Executives
Joel F. Bonder – Executive Vice President, General Counsel & Secretary
Douglas J. Donatelli – Chairman of the Board & Chief Executive Officer
Nicholas R. Smith – Executive Vice President & Chief Investment Officer
Barry H. Bass – Chief Financial Officer & Executive Vice President
James H. Dawson – Chief Operating Officer & Executive Vice President
Michael H. Comer – Senior Vice President & Chief Accounting Officer
Timothy M. Zulick – Senior Vice President Leasing
Analysts
Jordon Sadler – Keybanc Capital Markets
Tony Howard – Hilliard Lyons
Chris Haley – Wachovia Capital Markets, LLC
Allan Seymour – Columbia Management Group
Charles Place – Ferris, Baker, Watts, Inc.
Philip Martin – Cantor Fitzgerald
Christopher Lucas – Robert W. Baird & Company
John Guinee – Stifel Nicolaus & Company, Inc.
Analyst for John [Founey] – Merrill
First Potomac Realty Trust (FPO) Q4 2007 Earnings Call February 27, 2008 11:00 AM ET
Operator
Good day and welcome to the First Potomac Realty Trust conference call. Today’s call is being recorded. At this time ladies and gentlemen I would like to turn the conference over to Mr. Joel Bonder, the company’s general counsel. Please go ahead.
Joel F. Bonder
Good morning. Welcome to the First Potomac Realty Trust fourth quarter 2007 conference call. On the call today are Doug Donatelli, Chairman & CEO; Nick Smith, Chief Investment Officer; Barry Bass, Chief Financial Officer; Skip Dawson, Chief Operating Officer; Mike Comer, Chief Accounting Officer; and Tim Zulick, Senior Vice President of Leasing.
After the market closed yesterday our company issued its earnings press release and we posted supplemental information relating to fourth quarter operating results and portfolio performance on our website. Many of you have signed up to receive this information automatically by email. If you did not receive it, please contact Tripp Sullivan at 615-254-3376.
During this call we will discuss our anticipated operating results and future events including our anticipated earnings FFO, AFFO, dividends and our ability to identify additional acquisition and disposition candidates. These forward-looking statements are within the meaning of the private securities litigation reformats of 1995. We believe the expectations reflected in these statements are based on reasonable assumptions however, the company’s actual results or events might differ materially from those projected in the forward-looking statements. Additional information concerning factors that could cause actual results or events to differ materially from those forward-looking statements is contained in our company’s 2006 annual report on Form 10K and described from time-to-time in the company’s other filings with the SEC. Many of these factors are beyond our ability to control or predict.
Now, I’ll turn the call over to CEO Doug Donatelli.
Douglas J. Donatelli
We reported a strong fourth quarter with $0.46 in FFO at the upper end of our guidance range. The quarter was helped by termination fees and other income and lower G&A expenses. As a result of late fourth quarter move outs we ended the year with our portfolio 86% occupied. Skip Dawson will discuss our occupancy in more detail later in the call as well as the decisions we made to take early terminations from some of our tenants in the fourth quarter.
Throughout our market we continue to see positive economic growth although at different levels in our three regions. Overall, demand for space is down but not down by much. In Maryland we’re seeing healthy leasing velocity and good rental rate increases all though retentive costs are up and construction costs remain high. In Northern Virginia and Southern Virginia we’re seeing signs of an economic slowdown. What we’re seeing on a day-to-day basis are companies not necessarily doing badly but hesitating to commit to making new investments especially amongst smaller tenants. This will slow absorption in our market. However, this hesitation to move is helping our retention rates which will improve significantly in 2008. Most of the new leasing we’re seeing is coming from large tenants, especially tenants doing business with the federal government. Among those tenants we’re seeing good leasing momentum and expect our positive net absorption this year to come from our larger tenant base. Another thing that’s helping our leasing prospects is the concentration of our portfolio. Today, 20% of revenue comes from the US government of federal government contractors and 75% of our revenue comes from tenants larger than 10,000 square feet.
A focus for us in 2008 will be to further concentrate our portfolio through property sales and then acquisitions and developments when appropriate. Over 7 million square feet of our portfolio today is concentrated in just 18 business parks located in nine key submarkets in our three regions. These 18 parks generate over 16% of our annual revenue and are really the focus of our future growth and success. We’ve assembled these parks in 31 separate transactions over the past five years or so. In most of the parks we have additional growth potential through acquisition or development opportunities and it’s these opportunities we will focus on. Our properties in these 18 parks today are 93% leased and on our experience in the best rental rate increases, tenant retention and new leasing of all the properties in our portfolio.
A good example of this concentration is Crossways Commerce Center in Chesapeake, Virginia. We own today nine separate buildings totaling 1.1 million square feet in this park which is a premier park, premier business park in the Norfolk region. Our properties are over 95% leased in this park and represent nearly $10 million in annual base rent. We assembled this park through five separate acquisition transactions over almost a 10 year period. We now own more than half the park but still have opportunities to add to our position. The area around Crossways is improving with new mix use development and redevelopment and we expect our properties in this park to benefit greatly from this. Sterling Park in North Virginia is another good example of our growing top property concentration. We currently have 400,000 square feet in this park which we acquired in three separate transactions. Our existing buildings at Sterling Park are now 96% leased significantly better than they were when we bought the buildings. We have one building under construction now and have the ability to build out this park to a total of 1 million square feet.
Our relationships with tenants in these two parks and in all the parks in our portfolio allow us to profit by meeting tenant needs. We’re able to move tenants between buildings which we’ve done on many occasions, meet their expansion needs without requiring a significant move and use other creative means to work with our tenants for our mutual benefit. We cannot do this without property concentration. What you’ll see us doing in upcoming months and years is focusing on our growth through acquisitions and development in parks and submarkets where we have concentration or where we can get concentration and disposing of properties in areas where we cannot. This is done well with properties in isolated locations and in many cases we have, we’ve decided it’s in our best interest to concentrate our portfolio.
We do intend to sell properties this year, properties to which we’ve add value and also properties which are outside of the concentrations we’ve built up. This is the beginning of our capital recycling strategy and we expect it to work well for us beginning this year. Overall, our balance sheet is strong and we’ve refinanced several strong pieces of debt already this year. Now, we have only one significant piece of debt to refinance this year, a $70 million short mortgage maturing in September but we have multiple options to get that done. The underlying assets are worth $140 to $150 million so we will be refinancing debt at 60% loan to value or less. In order to improve our balance sheet capacity we will continue to explore private equity sources as a way to finance any future acquisitions or developments. Barry will discuss these plans in more detail later in the call.
