American Assets Trust Inc (AAT) 2012 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the quarter-two 2012 American Assets Trust earnings conference call. My name is Ian. I'll be your operator for today. At this time all participants are in a listen-only mode. We will conduct a question-and-answer session towards the end of this conference. (Operator Instructions). As a reminder, the call is being recorded for replay purposes.

I would like to turn the call over to Mr. Adam Wyll. He is the Senior Vice President and General Counsel. Please go ahead, sir.

Thank you. Good morning. I'd like to thank everyone for joining us today for American Assets Trust's second-quarter 2012 earnings conference call. Joining me on the call are Ernest Rady, John Chamberlain, and Bob Barton. These and other members of our management team are available to take your questions at the conclusion of our prepared remarks.

Our second-quarter 2012 supplemental disclosure package provides a significant amount of valuable information with respect to the Company's operating and financial performance. The document is currently available on our website.

Certain matters discussed on this called may be deemed to be forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include any annualized or projected information, as well as statements referring to expected or anticipated events or results.

Although we believe the expectations reflected in such forward-looking statements are based on reasonable assumptions, our future operations and our actual performance may differ materially from the information contained in our forward-looking statements, and we can give no assurance that these expectations will be attained.

Risks inherent in these assumptions include, but are not limited to, future economic conditions, including interest rate, real estate conditions and the risks and costs of construction. The earnings release and supplemental reporting package that we issued yesterday; our Annual Report filed on Form 10-K; and our other financial disclosure documents provide a more in-depth discussion of risk factors that may affect our financial conditions and results of operation.

Additionally, this call will contain non-GAAP financial information, including funds from operations, or FFO; adjusted FFO; earnings before interest, tax, depreciation and amortization, or EBITDA; and net operating income, or NOI. American Assets is providing this information as a supplement to information prepared in accordance with generally accepted accounting principles. Explanations of such non-GAAP items, and reconciliations to net income, are contained in the Company's supplemental operating and financial data for the second quarter of 2012, furnished to the Securities and Exchange Commission. And this information is available on the Company's website at www.americanassetstrust.com.

I'll now turn the call over to our Executive Chairman, Ernest Rady, to begin our discussion of second-quarter results. Ernest?

Thanks, Adam, and good morning, everyone. Thank you for joining American Assets Trust's second-quarter 2012 earnings call. Our West Coast and Hawaii-focused investment strategy continues to provide solid, consistent and reliable returns; both to date, and, we believe, going forward into the future.

For nearly 45 years, American Assets has been acquiring, improving, developing and managing premier retail, office and residential property. We have built a team of seasoned experts adept at adding value to real estate through increased occupancy, merchandising, and renovation. American Assets Trust is Company whose growth is guided by unwavering principles; a Company where success is measured over the long term, and prosperous business relationships are built on enduring foundations of trust and opportunity. We believe that the disciplined approach toward everything we do will, over the long-term, avoid setbacks, errors and disappointments, creating a welcome stability and growth.

We are really excited about our newest acquisition in Bellevue, Washington, which John and Bob will talk about more during their prepared comments. On behalf of all of us at American Assets Trust, we thank you for your confidence in allowing us to manage your Company. And we look forward to your continued support.

I would now like to turn the call over to our President and CEO, John Chamberlain. John, would you please take it from here?

Good morning, and thank you, Ernest. Overall conditions in our core markets continued to show signs of strengthening in all three asset classes. We expect this to continue into the foreseeable future. Our office properties continued to perform extremely well relative to their respective submarket competitors.

Portfolio-wide, second-quarter net absorption was positive. And the overall leased building area was 95% as of June 30, compared to 94.7% at the end of the first quarter.

Our San Francisco portfolio is 99.5% leased, and the market continues to experience aggressive rent growth. Notably, a lease was executed for a half-floor, 18,000 square feet, in The Landmark for a term of seven years, with a starting rate of $74.00 per square foot, the highest rate ever paid in the life of the building.

Torrey Reserve in San Diego will likely see a September groundbreaking for Phase III, a three-building, approximately 40,000-square-foot expansion. Phase IV, an additional approximate 40,000, two-building expansion, will follow shortly thereafter.

As just announced, we are very pleased with our pending transaction with Beacon Properties for Center City Bellevue, a nearly 500,000-square-foot, LEED Gold, 27-story, Class A office tower, strategically located in the heart of the Bellevue CBD. Major tenants include Caradigm, a healthcare IT joint venture of GE and Microsoft; HDR, a worldwide architecture and engineering firm; and Sucker Punch Productions, a gaming software company fully owned by Sony.

