Alexandria Real Estate Equities Inc (ARE) 2005 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Alexandria Real Estate Equities first-quarter 2005 conference call. Today's call is being recorded. At this time, for opening remarks and introductions, I'd like to turn the call over to Ms. Rhonda Chiger. Please go ahead, ma'am.

Thank you for joining us today.

This conference call contains forward-looking statements within the meaning of the federal Securities laws. The Company's actual results may differ materially from those projected in the forward-looking statements. Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements is contained in the Company's annual report on Form 10-K and its other periodic reports filed with the Securities and Exchange Commission.

Now, we'd like to turn the call over to Joel Marcus. Please go ahead.

Thank you, Rhonda. Welcome, everybody, to our first-quarter '05 conference call. Joining me today are Jim Richardson, Dean Shigenaga and Pete Nelson, so welcome, all.

I want to make a few very brief macro observations and then highlight some of the items of the quarter, have Jim comment on a number of real estate-related matters and then go to Dean for accounting issues, and then it open up for questions as soon as we can.

First quarter evidenced a somewhat-shaky economic picture. Obviously macro fears of higher oil prices and potential accompanying inflation certainly were there. For our sector and particularly, certainly the impact of the Vioxx recall, the safety of the Biogen Idec MS drug, Tysabri, became important news items. I think, on the positive side, kind of a one-word would be Genentech. In many cases, their four cancer drugs have overwhelmingly become very, very hot and impactful in the market place, Avastin for colon cancer, herceptin for breast cancer, Rotuxin for non-Hodgkin's lymphoma and Tarceva for lung cancer. In fact, during the quarter or shortly thereafter, Genentech's market cap passed Amgen's by about 74 billion, which is a pretty big milestone. Then as most of you know, the recent selection of San Francisco and Mission Bay for the headquarters of the California Institute of Regenerative Medicine, which will essentially administer and dole out something in the range of $3 billion over the next ten years, certainly was important news both for I think Mission Bay and for San Francisco. In fact, we have noticed, since the Prop 71 was passed, quite a number of scientists and other companies have in fact targeted the Bay Area for moves and we know of a number of specific cases already. So we believe this is going to be impactful for our efforts at Mission Bay and believe Mission Bay will be one of the two top submarkets in the Bay Area in the years to come.

Moon moving to earnings, guidance and dividend policy, it was a solid first quarter at $1.19 per share diluted. Our revenues and FFO in general were up nicely. Again, the economy is in a modest recovery mode but commodity prices still are a worry.

Guidance, we have amended guidance upward from 4.78 to 4.79. Back-end weight that. We were hoping to give '06 guidance and we hope maybe to do that in August. The big factor there for us is that we have two noncore assets that are important assets, fully occupied, which are likely to be sold in '06. Those situations are evolving, and we will have hopefully better color on that in the near future. They are not yet finalized for discontinued operations. They will impact '06 and clearly, we will look to replace that NOI by recycling that capital into strategic core assets.

On the dividend policy, the Board will obviously continue to look at the dividend. We still maintain one of the lowest payout ratios in the office sector at about 58.9%, so we clearly have continued room to grow the dividend.

Moving onto the operating and financial performance and some of the key metrics, again same-store GAAP growth was up steadily at about 1.6%. Again, we believe we are about the only office company out there to have had positive same-store sales per quarter every quarter I guess for the last 31 reporting quarters, a feat that we take great pride in.

It was a solid leasing quarter. Jim will give some detail on that but overall, 24 leases at about 378,000 square feet and a 12-plus increase in GAAP rent, which we think is very good, with an average lease term in kind of the medium range. Our average lease duration of our top 20 tenants remains in about the 7.5-plus year amount and so -- or year duration, so we feel good about that.

Occupancy this quarter down to 42% and this was principally due to the nonrenewal, from our standpoint, not the tenants' standpoint, of a lease in Seattle. Jim will give highlights on what we're doing to re-lease that space. Dean will comment a little bit more on some of the other factors, but if you look at the overall occupancy at 94%, we think that's in fact pretty good. If not a rate-weighted -- rent-rated occupancy, sorry, (indiscernible) we have one building that's weighing down the Southeast, an office building we hope to sell at some point that's only 30% occupied, so that does weigh down those figures, but we think, again, pretty solid quarter.

As of the end of March, our land bank for development was a little over 4.5 million square feet and redevelopment over 500,000 square feet. We are working intensively, as we speak, on our entire Mission Bay project, where we have total entitlements to date in excess of 2 million square feet. We are also pleased to report progress on redevelopment and development, redevelopment where we've got I think good momentum and the same thing on development.

Our operating margins dipped a bit this quarter from the traditional about 78-plus% to about 77.1%, primarily due to acquisitions with inherited leases. Hopefully, as those turnover, the margins will even bounce back up but so at 77% I believe, I think BFA (ph) (indiscernible) issued on March 4 of this year reported that we were the fourth highest operating margin in their selected universe, so again feel very gratified about that. Solid coverage ratios this quarter at 3-4 on overall interest coverage in 2-3 on fixed charge, no current reserves for bad debts or on account of rental revenues, so again very, very good operational statistics.

External growth -- our strategy has and will continue to remain focused on our key life science clusters. We did enter the international market with one acquisition in the Canadian market this past quarter. We feel very comfortable and good about that particular deal and building a bigger presence in that market. Our goal, obviously, is to achieve the highest return on invested capital practicable, and we have been and continue to remain very disciplined in a pretty frothy market. You know, we will not pay in excess of replacement costs, or very high costs per square foot or for old or shell buildings, and we've been much avoided competitively-bid situations because there's no obvious advantage in those cases. Again, we view ourselves as a highly value-added operation and that's where we will continue to focus.

