets with below market rents most of which have had substantial near-term rent roll.

On page nine of our supplemental you’ll see that our total GAAP interest expense was $18.7 million for the fourth quarter compared with $20.2 million in the third quarter and $19.2 million in the fourth quarter a year ago. The prior period results include both interest expense and interest expense associated with interest rate swaps from our income statement, which were related to a mortgage we paid off in the third quarter.

The sequential and year-over-year declines were related to the pay down of mortgage debt offset by our $350 million bond issuance in March 2015. We also transferred the $325 million mortgage on Market Square to our new joint venture with Blackstone, which shifted future interest expense for that loan into loss from unconsolidated joint venture in our income statement.

AFFO for the quarter was $0.27 per share, down from the third quarter due to leasing and capital improvement cost, but comparable to the $0.28 per share for the fourth quarter a year ago. Our dividend continued to be well covered with $1.36 of AFFO for the full year.

Same-store cash NOI for the fourth quarter was down 1.7% compared with the prior year and down 0.5% from the third quarter. For the year we showed a 2% decline from 2014, which is slightly better than we had anticipated. Consistent with what we’ve highlighted throughout 2015, the decline was driven by the Fullbright expiration at Market Square, the Oracle expiration at One Glenlake in Atlanta, the KeyBanc downsize in Cleveland and the CH2M renewal in Denver offset somewhat by leasing at university circle in Palo Alto and 515 Post Oak in Houston.

As you may recall we provided guidance at the beginning of 2015 that we expected our same-store cash NOI to decline by 3% to 3.5% for the year and as I just mentioned we ended with the year with the 2% decline.

Our expectations for the year were based on the fact that most of our recent acquisitions were not in the same-store pool for 2015 and some of our legacy properties have had lease renewals below their previous levels on a cash basis. This will continue to be true in 2016, as we purchased several significant properties in 2015 that won’t be in our same-store pool until 2017 and we also renewed CH2M in Denver with a roll down in cash rents.

In addition, even though we’ve accomplished a great deal of leasing with substantial rollups at the properties we acquired in 2014, free rent will delay the effect of this leasing on same-store cash NOI. As a result we expect our same-store cash NOI will also decline slightly in 2016. Because we know that many investors and analyst pay close attention to same-store NOI, we will continue to disclose it in our supplemental package, but we do not believe it is a helpful metric to evaluate our performance until our transition is well behind us. So we have not provided guidance for this metric in 2016.

However, the rollups and renovates we’ve achieved over the past couple of years will eventually result in significant increases in both NOI and FFO. So I believe today same-store cash NOI decreases should be viewed alongside our leasing spreads, which as I mentioned were up substantially for 2015.

I want to remind you of a new disclosure we implemented last quarter on page 22 of our supplemental package. This page should give a clearer picture of the impact of our leasing. It’s broken down by market and for each market shows percent leased, percent occupied and percent economic occupancy. The difference between leased and occupy are leases that have been signed, but are not yet contributing to FFO or GAAP earnings. The difference between occupied and economic are leases that have commenced but are in free rent periods so they are not yet contributing to cash NOI. We hope this is useful in addition to the disclosure about our upcoming lease expirations.

Utilizing the disposition and Market Square joint venture proceeds, we reduced the balance on our $300 million bridge loan to $119 million at year end. With upcoming disposition proceeds in the first half of the year we expect to pay off the balance of the bridge loan and pay down the $294 million outstanding on our unsecured credit facility today.

With only six mortgages in the portfolio one of which is in the joint venture and another of which is on a planned disposition property and an unencumbered asset pool of approximately $4.3 billion. We believe we have one of the most flexible balance sheets in the office sector. Our liquidity and flexibility should give us an advantage as we evaluate our options to put capital to work in 2016.

One way we have used some of our capital is our share repurchase program. We bought another 151,000 shares in the fourth quarter in addition to the 570,000 shares we bought in the third quarter. That brings our total repurchases in 2015 to $16.3 million with the weighted-average price of $22.62 per share.

So far in the first quarter of 2016 we have purchased an additional $25 million of shares with the weighted-average price of $22.60 per share bringing our total purchases since last fall to $41.3 million. We ended the fourth quarter with leverage of 36%, which was down from 39% for the third quarter as a result of the sale of our Western Virginia property and our joint venture with Market Square.