I’ll now turn the call over to Skip Dawson our chief operating officer to discuss our leasing activity.
James H. Dawson
As we discussed in our second and third quarter calls, we had some move outs at the end of 2007 that drove our tenant retention rate for the year down to 66%. We had 1 million square foot of space returned to us during the year through non-renewals or lease terminations. Half of this space was returned to us in the fourth quarter. 2008 is already shaping up to be a different story. At the start of the year we had 1,180,000 square feet set to expire this year. As of today, we already have over 70% of these expirations either renewed, amendments out for review or LOIs in tenant’s hands. We are very encouraged with our early traction with 08 renewals and are on track to get back to our 80% plus retention rate for 2008.
Let me give you a quick recap for the quarter and update on each one of our regions. We signed 338,000 square feet of leases in the fourth quarter. Of that total 170,000 square feet were renewals on which we had roll outs and rental rates averaging 5% on a cash basis and 14% on a GAAP basis. For the year we had signed 119 renewals averaging 10,000 square feet per renewal. The average length of term for our renewals is 41 months. The capital cost for renewals in the quarter was $2.38 per square foot and for the year we averaged $2.32 per square foot. We signed approximately 160,000 square feet of new leases in the quarter on which we had increase of 8% on a cash basis and 19% on the GAAP basis. The capital cost for new leases in the quarter were $13.68 per square foot which included first generation space. Our leasing activity was strong all year with a total of 2 million square feet of leases signed in 2007 representing roughly 17.5% of our total tenant base.
We also achieved double digit in rent on a GAAP basis. I’d like to give you a brief overview of each one of the regions. We own over 3.2 million square feet of space in our Baltimore region that was 91.7% occupied at the end of the year. The concentration of our property in the Baltimore region is found in seven business parks representing a majority part of our holdings in this region. We’re seeing strong traffic in these business parks driven by increase demand in the healthcare, biotech and government service sectors. What is also helping is the limited supply being added in our property type. We’re very pleased with the leasing traffic and believe we can continue to increase occupancy in this region.
We own just shy of 3 million square feet in the Northern Virginia region. Our end of year occupancy for this region was 85.9%. The dip in our occupancy in the fourth quarter was a result of a recent return by GSA of 107,000 square feet at our Interstate Plaza property in Alexandria, Virginia. We are seeing strength in certain pockets of Northern Virginia. Our Sterling Park Business Center is now 96% leased and our new 57,000 square foot building which we broke ground on in October is scheduled to be completed this May.
At the beginning of the fourth quarter we signed a new 49,000 square foot lease at our property in Battlefield Business Park in Manassas, Virginia bringing that property to 100% leased also. The build out is on scheduled to be completed by the end of the first quarter. This property is now stabilized and will provide north of 11% return on invested capital. While we are encouraged by demand in certain parts of Northern Virginia know that we will have challenges with some of our business parks that are located near the Dulles toll road and the 28 corridor. Northern Virginia has been getting a lot of attention these days because of the over building that took place in Class A office market but it would be a mistake to generalize too much about this region. If history is any indication, in tough economic times business park flex appointed properties seem to gain in popularity as tenants look to minimize their rental exposure.
We own over 5 million square feet of property in our Southern Virginia region. In the Richmond market we have our 1,750,000 square feet that was 88.5 occupied at the end of 2007. Our concentration of properties in two submarkets Hanover and Chesterfield counties were doing very well with smaller users in these markets especially in Chesterfield. The main driver for improving our occupancy in these markets will be how well we do with blocks of space over 10,000 square feet and this will be our focus during 2008.
In the Norfolk market we own 3,250,000 square feet in five major business parks. We ended the year with an occupancy rate of 82.6% in this region because we choose to terminate a TDS lease by the end of the year. PBS, a Ford Motor Parks supplier was occupying 248,000 square foot at our Diamond Hill Distribution Center. This lease was scheduled to expire in April. Taking the termination fee in December allowed us to satisfy expansion needs of three of our existing tenants. In controlling the balance of space has allowed us to begin actively marketing the space to a number of potential users in the area. Our effectiveness in working with large tenants will be a main driver in increasing our occupancy in the Norfolk market.
The lease termination and move outs in the fourth quarter brought our overall portfolio occupancy starting the year at 86%. We are confident we can move our occupancy up to a targeted range of the low 90s by the end of the year. We are encouraged with the tractions that we’re experiencing with our renewals and the pace of our new leasing in the first quarter. Based on our current activities we should see strong net absorption for the first half of 2008.
Now, I’d like to turn the call over to Nick Smith our chief investment officer.
Nicholas R. Smith
As I am sure all of you know today’s acquisitions environment is quite different than it was a year ago. After a few years as one of the most active buyers in the mid Atlantic we bought only $89 million worth of property in 2007. We essentially dropped out of the acquisitions market last year when we felt it go overheated. The market is now changed. There are a few transactions to track and the auction environment no longer exists. As credit destruction continues to discourage highly leveraged buyers we expect to see our patience rewarded. We are now beginning to see a shift regarding how properties are marketed. 2008 will be a year with more moral market transactions. We’ll be getting more calls from brokers trying to quietly introduce transactions off of market, the same brokers that just a year ago had a large number of buyers for each transaction. We’re well positioned for this since half the transactions we’ve completed over the last four and a half years have been off market and we’ve always been comfortable pricing assets without being made aware of other buyers intentions. Our market knowledge and reputation should serve us well in this changed environment.
The acquisition markets is off to a slow start this year however, as I’ve been describing it the market currently feels like an awkward high school dance with buyers and sellers on either side of the room, neither willing to make a bold step. This will not last for long and out attitude is that we feel the market is close to being ripe for acquisitions and we look forward to the opportunities. Our acquisition concentration will likely be more focused in the Washington Baltimore region as we see prices coming down to more affordable levels. Buyers in general may shy away from Northern Virginia given the high office vacancy rates in the Dulles Corridor. But, as Skip mentioned our Sterling Park property for instance has been steadily leasing up demonstrating the flex business parks don’t always compete directly with high rise office properties. More office development benefits business parks over time because many of our tenants are ancillary service providers to the government and government related tenants that occupy large blocks of space in office developments. Over time as markets become more sophisticated as a result of this development industrial and office park product will benefit greatly.
