Alexandria Real Estate Equities Inc (ARE) 2005 Q2 法說會逐字稿

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

This conference call contains forward-looking statements within the meaning of the federal securities laws. ARE'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 our annual report on Form 10-K and other periodic reports filed with the Securities and Exchange Commission. Now, I will hand the call over to Joel Marcus, CEO. Please go ahead.

Good afternoon to everybody on the East Coast and good morning on the West Coast. Thank you for joining our second-quarter earnings call. I want to welcome everybody. This is the 32nd reporting quarter of ARE as a public company. We're pleased to report that the consistency, predictability and reliability of both our operational and financial track record have again continued really truly an outstanding effort and we appreciate it on behalf of all the employees of ARE.

With me today, Jim Richardson, Dean Shigenaga and Pete Nelson. I want to, as I always do, make a few brief macro comments and then move into some of the operating and financial results for the quarter. As everybody knows, we continue to note that Feds are pushing interest rates at least through year, which we certainly wave on our own view of the future. The Business Week, June 13th article cover story was on the stunning biotechnology medical progress and we think that some pretty important lessons in that article about the future of some of the most important products in the industry.

Also it's important to note, Senate majority leader, Bill Frist on the floor of the Senate, acknowledged that stem cell research has huge potential and if we as a society can get both the scientific and ethical policies right, it really has some huge implications and certainly for our efforts at Mission Bay, Jim will talk about that in a little while. Also Bill Frist did, at a Harvard Medical School speech in June, talked about what he views as the Manhattan Project for the 21st century, akin to the atomic bomb in World War II, our efforts there. He noted that the U.S. and the world must be prepared for the inevitable pandemics outbreaks that would be the natural, accidental or intentional result of the various chemical, biological and radiological situations out there today. Clearly, we as a company are very focused in the biodefense sector as we have talked about many times.

Moving to human drug trials. The NIH potentially or has announced that it may very well fund a number of clinical trials and this may have very significant a positive future or positive impact on the future of the pharma industry. It is also important to note that much more offshore -- much more than offshoring effective human drug trials, as an industry, it takes place as the industry really becomes much more internationalized. Again, Jim is going to have some details on Mission Bay but our initial 3Q start, this is this quarter not our former or our prior operating quarter, we have broken ground and are accelerating the development opportunity of over 2 million square feet in that market. Again, surrounded by or surrounding 2.5 million square feet of UCSF research space and another million of their clinical space. And again, Jim will have a lot more to say about that together with the location of the California Institute of Regenerative Medicine.

We have a full-scale national and international recruitment underway. I had the honor of doing a presentation last week to almost 1000 people in San Francisco with the Mayor on the future of San Francisco and Mission Bay was prominently featured. I also want to say a number of analysts and other publicity sources have -- or other publicity sources have indicated that we are a finalist in the East River Science Park competition for the seminal commercial life science center in New York City that is correct back in November of '04. Mayor Michael Bloomberg did formally announce this process to locate again the key commercial Life Science Center for New York at the East River site, approximately 900,000 square feet. We are a finalist and we expect the final conditional designation from the powers to be there will be awarded we think very soon.

Moving on now to earnings, guidance and dividend policy. We had a very solid second quarter, a $1.20 a share diluted. Dean will talk about some of the stats. If you exclude the D-42 charge, it was over 8% increase for quarter-to-quarter so we're very pleased about that. We did give '06 guidance and we updated '05 guidance. As you know, we updated '05 guidance from 479 per diluted share to 41 per diluted share and our '06 guidance, we initiated that with a 514 number, approximately 7% increase and as you know, Alexandria has been a leader really in giving early future guidance for the next year. Certainly, we have for '06 here with I think a very solid 7% increase.

Some of the factors that have weighed in our own view of this guidance is certainly the rising interest rate environment, two likely dispositions in the early part of '06 and there may be more to follow and then I think certainly a significant ramp up could be two to three X times our historical development levels. On the dividend policy, the Board has raised the dividend 3% so far this year to $0.68 per share. They will continue to evaluate this quarter-to-quarter. As you know, ARE still has one of the absolute lowest cap ratios well covered in the industry at about 56.8%.

Moving onto second-quarter operating and financial performance and some of the metrics. We are very pleased to announce again same-store GAAP increase of 2.4, 5.6 on a cash basis and this marks I think unique in the REIT universe for either office or industrial companies, 32 quarters in a row of positive same-store growth. So we are immensely pleased with that. Also on the leasing side, very strong second quarter, probably even stronger than we thought. Thirty leases signed, 374,000 square feet with 14% GAAP rent increase, and again, 32 consecutive quarters on new or renewal. Leases of rental rate increases, again, I think pretty unique in the industry. I think we're very pleased with the average term of the thirty leases executed this quarter for approximately 7.5 years, pretty much akin to what our top 20 and then top some 50 leases are, which generate the majority of our income weigh in about the mid sevens. So it's very solid, stable, long-term cash flow.

Occupancy bumped up, as you can see, sequentially quarter-to-quarter. Operating margins bumped up a bit again to about almost 78%. So again, very solid at 77.7. Again, one of the things we are most proud of, no current reserve for bad debts on accounts of rental revenue; truly, I think, remarkable for the Company. On redevelopment, we will continue to deliver redevelopments that will drive future growth. One thing we have noted in the press materials, we have now inventoried one million square feet in our redevelopment bank and this is very positive for future growth into '06 and '07 and beyond.