The greater Seattle area, Bellevue in particular, has been a target investment region for the Company and its predecessor for many years. We are extremely pleased with our eventual entry into this highly constrained market. We expect that our efforts will enable us to continue to expand our presence in the area. The building is currently 92.1% leased. Bob will provide more details shortly, including how we expect to fund the acquisition. We consider this a flight to quality in our office portfolio, and intend to recycle capital from other office assets to maintain office NOI at approximately 35% of the entire portfolio.

The leased building area of our retail portfolio increased to 96.2%. Seattle-based Nordstrom Inc. intends on opening the previously announced Nordstrom Rack location shortly; the Carmel Mountain Plaza store in September, and the Alamo Quarry Market store in October. Leasing and repositioning activities continue in full swing, with several significant executed LOIs in place.

In closing, on retail, our Monterey property, Del Monte Center, continues to perform very well, finishing the second quarter at 97.7% leased. We have an executed LOI on the recaptured Borders space, at economics significantly above the previous lease. H&M, occupying approximately 20,000 square feet, opened to a nearly overwhelming crowd on May 31. Our San Diego retail properties finished the quarter at 94.6% leased as compared to 94% leased at year-end 2011.

Our multifamily assets saw significant improvement in leasing levels at the end of the second quarter, primarily due to management changes and seasonality. At the end of June, our multifamily portfolio was 97.7% leased, up 9.3% over the prior quarter. This was accomplished with little to no rental concessions. We feel we are poised for a strong second half of the year in our multifamily portfolio.

The Hawaii economy continued to show positive growth, in both spending and arrivals at the end of the second quarter. Total visitor arrivals grew to approximately 622,899, a new record for the month of May, surpassing the previous high in May 2007. The following percentages are all year-over-year for the month of May -- expenditures by visitors increased 17.5% to $190 per person; arrivals by air increased by 12.2%. Notably, in Japan had the largest growth of visitors at 31.4%, still rebounding from the impact of the March 2011 earthquake and tsunami.

West Coast rose 8.7%; US East grew 6.8%; and Canada remained comparable to last year.

Gap Outlets opened in May, and Brooks Brothers will open later this month at our Waikele Center, completing the repositioning of the former Borders premises. Waikiki Beach Walk was 93.9% leased, and 93% occupied at the end of the second quarter. Retail, full-service and quick-service restaurants at Beach Walk continue to show strong upward sales trends. Our Shops on Kalakaua remained 100% leased and occupied. Overall, our Hawaiian retail portfolio was 94.8% leased at the end of the second quarter.

Our Embassy Suites at Beach Walk continues to exceed our competition in ADR and RevPAR measurements for the quarter. For the month of June, the property's ADR and RevPAR index were 130.7 and 125.1, respectively. RevPAR of $241 surpassed budget by $20.58, or 9.3%, and total suite revenue of $2,672,000 was ahead of budget by $228,000, or 9.3%. The outlook for the second half of 2012 remains consistent with our expectations, pacing ahead of 2011.

Now, a brief update on our development activities in Portland, Oregon. The schematic design phase is well underway at our Lloyd District property. Our development program has been defined to include approximately 60,000 square feet of retail commercial area, and 655 multifamily units, in addition to the existing 247,000 office tower -- 247,000-square-foot office tower, sorry.

The project will also include 940 stalls of underground parking. We currently anticipate securing the necessary permits and approvals in the second half of 2013. Construction is expected to take 26 to 28 months. Currently, the apartment vacancy for the Lloyd District submarket is slightly below 2%, the best in the Portland metropolitan statistical area.

Now, regarding Sorrento Pointe, the habitat issues concerning the California Coastal Commission have been identified and resolved with local staff. We expect to be scheduled for a hearing shortly. Once approved by the Commission, we will move immediately to prepare construction documents and obtain building permits; a 12-month process. We consider this a premier office site in San Diego, with views of the Pacific Ocean and Torrey Pines State Reserve; while sitting, with great prominence, toward Interstate 5 in Del Mar.

As you know, each of these potential development and redevelopment opportunities are subject to market conditions, and may not ultimately come to fruition. We will certainly keep you updated.

Our acquisition efforts remain in full swing. However, we continue to be very disciplined. All opportunities are of high quality, located in our existing and target core market, and include all three of our asset classes. And currently, we continue to evaluate opportunities to recycle capital where the probability to increase internal growth exists.