To talk about financing matters I’ll turn the call over to Barry Bass our chief financial officer.
Barry H. Bass
Our FFO for the quarter was $11.4 million or $0.46 per share compared to $10.3 million or $0.41 per share a year ago. Our AFFO for the quarter was $8.5 million or $0.34 a share compared with $0.30 a share last year. As expected we received approximately $0.03 a share in lease termination fees in the quarter as we actively managed our portfolio to get access to several spaces to facilitate their releasing. For the year we reported $1.67 in FFO compared with $1.62 per share in 2006. Our calculations of FFO and AFFO are reconciled to net income in both our earnings press release which was released yesterday after the market closed and was filed with the SEC under cover of an 8K as well as in our supplemental financial report. These documents are available on our website.
Same property NOI was up .5% on an accrual basis and $1.8% on a cash basis for the quarter primarily as a result of higher occupancy which was partially offset by higher real estate taxes. At the end of the fourth quarter we had $677 million of debt outstanding including $588 million of fixed rate debt with a weighted average interest rate of 5.5% and a weighted average maturity of 4.6 years. We had $89 million of floating rate debt outstanding at the end of the year comprised of $39 million of our line plus our $50 million term loan. Our interest coverage ratio for the fourth quarter was 2.2 times. Last month we entered into a swap to fix the interest rate on our $50 million term loan for the duration of its three year term. The underlying rate is now fixed at 2.71% so that with a spread of 70 to 125 basis points the all in rate on that loan will be 3.41% to 3.96% depending on our overall leverage levels.
We’re working on several things to ready our balance sheet to allow us to take advantage of acquisition opportunities that we expect to see. Right now, our capacity to fund acquisitions is limited. Based on our various debt covenants at year end we have approximately $50 million of debt capacity for general corporate purposes and approximately $100 million capacity if all the debt were used to acquire assets. As Nick mentioned we haven’t acquired an asset in nearly a year so we had less than $40 million drawn on our $125 million unsecured credit facility at year end. We have sufficient capital to complete our tenant improvements, to get the portfolio [inaudible] and to fund all of our development and redevelopment projects that we currently have underway.
As Doug mentioned our $70 million suburban Maryland portfolio loan matures in September. The loan to value ratio on that debt is approximately 50% and we’ve had conversations with enough lenders to give us comfort that we’ll have several options for refinancing that debt with a mortgage debt even in today’s challenging credit environment or with our line of credit. As Doug also mentioned, we’re planning to sell some assets to gain additional liquidity. This strategy is a natural evolution of our business as we add value to properties and bring them to stabilization. We’ve patiently and strategically taken advantage of opportunities in select submarkets in our region over the last several years and have created strategic concentration of our assets. It’s interesting to note that the assets that we acquired have deeper value add projects those with less than 80% occupancy at acquisition, saw significant net absorption in 2007 while we loss over half a million square feet of occupancy in our core portfolio as we reposition several of those assets. As a result of leasing at these deeper value add assets, many of them are at a near stabilization at this point and we can now begin realizing the value that we’ve added.
We also plan to enter into a joint venture in 2008 which will go a long way towards further solidifying our balance sheet and yields additional capacity to take advantage of what we think will be some great opportunities over the next couple of years. We put our pursuit of a joint venture on hold in late 2007 given market conditions but have more recently had conversations with a number of potential joint venture partners. Our primary aim there is to find a good long term strategic partner with whom we can forge a strong, long term relationship to take advantage of the opportunities we expect to see.
Our guidance for 2008 reflects the gains on sales that we expect to achieve from our capital recycling efforts. We’re projecting FFO for the year of $1.95 to $2.05 per share including the cash gains on sale. The guidance is based on several assumptions that we outline in the release including yearend 2008 occupancy of 90% to 92%. We expect much of these gains to be released in the second half of the year. Primarily as a result of these occupancy gain we expect same property NOI to increase from 1% to 4% on a GAAP basis, again more heavily weighted to the second half. Lease termination fees of half a million to 1.5 million. G&A expenses of $11 to $12 million. Cash gains on sales of $7.5 million to $10 million or roughly $0.30 to $0.40 per share and that’s based on dispositions of $50 to $150 million. Development and redevelopments being placed into service totaling $15 to $30 million.
Quarterly FFO fluctuations will be higher than normal as we pursue this strategy but we will make it clear the level of cash gains that we’re reporting each quarter. We continue to believe that it is important to highlight these gains as they are an integral part of our business plan. We’re confident that we’ll demonstrate the strength of this business plan in 2008 despite the challenging economic environment and we look forward to reporting to you on our continued progress.
We’d now like to open it up for questions.
Question-and-Answer Session
Operator
Ladies and gentlemen we will now begin the question and answer session. (Operator Instructions) Our first question comes from the line of Jordan Sadler, Keybanc Capital Markets. Please go ahead.
Jordon Sadler – Keybanc Capital Markets
Maybe in context of the Nick’s commentary on the market changing, the transactions market maybe Nick could you just give us a little bit of sense of what you’re seeing in terms of the changes? I know it’s still a bit tentative but I’m just curious maybe if you could just bridge that you your expectations on the disposition that you’ve lined up for the year maybe in terms of cap rates?
Nicholas R. Smith
Well, the cap rates have obviously gone up a little bit. There’s not a whole lot of data that’s out there however. It’s just sort of the personality of the market that’s changed a lot. If you remember in the housing market people would be selling a house and they’d have an open house on Sunday and then say put in all your offers by Tuesday night. Well, those days are going in the housing market. In the same sort of auction like frenzy that was going on in the commercial market is gone as well. There’s deadlines for putting in offers and I’m not sure a whole lot of buyers out there are respecting that sort of thing. How this translates into how we’re going to deal with our dispositions, if you remember a lot of the stuff that we bought was value add, it was bought four years ago and we’ve done a lot of work for instances to get some of these properties fully leased so we expect even given a little bit of an uptick in cap rates we still expect to have a significant gain on some of these sales since we were able to buy them at the right price in the beginning.
