American Assets Trust Inc (AAT) 2014 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q2 2014 American Assets Trust earnings conference call. My name is Whitley and I will be your operator for today. At this time, all participants are in a listen-only mode. Later we will conduct a question and answer session.

(Operator Instructions). As a reminder, this call is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Mr. Adam Wyll, Senior Vice President and General Counsel. Please proceed, sir.

Good morning. I would like to thank everyone for joining us today for American Asset Trust's second quarter 2014 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 2014 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 call 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. 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 rates, real estate conditions and the risks and cost 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 operations.

Additionally, this call will contain non-GAAP information including funds from operations or FFO; earnings before interest, taxes, 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, reconciliations to net income are contained in the Company's supplemental operating and financial data for the second quarter of 2014 furnished to the Securities and Exchange Commission, and this information is available on the Company's website at www.AmericanAssetsTrust.com.

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

Thanks, Adam, and good morning, everyone. Good morning, Jim. Thank you for joining American Assets Trust's second quarter 2014 earnings call.

Our multi-asset class platform and disciplined investment strategy continues to demonstrate that diversity is additive to our ability to provide consistent growth, strong returns, and value creation. We do not operate or make decisions with a view of how things will look next quarter or even the quarter after that. Our view of value creation for our shareholders is long-term.

As you all have heard me say before, AAT trades at one of the highest FFO multiples amongst our peers, yet we are still trading at a discount to our net asset value, as we published during this past quarter. This is very frustrating. As I think back about the time when we went public, we had about $1.8 billion in assets. Now we have about $3.2 billion in assets. This accomplished over the last three years.

If you look at our internal net asset value estimate of approximately $22.78 when we went public almost four years ago, and compared that to where we are today, we believe we have created approximately $16 in net asset value, a 70% increase. That growth in net asset value is split approximately 50%/50% between cap rate compression and what we believe is value added by management, or what we refer to as alpha. That increase in net asset value has produced a total return of approximately 20% annually for our stockholders.

If you attribute 50% of that total return to rate compression, that leaves the balance of approximately 10% attributable to what management has added through accretive acquisitions and good management development, asset management, and exchanges. This reconfirms our view that we can and will continue to try and create a 10% annual compounded return for our shareholders over the next decade excluding cap rate compression.

On top of that, acquisitions, development opportunities, and the recycling of equity is what we like to call icing on the cake, and we hope we have a well-iced cake. It won't be every year. Some years will be up and some years will not be up, and some years will be down.

But, in the long run, our focus will always be on creating long-term asset value for our shareholders, which we believe, hope, and count on translating into at least a 10% compound annual return over the long run. It is what we have been doing for almost a half a century.

Looking forward, we feel -- continue to feel confident about our assets, our momentum, and the strategy for the remainder of this year and into 2015. On behalf of all of American Assets, 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 it 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, Seattle, Portland, San Francisco, San Diego, and Oahu, continue to show significant signs of strength in all three of our asset classes. We expect this to continue into the foreseeable future.

In addition to the FFO performance Ernest just mentioned, net income available to common stockholders was $3.7 million for the three months ended June 30, 2014, or $0.09 per diluted share. Bob will provide more details on our FFO and same-store NOI shortly.

In San Diego, we completed construction this month on phase 3 of Torrey Reserve, both on track and on budget. Building 6 is 100% leased. Buildings 4 and 5 are experiencing considerable tenant interest. Our 500 kilowatt photovoltaic installation is complete and was attached to the grid on July 21. Phase 4, Buildings 13 and 14, are well underway and now anticipated to be complete in April of 2015.

The final steps are taking place in the building permitting process for Sorrento Point, our approximate 90,000 square foot two-building complex across the freeway from Torrey Reserve. Grading is now anticipated to commence in October of this year.

At Loma Santa Fe Plaza, we are pleased to report that we executed a lease with TJX Companies for a Home Goods in place of the previous Ross unit. Home Goods will be a welcome addition to the center when it opens, anticipated to be in February 2015. Also in San Diego, at Carmel Mountain Plaza, Saks Fifth Avenue's OFF 5TH outlet store opened adjacent to Nordstrom Rack on May 23 to an all-time chain-wide record sales opening. Both stores continue to have very strong sales performance.