Our leverage will continue to come down as we complete the disposition to Key Tower and Marriott in Cleveland 100 E. Pratt in Baltimore, 80 Park Plaza in Newark, New Jersey and 263 Shuman Boulevard in Chicago. I want to point out that our GAAP financial statements use the equity method for our joint venture with Blackstone on Market Square. As a result the debt is shown off balance sheet in all operations including interest expense on the debt are collapsed into one line on our income statement for the last two months of 2015.

For our supplemental package though, we’ve shown the joint venture at our pro rata share so you will see 51% of the Market Square debt in our leverage calculation and 51% of the properties revenues, expenses and other items in our statistics. We believe this is the most straight forward way to provide information on the properties performance.

Turning to our 2016 guidance, I’ll first note that this is virtually identical to what we laid out on our third quarter call last November. The quarterly cadence will be largely determined by the timing of the major inputs, the closing of the planned dispositions and any acquisitions or share repurchases that might be made.

But there are several constants throughout the year. These include the overall trend of NOI to be slightly down from the large renewals signed over the last 12 months. The loss of NOI from the sale of a 49% interest in Market Square, 2016 leased expirations with known move outs and the timing of lease commencements together with an overall leverage target in the high 20s to low 30s as a percent of gross assets.

Further breaking down our major assumptions we’re anticipating a lease percentage at year end of 90% to 92% that’s down from the 93% average we’ve experienced throughout 2015, so let me add some color to this. Absent the known move out of Jones Day at the end of October and the four dispositions still in the market, we expect to see net absorption. With Jones Day lease as the biggest factor for the year end number. And our lease percentage should be higher than it is today if we’re able to fully release this building in 2016.

We have one vacant building left over from last year’s CH2M lease renewal that we will get back in the first half of the year and all of this implies the sizable amount of new leasing activity and we’re working hard to make that happen. Our G&A is now projected to be about where we thought it would be this time last year between $32 million and $34 million. Recall that we raised guidance a few cents per share in the second half for 2015 due to the timing of the build out our New York team. In addition to Adam Popper we’re planning to hire two to three others similar to what we’ve done in San Francisco.

Our guidance also includes about $1.8 million of one-time cost associated with the regionalization of our investment in asset management team that we expect to incur in the first quarter of 2016. As a result of this continued regionalization, our Atlanta based team will be somewhat smaller and teams on both coasts will have more operating and leasing responsibility.

Our guidance for 2016 assumes we are able to close our sale of three large dispositions in Cleveland, Baltimore, and Newark around the end of first quarter. All three as Nelson mentioned have been awarded but are in due diligence. We expect the sales prices for these three will fall within the range we’ve provided last year of $600 million to $700 million. We also anticipate the sale of [indiscernible] Maryland at some point during the year and the resolution of the OfficeMax headquarters building in suburban Chicago later in the year, which should bring us to $700 million to $800 million in total.

We continue to work with the developer interested in purchasing Gaithersburg and the entitlement process is moving more slowly than we would like, but it is moving ahead. We’re also assuming approximately $200 million to $400 million of acquisitions for the year, we continue to maintain an active pipeline, but with some short-term debt on our books and significant asset sales spending. We’re not inclined to make any acquisitions in the next few months.

After that, we plan to use very conservative underwriting given the uncertainties that could affect office leasing fundamentals. Our pending asset sales however should put us in a good position to take advantage of opportunities caused by any market dislocations later this year. Also I want to comment on our share repurchases in light of current market conditions and our balance sheet, as I mentioned, we’ve now purchased $41.3 million of stock is what we believe are very favorable prices.

These repurchases should provide good value to our shareholders overtime. However even though we would like to continue to make these repurchases we expect not to buyback any more stock until we have closed at least some of our large pending asset sales. It is never a good idea to increase leverage to repurchase stock or to use short-term debt to do so. After our asset sales we will reevaluate what make sense going forward.