The acquisitions we closed this quarter -- again, we are relatively opportunistic -- virtually all sourced-out market -- one in the Bay Area, which is in redevelopment. The remainder are fully occupied and we feel good about that. Average costs on the acquisitions was around 238 cost (ph) per square foot less than replacement. Cash on cash yields, Day One in a -- we think is very solid and again, we feel like we've exercised great prudence and discipline in that market. Completed acquisitions on the additional development land parcels, we talked about some 830,000-plus square feet this quarter.

Moving to the balance sheet at capital markets, we have continued to maintain I think a strong and flexible balance sheet, 44% debt-to-total market cap at quarter end. Our target leverage will remain generally in the mid-40s at this point. Our variable fixed-rate debt, which Dean will talk about, we've got about a 60/40 situation. Obviously, we do need the line for both development and redevelopment, but our target goal is to move that more into a 50-50 range with the 50% that's variable at least 50% hedged. We're moving -- in the process of moving a chunk of variable to ten-year fixed-rate debt.

We completed a public offering, as you noticed from the press release in the quarter -- about 1.4375 million shares and our goal was to match-fund that and minimize dilution, which I think we've done, given that we've raised guidance for this year.

Let me now turn it over to Jim for his comments.

Thanks, Joel.

I'm going to start with some broad market commentary, as I typically do, and then -- (technical difficulty) -- move into more specific dialogue.

Leasing conditions in the submarkets that Alexandria resides in continued to show steady improvement. The overall market indicators continue to move in the right direction. Some of the submarkets are actually bouncing back very quickly, and I think that, generally, the markets we are in are characterized by rent stabilization and we are seeing modest growth occurring on a more broad basis.

One of the things that certainly is not unique to our experience but which has been extremely persistent is the supply/demand imbalance on the capital flow side. The availability of product and competition to purchase assets continues at what we believe are unprecedented levels, so much so, the transactions are really moving further down the risk spectrum to second-tier submarkets and not stabilized properties, which we think indicates not only a continued supply/demand imbalance but also some more confidence in overall market conditions.

Just very briefly, a Bay Area anecdote, recently with EOP putting on several substantial portfolios on the market, and one of the predominant, legendary developers in the region, (indiscernible) Yaga (ph), putting 5-plus million square feet of their portfolio on the market. It has been a really unique dynamic to observe. There's been tremendous interest in all of those portfolios and again, with a common characteristic that is unique to what we had been experienced (sic) previously, lease-up risk and the overall scale and size of the portfolios, so the pricing, market risk and relative returns in this environment are certainly very challenging.

But what that does is it validates what we think is a strong and diversified growth strategy, combining a land bank with the assets that have substantial magnitude and the best locations, steady flow of quality redevelopment product, and an operating portfolio that provides consistent, positive same-store growth, as Joel referenced in his introductory comments. We think, despite some pretty extraordinary challenges in this acquisition environment, the unique niche that we are operating in and this unparalleled network we developed over a long period of time really continue to provide us with great opportunity.

Well, we're going to start doing on our quarterly calls is a new feature -- is to provide some highlights on a particular market or region. This quarter, what I want to do is talk about actually two specific submarkets and/or regions, suburban Maryland and the Mission Bay area of San Francisco. I'm going to start with suburban Maryland. This is the Company's largest core market with 2.5 million square feet of existing property and a land bank in the key cluster locations exceeding 0.5 million square feet. The operating portfolio has less than 5% vacancy, so this is clearly a key submarket for the Company but it's also (indiscernible) become a very important cluster for the life science industry as a whole here in the United States.

As we've talked about before, every region has similarities but generally do come with a unique set or balance of drivers. In Maryland, those drivers are the proximity of the federal government, the heavy current focus publicly and privately on bio-defense initiatives, and maturing commercial for-profit core group of companies. The real concentration of this cluster is located along a stretch of the freeway called the I-270 corridor between Bethesda, Rockville and Gaithersburg. Embedded or approximate do this cluster along I-270 are a variety of different government agencies, NIH, NIST, the FDA, Army Corps of Engineers, Tiger and a number of affiliated research institutions, many of which are ARE tenants.

Also, a key growth driver that we've observed over the past and benefited from in the past five to seven years is really a maturing for-profit and commercial company base. Medimmune and Human Genome Sciences are two of the largest biotech companies in the country by most measures. Celera has a prominent position there; they are a well-diversified therapeutic, genomic and drug discovery company. There's also a core group of Next Generation firms that are making solid progress on the for-profit side. So the net result here has been the evolution and development of a diversified and broad tenant base that's very highly concentrated, from a geographic perspective, and has really become one of the most important R&D nodes in the country. As a predominant operator in the region, we've benefited tremendously from a focused, strategic and diligent effort in this cluster since the Company was conceived. I'm going to highlights a little bit later in my comments the leasing that took place in Maryland, which was fairly substantial in the first quarter.

Let me move to Mission Bay. I mentioned, in our last call, that we had done a January launch of our Mission Bay efforts. This is obviously a very important and critical component of growth for ARE, so we wanted to elaborate a little bit on some of the key compelling drivers here and briefly highlight the progress that's been made in the short period of time.

Mission Bay, for those that are unfamiliar, is a really unique cluster in the making. UCSF is the anchor; it's one of the premier research institutes in the world, and it's got a concentrated research campus that's in full-scale development there, which ultimately will consist of 2.5 million square feet either to be used by UCSF. Additionally, there are two specialty hospitals associated with UCSF that have an emphasis in the clinical study area that are going to be adjacent to their research campus. There are existing specialty research institutes existing already within Mission Bay, and there are several others that are pursuing sites currently. As Joel had indicated, there's a heavy interest from various components of the for-profit sector, as evidenced by several relocations to the area from other regions and states, despite a dearth of research space. The project has a very well conceived master plan and a robust infrastructure, and as anyone knows who has been there, its proximity to the cultural amenities of one of the most desirable cities in the world really give it a clear advantage in formulating this cluster.

