HRPT Properties Trust Q2 2008 Earnings Call Transcript

Sep.17.08 | About: HRPT Properties (HRP)

HRPT Properties Trust (HRP) Q2 2008 Earnings Call August 5, 2008 1:00 PM ET

Executives

Tim Bonang - Director of Investor Relations

John C. Popeo - Chief Financial Officer, Treasurer and Secretary

Adam D. Portnoy - Managing Trustee

Analysts

Philip Martin - Cantor Fitzgerald

John Guinee - Stifel Nicolaus & Company, Inc.

Dave Rogers - RBC Capital Markets

[Powan Milgirey - Wells Fargo]

[Shu Ping Lee - NR Capital Management]

Sabina Bhatia - Basso Capital

Operator

Welcome to the HRPT Properties Trust second quarter 2008 financial results conference call. (Operator Instructions) At this time for opening remarks and introductions, I would like to turn the program over to the Director of Investor Relations, Tim Bonang.

Tim Bonang

Joining me on today’s call are Adam Portnoy, Managing Trustee, and John Popeo, Chief Financial Officer. The agenda for today’s call includes a presentation by management followed by a question and answer session.

Before we begin today’s call, I would like to read our Safe Harbor statement. Today’s conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and federal securities laws. These forward-looking statements are based on HRP’s present beliefs and expectations as of today, August 5, 2008. The company undertakes no obligation to revise or publicly release the results of any revisions to the forward-looking statements made in today’s conference call other than through filings with the Securities and Exchange Commission regarding this reporting period.

In addition this call may contain non-GAAP numbers including funds from operations or FFO. A reconciliation of FFO and the net income is available in our supplemental package found in the Investor Relations section of the company’s website.

Actual results may differ materially from those projected in these forward-looking statements. Additional information concerning factors that could cause those differences is contained in our Form 10K filed with the Securities and Exchange Commission and in our Q2 supplemental operating and financial data found on our website at www.hrpreit.com. Investors are cautioned not to place undue reliance upon any forward-looking statements.

And with that I would like to turn the call over to Adam Portnoy.

Adam D. Portnoy

For the second quarter of 2008 we are reporting fully diluted FFO of $0.28 per share compared to $0.27 per share in the first quarter of 2008 and $0.29 per share in the second quarter of 2007. It is important to note that our second quarter 2008 FFO per share includes $1.2 million of non-recurring lease termination fees. Although FFO per diluted share declined from last year we have made great improvements in reducing our capital expenditures. As a result, for two consecutive quarters we have generated more cash from operations and paid in dividends. A combination of an improved payout ratio and our efforts to recycle capital into accretive acquisitions are two important steps for our company which may better position HRP in the market place going forward.

During the second quarter of 2008 we signed leases for about 1.7 million square feet, and 78% were renewals and 22% were new leases. Leasing activity during the second quarter resulted in a 9% rollup in rents and about $8.00 per square foot in capital commitments. The average lease term was 5.6 years and the average capital commitment per lease year was $1.40 which is the lowest rate we have reported in the last five quarters. Also, I think it is important to note that we have reported rollups in rents during the last 11 consecutive quarters.

Although we are pleased with our ability to sign renewals with many of our tenants at attractive terms, the pace of new leasing activity or the leasing of currently vacant space has slowed significantly since the end of 2007. Within most of the markets where we operate net effective rents are trending downward. This is the result of a slowing economy which is leading to a reluctance of companies to commit to expansion space or lease new space. This trend is evidenced by the reported decline in office net absorption and occupancy rates across the country in the first half of 2008.

At the same time development activity has not yet slowed with many new projects scheduled for completion during the remainder of 2008.

As a result of these market dynamics, overall company occupancy at June 30 was 90.9% which represents a 180 basis point decrease from the prior year. Despite the difficult market environment we are doing a good job of outperforming in many of our market areas. Although our total same-store NOI declined by 2.7% in the second quarter, this decline is primarily the result of a decline in occupancy in Philadelphia and our Boston markets which we anticipated and discussed with investors in the past. Excluding the decline in same-store NOI in these two markets, our total same-store NOI would have been flat this quarter.

