Armada Hoffler Properties Inc (AHH) 2016 Q1 法說會逐字稿

Welcome to Armada Hoffler's first-quarter 2016 earnings conference call. (Operator Instructions.) As a reminder, this conference call is being recorded today, Tuesday, May 3, 2016.

I will now turn the conference call over to Michael O'Hara, Chief Financial Officer at Armada Hoffler. Please go ahead.

Good morning and thank you for joining Armada Hoffler's first-quarter 2016 earnings conference call and webcast. On the call this morning in addition to myself are Lou Haddad, CEO, and Eric Smith, our Chief Investment Officer, who will be available for questions. The press release announcing our first-quarter earnings, along with our quarterly supplemental package, was distributed this morning.

A replay of this call will be available shortly after the conclusion of the call through June 3, 2016. The numbers to access the replay are provided in the earnings press release. For those who listen to the rebroadcast of this presentation, we remind you that remarks made herein are as of today, May 3, 2016, and will not be updated subsequent to this initial earnings call.

During this call, we will make forward-looking statements including statements related to the future performance of our portfolio, our development pipeline, impact of acquisitions and dispositions, our construction business, our portfolio performance and financing activities, as well as comments on our outlook. Listeners are cautioned that these statements are subject to certain risks and uncertainties, many of which are difficult to predict and generally beyond our control. These risks and uncertainties can cause actual results to differ materially from our current expectations, and we advise listeners to review the risk factors discussed in our press release this morning and in documents we have filed with or furnished to the SEC.

We'll also discuss certain non-GAAP financial measures, including but not limited to FFO and normalized FFO. Definitions of these non-GAAP measures, as well as reconciliations to the most comparable GAAP measures, are included in the quarterly supplemental package, which is available on our website, www.armadahoffler.com.

I would like now to turn the call over to our Chief Executive Officer, Lou Haddad. Lou?

Thanks, Mike. Good morning and thank you for joining us today. This morning we reported normalized FFO per share of $0.25. Based on our revised estimates for the year, we've raised both the top and bottom ends of our 2016 normalized FFO guidance range. We continue to successfully execute across all areas of our business, demonstrated by significant year-over-year growth in NOI, same-store NOI, and normalized FFO. I'll discuss the highlights of the quarter before turning the call over to Mike to discuss our quarterly results and 2016 guidance in detail.

The fundamental and guiding principle of our real estate company for the past 37 years remains unchanged -- to invest in and develop the highest-quality real estate in our target markets. As you will see with the number of high-quality transactions that I will discuss this morning, we continue to aggressively manage our portfolio in order to position the Company for sustained long-term value creation.

We started the year with our acquisition of a $170.5 million retail portfolio totaling 1.1 million square feet across 11 assets. The core of the acquired portfolio consists of six retail centers anchored by brand-name credit tenants and well-positioned along the I-85 corridor between Raleigh-Durham and Greenville. Four of the non-core acquired assets are currently under contract or LOI for an aggregate sales price of $32 million. We expect to close on all four dispositions this year, as we had previously anticipated. The fifth non-core asset is still under evaluation.

We partially funded this portfolio acquisition with the net proceeds from our sales of the Oceaneering International and Richmond Tower office buildings. This allowed us to redeploy the equity from predominantly single-tenant office assets in the Richmond and Hampton Roads market into a portfolio of high-quality retail assets in the Carolinas.

With this transaction, we accomplished three major objectives. First, we increased our presence in the major Carolina markets. Second, we decreased our overall risk profile. And third, we deferred the taxes on the significant gains realized on the sales of both office buildings.

Continuing the theme of investing in high-quality real estate, this quarter we announced our participation in a joint venture to develop One City Center in downtown Durham, North Carolina. This is a 27-story mixed-use project that is expected to include 130,000 square feet of office space, 22,000 square feet of street-level retail space, a two-level underground parking garage, and a residential component. The office space will be anchored by Duke University, which has agreed to lease 55,000 square feet.

As a minority partner in the development joint venture, we intend to retain ownership of the $34 million office and retail components of the project upon completion. Our construction company will also serve as general contractor for the overall project, with expected completion in mid-2018.

Just over a week ago, we announced our $42 million investment in the Residences at Annapolis Junction Town Center. With estimated completion in the first quarter of 2018, the project will pursue LEED silver certification and feature 416 apartment units with structured parking. This residential project represents the multifamily component of a planned 18-acre mixed-use development conveniently located adjacent to a MARC commuter rail station. Upon completion of all phases, the development will include office and retail space as well as a limited-service hotel. Most notably, the project is located approximately two miles from Fort Meade, Maryland's largest employer, the nation's third-largest Army installation, and home to both the National Security Agency and the US Cyber Security Command, as well as an additional 6 million square feet of commercial office park space.