Joel highlighted quickly the most recent high-profile achievement in the life science's realm in San Francisco with the decision of the California Institute of Regenerative Medicine to locate its headquarters there. This clearly is a very important win for San Francisco and Mission Bay in particular. However, we see it as much as a validation for the dynamic in this area as a driver in and of itself. We think there's a strong connection to having the proximity to the world-class research being conducted blocks away. It also clearly illustrates the community -- San Francisco community's commitment to be a player on an international level. So we are clearly very bullish on Mission Bay and believe it's going to evolve, become one of the most unique and important clusters for scientific research in the world. With all the necessary components, it's poised to truly capitalize on this new paradigm of patient care and drug discovery, which is translational medicine.

So with that, let me shift into some of the highlights from the past quarter. One the acquisition side, Joel did address this -- the acquisitions that we did in the first quarter really were in great alignment with the roadmap for growth that we have discussed on prior calls. Our acquisitions were consistent with the diversified and comprehensive outcome of our activities in '04 as well. Four of the acquisitions were stabilized properties in three different markets, including the new market in suburban Montreal that Joel reverenced, two key land parcels adjacent to other core holdings, giving us another 835,000 square feet for long-term growth and pushing our land bank over 4.5 million square feet, and then a redevelopment property in the important Stanford cluster of Palo Alto.

I think what is really important to note here is that each of these acquisitions, all of them, were sourced through our network, either purchased on an off-market basis through a direct relationship or with very limited exposure to the broad market. The result was favorable pricing below replacement, faster pricing and yields that are generally above those being achieved in the market. Although this may seem to be a little inconsistent with my prior comments, the reason we can do this is because the relationships and network that we talk about are real. We have a reputation for performance and integrity that we've established over our long track record period of time. What is really interesting is in six of these seven acquisitions, the post-transaction relationship of the seller was a key factor in their decision and obviously further validates our company and our efforts in this arena. So, we're going to continue to pursue this external growth strategy, consistent with the principles and discipline that have allowed us to be successful over an extended period of time.

Leasing in first quarter '05 -- solid quarter with a run rate 30% ahead of our 2004 figures, GAAP increases of 12%. We ended the quarter at the upper end of our range of annual guidance of 0 to 10% on a full calendar year basis, and we had activity in all eight regions with a predominant orientation to the East Coast. About three-quarters of the activity was on the East Coast. Also, as I referenced briefly before, very strong activity in the suburban Maryland portfolio, which represented over half of the leasing activity in the first quarter. Many of the new and renewed leases were actually in the bio-defense and vaccine area related both to detection and development.

2005 rollovers, as we see them today, over 300,000 -- a little bit over 300,000 square feet for the remainder of the year. About 60% of that is in the second half with a majority of that weighted towards the fourth quarter. Our current projections show about 60% either committed or in negotiations and anticipating commitment with most of the balance being in the Sylvan (ph) marketing phase or too early to tell, which is very consistent with the projections from last quarter. Again, we remained confident in our full-year projection of fairly modest increases in a 0 to 10% range.

For 2006, obviously a significant increase in the amount of rollover exposure, about 14% of the portfolio. Again, our projections remain consistent with last quarter's analysis. 25% of the space -- actually more than 25% of the space -- either committed or in active discussions and negotiations. Important also to note that two-thirds of the rollover is in the second half of '06 with a very heavy orientation to the fourth quarter. We are projecting, at this point, we're confident in projecting rental growth in the 5 to 10% range.

Let me move to vacancy. With a little bit shy of 400,000 square feet or 6% of the portfolio currently vacant, this does represent an increase of 120 basis points and is really related very specifically to one rollover in Seattle, as Joel indicated. Excluding that impact, the occupancy rate would have remained the same as the prior quarter. That particular rollover is in a multi-tenant office lab building. There has been significant market interest. We've been marketing this space over the past six months. We are in active negotiations on much of the space and we are confident in our ultimate success here. It's in the heart of one of the primary medical research submarkets with very limited vacancy, and we anticipate substantial retenanting in '05. So, as we look at kind of projections on that segment of the portfolio, about a third of it we have either leased or are negotiating and the balance we are continuing to market.

So in conclusion, I would just say that activity on all fronts related to our portfolio performance continued to be steady and encouraging as we progress into the second quarter.

With that, I will turn it over to Dean.

Thanks, Jim. I want to spend a few minutes on highlights of very important financial and accounting matters for the first quarter of 2005.

We continued to execute and deliver on our unique model for growth, providing for our 31st consecutive quarter in growth in FFO per share and, as Joel had mentioned, our 31st consecutive quarter a positive same-property growth on a GAAP basis.

FFO for the first quarter of 2005 was $1.19 per share diluted, which represents an increase of approximately 8.2% over the first quarter of 2004.

I briefly want to remind everybody that we've consulted with our auditors regarding the lease accounting issues that are being faced both by real estate and non-real estate companies. We've not identified any issues in our lease accounting. I want to also point out a key fact that our financial and 404 audits for 2004 were extremely clean with no adjustments or deficiencies.

Moving over to highlights of our operating assets, as Joel had mentioned, our statistics for our operating portfolio continue to reflect the overall stability of our operations. Occupancy for the first quarter of '05 was 94.0% as compared to 95.2% for the prior quarter. What is interesting is, if you exclude the vacancy from the operating properties that we acquired in the last two quarters, occupancy for the first quarter of 2005 would have been 94.7% as compared to the 94.0%. In addition, our occupancy statistics for the quarter also included approximately 70,000 square feet of vacancy, or approximately 1% of our operating portfolio rentable square feet, related to one lease that we elected not to renew in the first quarter.

A couple of key points here -- first, the occupancy stats again would've been approximately 96.4%, excluding these two items that I just mentioned. Second, as we had previously discussed last quarter, our level of occupancy provides us with an opportunity to grow operations within the operating portfolio.