Our Austin, Texas portfolio continues to post strong leasing results with a 14% increase in same-store NOI during the quarter. This is reflecting consistent rent growth on leases signed during the last few quarters and a modest increase in occupancy.

Washington, DC is still a market experiencing weakening fundamentals with between 1 million and 2 million square feet coming on line per quarter. Our same-store NOI in this market increased by 3.6% during the quarter driven by occupancy gains and rent growth.

Southern California is also a market experiencing weakening fundamentals. Second quarter same-store NOI was flat reflecting rent growth offset by the decrease in occupancy of 5.4% in this market.

In Oahu the market for industrial properties is still the strongest in the country with gross industrial rents approaching $40 per square foot in certain areas. As a result the Oahu Industrial Real Estate market continues to experience one of the most dramatic increases in rates among all real estate segments in the United States. HRP is largely benefiting from this market improvement because we are the largest owner of industrial properties in the State of Hawaii. During the second quarter we saw rents roll up by almost 150% in this market and we anticipate significant rollups in rents to continue in the future. During the quarter same-store NOI was basically flat in Oahu due to the timing of recent leasing activity.

Our Philadelphia portfolio experienced a 7.4% decline in same-store NOI reflecting Comcast vacating around 350,000 square feet on April 1. As announced previously we have pre-leased over 50% of the Comcast space and we hope to report additional progress with this re-leasing effort in the future. The Philadelphia leasing market has shown steady improvement during the past year especially in the downtown market where we own a large percentage of assets. The Philadelphia market also appears to be benefiting from companies leaving the New York City market in search of lower rental rates. We continue to believe that we are well positioned in the Philadelphia market with less than 1% of our total square feet rolling to the end of 2008 and in place rents equal to or below market rents.

Boston same-store NOI decreased 19.8% during the quarter reflecting almost 300,000 square feet of space vacated in two of our south suburban office buildings. As of today this is our only major market where we may continue to experience significant lease roll-downs through the end of the year.

There are other markets located throughout the country. Our portfolio experienced a 2% decline in occupancy which contributed to a 2% decline in same-store NOI during the quarter. We have 2.2 million square feet scheduled to expire during the last six months of 2008 which represents approximately 4% of our total square feet and 5% of our annualized rents. The majority of the leases scheduled to expire through the end of 2008 have in-place rents that are below current market rents which may lead to some rent rollups in the future.

As we discussed last quarter, we recently agreed to sell 48 of our medical office clinic and biotech laboratory buildings with 2.2 million square feet for $565 million. We closed the sale of five of these buildings for $84 million during the second quarter and recognized gains totaling $40 million. We sold three buildings for $39 million in July and expect to sell another 20 buildings during the month of August for around $110 million. The remaining $332 million is expected to close in phases during the remainder of 2008 and into 2009.

As stated previously we anticipate using the proceeds from this sale over the long term to take advantage of current favorable market conditions to purchase properties at higher cap rates than the properties being sold. A good example of this is our second quarter purchase of one of the best Class A office buildings located in Milwaukee, Wisconsin with 374,000 square feet of space for about $53 million. We purchased this high quality asset at a cap rate of over 9% and as a result of recycling capital from the announced sale of properties, this purchase is expected to be accretive to FFO per share in the future. This property is 97% occupied with an average lease term of over six years.

Also, subsequent to the end of the quarter we purchased a portfolio of well leased office and industrial properties in the Kansas City market with 1.8 million square feet for approximately $112 million and the initial going in cap rate is close to 11%. We will provide more information on this acquisition when we announce third quarter results.

As of today we have one additional property under contract for sale at a sale price of around $15 million. Obviously the closing of this sale is subject to completion of diligence and other contingencies and may or not occur for a variety of reasons.

