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DCT Industrial Trust (NYSE:DCT)

Q2 2008 Earnings Call

August 5, 2008 12:00 pm ET

Executives

Phil Hawkins - CEO

Jim Cochran - President and Chief Investment Officer

Stuart Brown - CFO

Daryl Mechem - Managing Director Operations

Sara Knapp - Corporate Communications and Investor Relations

Analysts

Paul Atarata - BMO Capital Mortgage

Derek Bauer - Merrill Lynch

Chris Hailey - Wacovia

Michael Mueller - JPMorgan

Cedric Lachance

Nat Overton - Watings, Kagon

Mitch Germane - Banc of America Securities

Operator

Hello, and welcome to the DCT Industrial Trust second quarter 2008 earnings conference call. All participants will be in a listen-only mode. (Operator Instructions) Please note, this conference is being recorded.

Now I would like to turn the conference over to Miss Sarah Knapp. Miss Knapp you may begin.

Miss Sarah Knapp

Thank you Camille. Hello everyone and thank you for joining DCT Industrial Trust second quarter of 2008 conference call. Before I turn the call over to Phil Hawkins, our CEO, I would like to mention that management's remarks on today's call may include statements that are not historical facts and that are considered forward-looking within the meaning of applicable security laws, including statements regarding projections, plans and future expectations. These forward-looking statements reflect current views and expectations, and are based on currently available information and management's assumptions. We assume no obligation to update these forward-looking statements and we can give no assurance that the expectations will be attained.

Actual results may differ materially from those described in the forward-looking statements and will be affected by a variety of risks including those set forth in our earnings release and in our form 10-K filed with the SEC as updated by our quarterly reports on form 10-Q. Additionally, on this conference call we may refer to certain non-GAAP financial measures. Reconciliation of these non-GAAP financial measures are available in our supplemental package which can be found in the industrial relations section of our website at dctindustrial.com. Now, I'll turn the call over to Phil.

Phil Hawkins

Thanks Sara and welcome everyone. Operationally, we had another good quarter. We signed a record 2.5 million square feet of leases as we remained focused on competing in a leasing environment which is becoming increasingly competitive. Retention of additional tenants remains strong at 74%. Rent growth on signed leases in this quarter was 5.4% on a cash basis, and 12.7% on a GAAP basis, with turnover costs averaging $1.18 per square foot. Total occupancy of our consolidated buildings has declined to 93.1% on March 31st, to 91.8% as of June 30th, due in large part to the 440 000 square foot vacancy at Wickes in April, as we discussed last quarter.

Excluding Wickes and portfolio changes such as the disposition of fully-leased buildings, occupancy was essentially flat, quarter over quarter. Same Store NLI increased 1.3% on a cash basis and 0.3% on a GAAP basis, excluding the Wicks Bank up city, Cash Same Store NLI would have grown 2.5% on solid rental rate growth. Our pipeline of lease deals shows that the proposal and the lease negotiation stages remains consistent with the last couple of quarters.

We also had another good month in July, with the completion of 1.6 million square feet of leases. I want to make two comments. First, a note on last quarter deals are taking longer to complete which is no surprise given the uncertainty that customers are facing in this environment. Second, we are seeing better activity on renewals of all sizes, and on smaller vacant warehouse spaces as compared to larger vacancies in both our development and our operating portfolios where activity has slowed somewhat. With market vacancy rates having risen by about 30 basis points over the past quarter, and likely to continue rising modestly over the next few quarters, we expect that the leasing markets in general will continue to weaken.

Therefore, we are running our business with a bias towards making deals and emphasizing occupancy.

Current conditions are highly competitive, but long term we are very bullish on both building values and rental rates given that replacement costs have increased and are expected to continue to increase substantially. Construction costs have increased by about 7-10% in the past year and 40-50% over the past three years while financing costs have also moved up significantly in the past twelve months. Over time, rental rates have to go up to keep pace with higher replacement costs.