As Joel had mentioned, our margins continue to remain very solid at 77% for the first quarter compared to 78.3% for the fourth quarter of 2004. This slight decrease in margins reflects the impact of vacancy and recently acquired operating properties, certain recently acquired gross leases, and the simple fact that triple net leases with a certain level of operating expenses may actually have margins lower than our historically solid operating margins.

77%, I believe, remains a good run-rate on a go-forward basis. Just to point out again that we have 91% of our leases that provide for the recapture of certain capital expenditures. Therefore, CapEx does not have a significant negative impact on our margins.

Moving to same-property results, as Joel had mentioned, our same-property results remain truly remarkable at 1.6% on a GAAP basis, 4.6% on a cash basis. I guess what I want to point out here is, historically, same-property results on a GAAP and cash basis have moved around a bit in relationship and there's really nothing odd in the difference between GAAP and cash same-property results. More importantly, as we had mentioned earlier, this quarter, the first quarter, represented our 31st consecutive quarter of positive same-property results on a GAAP basis. Smith Barney had noted that we were the only office and/or industrial REIT with positive same-property growth since we went public in 1997.

Most of our same-property results for the quarter resulted from increases in rental rates with a slight increase due to increase in same-property occupancy. Same-property occupancy for the first quarter of 2005 was 95.6% versus 94.9% for the first quarter of 2004. Our guidance for 2005 for same-property results remains fairly consistent at 1.5 to a 2% range for same-property NOI growth on a GAAP basis.

Briefly, on FAS 141, the Company complies with the provisions of FAS 141 and allocates the purchase price of real estate acquired to the various tangible and intangible assets acquired. None of our acquisitions in the quarter had FAS 141 adjustments for above or below market leases that would impact FFO. Our straight-line rent adjustments for the first quarter were approximately 3.3 million. I think, looking forward into the remainder of 2005, 3 million per quarter would be a pretty good run-rate.

Moving briefly to our debt strategy, as of March 31, 2005, our debt-to-total market cap was about 44% with about 68% of that being fixed-rate debt, about 32% being variable rate debt; this is after consideration of the 350 million of swaps in effect at March 31, 2005.

In May of 2005, we executed interest rate swap agreements for an additional 75 million in notional and will continue to evaluate additional hedges against our variable-rate debt, which is so important in funding our non-stabilized value-added redevelopment and development assets. We are also working on the conversion of 50 to 100 million of variable rate debt to fixed-rate debt over the next few quarters.

Again, briefly in our redevelopment and development programs, we feel it's important to make a few statements. Our redevelopment and development value-added programs are integral to our strategic roadmap to growth. These programs involve the strategic conversion of and ground-up development of life science properties in key life science cluster markets at attractive yields. Our redevelopment program involves the permanent change in use and conversion of the infrastructure and generally takes 12 to 24 months for full building conversions and requires an investment in the range of 75 to $90 per square foot. Our development program generally takes 24 to 36 months with a much larger investment than required for our redevelopments.

Briefly, on accounting for redevelopment and developments, capitalization of interest is required under GAAP, under FAS 34 and FAS 67. Interest is capitalized during the period; activities are ongoing to prepare an asset for its intended use; and capitalization of interest is discontinued when a project is substantially complete.

Consistent with our prior quarters, we feel that it's important to briefly comment on NAV. We believe that ARE is truly a unique company and not just a collection of assets. Our growth and therefore a substantial portion of our value is derived from nonfinancial measures, our distinctive business model, our franchise value, our people, our network and our reputation. These key factors have distinguished us and will continue to distinguish us from other REITs and real estate organizations. We do encourage observers who want to try to evaluate Alexandria on a NAV basis to fully consider the additional value of our development and redevelopment programs.

Lastly, briefly on our guidance and consistent with our prior disclosures of our policy, we do not comment on individual detailed assumptions going into our guidance. As Joel had mentioned at the beginning of the call, FFO and EPS guidance has been revised and updated to 4.79 and 2.43 respectively for 2005. As you will recall and as you may have noticed that our EPS guidance does not always move in concert with our FFO guidance. It is impacted by our depreciation expense, which we adjust as we get better visibility of in-service stage for developments and redevelopments and specific dates for any acquisitions or dispositions.

With that said, I guess I will turn it over. One brief comment I should probably add is cap interest for the quarter was approximately $6.3 million, and the increase is primarily due to a couple of things, a higher level of basis of qualifying project under construction an and increase in our weighted average interest rate use for capitalization of interest.

So with that said, I will turn it back over to Joel.

Okay, operator, we would like to it open up for questions, please.

Thank you, sir. The question-and-answer session will be conducted electronically. (OPERATOR INSTRUCTIONS). Brian Legg of Merrill Lynch.

Can you explain the increase in capitalized interest in your comment about higher qualifying? Does that mean you're capitalizing interest on your land development sites like Mission Bay and so forth?

That is correct. Mission Bay and other projects that have been in the portfolio for redevelopment/development and other construction activities.

So does -- those qualify even though you haven't really effectively started building on those sites?

Yes. Actually, under GAAP, GAAP actually requires capitalization of interest while activities are ongoing to bring the asset to its intended use. For example, on the Mission Bay project, you are correct; there is quite a bit of ongoing activities (sic) in the entire project to bring it to its intended use.

Okay. You talked about, you mentioned the 70,000 square feet of space in Seattle that you purposely did not renew. Can you explain the situation there? If you just look at your -- did the expirations versus what the leases you actually renewed, there was about a 160,000 square feet difference between the two. Can you sort of explain why you didn't have a higher renewal percentage?

Yes, let me just take the first part of that, Brian. I'd don't really want to get into the specific situation but it was a case where a tenant had come to us regarding potentially a renewal and expansion. Based on a whole variety of factors, which we would prefer not to detail, we decided that we would not go down that path with this tenant and that ended up in the termination of their lease at the end of the lease term.