As both the mezzanine lender and the project's general contractor, we realize market rate interest income and fees during the lengthy development and construction process, while at the same time avoiding the stress on our balance sheet during development and initial lease-up. With our option to purchase an 88% interest in the project at cost upon completion, we preserve a healthy wholesale-to-retail spread.

One City Center and the Residences at Annapolis Junction Town Center, along with the Point Street Apartments at Baltimore's Inner Harbor, represent the next building blocks in expanding our portfolio of the highest-quality real estate. Our broad-based capabilities and track record allow us to selectively invest in some of the projects in our target markets. We remain confident that over time, the quality of our assets and the lower cap rates they command will translate into a higher NAV for the Company as a whole.

Moving from our joint venture platform and mezzanine loan program to acquisitions, today we announced our acquisition of Southgate Square, a retail center located in Colonial Heights, Virginia, just south of Richmond. Southgate Square adds approximately 220,000 square feet of 100% occupied retail space to our portfolio. The center is anchored by a brand-new Burlington store as well as Michael's, Staples, and PetSmart. The center is strategically situated within the submarket adjacent to the 900,000-square-foot Southpark Mall, as well as a Walmart SuperCenter and across the street from Dimmock Square, which we acquired in 2014.

We acquired the asset for a combination of approximately $21 million of debt and nearly 1.6 million operating partnership units, increasing our capital base and generating earnings for all shareholders. The acquisition is expected to be accretive by $0.01 to 2016 normalized FFO per share and $0.015 per share on an annualized basis. This opportunity was born out of the same longstanding relationship that led to our acquisition of Dimmock Square nearly two years ago and is an example of a partner taking a second meaningful equity position in our Company.

Shifting to the foundation of our Company, our core portfolio, the stabilized assets continue to outperform. The first quarter of 2016 marked our seventh consecutive quarter of significant same-store NOI growth. At the end of the quarter, our core portfolio occupancy stood at just under 95%. Occupancy across all product types at the end of the quarter remain in the mid-90s. While we continue to enjoy organic growth in our stabilized portfolio, it should be understood that the primary growth engine of our Company is our investment and development platform.

Next, I'll briefly touch on the projects in our active development pipeline. Both Johns Hopkins Village and Lightfoot Marketplace are on track for mid-2016 delivery. Preleasing for Johns Hopkins Village has been robust. As of today, 62% of the residential components and over half of the retail space is preleased. We expect to open for the fall semester on time and on budget and are confident that the asset will reach full stabilization next year. Lightfoot Marketplace currently stands at over 70% preleased, with the anchor Harris Teeter store scheduled to open in July.

Turning to our third-party construction business, our progress on the $170 million Exelon Tower within Baltimore's Harbor Point continues on schedule towards completion this spring. Adjacent to the Exelon site, construction on Point Street Apartments is well underway. Additionally, we have mobilized our construction company on both the One City Center and Annapolis Junction projects. With over $176 million in backlog and several promising opportunities in the pipeline, we expect this segment of our business to continue to generate profits at the high end of our historical average.

With that, I turn the call over to Mike, and then we'll take your questions. Mike?

Thanks, Lou. Today I want to cover the highlights of the quarter, thoughts on our balance sheet, and additional details on our 2016 guidance.

This morning we reported FFO of $0.18 per share and normalized FFO of $0.25 per share, which was at the high end of our expectations. This quarter, we reported gains on the sale of real estate of $27 million resulting from two transactions. The first, a gain of $437,000 from the sale of the police precinct to the City of Newport News. This was basically a construction contract structured as a sale with the gain equating to our construction fee. Unlike previous sales, this gain is included in FFO because the asset was never placed in service and was a sale of inventory.

The second transaction is a sale of the Richmond Tower office building, which resulted in a gain of over $26 million that is excluded from FFO. Including this sale, we have recognized over $44 million in gains since the beginning of last year. As we've discussed in the past, asset sales and capital recycling will continue to be an element of future shareholder value creation. On a related note, because we structured these transactions as 1031 tax-free exchanges, the gains from these sales are not taxable, as tax efficiency remains one of our corporate objectives.

Please see page 10 of the supplemental for the normalized FFO calculation. Excluded items this quarter consist of property acquisition costs, development effort pursuit costs, and mark-to-market adjustments for interest rate derivatives. The most notable of these is a non-cash adjustment of $2.4 million related to the $15 million swap walk on our term loan. The other adjustment, $704,000 in acquisition, development, and other pursuit costs, which is largely due to the January portfolio acquisition.