Also given our expectation of lower FFO in 2016 I’d like to take a minute to address our dividend. As we’ve said before our recurring CapEx was at a high level in 2015, due to recent activity and we expect recurring capital to be lower in 2016. However we are also expecting lower FFO in 2016 due to our pending asset sales. And we will need to spend significant capital over the next few years to release the Jones Day space in New York. As a result it is likely that our dividend level will exceed our adjusted AFFO in 2016 and probably 2017, but we believe today’s dividend will be well covered after that point.

While it is ultimately a Board decision our view is that it makes no sense to cut the dividend just to build it back in the near-term. And our pending dispositions should provide plenty of balance sheet capacity to allow us to continue to pay dividends at the current level.

I’d like to mention one final detail on our dividend for the fourth quarter of 2015 we declared our dividend in November, but we did not pay the dividend until early January 2016. We did this because we didn’t need the fourth quarter dividend to cover our tax distribution requirement as a REIT in 2015 and this move allows us to use that dividend to cover any taxable income distribution requirement we may have from asset sales in 2016. Paying the dividend in January also provides the most flexibility in tax planning so we expect to continue this practice going forward.

And with that I’ll turn it back to Nelson to finish up.

Nelson Mills

Thanks, Jim, we have some clear opportunities ahead of us in 2016. This should serve as definitive milestones for tracking our progress on both dispositions and leasing. We believe we’ve already been successful improving the value of portfolio with NAV accretive transactions and leasing achieved to-date. The harder work is behind us in our opinion in terms of distributions of suburban single tenant assets and renewals of large tenants in those markets.

As Jim explained and as long anticipated 2016 and 2017 have lower FFO and AFFO as a result of this, but it was as planned and we think we now have the portfolio in place to turn that in the next year or two so we’re looking forward to demonstrating that. We are confident that we have the team in place and the balance sheet to execute the strategy built on our portfolio of high-barrier properties with improving leasing markets and embedded rent growth.

So we really appreciate your time this morning and now we look forward to answering any questions you may have.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] And the first question comes from John Kim of BMO Capital Markets.

John Kim

Thanks, good morning.

Nelson Mills

Hi, John.

John Kim

A question on your guidance because I know there are lot of moving parts that you’ve walked through, but the 2016 guidance adjusted a 19% decline in the fourth quarter run rates and I think the majority of that is from the net dispositions on our numbers roughly 12% to 14% of that, but can you walk through some of the other items that gets to your guidance and if you’ve seen any softening in the pricing dispositions or timing of leasing or anything like that that gets you to your 2016 guidance?

Jim Fleming

John thanks this is Jim, and Nelson may chime in to add some color. We are expecting pricing really well within the range we have previously announced and things have moved along it’s we know that there’s some disruption in the capital markets, we know that the debt markets are tougher for folks of higher leverage. But there does seem to be substantial interest still in the three main properties we have on the market.

And so that’s really not affecting our guidance for this year. What I would say in terms of our guidance is that I would go back to what the remarks we made last quarter in the conference call and this is a bit of a simplification, but I think it gets -- we get folks in the ballpark, which is we had FFO in the third quarter $0.47 and then it will course with $0.48 in the fourth quarter. We work from that level. And we talked about the dispositions that we had in the market expectation of 6% to 7% cap rates for the large dispositions, which I think we still expect to be the case. We do have a couple of small ones that would be at more higher cap rate, but if we do that, essentially we’ve said last call we would lose $0.40 to $0.45 per share at FFO from the dispositions.

And then we will be able to pay off about $400 million of short-term debt at low rates that would add back about $0.05 per share. So that took us down to $1.50 there are a lot of moving parts. We’ve got the Fullbright expiration at the end of March, we’ve had a roll down on a cash basis, but not on a GAAP basis of the Denver property we’ve had a lot of things happening. We are expecting to get some benefit from some leasing this year and as Nelson said we are expecting a turn, but I would say this year we’ve tried to do the guidance in a fairly transparent way and I think we’ve taken all the different factors into accounts as best we can.

Nelson Mills

So as Jim said it’s largely a result -- the drop as a result of transactions. And Jim did walk through that last quarter and what we’re presenting today for ‘16 is consistent with that. But no, there is no -- we feel as optimistic as ever in terms of our lease rate and the leasing pace. And so it really is a matter of transactions the dispositions has moved a little slightly slower than we had hoped or anticipated but those are on track and we expect to get those done in the next couple of months nothing certain particularly in these times we’re in.