Looking forward to the remainder of 2008, it appears that leasing fundamentals are weakening. During the first half of the year we’ve seen a decline in leasing of vacant space and an increase in early lease renewal activity. We suspect this trend will likely continue through the end of the year.

Nevertheless, even in this weakening market environment I think we are achieving some great milestone. During the last five quarters we have seen a consistent improvement in leasing metrics with rental rates rolling up and low cap ex commitments. This is having the desired effect of improving our dividend payout ratio in the first six months of 2008. However, the consequences of these actions are affecting our occupancy which has declined during the last year and this has led to a decline in same-store NOI. As a result we expect capital expenditures may increase in the remaining quarters of this year in order to maintain occupancy rates in this market environment.

I’ll now turn the call over to John Popeo, our CFO.

John C. Popeo

Looking first to the income statement. Rental income increased by 4% and total expenses increased by 7% during the second quarter of 2008.

Year-over-year quarterly increase in rental income, operating expenses and G&A expense reflects properties acquired between April 2007 and June 2008 partially offset by the decline in occupancy and same-store NOI. Depreciation and amortization increased by 6% reflecting properties acquired and to a larger extent depreciation and amortization related to building and tenant improvements. Our consolidated NOI margins were 59% for the second quarter of 2008 and 60.4% for the second quarter of 2007. Current quarter EBITDA increased by around 1% from the same period last year primarily reflecting property acquisitions since March 2007 offset by the decline in occupancy in Metro Philadelphia and Boston. Interest expense increased by 5.2% reflecting property acquisitions.

Net income available for common shareholders for the second quarter of 2008 was $55.4 million compared to $16.1 million for the second quarter of 2007. The increase reflects $40 million of gains on the sale of five properties in June.

Diluted FFO available for common shareholders was $0.28 per share for the second quarter compared to $0.27 per share last quarter and $0.29 per share for the prior year. The year-over-year decrease primarily reflects the decline in occupancy and same-store NOI partially offset by the reduction in preferred distributions and earnings from properties acquired since March 2007. As Adam mentioned, FFO per share during the second quarter included $1.2 million of non-recurring lease termination fees which may result in a decline in FFO per share of around $0.01 next quarter. Of course any 2008 estimates are not guaranteed to occur and may be different than expected.

In July 2008 we declared a dividend of $0.21 per share which represents 74% of our second quarter FFO. Our Board considers the dividend level on a quarterly basis and they’re comfortable with this current payout ratio.

During the second quarter we spent $14 million on tenant improvements and leasing costs, and $3 million or $0.05 per square foot for recurring building improvements including lobby and façade renovations, elevator upgrades and other capital projects throughout the portfolio.

Combined cap ex declined by more than 35% from the same quarter last year. We paid $3 million on development and redevelopment activities during the second quarter.

Turning to the balance sheet, on June 30 we held $33 million of unrestricted cash. The increase in restricted cash reflects over $80 million of proceeds from asset sales that were temporarily deposited with an escrow agent during the second quarter. The $312 million of assets held for sale includes the net book value of assets under contract totaling $274 million plus the reclassification during the second quarter of rents receivable and other assets related to these properties totaling $38 million. Rents receivable include approximately $139 million of accumulated straight line rent accruals as of June 30.

The decrease in other assets also reflects a $15 million decrease in purchase deposits related to the property we acquired during the first quarter. Other assets include approximately $87 million of capitalized leasing and financing costs.

On June 30 we had $501 million of floating rate debt, $391 million of mortgage debt, and $2.1 billion of fixed rate senior unsecured notes outstanding. The weighted average contractual interest rate on all of our debt was 6% at the end of the quarter and the weighted average maturity was six years. We have no debt maturing in 2008 or 2009 and only $50 million of senior notes maturing in 2010.