We had our seventh consecutive quarter of same-store NOI growth. Same-store NOI growth was positive 2.2% on a GAAP basis and 3.8% on a cash basis.

At the end of the quarter, our core operating portfolio occupancy was 94.7%, with office at 95%, retail at 95.1%, and multifamily at 93.5%. The slight decrease in occupancy is due to our recent asset recycling activity.

On the construction front, we reported a segment gross profit in the first quarter of $1.8 million on revenue of $37 million. At the end of the first quarter, the Company had a third-party construction backlog of $176 million, which does not include the $68 million Annapolis Junction construction contract that was signed in April.

Now turning to our balance sheet, we continue to take actions to enhance flexibility and strengthen our balance sheet, including increasing the capacity of our credit facility, hedging our interest rate exposure, and continued use of the ATM program. During the first quarter we added eight properties to the credit facility borrowing base and increased the capacity by $50 million to $250 million. This facility is now structured with a $100 million term loan and $150 million revolver.

In addition, we continued to use the ATM program last quarter, raising $10.1 million of gross proceeds at an average price of $10.76 per share. This amount was higher than our expectations due to a couple of reverse inquiries. With the announcement of two new development projects, this quarter we decided to take advantage of these inquiries to use capital in an efficient manner. We intend to continue the use of the ATM program at this level if market conditions are favorable in order to continue strengthening the balance sheet.

During the quarter we closed on the 11-property portfolio acquisition. This was funded through the 1031 proceeds from the sale of Oceaneering, Richmond Tower, as well as cash from the credit facility. The core properties from this acquisition are unencumbered or added to the borrowing base of the credit facility. Four of the five non-core properties are under contract or LOI for an aggregate sales price of $32 million. The proceeds from these sales will be used to pay down the revolving credit facility.

At quarter end we had total outstanding debt of $472 million, including $101 million outstanding under the $150 million revolving credit facility. We continue to evaluate our exposure to higher interest rates and look for opportune times to enter into hedges. During the quarter we purchased a $75 million LIBOR interest rate cap at 1.5% for two years that only cost $57,000. As I said before, we believe using interest rate caps is the most efficient way to hedge against increasing rates. With this new cap, 88% of our debt was fixed or hedged.

We're also working on refinancing the 2016 and 2017 debt maturities. We're expecting a commitment any day now to refinance 4525 Main Street and Encore Apartments. We're also out to market to refinance the Town Center 2016 maturities with expected financing proceeds greater than the maturity amounts.

At the start of the year, we have announced two new pipeline projects, the first being One City Center, a mixed-use high-rise in Durham. Upon completion, we'll own the retail and office components, which represents 37% percent of the joint venture. Since we are the minority owners of this project, it will not be consolidated on our balance sheet. Our cost for this project is $34 million, which is funded through the joint venture construction loan, and our equity requirement of $9 billion funded through our credit facility. But the impact on our balance sheet is minimal until completion in two-plus years from now.

The other recent announcement is the Annapolis Junction project. This is structured similar to the Point Street Apartments project, with our investment funded through a mezzanine loan. The project is not consolidated and therefore does not stress our balance sheet during construction lease-up. Projects of this size and duration require debt and equity for over two years with no return on that capital. With the mezzanine debt structure, we have made a return on our investment, earned a construction fee during development, and have the option to purchase a controlling interest in the property upon completion. Our current investment in Annapolis Junction is a form of a $42 million mezzanine loan which bears interest at 10%.

These are the two pending projects included in the guidance issued last quarter that we anticipated being finalized in this timeframe. We now have three large pipeline projects with 24-plus-month construction schedules that are neither consolidated nor stress our balance sheet during development. This structure provides significant flexibility to manage the balance sheet in preparation of acquisition so existing properties can use the proceeds in a 1031 exchange or sell the asset and monetize the wholesale-to-retail spread.

Let me walk you through our full year of 2016 guidance that we updated this morning. We expect normalized 2016 FFO in the range of $0.94 to $0.98 per share. This updated 2016 guidance is predicated on the following assumptions -- GAAP NOI in the $64.5 million to $65.2 million range; third-party construction company gross profit in the $4.5 million to $5 million range; general and administrative expenses in the $9.1 million to $9.4 million range; interest income from our mezzanine financing program in a $3.2 million to $3.5 million range; interest expense in the $16 million to $16.5 million range; the sale of the three non-core retail properties by June 30 totaling $28.3 million; and the fourth property during the third quarter for $3.8 million; and 48.9 million weighted average shares and OP units outstanding.