While we had a good second quarter, we have reduced our guidance for the balance of the year. The primary reason behind the reduction is slower that previously expected lease-up of several of our development assets. This results in a reduction in our forecast of merchant building gains of approximately five cents per share. The remaining reduction of about two cents per share is split evenly between lower occupancy and a reduction in expected new acquisition activity with our two active joint venture partners. We continue to look at acquisition opportunities with both of our partners, but they, like us, are appropriately cautious in this environment. We therefore considered it prudent to reduce our forecast of additions to assets in the management by about $150 million.

While the reduction in guidance for the year is obviously disappointing, we remain very committed to and very confident in our longer term strategy of building value through development and value-adding investments, including SCLA, growing our funds management business, and expanding our presence in Mexico. With a softening in the real estate markets we also believe that now is an excellent time to expand and strengthen our organization; especially in the areas of capital employment and development execution in Mexico. For example, we recently hired Tom Tucci, formerly the head of CBRE's New York Tri-State industrial practice.

Regarding our development activities in the North East, today is certainly not the time to start new methods of developing projects, but we are convinced that exciting opportunities will arise out of the current leasing and financing environment to acquire shelves and other under-leased assets from distressed developers and owners. We are starting to see a few interesting deals, but we also believe that patience and discipline are the key. It is out expectation that operating and financial conditions will continue to soften over the next couple of quarters and therefore increase the stress on developers and owners.

We continue to make good progress in Mexico and in SCLA. Leasing activity in Mexico remains strong and we are also encouraged by our pipeline of land and building acquisitions in Mexico. User-activity in SCLA remains active, especially in the area of land sales. Jim will provide more color on both SCLA and Mexico in a moment. Our balance sheet remains a strength as we position the company to take advantage of what we believe will be increasingly exciting investment opportunities.

Through July we have closed on a sale of $90 million in lower growth, non-strategic assets at decent cap rates, which is on pace with our annual targets. We are now marketing additional assets for sale and are encouraged by preliminary responses. The new term loan which we announced earlier in the quarter as well as the extension of $125 million of unsecured notes, also provide us with strong liquidity in a market in which such capacity is valued at a premium. Frankly, I wish we could isolate ourselves in the broader economic slowdown, but I am excited about the opportunities that the increasing stress will generate. DCT is in a position to take advantage and profit from those opportunities.

We remain very focused on successfully executing in this environment, as well as in leveraging our financial and organizational strength to grow cash flow and value over the long term. With that, I'll turn the call over to Jim Cochran for further comments.

Jim Cochran

Thanks Phil. As Phil mentioned, the industrial market in the US continued to flow in the second quarter as we anticipated. Overall, vacancy increased by 30 basis points. There was a significant amount of industrial space started in late 2007 through early 2008 that is being delivered through the course of 2008. While this overhang of delivered space is coming on the market at an inopportune time, new starts are down 40% in the first half of 2008. Starts in the second quarter were the lowest in over four years. Thus, the supply of new space to be delivered in late 2008, and early 2009 will be down dramatically from the level seen over the past few years, which will help position the markets for recovery.

Last quarter we told you that sales were difficult, due to the large amount of capital on the sidelines. Investors continue to be cautious but we are seeing as of the end of the second quarter, both an increase in the amount of product on the market and an increase in the number of legitimate bidders. Cap rates have moved up 5-50 basis points for class-A products in the first half of the year, based on our experience. Even in the tougher sales environment, we have closed 89 million dollars in third party dispositions.

Through our recycling efforts, we continue to maintain a strong balance sheet which allows us to be poised to react to attractive investment opportunities that may become available in the coming quarters.

The amount of space we have under development decreased to 8.9 million square feet as we stabilized several buildings, and have effectively stopped new starts in the US. During the quarter, we stabilized 873 000 square feet by leasing our remaining spaces or finalizing long term leases in four buildings, two of which are in Mexico.

Unfortunately, several of our other projects that we budgeted for development gains have not yet leased. Given a slow-down in a number of buildings and the time required for fund-contribution we have pushed the forecasted time for gain recognition for certain assets to 2009.