And we are moving with a great sense of urgency both on the transactions and some of these major leasing opportunities. But we’re optimistic about that and we certainly haven’t pull back any on rate expectations or operational leasing expectations. Of course so like I said working with some urgency to move a couple of these big items. The Jones Day lease at 222 East 41st obviously is a big lynchpin as well as some big leasing in San Francisco.

John Kim

Thanks. And Nelson I think you mentioned that you’re maybe refraining from acquisitions at this time. Do you see any softening or opportunistic acquisitions in your targeted markets currently?

Nelson Mills

Well we think that’s coming and we’re seeing some evidence of it. I think there is still a pretty significant bid ask of spread in that regard. We do think that that’s coming. I’d say we’ve pulled back our acquisition expectations a bit. I mean the team has a very active pipeline. We have several assets we’re currently looking at in our key markets from West LA, New York and DC. Our first priority is to get these dispositions done. And hopefully and get a little bit more movement in our couple of big leases. But we do expect to do some acquisitions this year. And hopefully to your point of your question, there will be a bit of a thinner capital pool competing with us for that the way things are going.

John Kim

Thinner coming from where?

Nelson Mills

Well I’m just say is I am saying that under current market conditions, capital competing for the assets we like to acquire may not be quite as frothy as it has been in recent last couple of years. And so leading to opportunities. With our strong balance sheet and our position and our focused strategy we’ll be looking for opportunities to come our way.

John Kim

Okay. And I know unicorn maybe a four letter word currently, but you have one on your tenant roster at least and potentially another one in discussion at 650 Cal. Are there any changes in the way tech companies have been making leasing decisions as far as the amount of leasing or the timing of decision making?

Nelson Mills

There has begun to be some apprehension obviously in San Francisco where the vast majority of the so called unicorns are located. We do have a couple in our portfolio. We then and now we put a lot of insist on credit underwriting and in the case of our credit private tech companies in our portfolio examples would be DocuSign, Prosper for example in Francisco, they are in very strong financial positions both in terms of balance sheet and cash flow.

So we watch that very closely as far as those type tenants moving slower or needing less or being more wary, we haven’t really seen that too much on the ground. Obviously that would be a natural conclusion given where we think is, but so far on the ground we are still seeing a pretty healthy amount of demand. We’ve mentioned early for 650 Cal we’re in discussions with a tenant right now that is committed to moving forward it appears.

John Kim

Okay. That was my next question, is the reported tenants at the spaces has still running or not?

Nelson Mills

They are never done until they are done. But we are hopeful based on how that’s going.

John Kim

Okay, great. Thank you.

Nelson Mills

Thank you.

Operator

The next question comes from Brad Burke of Goldman Sachs.

Nelson Mills

Hey, Brad.

Brad Burke

Question on the guidance, it looks like you are implying that you are going to sell all three the bigger assets that you have for sale in the first quarter and I might have missed it, but it doesn’t sound like you currently have any of those under contract. So should we read that as just being conservative and giving FFA guidance or is there a high probability of closing on all three of those asset sales in the next seven weeks?

Nelson Mills

There is an expectation of strong probability that we’ll get those done. There they’ve been awarded we’re in diligence both sides are spending money in every case, money and time. So we are confident in the intent of the buyers to get those done. But again they’re big transactions and they are not done till they are done. So we are optimistic.

Jim Fleming

And Brad you are correct, our guidance assumes we get those closed around the end of the third quarter. Looks like it’s possible we might get one done a little earlier, it’s possible a couple might be a little later. But we are targeting somewhere in that range. Now could delay a little bit, you never know. But things are moving forward.

Brad Burke

Okay. And another one on the guidance with the leasing guidance. Just what does that presume in terms of what you are going to be able to do at 222 East 41st both in terms of leasing and then in terms of GAAP revenue recognition?

Jim Fleming

Yeah. GAAP revenue recognition really nothing, Brad and that could change. It could be a little bit of upside there although it would only be at best at the last couple of months of the year. But from a leasing standpoint we said we are still expecting to get half of that building committed by the time Jones Day moves out. Obviously if we wind up with the full building user that that will change as well. But that’s not in our guidance either.