In San Antonio, at our Alamo Quarry Market, we replaced bankrupt Bally's gym with Gold's Gym, a 26,000 square plus foot premises consisting of primarily second-level space. Opening is scheduled for January 2015. With the execution of these three retail leases, it raises the overall occupancy of the retail portfolio to 98.8% leased as of June 30, 2014, and is now poised to have an outstanding 2015.

In Bellevue, Washington, our tenant, VMware, takes occupancy of their 17,000 square foot premises in September, with their tenant improvement work now approximately 75% complete. In Portland, Oregon, construction continues on our Hassalo on 8th project. Approximately 328,000 man-hours have been expended to date.

The three city block subterranean garage is complete and all three blocks are beginning to take shape. Block 92 was just topped off with its fifth floor. Block 100 is close behind, and block 101 is currently eight floors high, adding an additional floor every two weeks. Approximately $72 million of the budgeted $192 million has been expended to date. Again, we are on track and on budget.

The apartment occupancies and rent growth for the Lloyd District continue to tighten as does the greater Portland metropolitan statistical area. To give you an idea of what that means, according to the Portland Business Journal, the area's average apartment rent in June was $1160 a month, $167 a month more expensive than this time last year.

As you know, each of these potential development and redevelopment opportunities are subject to market conditions and results may vary. In May, the Hawaii economy continued to show positive growth in both per person spending, up 3.2% to $193. And total visitor arrivals grew by 1.8% to approximately 650,000 over the same period last year. Notably, Canadian arrivals increased over 10% to approximately 29,000 visitors and other Asia grew 15%, with a 29.4% increase from China and a 4.9% increase from Korea.

Our Embassy Suites at Beachwalk continues to exceed our competition in ADR and RevPAR measurements for the quarter even during our Aloha Tower hotel room refresh, which was completed June 16. According to Smith Travel Research Report for the month of June, the property's ADR and RevPAR index were 125.2 and 116.7, respectively. ADR was $1.04 or 0.3% higher than last June.

As published in Travel & Leisure's August 2014 edition, our hotel is listed in the 2014 World's Best awards as one of the top hotels and resorts in Hawaii. Our hats are off to our Waikiki management team.

Finally, for the retailers at Beachwalk, tenant sales continued to increase, up 11.5% for the month of May over the same month last year. The performance of this asset continues to astound us.

Our acquisition and venture efforts remain in full swing. However, the pricing of assets equal to or greater in quality than our existing portfolio provide returns of unacceptably low levels. Disciplined investing is a core metric at AAT. If it is dilutive to shareholder value, we just won't do it. Nonetheless, we continue to evaluate growth opportunities and recycling 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 second-quarter 2014 FFO of $0.39 per share. Net income attributable to common stockholders was $0.09 per share for the second quarter. The Company's board of directors has declared a dividend on its common stock of $0.22 per share for the quarterly period ending September 30, 2014.

American Assets had a solid second-quarter performance. Our high-quality, coastal West Coast, diversified strategy continues to have stellar performance. Our retail portfolio ended the quarter with 98.8% occupancy combined with the highest annualized base rents amongst our peers. That represents less than 90,000 square feet of vacancy in a 3 million-plus square foot portfolio.

Our office portfolio ended the quarter at approximately 88.5% occupancy as we expected. Total office vacancy represents approximately 300,000 square feet of a 2.6 million square foot office portfolio. Approximately 60% of the vacancy relates to our development projects at Torrey Reserve campus and the Lloyd District portfolio, due to tenants that have been impacted by ongoing construction activity. For this reason, we continue to exclude these two projects from same-store NOI metrics.

The Tax and Treasury Administration at our First & Main building in Portland, Oregon, represents approximately 23% of the vacancy and is consistent with our expectations from our initial underwriting when we acquired the property. I can tell you that Jim Durfey, who heads up our office leasing, is working closely with the local brokerage community to fill this 70,000 square foot vacancy.

Portland continues to achieve levels of job growth with the year-over-year expansion hitting 2.8%, one of the highest levels of major western metro areas. According to a recent research report from JLL, the Portland CBD office market has again tightened with vacancy dropping to 8.4%, its lowest level in at least 10 years, and down 60 basis point from last quarter. The vacancy in the federal CBD, where our First & Main building is located, is even lower.