Then on the development side, at least as of quarter end, 4.6 million square foot land bank and growing. On external growth, Jim will talk a little bit about the acquisitions but the moral of the story here is highly disciplined and careful strategy, especially in this frothy environment. And then now moving finally to the balance sheet and some capital matters. We ended the quarter at about 42.6% debt to total market cap. So again continued strong and flexible balance sheet should enable us to grow smartly into the future. Dean will highlight a little bit more on our ongoing efforts, which we will report on hopefully next quarter to move hopefully more than $100 million from variable to fixed-rate taking advantage of the current environment.

So with that said, let me turn the call over to Jim to comment on some of the other matters that our of importance this quarter.

Thanks, Joel. I will, as typically my approach, start with some broad market thoughts and then move into some more specific comments and metrics. Like most office REITs and primary domestic markets, as well as the real estate research houses, we have seen continued broad improvement in most of the office and flex R&D submarkets consisting of declining vacancy, increased absorption at increasing rates, solid employment growth and firming and/or increasing rents. While these encouraging trends may not fully justify some of the evaluation metrics that have been observed broadly, which have resulted in the frothy environment that Joel referenced and certainly less disciplined underwriting, they are having a positive impact in most of our submarkets. Our internal research department very closely tracks and specifically tracks nearly three to thirty submarkets across the country that we operate in. We are considering current vacancy and availability, current construction levels, planned development and submarket job growth and absorption rates, we project confidently that ARE's submarkets will on average achieve a market equilibrium state during the second half of 2006. And the important impact here should be a broad increase in rents across most of the submarkets rather than the selected improvement that we have experienced over the last 12 months.

On the acquisition front, our global observations are consistent with last quarter's comments and the trends that have been broadly reported both in the real estate and the mainstream media. Clearly, too much capital chasing too few opportunities. Yields remain depressed; although yield compression is not necessarily continuing but it also has not eased upward in any measurable fashion. Investor risk profiles are clearly more aggressive both relative to lease up risk and pricing on a per square foot basis. Bottom line is that we believe, generally speaking, that investors are paying too much for too little. That said, we continue to employ a rigorous, disciplined and focused approach to acquisitions, emphasizing the roadmap for growth that we have talked about many times in previous calls in the best locations within our submarkets.

Continuing our solid activity, as Joel referenced in the first quarter, up acquired four properties in our Massachusetts franchise providing a combination of stabilized income as well as future redevelopment product. The stabilized properties were all purchased below replacement costs at going in cash yields north of 8% in solid submarkets. Effectively, these acquisitions have expanded our presence in a critical region, which we have steadily grown over the past five or six years through selective and strategic acquisitions, redevelopment and development efforts and as in all of our markets, critical to our success specifically here has been a core network in the region resulting from a set of unparalleled relationships and experience.

Just a couple of kind of highlight and features about the Massachusetts, or the eastern Massachusetts region. The franchise now consists of nearly 1.3 million square feet and 21 properties that includes redevelopment assets and this product services 41 tenants across a very broad spectrum of the industry. The redevelopment and development capacity in the region exceeds 300,000 square feet providing us with the ability to serve an ever expanding tenant base in an adequate and growing manner. And as referenced in the supplemental, our operating portfolio as of June 30, '05 had an occupancy rate of 93.8%, up 130 basis points from the prior quarter benefiting from consistent activity driven by a diverse and deep set of unique regional characteristics. And again, our kind of integrated comprehensive effort to develop that franchise has been very successful to date and will continue in that region.

Just a quick set of highlights on Mission Bay. Obviously with the magnitude and importance of that project, we want to make sure that everybody is fully informed as we see things evolve. Last quarter's conference call, since last quarter's conference call, significant progress has continued in and around the Mission Bay area relative to ARE-specific activities. We are, as Joel mentioned, under construction with our first building; a five-story, 165,000 square foot integrated sciences building that will be unique not only to Mission Bay but to the Bay Area region as well. We are advancing entitlements at various levels for multiple parcels and phases that comprise all of our land holdings in Mission Bay. We have seen, not surprisingly, an increased number and quality of increase from prospective users from the broad swath of the industry universe.

Outside of ARE-related activities, also in the quarter, some other significant developments have occurred. The UCSF Hospital transaction has evolved to the final stages. Ultimately, this will entail 650 beds immediately across the street to the south of our land holdings. It will incorporate specialty hospitals for women, children and cancer. UCSF is also nearing completion on a residential tower, parking structure and a rather large, robust and state-of-the-art athletic community center. They are also poised to begin the next phase of their research development, which will be the fifth building on the campus, the other four totaling over one million square feet.

As we announced last quarter, the CIRM has selected a site adjacent to Mission Bay for its headquarters. During the quarter, GAP announced it will be relocating to a building within Mission Bay, 300,000 square feet and also there is a -- the lightrail line will be finished, which will dissect Mission Bay at third Street towards the end of this year. So tremendous progress has been made there as well. And then surrounding Mission Bay, there have been frenetic levels of residential development activity in this core development. So progress is moving on many fronts and creating quite a buzz as Joel referenced in his comments.

So with that, let me turn to leasing. Second quarter '05, general activity in most of the markets within the office lab sector has remained consistent with prior quarters -- prior recent quarters. Generally consistent and steady demand, however not robust, with the exception of some isolated pockets. Most of the markets are at general equilibrium state with stable or modest rent growth characterized by limited new supply and single digit vacancies. Most of the growth is concentrated through a larger public company, research institute or academic user growth and some government and biodefense-related applications, particularly vaccine products, new company formation, early stage growth remains an industry challenge.