Our senior unsecured notes are rated BAA2 by Moody’s and BBB by Standard & Poor’s. The book value of our unencumbered property pool totaled about $5.7 billion at the end of the quarter. Our secured debt represents 7% of total assets and floating rate debt represents 17% of total debt. At the end of the second quarter our ratio of debt to book capitalization was 51%. Our EBITDA and fixed charge coverage ratios were 2.7 times and 2.1 times respectively. As of the end of the second quarter we were comfortably within the requirements of our public debt and revolver covenants.

As of the end of the second quarter we had $301 million outstanding on our revolving credit facility with $449 million of additional borrowing capacity at a current interest rate of around 3%.

In summary, we think this quarter produced good results in light of a difficult market environment. We also think that the combination of an improved payout ratio and our efforts to recycle capital into accretive acquisitions are two important steps for our company which may better position HRP in the market place going forward. We continue to believe HRP’s strong tenant base, limited near-term lease expirations, strong balance sheet and current annual dividend yield of almost 12% make HRP a logical choice for long-term income oriented investors.

That concludes our prepared remarks. We are now ready to take questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Philip Martin - Cantor Fitzgerald.

Philip Martin - Cantor Fitzgerald

Adam, a bit on the opportunities that you’re seeing out there going forward. Can you give us some sense of where relative to replacement value you’re seeing transactions valued using possibly Kansas City as a good example?

Adam D. Portnoy

I think overall comments on the market are there’s a lot less volume of deals to look at. I think it’s safe to say that generally speaking investors, and again this is a general statement, maybe not in all cases, but generally investors if they don’t have to sell are not selling in this market given the difficulties in raising get financing from most buyers. So that’s resulted in a deep drop off in the number of deals that we can look at.

That being said, there are some deals out there. There are sellers that have for whatever reasons need to sell or create liquidity and in those situations there are a lot less buyers available in the market place simply because all the levered buyers have disappeared.

We are actually in a very good position because we don’t have any finance contingency associated with our acquisitions because we can use our revolver for the acquisition, so oftentimes we are not even the high bidder and the properties that we’re seeing, for example we mentioned Milwaukee, that’s probably half replacement costs we bought that at and we weren’t even I think the highest bidder there. In most cases today the surety of closing is becoming more important than whatever price somebody puts on the table. So if they think you can close and you might be 5% or 10% less than the highest bidder who might have a finance contingency, the seller and the broker are more likely to want to go with you or with us when you don’t have a financing contingency.

So it’s a pretty good opportunity for us and as you can tell our volume this year has been much off what we’ve done in past years. I think it’s safe to say we’re being very selective in what we’re buying and the prices that we’re paying and the cap rates that we’re achieving, especially on some of these very good assets that we’ve been able to buy.

I’ll also point out that we’re doing this probably it’s actually working out a little bit better than even we thought. We thought we might sell a lot of these buildings, these medical office buildings, through S&H and that we might be sitting on a lot of cash and there might be some negative arbitrage in the interim until we actually were able to reinvest the proceeds. More by luck than by planning we’ve been able to actually offset the sale proceeds with acquisitions on an accretive basis. The timing’s actually worked out very nicely so far on these deals. It feels like a good environment if you have capital like ourselves and you’re looking for deep value. You can buy buildings today, again there’s not a lot to look at, probably less than half the volume or transactions to look at, but the purchase price or price compared to replacement cost is at least half, sometimes less.

Philip Martin - Cantor Fitzgerald

Is that what you found with Kansas City as well? How far below replacement value do you think you acquired those buildings?

Adam D. Portnoy

It’s probably more than half but it’s certainly less than replacement value. Those buildings we can get into more detail. Most of those buildings are relatively newly built within the last 10 years; some of them built within the last five years. They’re about 85% or 86% leased. There’s a little bit more leasing we could do there and the average lease term is just about five years. But they’re great assets; some of the best buildings in the market. And we got in at a very attractive yield. I think that’s probably another example of an acquisition - Kansas City as you mentioned, Milwaukee, Cleveland earlier this year - these are deals that we’re buying at great rates and what I consider deep value that we would have never been able to buy at these prices a year ago, two years ago, three years ago.