There are currently no existing options for any class a tenant needing over 75,000 square feet in the CBD. Large tenants, which are over 50,000 square feet, have seen their leverage shift dramatically in the past two quarters. Overall, CBD asking rents have jumped 6.4% since the end of last year and other concessions are moderating. And the construction pipeline is expected to deliver limited product over the next two years.

There are currently only four spaces over 50,000 square feet currently vacant in the CBD and the Lloyd District combined. We view this as an opportunity for our First & Main building in Portland, Oregon.

The remaining vacancy in our portfolio relates to general vacancy from smaller tenants. We continue to limit our office NOI to approximately 35% of our total NOI as part of our diversified coastal West Coast strategy.

Let's talk about same-store NOI for a moment. Same-store retail cash NOI for the quarter decreased by 4.6% in the second quarter. Q2 year-over-year comparables were primarily impacted by the Foodland vacancy at our Waikele shopping center in Hawaii, as we expected, and representing approximately 80% of the decrease in same-store retail cash NOI. The balance is attributable to a real estate tax refund relating to our Alamo Quarry shopping center that we received in the previous year.

We expect our same-store retail comparables to improve in the third and fourth quarters of this year as OFF Saks Fifth Avenue at Carmel Mountain Plaza in San Diego both then have began paying rent towards the end of Q2. It is also important to point out that our same-store retail cash NOI over the last eight quarters has averaged over 3.5%.

Additionally, we have another 45,000 square feet of various retail tenants expiring in 2014, assuming all remaining lease options have been exercised at a time when our in-place rents are approximately 7% below market on a cash basis. This is also consistent with the re-leasing spread shown in our supplemental filing, which reflects 18 retail leases that were signed during the quarter at a 14.5% cash increase over prior rents and a 25% increase on a straight-line basis over prior rents. For me, this helps paint a picture of a consistently strong-performing, high-quality coastal West Coast retail portfolio.

Same-store office cash NOI was up 6.5% in the second quarter, primarily due to contractual rent bumps at both our Landmark at One Market Street building in San Francisco, and City Center Bellevue building in Washington State. Real estate tax refunds on our Landmark building also contributed to the increase in same-store office NOI. It is also important to point out that our same-store office NOI over the last eight quarters has averaged over 6.5%.

We expect same-store office comparables to remain positive for the remainder of 2014. Our total office portfolio in-place office rents are approximately 19% below market.

Our supplemental filings shows the re-leasing spreads on nine office leases that were signed during the quarter at a 6.6% cash decrease over prior rents and a 4.8% decrease on a straight-line basis over prior rents. However, if you exclude the two leases signed at our Lloyd District portfolio in Portland, Oregon, and exclude the three leases signed at our Torrey Reserve campus, both of which are under active development, our office re-leasing spreads would be 9.2% cash increase over prior rents and a 13.5% increase on a straight-line basis over prior rents.

These numbers are more reflective of our total office portfolio in-place rents being approximately 19% below market. Again, this is a picture of forward-looking growth in a high-quality coastal West Coast office portfolio.

Same-store multi-family NOI, which comprises approximately 7% of our NOI, was up 3.8% on a cash basis for the second quarter. Higher year-over-year occupancy and higher rents are the main drivers of the same-store growth of the multi-family portfolio. We continue to be pleased with the execution and direction of our multi-family portfolio.

Waikiki Beachwalk, our mixed use property in Waikiki, Hawaii, which represents approximately 11% of our NOI in the current quarter, was impacted by the room renovation at the Embassy Suites Hotel as same-store cash NOI decreased by 11.1%. Approximately 6700 room nights or 20% of our total room nights were unavailable due to the refresh during the second quarter.

On a more comparable basis, average daily rates increased to $294 in the current quarter, representing an increase of 5.8% on a year-over-year basis. RevPAR increased year-over-year by approximately 3.2% to $262 in the current quarter. We are anticipating the room renovation or, as we call it, a room refresh, will have little or no impact on Q3 results. We expect to finish the room refresh in the fourth quarter as expected, as approximately 17% of the available rooms will be off line in the seasonally slower months of October and November.

