SL Green Realty Corp. Q2 2008 Earnings Call

SL Green Realty Corp. (SLG)

Q2 FY08 Earnings Call

July 29, 2008, 2:00 PM ET

Executives

Marc Holliday - CEO

Andrew W. Mathias - President and Chief Investment Officer

Gregory F. Hughes - CFO and COO

Steven M. Durels - EVP, Director of Leasing

Analysts

Christopher Haley - Wachovia Securities, LLC

Anthony Paolone - JP Morgan Securities, Inc.

Jonathan Habermann - Goldman Sachs and Company

Michael Knott - Green Street Advisors, Inc.

Michael Bilerman - Citigroup Smith Barney, Inc.

James C. Feldman - UBS Securities, LLC

Louis W. Taylor - Deutsche Bank Securities, Inc.

Mitchell B. Germain - Banc of America Securities, LLC

John Guinee - Stifel Nicolaus

Jordan Sadler - KeyBanc Capital Markets

Presentation

Operator

Thank you everybody for joining us, and welcome to the SL Green Realty Corp.'s Second Quarter 2008 Earnings Results Conference Call. This conference call is being recorded. At this time, the company would like to remind the listeners that during the call, management may make forward-looking statements. Actual results may differ from predictions that management may make today. Additional information regarding the factors that could cause such differences appear in the MD&A section of the company's Form 10-Q and other reports filed with the Securities and Exchange Commission.

Also, during today's conference call, the company may discuss non-GAAP financial measures at defined by SEC Regulation G. The GAAP financial measure most directly comparable to each non-GAAP financial measure discussed and a reconciliation of the differences between each non-GAAP financial measure and a comparable GAAP financial measure can be found on the company's website at www.slgreen.com, by selecting the press release regarding the company's first quarter earnings.

Before turning the call over to Marc Holliday, Chief Executive Officer of SL Green Realty Corp., we would like to ask those of you participating in the Q&A portion of the call to please limit your questions to two per person. Thank you. Go ahead, Mr. Holliday.

Marc Holliday - Chief Executive Officer

Okay, thank you. And thank you everyone for joining this afternoon. Last night, SL Green released its earnings for the second quarter. We had results that were in line with our projections and consistent with our prior guidance.

It was a very balanced quarter where we posted good results, exhibited strong leasing performance, had various sources of other income, and executed on approximately $100 million of external activity consisting primarily of the acquisition of the fee interest in 919 Third Ave nue and the origination of two separate structured finance investments.

Clearly, now the company is benefiting from the strategy of buying core assets with near tern and long-dated embedded growth. Now in addition to harvesting profits, as we've done so over the past several years, we are also harvesting rental growth and the results are pretty powerful, as you saw last night. We achieved these results in part through the early leasing of space, which would have otherwise expired in 2009 and 2010.

In the aggregate, since the beginning of this year, we have early renewed or pre-leased 433,000 square feet of space, thus accelerating the realization of the embedded mark-to-market and mitigating future role risk. Our total leasing performance for the first half of the year is impressive with approximately 940,000 square feet leased with an approximate 48% rental uptick, and an excess of a 10% growth in same-store NOI.

We have now reduced our scheduled lease expirations for the balance of the year to 421,000 square feet of space, which will get much of our attention. With so little exposure for the balance of 2008 and only a million square feet expire in 2009, we are in the enviable position of focusing on 2010 leasing opportunities. Our occupancy climbed by nearly 50 basis points during the quarter to 96.7% and that's without the benefit of any leasing activity at our 100 Park Avenue which houses our largest blocks of vacancy totaling 280,000 square feet.

Given our early successes in leasing the mid and upper floors at our 100 Park Avenue on the heels of a successful redevelopment, we have been patient with the leasing of these remaining blocks in an attempt to find the right tenants at rents which are commensurate with this repositioned building.

Other remaining vacancy beyond the 100 Park tends to be scattered throughout the portfolio and we have again made some forward progress with our leasing in July, a typically slow summer month where we have already signed 82,000 square feet of leases. Highlighted in our press release are the five largest lease deals that we transacted in the quarter, which notably excludes any financial service tenants.

While this demonstrates the vibrancy and diversity of Manhattan space users, it also foreshadows lower rents in the future due to lack of demand from Manhattan's largest business sector. While this softening is not evidenced in our year-to-date performance, we are still anticipating a 10% to 15% across the board drop in net effective rents as businesses continue to work their way through the current economic environment.

However, every quarter we put behind us eliminates more and more near term role and potential exposure to increasing vacancies. Our primary focus is on moving space of 15,000 square feet and under where we are still seeing relatively good demand for built and available space. Fortunately, space falls within this smaller size does not generally directly compete with the sublet space being put on the market by the larger financial services companies, which tend to be of much larger blocks.

The companies that have either put sublease space in to the market or have indicated an intention to do so consist of Bank of America, Citigroup, and JPMorgan Chase. Others such as Lehman Brothers and UBS are rumored to be weighing their options, but have not yet made space available.

Last quarter, I mentioned that financial services sublet space was between two and three million square feet, and that number still holds today, with the exception of an additional potential 750,000 square feet coming from the non-financial service firm of Pfizer. However, a number of these sublet availabilities are in active discussions with tenants that may result in several blocks becoming notable signed transactions by year-end.

In total, the vacancy and availability rate stands at approximately 7.4% today, approximately 200 basis points above the lows achieved in 2007, but still decidedly a landlord's market. We will continue to monitor the sublet availabilities with you quarter-to-quarter and use this as our guide in directing our leasing strategies for our own portfolio.

We received a few questions this morning regarding SL Green's structured finance portfolio. So I would like to take a few minutes to discuss the composition of that portfolio and how it fits into our overall strategy. At June 30th, SL Green structured finance balance stood at approximately $839 million. That balance is expected to grow modestly throughout the third quarter, topping out at approximately $900 million. Of that amount, approximately 77% of such loans are collateralized by mortgages or other interests in properties located in Manhattan. Of the non-New York City investments, approximately $25 million relates to loan positions inherited in the acquisition of Reckson in 2007, against which 2 million was reserved in Q2.