On a positive note, from our gain recognition standpoint, we do have 5.2 million square feet of class A products that is or will be complete by the end of this month and could possibly produce gains in the short term. During the quarter at SCLA, we completed our 296 000 square foot building, tilted walls on our one million square foot building and continued to make leasing progress on our two smaller multi-tenant properties. We are pleased with the level of enquiries on our large buildings given its early stages of construction. While we have lease proposals outstanding for our 296,000 square foot building, we are facing competition due to an oversupply of space in this size range in the Inland Empire East. Net absorption in the Inland Empire market was positive in the second quarter but at a level that was 70% lower than the first half of 2007.

On a more positive note, construction activity is down by a meaningful amount. As of the second quarter 2008, there were 10.9 million square feet under construction, compared to 16.2 million square feet under construction the same time last year. We have discussed strong land sale activity at SCLA on recent calls. We continue to work with multiple users that desire to own land at SCLA. You may have seen an announcement put out by Dr. Pepper's Snapple group to purchase land for a large facility on 55 acres at SCLA. We expect this transaction to close by the end of the year.

Activity in Mexico continues to go well. We have stabilized five of the six initial buildings in Monterey and are developing four additional buildings totally 482 000 square feet of which 108 000 square feet are pre-leased. We continue to work on development and building acquisition opportunities and our other target markets, as well as to expand our organization in Mexico. We mentioned that we are going to use this period to strengthen our organization especially on a capital deployment side of the business.

During the quarter we hired Tom Tucci to oversee our capital deployment activities in the North East. Tom comes to us with 30 years of experience and will reside in New Jersey. We also hired Mark Erler to handle product management for development-related activities. Mark comes to use from Panattoni with eleven years of experience, and will reside in Atlanta. We are pleased to have both Tom and Mark join us as they will strengthen our capital deployment team and allow us to better capture value and opportunities in the future. The slowdown in the economy and the industrial market has made our business more challenging and certainly the economic climate has helped with our high renewal rate on our operating portfolio but put expansion and relocation plans on hold, which has impacted our development portfolio. We continue to believe that our development assets will lease and be profitable but at a slower pace. I'll now turn over to Stuart.

Stuart Brown

Thanks Jim, and hello everyone. Funds from operation were 16 cents per share for the second quarter and 30 cents per share here to date. Versus a year ago, FFO declined 3 cents per share, through mainly lower development gains. Earnings per share this quarter was 9 cents, compared to 5 cents per share in 2007. We sold $71 million of real estate during the quarter generating gains of $16.7 million, or 8 cents per share. In addition, we recorded a loss of $1.2 million in the second quarter, related to the sale of three properties which reduced both FFO and earnings per share. We sold these three properties and one additional building in July for approximately $12 million. Phil review the highlights of the operating performance, this quarter. Overall, our leasing activity remains solid and occupancy remains on track with our earlier guidance.

Same store occupancy on June 30th was 92.3%, excluding the Wicke's Furniture Bankruptcy, Same Store occupancy would have been 93.1%, which is flat when compared to March 31st, and down from 93.9 % at December 31st. Looking at customer receivables, we saw little change this quarter, with bad debt expense dropping to less than $200 thousand, from $600 thousand last quarter. The ageing of receivables is held steady and we had only one new tenant bankruptcy of 17 000 square feet. Otherwise our tenant watch list remains largely unchanged.

As you saw in our earnings release and discussed by Phil, we have reduced our funds from operation guidance for 2008 to a range of 60-66 cents per share. This reduction of 7.5 cents at the midpoint of guidance primarily reflects a slower release of certain development spaces which has delayed the timing of development gains. This delay in gains accounts for 5 cents of the reduction. Our guidance for FFO gains has been lowered to a range of 0-4 cents per share, compared to our previous guidance of 6-8 cents per share.

As Jim discussed, we have a number of buildings eligible for FFO gains; either leased or shelf complete, plus the possibility of land sales at SCLA, but the timing of recognizing gains is more uncertain in the current economic environment. We believe that we will generate some development in land sale gains in 2008, the lower end of our guidance assumes that no such gains are realized. The remainder of our change in guidance is due to lower NOI from the impact of the Wick's Bankruptcy, accounting for about one cent per share. Slower growth in the institutional capital management business reducing results by about one cent per share, and a $1.2 million impairment charge mentioned earlier. The lower expected results from our institutional capital management business reflects expected growth of assets under management of $125-175 million which is about half of previous guidance. Our guidance for Same Store net operating income growth remained consistent with out comments last quarter of near one.