Waikiki Beachwalk retail continues to benefit from a new Hilton Grand Vacations high-end timeshare called the Hokulannio that recently opened about our end cap retailer Quicksilver, which fronts Kawakawa Boulevard, the main boulevard in Waikiki, and has increased foot traffic and sales in our retail center. Tenant sales at WBW retail were up over 11.5% on a year-over-year basis as the center continues to outperform.

Now, turning to our results, second-quarter FFO increased 561,000 and remained at $0.39 per FFO share compared with first quarter 2014 FFO of $0.39 per FFO share. Although FFO per share did not change quarter over quarter, the following five items did impact Q2 FFO.

One, the Embassy Suites is down approximately $0.02 per FFO share, as expected, due to both the seasonality from the shoulder months of April and May, along with the room refresh on the first tower that took approximately 20% of the rooms off line for approximately 10 weeks during Q2. Approximately half relates to seasonality and half relates to the room refresh.

Secondly, the dilution from the shares issued from the ATM in Q1 and Q2 reduced FFO in Q2 by approximately $0.012 per FFO share in Q2. Straight line rents in Q2 from both Saks OFF 5FTH at Carmel Mountain Plaza and VMware in City Center Bellevue added approximately $0.005 of additional FFO per share during the quarter.

Fourth, we received a nonrecurring termination fee, net of acquisition due diligence costs of approximately $0.015 per FFO share that related to a break fee that we had built into a binding letter of intent. And, lastly, we received a real estate tax refund for our Landmark property relating back to the 2011 base year that increased FFO by approximately $0.005 per FFO.

Let's talk about the common shares that have been issued through the ATM during Q2 for a moment. During the second quarter, we issued approximately 675,000 shares of common stock through the ATM equity program at a weighted average price per share of $34.46, resulting in net proceeds of approximately $23 million. Combined with the approximately 1.4 million shares issued through the ATM in Q1, Q2 FFO dilution was approximately $0.012 per FFO share.

These proceeds will be used in funding our development activities at both of the Lloyd District in Portland, Oregon, and our Torrey Reserve campus in San Diego. We estimate the full year FFO dilution from the ATM proceeds raised during the first six months to be approximately $0.04 per FFO share, net of interest savings.

On a net AV basis, which is our primary focus, we estimate that the full year dilution to NAV will be approximately $0.14 per share, compared with approximately $2 per share in net asset value that we believe we are creating through accretive developments at our Hassalo on 8th development of 657 multifamily apartment units in Portland, Oregon, and Torrey Reserve campus expansion in San Diego. And our Sorrento Point office development in San Diego, which we believe will offer the best office location in San Diego at the confluence of three major freeways and unobstructed views of the Pacific Ocean.

For a more detailed calculation on how we calculate our $2 per share net asset value, I would refer you to our Q1 earnings call script.

Although the Company's balance sheet is strong, and provides ample capacity to fund its in-process and existing development, we thought it was prudent to raise the additional cash on the balance sheet during the second quarter because it allowed the Company to maintain financial flexibility as we continue to pursue three things. First, accretive developments within our existing pipeline. Second, accretive and opportunistic acquisitions. And, third, it allows us to maintain a conservative leverage profile as we continue to align our balance sheet with investment grade metrics, as we approach the investment grade market in 2015, subject to market conditions at that time.

I also want to point out that there are other options that are also available to us other than using cash on the balance sheet or using the line of credit or issuing shares of common stock. We also have the ability to sell other assets that we continue to evaluate on a quarterly basis as to their future internal cash flow growth. Suffice it to say that we have many options, but it is key to maintain financial flexibility and an overall strategy of NAV accretive transactions.

Everything we do is focused on creating net asset value for our shareholders, so we are very thoughtful when it comes to the issuance of additional common shares. We believe that, from time to time, it is prudent to incur short-term earnings dilution that will increase both long-term NAV and earnings growth. Our focus continues to be on long-term net asset value creation.

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 our core West Coast coastal markets. At the end of the second quarter, we had approximately $329 million in liquidity, comprised of $79 million of cash and cash equivalents, and $250 million of availability on our line of credit. We also have access to an additional $250 million accordion feature attached to our unsecured line of credit should the need ever arise.