Okay, the question, the other question that you had --.

There's a difference between the expiring leases and the renewal and month-to-month leases of about 160,000 square feet in total. It sounds like 70,000 square feet of that is this one lease. I just want to understand the difference. I think like 20,000 would be increased into your conversion pipeline.

Brian, just looking at -- it is a series of smaller spaces sprinkled kind of around the country. There is no kind of specific trend here or significant impact. It's in most regions, spaces ranging from 2,000 square feet to 10,000 feet, so it's really kind of broad with the exception of the one that we talked about.

Okay. Just the last couple of questions here -- in the last supplemental, you had 29,776 square feet in Seattle that was going to be demolished. That sort of fell off the conversion chart. What happened to that space?

Right. Actually, we think, as we began to think about it -- because a lot of people wondered, well, why would you have this item in redevelopment for many years. It is a site that's adjacent to an existing large facility that is essentially a tear-down. So we decided that it probably would be better just not placed in redevelopment because what will actually happen is the tear-down and a brand-new development. So, that we've just recharacterized it as such.

Okay, but it doesn't show up on your development either, so I -- (multiple speakers) -- sort of like a land bank right now then, right?

Correct. There is an existing, old building there that is -- all the tenants are on month-to-month, so we just decided to leave it there because it just got too confusing for people looking at it, what it really means and it probably is better as a future development site rather than an active redevelopment site.

I got you. The last question, your 45,000 square foot building, I believe they're in Torrey Pines. It dropped off the construction-in-progress.

Right.

What was the leasing percentage on that and yield?

Yes, it was delivered during this past quarter. The leasing percentage was, I believe -- Jim?

75% -- (multiple speakers).

Yes, it was either 75% to 80% of the building. The yield I really can't give you because we got a very good market rate in Torrey Pines; it's kind of a probably -- it may be the premier location. We had a 0 basis in the land because it was in a site that we had previously bought and built and allocated. So you know, I would say it was a very, very strong yield and certainly a very good return on costs as well, assuming even a 0 land basis.

Moving on Jonathan Litt of Smith Barney.

It's Jon Litt. I'm here with John Stewart. A couple of questions -- can you talk about the amount of capital that you need to fund your development and your redevelopment program this year and next year?

Yes. Maybe starting with this year, if you look at redevelopment, we probably incurred about $30 per square foot to date and probably about $65 a square foot remaining. On development, we've got about maybe somewhere in the range of 2, or a little less, a little more, $200 a foot incurred to date with about somewhere between 50 and $75 a square foot remaining.

Now, when you say, if you look at it, I should be looking at what? Pages 13 and 14 to get your --?

Right. If you just took the development, you know, what's in development, the square footage that is there -- which is what? 312.

Yes, 312.

So of that, we've got about 200 to date just round numbers per square foot that's actually into the project and about $75 a square foot -- yes, actually probably even higher, probably maybe 80, $80 a foot left. In redevelopment, if you go to the page after this, the 613-14,000 square feet, $30 a foot to date and about 65, give or take, up or down, per square foot remaining.

I'm not sure I can give you -- we can get back to you with numbers for '06. I don't know that we have those instantly at hand.

Well, some of the redevelopment that is estimated in service dates are '06, so I assume some of that -- (multiple speakers).

Right, if you look those schedules. I wasn't sure if you meant things that we may be starting that may either starting this year or in '06 that don't show up here.

Well, I'm trying to get a sense. I mean, you just outlined about $65 million worth of expenses and your debt level is at 44% and debt with preferred is at 52%. We are kind of pushing the top end of where you've historically operated.

Well, yes, those were at quarter end, Jon, and those have come down since then -- that time.

The debt level?

Yes.

They came down through --?

Well, percentages. They've come down through -- on a debt-to-total market cap certainly -- (multiple speakers).

Whatever, debt to net asset value. But the question is, you know, you're -- I guess my next question was, I know you can't talk about the details of these asset sales, but could you give us ballpark ranges of how much proceeds you expect to see out of them? Is it a $100 million number?

No. I would say, gee, maybe -- yes, I mean, it could be anywhere from 25 to 40 million. That's the only two that we have a high belief in their happening, and there are six others behind those. At this point, they are pretty uncertain at this point but two are advancing.

So what's your thoughts in terms of funding the redevelopment and development program going forward? Are you going to look to do some asset sales to fund it, particularly if your land bank is growing?

Right. I think we would look at partially some asset sales. I think recycling makes sense, certainly with pricing in this market. I think there is -- we've been approached on one or two projects for joint opportunities for development, which we might very well consider. So, I think we will continue to look at the range of options there and pay careful attention to how best to maximize the return on invested dollars that we're putting in, for sure.

On page 14 on your redevelopment schedule, the amount of square footage you have under redevelopment is down; I think it's about 50,000 square feet from the last supplemental. Can you talk about what happened there, or how it came down?

Yes. Bear with us one moment here. There was one property that had been in development -- yes, in the Palo Alto area, that we have delivered. I think it is the first nanotechnology campus that I think has been built on the West Coast, and that was delivered. What also came out of there, Jon, was the tear-down that we just dialogued with Brian about, which was in Seattle, so that brought a little bit down. Then we also have delivered another building in the -- in Maryland.

On the deliveries, as opposed to the tear-downs, can you give us sort of ballpark returns that you're generating, not on specific ones but the range is that you think you are --?

Yes, cash on invested dollars -- I think it's fair to say you could assume they are into the low to mid teens.

That's on incremental invested or in total invested?

Incremental invested.

I was making a note. Can you give us -- do you have a sense of the average age of this redevelopment portfolio, the 600,000-plus square feet? How long has it been in redevelopment, on average?

I can do that.

Ballpark.

Yes, bear with me a moment. Yes, I would say, if you averaged them, you're looking at something between one and a half and two years.