Brad Burke

Okay. And then also you’ve made a comment in the press release about leasing activity causing substantial FFO growth over the next several years and when we think about the portfolio it looks like an outsize component of that embedded rent growth is coming from properties that you purchased relatively recently the two in New York. The two most recent in San Francisco and since when you make those acquisition for GAAP purposes you need to mark those leases to market. I’m trying to understand what would be driving significant FFO upside from those properties. Is it that the market rates have increased meaningfully since you bought them or maybe the mark-to-market assumptions when you bought them were conservative or is this something else that we got to be thinking about?

Jim Fleming

Brad, I wouldn’t say that we did not believe at the time we bought the assets that our assumptions were conservative. We try to play straight up, you are require to value those leases at what we think current market is and you are correct what that a GAAP rules there do wind up really changing the dynamics of rent growth because what happens is we may have bought something at a 3% or 4% cap rate, but it may have then from a GAAP yield standpoint a couple of hundred basis points better than that. Couple of -- few things one is vacancy and we did have some vacancy at 221 Main, we got some at 116 Huntington in Boston, that doesn’t get mark-to-market. And so that is an opportunity to increase FFO.

Second I would say yes, San Francisco even today even with all the concern is at much higher rent levels than what we underwrote. And we’ve already realized some of that through leasing that’s been done at 221 Main and even at 650 California all above our pro-forma. And that’s really just a function of the fact that the market continue to go up. So we do have a lot of cushion there between our pro-forma and what rental rates having signed at and what we’re still anticipating. So yeah there is some accretion there.

And then finally as we roll leases over in the rest of our portfolio again GAAP does some hard things for the folks to follow cash may not care about. But when you sign a long-term lease that has rent bumps and if you wind up moving up from an FFO standpoint even though on a cash basis in that particular year you may not move up. So FFO and AFFO are different, I will comment that our AFFO will move up much more dramatically as we get leases rolled up and our cash flow will move up much more dramatically. And that’s the reason really for our view on the dividend.

Brad Burke

Okay, no that makes sense. And maybe just touching on one of the specific assets 650 Cal you bought it later in 2014 I mean broad strokes are you able to say what kind of rent growth you’re anticipating when you bought that and where you think it would be at today?

Nelson Mills

So I think the underwriting on that particular space that we’re talking about the lower half of the building was low 60s. And we’re probably closer to 70 on that. So some $7 or $8 probably, I would say.

Jim Fleming

And Brad those are gross rents so the impact on the net rent will be greater.

Nelson Mills

That’s right.

Brad Burke

Understand. Thank you very much.

Operator

The next question will come from Sheila McGrath of Evercore ISI.

Sheila McGrath

Yes, good morning. Now I was wondering if you could give us a little bit more detail on 41st Street. You’ve been talking to that large user for some time. Is the timing a little slow because of pricing issue or are they looking at a competing option? Just give us a little bit more detail on that process.

Nelson Mills

Well we’ve been in discussion really began back in the fall few months ago. And it’s a big project it’s 390,000 feet. So from their point of view and both in terms of evaluating opportunity and then begin to talk about terms it just take some time. We are -- again we’re very optimistic that it could happen, but we’re -- it’s premature to announce anything more than that.

Sheila McGrath

Okay. And then…

Nelson Mills

And so it’s not being -- we think they have a strong interest in the property, we think we’re the lead horse for their demand for their need. But again we got to work it out.

Sheila McGrath

And then would the pricing be much different from a multi-tenant versus single tenant on the rent?

Nelson Mills

No maybe just a couple of dollars of average rates, but no more than that and that’s more than made up for by the other positive attributes, long-term nature of the lease, quality of the tenant, et cetera. So it would be a very nice win for us relative to our long time multi-tenant strategy. And also the big thing of course is just time and cost of getting there.

Sheila McGrath

Okay that’s helpful.

Nelson Mills

We’re pulling for that result; I'll just leave it at that.

Sheila McGrath

No, I think that will be good news, certainly. Just on that G&A guidance Jim, does that incorporate getting New York office space for your new office or and if you are going to get some space do you plan on putting Colombia’s New York office in one of your building?