At the end of the second quarter, our total debt to total capitalization was 33.7%. We are focused on keeping our leverage ratio below 45% and positioning our balance sheet so we have the ability to approach the investment grade market in 2015, subject to market conditions at that time.

Conservative and disciplined balance sheet management is a guiding principle at American Assets Trust. We are not only focused on long-term NAV 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 are increasing the lower end of our 2014 guidance range from $1.54 to $1.56, updating our guidance range to $1.56 to $1.62 with a midpoint of $1.59. The updated guidance also reflects the additional shares issued through the ATM, which, as I mentioned earlier, are dilutive to FFO on a full year basis by approximately $0.04 net of interest savings. Yet, we still have maintained the upper end of our guidance range, which speaks to the high quality of the real estate portfolio that continues to outperform even our own expectations.

From my perspective, as I look at our corporate operating model, 2015 and beyond is looking promising. Retail, office, and multi-family comparables are expected to be positive from what we know today. Our Embassy Suites Hotel in Waikiki, which is the best-performing Embassy Suites in North America, measured by RevPAR, will have completed its room refresh and all rooms will be back online.

And we also hope to pick up some interest expense savings from the refinance of our 2015 maturities. We hope to share with you the details of our 2015 guidance during our Q3 earnings call. We will continue to be -- continue to do our best and be as transparent as possible and share with you how we are thinking about our 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 will now turn the call over to you for questions.

(Operator Instructions) Jason White, Green Street Advisors.

Just had a quick question for you as you backfill and re-lease some of the retail spaces and some of the boxes that you discussed in the prepared remarks, can you give me an idea of the length of the line for negotiations and how many tenants are showing up and what types of tenants? And, really, what is driving the supply/demand dynamic for your portfolio which is at the high end of the quality spectrum?

This is Chris Sullivan, the VP of leasing for the retail. On the big box leasing, it can take anywhere from 6 to 9 months to get a deal done, and even sometimes longer because you have the positioning or, I should say, the scheduling of when that particular retailer is going to open. Typically they're only going to open in the spring or the fall. So that is kind of what takes that.

The guys that are lining up for the boxes, the discount clothing apparel guys have gotten pretty aggressive and the sports guys have gotten pretty aggressive. As you read, the grocery category has also gotten pretty aggressive, but in our portfolio, as with most portfolios, the grocery category is usually taken. So it is hard to do -- you can't do two grocery stores. Does that answer your question?

Yes. Yes. Just also, what you are seeing, is the competition enough to where you are seeing a decent amount of rent growth in these boxes as you are looking at, say, backfilling the Waikele box and the Home Goods that replaced the Ross box? Or what are you seeing in terms of rent increases from the prior tenant? And, obviously, it is a roll down, but I'm just curious where you thought you were going to end up versus where you may be trending towards.

I mean, getting into the low to mid 20s, typically, on a box when you have got your triple net is probably where you're going to end up in San Diego, all depending on the particular location. But, the boxes are so selective of where they are going to go. And so, most of San Diego is pretty much a built out market, so there is not a whole lot of room left for them. But, yet, they are also not going to trip over each other just to get into a position in pay a lot higher rent. Their spreadsheet in their return on cost is just as important as ours.

Todd Thomas, KeyBanc Capital Markets.

This actually Grant Keeney for Todd. Just want to touch on the termination fee from the canceled acquisition. Was that related to a single acquisition or was it a portfolio? Maybe just some more color on anything else you can provide in terms of the property type or geography or anything like that.

This is Ernest. It was a single property acquisition. We negotiated it first time and we had an LOI and then the seller changed his mind. Actually to categorize it correctly, he welched.

And the second time he said he would like to come and do the transaction again. I said, okay, if you don't go through with it this time you have got to write us a check for $1 million. And sure enough, he wrote us a check for $1 million. He changed his mind the second time.

It was for a type of property that would have resulted in additional apartment portfolio and some additional commercial in San Diego, and we're really sorry that it didn't go ahead. It would have been a great, great acquisition. But you win some, you lose some.

Okay. Well, I guess, given that, can you just update us on the pipeline, then, for acquisitions? I think you guys mentioned some Hawaii and also Southern California, but maybe just an update there.

