Alexandria Real Estate Equities Inc (ARE) 2012 Q3 法說會逐字稿

Welcome to the Alexandria Real Estate Equities Incorporated third-quarter earnings conference call. My name is John and I'll be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please note that this conference is being recorded. I will now turn the call over to Ms. Rhonda Chiger. You may begin.

Thank you and good afternoon. This conference call contains forward-looking statements within the meaning of the Federal Securities Laws. 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 Form 10-K annual report and other periodic reports filed with the Securities and Exchange Commission. Now, I would like to turn the call over to Mr. Joel Marcus. Please go ahead.

Thank you, everybody. And welcome to the third quarter call. All of us here are obviously praying for the safety of those impacted by Hurricane Sandy. I'm going to try to breeze through my comments pretty quickly, turn it over to Steve Richardson, and then to Dean Shigenaga, and then go to Q&A. As I finished my first Board meeting last week for the NIH it reminded me actually of the great work that the life science industry has done in disease management. If you think about what has happened to HIV-AIDS, moving that disease from a death sentence to a chronic condition I think emphasizes the critical nature of this industry and its ability really to manage the economic cost of disease to society. So I think we remain very positive on the critical nature of this industry's impact on society.

I think the third quarter and certainly year-to-date for the industry, and then our tenant base in particular, has been I think a good year in an otherwise very tough macro market and one that seems to be eroding pretty much daily. The NASDAQ Biotech Index was up almost 40% year-to-date. We've had 13 IPOs in the first nine months and many of them are performing pretty well. The FDA approvals, as I mentioned on past calls, are up 27 to date and 59% are our tenants, which is pretty amazing. And then a recent notable clinical success was Lilly's success with the huge market potential of that drug for CNS for Alzheimer's, so all pretty good news in general.

Moving real quickly to balance sheet leverage, capital allocation and Dean's going to have a lot to say about this, so we'll focus his comments pretty detailed. Our target, as Dean will get into, our target debt to EBITDA for year end is about 7.2. That will be almost leverage neutral from last year's 12/31/11 at about 7.1 times and again, he'll talk about -- we don't expect to draw down on or to use the ATM this quarter. I think one of the highlights for the balance sheet this quarter has been land sales. We've got $46 million completed for this year, as you see from the supplement. We've got $34 million pending and another $13 million headed in the sale direction. So that will aggregate a total of almost $93 million. So that's good news and strong effort by our teams in many of the regions and we will continue this effort into 2013.

Steve's going to talk about asset recycling, but in general, again by the supplement, we've had about $30 million to date, $84 million pending. We're looking at potentially others. Again, this suburban to urban theme, and Dean implicate the details -- detail the implications on the NOI run rates, so you'll want to take account of that. On construction spend, $167 million for the fourth quarter, at the midpoint, about $630 million-odd-some for 2013. We've got many spec assumptions in that, as that will be the peak year trailing down into 2014. And we're working hard to manage down those costs, project by project, and we've done some good work even since earnings release.

Dean will walk you through the categories of spending for 2013 and the likely specific sources of capital for each. So with significant land sales, free cash flow and construction financing, our needs for equity for the coming year are actually more modest than I think some of the Street has anticipated. When we get to internal and external growth for the third quarter, I think one of the highlights continues to be our quality of tenants, 48% of the ABR from investment grade tenants is about equal to last quarter. Again, particularly important in a tough macro economy. Our leasing, as Steve will try to give you some granular views, was pretty solid at 732,000 square feet. Dean will talk detail about the core. We're pleased with our deliveries this quarter, 131,000 square feet out of development, 100% leased, and 226,000 out of redevelopment, 99% leased.

When it comes to the Alexandria Center For Life Science in New York City, as we announced on September 20, we'll begin vertical construction of the 420,000-odd square foot West Tower in the fourth quarter with delivery approximately fourth quarter of 2013. In our fourth quarter and year-end release in February, we'll detail the estimated construction costs and expected initial stabilized yields. Talking about pre-leasing progress to-date, again, about a 420,000 square-foot building. Roche has signed a lease for two floors as we've highlighted in our release and there's been many articles written.

We're in negotiations with two biotech companies to move to the Alexandria Center and they would take between a 0.5 of a floor and one floor each. We're also in discussions with an existing tenant for two floors and others at the showing stage, we have one floor to a contract research organization and another floor showing to an institutional shareholder. So we feel pretty positive about progress to-date and our target rental rates, we're comfortable with.

Dean's going to get into guidance. We'll release 2013 very detailed guidance in conjunction with our Investor Day in New York City on December 5 and a top-side view of 2014, to put a longer range view into context. And finally, on the dividend, the Board will continue to assess an ongoing increase in the dividend as a way to share increasing cash flows with shareholders. And you'll hear more about that. So let me turn it over to Steve for a pretty detailed view on the leasing side.

Thank you, Joel. And today my comments will focus on four key areas. Asset recycling, life science real estate markets and 2012 leasing, a preview of 2013 rolls and prospects, and finally the 499 Illinois evolving demand. First on asset recycling, the Company's pursued an asset recycling program, a very careful and disciplined fashion during the year.