The balance of the exposures relate to the other investments, generally originated in participation with Gramercy. Accordingly, the vast majority of these loans are secured by commercial office properties located in Midtown Manhattan, which have an aggregate last dollar exposure per square foot of $355 and generate a current yield of approximately 9.6%. The loan secured by Manhattan office properties represents the majority of our outstandings and our season loans made in connection with 13.2 million square feet of Manhattan office properties.

As I mentioned earlier, the loan exposure is only $355 per square foot. And as such, we view the likelihood of collectibility is high; however, in the event of a protracted downturn, some of these investments would represent proprietary future pipeline for the company. Recall that back in the late '90s and early 2000, SL Green benefited through its structured finance program by converting to equity ownership 1250 Broadway, 521 Fifth Avenue, 609 Fifth Avenue, and The News Building at 220 East 42nd Street.

We continue to view that this program has the double-edged advantage for our shareholders of high current yield with potential for future opportunities dependant on prevailing market conditions. This program has been enormously profitable to Green over the years. Two of the three non-accrual loans that Green has on its books relate to investments inherited through the Reckson transaction, one of which is a $27 million or $28 million mezzanine loan on a Manhattan office property that has a last dollar exposure of $618 per square foot. That's a core Midtown Avenue Manhattan property, Class A. We believe we are properly reserved on those assets given current market conditions.

Before turning the call over to Andrew Mathias, I would also like to discuss SL Green's investment in Gramercy Capital Corp. As you recall, SL Green owns approximately 16% of Gramercy and is the external manager. On an earnings call last week, Gramercy issued downwardly revised earnings guidance as a result primarily of nonperforming loans and low loan loss provisioning taken predominantly in connection with certain of its non-New York exposures.

We see the effects of a deteriorating credit market in several submarkets around the country and know that in the next 12 to 18 months, Gramercy will be very focused on asset managing its investments to mitigate the effects of the market as much as possible and taking advantage of new opportunities on a selected basis.

While Gramercy has been strong earnings contributor since its inception four years ago, we are expecting earnings contribution from Gramercy going forward to be much more muted than in the past and have adjusted our projections accordingly.

Further, as a result of the closing of the AFR transaction, both companies, Gramercy and SL Green, have established independent committees which are contemplating a possible internalization of the GKK manager or a modification of the existing management agreement.

As I stated on last week's call, we are considering internalization because to have management in-house is consistent with the progression of GKK. Both companies have committees made up of independent directors looking at this. No decisions have been made yet to proceed and anything that does happen would obviously have to be acceptable to both parties. If the committee is determined not to internalize at this time, then it is possible that with 18 months remaining, the management agreement would be modified and extended.

I would just also like to add that on the heels of the AFR merger, the infrastructure within Gramercy has expanded to a size both in terms of people resources, in terms of systems and IT, that along with additional strategic hires that we made such as John Roche who is Gramercy's new CFO; Michael Berman who is Head of Gramercy's leashing and asset management, we have made great strides in being able to make this consideration for internalization at this time. But as I said, whether we do that now or the committee is determined to do that in the future, we think Gramercy's has got the right infrastructure in place to carry it through for the foreseeable future to take advantage of this market with its existing liquidity base.

So with that, I would like to turn the call over to Andrew Mathias.

Andrew W. Mathias - President and Chief Investment Officer

Thanks, Marc. Transaction volume in the Manhattan market continues to slow with fewer assets changing hands due to the stand off between buyers and sellers. With sellers still achieving their leasing targets, they are just less inclined to part with our assets and anything other than prices that reflect continued roll to market potential of their rents, i.e., lower cap rates.

Foreign interest in Manhattan assets has remained strong with overseas money playing a role in most of the major transactions announced this quarter, including GM, Chrysler and 13016. Each of those sales also featured in place for seller financing which continues to be a major consideration for the universal buyers out there.

When class B assets have traded, prices have softened modestly with prevailing cap rates seemingly in the 5% to 5.5% range, unclear if this is a trend that will carry over to A assets, or if this just represents the market returning to its historical norm of wider B cap rates. Either way, it was the convergence of B and A cap rates that was the thesis of our aggressive class B sales program over the last 18 months, taking advantage of these historically low cap rates in the assets.

To this end, second quarter investment activity was highlighted by the continuation of our sales program. In May, we closed on a previously announced sale of 1250 Broadway, triggering a large gain in incentive fee, and reverse 1031 in all proceeds of that sale on a tax-free basis into 388-390 Greenwich.

In July, we entered into a non-contingent contract to sell our remaining 15% interest in 1372 Broadway. Recall that in lieu of selling 100% of the assets last summer, we accepted an offer from Wachovia to purchase 85% of the equity interest in the property. Wachovia elected to discontinue its equity program recently, and we're able to quickly arrange a sale of the property at continued very attractive valuation metrics, namely a 4.25% cap rate, and about $514 per square foot at the $294 million purchase price for the asset. This sale was clearly helped by some very attractive assumable financing we had put in place at the time of the recapitalization last year.

On the acquisition front, in June, we completed our consolidation of the fee interest in 919 Third Avenue. Recall this building, acquired as part of the Reckson acquisition, is owned in a 50:50 joint venture with NYSTERS. Our investment team led by Brett Herschenfeld was able to privately negotiate the consolidation of disparate interest in two separate transactions, greatly improving our ownership structure.

We clearly took advantage of the complexity of this structure and the off-market nature of the transaction as based on our projections in three years, the cash yields to the positions we purchased at the basis we purchased them at will be over 10.5%.

We continue to be conservative with our capital as we believe our best opportunities will be ahead of us. In the direct real estate side, we continue to mine off-market, highly structured opportunities where we have made our best deals in the past. The broadly marketed headline transactions of this quarter just didn't meet our return expectations for our capital.