Our performance in the quarter was again, very solid and was really remarkably similar to the statistics that we reported in the first quarter. 375,000 square feet of gross activity with the aforementioned GAP rental rate increase of 14%. A very heavy East Coast orientation characterized this past quarter similar to last quarter with more than 80% of the activity with a very strong performance, specifically in Massachusetts, with several important and large lease transactions and Maryland activity was highlighted by a full building lease exceeding 100,000 feet in Gaithersburg.

Looking to rollovers, 2005. We have a remaining balance of just over 0.25 million square feet. Of that, approximately 60% has either been committed or is in serious negotiation with the remaining unresolved. Of that unresolved space, that 40% that exists in about 12 separate spaces sprinkled throughout most of the regions of the Company and is generally quality lab space and we continue to maintain full year rent growth projection between 0 and 10% for 2005.

Turning to 2006, we have, as you know, a significant challenge and /or opportunity in '06 with nearly one million square feet rolling over. Our current expectations are in alignment with what we communicated during last quarter's conference call. Very heavy concentration on these rollovers in the second half of '06, approximately two-thirds. Geographically, the rollover is well dispersed with our foremost significant markets accounting for 85% of the total given that are four largest markets are also the most highly concentrated and generally active, we are optimistic about the prospects for successfully managing this rollover.

A couple of other quick statistics. The first-half rollover, approximately half is either committed or in process and over the course of '06, we currently project about 15% of the rollover will be placed into the redevelopment pipeline. Broadly speaking, about 60% of the space remains unresolved with more than 70% of that unresolved space falling in the second half. And then finally, from a rental growth projections perspective, our analysis here remains consistent at between 5 and 10%.

Finally, vacancy. Currently, 366,000 square feet, which is slightly down from last quarter or about 5.3% of the operating portfolio and the exposure here is spread pretty evenly over five markets with good progress being made incrementally. 30% is either leased or we are in negotiations and 50% of the vacancy is in low revenue office product as well as some flex space consistent with prior summaries. The financial impact is less significant than the actual vacancy percentage and I would just say in conclusion, that we are really pleased with our consistent external growth progress in light of the aforementioned frothy environment. The position that we have in each of the submarkets, given broadly improving fundamentals and our on-the-ground regional operations and unparalleled networks. Our progress to date on addressing current vacancy and our pending rollover has been very solid and the consistent incremental maturation of the development and redevelopment pipeline is going to well serve our client tenant needs and provide additional means for growth. So with that, I'll turn it over to Dean.

Thanks, Jim. Good afternoon, everyone I just want to spend a few minutes to review very important financial and operating results for the quarter. As Joel had mentioned, we continued to execute on our unique roadmap for growth providing for our 32nd consecutive quarter in growth and FFO per share and our 32nd consecutive quarter of positive GAAP basis and property growth. FFO for the quarter was $1.20 per share on a diluted basis representing an increase of 8.1% over the second quarter of 2004. That is of course if you exclude the $1.9 million or $0.10 per share D-42 charge that we recognized in the second quarter of 2004.

Briefly, I want to comment on discontinued operations. You probably noticed that we have presented a discontinued operation in an asset held for sale, which is one building that is 100% office building, held for sale as of June 30th that we anticipate will be sold this month at a slight gain. Because we have not completed the transaction, I would prefer not to discuss the details. But it is safe to assume that the sales price is immaterial. We continue to monitor at least accounting matters that all of us are reading about currently and in consultation with our independent auditors, we have not identified any lease accounting issues.

Moving next to our operating portfolio. Our statistics for the portfolio continue to reflect the overall strength and stability of our operations. Occupancy for the second quarter was 94.7%, up from 94.0% on the prior quarter. Margins continued to remain very solid. They were up at 77.7% for the second quarter compared to 77.0 % for the first quarter of '05.

Looking forward, I would suspect a 77% to 78% margin would be our expectations looking forward. Same property results, as Joel had hinted, were truly remarkable at 2.4% on a GAAP basis, 5.6% on a cash basis with a significant portion of the results being attributable to increases in rental rates in the same property pool. It is important to note that our same property results for the current quarter includes the impact of one property that had been in the same property portfolio for many years. The tenant vacated the entire building in early 2004. The space in the building did not require a significant change of use and accordingly, the property was excluded from our properties under active redevelopment and remained in our operating portfolio. As a result, this asset had a negative impact on our operating and same-store statistics for 2004.

Our guidance for same property results for 2005 and forward remains in the 2% range on a GAAP NOI basis. Briefly on FAS 141, the Company continues to comply with the provisions of FAS 141 and we allocate the purchase price of real estate acquired to the various tangible and intangible assets. However, there have been no purchase price allocations in 2005 for above-market or below-market leases that would impact the FFO.

Briefly on straight-line rents, straight-line rent adjustments for the second quarter were approximately 3.3 million, and I think looking forward into the remainder of 2005, 3 million per quarter should be a good run rate. Moving next briefly on our overall debt strategy, as of June 30th our debt to total market cap was approximately 42.6%, with about 64% of that being fixed-rate debt and 36% being variable-rate debt. Of course, this is after consideration of the 350 million of swaps in effect at June 30th. As mentioned in our last quarter call, in May of 2005, we executed additional interest rate swap agreements for about 75 million in notional, and we will continue to evaluate additional hedges against our variable-rate debt, which is very important in funding our non-stabilized value-added redevelopment and development assets. As Joel had mentioned also, we are also working on the conversion of up to $100 million of variable-rate debt to fixed-rate debt over the next few quarters.