We're seeking to monetize nonessential land assets, as Joel referred to, and suburban assets lacking strategic long-term importance as we really move the concentration of our facilities to tightly-integrated brain trust cluster submarkets in high barrier-to-entry core urban locations. A number of these recycled facilities are legacy assets that originally served as viable locations for life science companies 10 to 15 years ago. As the industry has grown and matured over time and high quality facilities became available in more desirable urban knowledge locations, adjacent to the major academic institutions and in high quality recruiting locations, the nature of the demand for these locations has evolved and so it makes good sense to recycle this capital.

Moving on to the life science real estate markets and 2012 leasing. We've leased 2.6 million square feet to-date during 2012 including another strong and solid quarter with 732,000 square feet leased. The 7.6% GAAP increase for renewals and re-leased space will provide consistent internal growth going forward. And let me also add for a moment the important factor of lease term. The renewals and re-leases are an average term of approximately five years. Again, bearing out that the sector provides significant stability to the Company's leasing profile as these enterprises are engaged in mission critical activities.

And the new leases for redevelopment and development facilities average approximately nine years and highlight not only the long-term commitment companies are making to these facilities, but oftentimes the significant hard capital investment made directly by the life science tenants. Let me get into the details of some of the regional statistics and trends for the third quarter. The greater Boston market remains strong with about a 10% vacancy rate for life science space and about 11% for the office tech market. Our facilities in fact exceed this market benchmark as we're 94.3% occupied in our operating properties and have significant pre-leasing in our redevelopment projects.

Lease rates for life science space in the East Cambridge market are solidly in the 50 to 60 triple net range and higher for build-to-suit projects. The regional teams this quarter leased a total of 313,000 square feet with 106,000 square feet of renewals in our Cambridge and adjacent facilities and another 206,000 square feet in our redevelopment pipeline. This success clearly highlights the Company's ability to conceive, design, market, and complete strategic redevelopment projects with high quality client tenants at solid yields.

The San Diego market is active as well and is currently at a vacancy rate of approximately 11% across its key submarkets. Alexandria's properties, again, are better than this market level with a 95.2% occupancy rate as the regional team has very artfully and successfully moved a number of the projects from the redevelopment pipeline into cash flowing assets. Lease rates are in the $24 to $36 range, depending upon the product quality and submarket. The regional team leased 97,000 square feet during the quarter, highlighted by a significant renewal with a strong credit tenant in the Torrey Pines submarket, and a long-term lease renewal and expansion stabilizing a key property in the Sorrento Mesa submarket.

Moving on to the San Francisco Bay Area, that market is highly dependent upon the subcluster segment. The Stanford and Mission Bay clusters have vacancy in the 10% range while the South San Francisco market has had another supply increase with subleases from Alnylam and Amgen driving the vacancy to approximately 16%. The Company's operating properties, however, are very strong at 98% occupancy. Lease rates remain in the low to mid $40s triple net for Mission Bay, the $30 triple net range for South San Francisco, and the mid $30s for the Stanford area. The region leased 88,000 square feet during the past quarter.

Moving over to the East Coast, the Maryland market is holding its own in a generally soft market as we are roughly in line with an occupancy rate of 89.4%, although this is down from 2011. Lease rates range from $14 to $26, depending upon the submarket and the regional team leased another 80,000 square feet, highlighted by a key tenant renewal there. Seattle and North Carolina remained steady with 96.3% and 95.5% occupancy rates in our operating properties and they leased 17,000, and 12,000 square feet, respectively.

Moving then to a preview of the 2013 rolls and prospects. We have a total of 953,000 square feet slated for rollover during the next year, summarized at a high level in the following fashion. About 25% of that, or 242,000 square feet, are in active negotiations; 6%, or 55,000 square feet, are specifically targeted for redevelopment; and finally, 69%, or 653,000 square feet, are in marketing or early discussions. Let me get into a little bit more detail on that remaining 653,000 square feet.

About 80,000 square feet of that is in the greater Boston market, primarily located in our urban facilities. It's important to note that 50% of the square footage is actually rolling during December 2013, so we have plenty of runway and are optimistic we will renew or secure new tenants for the majority of these spaces with little or no down time given the ongoing strong demand for high quality early stage lab space in Cambridge and its immediately adjacent urban clusters.

Moving back over to the West Coast, we have about 234,000 square feet rolling in 2013 in the Bay Area. Approximately 95,000 square feet is concentrated in the very hot Stanford, Palo Alto cluster and good progress is being made with a large 65,000 square foot tenant that is on the verge of commercializing its product as well as securing a new tenant for a 30,000 square foot space at an attractive lease rate. Another 95,000 square feet is located in attractive smaller suites in the greater South San Francisco market, where we've done very well in spite of the supply overhang in the large blocks of space.

Finally, about 44,000 square feet is located in Mission Bay in smaller suites, where we've had no meaningful vacancy and so we anticipate positive outcomes. We have about 129,000 square feet in the San Diego market, primarily in the Sorrento Valley and Sorrento Mesa clusters and we are actively marketing these remaining set of suites. Moving back to the East Coast, we have 127,000 square feet in the Maryland market distributed across its submarkets.