Philip Martin - Cantor Fitzgerald

Are there opportunities out there in some of your markets to take over some development? Developers that have had their problems looking for some help in finishing a project? Are there opportunities like that?

Adam D. Portnoy

There are but we’re shying away from them. We have been focusing more on the core products. What we’ve been doing in this environment is looking for better assets that are well leased and looking for people that are in search of liquidity. But there are opportunities to buy buildings that are just completed, that have almost no occupancy. They’re beautiful buildings. It’s just very difficult to be buying a building like that with the uncertainty about what you’re going to do in terms of leasing it up.

Operator

Our next question comes from John Guinee - Stifel Nicolaus & Company, Inc.

John Guinee - Stifel Nicolaus & Company, Inc.

Do you have any raw land on your balance sheet that’s entitled and ready to go and could either be developed upon or sold?

Adam D. Portnoy

Yes but it’s not very much. I’m trying to think of the exact number. It’s developable acres across all of our markets. It’s going to sound like a big number. It’s close to 300 acres. But these are parcels that are typically next to an existing building so we bought a building; it has a parcel sitting next to it. It’s not vast wafts of developed land where you could do multiple buildings in one area. These are more one off areas next to an existing building. But all told it’s close to 300 acres. We do have some developable land I’m thinking outside Pittsburgh and the Cherrington Office Park. There’s some developable land out there. John, do you remember how many acres that is?

John C. Popeo

That’s around 158.

Adam D. Portnoy

That’s the biggest piece. That’s 158 acres outside of Pittsburgh. With the one exception of that piece of land, which could support multiple buildings, that’s it basically.

John Guinee - Stifel Nicolaus & Company, Inc.

On page 11 John Popeo, can you walk through how you calculate the straight line and FAS 141? They seem to have come down significantly since last year.

John C. Popeo

Sure. First of all, straight line rents have a life cycle depending on the length of the leases so the fact that straight line rents are going down in many cases is just reflective of leases coming closer to maturity. We also have a couple of large tenants within the portfolio though that pay rent twice a year so that also SKUs the number a little bit. As far as lease value amortization goes, it’s the same concept but in reverse where the amortization of lease value amortization is tied directly to lease maturities. So we have leases that are cycling off and maturing that are reducing the amortization numbers.

John Guinee - Stifel Nicolaus & Company, Inc.

So to go from a GAAP to a cash number this year this quarter we should be deducting $3.26 million for FAS 13 and then adding back $2.3 million for FAS 141?

John C. Popeo

That is correct. But as far as third and fourth quarter go, you should probably add around $1 million to your FAS 13 run rate.

John Guinee - Stifel Nicolaus & Company, Inc.

How about FAS 141?

John C. Popeo

No, that should be a pretty recent run rate.

John Guinee - Stifel Nicolaus & Company, Inc.

That was $1 million per quarter John?

John C. Popeo

Yes. And then, I read something - I didn’t actually read it but someone said that S&P or Moody’s had changed the rating on some REITs’ preferred shares. Were you involved in that?

Adam D. Portnoy

Yes. What S&P did is they blanket all REITs that have issued preferreds, they’ve taken the position that the notching will be two notches below the corporate credit rating. Before it used to be just one notch. So for example, HRPT we are BBB rated by S&P and we used to have our preferreds were BBB-. So they were investment grade rated. As a result of this change, now the preferreds from S&P’s standpoint are rated BB+. But that affects us; it affects every REIT in the market place. This was a broad change they made to the way they rate preferreds across the board. It’s safe to say we’ve also talked to Moody’s. Moody’s does a one notch below your corporate rating and in our conversations with them it’s our understanding that they don’t plan on making the same change that S&P did.