Lastly, regarding our guidance consistent with our policy that we had mentioned on each of our calls, we do not comment on the individual detail going into our guidance. Our FFO and EPS guidance was revised and updated for 2005 to $4.81 and $2.34 respectively. We also presented for the first time our EPS and FFO guidance for 2006, FFO at $5.14 and EPS at $2.48 on a diluted basis. As you'll notice, our guidance for EPS does not always move in concert with our FFO guidance, and it's impacted significantly by depreciation expense which we adjust as we get better visibility of in-service dates for our developments and redevelopment, and specific dates for acquisitions or dispositions.

With that, I will turn it back to Joel.

Thank you very much. To the operator, we want to open it up for Q&A if we could.

(OPERATOR INSTRUCTIONS). We will take our first question from Ralph Block with the Focus Financial Corporation.

Good morning, guys. This, I guess, is a question for Jim. You talked briefly about where you're seeing demand for space, and I think you mentioned larger public companies, academic and biodefense. Are you seeing any significant tilt or change between big pharma and some of the up-and-coming biotech companies in terms of demand?

Ralph, I want to make sure I understand the question. You mean the marriage or kind of evolving set of relationships driving new demand between those companies?

Yes. In other words, the relationships that you have with prospective lessees and sort of coupled with where you are seeing more interest in leasing space, types of companies.

I think the -- well, relative to pharmaceutical, I think that is really case-by-case. I think generally speaking, you could probably say that there has been a retrenchment, if anything, relative to space demand on the pharmaceutical side. However, that said, they are buying or merging in biotech companies and driving growth in some instances. Larger public biotech companies with products are really kind of getting a second wind in a variety of situations and driving, I would say, more sporadic growth. I don't think that is necessarily a broad trend to this point. And then kind of middle-tier preproduct bio company, whether it is private or public, is still kind of meandering around and somewhat stagnant. And then I guess I'd comment a little bit about early stage bio being still a challenging environment, although we are seeing some company creation in certain markets. So I'm not sure that fully answered your question.

Yes, I think it pretty much does, Jim. Just a kind of clarification, though, on biodefense. I think you covered this once before, but can you refresh my memory on the types of biodefense demands for space? Are these like startup companies or are these subsidiaries of companies that have been around for a while?

Ralph, this is Joel. I'll maybe address that. I'd say it really runs the panoply of entities focused in this area. Even from academic to commercial, the vaccine area is probably the highest priority right now. One company in Northern California received recently almost $1 billion for anthrax vaccine technology and products, so kind of extraordinary. There is a lot of money flowing out to a number of companies, both big and small, for smallpox vaccine inoculations. So there is a pretty broad set of parties who are focused in this area, and size really doesn't have much to do with that. It really is much more focused on their core technologies and their ability to move research to development and then quickly to commercialization.

David Aubuchon with AG Edwards.

Jim, I'm trying to balance your comments regarding the markets reaching -- I guess all of your markets reaching equilibrium at some point in the near future. Your role next year being 85% of that in your four largest markets, in other words, in your best markets with 12% rent increases in the first quarter, 14% in the second quarter with your 5 to 10% rent guidance on the roll. Are you just being really conservative?

I don't think we're being really conservative. As I have commented many times in the past, you have to look lease by lease and see where you are in a specific space and a particular market. And that is what we do all the way across the board, and that is how we come up with a number, and what we present to you guys is what we see in our own internal reports. My comment about equilibrium is certainly important, and so I don't want to discourage the possibility that we could do better than we think. But it is really a broad comment about the overall office and flex market in those submarkets. And as I have said before, we get -- either indirectly we benefit or get penalized by those broad market conditions, so we see them all moving on a kind of an average basis to equilibrium in '06. That has got to be positive for us, and so as we look out today, the rent growth that we're projecting is based on how we see the world today, but that could improve. So I don't know if that -- so there is an element of caution, but I wouldn't say we are overly cautious.

In your expectation, let's say, fourth quarter of last year, the beginning of this year for rent guidance, I think was the same 5% to 10%. So you are just beating what you thought you could get at that point in time?

Just beating what we thought we could get?

I think your guidance on rent increases on expirations has been 5% to 10% for a good two or three quarters now. And again in the first quarter and second quarter, it has been double digits. And I am not trying to beat you up about this. Obviously, it's positive. I'm just trying to get a hold of what the future holds for in that lease, on those leases relative to a rather consistent beating of that guidance.

Sure. I guess, again, it gets back down to the individual leases. We may in some instances have outperformed our projections, but also kind of constant projection is a full-year projection for '05, both past and present and future. So you have to kind of roll it up at the end of the year and see how we did relative to our projection.

Right. Are you seeing -- I think we've seen this a couple -- at least starting a couple of years ago where the demand for office space, traditional commercial office space, was pretty anemic, but the demand for lab space obviously was a little bit more consistent and steady where you saw a lot of competition from conversions. Are you still seeing that in your markets? And because of the pricing that we're seeing for a lot of assets, has that increased at all?

I would say it really hasn't changed a tremendous amount. I think there was a ramp-up in hype and hysteria about this in certain markets, and a lot of -- I don't mean to be coarse here, but a lot of pretenders never came to fruition. So the folks that do this for a living are continuing with their business like they always have. Those that were looking at this from a kind of an opportunistic perspective did not generally materialize. So I would say the dynamic really hasn't changed much. There has been no more attention than there has been in the past, but I don't think there has really been less attention to it either. I would say it has been kind of steady-state.

Dave, one other thing I think that is important whenever you look at what is potential competitive product in any submarket, in this sector location is more important than it is in other sectors where location, location, location is still kind of a key. And so to the extent that other product could be theoretically competitive, in a number of submarkets it really just isn't, and that is really an on-the-ground fact from circumstances looking at each submarket.