We're now in very early discussions to resolve about one-third of these rollovers. Another one-third, it's too early to tell and we're actively marketing the remaining one-third to new prospects. 53,000 square feet rolling in the North Carolina market, early discussions with tenants to resolve about 50% of this rollover, and we're actively marketing the remaining 50% to new prospects. Finally, no square footage rolling in Seattle during 2013 at all.

Finally, let me comment on 499 Illinois. We still firmly believe this is an absolute Class A trophy asset with long-term durable value. It's provided significant current cash flows on the order of $14 million for the 50% occupied portion. And really the game-changer for the development portion will be the UCSF Medical Center. We are willing to be patient to capture the high quality and innovative initiatives that are ongoing between key public and private institutions and at the same time we are also intensifying our focus on the technology sector with a comprehensive outreach effort and reimagining of the amenity configuration and offering of the facility.

I've been in the San Francisco market for 20 years and I've seen time and time again the best located properties with dramatic waterfront views commanding absolute premium pricing. Today's cap rates for core San Francisco property in the 5% range are certainly clear evidence of that historical pattern. With that I'll hand it off to Dean for further commentary.

Thanks, Steve. Let me start with our core operating metrics, specifically net operating income. The third quarter NOI was generally in line with our expectations. NOI from continuing operations was reported at $100.8 million and NOI before the reclassification of discontinued operations was about $104.2 million. Income from discontinued operations net was approximately $4 million and consisted of the following -- approximately $3.5 million of NOI; about $1 million of depreciation incurred in the third quarter, up to the point of classification as held for sale; and about $1.6 million in gains on sales of real estate.

The NOI from continuing operations of $100.8 million for the third quarter includes NOI growth from the completion and delivery of the redevelopment of 10300 Campus Point with 96% occupancy and the development of 4755 Nexus Center Drive with 100% occupancy. Both projects are located in the San Diego market. These projects, on average, were in service for approximately 18 days in the third quarter and generated approximately $370,000 of incremental NOI. This really represents about $7.5 million of NOI on an annualized basis.

Our forecast for the fourth quarter NOI is in the range of $110.5 million to $112.5 million. But keep in mind, $3 million of this NOI relates to the increase in assets held for sale for incremental dispositions. Accordingly, our NOI from continuing operations for the fourth quarter excluding discontinued operations is forecasted to be in the range of $107.5 million, to $109.5 million. And our projected quarterly NOI for the fourth quarter from continuing operations represents an increase from the third quarter of $6.7 million to $8.7 million. Page 17 of our supplemental package provided a forecast of 342,000 rentable square feet rolling in the fourth quarter and targeted for redevelopment, mostly late in the fourth quarter, as well as 55,000 square feet rolling in the fourth quarter of '13.

Of the 342,000 square feet rolling in the fourth quarter, 78,500 square feet will be placed into land held for future development. The remaining 264,000 square feet is expected to undergo redevelopment. 41,000 square feet is pre-leased, at 1616 East Lake in Seattle and 67,000 square feet at 4757 Nexus Center Drive, is expected to be leased to a single tenant user within the next week or so. The 342,000 square feet rolling in the fourth quarter that's targeted for redevelopment is expected to generate approximately $800,000 of NOI in the fourth quarter, so for modeling purposes, assume this $800,000 of NOI goes away by 12/31/2012.

Turning to occupancy. Year-to-date 2012 we've really made good progress increasing our cash flows in occupancy, offset slightly with a step down in cash rents year-to-date related to two leases, one of which was in Research Triangle Park and another one related to an industrial-type building in suburban Washington, DC. Overall occupancy, including spaces undergoing redevelopment in greater Boston, has increased nicely to 84.3% as of September 30, up from 83% as of March 31. Additionally, occupancy is projected to increase meaningfully by year-end as we deliver pre-leased spaces from redevelopment at 20 Walkup which is about 91,000 square feet. And 400 Technology Square, we expect to deliver about 70% of the 212,000 square feet under redevelopment primarily related to Aramco, Epizyme, and Ragon.

Overall occupancy in the San Francisco Bay Area including space undergoing redevelopment has increased to 95.7% up from 93.9% as of March 31. The increase really reflects lease-up of some vacancy and short-term temporary space leased to Onyx while we complete their build-to-suit development. Occupancy in San Diego including space undergoing redevelopment has increased to 93.3%, up very nicely from 81.5% since March 31. About one-third of this increase relates to the lease-up of vacancy and about two-thirds related to the transfer of 100% leased spaces from our value-added development and redevelopment programs into operations.

Overall occupancy including spaces undergoing redevelopment of 93.3% as of 9/30 is expected to decline to 88% to 89%, primarily due to the 165,000 square feet of space at Science Park which was recently acquired specifically for redevelopment and 4757 Nexus Center targeted for redevelopment in the fourth quarter of '12.