We continue to look. That is probably the best way to characterize the acquisition activity. We continue to underwrite assets. We are constantly looking at the recycling of capital internally. But, frankly, the pricing of assets today, believe it or not, is continuing to get more and more aggressive. Every time we thought we had seen the bottom for cap rate compression, another deal gets reported and the cap rates are even lower. So we are looking, but we are not actively pursuing anything at this time.

Okay. And then, in terms of funding the development, obviously a very robust development pipeline. I know you were active in issuing some shares out of ATM, which is below that $39 internal NAV, but I think the short-term dilution kind of makes sense for the long-term growth that you guys have mentioned before. But, just other options -- you mentioned selling assets. How do you feel about bringing on JV partners, anything like that? How do you rank the other options there?

Okay. Historically, we have not done joint ventures. We had one joint venture partner in the history of the Company that I can remember -- one significant anyway, the General Electric pension fund. And joint venture partners are apparently not a good thing from an accounting point of view, and not a good thing from a transaction point of view. So we don't think joint ventures are really something that is on our radar screen. But, you never know. Something may come up that may be compelling.

What we look at, really, is you know that market for assets today is heated. One might even describe it as overheated. So our opportunity, should it present itself and, as John pointed out, we constantly are examining the opportunity. Do we have something that sells at a heated price that we can buy, transition it into another asset at a heated price, that will be a better asset for us in the long run? That is really where our efforts are focused now. And that is what we are constantly looking at. Can we buy something? And it has to be in a heated price, but can we sell something, and it has to be at a heated price, and improve our overall position. That is our strategy. That is what we are looking at and we have a history of doing that over many years. I think over the life of the -- recent life of the Company, we have done over $2 billion of these transactions, and I refer that as icing on the cake. We hope to have icing on the cake at some point in the future. We don't know when. It is something we constantly look at. It's something we dream about and something we hope for.

Would you sell one of these assets that are at a heated price if you didn't have an acquisition to that, just to raise proceeds?

Probably not, because, first of all, there are tax consequences. Second of all, our objective is to be a larger enterprise rather than a smaller enterprise. The cost of being public is very significant. And, as I said in the opening statement, our total assets have gone from $1.8 billion to $3.2 billion.

Our objective is to grow, to increase the quality of the assets and increase the NAV for the stockholders. So selling something just for the sake of selling ought not to be on our raters thing screen radar screen. We ought to look to be selling something where we can improve our overall position now and going into the future.

Okay. That's fair. And, just lastly, quickly on Alamo Quarry, I saw the leased rate increase from 94.5% to 99.5% and you mentioned the Gold Gym signing. So that opens in January. I was just curious, does the rent commence in January? And then what kind of cash rent spread was that?

This is Chris Sullivan again. So your question was, does the rent start in January?

And the spread.

Yes. They should open in January. And then the spread off the Bally's, it was approximately the same. I think the average rent was approximately $15 and that is about where Bally's was on the average. Bally's went bankrupt two years ago, so we had a subtenant in there at Bally's which was called Blast. It was operating at a substantially less rent than that, but that really wasn't a fair comparison. Remember, this space is the majority of the second-floor space.

Blaine Heck, Wells Fargo.

(technical difficulty)

It's a possibility his line is muted.

Let's go to the next guy.

Craig Schmidt, Bank of America Merrill Lynch.

It is actually Katie on for Craig. It sounds like the Lloyd District and Torrey Reserve developments are going well and perhaps a little better than expected, I guess from a demand perspective. Just wondering if you guys had an update related to the yields on these projects at this point.

Hi Katie, Bob. No, we are keeping the yields where they are. We are halfway through the development and probably 80% of the contract is bought out. So we are very comfortable on that side. But, on a project of this magnitude, we're going to keep a conservative yield that is -- that we have currently published, and if something changes, we will let you know.

On a personal basis, I am pretty excited, Katie, about having the opportunity to participate in that market with the product we are bringing online.

Great. Then, I guess, just -- you mentioned being pleased with the multifamily portfolio. Is that a format that you will be looking to do more acquisitions? I know you mentioned the one -- the apartments. Would you be willing to increase the size of the multi-family as a percentage of the total portfolio?