Jordon Sadler – Keybanc Capital Markets
Is there a range of cap rates that’s sort of underwritten or implied by – I assume you guys have identified the assets that comprise the $50 to $150 million. Have you kind of made some assumptions in there?
Nicholas R. Smith
With regard to?
Jordon Sadler – Keybanc Capital Markets
What the cap rates will be? Because, you’ve got the assets, the NOI and then you have an assumption of what the volume will be and plus it matters that there would be a cap rate?
Nicholas R. Smith
We’re probably – you know, we’re probably higher than where you were even in the fall, you know maybe 50 basis points higher or something like that. Somewhere call it in the sevens to low eights.
Jordon Sadler – Keybanc Capital Markets
Then, would you expect to be a net seller this year? Just because you’ve got the sales teed up and it might take a little bit longer to really take advantage on the buy side?
Douglas J. Donatelli
That’s a possibility Jordan. I think that we’re looking out for good investment opportunities and there could be a timing differential between when we get sales closed and when we are able to redeploy the proceeds of the sales in a new acquisition so it could very well be that at the end of the year we’re a net seller.
Jordon Sadler – Keybanc Capital Markets
I guess the plans for the proceeds generally to the extent that you’re successful getting the dispositions off or raising capital through the JV, what are sort of the plans for capital? I mean, will you initially pay down debt? Then, we should assume that you’ll be buying additional value add assets?
Barry H. Bass
It would be a combination of paying down debt, obviously that’s the first order of business and then, in terms of the redeployment of capital we are waiting to see a little bit more how the market shapes out. It could be some value add investment but we also think that the market that we were seeing just a couple of years ago that we were able to buy assets that we could add value to but still provide a good going in return so that you had positive leverage going in, that type of transaction could resurface over the next six to 18 months.
Jordon Sadler – Keybanc Capital Markets
Are you factoring in any dilution in your guidance from these sales Barry?
Barry H. Bass
We are factoring in some dilution, yes. And I guess, just to answer a question that will probably come up in our call, in our guidance it was a bit confusing in that we showed the higher gain on sale at the lower end of the range and that is because we do assume that there will be some dilution the more assets that we sell.
Jordon Sadler – Keybanc Capital Markets
Okay. I got you. You’re adding the cash gains, that makes sense. So the low end actually has the bigger gain number on it?
Barry H. Bass
Correct.
Jordon Sadler – Keybanc Capital Markets
But do you know what the dilution number is? What the range of dilution is off hand?
Barry H. Bass
It’s going to be anywhere from zero to $0.10.
Operator
(Operator Instructions) Our next question comes from the line of Tony Howard, Hilliard Lyons. Please go ahead.
Tony Howard – Hilliard Lyons
I was wondering if you could give a general comment as far as I believe 2007 is now the third year of your value added strategy, looking back whether that was successful or not? And maybe if you need to tweak that going forward?
Douglas J. Donatelli
The value added strategy has been quite successful for us. If we were really to look at the properties that had tougher retention issues with this year, is really in the core portfolio, the “stable” portfolio which turns out you run into some tenant retention issues. We were able to gain significantly from adding value to the properties that we had acquired with some vacancies and if not for that it would have actually exacerbated the retention issues that we faced in 2007. The one thing that the value add strategy brings about is some additional volatility and on a quarter-by-quarter basis it makes it tougher to predict exactly when lease up will be done, when you’ll begin recognizing revenue on vacant space that you’re acquiring and that’s the one significant issue with the value add program but it’s something that we are quite good at and we’re trying to figure out the best way to continue to pursue value add while at the same time keeping that volatility down.
Tony Howard – Hilliard Lyons
For a second question, if you meet the middle of your range for you G&A of $11.5 million that’s about a 10% increase over 2007 results. I mean, that’s one way to help the bottom line is to reduce expenses and it seems to me if you’re being a net seller of properties maybe your D&A should be coming down some instead of increasing it that much.
Barry H. Bass
Absolutely. We take a long hard look at D&A every year. D&A as Doug mentioned in the fourth quarter of 07 was lower as a run rate primarily because we had some incentive comp true downs in the fourth quarter. It’s hard to use 07 really as a good run rate. We would expect that – our estimate for 2007 was closer to the $11 million range initially and that was really where we were headed until we had a pretty significant true down there. I think going up to $11.5 so call it a 4% increase is within reason. We just had a long conversation as well internally with our board talking about what our strategy was going to be going forward to the extent that if we do pursue joint ventures and the like we need to keep the infrastructure in place obviously to be able to pursue everything that we expect to be able to achieve in 2008.
Tony Howard – Hilliard Lyons
Doug, last question is our retail clients are very concerned about the safety of the dividend, subtracting gain on sales adjusted FFO for 2008 would not cover the dividend. What’s your aspect of the dividend safety?
Douglas J. Donatelli
Again, this is something we’ve had discussions with our board about. You’ve got to look at how much of the tenant improvement and capital expenditure projecting for 2008 and separate out what our ordinary run rate cap ex and TI numbers and what are investment cap ex and tenant improvements to be able to lease the space up from where it current is and taking our portfolio from 86 to 91 or 92% leased. It is going to require some investment TI and we see that as different from our ordinary run rate.
Barry H. Bass
We separate out, I think it is important to separate out the dollars that we are spending as Doug said to get the portfolio at least to a stable point. That’s not going to be ongoing cash flow that’s required to keep the properties operating. Roughly, half of our tenant improvements leasing commissions kind of fall into that category. If you look at ongoing tenant improvements, leasing commissions, capital improvements it’s going to be about $7.5 million or $0.30 a share. So, I’m not sure what number you’re using to get down to your FAD number. Also, I’d say that you don’t want to necessarily totally ignore the gains on sale, those gains are going to be real cash gains that does provide both cash available for distribution also they’ll translate into taxable gains on which we sometimes will be forced to make a distribution in order to maintain our REIT status. I think ignoring gains on sale can leave a pretty significant part of the equation out of the analysis.
Operator
Our next question comes from the line of Chris Haley, Wachovia. Please go ahead.
Chris Haley – Wachovia Capital Markets, LLC
The sales velocity, what type of annual dilution are you assuming that will be offset by your cash gain recognition in your high and low end?
Barry H. Bass
Again, at the high end we’re not assuming any dilatation from sales. At the low end we’re assuming about $0.10 of dilution.