Occupancy in Suburban Washington, DC reflects the rollover in May of 2012 of approximately 110,000 square feet related to Baxter's lease of office, warehouse, and industrial space in a non-core submarket. Consistent with our prior comments, we expect this space to require some time to re-lease. Occupancy including space undergoing redevelopment at Seattle has been stable through 9/30, but expected to decline from 90% as of 9/30 down to about 80% by year end, while we complete the redevelopment of space at 1616 East Lake.

In October, Fred Hutchinson Cancer Research Center moved out of a portion of their space, aggregating about 80,000 square feet at 1616 East Lake in South Lake Union. About 67,000 square feet of this space is office space and, as forecasted in October, we began the conversion of this office space into laboratory space through redevelopment. Approximately 41,000 square feet or 61% of this space undergoing redevelopment is pre-leased. No other significant changes in occupancy is expected next quarter in our other markets.

Turning briefly to same property performance, as expected cash same property performance improved in the third quarter to growth of about 4.3%, representing an increase over both quarters for same-property performance in the first half of '12. And again, we continue to forecast better cash same-property NOI performance in the fourth quarter as compared to, again, the first half of the year. Straight line rents for the same properties declined, resulting in higher cash NOI due to the start of about $5.7 million of annual cash rents from one lease in New York City that started back in February of 2012.

We also had a couple of other leases with slightly higher rent steps on a cash basis, one in San Francisco at 901 Gateway and one in Maryland at 5 Research Place. Same property operating expenses for the quarter were relatively in line with the same quarter last year. Same property operating expenses for the nine months, however, were up about 2.4%, primarily related to an increase in recoverable repairs and maintenance expenses by approximately $1.7 million. Excluding this $1.7 million increase in repairs and maintenance, the increase in same property operating expenses would have been in line at about 1%.

Moving importantly on to leverage. As Joel had mentioned on our Investor Day on December 5, we'll provide a detailed review of guidance for 2013 including a projection of core operating metrics and other important items as well as, hopefully, a high level view or thoughts on 2014. The following recap focuses on the leverage component of our capital strategy for 2012. We started the year with a goal to have slight improvement in leverage to approximately 7 times on a debt to EBITDA basis. Projected debt to EBITDA as at 12/31, as Joel had mentioned, is targeted to be about 7.2 times.

Our total spend for 2012 is forecasted just under $600 million, consisting of about $429 million for the nine months ended 9/30, and $167 million for the fourth quarter. Our asset sales for '12 are expected to be in the range from $151 million to $156 million, with the fourth quarter sales target being about $76 million to $80 million of that including about $34 million of land sales. So the total increase of NOI from continuing operations from the fourth quarter of '11 to the fourth quarter of '12 on a quarterly basis was about -- it's projected to be about $9.8 million to $11.8 million, which represents an increase on an annualized basis from $39 million to $47 million. And we focused on continued reinvestment of cash flows from operations. Our ATM equity proceeds for the year through 9/30 has been about $98 million and, as Joel had mentioned, no further proceeds from the program are anticipated in the fourth quarter.

So in summary, we expect to end 2012 at roughly a leverage neutral position from the beginning of the year. We expect to complete about $600 million of construction spending. And we successfully minimized common stock equity offering proceeds to approximately $100 million. Very high level, our goal for 2013 is to end leverage neutral to slightly less leverage from our target debt to EBITDA as of 12/31/2012 of approximately 7.2 times. Our goal beyond '13 is to improve debt to EBITDA closer to 6.5 times in 2014 when we also anticipate construction spending to decline from our high point in '13 as we go into 2014.

Moving on quickly to our construction spending, again, on our Investor Day on December 5 we'll provide significant detail on our 2013 construction spend forecast. But today we'll provide a few high level thoughts. Our forecast for 2013 construction spend is $615 million to $665 million. Our active developments in North America, we're forecasting a spend of about $123 million focused on a few key projects, the largest of which is about $80 million or so for 225 Binney which is the build-to-suit for Biogen. And again, we've forecasted an initial cash yield of about 7.5%.

We also have about $16 million forecasted for 259 East Grand for the Onyx Pharmaceutical project with an initial cash yield of approximately 8%. Most importantly, the funding for this project will be provided by the construction financing we have in place. We also have about $13 million forecasted for 499 Illinois, again, with an overall yield on the 409 and 499 Illinois property within our original initial cash yield range of 6.5% to 7% that was announced upon acquisition. However, we are moving to the lower 50% of this forecast. Funding broadly for these projects, the active developments in North America, is expected to come from cash flows from operations and some use of our ATM equity program.

Moving to our active redevelopment projects in North America, we're forecasting about $59 million of spending. The key project in redevelopment spending for 2013 is about $18 million at 400 Technology Square for various tenants with solid initial cash yields at about 8.1%. The remaining $31 million is spread across several other projects and I think as you look at this group of redevelopments that we've projected for 2013, we're forecasting an average yield in the low 7% range. Funding for this group of construction projects will come from proceeds from sales of land parcels and the reinvestment of proceeds from sale of income producing assets.