John Guinee - Stifel Nicolaus & Company, Inc.

Any projections as to where you’ll be on occupancy by the end of the year? You’re at 90.9% now. Do you see that staying flat, trending up a bit, trending down a bit?

Adam D. Portnoy

I see it flat but trending down a little bit.

John Guinee - Stifel Nicolaus & Company, Inc.

So maybe between 90% and 90.5%?

Adam D. Portnoy

Yes. I don’t think it’s going to drop below 90%. I would think of that as the floor.

Operator

Our next question comes from Dave Rogers - RBC Capital Markets.

Dave Rogers - RBC Capital Markets

This is John’s question I guess. On the capital costs, you mentioned capital costs might be up in the second half of the year to support occupancy a little bit better to keep NOI up. I guess given your comments earlier how new leasing is really slow, is it really a capital cost issue or I guess following up on John’s question, is it really just no new leasing activity so the capital costs are not really that important today?

Adam D. Portnoy

Are you asking about cap ex? New leasing, you’re right, is more expensive than renewals and you’re right, we haven’t had as much new leasing. But remember what we report as leasing from what we rent in a current quarter, that usually doesn’t flow through to the actual cap ex spend. It could be upwards the next two, three, four quarters at times. So often what you see in the leasing reports is what your future cap ex is going to look like. And right now I think you’re right in saying that cap ex is lower because our leasing costs are lower and part of that is because we’re not doing as much new leasing. It’s all renewals. I think I’m answering your question. Is that what you asked?

Dave Rogers - RBC Capital Markets

I guess a better way to ask it maybe is, were you losing a lot of leases because of the capital costs and because of your internal decision to avoid putting more capital in or is it really just that the market’s that slow? Trying to bifurcate the [inaudible].

Adam D. Portnoy

Yes. That’s a great question. I think the majority of it is the market; 20% to 30% of it is us walking away from some deals. But the majority of it is the market. I mean yes, we are walking away from some deals because of the change in a little bit of the way we’re more focused on making sure we can get the payout ratio more in line. That’s definitely been affecting it but I think a bigger influence has been the market.

Dave Rogers - RBC Capital Markets

You talked a lot about investment activity, both acquisitions and dispositions that you expected in the third quarter. Can you just summarize the dollar volumes of each currently that you expect with what’s under contract?

Adam D. Portnoy

In acquisitions we have the acquisition in Kansas City which we closed on in July for $112 million and as of today there’s nothing else under contract for acquisitions. We have in addition to what John said that we sold in July as part of the S&H disposition was $39 million, we have another $110 million we plan on selling in August, and then we have an additional property that’s separate from the transaction we announced with Senior Housing Properties Trust for sale of another building that’s under contract for $15 million. That’s it.

Operator

Our next question comes from [Powan Milgirey - Wells Fargo].

[Powan Milgirey - Wells Fargo]

I’ve got one question. Sorry, I jumped on this call a bit late. I’m wondering, for full year 2008 do you have any cap ex guidance? I know you talked about lowering that. Do you have any guidance on that?

Adam D. Portnoy

We don’t have any official guidance on it but I said in the prepared remarks that we think that the cap ex run rate would likely increase slightly as you go into the third and fourth quarters than what we’ve been running at in the first and second quarters. I think it’s going to trend upwards. I think at the end of the day overall 2008’s still going to look like a pretty good year when you do your payout ratio calculation after cap ex. I think it’s going to look like a pretty good year compared to years past.

Operator

Our next question comes from [Shu Ping Lee - NR Capital Management].

[Shu Ping Lee - NR Capital Management]

What’s your payout ratio after cap ex for 2008?