Jim Fleming

Sheila yes and yes. It’s the biological place will probably be 315 Park Avenue South because we’re going to have a lot of activity there, but that’s still to be determined our men on the ground hasn’t even started yet. So we’re just beginning to kind of think through that but yes, we’ll have an office in New York as we have in San Francisco and it will be in one of our properties and that is in really all of the costs in fact our G&A I mentioned in my comments that we’ve got some one-time cost from a shift to more regionalization that’s going to hit in the first quarter, we’ve got the continued build out of the New York office all of that’s in our G&A guidance.

Sheila McGrath

Okay, that’s great. And then on the TI discussion, I think you did mentioned in your prepared remarks that that CapEx level would be lower than last year and I am just wondering does that incorporate any the lower than last year does that incorporate any TI for 41st Street?

Jim Fleming

No, Sheila again where that lease runs till the end of October. And so our expectation is not to spend a lot of money in ‘16 it will probably mostly gets spend in ‘17. So that is coming, but it’s not in our expectation for this year.

Sheila McGrath

Okay, great. Thank you.

Jim Fleming

Thanks, Sheila.

Operator

Next we have a question from Mitch Germain with JMP.

Mitch Germain

Good morning.

Nelson Mills

Good morning.

Mitch Germain

So, just I am curious on your thoughts on asset sales, I mean, it seems like pretty much everything that you’ve got marketing right now is either been rewarded or pretty much is committed. So just taking into accounts some of the commentary from you Nelson about kind of where you’re seeing the investment sales market moving is there any motivation to maybe put the other couple of what you would consider non-core assets of for sale just to maybe get in ahead of any window of the sales market closing?

Nelson Mills

Yes. We’ve talked about that as a team and at the Board level. There are four to five other assets, we consider non-core not for ever hold they’re relatively small compared to these big three. And we have talked about doing that there are a couple that has near-term expirations in over the couple or three years that we’re in a process of addressing, renewing hoping to extend right now. So those might be difficult to pull the trigger on those couple.

There are others that we probably should get out into market within the next few months, it’s really a matter of focus and getting these others out of the way and then of course we’re going to have a very low net leverage after these three. So we have plenty of capital capacity, those do generate some cash flows and it’s a matter of balancing sources and uses, and we’re balancing all that along with your point Mitch is this the right time, is this sort of the best last window to sell those kinds of assets.

So, short answer is we’re thinking about that and we’ll probably will move along with some of them sooner rather than later, but there is no current plan to get them out. So we’ll see how it goes on these current dispose and then we’ll -- that will be our next big thing to talk about.

Mitch Germain

And is there any other assets that you would consider meeting the requirements kind of like Market Square where you would consider a joint venture?

Nelson Mills

Not at this time, it’s a matter of priority. So, we are finishing up the transition, as you know we’re almost done, we’ve got these three big assets, we’ve got these other four I mentioned that are relatively small, that really completes the transition now we’re in the markets we want to be in, the next thing we’ll look over the next couple of years is it time to harvest some of these more mature assets, we’ve got some assets around the portfolio that are really solid, stable well performing assets like 333 Market San Francisco is leased to Wells Fargo, fully leased Wells Fargo to 26. It’s got a little of an escalator built into the lease, but it’s pretty big is it time to take some of those off the table.


But again, it’s just the hierarchy of need issue, we like what those do for our cash flow streams and for our portfolio of quality and how it provides balance to some of the more value add opportunity, but yeah, we’ll look at that and it could happen through ventures as you say or an outright sale one day, but none of that’s on the board not likely to happen in ‘16.

Mitch Germain

Great. Last one from me is your appetite I know the majority of the acquisitions you’ve done to-date outside of one or two have been really of value add in nature, so curious is your appetite to do that sort of transaction today is strong as it’s been or are you really shifting to be more of a core buyer moving forward?

Nelson Mills

Well today our appetite is not quite as strong in the near-term as it has been for a couple of reasons one, we have quite a few of those in the portfolio which we’re very confident excited about, but we need to work through those, the 315 Park Avenue South, the big lease is 650 Cal getting the Jones Day lease replaced and we’re very excited about the near-term prospects for doing those things.