Chris Haley – Wachovia Capital Markets, LLC
Help me understand the math. Why would it be dilutive unless you were redeploying the capital into like yielding investments?
Barry H. Bass
Why would it be dilutive?
Chris Haley – Wachovia Capital Markets, LLC
Why would it not?
Barry H. Bass
Why would it not be dilutive? If we can quickly redeploy the proceeds into something that is like yielding or to the extent that we sell some of our less accretive assets and use those proceeds to pay down debt.
Chris Haley – Wachovia Capital Markets, LLC
Okay but earlier you said your first priority is to pay down debt.
Barry H. Bass
That was first priority but we don’t have a whole lot of debt that we can pay down frankly.
Chris Haley – Wachovia Capital Markets, LLC
A comment from I believe it was Skip earlier on the absorption trends on the first half of 2008 was quoted as strong yet your back end weighting your occupancy assumptions? Could you reconcile that please?
Barry H. Bass
It’s actually more of an accounting thing than a leasing thing because it’s going to take some time for us to recognize the revenue that’s generated by the leasing activity that we do in the first couple of quarters. That’s the error we made I believe it was last year when we assumed that a lot of the leasing that we did earlier in the year was going to have a more dramatic impact for the full year. I think if we learned anything it’s that we have to push that back because even if we lease space on March 1 probably not taking occupancy until the third quarter.
James H. Dawson
Even if we’re collecting rent on the space.
Barry H. Bass
Even if we’re collecting rent but the space isn’t built out we’re not allowed to recognize that rent.
Chris Haley – Wachovia Capital Markets, LLC
Right. Could you refresh my memory to what the difference has been between your leased and your occupied ratios go in the quarters?
Barry H. Bass
It’s generally hovered around a point to a point and a half.
Chris Haley – Wachovia Capital Markets, LLC
So, you would expect your leased percentage to accelerate at a faster pace during the first one to two quarters, three quarters of 2008 versus your occupied numbers, correct?
Barry H. Bass
That is correct.
Chris Haley – Wachovia Capital Markets, LLC
Then related to the cost to lease the space, if I take your assumptions of 400 to 600 basis points of occupancy lease up and just assign current tenant improvement and leasing commission costs to the expected leasing for 2008 how much of that are you going to define as first generation versus second generation?
Douglas J. Donatelli
We do that on a space by space basis. If we acquire something vacant and have to put in improvements to get that leased up, that’s first generation. Anything that we take back for example would not be considered first generation so it really does come down to a space by space analysis.
Chris Haley – Wachovia Capital Markets, LLC
Some companies will take a six, nine month or 12 month window if it was leased more than nine months or 12 months from the most recent lease it is viewed as first generation.
Douglas J. Donatelli
That is not the view that we have been taking.
Chris Haley – Wachovia Capital Markets, LLC
What view are you taking?
Douglas J. Donatelli
We don’t put anything back into first generation. First generation is something that we acquire.
Chris Haley – Wachovia Capital Markets, LLC
Okay. Alright because I just look at your 2007 capital expenditures, tenant improvement and leasing commissions totaled about $13.5 million which we’ve been able to match on our analysis. Your second generation costs recognized in your AFFO or FAD reconciliation were just about $7.5 $7.8 so about $5.5 million of that is called first generation and therefore is not included in your FAD reconciliation but it is real costs. So, when you think about the dollar amount that you will be spending in 2008 to get up 400 to 600 basis points how do you think about dividend coverage free cash flow? Excluding the gains on sale.
Douglas J. Donatelli
I think we can see similar numbers in 2008. More of that might fall into the category of second generation and so technically reduce our AFFO. The way we look at it however is that the dollars that we’re spending to get that space leased up whether its first generation or second generation space is investment capital. It is not money that is going to be kind of ongoing cash flow that’s required to operate the business. Does that make sense?
Chris Haley – Wachovia Capital Markets, LLC
Yeah. I think it does. My apologies for coming back to this occupancy issue. The amount of space that would be required for you to lease assuming no terminations to get up to 400 to 600 basis points from your yearend level will be about 1.6 million to 1.9 million and you leased 2 million in 2007 which is very good but, what gives you the confidence that you can move occupancy up 400 to 600 basis points where most of the private and public communications we have suggest that it will be very hard to see real net absorption particularly in the market that you’re operating in.
James H. Dawson
Sure. I answer it in two ways. The first, is we took a good hard look at our 2008 renewals and if we step back for a second we have seven renewals scheduled for 08 that are 40,000 square feet or greater and of the seven we’ve already executed four. We have two out for signature and then we have another one which is over 100,000 square feet that came in today. So, our retention rate for that 2008 sampling looks extremely strong back to our 80% plus range. The move outs we experienced in 07 will not be the same way in 08. Now, in leasing we’re at a clip of about 800,000 square feet of new leases signed in 08 and we’re seeing very good velocity in the first and second quarters. By working that combination we see the absorption occur.
Chris Haley – Wachovia Capital Markets, LLC
So, 800,000 square feet of new leases in 2008?
James H. Dawson
That was 2007 and we see a larger sampling of opportunity for leasing because of the product that came back in the fourth quarter. We see diminishing returns in 08 from our existing tenant base. So, if we continue to lease with the velocity with the reduction in the tenants leaving our portfolio, that differential will be much greater in 08 than we saw in 07.
Douglas J. Donatelli
And as Skip mentioned we have a lot of large tenants especially in Southern Virginia, our large spaces and its getting those large spaces leased that are going to drive the significant net absorption.
Chris Haley – Wachovia Capital Markets, LLC
The climate today versus where we were in 2006, 2007 I’m very interested in trying to develop a level of confidence that you can execute 400 to 600 basis points where that has not been the case in prior years where the economic landscape has been more favorable. Is there any type of leasing tactic that you’re doing?
Douglas J. Donatelli
We know our markets well. We understand that we’re communicating some pretty strong performance. We’ve been saying this for the last several calls because we saw this coming, our tenant retention rate in 2007 was terrible for us. It’s really not terrible compared to a lot of other companies but from our standards it was terrible but we saw it coming a long way away and I think even starting in the first or second quarter conference calls last year we started mentioning that and we said that was going to be the reason for under performance from First Potomac in 2007 an in fact, that came to pass. I wish it didn’t, but it did. But, at the same time we had a goal of executing 800,000 square feet of new leasing in 2007 and we hit that goal. We know our tenant retention story for 2008 is going to be different and analyzing our portfolio on a space by space basis understanding where we are with a variety of tenants in some of the vacant spaces that we have we’re confident that the goals and the guidance that we’re setting out for 2008 are absolutely achievable. We’d be foolish to come out today with guidance that was unattainable. I mean, we’re very confident the guidance coming out today is good.