That's great. I think John Stewart had a question.

Yes, just a couple quick follow-ups, guys. Jim, you mentioned 5 to 10% rent growth. Just to be clear, were you reverencing the mark-to-market on expiring leases or do you really see rents for your product type increasing 5 to 10% over the next 12 months?

That reference was for mark-to-market. I think I was reverencing '06 rollovers.

I got it. Then Joel, you referred to the yields on the acquisitions during the quarter as very solid, but I didn't catch a number if you gave it. What were the yields on acquisitions last quarter?

(LAUGHTER). Yes. We always like to kind of refrain from kind of throwing out yields, but I would say the yields on the acquisitions were north of an 8 cash on cash yields.

Then where do you think you could sell for with the dispositions that you have teed up?

The two that we are working on actually are sales to tenants, both of which are actually very nice properties but in noncore submarkets. So, I think -- but don't know. I'd kind of throw it to Jim maybe for a little bit broader preview, but I think, on these, these are nice turns to us, I guess, if we were to broadly market them. You know, it's a little hard to say.

Yes, that's a tough question to answer, John, because the lease itself is tied in with the right to purchase, and so the dynamic -- trying to calculate a return would be a little challenging as it relates to what market would be for the acquisition, because it was in kind of -- in each one of them, it was an integral part of the deal. If we went to market, I'm not sure we would do a whole lot better than what we are committed to under the leases.

But cap rates broadly on sales of our product -- if we went to market in some of our really core markets, I think you would see cap rates in the 7 range.

So you think this will be an accretive trade?

Yes.

Then lastly, you had mentioned plans to term out some of your debt for ten years. What form will that take? Are we looking at another hedge, or -- (multiple speakers)?

No! No, this is actual movement of variable to essentially fixed-rate, either through CMDF (ph) life insurance or a loan type like that that has a ten-year duration.

Philip Martin of Stifel, Nicolaus.

Good morning, gentlemen. A couple of questions here -- regarding Mission Bay, what's the average time? I know you've talked about this a little bit in the past, but now with the Stem Cell Institute coming on here and choosing its site, does this speed things up for you a bit?

Yes. I would say, in general, probably the answer is yes, and maybe what may be even more important, although we think that's of significant importance, is really the rapid pace -- and Jim alluded to this -- at which UCSF is building out their campus and their impending approval of two specialty clinical hospitals, which I think will even make it more -- probably put it on a faster track than it is. We are working -- I mean we right now own 2.1 million of square feet of entitlements. We are working pretty broadly and pretty intensively on a whole range of site designs, site development work, and a lot of issues regarding infrastructure with Catellus (ph) as well. So I would think that we've announced one building kickoff; I think it's fair to assume that our timetable would generally be maybe more accelerated than we would have guessed, say, 90 or 180 days ago.

Can you quantify that? You know, there's 2.1 million -- (multiple speakers).

Yes, it's very hard to do.

(multiple speakers) -- the timing of that buildout is approximately what?

Well, I think, when we gave our first kind of view of that last quarter, I think we had talked about anywhere from like three to seven years. I think that's probably the right range, but it could be maybe even a little more rapid than we thought.

Okay, fair enough. You know, driving rent growth -- I mean, rent growth in the quarter certainly was pretty impressive. You know, what were the specific -- were there some specific or special drivers of that? I know improved office fundamentals is one thing; certainly tenant-specific demands and needs are another. Can you break that down for us? Was this a -- driving this -- was this a tenant need, tenant demand or was it improving fundamentals or was it kind of 50-50?

Okay, bear with us for one moment. We will scan the leases and try to get -- Jim will try to give you some color there.

Okay, that would be helpful.

While you looking that up, I just wanted to -- I just didn't write it quick enough. The May interest rate swap, that was 75 million?

Yes, it was 75 million in notional that we added to our swap program.

Okay, okay.

Philip, just looking at this, I hate to give it this answer all the time but it's the right one; it's just all case-by-case. The leases that rolled over at that point were just, you know, they were in the right position to take a good strong, positive mark-to-market. So, as I said, I think, on a full-year basis, we are pretty confident in the 0 to 10% range. This just happened to be a good quarter from that perspective.

Okay, that's fair as well. My last question -- on the lower operating margins, I know, as you mentioned, that's being -- it was driven down a bit because of some of the acquisitions and more gross leases than triple net, etc. Is the 78 still a good run rate, or will this kind of drag down the margin for another couple of quarters?

I think Dean maybe made a statement that I think if you assume maybe a 77 at this point, but that's -- you know, may wind its way up over time. (multiple speakers).

This is the last question -- can you quantify the overall development/redevelopment and land bank portfolio for us? I just want to update some of my numbers there. I know that we have the schedules here that show kind of '05, '06, but just to get a sense of the overall, the aggregate.

Yes. I think, earlier in the call, at quarter end, I think we had in excess of 4.5 million square feet in the land bank, and that excludes everything that is inactive redevelopment on that list. It is an active -- I'm sorry, active development. Much of that is inactive development but it's not under physical construction, if you will, so 4.5 at quarter end. That's growing a bit. On the redevelopment, I think the number is something in the range of almost 700,000 square feet of space that we have embedded in the portfolio, which could be redeveloped. Now, some we have -- this office that cannot be, but this is stuff that can be.

So together, the total is -- remember, in the land bank, that would be new square footage; on the redeveloped bank, that's converted square footage, but those are the two numbers that are useful as of quarter end.

The 4.5-plus -- and that 700 does not include what's on the schedule here?

Right, 4.6 in the land bank and actually the number is I think 682,000 in the redevelopment bank, not on the schedules.

Okay, then on top of those two numbers, then what's on the schedule as well, that's your aggregate?

Correct. Then the numbers we've invested and have left to invest that we talked to Jon Litt and John Stewart about, we've given you those numbers.