We see additional pipeline through our robust book of existing structured finance positions, as Marc went through. We've been very selective about asset quality and sponsorship in our new structured finance originations and purely focusing on the Manhattan area, as we believe our third quarter originations will show.

And with that, here is Greg to go through the numbers.

Gregory F. Hughes - Chief Financial Officer and Chief Operating Officer

Great, thanks, Andrew. The second quarter was once again highlighted by strong internal growth as we continued to benefit from the repositioning of our portfolio last year, and we capitalized on opportunities within our existing portfolio.

Our balance sheet at quarter-end reflects modest changes from 331. A couple of the noteworthy changes are as follows: Our land balances were up slightly, principally as a result of the consolidation of the fee positions at 919 Third Avenue. Our structured finance investments were up approximately $65 million for two new investments. And our investments in joint ventures were down as a result of the sale of 1250 Broadway and the deconsolidation of a portion of the 388 Greenwich investment.

During the quarter, we were successful in modifying the structure of our partnership arrangement there, which resulted in the entire investment being deconsolidated from our balance sheet. Previously, approximately $276 million of the debt associated with this investment was shown as a corporate obligation.

During the quarter, we spent $13.9 million on redevelopment costs, bringing the total year-to-date to $20.2 million. We continue to reinvest in our properties based upon the outsize returns we have achieved through the redevelopment of 485 Lexington and 100 Park Avenue. Major initiatives currently underway include lobby renovations at 1350, 1185, and 810 7th Avenues, the build outs of the American Eagle Space at 1551 Broadway, the build out of Geox and Aldo spaces at 34 Street and most recently, the commencement of our $160 million renovation at 1515 Broadway.

During the quarter, we brought back $29.4 million of our stock at an average price of $85, as we continue to believe our stock represents an attractive investment opportunity.

Our balance sheet continues to be strong and flexible. The sale of 1250 Broadway this quarter helped pay down our credit facilities, which ended the quarter with approximately $818 million of availability. This availability provides us with purchasing power in excess of $1 billion.

Our debt to total market capitalization on a combined basis finished the quarter at 57%. However, the actual leverage pursuant to our corporate covenants, which values our assets higher than the market does, has this currently at approximately 50% leverage.

We expect to announce shortly the terms of our refinancing at 770 Fifth Avenue, which represents our only remaining maturity this year. As we look out for 2009, we have only one scheduled maturity of note, which is a $200 million unsecured bond obligation we assumed in connection with the Reckson transaction.

As we have stated before, the company remains very financially flexible with over $3.8 billion of unencumbered assets. These assets are eminently financiable even in a difficult credit environment, and so we believe that balance sheet is sound and very liquid for any opportunity.

Turning to the P&L, it was obviously another very strong quarter, which contributed to our exceeding First Call guidance by $0.29. The highlight of the quarter was the $25 million incentive fee recognized on 1250 Broadway. This fee came in substantially ahead of the $15 million estimate we originally provided as the final cash waterfall benefited from certain escrow reserves, which dropped right to the bottom line.

Even when one excludes the $10 million of additional incentive fee during the quarter, we were still substantially ahead of the guidance. Thanks in large part to the strong operating activity of the portfolio.

As with the first quarter this year, the operating results were once again strong. With over 400,000 square feet of leasing activity and a 53% mark-to-market, we continue to benefit from strong leasing activity. The average rent of $65.89 during the quarter was the highest ever recorded by the company during any one quarter.

Tenant concessions average $17.70 and free rent approximately two months, which once again remain relatively modest. Our consolidated same-store NOI increased by approximately 9%.

Note that our results were achieved notwithstanding $2 million of FAS 141 receivables, which were written off in connection with the take back and re-leasing of a floor at 1185 Sixth Avenue.

Additionally, the quirky accounting for 1372 resulted in the property operating expenses being $2 million higher than they otherwise would be to reflect the 85% joint venture participation in 1372. Excluding these two non-recurring items would have resulted in quarter-over-quarter combined NOI being sequentially higher rather than the slight decline currently reflected in our supplemental.

We expect the NOI to continue to grow over the balance of the year benefiting from strong leasing activity and the commencement of income recognition on over 400,000 square feet of signed leases, with an average rent of $63 a foot. With a more modest investment climate, our operations team has been able to redouble its efforts on maximizing recoveries and generating incremental revenue opportunities.

One final point of clarification as it relates to 1372 since the sale of our remaining 15% partnership interest has created some confusion. We expect to recognize again the sale of our remaining 15% interest of approximately $31 million. So, with the sale about 15% interest will not be as lucrative as the sale of our 85% interest, which generated a $211 million gain, that will still be a sizable gain.

Occupancy for the quarter finished at 96.7%, reflecting gains at 1185 Sixth, 420 Lexington, and 800 Third. As Marc mentioned, this occupancy level was achieved with 100 Park Avenue at just 67% occupancy. 461 Fifth Avenue and 810 Seventh Avenue also finished down for the quarter as a result of scheduled lease expirations. The space at 461 Fifth Avenue has already been re-leased at very favorable terms, which has given us a good head start on the third quarter.

SL Green's share of FFO from Gramercy declined during the quarter and based upon the new guidance from Gramercy, there is an expectation that this trend will continue over the balance of the year. The midpoint guidance of $0.50 per quarter provided on Gramercy's call would suggest that SL Green share of Gramercy's FFO will be approximately $4 million per quarter for the balance of the year compared to the $5.1 million of FFO contribution recognized during the second quarter.

The structured finance income for the quarter was $18.3 million. This amount is net of approximately $6 million of loan reserves, which were taken during the quarter on four different loan positions.

Other income for the quarter was up substantially, and included $25 million incentive fee on 1250 Broadway, $4 million of lease cancellation income, a $6.6 million acquisition advisory fee received from Gramercy, and $11.7 million of management fees from Gramercy. Based upon Gramercy's new guidance, we currently expect the incentive fees for the balance of the year to be modest, if any at all.