The next category is preconstruction and we're forecasting about $84 million of spending. The Alexandria Center for Kendall Square, sometimes referred to as our Binney Street development project, is the key project consuming capital in preconstruction. As you recall, the build-to-suit project for Biogen which is now under active development has an initial cash yield of about 7.5%. This provides some insight into potential yields from this development site and we expect initial cash yields to move into the 8% range. Funding for preconstruction is expected to come from proceeds from our ATM equity program.

The next category is future construction projects where we're forecasting a range from $250 million to $300 million. The key projects consist of first off, the West Tower in New York City is expected to have about $115 million of spending in '13 and, as Joel had mentioned, we'll provide our usual detailed yield information in our fourth quarter earnings release. The next $59 million is really for future targeted redevelopment projects which have been detailed out in our press release including Hanover Street, Science Park Road, 4757 Nexus Center, and 1616 East Lake, and the yields are expected to range from roughly 7% to the mid 8% range.

We also have a spend forecast as we normally do for unidentified future construction projects and a few other projects. Funding for this category of future construction projects will consist of a significant construction loan, coupled with some proceeds from our ATM equity program. We also have about $30 million of spend forecasted for development and redevelopment projects in Asia and we are looking to develop a new source of funding for our Asian operations. Lastly, our generic infrastructure and other building improvement projects are forecasted to use about $68 million.

$18 million of this represents our share of our JV development in Longwood and remember we have a low to mid 8% initial cash yield on this project and we plan to reinvest almost all of the cash of the sale of 50% of our 55% interest in the joint venture. The remainder of the projects are spread across really two dozen different projects including a few in San Diego like the Amenity Building for Illumina in San Diego. This building, for example, was based on an initial cash yield of 8%. We expect funding for these projects to be provided by cash flows from operations.

Moving on to balance sheet matters. Let me quickly comment briefly on a few areas of the asset sales in our ATM program. We have four income producing assets classified as held-for-sale as of quarter end with an aggregate sale price of approximately $84.5 million. We expect to close on one sale for roughly 50% this amount by the end of the fourth quarter. Including this additional sale for 2012, our target sales for the year will be just north of $150 million. In September of 2012, we recognized an aggregate impairment charge of approximately $9.8 million upon classification of the four assets as held-for-sale. The sale of these assets are in process so the information we can provide at the moment is limited.

Additionally, we should point out that the sales price of the $84.5 million for the four properties really reflects significant capital the buyers are expected to reinvest to renovate the properties. As we complete the sales, we will provide our usual detailed disclosures for each transaction. We expect to complete a detailed review later this year of potential assets to sell in 2013 with the goal of continuing our asset disposition program. We expect to provide an update of our target disposition amounts at our Investor Day, again on December 5.

Year-to-date, we issued $100 million under our ATM program at an average price of about $73.15. This includes approximately $59.5 million issued in the third quarter at an average price of $74.97, leaving us with about $150 million remaining under the program. Again, at this time we do not require any further ATM equity proceeds in order to achieve our targeted debt to EBITDA metric of approximately 7.2 times by year end.

Lastly on guidance, our guidance for 2012 was adjusted slightly related to our same-property performance. We have been projecting our desired transition of a few tenants that we inherited when we acquired Technology Square, that's 300 Technology. We plan to re-tenant these spaces with high quality tenants in a similar manner to our success of redeveloping and re-tenanting 200 and now 400 Technology Square. We have absorbed some down time between tenancy due to the leasing and minor construction and remain confident that we will be successful with 300 Technology Square. This transition has impacted same property results this year, slightly more than we expected in the second half of 2012. But again, just slightly.

Accordingly, we narrowed our range of same property performance on a cash basis from a range of 3% to 5% to a range of 3% to 4%, and on a GAAP basis from zero to 2%, to slightly negative to slightly positive. I should also point out that our same property performance for the second half of '12 is expected to be better than the first half of '12. Guidance for NAREIT [ethical preferred] diluted for 2012 was reconfirmed at a range of $4.32 to $4.36. And our guidance for EPS diluted was reported at $1.16 to $1.26. With that, I'll turn it over to Joel.

Operator, could we go to Q&A please?

Thank you. We will now begin the question-and-answer session.

(Operator Instructions)

Philip Martin, Morningstar.

Just a question on -- well, first of all, retention rates. Based on discussions you're having with tenants, what do you think your retention rate is likely averaging in 2013?

In 2013 or --?

For 2013, the lease expirations, the discussions you're having around those lease expirations, retention rates in the upper 80%s? I know this quarter I believe it was 88% so it's fairly high. Through the nine months it was 78%. Just trying to get a feel there.

Yes, I'll have Steve comment. One item that might take exception to that general rule is 300 Tech Square that Dean had alluded to.

Yes.

That's a building that we did not fully -- we did not go and rehab it like we did 200 and 400 because it was in very good shape when we bought it. But we bought it in 2006 and MIT had recruited a number of companies there that at the time we did not necessarily view as long-term tenants. So we've sought as they've rolled out of their leases not to renew or to seek to retain them and looking to aggressively backfill that space with new tenants.

So I think our goal is, given our 48% of ABR being investment-grade, really where we see opportunities in core in-fill locations where we can replace, I would say less credit-worthy tenants with more credit-worthy tenants but I'll leave it to Steve to give you color generally speaking.