Exactly, exactly. I appreciate it. Thank you very much.

David Aubuchon of A.G. Edwards.

Good afternoon. First, a couple balance sheet questions - Dean mentioned the increase in capitalized interest was due to two factors, one the higher level of qualifying properties; the other was just a higher rate of assumed interest. Can you kind of give some background on the reasoning behind increasing that assumption?

It's not really a selective increase in the assumption; it's actually just a simple mathematical formula on the weighted average interest rate for the Company's debt. Under GAAP, we are required to apply the weighted average interest rate to the qualifying basis under construction. So both the basis and weighted average interest rate were up for the duration of the quarter.

Okay, so it's the 5.12% that you outlined in the supplemental?

That's actually just the interest rate of the -- wait, let me pull that page. That's not our effective interest rate. Let me pull that page. Hang on. It's really the cash interest expense, on average, of our outstanding debt at 5.2%, 5.12%.

Okay, so the movement in that number from quarter-to-quarter, Q4 '04 to Q1 '05 is approximately what?

The movement in the effective interest rate that we use for capitalization?

Correct.

It probably went up amount 25 basis points.

Okay. Then the 75 million that you hedged in May, can you give terms? What was the actual hedge?

Sure, 25 million of the notional was effective at December of 2005, December 31, and another 50 million of notional takes effect at June 30 of '06. They both go out three to four years.

And the rate?

I actually don't have that handy, Dave. I'll have to get back to you on that.

Okay. I'm not sure I followed the comments about the 70,000 square foot leased space that was elected not to be renewed during the quarter. Was that in reference to the Seattle lease or is that a different lease?

No, that is the Seattle lease. That actually was determined not -- it came about during the quarter, but it was determined well before the quarter.

Right, so the lease ended during the quarter?

That is correct.

Then so the -- and that was I guess it caused a percentage point or so of the vacancy decline?

Right.

So that -- but I thought -- I think Dean mentioned a same-store property occupancy that increased to 95.6 from 94.4. Is that correct? I'm just trying to figure out why the same-property occupancy might have increased but the overall occupancy dropped.

They are really different statistics on our occupancy, our operating portfolio, versus the same-store portfolio. It does consists of a different pool of properties, so you could have different statistics in the operating portfolio and the same-store pool.

Right, but so the 70,000 square foot lease was a multi-tenant or single-tenant building?

Yes, multi-tenant.

Multi-tenant building, and it was not in the same-property portfolio? I guess how long has it been known (ph)?

We will check.

Let me check.

While you check that, Joel or Jim, the difference between -- I think you characterized your yields that you acquired in the quarter on assets was 8%, north of 8%. The marketed transactions -- and obviously it varies by market -- but can you give just a general feel of where cap rates are? I think it's sort of somewhere around 7%. Do you feel that that number is continuing to drop as we -- over the last couple of quarters and maybe out into the rest of the year, in terms of the deals that you're seeing in the pipeline right now?

Yes, I would say that, remarkably, it seems to be just the Bay Area anecdote that I provided. There were dozens of serious buyers for each one of these portfolios, and these portfolios are not stabilized, so it's hard to actually -- you know, you can do a projected cap rate, but I think that you're seeing buyers justifying projected, stabilized cap rates below 8% for a product that has a lot of leasing risk. So I would say that my view of the world, based on the markets that we are in and the opportunities we're looking at, is that that has continued, that the excessive demand has continued to push assumptions to less-conservative levels and yields, down further.

Now are you referring to traditional, a more traditional type of commercial office space, or are you speaking to lab space?

I think I'm talking about both. I think, on the stuff that's maybe more closer to the line with what we do, it would be either lab space or a combination of flex -- convertible R&D space that's right in the middle of one of our clusters. So, it's kind of a combination of both.

So the premium that you get looking at non-marketed transactions versus traditional deals that are floated out to the market is 100 basis points-plus, that you save or gain?

I wouldn't say that. I would say yes.

Okay. Then, the two assets that you speak about in terms of selling in the future, you said the tenant had right-to-purchase options?

Yes, part of the lease negotiations with each of those -- and again understanding we are kind of noncore assets to begin with -- a requirement was a purchase right out into the future, so the negotiation was a combination of the overall lease transaction but obviously the negotiation of a price was fundamental to that.

Right. Both of those leases I believe were negotiated last year, so these-- other than those two leases, I don't believe we've any more -- well, there's one other but it's kind of a governmental entity on a situation. There are no other purchase options in the portfolio, but these are two. Actually, we're happy to make these sales. Just the timing is a little unclear at this point because, again, they are located in submarkets that we probably -- well, not probably, we had decided some time ago to exit.

Right, so the trigger on the purchase option doesn't necessarily coincide with the end of the lease?

Oh, no, for sure it does not. Yes. (multiple speakers).

They just have a right to buy certain ones.

Certain windows, exactly.

Then one last question -- (multiple speakers).

Hold on one second, Dean has one.

Dave, let me get back to your question about the same-store in that property and new vacancy that popped up in the first quarter. As you probably recall, our redevelopment properties are always excluded from our same-property results. This asset was actually under redevelopment last year. So, it will actually come into our same-store portfolio in the next few quarters, but it's not in there yet.

It's not in the schedule this quarter but it came off at some point within the last three quarters? Right?

It was under redevelopment -- are you saying off the redevelopment schedule?

Right. It was in the redevelopment schedule in the first quarter of last year, is what you are saying?

That's correct.

One last question was, one of the acquisitions you acquired in the quarter, the Bay Area I think, Joel, that was that property that is going into the redevelopment pipeline?

That's correct.

What was the general allocation or price, or just the price on that property? So, if you acquired $71 million of properties in the quarter, that was -- which we subtract out of there that it's not income-producing.

Per square foot?

Just a -- or the total price would probably be more helpful at this point because I don't know the square footage.