MG&A for the quarter was up $5 million. This increase is principally attributable to $3 million of incremental personnel costs at the GKK manager for AFR-related personnel, as well as a $2 million one-time expense associated with the pursuit of a redevelopment project.

Consolidated interest was down approximately $5 million, reflecting lower LIBOR rates, coupled with lower average balance on our credit facilities. With $3.44 of FFO per share half way though the year, we naturally feel good about our ability to meet the high-end of our currently established guidance. This would represent an 8.1% increase over 2007, a year in which we grew FFO per share by over 25%.

As I mentioned, we expect to see a reduction in FFO contributions from Gramercy for the balance of the year and this will also translate into substantial reductions in the incentive fees we receive from them. This could reduce FFO per share by up to $0.06 per quarter. As a result, at this point in time, we are not increasing our guidance.

We may also look to sell certain assets during the second half of the year in order to redeploy these moneys into higher growth opportunities. Such transactions could be temporarily dilutive depending upon sales prices achieved and the timing and nature at redeployment of these moneys.

Additionally, inflationary concerns may send rates higher, which could result in higher interest expense over the balance of the year on our $1.5 million of floating rate debt. While we are disappointed by the expected declines in contributions from GKK, we are pleased that it's being offset in part by the strong performance of our core operations, a trend which we expect will continue given the sizable mark to market, which is still embedded in our portfolio.

And with that, I'd like to turn it back to Marc for some closing comments.

Marc Holliday - Chief Executive Officer

Okay, thanks, Greg. From what you've heard today, before we get to questions, I certainly believe we are taking the appropriate steps in response to the current environment and the expectation for significant opportunities down the road. These steps consist of mitigating leasing exposure and maximizing mark-to-market of rents by actively pursuing early renewals of near-term lease maturities, continuing to sell interest in non-core properties like 1250 Broadway and the remainder of 1372 Broadway, new structured finance investments, and the continuation of stored liquidity and capacity for what may be substantial opportunities down the road.

Implementing this strategy in the current environment is very challenging. But as you've heard, we are making headway on many fronts, not withstanding a very a tough economic climate.

With that, we'd like to open up the call to questions.

Question And Answer

Operator

[Operator Instructions] And your first question comes from the line of Chris Haley with Wachovia. Please proceed.

Christopher Haley - Wachovia Securities, LLC

Good afternoon. Impressive, congratulations on the results.

Marc Holliday - Chief Executive Officer

Thanks, Chris.

Christopher Haley - Wachovia Securities, LLC

And I am also encouraged to hear the commentary regarding Gramercy and the internalization potential. I wanted to know if you could provide a little bit of color on some of the considerations and the timing of those considerations and how you expect to communicate those to us over the next six to 12 months. So specifically, could you comment on the overhead levels or the expense levels at SL Green that would be potentially duplicative or could be saved to a management agreement change, if you can.

And also, how you think about the time allocation of the SL Green executives to the Gramercy to the effort of the challenges that exist in the specialty finance market? How that might impact or be alleviated to the parent SL Green, as I call it?

Marc Holliday - Chief Executive Officer

Okay. Sort of break that down to a couple of responses, Chris. Your last question, which was time considerations; obviously I think throughout the four years we've had... the four year run we've had at Gramercy and Green, we've been able to devote sufficient time to both platforms. And I think that there's an expectation if there is an internalization or in other words, the restructuring of the management agreement, there would be some continuity of the senior management people at SL Green working to transition ultimate full interference of Gramercy over a period of time. So there is no notion of what I would call a near or immediate change in that MO, but clearly we setup a path towards an ultimate independence pursuant to a timeframe that everybody was onboard with.

So that again is in its very early stages of discussion, but that's certainly one of the items being discussed. But I think that in terms of alleviation of time, the closing of AFR and the hiring of substantial number of people to support the realty exercise, the asset management exercise which are full-time Gramercy people, I mentioned earlier, John Roche and Michael Berman, you know Bob Foley is one of the founding members and continues to be a full time partner with John.

We have guys like Mike Kavourias, Sean Townsin [ph], Jim Gregory, and Joe Romano, and I am going forget to mention a couple of others, but these are all very senior members of the team, John Clark, Chris Bjorklund on the AFR side, along with Ed Mady who is General Counsel of real estate, and Alan Rothchire [ph] we brought into do transactions. This goes on and on. Point is all these people are kind of SVP level and up, full-time Gramercy people that many of which didn't exist before AFR, and therefore now give us the ability to really seriously consider this.

As to your other part of question as it relates to just the economics of what Green could save by shifting out some resources, I think we can answer that in terms of what Gramercy would incur going forward, that's really up to Gramercy. I don't think we are in a position to respond on that, but you got [ph] the first piece.

Gregory F. Hughes - Chief Financial Officer and Chief Operating Officer

Yes, I think if you look at the metrics we took in for the quarter $11.7 million of fees, which included the $2.6 million, which probably goes down from there. You can see in the manager statement that we provide you there is $7 million of G&A expense related directly to GKK and then probably another $1 million of shared costs that would be transferred over. So the quarterly metrics are probably $12 million of revenues and $8 million of expenses.

So, our run rate of $16 million bottom line, but that number may be diminishing as I mentioned over the balance. But that's the current quarterly metrics.

Christopher Haley - Wachovia Securities, LLC

Thank you.

Operator

And next question comes from the line of Anthony Paolone with JP Morgan. Please proceed.

Anthony Paolone - JP Morgan Securities, Inc.

Okay, thank you. First question, Andrew, you mentioned the potential for some of the structured book investments to become opportunities. When do you think we might start to see those and can you give us any property level details on some of the bigger exposures?

Andrew W. Mathias - President and Chief Investment Officer

It's tough to tell when they mature its opportunities. I mean, look... as Marc went through, we have a long track record of doing it and it's sort of taken a lot of different forms. But generally because of familiarity with these properties, when they go to market or when there is a situation we're ownership's first call and we are able to do something privately in off-market, that was the case certainly with some of the examples Marc went through earlier.