That was a bit where my question was heading anyway, in terms of if they were a little bit lower, might they be lower because you were seeing demand from a different or higher quality tenant.

Yes, the answer is for sure, and it's a good question.

I think when you start looking at the specific markets and where we're going to have product available, greater Boston is really concentrated in the urban core area, the Bay Area market will be in that Stanford, Palo Alto cluster. I think we're actually okay generally in Maryland. So we're going to be in places where either the retention rate will be consistent with what we've experienced in the past or as Joel just alluded to, we may have a chance to backfill with higher quality tenants.

And when you look at the lease term, I know you mentioned that in your opening remarks, looking at the TIs and leasing commissions, they're right around 523 right now, pretty consistent I think throughout the year, but do you see that leveling off at this point and do you see that average lease term going north of 5? Can you just give us an idea of trends based on discussions?

Yes, Philip, it's Dean here. I would say that the renewed and re-leased spaces typically average somewhere between five and seven years historically if you go back five or seven years. So I think that 4.8 year statistic for the three months or 4.6 for the nine months is right down where it's been historically. And the development and redeveloped space traditionally is closer to 10 years. So I think the statistics for lease term is right in line there as well.

Yes, I think as spaces turn, just remember small- and medium-sized spaces generally re-lease for shorter to medium term. Where you have larger blocks of space, those tend to renew for longer term. It's just kind of the way it is. And so I think we feel comfortable and as we migrate more space from suburban to urban, that I think can only help us.

Okay. Okay. And my last question, just could you provide a little more detail on Asia. I know you mentioned potentially looking for new sources of financing there, but can you just give us a better feel for how those developments are coming along in terms of pre-leasing, timing, that sort of thing? And that's it.

Yes. Well, I think in China we have had some success, although not at great yields in South China and in North China we're still working hard to complete that project and lease that up. Our goal in China over time will be to obviously look at finding someone who can come in potentially and help us potentially take the burden of those properties from us.

So that's something medium term we're looking at. And I think the India operations we had good success this quarter on -- reasonable success on leasing. And as I said previously, we're looking at trying to bring in a third party to help us finance those operations.

Because I think the real key message and you kind of got it from Dean's -- Dean took the time to go through in a very detailed fashion, category by category. We have more opportunities here in the US than we actually have sources of funding for and so even though that has jumped a bit from this year to next year, we've got a full platter for investment here in the US on redevelopment and development. So I think that's a good sign. So we're looking to kind of shift some of the burden of overseas investment to a third party and hopefully over the coming months and quarter or two I'll have more detailed news on that.

Okay. That is helpful. Thank you.

Yes, thanks, Philip.

Michael Carroll, RBC Capital.

Can you give us -- I know you alluded to this in your comments, but a little more details what's going on at 499 Illinois Street? What type of tenant's looking for that space, what kind of interest do you have so far, and kind of what the outlook for that property is?

Sure. We really do have the breadth of interest there. Technology companies are looking very closely at the cluster. They're very impressed by the facility, the ability to expand as well as the SoMa market gets tighter and tighter, large blocks of space are becoming a little more precious. So that's certainly a set of discussions we're having with various people on the tech side.

Then the life science side as well. Early discussions with groups looking to anchor the building and a couple of very intriguing opportunities that I had mentioned, kind of innovative public/private types of institutions working together in collaboration on solving some very big challenges in the life science world.

So we do have what I would characterize as a series of discussions and in some cases warm discussions going on.

One of the challenges there is, because this is a heavily institutional market, it by its nature moves more slowly than a dynamic market like a Cambridge or a Palo Alto. That's just the nature unfortunately of that submarket so we just have to be patient. I think as Steve said, we view the back end to be a good one, if we can get a high quality set of tenants -- tenant or set of tenants with solid rental rates, I think we'll have a cap rate there if we ever chose to exit that would be phenomenally attractive.

All right, great. Dean, can you explain why you believe capitalized interest is going to drop, I think it was at $16.8 million in the third quarter, and I think the guidance in the fourth quarter is between $13.6 million and $14.6 million. Is there a specific large project coming off capitalization that's dropping those estimates down?

It's actually two primary items, Mike. Partly the delivery of 10300 Campus Point and 4755 Nexus, which I described in my commentary.

And then as we all know, we've been preparing for a significant increase in NOI, primarily driven by the delivery of our value-added projects in the fourth quarter. I think my commentary described the growth in NOI in the fourth quarter. So that NOI is offset by the shutdown of capitalization as we deliver those projects. So it's really being driven by that, offset slightly by an increase in overall CIP from the spend that we'll incur in the fourth quarter.

So then the commencements and the value-add portfolio is largely driving that increase in NOI from 3Q 2012 to 4Q 2012?

That's correct.

Great. Thanks, guys.

Thank you.

Quentin Velleley, Citi.