I would now like to turn the presentation over to our Chief Financial Officer, Bob Barton. Bob?

Thank you, John, and good morning, everyone. Last night, we reported both second-quarter 2012 FFO and FFO as adjusted of $0.30 per share. Net income attributable to common stockholders was $0.04 per share for the second quarter. The Company's Board of Directors has declared a dividend on its common stock of $0.21 per share for the quarterly period ending September 30, 2012. The dividend will be paid on September 28, 2012, to stockholders of record on September 14, 2012.

American Assets had a solid second-quarter performance, based on steady leasing in retail and office, with occupancy at the end of the second quarter increasing 140 basis points to 96.2%; and 30 basis points to 95.0%, respectively. This is the first quarter where same-store comparisons capture the entirety of the original IPO portfolio. Same-store retail NOI for the quarter had steady growth, at 1.8%, and primarily reflects a full-quarter pickup of straight-line rent for Nordstrom Rack in Carmel Mountain Plaza.

Retail leasing spreads are a testimony to the quality and location of the retail product available for lease, as spreads on new leases rose 38.1% on a cash basis, and renewals were approximately flat, for an average increase of 3.6% overall. Same-store office NOI for the quarter jumped to 18.2%, and reflects full quarter of the salesforce lease at Landmark, compared with only one month in the prior year, together with leasing gains at Solana Beach Corporate Centre and the additional PECI space at First & Main.

Office leasing spreads on new leases rose 56.4% on a cash basis, and renewals were proximately flat, for an average increase of 29.8% overall. At Waikiki Beach Walk, our mixed-used property occupancy increased 4.9% -- decreased 4.9% to 93.9%. This decrease was primarily the result of loss of three smaller tenants. We view this as an opportunity to enhance the tenant mix and improve the tenant credit, as we focus on re-leasing the space.

The Embassy Suites is performing on track, and as expected. Same-store mixed-use NOI is primarily attributable to the increased performance of the Embassy Suites Hotel. Same-store multifamily NOI is down 5.9%, principally due to a lower occupancy throughout the quarter, combined with additional real estate accruals during the second quarter, which I will talk about in more detail later on.

As John mentioned earlier, our multifamily occupancy is up 9.3% at quarter-end, at 97.7%. So we would expect to see this occupancy growth translate into NOI growth in the following quarter.

Turning to our results, second-quarter FFO as adjusted decreased approximately $0.8 million or approximately 4.6%, $0.015 per FFO share to $17.2 million, compared to first-quarter 2012 FFO as adjusted. The primary changes between Q1 and Q2 were the following five items -- total revenue increased by approximately $0.8 million or $0.015 per FFO share, primarily comprised of the following two items -- approximately $0.4 million relates to partial straight-line rent in Q2, related to Brooks Brothers at Waikele and Nordstrom Rack at Alamo; along with a full quarter of straight-line rent related to Nordstrom Rack at Carmel Mountain Plaza. And, secondly, approximately $0.4 million relates to 2011 recurring -- nonrecurring supplemental real estate taxes received in Q2, that were accrued as rental income and billed to office and retail tenants.

Rental expenses increased $0.7 million in Q2, and relate primarily to the following three items -- repairs and maintenance increased $0.3 million; utilities increased approximately $0.1 million; and insurance increased approximately $0.3 million. Real estate taxes increased approximately $0.6 million, as a result of receiving supplemental California real estate tax bills in Q2 relating to 2011, which we recorded prospectively as a change in estimate in Q2.

As you may recall, these supplemental taxes were due to reassessment in conjunction with the IPO. As I just mentioned, approximately $0.4 million was billed to office and retail tenants, while the remaining $0.2 million relates to the multifamily properties, which will not be reimbursed. We are still anticipating a roll-down in our Northern California property tax assessment at our Landmark and King Street properties.

For modeling purposes going forward, excluding additional acquisition, I would expect a quarterly run rate for real estate taxes of approximately $5.5 million per quarter, subject to finalization of any further reassessments, and excluding any new acquisition.

G&A increased approximately $0.2 million to $4.0 million, but less than our expected quarterly run rate of $4.2 million. Interest expense increased in Q2 by approximately $120,000, primarily as a result of a full quarter of financing on One Beach Street, versus three days in Q1; and offset partially by capitalized interest on our properties classified as construction in progress, including Torrey Reserve, Lloyd District, and the Carmel Mountain Plaza pad development.