Average occupancy for our consolidated operating portfolio is expected to be between 92-93%, reflecting a slight decrease in occupancy for the remainder of the year. We have also revised our guidance for earnings per share to between 9 cents and 15 cents per diluted share. Before turning the call over for questions, let me touch briefly on our balance sheet and capital position. We are very pleased with the terms of our new term loan which we closed in early June. We were able to put in place a $300 million facility of which we initially drew $100 million to pay off maturing unsecured notes.

We swapped the initial draw to fix the liable rate for two years which, with the current spread, results in an all in rate of 3%. The remaining $200 million remains available to draw any time up until December 31st 2008. The term loan matures in June 2010, and is extendable for one year. As a result of these transactions, 89% of our debt at June 30th was fixed rate. In addition to the $200 million capacity on the term loan, we had $172 million available on our credit facility as of June 30th, which gives us a liquidity of almost $400 million including cash. With less than $40 million of debt maturities remaining in 2008 and none in 2009, liquidity available to us exceeds 10% of our total market capitalization. We were very well positioned to fund the growth in our business plan and take advantage of any opportunities that may arise as a result of the distress in the capital markets. With that, we will now turn the call over for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question will come from Paul Atarata from BMO Capital Mortgage. Please go ahead.

Paul Atarata – BMO Capital Mortgage

Phil, in your comments you mentioned that you expect the stress that is out there in the marketplace to eventually lead to some opportunities. What did you have in mind, and how soon do you think that those opportunities will present themselves?

Phil Hawkins

I think there are going to be a number of opportunities, first and foremost probably leasing related. Undercapitalized developers and/or owners with shell buildings, or buildings that are going to a releasing, are under stress and create opportunities to acquire assets at significant discounts to replacement costs. For us to get excited about that, there has to be a significant discount, but also more transparency in the market from sales to lease which is why, I don't expect any material acquisitions on our own balance sheet from a value added perspective the rest of this year, as we let the markets settle out. Frankly the pain to strengthen a little bit, but that is one area that we could get excited about but not likely at least not at this point.

Jim Cochran

I would add that we think land is at a typical high right now, and if you think about it costs are continuing to rise, rents at best are flat and cap rates are up so something has to give if new products are to be delivered. That pressure, we believe, will be on land prices, which will probably go down. That will take some time to work it's way through the cycle. We're thinking sometime in late 2008, certainly in 2009 we will see some opportunities.

Paul Atarata - BMO

I believe you also mentioned that in terms of the attractiveness or the performance of large boxes versus small boxes; the small ones seem to have a little more resiliency. Did I hear you correctly?

Jim Cochran

In today's leasing, that is exactly the activity which we are seeing. My theory on that is that smaller decisions are easier to make in uncertain times, and therefore renewals, which is the easiest decision, and or small-sized spaces are next easiest its the bigger spaces that become more of a capital and operational commitment on the part of the customers when deferred, that’s what we’re seeing today.

Darryl Mechem

This is Darryl, We’re also seeing on the Big Box side though. Phil referenced the renewals; we are seeing the users on the Big Box showing a strong tendency to renew and had good activity this year.

Paul Atarata – BMO

Ok, and finally, do you guys have a stock buy-back authorization in place?

Phil Hawkins

No we do not.

Paul Atarata – BMO

Given where the stock is trading now, do you think you will recommend that for the board?

Phil Hawkins

You will be the first to know once we do. I’ll tell you, the group will be, it will not be just you individually. I can tell you how we think, and that is, in this environment, we’re focusing on growing the business, and we’re also focusing on preserving our balance sheet, to take advantage of that. We also compare that to investment opportunities in light of stock price, including a comparison to our view of NAV, but at this point, today, we have not announced anything.

Paul Atarata - BMO

Ok, thank you.

Operator

Our next question will come from Chris Hailey from Wachovia. Please go ahead.