In fact, I think in the past we even maybe talked about the kind of couple, three exits down concept where you have properties that have languished in their current use that have been repositioned as office lab space, and it just doesn't happen. Because the companies go -- as Joel hit it on the head, they want to be where they want to be.

And one other thing. Some jurisdictions are very unfriendly to this use, so somebody who may be in that jurisdiction with a building that maybe they think they can convert may have a real difficult time getting it done.

Even completing the buildout.

Right, because you have got approval issues. People are very sensitive to a variety of uses in this sector or even just growth in general, so some locations where you'd almost want to be, just the natural governmental restrictions prevent you from doing it, even though there is product that could be available.

One last question for now is, Joel, regarding I guess how you are going to allocate, how you envision right now how you're going to allocate capital over the next 12 to 18 months because of your development pipeline, obviously very big, at least potential, relative to your current size of your portfolio. Where do you see development, redevelopment acquisitions playing out over the next 12 to 18 months as a percentage of your overall allocation account?

I think from the remarks that I made, I think you could assume that development will begin to take an ever increasing share of capital need and certainly as we have said before, we intend to maintain a very flexible and strong balance sheet. So we will look at a variety of ways to finance that growth to the extent that we need to look at approaches that we haven't traditionally looked at and we feel like we have the capability, we have the track record and we have the relationships that can enable us to really execute on what we are undertaking here, which I think is truly pretty, pretty spectacular and pretty special. So that may be code for saying we have a plan in mind but we're not ready to unveil it at the moment.

And your acquisitions have always been pretty much opportunistic?

Absolutely. Absolutely. I think you have to look at this Company, as Jim really characterized it, not as a growth by acquisition story because in today's market, I think that is going to be a failed strategy. At the end of the day when you have got such frothy prices and very sophisticated money people going after assets that get exposed broadly to the market, you just can't continue to do that in a sensible way.

I think we have really never kind of characterized our acquisition effort in a traditional pipeline orientation. I think it is really difficult in our niche to project out a summary pipeline because it changes almost week to week and I think as evidenced by our success last year. If you had asked us at any point in time what your pipeline looks like, it wouldn't have been at the level that it turned out being. So anyway, grossing up and summarizing on that basis is difficult in our sector.

Merrill Lynch's Brian Legg.

Joel, if you were to win the development of the East River Science Park, what would your expected investment be?

Well, I think if you look at a 900,000, going on 900,000, total square feet that includes really two sites and you looked at maybe a $400 per square foot development cost over a number of years, that would be kind of what one would look at as a total project cost just kind of very roughly.

Could you take that on yourself?

Well, as I said, go back to the comments I just made to Dave. I think it's fair to say that we have clearly positioned the Company in over time and certainly over the recent time to take advantage of very significant opportunities. So I think that ourselves based on our capability to obtain the capital, however it is obtained in a smart and accretive fashion. So you can kind of take that for what it is at the moment. I think it would be hard for me to make any formal statement.

But I guess what you're saying is that you might do that in a joint venture?

Anything is on the table that makes sense and would be accretive for our shareholders.

Can you just talk about the leasing interest at Mission Bay for this 165,000 square foot building that you just now started?

Maybe I'll take a couple of comments and ask Jim to comment as well. We actually, up until we could formally break ground and have final permits, we actually were very careful not to be out marketing because it would be a little foolhardy in a city that has not had commercial life science before to be doing that until you had all your ducks in a row. But we really do have an extremely powerful network up there. Jim has spent the last 2.5 decades in the area. We have a team up there that is highly seasoned in that market and really our reach for Mission Bay is both national and international and we have spent a good deal of time with a variety of international players having some pretty interesting discussions about Mission Bay without getting necessarily space specific. And there have been a number of recent companies who have actually moved to that area and who are looking to set up shop in a much more substantive way from a research and development standpoint. We haven't really formally kicked off our marketing effort but we have been doing a lot of positioning of it and I think so far, we have seen very, very good response. Jim, you may want to comment.

Not much to add other than my comments, Brian, really related to the broad Mission Bay project. There just has been a tremendous level of interest from a pretty broad diversity of user types within our sector since we really commenced this process, not the marketing process but just have become kind of the known entity of the developer here. Relative specifically to the building that you are talking about, as I said, it is an integrated sciences building so we're bringing in a number of components that we have developed in other markets and integrating them here. So there are all servicing kind of different segments of our niche and there has been a lot of interest in each of those components. But we're still pretty early in the process.

Do you expect to market future buildings as a campus maybe for an Amgen or other large users or do you expect most of your buildings will be this multitenant?

Bingo.

Most of them will be multitenant?

No. We have already had a number of discussions just broadly, again, not marketing specific space or building but broadly with a number of companies, one of which is already in the Bay Area in a significant way and has a growth trajectory we think is spectacular, which doesn't happen to the Amgen. That group was talking about something north of 500,000 square foot campus. So we view it as yes, probably users who are looking at bigger chunks of space.

How quickly could you deliver a 500,000 square foot --? You're having to go back through the approval process and that would be maybe two years down the line before you could really put a shovel in the ground. Is that correct?

Yes. I think, and what I said about users too, you can't just assume we're going to lease the campus to a 2 million square foot user. I think you have to again look it. We are viewing it as really not only a real estate development but really creating a very vibrant cluster that really has tremendous cross pollenization with a variety of users. So even today, we wouldn't just lease the whole -- if somebody came and said here's 2 million square feet, that is really not what is targeted by the city, by UCSF or the other stakeholders. So we want to do it very carefully and very methodically.

But on timing, Jim, you can maybe talk a little bit more about timing. I think it could be sooner, it could be more medium-term but I think --.