Now let's spend a few minutes on our latest acquisition, City Center Bellevue. As noted in the press release and 8-K that was recently filed, we have entered into a definitive purchase and sale agreement to acquire the fee-simple interest in City Center Bellevue. It is located in the CBD of Bellevue, Washington, adjacent to Bellevue's transit center and two blocks from the I-405, with spectacular view corridors.

City Center was built in 1987, and has approximately 497,000 rentable square feet, and is 92% leased to a strong and diverse credit rent roll. We have been looking for many years for an entry point into Bellevue/the greater Seattle area; with a high-quality, Class A asset, in a [Class] A location, at a fair price. We expect to close on this acquisition before the end of August.

What we like about this asset is -- one, its irreplaceable location in the CBD, adjacent to the Bellevue transit center, with spectacular panoramic views of Mount Rainier; Lake Washington; the Cascade and Olympic Mountains; and the Seattle skyline. Two, we like the trophy quality of this asset; this trophy quality of this Class A, LEED Gold office tower.

Our due diligence leads us to believe that in-place rents are approximately 15% to 20% below market. As noted in the 8-K that was filed, the purchase price of this asset is approximately $229 million on a gross basis. Approximately $8 million in credits to the buyer had been agreed to in the purchase and sale agreement, which gets us to a net purchase price of approximately $221 million, subject to customary closing prorations, and is how we are thinking about the transaction.

Based on our underwriting, at a $221 million net purchase price, we are acquiring this asset at slightly north of an unlevered 5.5% cap rate of in-place rent -- which is what I would use, for those of you who that are updating your models on AAT. On an unlevered basis, we expect to be in the low 7% cap rate range within a four-year period, which we think is a very fair price for such a high-quality asset as City Center Bellevue.

As John has mentioned in the past, acquisitions create the opportunity for disposition, and pruning our portfolio if the opportunity presents itself. This is why we generally set up most of our acquisitions as either a forward- or reverse-tax-deferred exchange, as we will do with this asset. As noted in the 8-K that was filed, we are looking to place approximately 50% leverage on this asset at closing, or subsequent thereto. Our acquisition underwriting assumes 50% leverage at an estimated and conservative 4% interest rate, with levered cash-on-cash yields over 8% in the second year, and over 9% in the third year.

At closing, we intend to fund approximately 50% of this acquisition with the remaining cash our balance sheet; and the remaining balance with our unused line of credit, which would be repaid shortly thereafter from a mortgage secured by the asset. Another alternative would be to sell another asset in exchange for proceeds into City Center. We have many ways to go, and are currently evaluating all of our alternatives.

Although we tend to put attractive leverage on this high-quality asset, we remain disciplined in the use of leverage, and continue to target a net debt to total enterprise value of less than 45%. We believe to lock in long-term debt at historically low rates, even much better than what we currently have on the balance sheet, is the right approach at the present time to create NAV for our shareholders. However, we also remain committed to our strategy to approach the unsecured investment grade debt markets in 2015, with the maturity of our CMBS in 2014 and 2015.

With the acquisition of City Center, our portfolio NOI allocation increases the office sector from 35% to approximately 42%, which we view as an opportunity to increase the quality of our office portfolio. Going forward, our focus will be on accretive, high-quality retail and multifamily acquisition, until such time as our office portfolio NOI allocation approximates 35% once again. This is how we view our internal capital allocations.

Now, as we look at our balance sheet and liquidity at the end of the second quarter, we are well-positioned to continue to execute on our strategy of selectively acquiring or developing accretive irreplaceable assets in core West Coast markets. We have approximately $337 million in liquidity, comprised of $123 million of cash and cash equivalents and marketable securities, and $214 million of availability on our line of credit.

All in, at the close of the acquisition of City Center Bellevue, we will still have ample access to capital to fund existing CapEx and acquisition with what we have on our balance sheet, including positive cash flow from operations; $214 million of availability on our line of credit, once we obtain a mortgage on CCB, or City Center; and, lastly, which John has mentioned, is in our opportunistic ability to sell, exchange, or joint venture our existing assets.

As we have previously mentioned, we amended our existing line of credit with our banks in January of this year, which significantly reduced our cost of borrowing, and provides American Assets with greater flexibility. With our current leverage less than 45%, our borrowing rate on the line is currently LIBOR plus 160 basis points, or approximately 1.85%, assuming a LIBOR rate of 25 basis points. In addition, the maturity of the line of credit was extended from January 2014 to January 2016; plus an additional one-year extension option was added that would take us out to January 2017.