But until we check some most things off a pretty substantial portion of our portfolio has that sort of leasing opportunity/risk in it. So I would say it’s fair to say that the next acquisition and it may be several months and is likely to be a little lighter on risk than some of the leasing opportunities, some of the ones we’ve just thought. I’d say that’s the general feeling right now, but at the same time we’re demonstrating quarter-to-quarter, we’re demonstrating our ability to capture that value add. So we’ll -- that’s our new MO going forward we just want to balance that overtime.

Mitch Germain

Great, good luck this year.

Nelson Mills

Thank you.

Operator

The next question comes from Sumit Sharma of Morgan Stanley.

Sumit Sharma

Thank you, Nelson hi how are you guys?

Nelson Mills

Good morning.

Sumit Sharma

Question regarding the debt side of things, and you’ve indicated you’d use around $500 million of the disposition proceeds to pay down debt some of them about flexes, and this should bring down your debt to gross asset value ratio down to mid-to-high 20s on the lower end most other REITs and I guess from a covenant perspective as well it appears that you have a lot of headroom. So why push the leverage so low at this stage of the game has anything that has recently happened in terms of leasing momentum or investment sales volume something that has contributed or changed your view on this?

Nelson Mills

No it’s really a matter of timing so for me seesaw effect, like for example we’ve historically been in the mid-30s, low 30s sort of leverage and we like that, but we will stretch beyond that too. When we acquired to 229, West 43rd deal, New York Times buildings we stretched to the high 30s we took advantage of that balance sheet and to stretch and buy that asset knowing that we were going to exist these Cleveland, New York, Baltimore properties anyway.

So the drive to exit these assets and to boost this portfolio is not driven by getting leverage lower. I do think given the volatility in the world today I think a bit lower leverage, a bit more patience on acquisition is in order, but no we haven’t taken a gloom review of our portfolio opportunities such that we’ve said list that in the hatches and lower leverage it’s just a matter of timing. We think rebuilding a balance sheet and having some patience for a few months to look for next opportunities will serve us well and we need to dispose of these assets and move to our focused markets. So like I said it’s a bit of a seesaw effect.

Sumit Sharma

Understood and very good. On the acquisition guidance I guess most of your peers seem to either have muted or very subdued acquisition guidance that usually starts with a zero at the low end of the range while you guys talk about $200 million to $400 million of acquisitions this year, I guess what are you seeing in terms of the pipeline and which markets specifically that gives you at a very least confidence in the lower end of the range?

Nelson Mills

Okay. Sumit you should ask that question first, before the previous question. No, there’s a lot of uncertainty and so we have a very healthy pipeline in the West as I mentioned earlier West LA, New York, DC we’re looking at some interesting opportunities we don’t think the pricing is we haven’t gotten there in terms of pricing and as I mentioned earlier we’re in this window of needing to resolve these dispose.

But they’re out there, there are some interesting opportunities and we think the pool of competition is probably spending a bit in this market we’re in. So we’re optimistic that in a few months we’ll be able to find something that fit our strategy in our key markets that we can take advantage of. But the 200 is I don’t know -- we don’t know if it will zero or double that that’s our best estimate at this time, the 200 to 400. So we’ll see it’s lumpy as you know in the last four years we bought six assets and we’re always going to be measured and disciplined in how we approach that.

Sumit Sharma

Okay, thank you so much. And last question I promise just like everyone else. But this is about the guidance specifically leasing, are you guys assuming any downtime associated with the large leases 222 and 650? Besides this or a lag in signing and commencement that factors into some of the depression or also the trough in FFO growth that should be in the middle of the year I guess.

Jim Fleming

Sumit that is exactly correct. We in fact it’s within the case to some extent in ‘15 as well as ‘16 with some of the Oracle lease expiration in Atlanta and the Fulbright and Jaworski lease exploration in DC. We are expecting some down time with the Shearman & Sterling expiration in DC with the even though it’s going to be a big rollup with the San Francisco lease expiration. So there is element of fact that does affect FFO that overtime should go away.

Sumit Sharma

Thank you, gentlemen.

Jim Fleming

Thank you.

Operator

And our final question today will be a follow up from Brad Bark of Goldman Sachs.