We would love to. It is just -- it is the difficulty of finding a product that meets our quality standards, that meets our opportunities for the future we look for, and that matches the other opportunities. But we would love to have more multifamily.

Wes Golladay, RBC Capital Markets.

Sticking with that last question, would you guys consider developing more multifamily once the Lloyd District portfolio is complete?

Yes.

And are you actively looking to permit or is it just too, too soon?

We have started planning.

What Ernest was referring to is phase 2 of the Lloyd District project. That is in the planning stages. We continue to look for other opportunities. As Ernest just mentioned, the one that we were just looking at that we were paid the termination fee, was a very large site -- about a 35-acre site here in San Diego. And that would have been a project that would have commenced concurrent with what we are doing up in the Lloyd District. But, at the moment, finding opportunities is difficult. And at the same time, we are very pleased with the pipeline that we have up in the Lloyd District, so we have got plenty of work ahead of us up there. And, as I mentioned, we started the planning for phase 2 and it will be in the position to break ground upon the completion of phase 1.

I think that pretty well sums it up. I mean, we have great pipeline and we are looking forward to adding to the size of the portfolio and increasing the quality and the income from the portfolio. And the metrics are in place and the properties are in place to accomplish it.

Blaine Heck, Wells Fargo Securities.

Bob, when I look at your office same-store NOI, it looks like there is a pretty sizable difference between cash, up 6.5 and GAAP down [0.2]. Was there a lease that just had a large amount of free rent burn-off or something else that is driving that?

Yes. On the -- between the GAAP and the office, the office same-store is primarily just First & Main, the impact. The others are CCB and Landmark, which impact the cash same-store NOI.

Okay. But there was nothing out of the ordinary there that caused the big difference between cash and GAAP?

No. I mean, on the cash side, it is really -- so for instance, on the cash side, the difference is $648,000 if you look at for the three months ended June 30. And that is really a lift in the CCB -- City Center Bellevue in Bellevue, Washington. That is probably $150,000. Landmark continues to increase by about $1.1 million, $1.2 million a year because our large anchor tenant in there has $2 per square foot bumps a year, which take place generally in the second quarter. And then, First & Main reduced that because of the Tax and Treasury that had left in the first quarter. So that is where you come out with your same-store (multiple speakers).

Sure. Okay. That makes much more sense. I am not sure if Jim is on the call, but can we get a little more detailed update on how leasing negotiations are for the backfill of Tax and Treasury at First & Main, and maybe some sort of feel for when we may see a lease come through?

Blaine, let's talk about First & Main, first.

This is Jim Durfey, who is responsible for office leasing and does a great job.

We have several prospects for the portions of the First & Main space. I can't go into elaborate detail on who those people are, but we are currently negotiating approximately a full floor deal and we have several other interested prospects for other portions of that 70,000 square feet. So that market, as you know, has improved markedly in the last six months, not only in the CBD, but also in Lloyd District. Although you didn't ask the question, I will tell you in Lloyd District, we are working on 100,000 square feet of leases in the combination of the Lloyd 700 building and Lloyd Center Towers, so very active over there. So, things are definitely improving in both of those submarkets.

It would be difficult to over-describe the turmoil that was created by the construction. So the fact that our occupancy went down in the Lloyd 700 building is not surprising. On the other hand, as the project starts to materialize, I think that the people who are looking at leasing there realize that is going to be a very, very good place to locate their business.

Understood. That sounds great. And then, similar question on the Foodland space; I think the last time we talked, it seemed as though you were getting close to signing a tenant for about half of that space. Can you give an update on what your thoughts are for timing at that property?

This is Chris Sullivan, again, the VP of the retail leasing. I am still working with several prospects on it. My timing is -- I don't want to leave that punch for you and give you an exact timing, because I'm just having difficulty positioning tenants. There is a lot of activity on the island right now in respect to development and retailers looking for space; quite a bit of it, as you know. Ala Moana is just exploding with growth at their mall there. It's a lot of opportunities in the market which is causing a little extra confusion for me. So the long and short, to answer the question, I am still working on it and I hopefully will have some done in the next 3 to 6 months.

Okay. Great. That's fair enough. And my last one for Bob: is there any change to the AFFO guidance? I think it was [95 to 101] or any of the same-store NOI guidance numbers?