I think what you said, Brian, is probably right. We are in various levels of advanced entitlement processing on all of the parcels and to deliver something of that magnitude would be a couple of years out.

And Dean, a few questions for you just quickly. Can you give us the capitalized interest in the quarter and can you break that down between the 217,000 square foot development pipeline, your redevelopment pipeline and land?

Yes. It is right about 7 million for the quarter. I do not have the breakdown on the components.

Do you have the interest rate that what you're capitalizing?

No, but if I recall looking back, the overall stats on the weighted average effective interest rate in general is up because of the increase in LIBOR rates since December 31st through June 30th.

And do you have a total amount that you're capitalizing?

The basis, I don't have that at the moment. I'd have to get back to you.

And on the redevelopment pipeline, how much do you have planned to spend per square foot and how much have you spent to date?

Well, in general, on average, we have about 240, $250 per square foot basis on our redevelopment portfolio and we probably have a remaining budget to incur of about $65.

Last question, Joel, you talked about the dispositions in '06, any thoughts on how much that could be? In dollar terms?

When you say how much what could be?

The dispositions that you were talking about, two dispositions '06.

They could be in the 40 to 60 million range through '06.

JP Morgan's Anthony Paolone.

Can you talk about the economics on your four property acquisition in eastern Mass.?

I think what I said, Tony, which kind of goes beyond what we typically say, is that our yields were north of 8% on a cash basis going in and that is kind of consistent with what we have seen in the market relative to stuff we are interested in.

Any census to what that goes to after you put capital into it with the part of the debts not leased and release that?

Are you talking about the redevelopment portion?

Yes.

That project is relatively small. I don't have it in front of me. It is kind of consistent with how we have been doing across the board in Massachusetts and elsewhere.

And the north of eight going in, is that for just the part that was brought into service or across the whole --?

That's a stabilized piece.

That's the stabilized piece. Got it. In terms of leasing in the quarter, it has been a couple of quarters now with your releasing and renewal leases having average lengths of just a little over four years. It seems a little bit shorter than what your typical expiration schedule would imply. Anything going on there? How should we think about that?

Maybe let me answer that, Tony. I think if you look at the overall leases, they are actually very consistent. As we said before many times, smaller spaces, you get shorter leases; medium spaces, medium-term leases and larger spaces, larger term leases. That's just the way it works out and you've got 14 leases for 134,000 square feet on renewed and released. Then you look at the redeveloped and developed, which some of which are larger so you get much larger length. So this is absolutely consistent with what we have had and if you look at that schedule on page 12, the blended averages, 7.5 years, which is just perfect down the fairway of where are average lease terms are for the portfolio.

And I would say, Tony, that consistent with maybe my remarks in prior quarters, especially the smaller companies and smaller spaces, they are looking to retain flexibility. Their Boards want to very carefully manage occupancy costs and frankly in a market that has been kind of somewhat neutral for a period of time, that has been fine with us. We would rather have those leases rolling over three or four years down the road if we're negotiating them or have been negotiating them during this kind of more moderate period of time.

On East River Science Park, Joel, you mentioned $400 a square foot. Did that include the land or is that just development cost?

No. It's a ground lease.

It is ground lease.

So that includes -- that is primarily construction.

And then just from an organizational point of view, if you were to get something like that or be involved in a project like that, do you think you would have a pickup in G&A just from a people point of view or you think you have staffing in place to handle it at this point?

No. I think with all of our efforts, I think Mission Bay may be the best example, you know we established an office at Mission Bay given the breadth and depth of that effort over a number of years. So we clearly, in any market where we would take on a significant development challenge or operational challenge, we clearly would staff up for that.

Last question, Dean, you mentioned $7 million of capitalized interest, any capitalized overhead in the quarter?

No, we don't capitalize any G&A.

Jonathan Litt with Smith Barney.

It's John Litt here with John Stewart. I wanted to get a sense of how you're factoring in rising rates for this year and your next year guidance.

We tend to follow the forward curve, John, and make some assumptions to adjust slightly from the forward curve outlook.

You have, of your 850 million in floating rate debt or 823 million floating rate debt, it looks like you have 350 covered by the swaps. Is that right?

That is correct. As of quarter end, we had 350 and keep in mind, the effective notional amount at year end goes up to 375.

And as I look at this, you have about 100 million of your swaps expire by the end of the year, which would reduce the amount you have covered to 250. You have another 150 that expires next year, which would get you down to about 100 swaps outstanding. How are you thinking about renewing the swaps, the amount that you want to have swapped out and what the possible cost is if you had to put a swap on today to go out a little bit further?

Let me just try to clarify some of the facts of how much swaps will be in effect forward-looking. As I briefly mentioned, at year end, we will have 375 million in effect, which will continue through the end of 2006. Then it currently drops down 50 million to 325 for a few quarters and then some of it burns off at that point. So through December of '06, we have 350 -- I'm sorry 375 million hedged.

Oh, I see. I must've been reading this wrong. I thought it said the termination date on 100 million was December 31.

Some of them maybe terminating but there is a corresponding swap that extends the effective piece and the protection on our exposure there.

Is there a cost associated with that extension?

To the extent that rates vary from what we have hedged, there could be a payment under the fixed rate if rates stayed below our fixed-rate contracts. To the extent that rates exceed that, we will receive payments but either case, our swaps fix our exposure.

So when it says in your supplemental, termination date December 31 '05 on the 100 million, what is terminated?

The contract for that individual swap matures and an additional swap, which is forward-looking, has been negotiated and executed, which will pick up that 100 million that is terminating. All the swaps by the way are included in our guidance.