Chris Hailey - Wachovia

To expand a little bit on the Small box vs Shallow bay versus modern cubes, is the velocity down for both, or is velocity down for the bigger customers in that there are just more options to choose from, in that the supply adds were greater in the Big Box category? An interesting thing on supply-demand dynamics between the two product types.

Darryl Mechem

Chris, your comment as to supplying the Big Box is a primary reason that it’s slow, there’s an oversupply in several markets. I referenced earlier on a pulse-question, and what we’re seeing; renewals for big boxes remain strong, activities for smaller bulk remain strong, so supply really is driving the slowness of Big Box absorption. There are some markets oversupplied.

Chris Hailey - Wachovia

Would you care to list those for us?

Darryl Mechem

Sure. Phoenix, for example, has been hit by the housing slump. There is oversupply there to 6,000,000 square feet. Jim might comment on other markets, there's some construction in Orlando that’s a little soft.

Stuart Brown

Here in Atlanta, even though construction is down, there's an overhang of large on large-space in Atlanta. Memphis, for products on the Tennessee side, as opposed to Mississippi and so, we’ve commented on this in the past. We have product available for both, it’s highly divisible, as well as all of our properties are divisible, i.e. distribution buildings. We’ve had success in both, I think what you’re expecting is development building, say divisible down to 10,000-30,000 square feet, and you’re going to get incremental leasing over time. At a point in time, it looks like you’re making more progress as opposed to a bigger box, where it contains all or nothing.

For example, in California we’ve stabilized a 400,000 square-foot building and a relatively soft segment of that market. We also have a building next door that we’re attempting to lease. I think the issue is that users in an uncertain economy are putting expansion on relocation decisions on hold, that’s really the issue. That’s why we’re seeing higher renewals in our existing portfolio and large users as well. They are not downsizing, they still want the same size. I think that inventory sales ratio are low, so people need space as far as expanding and moving, I think they are waiting for better signs for the economy. That’s how I’d describe it.

Chris Hailey - Wachovia

Ok Stuart, thanks for that. When you look out over the next 6-12 months, the development efforts that you do need to be differentiated in that you are in most cases using third parties and doing a pre sale by-out venture structures rather than actually looking at your overhead for these development projects. Any revisions to forward expectations will be must less driven by capitalization to expanse issues, is that correct?

Stuart Brown

As a matter of fact, I’m not sure exactly the question.

Chris Hailey - Wachovia

For example, your peers have been expanding and loading up on internal overhead to hopefully take advantage of intermediate and longer term development cycles. Your strategy initially at this point in time is largely out-sourced.

Stuart Brown

Yes, as we’ve talked about strengthening the development team a little bit, I think the relative size of our development team relative to our peer group. As you look at our business model as we branch up our development program is utilizing third-party developers who have access to the land sites and things like that, and so therefore, haven’t had a large overhead burden compared to some of our peers. We will selectively add to that peer-group, to our development team, where necessary, but wouldn’t anticipate the large staff coming on.

Phil Hawkins

The simple answer to your question is that we don’t have nearly the GNA nor the land burden that some others might have, and it’s a lot easier for us to stop, which we stopped frankly at the beginning of the year, which was intentional at the time and makes it easier for us, more flexible for us to respond to the US market.

Chris Hailey - Wachovia

Just to clarify the revisions in terms of expectations of leasing are largely based upon domestic US rather than Mexican efforts.

Phil Hawkins

Correct. The Mexican leasing a) is going very well, but b) was not in the plan to recapitalize in 08, and probably not in 09 either. We want to build critical mass and create value through aggregation of both development and operating assets so it’s the miss is entirely in the US and driven by slower-than-expected and desired leasing.

Chris Hailey - Wachovia

Thank you.

Sarah Knapp

Our next question comes from Michael Mueller from JP Morgan. Please go ahead.

Mike Larisse – JPMorgan

Hi this Mike Larisse on Mike’s line. I just have a couple of quick questions. First you mentioned “stopping-starts” and I was just wondering if that means to assume no new development starts for the balance of the year, and when and where do you think this start will come?

Unidentified Company Representative

The new development starts in the US in 2008, and that also includes SCLA. In that given guidance in Mexico, we are certainly pursuing a couple of more sites there and we are hopeful that we will be able to bring one or two under control and even start something by the end of the year, but it will be by the very end of the year, if that’s the case.