Adam D. Portnoy

We don’t give specific guidance on where it’s going to be. The simple way to do it is just take your FFO and subtract your capital expenditures. And what we’ve done in the first two quarters has been under 100% payout ratio. We’re on about 90% in the first quarter and about 95% or 96% in the second quarter. Again, extrapolating on what I said, in the third and fourth quarters it’s likely that on an individual quarterly basis we’ll probably go above 100% in the third and fourth quarters. How far above I’m not sure. But again overall for the year in comparison to 2007, 2006, 2005, I don’t think it’s going to be under 100% for the whole year when you look at the entire year 2008 but it’s going to look a lot better than the prior years.

[Shu Ping Lee - NR Capital Management]

Do you think that will change or improve in 2009?

Adam D. Portnoy

That is the goal. That’s what we’re trying to do.

[Shu Ping Lee - NR Capital Management]

Through cap ex reduction or through FFO?

Adam D. Portnoy

It all depends. The answer to that question is dependent upon what the economy looks like in 2009. I have some idea of what things look like or what I feel things might look like in the second half of 2008 but if this is a prolonged downturn in the economy, which some economists and pundits think it might be, it’s going to be very hard to maintain occupancy. It’s going to be very hard to push rates, maintain occupancy and not spend money on leasing in 2009. So much of it depends on what your view of the economy is going to be in 2009. I just don’t know.

[Shu Ping Lee - NR Capital Management]

Your revolver has gone up this quarter. Is that because you drew on the revolver to acquire the assets? And are you going to pull from the credit facility into long-term mortgage notes? I guess another way to say it is, do you think the balance of the revolver will decline next quarter?

John C. Popeo

Yes, the increase is around $160 million and the revolver balance since the beginning of the year does reflect acquisitions.

[Shu Ping Lee - NR Capital Management]

So you’re going to refinance that revolver using more long-term mortgage debt?

John C. Popeo

Were’ basically recycling capital so we’re selling assets and taking the proceeds and reinvesting, which looking forward at least should have a minimal impact on leverage in the balance in the revolver.

Adam D. Portnoy

Short term you sell assets, you pay down the revolver, and then you go out and replace those assets and you draw down on the revolver and so the revolver goes up. But what John’s saying, on average it’s probably going to go down next quarter but it’s likely to go back up at some point.

[Shu Ping Lee - NR Capital Management]

So the covenants in that revolver are similar to the covenants in the unsecured debt?

Adam D. Portnoy

Yes. They’re similar.

John C. Popeo

There are some specific nuances to revolver covenants. They tend to be somewhat more restrictive but we are comfortably within our covenant requirements.

[Shu Ping Lee - NR Capital Management]

Can you go through the key covenants?

Adam D. Portnoy

In summary they’re very similar. They define things a little bit differently but they’re very similar to the public debt covenants. And again we’re comfortably within all those covenants.

[Shu Ping Lee - NR Capital Management]

Why does the restricted cash balance go up each quarter?

John C. Popeo

That’s because we sold during the quarter around $84 million worth of properties and the proceeds were deposited with an escrow agent on a short-term basis. The proceeds are going to be used to reinvest in new acquisitions.

Operator

Our next question comes from John Guinee - Stifel Nicolaus & Company, Inc.

John Guinee - Stifel Nicolaus & Company, Inc.

Just want to make sure we’re all on the same page because the numbers have been bouncing around. Can you give the summary on a quarter-by-quarter basis for the $565 million deal with your sister company? It was $85 million in 2Q. What’s 3Q, 4Q, 1Q, 2Q?

John C. Popeo

In the third quarter our expectation is around $150 million of dispositions including the $110 million that we discussed and around $40 million that’s already been sold. What’s scheduled to sell, and these are just in P&S agreements that were filed, is another $115 million by the end of the year and then another $200 million or so in 2009.

John Guinee - Stifel Nicolaus & Company, Inc.

First quarter, second quarter?

John C. Popeo

It’s hard to say right now. It’s a combination. Right now at least as originally laid out, the $217 million or so was scheduled to close in the first and second quarter of 2009.

Adam D. Portnoy

John, if you’re trying to put it into a model, just assume 50/50 first and second quarter.