The importance of this is that the line doesn't expire until after our secured debt maturities in 2014 and 2015, giving us additional flexibility. We continue to have a well-laddered maturity schedule over the next decade, and no maturities until 2014. Our fixed-rate secured debt provides a hedge against rising interest rates that will occur at some point in the future, with a weighted average fixed rate of interest of approximately 5.4%.

We have no variable rate secured debt. As previously discussed, our leverage goal continues to be less than 45%. At quarter-end, net debt to adjusted EBITDA increased to 6.7 times from 6.5 times. Our net debt to total enterprise value at quarter-end decreased to 38% from 39.3%. And our fixed charge coverage ratio at quarter-end decreased to 2.3 times from 2.4 times. We are not only focused on long-term net asset value growth for our shareholders, but also on positive same-store NOI growth on a relative basis, which we believe will ultimately translate into organic FFO growth.

Lastly, we have tightened up the range of our 2012 guidance to reflect the stable performance in our portfolio. Our prior 2012 FFO per share guidance was $1.14 to $1.22, with a midpoint of $1.18. We have increased the lower end of our guidance to $1.17, tightening up the range of our guidance to $1.17 to $1.22; with a midpoint of $1.20 to reflect our confidence in the stable performance that we are seeing in our high-quality portfolio.

Our guidance excludes any future acquisitions -- including City Center -- dispositions, equity issuance, repurchases, debt financing, or repayments. Our guidance excludes -- as I mentioned, the acquisition of City Center Bellevue; however, we will update guidance to reflect the acquisition of City Center Bellevue once we have closed the transaction and have completed all of the purchase price accounting adjustments, including straight-line rent and below-market adjustments, which we believe will be accretive to our shareholders.

Obviously, if we financed it at approximately 4%, and used balance sheet cash, we expect to be accretive to full-year FFO. We will continue our best to be as transparent as possible and share with you how we are thinking about quarterly numbers. We are well-prepared, with a strong balance sheet, to capitalize and execute on the opportunities that we believe will present themselves over the coming quarters.

Operator, I'll now turn the call over to you for questions.

(Operator Instructions). Todd Thomas, KeyBanc Capital Markets.

Hi, thanks, good morning. In your comments about City Center at the beginning of the call, you mentioned it was a defensive acquisition. So just a couple of questions on that. First, I was just wondering what makes that a defensive acquisition? And then, also, does that imply that you expect office market fundamentals to start moderating a bit, in San Francisco, perhaps, where rent growth has been much stronger?

Well, in terms of the acquisition in Bellevue, we believed evaluating all of the properties that we have in our office portfolio -- this was an opportunity for us to have both a flight to quality and a flight to internal growth. So we are evaluating, currently, what properties may be exchanged into that asset. It is not reflective of our opinion of the San Francisco market. San Francisco continues to experience aggressive growth in rent. And it's really more of a decision to improve the overall quality of the portfolio, as we mentioned.

Rather than characterize it as a defensive move, I would characterize it as an aggressive move, to enhance our cash flow, increase the quality the quality of the property -- we've looked at every property in our office portfolio -- and see how it stacks up against the great opportunities we see that we have at Bellevue. I hope that answers your question, Todd.

Yes. And then, sticking with City Center, you talked about how you expect the cap rate to move from, say, 5.5% up to 7% over a four-year timeframe. I was just wondering, how much of the GLA expires during that four-year period?

We have, in the fifth and sixth years, I believe we have probably 40% expiring. Is that --?

Yes. And then, in the next four years, we have very little turnover. There is some significant turnover in the fifth year. But based on the tenant, the space that they're leasing, we expect a fairly robust renewal of those leases.

On top of that, if I understand it, the top two floors are where the vacancy is; the [opportunity] is here. Excuse me, the opportunity to lease that footage at rent that would compare favorably with existing footage opportunity for us. So from 92.5%, we hope we can work that higher in the course (technical difficulty). Apparently, it's the best space in the building that's available at less rent.

Okay. And then, just moving over to your comments on dispositions or recycling capital. How should we think about what assets you might be looking to sell? What are the key determinants? Or what markets might you be looking to reduce exposure in?

I think we look at every asset we have in every market we're in. And we now have a very high standard to compare our existing assets -- which are prime, prime, prime -- to this acquisition in Bellevue. And as we go through that rigorous process, we'll -- and, of course, test the market, to see what prices some of these things will command. (Multiple speakers)

I would add to that that there are no sacred cows. What we're looking to do is to improve long-term internal growth. So if we have an asset that will perform at a lower level than what we anticipate Bellevue to perform at, that asset will likely be brought to the forefront of consideration for selling.