Mike Larisse – JPMorgan

When do you anticipate starts in the US again, or is that too far out on the radar?

Unidentified Company Representative

It’s tough enough to go through the end of the year. Certainly, I believe that the environment is going to remain soft for several quarters, and then from there, it will take at least several quarters to recover where rents justify new construction. I think the next opportunity, not yet, but the next opportunity will probably in the acquisition of shells at discount replacement cost before you start putting shovel on the ground in a meaningful way new construction. That’s probably how it all unfolds.

Mike Larisse

Ok great, just one more thing, any detail you can give on capacity for your investment funds at this point?

Unidentified Company Representative

For our investment relationships, both have, from a capital standpoint, significant amount of capacity. JP Morgan have very large funds, so capacity is not the issue, rather, understanding the market and deciding how much capitals to deploy in 2008, and same with other relationship is open, TRT, they continue to raise money and again, capacity is not the issue.

Mike Larisse

Ok great. Thanks you guys.

Operator

Our next question comes from Cedric Lachance

Cedric Lachance

Thank you. When we look at the development schedule, I see a few of the shells complete that started in 2005 and 2006. At what point do you take those properties after development schedule, and you say, they are in operation but they are just not leased.

Stuart Brown

Cedric this is Stuart. Let me answer that. Our view is that we want to be transparent in terms of how the development pipeline is performing and what we’re doing there, it’s easy for me to just take it all and put it in the operative pool and move it that way. From the accounting standpoint after 12 months after shell complete, we stopped capitalization of interest another overhead cost, but what we try to do is put them on the air just from a transparency standpoint, where people can track to see how the developments are doing when they stabilize. Our view is that they should stay on the list just to keep them out there for people to see what they are doing, so once they become stabilized and they would move either in to the operating pool or potentially, we can fit it into a fund.

Cedric Lachance

What you are trying to say is that all 2005 and 2006 starts that you no longer capitalize any kind of expenses, interests or GNA?

Stuart Brown

I wouldn’t say that that’s 100% correct, but that’s correct yes.

Cedric Lachance

In terms of booking merchant building games for FFO, what properties could still qualify, and what properties might not qualify if you at this point, stop capitalizing interest ?

Stuart Brown

There is obviously some difference in the interpretations of the FFO calculation, and we’ve done a review of how well our peers are doing it. I think our definition is relatively consistent compared with our peer group. Generally, non-depreciated assets clearly would be eligible for FFO. Currently, none of the development projects or the assets that are held for contribution been depreciated, so there are some assets that may be in the development pipeline be held for contribution and be put into the fund; and while it’s held for contribution it’s not depreciated either. If all goes in consistency with our peers, if any of these development projects were required to be depreciated for GAAP purposes, we would take the economic game in FFO.

Cedric Lachance

You would.

Stuart Brown

We would, in consistency with our peers and with the FFO definition, that merchant building games, development games are sort of separate from NOI. So once it becomes not building assets, we wouldn’t.

Cedric Lachance

Why haven’t you started depreciating South Creek which is one of the 05 vintage.

Stuart Brown

South Creek is a little bit in each building that’s got own store area where we can sort of go to it offline, but South Creek was a building that started in a joint venture, we only acquired that building out of the join venture in consolidated it, basically about 12 months ago.

Cedric Lachance

In regards to your guidance, can you refresh my memory as to what it is for you?

Phil Hawkins

That guidance is near 1 percent for the year. The original guidance we put out was 1 to 3 percent.

Cedric Lachance

Now you’re expecting roughly 1 percent?

Phil Hawkins

Right.

Unknown Analyst

Phil, you talked about your view of NAV. What do you think about buying shares back, if they’re able to share with us, would your NAV ?

Phil Hawkins

No.

Cedric Lachance

At what discount to your NAV are your shares attractive?