Operator

Our next question comes from Philip Martin - Cantor Fitzgerald.

Philip Martin - Cantor Fitzgerald

I just had one of my questions answered. Also, with respect to the sales here, any debt on any of this?

John C. Popeo

No. None remaining. There was some.

Philip Martin - Cantor Fitzgerald

There was some, but of the $150 million as you’re showing in the third quarter and the $115 in the fourth quarter, that’s debt free at this point so all of those proceeds will be used to take down the line or used to fund incremental investments?

Adam D. Portnoy

Yes, that’s correct.

Philip Martin - Cantor Fitzgerald

Adam, would you be able to give us a bit of a roadmap the next 12 to 24 months what’s going on in Hawaii and how that may impact the growth story at HRP?

Adam D. Portnoy

Sure. The rental rates in Hawaii really have skyrocketed in the last two to three years. When we bought properties there, the existing rental rates were at $3.50 to $4.00 a foot. We’re typically doing renewals anywhere from $8.00 to $10.00 a foot now for rent resets. I think you’re going to see over the next 18 to 24 months us continue to try to push rates as much as we can.

I will tell you that rates have sort of flattened out in the last three to six months at that higher rate. They aren’t increasing anymore. There was sort of a two-year period where every quarter the rate was going up that we could charge more and more. But they’ve sort of leveled out depending on the area between the $8.00 to $10.00 a foot range depending on the area. We’ve got about 400,000 square feet scheduled to expire between now and the end of the year in Hawaii so that gives you a good sense of what we might be able to reset there or be able to renew at higher rates there.

Again if you just look at our, I’m starting to think beyond into 2009, the same sort of run rate is what I think you’ll see. What’s the number we show in Oahu? In 2009 we only have about 300,000 expiring and then another 300,000 expiring in 2010. But that doesn’t mean that we won’t be able to increase the rents more because as you know the leases out there have what’s called rent reset provisions, so even though it’s not expiring it gives you the ability to renegotiate at certain integrals throughout the lease term. So that’s something we will continue to do.

I can’t give you an exact number. I can just tell you we’re working very hard. We are pushing rates very hard especially in places like Hawaii. If you want to just Google us and look at some of the articles written about us in Hawaii press, we’ve gotten a lot of flack in that market because we’re pushing rates so hard and trying to push the rates so hard. In fact, there’s been a little bit of backlash from a lot of the tenants. So rest assured that we’re doing everything we can, as much as we can and as fast as we can to try to increase the rates there to push cash flow to HRPT.

Philip Martin - Cantor Fitzgerald

How about in terms of other uses for some of the land or parcels that you have there? I know in your set you’ve talked about in some cases maybe not renewing some of the leases that were coming up for renewal to use that for other uses, other projects. I know you’ve done some storage. Are there any other projects like that in the future here over the next 24 months?

Adam D. Portnoy

No. I think in the next 24 months what we might be doing is aligning some leases up in certain areas to maybe expire all around the same time. We’re not going to start realizing some of the benefits of that for 10 years.

Operator

Our next question comes from Sabina Bhatia - Basso Capital.

Sabina Bhatia - Basso Capital

Can you just give us some color on cap rates you’re seeing? I know you said that you might use some of the proceeds from sales in maybe possible acquisitions. Just trying to get some color to what you’re seeing in the market, what you have seen in the last six months, do you see any changes, anything at all please?

Adam D. Portnoy

Cap rates generally are moving upwards. I think you saw in the three acquisitions we’ve done this year, two of them are around 9% and one of them is going to be close to 11%. Clearly as I said earlier there’s a lot less product that people are willing to sell. I think cap rates in some of our markets have gone up 200% maybe 300% to be honest. So they’ve definitely moved. There’s no question.

Operator

At this time we have no other questions standing by on our question roster.

Adam D. Portnoy

Thank you everyone for joining us on our Q2 conference call and we look forward to talking to you in the future. Thank you.

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