It was within about $12 million.

Stephen Mead of Anchor Capital Advisors.

If you look at your land bank or you look out into 2006 and 2007 and kind of creating an inventory of new developments, what do you see in terms of sort of the opportunities, based upon the strength of the markets, in terms of demand for the kind of space that you create, relative to the cost of that new development and creating an additional sort pipeline of stuff to come on stream in 2007? What kinds of things do you see out there? Are the kinds of things that -- would they require, say, larger buildings, or smaller buildings? I mean, what does it look like out into the future a little bit?

Well, the land bank is well-diversified among a number of markets, but obviously the predominant concentration, about maybe a little less than half of it, maybe 40, 45%, is in Mission Bay. I think, from the comments we just made with a number of the analysts, it's clear to us that the demand at Mission Bay will be actually quite robust from a variety of users, from commercial tenants, commercial life science tenants, not-for-profits and from governmental and/or universities as well -- or university. So we see that as actually a very robust, built-in opportunity because it's in the such a concentrated area. But if you look out over -- and those would be medium-rise type buildings, and the return on cost, based on rental rates and cost, certainly gets you to double-digit returns.

In addition, if you look at our other markets where we have land in the best submarkets of San Diego, actually University Town Center in Torrey Pines, we think again there is a decent demand in those locations, as well as in a number of locations on the East Coast. Other than Mission Bay, the other developments would be more low-rise buildings. Again, costs -- or returns on cost would be again double-digit in most of those locations. Some of that -- much of that -- (technical difficulty) -- a number of parcels outside of Mission Bay, we have a very, very low or a 0 basis on, so the returns clearly are very -- should be very good.

But is it fair to say, as you look out into sort of 2007 and 2008, based upon what you have to pay for, say, existing space, is the growth really going to come from, you know, bottoms-up new development versus redevelopment --?

I think it's clear it's a combination. You have traditional same-store growth where we've been, again, maybe one of the only ones to have positive every quarter rental growth from, you know, leases turning, as Jim talked about. Redevelopments become a very important part of that because they are very strong yields, and then add on development before you get to any external acquisitions. So that's kind of how we think about it broadly.

I think I would also add that the land bank is -- you know, our clusters are very mature areas, so this land bank is kind of embedded in those clusters. You know, Mission Bay is obviously a very large master plan project or product being master planned, but the balance of these or many of the other properties are kind of sprinkled throughout our cluster. We will opportunistically develop or redevelop them as market or tenant requirements dictate. So, it's kind of hard to give you a real strong answer about how to look at that in a broad way, because it is so opportunistically positioned.

Yes, there isn't a lot of room for developments in those locations. These are among some of the very few parcels that are available for development.

Is there a change in the kind of investment that you need to make in the space in terms of the complexity of the space and the dollar investment that you have to make in that space -- (multiple speakers)?

Yes, in general, no.

Anthony Paolone of JP Morgan.

Thank you. Joel, and I know you talked about the development pipeline a lot but I may have missed this. What were the starts, or what are the planned starts for 2005?

well, one for sure is 165,000 square feet at Mission Bay, which we hope this quarter, and we have at least one other that we will probably announce when we report in August. Beyond that, there could maybe one, one other beyond that, so there could be three in the near term.

What about size of the two potentials?

I would say one is about 70,000 square feet and the other is about 125,000 square feet, so maybe another 200,000, plus or minus. These are in markets, again, where there's space-constraint and not a lot of land for further development. The factors seem to be, as Jim said, favorable for matching either an existing tenant or a requirement we know is out there.

Okay. But you have the land for obviously Mission Bay; you have the land. But the other two, that's the land that is on the balance sheet now?

That's correct.

Okay. The 95,000 square foot development in suburban D.C., that comes in it looks like Q2 here. What is the occupancy there?

It's a single-tenant lease that we are hoping to finalize shortly and a configuration that's one that we've kind of gone back and forth from single to multi and now back to single.

Okay. Then, on the same-store NOI, I know most of your expenses are passed onto the tenant, but what drove or what is driving such high operating expense growth? It's up about a little over 10% I think.

Yes, that's actually pretty -- if you go back in history, that's not untypical of that. You know, most that's recaptured, but that's not untypical.

Okay. I mean, what exactly makes it so high, though? Because it's a little bit higher, I think, than maybe what other, more traditional office experiences?

I don't have the actual statistics in front of me, but there is a bit of some seasonality that does occur that may not necessarily be recurring seasonality trends in the same-store pool. My guess, this quarter, you did had some pretty heavy snowstorm situations to deal with and heavy weather conditions across both the West and the East Coast, so I think you're seeing the dynamic of that coming through (indiscernible) and again, as you have mentioned, most of that is recoverable.

Yes, a tough winter in Massachusetts and a tough winter in California, actually, rain-wise.

Okay. Then just one last item to qualify -- when I look at your summary of leasing activity in the supplemental, you start with expirations, 43 of them or -- (technical difficulty) -- thousand square feet. What is that exactly? Because if I were to look to your last supplemental in the fourth quarter, like all of your '05 expirations I think totaled 472. What's the 407?

The number of leases expiring this quarter. I believe those also include month-to-month in that.

They do and --.

You have to back out the 24 down below, I think.

You could have an early renewal situation that makes it hard for you to watch the numbers flow and add up.

So that could be, if someone has an early renewal option and they exercise it, so that would not be in, like, your normal lease expiration schedule. It would have the natural lease expiration, not the early renewal option? Do I understand that right?

I think that's correct.

Okay, thank you.

That's all of time we have for questions today. I will turn it back over to you, Mr. Marcus, for any closing or additional comments.

Okay, well, thank you very much, everybody, for participating in the call, and we look forward to talking to you come August (inaudible) Q2 '05. Thanks again.

That concludes today's conference. We thank everyone for your participation. You may disconnect at this time.