Operator
Our next question is from the line of Allan Seymour, Columbia Management Group. Please go ahead.
Allan Seymour – Columbia Management Group
I take it that new development – maybe you could tell me two things, one is you’ve done some development I think of some of the spaces that you’ve had development in terms of new builds and I think that was – I’d be curious as to how well that worked out one and I presume those kinds of things are kind of off the table here for the foreseeable future? Unless you had a preleased kind of thing.
Douglas J. Donatelli
Development has not been a big part of our story ever really. We’ve done some new development in the past 18 months or so and some redevelopments as well and redevelopments have been a bigger driver for us. Any developments that we would look to start anytime soon would be either preleased or additions, smaller additions to existing property that we have and that’s basically more where the development has been anyways, inside of parks where we already own property or additions to existing buildings. In those cases we’re doing that in response to what we see as tenant demand in a particular space, a particular park. I think that especially in this current environment I think you have to be extremely careful with new development especially spec development because I think we’re at a rough absorption period for our entire market right now.
Allan Seymour – Columbia Management Group
You have a very large portion of your leases related to the government, how do you see that evolving here? Is there more military? Less military? More defense related stuff? How is that going at the moment? What’s your sense of that marketplace?
Douglas J. Donatelli
We do have something like 20% of our revenues coming from the federal government and government contractors but not all of that is defense related. We have a pretty diverse grouping of tenants inside of that government and government contracting space. We still see government spending in this region to be fairly good and demand for space both from the federal government and government contractors as still a driver in our marketplace. With the upcoming changes in administration there will be a slowly the government will shift its spending priorities I assume but we’ve always found that by having a diverse base of government and government contractor tenant that works out for us in the long run.
Operator
Our next question comes from the line of Charles Place, Ferris Baker Watts. Please go ahead.
Charles Place – Ferris, Baker, Watts, Inc.
Just a real quick question, Barry what was the amount of lease termination fees in the fourth quarter?
Barry H. Bass
It was about $700,000.
Operator
Our next question is from the line of Philip Martin, Cantor Fitzgerald. Please go ahead.
Philip Martin – Cantor Fitzgerald
I wanted to get a sense of the $50 to $150 million of assets that may potentially be sold in 2008. You mentioned cap rates in the high sevens low eights. Can you characterize this portfolio versus some of your core in place portfolio? I mean, is what you’re selling – I know you’re an asset recycler but again, I’m just trying to characterize the differences between the two. Is what you’re selling considered core or non-core? Those cap rates would be compared to what I’m calling your core portfolio?
Barry H. Bass
We have some assets specifically identified, at the high end of that range they’re less specifically identified but I guess I would say that as Doug mentioned we are planning to concentrate our portfolio in more business parks that we own and so several of the assets that we have kind of highlighted for potential disposition would be more one off type locations. They could – most of them will probably be somewhat stabilized but there could also be assets that we just think will be more valued by someone else and better off in someone else’s portfolio. I think Nick mentioned sevens to low eights, I think that there is a pretty wide range, we are trying to get more data points in terms of where will be trading. I think if you look across our portfolio we have some assets that would trade in the low sevens especially as we start to concentrate assets in higher quality business parks and then some of the one off stuff would be in the low eight range.
Philip Martin – Cantor Fitzgerald
Are the one off assets, are there just – is that a combination of no real opportunity to expand or gain efficiencies by concentrating or is it more market related where the market doesn’t have the future growth that you’d like to see?
Barry H. Bass
It could be a combination of all those things and I’ll add a third which is I’ve mentioned paying off the suburban Maryland portfolio loan that was 14 assets that we bought back in 2004. There were certain assets in that portfolio that really didn’t fit our business strategy but by buying the entire 14 asset portfolio allowed us to get an extremely attractive acquisition at a very good price so culling out some of the assets that were in that portfolio will make sense as well.
Philip Martin – Cantor Fitzgerald
Okay. My last question is on leasing. The leasing activity and velocity that you are seeing in your portfolio today, is that better than what the competition is seeing? What do you hear anecdotally from brokers anecdotally? Are you performing at a higher level than the competition in your market?
Douglas J. Donatelli
In our portfolio we had because of some move outs we had, we had negative net absorption so I think that’s worse than the overall market.
Philip Martin – Cantor Fitzgerald
But I’m talking about the velocity or leasing activity you’re seeing now. Certainly through the first half of 08 you’re expecting some pretty good activity and this goes back to Chris’ question in terms of having an increase level of confidence going forward that the strategy can be executed successfully. I’m just trying to get a sense of are you seeing better activity now and in 2008 than maybe some of the competition in your market space.
Nicholas R. Smith
We’re seeing good traffic in the blocks of space that we currently have available that we got back recently in our product type. Our competitors product type of Class A office I’m sure that they’re challenged in that area but what we’re seeing right now today good demand in our product type throughout the region.
Philip Martin – Cantor Fitzgerald
Okay. I guess it’s another way of asking are you finally starting to see – not finally that’s probably a bad term but are you really starting to see the benefit of the concentrated portfolios, the better than average locations and those locations and those characteristics are driving better activity relative to market I guess?
Douglas J. Donatelli
I think the expectations we have for 2008 are specific to our properties. I can’t talk about our competitors with too much detail, [inaudible] but what we are seeing is in some specific spaces, especially some of our larger blocks of space, the reason that we opted to take it back was the ability to take existing tenants and move them in. Skip had mentioned that TDS we’ve already executed three tenant expansions into some of that vacant space and we have the potential for more of that and that’s a 250,000 square foot block, that’s a big chunk of our current vacancy. We’re working on specific deals on other large blocks of space in our market and whether that ends up outperforming the market, whether that ends up – the net absorption we’re projecting in our portfolio is pretty strong and I doubt that’s going to be met by the market as a whole so I think we are expecting better performance in the market overall.
Philip Martin – Cantor Fitzgerald
My last question is in terms of any other, are you look at any other blotchy space in the portfolio or tenants where there might be an opportunity to terminate a lease and place that we a stronger tenant, better rent?