This guidance excludes any impact from future acquisitions, asset sales other than the four non-core retail assets, and other capital markets activity with the exception of continuing the ATM program.

I'd like to make a few comments about this updated guidance. The Southgate Square acquisition is accretive. It's one of the main drivers in raising the 2016 guidance. With the amount of OP units issued as part of this transaction, it's properly levered and does not stress the balance sheet. As our Company continues to grow, we increased estimated G&A expenses for the year due to additional employee costs. However, our G&A ratio has continued to decrease.

The updated average shares outstanding takes into account the OP units issued in the Southgate Square transaction as well as increased use of the ATM program during the year, as I mentioned earlier.

Before we turn to Q&A, I'd like to make a comment about next quarter. We do not expect the second quarter normalized FFO to continue at the same run rate due to the natural fluctuations in the construction company earnings.

I'll now turn the call back to Lou.

Thank you, Mike, and thank you for your time this morning and your interest in Armada Hoffler. Operator, we would like to begin the question-and-answer session.

Thank you. (Operator Instructions.) Dick Schiller, Robert W. Baird.

You guys talked about the Johns Hopkins Village development, and I noticed from the supplement that the stabilization date was pushed from Q3 2017, or from Q3 2016 to Q3 2017. What was the reason for this extension? With all the preleasing that you mentioned on the call, that seemed odd to me.

Thanks, Dick. We're trying to be cautious there with what we're reporting. The building is close to delivery. Preleasing has been going great. But as you know with student housing, there's going to be a big crunch right towards the end of August. We're feeling that it may well not stabilize by that time. And when it doesn't stabilize by August, then your next window isn't until January. So we wanted to be a bit conservative with our forecast there.

Okay, sure, that makes sense. And then with the properties that are under valuation to be sold at this point, are those mostly from the recent retail portfolio acquisition, or are those some core properties that were previously included in a portfolio?

Yes, what we referred to earlier was the one -- we had always intended to resale five of those non-core assets out of that acquisition. We now have three of them under contract and one under LOI. The fifth one is an interesting proposition that we're still looking at. It may well be something that we end up keeping, but we're not there yet.

Got it. Okay, great, thanks. And I think Dave is on. He might have a couple of follow-ups.

Yes, good morning, guys. I did want to touch on something. Mike, you had talked about maybe a cash-out refi on the bulk of the Town Center. Can you talk about the types of proceeds, maybe a range that you're expecting out of that? And do you look at that as an opportunity to pay down other debt in the portfolio, or is that acquisition capital that you're looking to deploy?

Yes, so we have the three block accounts that are coming up for renewal in September, have one term sheet in hand at $34 million -- $35 million -- which is around $5 million to $6 million greater than the maturity. Expecting some more quotes in here over the next couple of weeks. Our thoughts are if we can get -- to take the extra $5 million or so and take that and have that capital to put towards other things, like you said, towards acquisitions or development.

Okay. And as you look at your line, I think you said there's about $100 million outstanding out of the $150 million availability. You've got the asset sale proceeds coming in. Are you looking to do some kind of term debt on that or maybe increase the line to pursue more acquisitions? Talk a little bit about the financing strategy with respect to putting more capital to work.

Yes, so we are going to take the proceeds of $32 million or so from the sale of those assets and pay down the credit facility. As far as terming it out, we would have done that this past quarter. We increased the term loan by $50 million. We went from $50 million to $100 million on the term loan and used those proceeds to pay down the line. One reason we did that was because as part of the big acquisition, we used the line to fund the acquisition that was over and above the 1031 exchange money. And part of that, we ended up purchasing more assets than we really wanted, so hence the sale of those five assets which are under contract to pay down the line.

Great. Last one for me. Maybe, Lou, talk about the environment for new development projects. Sounds like you're seeing some good opportunities out there, but really interested in how the overall pipeline fits in with the risk profile and if you're comfortable expanding that pipeline further at this point.

Thanks, Dave. That's a great question, and it probably would take more time than we have here. We're continuing to see an abundance of opportunity. And again, what everybody should recognize on the phone, this is much more of a rifle approach than a shotgun. Now, as you guys know, we don't -- we look at not only markets, but submarkets and specific areas within those submarkets for the opportunities that we're going to invest in. We're seeing those types of opportunities across the board in all of our markets, and so we're basically cherry-picking what we believe to be the best.