Just in terms of the 2013 construction spend, the $615 million to $665 million. Dean, I know you went through a lot of he detail in terms of where the funding's going to come from. Can you maybe just summarize the key sources in terms of how much cash you're going to be using from the cash flow from operations after you pay the dividend, how much you're expecting to issue on the ATM and then how much you're broadly expecting to get from land and asset sales?

Yes, actually Quentin, that's a fair question. I think as we had discussed in the prepared commentary, our plan is to provide all that granular detail on December 5 at our Investor Day. But hopefully we helped to provide some sense of funding by the major buckets.

We're obviously at a cash flow perspective today from operations that allows us to reinvest into our business at about $80 million in 2012 and I would expect that number to increase. The mix of asset sales, whether it's land, operating assets and proceeds from the ATM program will be a little bit different than what it was in 2012. But it's safe to say that we're going to continue to monetize some land parcels and also monetize some income producing assets.

Yes. Maybe to give you a better fix on that, I think Dean's commentary on the free cash flow would be somewhere about $100 million-plus. Land sales and recycled assets, we'll have to give you more detail at a granular level on December 5. And I think when it comes to the ATM program, probably if you think in the $250 million range, that's probably where we'd be thinking about for 2013, if that's helpful.

Okay. Joint ventures, a development joint venture, something similar to Longwood, is that something that's on the agenda?

Not necessarily. I think on the big construction project in the Binney corridor, we would be looking at a large construction loan and mini perm takeout at about 100%. So that will cover a pretty sizable chunk of that funding requirement. I don't think we'll be joint venturing anything at least domestically in the US of size in 2013 at the moment.

Okay. And then just going to the West Tower. It seems that the Roche pre-commitment's pretty small relative to the size of the project and I know you covered it a little in your prepared remarks. Can you sort of talk through what gives you the confidence that you can commence the project when you've only got a very small amount of pre-commitment?

Well, I think having Roche there is -- and the decision was made, the visit was made and the decision made by the CEO. He actually wanted to know when our next building beyond that -- we have an option on the north parcel -- when that might be ready. So I think that's an initial commitment from their translational clinical group, but it is what it is at the moment.

We feel very good that we have two relationships with biotech companies that we believe have a very high probability. We're actually in negotiations with each one on additional space that could be as much as half a floor to a floor apiece.

And then we have a current tenant whose business has a milestone in the fourth quarter and if that's reached, they've requested and we've started to work a proposal out between us for two floors. Plus we've got a very, very strong set of active showings to a range of different parties. So I think we'll end up probably over the next couple of quarters, I'm pretty confident, probably in the 40% range.

So that gives us confidence. We own the steel; we own the curtain wall. We only have to go vertical and I think that gives us confidence we can -- it makes sense to kick off that project.

And it's also a time in New York where there's less construction going on, so the ability to buy out contracts and trades with the trades is somewhat more favorable.

Okay. Thank you.

Yes, thank you.

Steve Sakwa, ISI Group.

I guess the main question I had was the one Quentin asked so I guess we'll wait until December to get some more details. But Joel maybe you or Tom could talk a little about the demand up in Boston. I just wanted to get a little more granularity on what you guys are seeing in terms of either biotech, pharma, and possibly tech, up in the Binney Street area, and then I'll ask a question about San Francisco.

Yes. So I'll let Steve address that question but let me make a preliminary remark.

I guess what we've seen in Cambridge over the last couple of months is a number of companies -- and this has happened in the San Francisco Bay Area to some extent as well -- we call kind of the second generation of companies that are now commercializing products, fairly large market caps relative to the biotech industry as a whole. They will move to significant cash flowing entities and they need substantial space and that's really independent of the macroeconomic environment. That's because of product approval. So we're seeing, I think reasonable demand in Cambridge from those groups.

I think when it comes to pharma, we know that Pfizer's made significant in-roads in their work, MIT is doing a build-to-suit. We know they're looking potentially for more space. It's rumored that Sanofi and maybe another one or two are looking at Cambridge for moving some additional research units there.

So we feel pretty good about -- plus, there's a strong continuing evolution of early to mid-stage companies. That's the one market we see that in a pretty dramatic fashion, not so much anywhere else -- the Bay Area to some extent, other markets not so much. So Steve can give you a highlight on tech and maybe his observations as well.

Yes, just to add to that, Steve. I think if you look at 400 Tech Square and the leasing that was done in the last quarter, that's pretty indicative of looking forward. And you had Aramco lease a chunk of space; they absolutely wanted to be in this location. They are supporting MIT's energy fund initiative so you've got a classic case of a company having to be adjacent to these types of institutions. You couldn't get a better credit profile than that type of company.

And then you have Warp Drive, early stage company, very exciting technology, great venture backers and again, wanting and needing to be in this type of location. And we do actually have discussions and tours with a couple of technology companies, as well. So, similar to San Francisco, we do see that Cambridge has the mix of both tech and life sciences and we're experiencing that interest firsthand.

I think in the Warp Drive situation, there also is a big pharma that is I think both an investor and a strategic partner in that company, so it's -- you might think wow, start-up sounds kind of modest, but it's a pretty big start-up. And it has from day one not only substantial funding, but it has a partner and investor from big pharma which is actually likely the commercialization path. So we feel pretty good about that market.