So we do have positions in quite a number of buildings around the city and are constantly marketing those... monitoring those positions, monitoring asset-level performance, and the ownership's sort of current feeling to see when might be a good time to try and consolidate those assets in.

Anthony Paolone - JP Morgan Securities, Inc.

Do you think it's something that we might see by the end of the year?

Andrew W. Mathias - President and Chief Investment Officer

Probably relatively unlikely. And I think when the most impetus would be would be when the senior financing matures, and most of those maturities are around '09, '10, '11 and after. A good deal of our positions are fixed rate positions with longer term maturities. We did... in advance of falling LIBOR did lock up a bunch of the positions with fixed rates, and generally those... the fixed rate positions have longer maturities even into '14, '15, '16, '17.

Anthony Paolone - JP Morgan Securities, Inc.

Okay. And then just my other question on GKK, if you all step back and just looked at how much you've invested in, say, GKK's common, and then just compare with cash back to SLG with respect to fees, dividends et cetera, and given kind of the current stock price of about $6, any sense as to what the IRR on the whole thing has been at this point for SLG?

Andrew W. Mathias - President and Chief Investment Officer

Yes, we can get you the exact number, it's bouncing around. But we've done... and if you take all the net fees that we received, the dividends, the IRR, if you were to liquidate your stock position at today's price, which still be...would still be north of the 20% IRR.

Anthony Paolone - JP Morgan Securities, Inc.

Okay, great. Thanks.

Operator

Your next question comes from the line of Jay Habermann with Goldman Sachs. Please proceed.

Jonathan Habermann - Goldman Sachs and Company

Hey, good afternoon. Here it's slowing [ph] as well. You guys talked about dispositions possibly coming in the back half of the year. Can you give us a sense of just the dollar magnitude and is this... will this continue to be suburban assets or you're looking really at some of your midtown assets as well?

Andrew W. Mathias - President and Chief Investment Officer

I think we're focused on both, some suburban assets probably as the near-term priorities probably in the order of magnitude of $100 million or so. And then also probably in the back half of the year, looking at sort of where the market is and looking at some of our New York City assets, I am sort of judging where we think where we see value, where we see good leasing upside, and whether any more property should go. 1372 was sort of the end of a long string of dispositions totaling more than $2.5 billion. So, we've taken a bit of a breather right now in New York City sales.

Jonathan Habermann - Goldman Sachs and Company

Okay. And then back to Marc's comments along the line of the 10% to 15% decline in net effective rents, how far along in that process do you think we are? And then I guess a second part of their question, do you think we are going to see more subletting of space by non-financial services tenants, ala Pfizer?

Marc Holliday - Chief Executive Officer

Well, I would say rents have held up pretty well so far. So other than for the biggest of blocks where most landlords haven't really yet begun to discount their rents with the belief that since there's so little new inventories scheduled to come online in mid-term, almost none, except for really one project, that whatever dislocation there'll be, they won't necessarily be in need to discount those block rents.

So we only have one such block like that. That's at 100 Park, I mentioned that. And we've been fairly patient as have others. But for all the other space, certainly in our portfolio in the leases, we see getting down around town, the rents have held up strong. I think you see that in our results. As it relates to will there be more sublet space, I think we can say, certainly will be. Non-financial tenants as well as financial tenants we would think certainly.

So I wouldn't assume that we are going to be sitting at this 7.25%, 7.5% vacancy rate. If we were, you would still see, I think, rising rents because that's still a landlord's market. I think you have to assume that at minimum we are going to drift back towards the equilibrium and where you have been projecting a little past equilibrium to where rents or net effectives will be down 10% to 15%. That could be as high as 9% or greater with the additional sublet space that may come.

Jonathan Habermann - Goldman Sachs and Company

Okay. And do you have any updates on the Viacom lease and the progress there for 2010?

Marc Holliday - Chief Executive Officer

We gave an update on the last call and there is no update since then. They have renewal options, as I believe people know certainly, we've discussed the five-year renewal option that they have. And that we would expect that they'll be exercising, but that really isn't something that is going to be addressed by them or by us until much later in this year or next year. So, at this point, there is no update.

Jonathan Habermann - Goldman Sachs and Company

Okay. Thanks guys.

Operator

Next question comes from the line of Michael Knott with Green Street Advisors. Please proceed.

Michael Knott - Green Street Advisors, Inc.

Hi guys. Can you just comment a little bit on the economics of the gross leasing spread? Is there a trade-off with the old base years rolling off in terms of the net NOI impact?

Gregory F. Hughes - Chief Financial Officer and Chief Operating Officer

The mark-to-market that recorded the use of 53% that we realized during the quarter is... takes that into consideration because we are using the fully escalated inflates rent as a jumping well point for measuring that.

Michael Knott - Green Street Advisors, Inc.

Okay.

Gregory F. Hughes - Chief Financial Officer and Chief Operating Officer

Mike, does that answer your question?

Michael Knott - Green Street Advisors, Inc.

Yes, but that's on a gross basis, right?

Marc Holliday - Chief Executive Officer

The replacement rent is a new gross rent with today base year... but when we measure that gross rent as against the expiring old rent, we do it off the fully escalated base plus expenses. So it is an apples-to-apples comparison of that differential drops to the bottom line. Right?

Michael Knott - Green Street Advisors, Inc.

Okay, thanks.

Marc Holliday - Chief Executive Officer

It drops to the bottom line. And I would add one another thing to that. We may be mentioned it on the prior calls. That mark-to-market does not include just five conventions that we use... remeasurement. Steve Durels is here and I would say that on most of these deals, you're getting re-measurement upticks on top of that.