Brad Bark

Hey, guys I appreciate the follow-up, just a couple of odds and ends. Jim thank you for the comments on the dividend coverage and when you talk about the dividend being covered in 2018 is that inclusive of both recurring and non-recurring CapEx? And also am I right that 222 CapEx would be classified as non-recurring?

Jim Fleming

Yeah, the Jones Day lease would be classified as non-recurring and that's obviously a big element to the analysis. And I think it’s interesting Brad because if you have a big lumpy lease like that and especially if we get a very good outcome where we potentially lease the entire building to one tenant it’s been lot of time out at one time. You could easily say well you’re not covering any dividend. It's you got all this capital going out of the door. I don't think that's a right answer I think the answer is to take a longer term view and look at especially with a lease in place or leases in place where you know what your rental revenue stream is going to be in the near term I think and then you can quantify how much capital needs to spend you can evaluate your balance sheet and determine what’s appropriate.

And that’s really the view that we've taken is we're going to we think all of this is pretty manageable we think regardless if we get one tenant or multi-tenants at Jones Day, regardless of exactly how it plays out in San Francisco we believe by 2018 we’ll be well covering the current dividend and that's really what influence the comments that I made. But the answer is on your recurring and non-recurring, I think you and others have taken a view that that got to all capital not just what we would call recurring capital and as you think about the dividend.

And I would say we do not really share that view we look at recurring as a different thing than non-recurring. And for instance on a recurring if we buy a building that's got a lot of rehab or has we're going to go in and really change the lobbies and the common areas and particularly even add to the building in a way it's kind of like doing a ground up development. We're spending money in order to get to the place where the building has the value and the rental ability that we're expecting. And so we just do that differently. But having said that I do think that really even the non-recurring capital by the time we get through this transition in 2018 is going to be much more muted.

Brad Bark

Okay. But your comments on coverage specifically were inclusive of recurring, but not as certainly non-recurring.

Jim Fleming

That’s correct.

Brad Bark

Okay. I guess just a one last one, I don’t think you touched on Houston and I know it’s not your biggest market, but just interested in what you're seeing in the Houston office market and if you could remind me of what your lease role looks like over the next two three years?

Nelson Mills

Yes. So obviously it’s no secret that we are all a bit frustrated and concerned about Houston who knows its challenged market for sure right now and who knows when it will recover. But in that market we do have a -- we have three properties it's nice mix we have a downtown multi-tenant property that's well leased one of the newer buildings downtown is always been a great performer for us. That’s got law firm accounting firms, obviously indirectly related to the oil and gas, but very steady. We have a B+ building in the Galleria area that we renovated and we've been leasing it’s about 70% leased. It does okay. It's nothing to write home about. But it's got some momentum there and we’ll get that leased at okay rates.

And then we had I guess the biggest thing is though we have a single not the largest in terms of asset size, but the biggest opportunity and challenge there is we have a single tenant property out on the energy corridor that expires in August of ‘18. So less than three years away and we are in discussions on that as well. We are very confident in a rent role up there a year or two ago. A lot of that's been eaten away, but we'll see. It's a fairly new building; well located there will be demand for it, but who knows at what rate. So we are working through that. But all-in-all I think our total revenues from that market is less than 8% of our portfolio. So it’s not a huge exposure.

Brad Burke

Okay, appreciate the color. Have a good weekend.

Nelson Mills

Thank you.

Jim Fleming

Thanks, Brad.

Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Nelson Mills for any closing remarks.

Nelson Mills

Thank you, again. Again as you can hear we are -- we've got some near-term big milestone opportunities that we are addressing. We are excited about those, we are moving on those with a sense of urgency. We are looking forward to locking those up and being able to report those back to you in the coming months. But again just this is what we planned. This is the strategy, the execution of the strategy that we set around three years ago, the near-term cost of our strategy is dilution in earnings as we knew as we anticipated.

It’s actually turning out better than we’ve ever hoped when we set on this path a few years ago. But there is still lot of work to do. We are looking forward to that turn that turn upwards in FFO and AFFO following in the next couple of years and we are looking forward to giving you more clarity on that direction as some of these major items kick off in the few months. So anyways thank you for your time and thank you for your questions and we look forward following up soon.

Operator

The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.

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