No, pretty much on track.

Haendel St. Juste, Morgan Stanley.

I wanted to follow up on that theoretical asset swap that you put forth in your earlier comments. I was curious, perhaps, of your sense of forward IRR expectations for maybe high-quality apartments in your core markets, which appear to be a bit later in the cycle -- in the apartment recovery cycle. And offer perhaps a lower forward IRR versus perhaps strips and office, which may have more room to run, maybe a little earlier in the recovery cycle. Just curious as you are looking at potentially -- again, I know it is theoretical -- looking at the potential swap, how you are thinking about IRRs for the various asset classes in your portfolio at this point.

This is Bob. Let me address that. It would probably be helpful to just walk you through our acquisition strategy. We place less focus on the IRR. Our focus is more on unlevered cash on cash returns. And the reason for that is because the IRR can be manipulated on the back end through a terminal cap rate, whatever you want to put in there, to achieve that return, that would make you want to pull the trigger and buy that property.

The way we look at things is that we are less concerned with the going-in cap rate or the going-in yield. But what we are focused on is the growth, and we want to relate it back to our weighted average cost of capital. So if a multifamily asset out there is trading at, let's say, a 4 or a 5 or whatever the cap rate is, that doesn't bother us. We will take it down if it meets our other criteria of high quality in the markets that we are looking at.

But then it has to have growth, so that it will get our unlevered cash on cash over our weighted average cost of capital within a three-year period of time. And if it doesn't meet that, then we are destroying shareholder value. If it does, then we are creating shareholder value or creating value for our shareholders. I hope that answers question.

It gives me some context, appreciate that. One more small one. We have heard from some apartment REITs who have high-quality West Coast assets that they are starting to see condo bidders reemerge into the marketplace. Curious if you have seen that, if you have been approached, et cetera. Thanks.

Not to my knowledge. It's Ernest.

Wes Golladay, RBC Capital Markets.

Looking at the multi-family portfolio, it seems like you are running at 100% occupancy, ex the RV resort. Are you going to start pushing rates there more aggressively?

Yes.

Okay. So maybe 5% rate growth next year would be a good estimate? Is that too aggressive?

We will try to get all we can, providing that we provide good value for our tenants. And with the occupancy rate we are running, I am optimistic that the portfolio will have very good returns. Do you have a thought, Russell? Russell runs that portfolio.

All right. I agree with Ernest. We have an aggressive pricing philosophy, and the fundamentals of our vacancy compression with occupancy allows us to push these rents. And we are going to absolutely push the limit next year.

We have no history of leaving money on the table. I will tell you that.

Wes, this is Bob. So, just to kind of put it into perspective, the multi-family is, what, 90% occupied at year-end. Or, I'm sorry, as of the end of this quarter. For a guidance perspective, we have factored in a 95%. So we factored in a reduction in occupancy for guidance to 95%, but we have had an increase in rates, which has got us to -- we are projecting a same-store cash NOI increase of about 3%, 3.5% for next year. So that puts it in context for you.

Yes. That is excellent color there. And then, when we look at the office portfolio, you have about 200,000 square feet of leasing next year assuming options are exercised. And you mentioned the portfolio on average is just about 19% below market. Is there any one-off difficult comps in next year's leasing or for the next 18 months?

For the next 18 months, no. And Jim might want to add something to that, but Landmark is pretty much locked up. City Center Bellevue is where we will see some roll. When we underwrote that property, we knew during the first five years of -- from the point of acquisition, probably 50% of the building would roll. And we see that -- we saw that as an opportunity because, at the time of acquisition, we determined and it was confirmed by a third-party that the in-place rents were below market by approximately 23%. And we are seeing that come to fruition on each roll that we are doing. In fact, in one of the leasing -- re-leasing spreads on this quarter it was like a 30% increase over the prior cash rents. But, over the next 18 months, no; but after that, we're going to see some activity.

That concludes our Q&A. I will now turn the call back over to Executive Chairman Ernest Rady for closing remarks. Please proceed.

Again, thank you all. It is a great pleasure to be able to bring you to the good news that our top-quality portfolio continues to produce. And we appreciate your confidence in allowing us to continue to manage our assets on your behalf. Thank you.

Ladies gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.