Phil Hawkins

We really don’t want to put a formula on it. It’s a subjective assessment. It’s trying to give some “color on Howard” thinking about it, but again, the first thing I think about is the liquidity and capacity in this environment but obviously, we’re looking at, that we started to play capital for looking at share buybacks as competing for those dollars. But it’s hard for me and that is not possible, it’s not a formula. It has been frankly a regular discussion as I’ve said on a few calls actually, at the board level as well as amongst the management team, about capital deployment and the use of capital including stock buybacks.

Cedric Lachance

In regards to the assets that you disposed of but worked on a permanent charge on, you said you prepared the marks that you’ve achieved reasonable capital rates on dispositions. My first question is: can you share with us what those reasonable capital rates are? Second question is: By how much of gas rates move in the acquisition of those assets?

Phil Hawkins

Well from our experience, caps rates are roughly 5-50 basis points, it depends on the assets, it depends really on what deals you are looking at. Our analysis is based on how we decide to buy assets, so we are very careful to discount both market rent and in buying assets, to offer buyers a higher going yield as opposed to what we call a stabilized yield. As it relates to the pyramid, it was less of a cap right issue as opposed to a troublesome state that did not leave. We picked up this portfolio in somewhat of an isolated location in California. It was in a troublesome state, so we decided to effectively eliminate the leasing challenge and sell the asset.

Keep in mind, the inherent charge of 1.2 million dollars through the geniuses of GAAP accounting flows through FFO, but there is also 17 million dollars in gains on the sales as well, which was reported, and is not reflected in FFO but are real.

Cedric Lachance

So when were those transactions made, those four or five acquisitions that you are now selling?

Phil Hawkins

They vary… No more than 4, 5 or 6.

Operator

Our next question comes from Nat Overton from Watings, Kagon. Please go ahead.

Nat Overton Watings-Kagon

Good morning. Stuart, you said that at the low end of your guidance there were no gains at 60 cents. Is the primary thing that you would need to get to the upper end of guidance some gains to show up in 2008, or what do you have to do to get to the outcome of that guidance plan?

Stuart Brown

The revised guidance for gains on development assets is basically a range from 0-4 cents, and so then on top of that we would need some momentum on the leasing and then attempting to get to the upper end of guidance. There is also a chance that development gains could exceed that, but we haven't put that in our guidance. As I mentioned, we have a pretty large amount of assets which we could sell, and are available for sale, or contribution that could generate gains if it's out there.

Nat Overton Watings-Kagon

Just to clarify, to the extent that gains don't get development stabilization, and basically get pushed out further, I think your previous gains were 6-8 cents per share and so have those just simply been pushed into next year or has the overall amount of gains that you expect from that pile of assets dwindled.

Stuart Brown

Those are basically the stabilization and therefore the expected gains out of those have been pushed back from 2008 to 2009.

Operator

Our next question comes from Mitch Germane from Bank of American Securities. Please go ahead.

Mitch Germane - Bank of American Securities

Good afternoon. The top end of your guidance range, does that include the Dr. Pepper deal, plus or … how is that in the mix? If I might ask…

Stuart Brown

We haven't put specific deals as it has been a 0-4 cents or a development gain; the guidance obviously would include land sales which presumably include the land at SCLA. But we haven’t gone through and said: 'here are the exact projects which make up that number'.

Mitch Germane - Bank of American Securities

Last question; in terms of Phil's comments regarding some potential stress to acquisitions, would that be on the balance sheet, or would that also be done through your other ventures?

Stuart Brown

Both of the above.

Operator

Our next question comes from Paul Atarata from BMO Capital Mortgage. Please go ahead.

Paul Atarata - BMO

Yes, just one additional question. It sounded like things were going well in Mexico, and if that is true do you think you may need some investment dollars or additional investment dollars, except for the border.

Jim Cochran

Yes this is Jim. Mexico’s going pretty well, we’re clearly watching the economy closely, given with what is going on in the U.S., but we’re in the early stages of building our platform in Mexico. I think we’re doing very well in modern rate but we’re targeting seven other markets and we feel there are opportunities in other markets that we’re actively looking at, so yes, Mexico would be a priority for capital employment, but we’re still going to be cautious in what we do in Mexico.

Paul Atarata - BMO

Thanks

Operator

Our next question comes from Chris Haley from Wachovia. Please go ahead.