I'm just trying to understand so the extension swap when this expires is not reflected on this page of the supplemental? When it expires and the new one comes into effect then it will be reflected?

All swaps that we have in effect -- I'm sorry, all swaps that we have today are included in our supplemental. Let me see if I can find the swap that you are --.

You have three swaps that expire at the end of this year totaling 100 million. It sounds like there is some sort of an arrangement you have to extent that out.

No, no, no. It is actually, for example, if you look -- there is a swap that was executed on May 2005 that has an effective date of December 30th, 2005 for 25 million. A little further up the chart back in December of '03, we executed a swap for 50 million that is effective on December 30th of 2005 and --.

So effectively, that 25 million that starts December 30th this year takes over from where the one that expires December 30th this year leaves off?

That is correct.

So actually what you are saying here is your effective at June 30th is 350.

Correct.

If I roll that forward to Jan. 1, it might be a different about.

It will be 375 million on January 1st of '06.

And then you roll it to Jan 1, '07 and it will be some other amount?

Correct. Through 12/31 of '06 it will be 375 million.

And then you are saying it drops to 325 Jan 1, '07 or something?

Correct.

And if you wanted to enter into more swaps, you have that factored into your numbers or are you assuming that you don't add more swaps beyond that which is on this page.

We do have various assumptions about our debt and capital needs going forward-looking through '06, which cover our best guess at our projections.

Do you have any plans to reduce the amount of your unhedged floating exposure, which looks like it's 400 or so?

Yes. I briefly mentioned during the call that we are working on up to 100 million of debt that will move from variable to fixed-rate over the next few quarters.

Do you think that will be a wash in rates or do you think that will be some uptick?

It will actually be a little dilutive to us because on a fixed-rate basis, your fixed-rate debt for most companies is a little more expensive than the variable rate exposure.

And if you did fixed, would that be like five-year, seven-year --?

It would be ten-year debt, like a thirty-year amort.

A question on your redevelopment schedule, you are adding 150,000 square feet to your development schedule. I think based upon, I forgot what that was related to, you have 50 of your leases which are expiring in '06, 150 of that is expected to go into your redevelopment pipeline? I think that was the statement that you guys made.

I think, John, I said that's a good quick computation. I think I said as we see it today, it looks like about 15% of the roll is going to move into the redevelopment pipeline. That would be about right. I mean I don't have the specific properties in front of me but that would be the correct calculation.

And I look at page 16 of your supplemental, which is very good and it gives the amount of space under redevelopment. What is your sense of how much space will come out of the redevelopment pipeline next year? My question really is will you stay around that one million square feet? Do you think it will go up or go down in the next 12 months?

Well the total, John, that you're looking at, one million, that is just the overall property. The actual amount in redevelopment on space is the 530. And then if you look at the estimated in-service space, you can see there are a couple of suburban DC properties that are likely to come out for the far right column. Then as you go up, there are a couple of other '06 deliveries that you can see up above one in the Bay Area and one in San Diego. So I think if you look at the first column and the last column you can kind of see what our best guess is at this point in time.

It looks like you may see some net reduction next year? You'll probably add to it with other --.

It may not go up. I think you'll see redevelopment in kind of anywhere from 4 to 600,000 square feet actually undergoing redevelopment; that's the change in use. Now some of them are parts of properties so they are somewhat larger on a total property square footage. But I don't think the actual amount undergoing redevelopment will vary significantly.

How many dollars do you think you'll spend on the 530?

Again, I think our guidance in the past has been anywhere from 75 to $90, something in that range. Again, it varies by space and so forth. But that has been a really good historical average for many years.

I thought I heard earlier in the call somebody say 250 plus $60 incremental cost per foot.

He was giving overall. I think he was talking about basis and then left to invest. That wasn't a per square foot number.

Oh, I see. So you have got about 250 a foot into it, another 60 in your incremental cost.

Correct. And the 250 is not necessarily redevelopment dollars. It is just overall cost of the property.

I guess one of the things I'm trying to get a sense of is when do you think we will be on -- you have been ramping up let's say you're non-income-producing side of your balance sheet between developments, redevelopments, land. I'm trying to see when that stops rising and when you start harvesting in order to give us a sense of what the growth --.

I think on redevelopments you can assume that there will be kind of a stable amount of again 4, 5, 600,000 square feet at any given time. I think part of the beauty of what we try to do is have a continuous pipeline to meet the needs of both current and targeted tenants. And then on the development side kind of a different situation as you know because in specific situations where we have a big landholding and we see the market opportunity, we clearly will initiate development and I think you'll see that ramp up, I said, by two to three X over the next quarter or two.

So you'll start harvesting on that side?

Yes. I think you'll see a big jump in the development side. But I wouldn't expect on the redevelopment side. You'll see that almost like a pool that kind of replenishes itself on a continual basis.

Thank you. I think John Stewart might have a question.

Just a couple of quick follow-ups. Joel, I assume the 40 to $60 million of dispositions that you talked about are the same two assets that you referenced last quarter that you previously expected to close this year.

No. I think I said, I don't have my notes with me, but I think I said we were looking for either late '05 or somewhat early '06 and I think those are on target for generally first or second quarter, maybe sooner, '06. And that could grow because there is a total of I think about eight properties, one of which I think Dean mentioned, we are selling one of the smaller ones. But I think you'll see a number of sales happening, two of which we kind of know are going to happen.

So it is not an additional 50 million in the first half of next year and 50 million in the latter half of this year?

Correct.