We don't want to expand. We don't want to get out over our skis. We've told people that this run rate is $150 million to $200 million every 18 to 24 months. We're skewing a little bit to the higher end of that range, but it must be said, this isn't a commodity business. The reason we're able to make these spreads that you've seen us monetize again and again is because they take a tremendous amount of effort and a tremendous amount of executive time in order to bring to fruition. It's not something that scales up easily, nor are we that interested in doing it. We've been doing it the same way for over three decades, and that's going to continue to be the process.

Great. Thanks, guys.

Rob Stevenson, Janney Montgomery Scott.

Lou, when you look at your office portfolio today, Oyster Point's essentially under sale. Is it other than maybe the Chesapeake asset, is there anything else that you're considering non-core going forward in the office portfolio as a source of funds down the road here?

We still have a couple of single-tenant build-to-suits. They're somewhat small. There's the State Office Building that we're not really viewing as core, but we're also not anxious to sell. But so we're fairly limited in what else that we would recycle on that end of the portfolio.

Rob, I'd just add onto that. So those two single-tenant office buildings went into service a little over a year ago at this point in time. And under the REIT rules, once we hit the two-year mark on that, we can sell those and not be a sale of inventory under the tax rules, and we could take those proceeds at that point in time and keep them in house and not have to worry about a 1031. So that's another reason that I think we'll be a little patient and make sure we get beyond the two-year point.

Okay. And then as you look at the retail portfolio, so the retail has gotten to be a bigger percentage of the NOI. Is there stuff in there, other than potentially the remaining Texas asset, that you guys may look to cull over time as you continue to add more retail? From an acquisition standpoint, is there stuff, whatever you classify in the bottom quartile of that portfolio today, as for recycling or, given the size of retail and where you want it to be, is it you're not really interested in selling retail at this point?

It's a really good question, Rob. It gives me an opportunity to, again, reiterate our philosophy. We don't fall in love with real estate. All these assets have a peak value, and we're constantly looking at the portfolio to see if we're at peak value and we're going to be looking at slower growth going forward. So I would tell you that there are opportunities for recycling in there. There's nothing imminent just now, but it's something we're very mindful of and not afraid to pull the trigger.

Okay, and then on the Southgate asset, you mentioned that Staples is a tenant in there. Have they already either leased or been downsized into their smaller footprint, or is that a risk for you guys going forward?

Thanks again, Rob. I'm going to turn that over to Eric Smith, our Chief Investment Officer, who headed up that acquisition.

Yes, I appreciate the question. So that lease is a 28,000-square-foot store that comes up in 2017. Our reconnaissance, our due diligence process, is that they're happy at the center. We have not heard the specific request yet that they'll be looking to shave square footage off of that lease. We obviously are familiar with the general trend that you mentioned, so part of that diligence was if that tenant or, quite frankly, a couple of the other larger box tenants there, show up and want to have that 3,000-, 5,000-, or 7,000-square-foot, et cetera, discussion to shave off some square footage, we're very comfortable in the ability to re-lease that space, and arguably, at a rental rate pickup in the process.

Okay. And then just lastly, on the Harper Hill Commons asset, where you're 79% occupied, is that all small space, or is there some big chunks in there to lease up? And how is re-tenanting going in that space these days?

Again, this is Eric. It's mostly small space, or it could easily be partitioned into small space. And the leasing, I would say, is reasonably solid. We think we have some things in the pipeline that we'll be able to talk about in the near future. So we're pleased with the activity, despite the fact you haven't seen that number move significantly quite yet.

Okay, thanks, guy. Appreciate it.

Let me add something else to that, Rob. Again, something else we look at very closely. When we purchase an asset, particularly on these retail centers, obviously, we're looking at credit and we're looking at location and all of the things that you typically would look at. But something that's very near and dear to our heart is sales per square foot in the existing anchors. When we see real high volume in those anchors, then we feel real good about recapturing space and being able to re-lease it. And when we don't see that, we don't pull the trigger and buy the asset. So I think, if you look behind the numbers and much more granularly into what the actual tenants are doing in the space that we've acquired, you'd be pretty impressed with the kind of sales volume that they're doing.

Is there any out-parcel carve-outs potentially at Southgate, given the size of that center?

Eric?

There is. I don't know if we've spoken about it before, but as Lou mentioned, we acquired this asset from the same seller pool who had transacted Dimmock Square with us. And at the time that we looked at Dimmock Square a couple of years back, we had looked at this Southgate asset as well. At the time, it was anchored by a Kmart. We were not comfortable with the Kmart, and so we obviously didn't transact at that time. Since then, that Kmart has been redeveloped, and two-thirds of that pad square footage is now the new Burlington lease that was mentioned, the 15-year Burlington lease.