Steven M. Durels - Executive Vice President, Director of Leasing

Yes, without a doubt and the majority of deals that we do, we... it's a market-driven number, but we've taken the most aggressive stance on the remeasurement space. For those who don't know the concept, it's Manhattan real estate, a percentage of tenants rentable area is dedicated to a share of the common area of the building, and this is defined as a loss factor. The amount of loss factor is specific to buildings, but also influenced by the market. And there's a lot of our products that we've bought over the years in that is rolling off that has loss factors as low as 15% to 18%. And traditionally it gets remeasured recently in the 25% to 27% loss factor, which... the consequence of that is a bigger annual rent that the tenant is simply as a reflection of artificial re-measurement of the space.

Michael Knott - Green Street Advisors, Inc.

Okay. And then my second question is on Gramercy. Obviously the market seems to have some concern about Gramercy being a growing concern. Can you just talk about a summary, liquidity position for the company? I know you had a call last week, but can you just sort of give us a summary 30,000 foot point of view on liquidity and would Green step up to provide liquidity if that were needed? Can you just talk about that dynamic a little bit?

Marc Holliday - Chief Executive Officer

Michael, on this one I am going to regretfully punt on this because it's a... it can't be done... it's not a short conversation. We did about an hour and a half call on Thursday going through everything from liquidity, balance sheet, opportunities, loan portfolio, dividends, earnings. It's pretty fully detailed. The question as to is Green gong to inject liquidity, I think that might have been answered someway on the Gramercy call. We're a shareholder and we'll do always as an investor what any investor would do in the best interest of the investment. So we're not... we have in the past participated in equity offerings when there was an offering. We have not done anything traditionally unusual in terms of injecting liquidity.

I think you should look at us as you would look at any shareholder making a decision on any incremental exposure in Gramercy as would a third party investor. The management agreement stands on its own, the investment in Gramercy stands on its own. And right now Gramercy is raising capital, not via equity, but via sales of AFR real estate, which was programmed, sales and syndication of loan assets that it had been doing since June of last year and continues to do, repayments both within and outside of its CDO that it's not reinvesting in new originations and that's by design as well, and other things to raise liquidity, including revaluating its dividend, which is stated on the last call.

So all of those things go towards an effort to enhance the balance sheet and put it in a position to take advantage of a pretty fertile environment to do new loans and to make new investments on the AFR side, but predominantly, new loans and high grade CMBS, and that's the strategy it's embarked on.

Michael Knott - Green Street Advisors, Inc.

Thank you.

Operator

Your next question comes from the line of Michael Bilerman with Citi. Please proceed.

Michael Bilerman - Citigroup Smith Barney, Inc.

Good afternoon. Aaron Katsman is here with me. I don't know for Marc or for Greg, as you think about the trajectory of growth in earnings going forward, you obviously have the embedded mark-to-market in the core which continues to be strong. But how do you sort of deal with the headwinds of potentially that net $16 million of fees that you are receiving from Gramercy, potentially going away, dealing with getting over the $25 million promote that you got this year, you have $200 million of structured finance investments rolling next year as well. So I'm just trying to piece together how your growth moves forward?

Gregory F. Hughes - Chief Financial Officer and Chief Operating Officer

Again, I think the biggest peace that you are point to is the property NOI and the same-store number. So I referenced close to 400,000 square feet of space. That's already been signed up at an average rent of $63, which you haven't seen make it's way into our NOI numbers yet, because we have to finish TI work there before income recognition commences.

We also had this 285,000 square feet of vacant space over at 100 Park Avenue, which represents tremendous opportunity. I think if you look at just that universe itself, that stands on a run rate basis to add $0.40 to $0.50 per share of FFO on top of where your existing run rate is. So that's going to go a long, long way towards replacing those fees. And again, we are sitting on over $1 billion worth of investment powder to do new external investment opportunities.

We talked in December, we talked on the last call as well, that new structure finance investments, which will more than likely replace the whatever it is that's rolling off, and are very attractively priced. And when you're funding those with LIBOR plus 100 money or 3.5% money, it's obviously very-very accretive to do those type of investments.

So I think the core NOI at the end of the day and future external opportunities more than serve to offset the diminution in some of the fees that we might see.

Michael Bilerman - Citigroup Smith Barney, Inc.

So you'd almost expect the composition of FFO even if the growth rate may decelerate if you're not able to overcome all the lost fees and other promote income, the composition of your FFO will be more weighted towards property operations.

Gregory F. Hughes - Chief Financial Officer and Chief Operating Officer

Yes. And I think you're seeing that... I think you're seeing that already, if you compare kind of this year to last year.

Michael Bilerman - Citigroup Smith Barney, Inc.

And then do you have any other incentive fees booked or expected to come in your guidance for the back half of the year?

Gregory F. Hughes - Chief Financial Officer and Chief Operating Officer

Probably not. I mean, the $25 million is roughly or a little bit higher than we had guided at year-end. I think we said around $20 million from non- Gramercy-related items. So if you think that you may see $0.5 million... excuse me, $5 million of incentive fees will roll off from Gramercy. I mean, you may see us harvest one or two other small ones, but more than likely the existing guidance relies just on the incentive fee from 1250.

Michael Bilerman - Citigroup Smith Barney, Inc.

Greg, it's only because I am here [ph], I am just curious the redevelopment write off that you reported in quarter, what projects was that related to?

Gregory F. Hughes - Chief Financial Officer and Chief Operating Officer

It was principally related to the Aqueduct Raceway bid that we've been pursuing where the outcome is... we're still waiting to hear. So we took the opportunity to just expense it during the quarter until we hear firmly where that bid ends up.

Michael Bilerman - Citigroup Smith Barney, Inc.

Thank you.

Operator

Your next question comes from the line of Jamie Feldman with the UBS. Please proceed.

James C. Feldman - UBS Securities, LLC

Great, thank you very much. Marc, you had mentioned that given there is a lot of sublease space in the market, but there are tenants looking, can you just give us a little more color about what's going on in the market and who may be filling that space, maybe how many users are looking at each space?

And then also just kind of what your view is... you said there would be more sublease coming on, just kind how bad you think it might get?