And this is not a new strategy that were implementing today. We've been implementing this strategy for the 45 years we've been at this. So it's a continuation of an existing strategy, which has proved to be very fruitful over the decades.

Okay. Are you currently marketing anything for sale today?

No, we are investigating a potential joint venture with one of our retail properties. It is just an investigation stage. Same with a number of office assets, but nothing is formally listed for sale.

Okay, thank you.

Mitch Germain, JMP Securities.

Good morning, guys. Remind me, give me a refresher, with regards to your RV. Obviously, that's where you picked up a good portion of your occupancy in the multifamily sector. How long do leases typically stand? Are they week-long? Are they month-long? Can you give some background on the leasing process there?

Well, the RV park, while it did take pick up in occupancy, as it always does during the summer, it's a very seasonality issue; the most significant pickup in occupancy was at Loma Palisades. We were successful in raising occupancy from about 88% up to 97%. And that, as we've mentioned in the past, we've had some difficulty filling up the larger units at Loma Palisades. That, we have now overcome.

With respect to your question on the RV park, it is a variety of leases that are there. Some are just overnight; some are for the week; some are for the month. But, historically, during the summer, it's not very difficult to fill that place up.

And you'd mentioned, a couple quarters ago, some management changes within the multifamily sector. You mentioned them again today. How confident are you in the team that (technical difficulty) there?

Very confident in who we have in place today; we went through kind of a bumpy road with a manager that we had, that chose to pursue another opportunity. She came back to us. We kind of got our arms around things again, and then she decided to leave again. So we think that's behind us. And we're very pleased and confident with her replacement.

And looking out at your investment pipeline, to shift gears -- curious as to -- I know that you talked about -- it looks like, at least, that office is something that you're going to at least be emphasizing, possibly even paring down over the next couple of quarters, years. Talk about what sort of opportunities that you guys are underwriting right now, maybe geographically and maybe by asset class?

Well, geographically, it's the same market that we've talked about from day one. We're not straying from that strategy. We continue to look at both multifamily and retail assets, but the compression in cap rates make acquisitions difficult. That being said, that is our primary focus. And as we mentioned on the prepared remarks, it's our objective and strategy to keep office NOI at approximately 35% of the portfolio, primarily due to the volatility that is inherent with office properties, and the stability that's inherent with multifamily and retail.

Ernest, do you want to add to that?

No, I think it's -- again, it's a continuation of the strategy we've had for years. What can we do to improve our position now and in the future? And there's nothing inconsistent with what we're doing to date. And, of course, I think that City Center Bellevue gives us the opportunity to look at all of our properties, particularly office, because we want to keep that approximately 35% ratio intact, and also look at the other properties. So we're just keep doing what we've been doing all these years. And, hopefully, we'll improve our position, and improve our portfolio.

Thanks, guys.

Chris Caton, Morgan Stanley.

Thanks. Just follow up on that question -- and you may have said so; and, if so, I apologize. What are your target allocations for your other property types? Talking about 35% for office.

Good morning, Chris, this is Bob. Keep the office cap at 35%, to the extent that we go above it; then we'll either increase our retail multifamily, so that comes down, or we will recycle some office assets that we don't see a strong annualized growth in. But, in terms of the allocation between the other two, I don't think there is any fixed allocation. I would say that you'd look at retail and multifamily together as one allocation.

Retail and multifamily are the balance of the portfolio. And while we don't see any great change in the allocation between those two asset categories; on a gross basis, we would think that office being 35%, the balance would be approximately 65%. And then, within those categories, we would again look at the same strategy, and how do we improve our growth and improve the quality of our portfolio? Which is difficult to do, because we have what I believe is the highest quality portfolio -- one of the highest quality portfolios on the West Coast. But we keep working at it.

Thanks for that. You talked about recycling capital. What's the timeline for realizing some value?

That's really out of our hands. It depends on the eagerness with which the buyers meet the opportunities we make available for them. So it would be difficult to comment on that and give you a timeline. We're working on it all the time. And we'd like to achieve that approximately 35% allocation to office within a reasonable timeframe.

Thanks, Ernest. And then, Bob, one last question on guidance. Can you talk about -- you alluded to some of the changes. What were one of the two major changes? And can you be specific. Is Bellevue in the new -- the new transaction at Bellevue, is that in your number?