There is the residual square footage of that pad that's available for redevelopment, so that is one opportunity that exists. The second opportunity is there is some parking lot area out upfront. It is not a near-term opportunity because it is captured in some sight line causes through some of the various leases. But longer term, as those leases come up and expire or are renewed and we have the opportunity to have those discussions about those sight lines, we think there might be an out-parcel opportunity there as well, longer term.

Okay, thanks, guys.

John Guinee, Stifel.

Great. Yes, I've got some questions on page 16. But first, hey, Michael, could you re-explain the profit on the police station, exactly how much that was and what lines that ran through?

This is -- we had contracted, or, say, did a purchase-and-sale agreement with the City of Newport News to develop the police precinct at the Brooks Crossing project. That was structured as a sale, and negotiating the sales price with the City of Newport News, at least they knew our cost upfront as we went into that and basically set that up as our gain on that sale would be equal to our construction fee, which was $430,000. On our income statement, that's included on the gains on sales of real estate, so it's in there on the income statement. And in our FFO calculation, when we go from net income to FFO, when we back out the gains on sale, we're only backing out the gain from the Richmond Tower in there, and thus leaving the $430,000 in FFO.

Got you, okay, all right. And then focusing on page 16, Lou, who's the developer on Johns Hopkins Village, Point Street Apartments, and Annapolis Junction?

On Johns Hopkins Village, it's us. On Point Street Apartments, it's Beatty Development Corporation.

Somerset Construction, or an SB affiliated with Somerset Construction, on Annapolis Junction.

Lou Haddad: (inaudible).

Got it, okay. And what you've got, essentially on this page, your total estimated cost plus purchase option is about $347 million against a total enterprise value of roughly $1 billion. So basically, you're going to be a serial equity issuer as these come onstream. Is that a fair way to look at it?

Not really, John. We're, again, this is the benefit of being an integrated real estate company. As Mike alluded to, we may well monetize those upon completion. We can also use them for 1031 exchanges with existing property. I would think it highly unlikely that we would simply keep all three and raise equity to properly lever them. I don't believe that's in the cards. Of course, you never know, but that's not our thought at this time.

Okay. And then on Main Street, essentially special occupancy a couple of years ago, stabilizing in a year. But you've got about 100,000 square feet to lease. Are there any tenants out there in the marketplace?

John, we have actively got a lease working for 14,000 or 15,000 feet right now. It's been slower than what I would have liked to have seen. We're happy to have some capacity here at Town Center. For many years we had to say no to the smallest of tenants. So I feel comfortable about having some space to lease going forward. But I would tell you that my expectation would have been that we'd be further along right now. The velocity of tenants just hasn't been there in those -- as far as the A-payers in that upper 20% rental rate. But again, I feel comfortable that they'll be there. This remains the best address in the region.

Got it. And then on One City Center in Durham, my understanding is that's an office-retail plus a condominium?

Yes. As well as multifamily for rental.

Okay, so you've got condo and for rent?

Not us, but yes.

So what would -- you're in there. You're in the entire project as a 37% joint venture, but for the office and retail 100%, or how exactly does that work?

Yes, let me make sure we make this clear. We are not a participant in either the residential for rent or the residential to own. Our joint venture partner will own both of those segments, which will ultimately be 63% of the venture. Our 37% is a 100% stake in the office and retail. And quite frankly, we believe that our partner's going to do real well with his residential. We could not get comfortable with the underwriting in order for us to participate there. And that, again, exercising some discipline, we insisted that our stake be limited to what we felt comfortable with.

So how are you able to do that on an off-balance-sheet basis if you ultimately are owning 100% of two of the four components?

John, the way the joint venture is structured, so from a debt standpoint, what we have here is one loan with two notes that the joint venture took out, with us guaranteeing the office and retail and our partner guaranteeing the residential piece. The big area from a GAAP standpoint, or the reason that it stays that way is because the notes are cross-collateralized. So there is a cross-collateralization there. Certainly, we've done everything in the operating agreement to protect ourselves if anything happens with our partners during this standpoint.

The other thing is we are -- we do not have majority vote in this joint venture. We have some blocking rights, but we do not control the venture.

So it's two individual construction loans, each guaranteed but cross-collateralized, which means essentially you're guaranteeing everything?

Just through construction.

Well, yes, you're guaranteeing it all, right?

Correct. But I'd certainly argue, John, that we spent a long time on this thing and making sure that within the operating agreement, we have the protection that we need on this project.

But help us just to understand this. You are guaranteeing both loans because they're cross-collateralized, so you are effectively guaranteeing the loan on the condominium aspect of this?