Marc Holliday - Chief Executive Officer

Let me... on the question of what kind of activity is out there, as it relates to space that's not as aggressive [ph], I don't like to talk about other people's deals which are rumored or we are aware of whatever reasons. So, I think we can generically describe to you what we see happening on some of the bigger block space. I am going to let Steve Durels take that.

Steven M. Durels - Executive Vice President, Director of Leasing

There's been a number of tenants that have been in the market for probably the last six to 12 months looking for big broad space because of the limited supply of not finding homes for themselves. But the names that I think are familiar to people from the headlines that... in publications that are... we've seen them come through our door on and inquire about availabilities. NBC is out there looking at space. There's a couple of big law firms looking at space, Paul Wise or Herrington [ph].

There are a couple of investment banks that are looking for space, Deutsche Bank reportedly on a deal, but they've floating around Allianz. HSBC has made the headlines today about a big block of space. They are apparently zeroed in downtown. So there is, business goes on and there is a lot of activities still out there. Most of these are driven by tenants who have lease expirations or a need to consolidate. Some of the law firms are driven by growth. The recent deals that you have seen signed by ad firms were lease expirations and some growth, but most of them are generally not growth-driven, it's more people that are... deal with expirations or other strategic reasons.

Marc Holliday - Chief Executive Officer

Alright. And as to how much do we think the sublet will get to, I think that's a hard question to answer. We are just monitoring it and looking both at what's out there and then what sort of rumors to be out there beyond that. It's easier said than done because by the time they restack and reorganize and the space is actually available, often you are at the beginning of a different business cycle and thing change. Space comes rumored on, it comes rumored off, it changes, it's never linear.

But I think we do expect there to be at least several million fees of addition of sublet space from institutions we haven't named yet, but that's offset by some level of absorption you are going to see by the kinds of the deals that Steve Durels was talking about, whether it's relocation, expansion, new requirements.

So that's not a net number, that's a gross number, which will be netted down to some incremental additions. So that's what we look at when we derive our estimate of moderate reduction in rents off of their highs, but that's something that will just have to be monitored quarter-to-quarter.

Steven M. Durels - Executive Vice President, Director of Leasing

It's also worth noting that most of the space, and Marc said it earlier, that's coming on the market are big blocks of space. You have seen in a lot of the stats lately where there is diversions where supply has increased, but rents have also increased, which you would have thought it would be the opposite. That's driven largely by the fact that it's big chunks of high-end expensive space coming on to the market that's moving everybody's statistics.

The good news is that there's been a pent up demand from guys that haven't been able to plan homes for themselves. This is going to create an opportunity to satisfy their needs. And specifically to our portfolio, a lot of this space is not directly competitive because of either location, or size or price points. So a lot of what we are dealing with today in the portfolio by the vacancy or when I look forward into the '09 schedule and even into '10, we are chipping a way at it more the sort of small to mid-sized blocks. And that's what we've got rolling off. We locked away a lot of our big spaces already.

James C. Feldman - UBS Securities, LLC

Okay. Thank you very much.

Operator

Your next question comes from the line of Lou Taylor with Deutsche Bank. Please proceed.

Louis W. Taylor - Deutsche Bank Securities, Inc.

Hi, thanks, good afternoon. Marc, just some of a hypothetical question, we don't have a lot of comps here when an advisor like you would... or when there is an internalization management like between GKK and SLG, and last time we saw one of these things, there was a payment to the advisor. If that were to occur again, do you have any preference whether that payment would be in cash or in GKK stock?

Marc Holliday - Chief Executive Officer

Well, I think that there are a number of comps out there that the committees are looking at. I think more often than not, it's in equity or equity-linked securities account for the bulk of the consideration or in some cases, all the consideration.

So, I think preference aside, that certainly seems to be the norm and I think even here so where we have a board presence, we have a substantial pre-existing investment in the company, there would still be an alignment of interest, and as I said, within interim continuity of management, no matter what we do. So I think it would air towards equity, equity-linked securities. But again, I just want to caveat that it's really going to be hashed out at the independence level on both sides. And I guess don't have to balance all sorts of different factors such as price consideration, accretion, dilution and the rest to the come to the right balance if they can. That's one path if not a restructuring of the agreement is also definitely being looked at.

Louis W. Taylor - Deutsche Bank Securities, Inc.

Alright. Any sense on when that review will conclude?

Marc Holliday - Chief Executive Officer

I would expect by the next quarter, by next conference call, we would have more light to shed on it. Whether it's concluded or not, I can't tell you, but I think certainly there will be a lot more light and direction on where that particular issue is headed by the next call.

Louis W. Taylor - Deutsche Bank Securities, Inc.

Great. Thank you.

Operator

Next question comes from the line of Mitch Germain with Banc of America. Please proceed.

Mitchell B. Germain - Banc of America Securities, LLC

Andrew, is the 1372 sale widely marketed?

Andrew W. Mathias - President and Chief Investment Officer

It was conducted through a broker. It was not widely marketed. They made calls mostly to people who have been interested on the building last summer and were able to re-engage with one party. I think Wachovia felt comfortable that they have seen enough bids and enough interest that they felt comfortable transacting at the $294 million level. And we certainly advise them based on market conditions 4.25 quarter cap is an attractive level to transact.

Mitchell B. Germain - Banc of America Securities, LLC

Great. And Steve, can you just talk about the interest in that large block at 100 Park, I guess, today relative to where we were six months ago may be?

Steven M. Durels - Executive Vice President, Director of Leasing

It's tough for us to illustrate because it's raw space for the big block. But we have a lot of guys coming through. We have had some very best discussions. We are feeling pretty good about our prospects of one last deal in particular. We have got... on the smaller pieces upstairs where we are looking at single floors in the tower, that's stuff has still gotten huge demand. We have got active negotiations at big rents upstairs right now. And I am pretty hopeful we are going to have some good news in the near term.

Mitchell B. Germain - Banc of America Securities, LLC

Thanks.