James H. Dawson
We are looking at other aspects of the portfolio as an opportunity for us to enhance that particular space in revenue or to do something that is long term beneficial for the park, we will do that. So, there are some other opportunities in 08 for us.
Philip Martin – Cantor Fitzgerald
Have you had to turn any potential tenants away because you couldn’t satisfy their needs?
James H. Dawson
Currently today we have not.
Operator
Our next question comes from the line of Chris Lucas, Robert W. Baird & Company. Please go ahead.
Christopher Lucas – Robert W. Baird & Company
Just a couple of quick follow ups, the G&A true up for the fourth quarter, how much was that?
Barry H. Bass
Roughly about $300,000 favorable.
Christopher Lucas – Robert W. Baird & Company
Okay. Then on the dispositions Barry, the $50 to $150 million does that include the formation of the JV and your contribution of those assets? Or, are these strictly one off?
Barry H. Bass
I mean some of that could be joint venture related but, I think we could – to get to the high end we would probably meet or exceed the high end if we went forward with the joint venture. But, I didn’t necessarily want to provide guidance on that basis.
Christopher Lucas – Robert W. Baird & Company
So, can you give us a status as sort of where the pursuit of the joint venture structure is at this point?
Barry H. Bass
Yeah. I mean, as I mentioned in the scripted part we talked to several potential partners. We’re continuing conversations. Our primary goal is to find a good long term strategic partner so we’re making assessments as to the best way to get a transaction completed with a long term strategic partner. These things take time so I don’t want to make any estimates as to when we’ll get something completed.
Christopher Lucas – Robert W. Baird & Company
So it’s not factored in to sort of your 08 thinking? Or it is?
Barry H. Bass
It’s absolutely something we want to get accomplished in 2008 so in terms of our 08 thinking it is. I would say in terms of our 08 guidance it really hasn’t been factored in that much.
Operator
Our next question comes from the line of John Guinee, Stifel Nicolaus. Please go ahead.
John Guinee – Stifel Nicolaus & Company, Inc.
I may have missed this so I apologize because we got on late. But, did you discuss your dividend or your dividend policy yet?
Barry H. Bass
Yes we did.
Operator
Our next question comes from the line of Jordan Sadler. Please go ahead.
Jordon Sadler – Keybanc Capital Markets
I just wanted to follow up on the leasing a little bit. Are there any other large tenants that you know about that are likely not to renew in 2008?
James H. Dawson
We did a sampling across the board on our major tenants. The only one we are not quite sure about is one that is at the very end of the year 12/31 but the rest of the ones we’ve talked with have either executed their documents or they’re on their way in. We’re not seeing what we saw in 07.
Jordon Sadler – Keybanc Capital Markets
Is First Data buttoned up yet?
James H. Dawson
That would be correct.
Jordon Sadler – Keybanc Capital Markets
It is?
James H. Dawson
That is correct.
Jordon Sadler – Keybanc Capital Markets
On the 70% that either in the bag or on its way to being done, what’s the releasing spread looking like?
Barry H. Bass
I think you can take a look at 07 and be pretty consistent with 08.
Jordon Sadler – Keybanc Capital Markets
Okay. Then, what is the nature of the prospects that you’re seeing in terms of the traffic that’s coming through? I mean has the characteristics of who’s looking sort of changed at all? I know you said the bigger tenants but what kind of industries are we looking at?
James H. Dawson
It differs by each region. Naturally in Maryland we talked about the government service sector, biotech and healthcare up in Maryland. Some demands from existing tenants for an expansion of contracts that they’re pursuing or they’ve already won. Then, some port related activities or other movement down in the southern region. We’ve worked hard with our existing tenant base, they feel comfortable that as they’re going after contracts they’ve identified us as a supplier of space for that. A number of good things going on that give us a good feel for the first half of the year.
Jordon Sadler – Keybanc Capital Markets
Of that 70% number, I’m sorry to do this to you but is there a – if you could break that into two buckets, the portion that’s done and the portion that’s under LOI or out for review how would that break up?
James H. Dawson
I would say probably half of it is done. Done by being that we’ve reached an executed document or that we’ve actually had – the transaction has been completed. I would say probably the balance of it’s broken out into 25% of amendments flying back and forth or strong discussions. The other 25 are letters of intent that are flying back and forth between tenants and us but, we’ve had really good strong discussions with the tenants prior to this year on their needs for 08 and beyond. It’s a different client base that we have in 08 that’s renewing than from 07 and it’s a strong feel from us on the communications that we’re receiving that these guys will be staying [inaudible].
Jordon Sadler – Keybanc Capital Markets
Should we assume retention rate wise just looking at the first half of the year that you’ll bounce back up to that mid 80s range that you had been at previously?
James H. Dawson
Yeah. I think 08 will be an 80 plus range retention rate for the entire portfolio for the year.
Jordon Sadler – Keybanc Capital Markets
Then Barry, did you mention the underwriting in the guidance on the September refinancing? What are you assuming as an interest rate versus the expiration?
Barry H. Bass
On a cash basis we’ll probably do a little bit better than the debt that’s currently in place. The debt has a 6.70 interest rate on it and GAAP we’ll lose a little bit because we had fair valued that debt at about 5.5%.
Jordon Sadler – Keybanc Capital Markets
A little bit like 25, 50 bips?
Barry H. Bass
Call it 50.
Jordon Sadler – Keybanc Capital Markets
Then is there [IOR] expectation on the sales that are expected to be done this year?
Barry H. Bass
Well, when we underwrite assets we’re generally looking for kind of a nine to 10 unleveraged [IOR]. I would say we would – some of the assets that we’ve looked at in terms of a value add property that we would be selling we should be able to exceed that.
Nicholas R. Smith
And some of the outlying assets that bought, specifically those in the Suburban Maryland portfolio you’re probably going to see a little lower [IOR] on those because they don’t quite fit in the portfolio.
Douglas J. Donatelli
And some of that is attributable to the fact that when we allocated the pricing on that portfolio we more heavily weighted it to the properties that we felt we would be selling sooner rather than later.
Barry H. Bass
But we intend to report [IORs] on property sales as we get them completed.
Operator
(Operator Instructions) Our next question is from the line of Chris Haley. Please go ahead.