No, it's not. In my prepared remarks, you can probably do the math and come up to what the accretion would be on a FFO share. But we don't want to include that in guidance, because we still have to go through the straight-line adjustment, the below-market adjustment; and we'd rather be on target when we do issue that guidance.

And, of course, as you pointed out in your prepared remarks, Bob, we haven't closed on it yet.

Right.

So we can't (technical difficulty) until we close on it.

Thank you.

Dreanna Maiorana.

I think it's Brendan, but thanks. Good morning out there. Question for you guys on a follow-up on Chris's question, just with the timeline on selling. Are there any 1031 candidates that you guys are thinking about? And does that impact the disposition outlook at all? Because I think, in the press release, for these City Center Bellevue, you had mentioned something in the language there about a potential reverse 1031 exchange.

Yes. The transaction has been set up to accommodate a reverse exchange. The reverse exchange has very specific timeframes in which we have to execute an exchange. The assets that we are contemplating are assets that we've talked about in the past. Again, if you look at our portfolio, and you've looked at -- you compare what we currently own with Bellevue, I think you can surmise what properties we consider to be a flight to quality. So I think that's about all we can offer, because we are evaluating quite a number of assets to include in this exchange.

I think the way you have to look at this is, we are delighted with the purchase of that asset on a standalone basis. If we can affect the trade, which, financially, improves the performance of our Company, it's something we want to do. If we can't do that -- and we hope we can, and think we will -- but if we can't do that, we're delighted with what we've acquired. And we think, on a standalone basis, it represents a very valuable asset in our portfolio now, and for the long-term.

Yes, thank you. That's helpful, guys. And then just curious on the lease at the The Landmark at One Market, the $74 number for half a floor. Do you think that's indicative of where rents are now? Because I think, when the salesforce lease got done, correct me if I'm wrong, but I thought it was maybe in the low $40s, when you guys did that just a couple of years ago. So has the market moved that much? And does that give you a big growth avenue, as leases roll there? I know you don't have much in the near-term.

Well keep in mind that the salesforce lease started in the 40s, but it moved significantly, year over year, upward, to the tune of about $1 million a year. So the lease that we've signed today, yes, I do believe reflects where the San Francisco office market is. And at the end of the lease that was signed a couple of years ago with salesforce, it will be close to or slightly under the lease that was just signed with them at $74 at its expiration. So I think what you're going to see in San Francisco, which will probably moderate rent growth, is the onslaught of additional development. There are a lot of projects that are in the pipeline. And with all that new development, it will likely have a cooling effect on rent growth.

Brendan, this is Bob. Overall, from a portfolio standpoint on the office sector, our in-place rents are approximately 9% below market, the way we're looking at it.

9% below. Okay, great. Thank you, Bob. And then, last one, so multifamily -- you guys have had a very nice pickup, as you talked about before, with the occupancy. It looked like the average base rent per unit went down. And I know, John, you mentioned in your prepared remarks that you guys weren't providing concessions, but is the market down? Or were you guys getting a little more aggressive on rate, to drive the occupancy up? Or was it just something particular that happened that drove it down in the quarter, relative to where you guys were in the beginning of the year?

Brendan, as John mentioned, there were little or no concessions given. It's just, we were just being aggressive in getting the apartments leased up. We had a big slug of apartments that we leased out to a corporate user. And we've just been very competitive in the marketplace.

Do you think that the rate that you're looking at now -- that you did in the second quarter to get the lease up -- is that likely to hold for the back half of the year? Or do you think you are going to be able to move rates a little bit up from where you are right now?

Yes, I would think that the rates would, from what we're seeing in the marketplace, that those rates will start to inch up over the remainder of the year.

Okay, great. All right, thank you.

Jason White, Green Street Advisors.

Good morning, gentlemen. A quick question for you about the Portland office acquisition, Lloyd portfolio. How does that has that been going? Has there been any hiccups, or any learning curve issues, with building into the new market there?

No. We've had a little slower fill-up than we expected. But the real attraction of that acquisition was the additional development opportunity. And that is moving along with great speed. And in the meantime, we continue to manage the existing office buildings up there, and we look forward to getting started on the new development.

Okay. And on that same note, as you enter into Seattle -- which is also a new market -- historically, we've seen that, as properties get further from the mother ship, they are more difficult to manage. What steps are you going to take? Or how do you think about that, in terms of managing those assets?