Operator

And your next question comes from the line of John Guinee with Stifel. Please proceed.

John Guinee - Stifel Nicolaus

Yes. I love you guys, but as a fiduciary to the shareholders, I have got to ask you to kind of walk through the proxy which came out between these two calls.

Marc Holliday - Chief Executive Officer

That's a question, John or is that --

John Guinee - Stifel Nicolaus

Just whatever comments you want to make on it.

Marc Holliday - Chief Executive Officer

On which proxy? On the shareholder... on the AFR merger proxy or on the SL Green proxy?

John Guinee - Stifel Nicolaus

SL Green.

Marc Holliday - Chief Executive Officer

Which particular area would you like me to comment on?

John Guinee - Stifel Nicolaus

Compensation.

Marc Holliday - Chief Executive Officer

I think compensation was based on all the factors that we laid out last year. We had a reasonably good year, we thought the compensation committee level, board level, evidenced by record FFO, the increase in FFO, the dividend increase, $2 billion of sales, three and five-year performance that was market-leading at the time. And I think it's still among where the market leading performance today. So all that goes into the level of comp that was done for the year.

John Guinee - Stifel Nicolaus

Good. Thank you.

Marc Holliday - Chief Executive Officer

Okay, Thank you.

Operator

Your next question comes from the line of Jordan Sadler with KeyBanc Capital Markets. Please proceed.

Jordan Sadler - KeyBanc Capital Markets

Thanks, good afternoon. Andrew, could you give us... may be talk about the character, the structured finance opportunities in the pipeline you mentioned, maybe in terms of sponsorship or structure, and maybe pricing?

Andrew W. Mathias - President and Chief Investment Officer

Sure. I think it's a fairly target-rich environment, because there's a lack of providers of this type of capital out there in the market. And as I said in my prepared remarks, we've been fairly conservative in terms of not going out there and doing a lot of deals because we want to continue to see how the market evolves and make sure that our capital has been priced as advantageously for us as possible.

There were... there's been a bunch of high profile transactions done and most of them have featured some mezzanine capital. It's just hasn't been... the pricing, in a lot of cases, has not been attractive enough for us. But we've... the situations we found, we think the risk reward is there and we're going after them aggressively.

So, I think we have one sort of a large transaction lined up for the third quarter, which we'll be able to give more detail on in the next call.

Jordan Sadler - KeyBanc Capital Markets

And that one's already closed?

Andrew W. Mathias - President and Chief Investment Officer

Yes.

Jordan Sadler - KeyBanc Capital Markets

The transaction, okay. And pricing relative to the spreads on the existing portfolio. So --

Andrew W. Mathias - President and Chief Investment Officer

Pretty materially higher. I mean, I would say our existing book, I think, Marc said it was at 9.5% or so return, and I would say, most of the opportunities we're looking at today are more in the low to mid to upper teens range depending on the opportunities.

Jordan Sadler - KeyBanc Capital Markets

Okay. And then just moving over to the existing portfolio; any new additions to the watch list, any delinquencies to note? I know you took some reserves. I think that might have been on some properties you've previously talked about. So any thing new coming up?

Marc Holliday - Chief Executive Officer

Well we have three non-accrual loans. And I mean, in terms of those... two of those three are non-New York loans. So that sort of eaten to some of the non-New York loans. I would say everything that's in the New York bucket or New York commercial bucket for sure, we don't see anything upcoming. I think the non-New York stuff, it's relatively small by amount. I think it's probably under $3 a share in terms of amount, but that's going to require high scrutiny because as we have come to see, everything that's in markets that are less liquid than here in Manhattan, the assets maybe fine, but there's no re-financibility, there's no credit out there. So these have to be watched carefully.

So nothing in particular we could point to and say as something that we think may become a promise or word [ph]. I think it would already be... we already have it either non-accrued or on the watch list. But I would say the non-New York exposure is what we're watching specifically.

Jordan Sadler - KeyBanc Capital Markets

And non-New York as a percent of that 840 you said was how much?

Marc Holliday - Chief Executive Officer

Under 20%.

Jordan Sadler - KeyBanc Capital Markets

Under 20%. Lastly for Greg. Have you... is it safe to say that you've not factored the termination of GKK manager... management contract into guidance whatsoever and is there any way you could give us some rough around the edges guidance as to what the impact might be from an earnings perspective?

Gregory F. Hughes - Chief Financial Officer and Chief Operating Officer

Well, I think we've walked through the metrics of what is contributing currently, which is kind of call it away from our stock investment, $12 million of fees, $8 million of expense, $4 million of bottom line. So call it $16 million of net fees. And so the guidance does not factor in any termination. And I think it'll be premature until we hear what... how the independent committees come back in terms of how they are thinking about the value of that fee stream and what form the consideration would take, and when specifically the consideration might be earned. I think they are all wild cards that I wouldn't want to venture a guess at this point other than to say it's definitely not included in our guidance.

Jordan Sadler - KeyBanc Capital Markets

Your annual net fees, you've got at about 16 million?

Gregory F. Hughes - Chief Financial Officer and Chief Operating Officer

It's kind of a current run rate basis off of the second quarter.

Jordan Sadler - KeyBanc Capital Markets

Okay. Thank you.

Marc Holliday - Chief Executive Officer

Is that it operator?

Operator

Yes. At this time, you do not have anymore questions and I would like to turn the call back to you for closing remarks.

Marc Holliday - Chief Executive Officer

I just want to clarify one thing I said earlier, which someone has looked into and slipped me a note. The mark-to-market calculation does include the remeasurement. So the bulk of that mark-to-market, 53%, is the gross rent number if we do grow this space that is included in that firm number also, which is again apples-to-apples because it's all rental revenue differential drops to the bottom line. Just want to clarify that one piece.

And with that, I appreciate everyone dialing in today and we look forward to speaking to you all after the summer. Thank you.

Operator

Thank you for your participation in today's conference. This concludes the presentation and you may now disconnect. Good day.

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