It's totally more complicated. Maybe we could talk about this offline, but I don't want to get into the way our partner structured his loan. But there's other aspects with the bank loan and the structuring of the loan that we felt comfortable with. And I'll gladly talk with you offline so we don't have to get into publicly talking about someone else's loan. As I said, we can (inaudible).

A very good friend of mine bought the top floor condo in that building, so thank you.

We'll be glad to go through that with you, John, offline. We got very comfortable with the way it was structured on his end.

Bill Crow, Raymond James.

Bigger-picture question and then a smaller-picture question. Bigger picture is with occupancy down in all three segments, and some of that due to basically just portfolio recycling, et cetera, but certainly there's got to be some impact from the broader economy. I guess my question is, is it feeling a little toppy, a little like we're nearing an end of the cycle? Maybe it persists for a while, but have we seen the best of times now?

Again, that's a fairly long discussion, Bill. I appreciate the question. First, let me say that 100% of the dip in occupancy was due to capital recycling. Essentially, when you sell 100% full properties and acquire some that are in the 90s, that's what happens. And so we have not seen any decrease in occupancy in the core portfolio.

However, our take is a little bit different. We believe that we've been bumping along the bottom for quite a while, and I'm not sure that there's an end in sight. What we're not seeing and haven't seen for quite some time is the general list of our tenants expanding. And I think as long as the economy continues to do what it's doing, we're not going to see a whole lot of internal growth from existing tenants. I hope that that happens at some point. Maybe this election will yield some results for us all. But no, we're not seeing toppiness. We're seeing status quo. And quite frankly, we're getting a little tired of it.

I hear you. The second question is, given the pipeline and the development in the construction company, are you comfortable at this point giving us an idea of where you think the fee income could be in 2017?

We haven't run those numbers yet. I'd like to think for the third or fourth consecutive year, it's going to skew towards the higher end of the range. There's certainly going to be some significant backlog. But not ready to comment on that.

Okay, thanks, guys. That's it.

Laura Engel, Stonegate Capital.

Well, most of my questions have now been answered, but I wanted to see if there was, I guess as far as the information you gave us on the project with the Residence at Annapolis Junction, is there a little more specifics on where you are exactly with that project as far as timing and moving on to next phases of that project?

Sure. This is Eric. We've broken ground on the project. As you can see from the disclosure in the supplemental, 2/2/16 start, with initial occupancy at the beginning of 2018 and stabilization approximately a year later, and so we're comfortable with that timeline.

Okay, and then I know you've gotten a lot of questions on industries and your thoughts. But is there anything that really -- what most concerns you about -- that coming year and changes in what you see with rates and occupancies, things you've already covered. But aside from that, I know you've given a lot of positive information. Anything that really concerns you going forward or that you all will really look for or avoid as you consider your capital recycling and what types of weights you're going to put in the portfolio going forward?

Laura, that's a lot of question.

You're sleeping well at night. We're all good.

I wish I could say we're sleeping well at night. Like I said before, we're not entirely comfortable with what's going out there in the economy. It would be nice if there as a rising tide and all the boats were being lifted. That's certainly not the case. We're having to do a tremendous amount of due diligence, more than we've ever done before we decide to pull a trigger on a project. One, because as you know, the underlying economy isn't all that strong. Secondly, when you look at the multifamily sector, we believe it's very late in the cycle. And so we're getting a tremendous amount of those opportunities thrown at us. And for the vast majority, they're going to be thrown back. But it takes a lot more due diligence these days for us to decide when and if to deploy capital.

Unfortunately, I don't see that changing any time soon. I can't wait until we can get on the phone here and give it the all-clear, but we're not there yet.

Okay. Well, again, thanks for all the information, as always. And we will look forward to following the story.

Craig Kucera, Wunderlich Securities.

I may have missed this, but what was the pricing on the OP units issued for Southgate Square?

Eric?

Great question. So when we valued that asset, we, as you know, price of OP unit and cap rate are somewhat of a fungible conversation between the two. As we were valuing that asset, we put the value in the low 7% cap rate, 7.25%-ish. At the time that we were negotiating that deal, our shares were trading anywhere from, on the high side, just getting into the $11 handle, and on the low side, $10.40 or so. And so we priced those with an $11 handle, I think $11.10, which put, like I said, the cap rate, in our minds, in that lower end of the 7% cap range. But again, as you know, that math is somewhat fungible, depending on where you want to place the OP unit value at the time of the transaction and then associated cap rate.

Got it. Were there any nuances to this structure, where the seller deferred taking a dividend payment or anything like that? Or was it just straight OP units?