Dean, I just wanted to clarify on the same-store anecdote that you gave, I thought I understood you to say that the building you referenced that did not go into the redevelopment pipeline negatively impacted '04. Is that correct?

That is correct.

Hence, the higher year-over-year growth?

Yes, that did contribute to some of the results on same-store for 2005 but I also wanted to point out it did have an effect on 2004 plus it is important to note that the same-store pool does keep vacant buildings in the pool on a same-store basis. If it doesn't go through a significant change in use and placed in our redevelopment pipeline, it stays within the operating portfolio.

Then lastly, Joel, just a follow-up to John's line of questioning on the swaps, at what point do you think you have outgrown swaps as a form of fixed-rate financing? When do think about a more permanent type of fixed-rate debt in the capital structure?

I think maybe one thing Dean said that we are undergoing right now, we are looking at moving a large chunk of variable-rate debt into long-term fixed-rate ten-year debt. I think that is something you will see maybe several larger transactions happen over time and I think on the developments maybe where you're leading here is I think as you see at Mission Bay and maybe other developments that we are likely to initiate in the not-too-distant future stabilized, our goal would be obviously to look at long-term fixed-rate debt on those assets once they become stabilized. So we aren't financing them with variable-rate debt and just simply hedging those. So that clearly is an important strategy that we are working on as well. Actually, as Jim reminds me, at some point, I think we are a ways from there. But at some point, when the company gets to be a much larger company, we clearly would look at potentially rated debt. I don't think we are there at the moment.

And we'll take our final question today from Philip Martin with Stifle Nicolaus.

Must've been in alphabetical order again. Good afternoon, everybody. A couple of quick things here. The New York Life Sciences East River project, can you give us a sense of the timing there to build that out completely?

I almost would prefer not to comment on that in general. But I think let me just say maybe from the city's perspective, they are looking at that -- they anticipate a ground lease period negotiation to kind of fix the ground lease. It's a very complex site, highly complex site actually, and then at that point, they would look at really accelerating this process. I mean I think if you read the public press and what has come out of the city from the Mayor on down, you will see that New York has wanted to really establish New York City a very serious commercial presence and it really hasn't happened over time. One, because other uses just predominate. I mean even today some of the office and other property types are struggling against some of the residential types. So the city is really trying to fast-track this situation. The city will be in full partnership with whomever the developer is really to make this, what I think, will be a spectacular success because they have all the right pieces except the commercial side of it in a real serious way.

A lot of this will be underway in, what, first half of '06?

I would say probably, as we sit here today, I would say certainly in '06.

Now in terms of Mission Bay, just overall timing there. I'm just trying to get a sense of over the next two to three years, let's say by year-end '07, what percentage of the square footage do you think would be built?

I think it would still not be a huge percentage. It could be, oh gosh I don't know, if look you at -- it could be --.

Maybe 10%

Maybe 10, 15. If you got 2 million. I think it'd be more 15; it could be 15 plus 15, 15, maybe even 20%.

Then does it ramp pretty quickly after that?

It could based on I mean again the issue will be how fast UCSF continues to put up their buildings and how fast the two specialty hospitals can get in place. There clearly will be a pretty big need we think for facilities that will augment those rather massive undertakings. So we see there will be an inflection point that suddenly things could dramatically ramp up. But I'm not sure I could give you the precise time frame. But it could go very quickly at a point in time when I think both the hospital campus and the research campus really begin to emerge with pretty critical mass. Although the research campus is well there already.

I know a lot of it is momentum-based.

Absolutely. But the powers to be are highly friendly in this particular location. This is one of the signature projects for the city. So I would expect that they will do everything they can to fast-track all the developments.

My last question, from your tenant strategy going forward and I guess what I am specifically referring to is the leadership change that we have been hearing and even reading about, the big pharma to now the biotechs, the Amgens, the Genentechs, etc. Maybe you could talk a little bit about how that is impacting your tenant strategy even versus a couple of years ago, etc?

For sure. I'll maybe make some comments and ask Jim to comment as well. I think we clearly track -- I mean we have a much like we have an internal real estate research group, we have I think a pre-eminent life science research group internally and we have been tracking in a very sophisticated manner this industry, both the technologies horizontally and the product and clinical trials vertically for a long time now. It is clear that like some of the historical industries whether it be steel or railroads or automobiles, leadership changes happen over time if the leaders don't change and be creative and constantly kind of reinvent.

So I think there will be some companies that will clearly I think continue to do well. Novartis has demonstrated extraordinary adaptability in this environment. I think Lilly has done a pretty decent job. I think Pfizer probably will continue to do pretty well. But I think like the Merck and others who stumbled whether it be on product issues or just lack of critical mass or an inability to develop really the biological side or the informatics side of their industry and the ability not to bring breakthrough products quickly to the market, I think the Japanese have suffered this for a long-time, will really hurt those companies. I think you'll see the emergence there already is of a new generation of innovative companies, obviously Genentech and Amgen. So we clearly have focused on those emerging leaders as important parts of our future growth in this industry and really we look, not only nationally, but really internationally.

I think China, I have had some recent discussions with some senior people in the Chinese pharmaceutical industry and they have a goal to be a leader if not the leader by 2020. So you have to take those promises seriously. Any country that has got one billion plus people and the fastest-growing economy in the world, you are going to see a lot happen.

I think back to the operator.

There are no further questions at this time. Mr. Marcus, I'd like to turn the conference back over to you for any additional or closing remarks.

Well, thank you for taking time to be on this call. We look forward to talking to you probably early November for third- quarter results and have just an excellent day and again, thank you for your time.

That does conclude today's conference. Thank you for your participation.