Well, with respect to the Bellevue acquisition, that will likely result in our hiring a regional manager; likely to be based in Portland. We will look to keep some of the existing people that are involved in the management of the Bellevue Tower in place, and operate that from, basically, a Portland hub. So we are not concerned about the distance that that property is from us. We have owned and managed property in that area before, as we have in Portland. And we look forward to the opportunity.

As we have in Honolulu, Hawaii and as we have in San Antonio. As we have in San Francisco. And, of course, we have office buildings in Seattle. With such a significant asset, it will command and merit very close management (technical difficulty).

Okay, thank you. And then one final question; on Torrey, your expansion down there in the office. Now that you're getting closer, and there is a little more clarity on what you are building, and it's getting closer to the forefront, have you had any tenant approach you for potential interest? Obviously, it's a little early to sign them, but has there been significant interest in the new space?

There's been significant interest in what we have been pursuing for years. The problem has been getting all of the necessary permits and approvals. You can imagine talking to a restaurant operator -- which we were in lengthy discussions with five years ago -- and, finally, the conversation just went to, look, call me when you get started. So the interest in this space, because most of it is amenities for the project, we do not anticipate having any problems leasing it. It's more of tenants being assured that we can deliver the premises.

It's been a multiyear task to get the entitlement, as John pointed out. And, of course, during that time, and since we built the project, the traffic on the street that runs through this project has increased dramatically. And so if people were interested five or six years ago, it would seem to be logical, with the increased traffic in the area, that they are going to have the same interest, if not greater, as the project does get underway.

Not to mention the traffic on Interstate 5.

Okay, thank you very much. I appreciate it.

Wes Golladay.

Good morning, guys. How much buying power do you guys have after City Center, in your mind, before I have to start modeling asset sales or equity?

Wes, this is Bob. The way I'm thinking about it, that after City Center, let's take two scenarios -- one scenario is that we don't recycle any assets, and we put a mortgage on the asset. And I still have the positive cash flow from existing operations; plus, I will, at that point in time, have an unused line of credit of about $214 million. Another way is, if we do recycle capital, we'll have just that much more to work with. So we have many ways to go. And as I mentioned in my prepared remarks, not only the positive cash flow; but we could joint venture on, maybe, any of our assets if we wanted to. Let's say there was a -- even San Antonio, you could do a joint venture on. But we have many ways to go, in terms to meet our obligation, CapEx, and additional accretive acquisitions.

I think in the short run, our focus is on, first of all, mortgaging property that Bob outlined. That's a significant addition to liquidity. And second of all, looking the recycling opportunity, which is a significant opportunity; and that's about enough on our plate to handle, all of which provides significant upside.

Okay, you guys also mentioned about boosting the retail and multifamily, where pricing is still a little tight. Would you guys look to develop multifamily at this level, and maybe even some retail?

The project and Lloyd is 655 multifamily units; so, yes to that question. What we're seeing in cap rates for apartment acquisitions in the markets that we're focused on, most of them start with either a 3 or a 4. In our Lloyd project, we expect to build to something north of a 7. So development in that area, in that asset class, is a lot more appealing than a straight acquisition. In retail, we are looking at several retail opportunities right now, and that still looks enticing. The problem is, the quality of a lot of the retail properties that are coming to market don't meet our standards. So we continue to look, but we are being very diligent.

Okay. And lastly, on City Center, should we expect any meaningful acquisition expense in the third quarter? And the marketable securities, can you use those? Or is there a -- do to have to wait for them to mature to fund the purchase?

The marketable securities have been sold in anticipation of their use in this acquisition. So the marketable securities were all government-guaranteed securities. (technical difficulty) near cash.

Okay. And acquisition expense for the third quarter?

In terms of acquisition-related expenses, I don't expect anything material. Maybe $100,000, Adam.

Not much.

Okay. Thanks a lot, guys.

There's no further questions, so I now like to turn the call over to Ernest Rady for some closing remarks.

Thank you all, again, for giving us your time this morning, and allowing us to explain the opportunities that we see going forward; also to, hopefully, convey our enthusiasm for the purchase of the Bellevue property and to continue the strategy we've had all these years of seeing how we can, A, upgrade our portfolio, increase our cash flow, increase the quality of our portfolio. So we're back to accomplishing what we've accomplished over the years. And we're really excited about the position we're in today, for now and for the future. And thank you again for your interest and your time.

Thank you, ladies and gentlemen. That concludes your conference call. You may now disconnect. Thank you very much for joining us. Do enjoy the rest of your day today.