No, it was just straight OP units. That nuance in a previous deal was obviously associated with that development opportunity; in this case, similar to the Dimmock Square transaction we did with the same group of folks, just last day OP unit.

Got it, okay. And going through the dispositions of the non-core retail properties, I know at the time of that acquisition, I think the overall portfolio was about a 7% cap. I think the core were at about a 6.5%. Are you hitting the -- so the assets, at least, that are under LOI -- are you hitting the cap rates that you thought you would, or has there been a move to the upside due to choppiness in the debt market?

We're actually really pleased with the way this has unfolded. Take you on a walk through a little bit of history over the last four or five months in our disclosures. So the initial disclosure was that we were going into this portfolio on a cash basis just south of 7% for the entire portfolio. And then followed up that disclosure, I think, on a conversation on our previous earnings call that after we disposed of the non-core asset, that would leave the residual core portfolio in the 6.5% cap rate range.

Through a combination of a number of positive things -- our asset manager team getting hold of the asset, scrubbing the various contracts with vendors and managing expenses, as our asset management team does very well, getting into leasing activity, both renewals and some smaller new leases, et cetera -- they were able to add some NOI to the ones we're selling and improve the sales prices relative to the acquisition price for the non-core ones under contract, which obviously helps to apply those increased proceeds against the price of the remaining core asset. You then combine those same asset management activities on increased NOI and leasing, et cetera, to the core.

All that ends up putting you at a going-in cap rate on the whole portfolio on a cash basis at the 7.2% range. And it leaves you with the core asset, after you dispose of the four we've talked about, in a 6.8% cap rate range, which on a GAAP basis is a little bit north of 7.2%. So we're really pleased that we've seen about 30 basis points of movement, whether you talk about the entire portfolio or you're talking about the residual cap rate on the core portfolio in the I-85 corridor.

Got it. No, I appreciate the color. One last one here, just because we're getting towards an hour, I just want to talk about the mezzanine loan funding. The new loan at Annapolis Junction at 10% -- is that all current, or is any of that accrued?

Yes, it's all current.

Got it. And how should we think about the funding of both that and Point Street? Will those capital outlays be put down in line with any other debt? Or how should we think about when those would be fully deployed?

So certainly the deployment's going to, based upon the construction schedule and drives as we go along here, it will take probably most of the year until those funds are out.

Got it. So as we look at our 2017, then you should have, call it $67 million outstanding, at least until you guys decide whether or not to exercise your option? Is that correct?

Correct, yes.

Okay, thanks. That's all for me.

One second. I'd like to make one point clear. There was a question earlier about OP units. Since our IPO, we've done a number of these transactions, and now with this latest one, we're closing in on $50 million worth of OP units that we've issued in acquiring properties. In each of those transactions, the units were priced higher than the then stock price. And in each of those transactions, the unit holder has made money. As you might expect, that has more and more people bringing properties to our door. We're going to continue to be selective about what we add to our portfolio, but that program is working exactly as we had hoped, and the opportunities are continuing to increase.

Next question?

John Guinee, Stifel.

Just going back to these mezz investments, I think just to clarify, somebody had asked you whether these were current or accrued, and you answered current. In reality, the mezz -- the interest payments on these mezz loans are being funded out of the loan proceeds, correct?

Correct, structured just like a typical bank loan. It works the same way as a construction, as an interest reserve built within the loan, and it funds out of that.

And then if these deals work well, it's very easy to understand your purchase option at 88% upon completion. But if they don't work out well, you're still essentially buying these, aren't you, because you're in the mezz financing position? This isn't really an option, in that on the downside, you almost have to buy them because you're the mezz lender.

Like any mezz lender, we have that right, obviously. The developer has the right to take us out. We feel very comfortable with the investments that we've made, again as a mezz lender would, and we feel comfortable at the level that we're in at on that wholesale level. But yes, in essence, you are in first position to take that asset -- good, bad, or indifferent.

So when you're sitting there with your Board and you're talking through this kind of situation, are you better off being a general contractor with a (inaudible) and an option and protecting your balance sheet optically, I think, or are you better off just being 100% primary developer on something like this?

Well, again, you don't have the ability to be 100% primary developer because you have developers that have worked for a few years to get these things to where they are, and those people want their share of equity as well as development fee. So more properly, you have the option of being a joint venture partner from day one, with essentially the same investment but without any benefits that Mike has described.

Right, okay. Thank you.

Thank you. At this time, there are no further questions. I will turn the call back to management for closing remarks.

Well, thanks very much. Appreciate all the time that you guys have given us this morning. We appreciate you following the story, and we look forward to having a great year, and hopefully, you'll continue to follow it. Thank you for your interest.

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.