Chris Haley – Wachovia

I follow up that. Can I get a clear number for the quarter, about 16, 17 cents. Is that fair Stuart?

Stuart Brown

Yes, that’d be fair.

Chris Haley – Wachovia

And there’s not much transactional income in there?

Stuart Brown

No, there’s basically no termination fee in available for bad debt.

Chris Haley – Wachovia

If I take a look at the first and second quarter of the second half, you’d want me to believe that your guidance assumes that without a transactional income your core operations are sideways or down? Is that right? Did they get to 60 cents?

Stuart Brown

There is one thing that messes with it. You have to remember that the second quarter includes the $1.4 million hedge gain so year-to-date shares at 30 cents, which they’ve neutralized the hedge gain because there was a loss in the first quarter and then a gain in the second quarter.

Chris Haley – Wachovia

If you’re looking at the CPA, he excluded this stuff, the plusses and the minuses just to get operating cash flow capability.

Stuart Brown

Right.

Chris Haley – Wachovia

You’re 16 or 17 cents, right and so, you’re basically at the low end of the range. You’re assuming no improvement operation.

Stuart Brown

That’s right. Slight D preach and occupants are especially for the rest of the year but essentially flat. We lost the Wicke's income for the second half.

Chris Haley – Wachovia

Right, that’s true

Unidentified Company Representative

The assumption is that leasing remains about flat plus or minus statistically, but flat INN) no gain income gets to 50 cents. There’s a way to get the 60 cents probably but simplifying it, we look at it as assumed no gain income and where are we? That’s not necessarily where we think we’ll end up by the way as Jim already indicated but at this point, in changing guidance, we want to lay out as a possibility.

Chris Haley – Wachovia

On the leasing side, Darryl, have you adjusted any of your initiatives regarding procuring new customers, retaining new customers in terms of inducements or other lease negotiation labors?

Darryl Mechem

On that topic, we are aggressively looking at occupants. Occupants are our number one focus and that most profitable and best way to achieve that is to keep what you have so we are talking to all of our key renewals for the balance of the year making sure we retain those customers, which will be the way we achieve our goals for the second half of the year.

Chris Haley – Wachovia

Work on 2009 is continuing.

Darryl Mechem

We’ve signed 1.2 million square feet for 2009.

Chris Haley – Wachovia

What would be our existing customer base, working hard to keep those customers?

In 2009, how much have you already done plus are currently in negotiations with in terms of retention?

Darryl Mechem

We’ve signed 1.2 million square feet for 2009 and we have another 800,000 square feet at least in the negotiation stage for 2009 expirations.

Chris Haley – Wachovia

Speaking about the economics on types of deals; are you having a pasture, a higher net rent and inducements holding?

Darryl Mechem

They’re holding. It’s going to be market-specific. That’s going to nearly tell the story, and so I’m hoping that things continue. Through the second half of 2009, we’ve seen the first half, but we’ll see.

Chris Haley – Wachovia

Right

Darryl Mechem

This gets off on the rent growth site.

Chris Haley – Wachovia

Appreciate the directness, thank you.

Operator

Our last question for today will be from Derek Bauer from Merrill Lynch, please go ahead.

Unidentified Analyst

Hey, guys, it’s Chris. Most of our questions have been asked and answered. Stuart, if you can just remind us; these from the funds, where are they buried in the income statement again?

Stuart

They’re for a line that’s called funds from capital management and other fees, it’s a separate line.

Unidentified Analyst

So it’s one just one wholly certain. There’s no other place that there are any fees associated with the fund business except for that one line?

Chris Haley – Wachovia

No other fees. The income from those funds is going through equity and income from non-consolidated GPs but no, all fees are going through that one line.

Unidentified Analyst

Thanks a lot Chris

Unidentified Analyst

Thank you Chris.

Operator

That stuff concludes today’s question-and-answer session. I would like to turn the conference back over to Mr. Hawkins for any closing remarks.

Phil Hawkins

Very simply, thank you for participating, listening and your questions. I’m sure we’re talking further with many of you and look forward to doing so. Have a good day and enjoy the rest of the summer.

Operator

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

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