Chris Haley – Wachovia Capital Markets, LLC
Do you have a full year number for termination fees in 07?
Barry H. Bass
Full year was about $1.1 million.
Douglas J. Donatelli
Okay right. The termination and other fee income was close to $2 so $1.1 of termination fees specifically.
Chris Haley – Wachovia Capital Markets, LLC
I’d be interested in three to four bullet points on what the two to three year strategy is for FPO? As you mentioned earlier in the call you have been speaking with the board. I’m assuming there is some beyond one year where we’re suffering potential dilution from recycling I’d be interested in your view as to how much more adjustments need to occur at the balance sheet level versus the operating performance of the portfolio? I'd just be interested in the strategic data points over a two or three year time period?
Douglas J. Donatelli
The basic strategic plan for the company is to continue to grow through acquisitions, to continue to grow through modest amounts of development, to concentrate the portfolio as I said to inside of parks where we’ve had success, inside of submarkets where we have concentration and have seen success, fuel the growth through the disposition of those assets where we don’t think we have as much future upside growth potential and to fuel the growth through the formation of strategic joint venture with a private equity partner and continuing to add value to the properties that we’re acquiring through leasing, moving rental rates up which we’ve been very successful with and concentrating on and taking advantage of the market knowledge and tenant contacts we have inside of our marketplace with our property type.
Chris Haley – Wachovia Capital Markets, LLC
With related to the disposing of assets and joint venture what is the amount over the next two or three years that you believe is appropriate to move the portfolio or the company to the leverage ratio you are comfortable running it at?
Douglas J. Donatelli
The question is related to the?
Chris Haley – Wachovia Capital Markets, LLC
Disposition and joint venture plans of the company over the next two to three years, what is the target or the range over that time period either of leverage that you are comfortable running at or related to that how much disposition that joint venture contributions should we expect over the next two to three years?
Barry H. Bass
We’ve always said that we’re comfortable running our portfolio at around 50% leverage. I think figuring out what the denominator is at this point is probably the biggest challenge when it comes to determining value. I think that’s why right now I’m not sure debt to market cap is that meaningful a number. We obviously look at the values that are in our loan documents and covenant compliant checklist because those are more real to us on a real time basis. But, I think given the nature of our portfolio the concentration in the DC market, operating a real estate portfolio at about 50% leverage makes sense to us.
Chris Haley – Wachovia Capital Markets, LLC
The way I calculate I just simply take the midpoint, thank you for that Barry and Doug, if I take a look at your economic gains on sales, the cash gains that you expect between a $7.5 and $10 million and compare that to a midpoint of $100 million my economic margin on sale is less than 10%. Is that indicative of the assets? Indicative of the market they’re in?
Barry H. Bass
Again, I think some of that gets to the point I was referencing earlier which is some of the assets that we’ve targeted if you will for disposition would include assets that were in the suburban Maryland portfolio that we put pretty high value on. We thought we might be selling some of those assets very shortly after the acquisition of them and didn’t want to get caught having to pay 100% tax on a gain on sale so I think that’s part of it.
Douglas J. Donatelli
And there’s some conservatism in that number as well.
Barry H. Bass
Yeah. I think we could have come out with a higher gain on sale number but I’m not sure that we would have gotten a whole lot of buy in.
Chris Haley – Wachovia Capital Markets, LLC
With these assets if I should take a look at how much dollar value and assuming a 50 to 60% loan to value or loan to cost rate, that would imply approximately $250 to $300 million of asset sales to occur over the next two to three years either through outright sales and debt reduction or joint venture contribution. Is that about right?
Barry H. Bass
That’s about right.
Chris Haley – Wachovia Capital Markets, LLC
So are you effectively, it’s one of the things that it’s unfortunate that we’re just not seeing any earnings power out of this company for the last couple of years and there are several companies that have a longer time period where they haven’t shown any earnings power. You’ve been public for a couple of years and I know it’s tough taking this pill now but I would just get out there and basically say, “We have $300 million worth of sales that we want on the market. Let’s get the bids in. Let’s right size this thing and let’s get growth back in order.” Recognizing how difficult the markets are right now but we expect them to open up over the next 12 months. I think you might be surprised by what type of bid you might receive if you actually just go out in the market and instead of $50 to $150 million just say, “Look we’re looking to sell $300 million, $200 to $300 million through a joint venture and an outright sale. We want to right size the balance sheet. In the meantime our earnings are going to be depressed and we expect to grow this thing.” instead of having this constant dilution that would occur over the next two to three years as with the line of questioning that I’ve had. I don’t want to have the sort of situation where we’re five years from now where we’re still earning $1.65 to $1.70.
Operator
Our next question is from the line of John [Founey], Merrill Lynch. Please go ahead.
Analyst for John [Founey] – Merrill
Barry, I just want to go back to your comments on the joint venture. Just to be clear with respect to your 08 guidance there’s been no assumption of forming and closing and contributing into a joint venture structure in 08, correct?
Barry H. Bass
For the most part that is correct. Some of the gains on sale however that we project could potentially come from the formation of a joint venture and the contribution of assets into a joint venture.
Analyst for John [Founey] – Merrill
You just don’t know who the ultimate buyer could be? It could be a joint venture partner, it could not and that’s kind of separate of the gain on sale assumption to begin with. One of your public peers went down this road after a major portfolio acquisition and continued to find it difficult finding a joint venture partner, actually had one and then it was on again off again. Have you guys actually come very close into inking a partner yet because of dislocation in the market, tighter credit, what have you, you know that relationship has sense falling out of bed? Or, has it been a situation where you can’t even get started out of the blocks given different tolerances and different assumptions and different expectations between you and a partner?
Douglas J. Donatelli
Neither. I think we described it earlier accurately we had contemplated going out to the market mid last year and decided based on what we saw where the market headed it made more sense to pull back and wait. More recently in 2008 we’ve gone out to network with a number of different partners and as Barry said what we’re looking for today is the best long term strategic fit for us.
Operator
Ladies and gentlemen that does conclude our question and answer session. I will turn the conference back to management for concluding remarks.
Douglas J. Donatelli
Thank you everyone for participating this morning and we look forward to speaking with you again on our first quarter call in April. Thank you.
Operator
Ladies and gentlemen this does conclude the First Potomac Realty Trust conference call. ACT would like to thank you for your participation. Have a pleasant day. You may now disconnect.
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