You want to take a crack at San Francisco? Maybe the second generation too?

Yes, similarly in south San Francisco with the Onyx build-to-suit that will be nearing completion I think in Q1 next year. Couple of companies that are doing very well, the anchor tenant in the 409 Illinois building. FibroGen is advancing their sciences well. They just had an orphan drug approval. So we're just very, very encouraged by that.

Okay. And I guess just I don't know if this relates to some of the comments you made earlier -- but obviously companies like Boston Properties and Kilroy are getting some of these new development sites by Transbay. I realize there's some overlap in terms of the tenants that you might be talking to. But how are you guys looking at the new development that might be taking place down in the SoMa area and do you feel like there's any kind of crossover tenants that may be looking at both areas?

Not in the near term, Steve. Those are probably a good 30 months away in general and Transbay is at least three to five years before that's going to ultimately be delivered and occupied. I don't necessarily see traditional tech companies considering more of a conservative traditional 60-, 70-story tower type of facility.

So as far as Transbay, I don't see that being competition. I think it's just different location, different product type.

Okay. Thanks, guys.

Thanks, Steve.

(Operator Instructions)

Dave Rodgers, Robert W. Baird.

Joel, maybe you could give us a little bit more color on the disposition market, obviously you guys have had success this year marketing the properties and the land and getting it out the door. Talk about any changes in the appetite that you've seen or any slowdown in the process, if any.

And then maybe a broader comment going into the December meeting -- give us your thoughts about the overall economic landscape with respect to being the time for you to start really accelerating dispositions. Should we expect to see a fairly sizable number relative to this year given that you've stabilized NOIs, the redevelopments have stabilized, you've got the leverage down, and it seems like now's the time to do that. That's my take. I'd love to hear yours.

I think we'll probably be able to give you a chapter and verse come December 5, but maybe broadly on the disposition market, and I'll ask Steve to comment because he's pretty deeply involved in that.

But I think when it comes to one set of dispositions, they really were generated in a suburban location by a user that really approached us saying now is a great time. We had targeted this for disposition. We can't really say much about the details yet because it's still in contract process. But that's a good example where our desire and their immediate need kind of collided in a positive fashion.

In another situation, we see that there's a need to really move the product into a broader product type in another location. And there we thought, not really our cup of tea, so we'd look for a buyer who had both the skill, expertise, and the ability to put in additional capital and look at that really interesting different product types. So that kind of met time and circumstance, which was very beneficial.

I think when Dean gave guidance last year at Investor Day for $112 million of asset sales this year, I think we'll clearly see that number very comfortably. But I think we were taking our time because this is a product type that is not necessarily common to lots of buyers out there as far as basic knowledge. But I think we've seen a good reception and I think we've got some good targets for the coming year.

But Steve, you can give your commentary.

There's probably two buckets to think about in terms of dispositions. The first would be the land. As we looked at the land sales, those were in high-quality locations and really a reuse of the property in terms of zoning was able to be effectuated. So you had property that we had looked to be lab product over time, ultimately be viable for residential. In another case, didn't require a land use change but the technology sector was stronger in that area, so that viability enabled us to move forward in the land side.

On the existing assets, I think it's important to note -- Joel mentioned it -- again, these assets are legacy assets. 10 or 15 years ago that's where the industry was located in some cases.

And as they've migrated away, we have a choice to make. Do we invest additional capital? Does the product type maybe get a little bit far from our core competencies and is it really a long-term strategic asset? And at that decision making point, the ability to raise capital, deploy it to our urban locations rather than the former scenario was, again, we just thought made good sense.

Great. Thanks.

Thank you.

Michael Bilerman, Citi.

Yes. I just wanted to come back to capital and leverage for a moment.

Joel, I think you talked about leverage being 7.2 times, and wanting to have gotten to 7 by the end of the year. Clearly, the agencies have you where they want, probably in the mid-6s and I guess you marry that up with what is significant spend into next year. Why not be more aggressive at getting that leverage down now to not have an overhang in the future as you embark on $650 million of spend next year?

Well, that's always the question of the hour, but I think that certainly based on what we have talked about from the last Investor Day, and I think you certainly have represented one of the views there that has been important in our thinking, is we wanted to develop a run rate visibility, an earnings guidance visibility, and I think a mode of operating that is not so much in and out all the time, that there's a consistency and a predictability to it. So that's one of the reasons we've sought to try to be pretty careful and pretty methodical and pretty logical about what we've done this year and into next year.

I think you'll see construction spend will start to tail off significantly in 2014. I think the agencies are pretty flexible, frankly, as long as we're moving in that direction. I think we'll be held in good stead.

I think we recently -- Dean and I -- recently looked at leverage numbers of a lot of the REITs and it was actually surprising to me that a lot of them are actually operating at pretty good -- when I say good, higher leverage levels than I would have actually even guessed.

But I think we're pretty comfortable where we are. I think we might decide at some point to -- if something came out of the woodwork that we could accretively match that isn't part of our program today, I think we would do that. But I think we're comfortable.

We're almost down to 7; I think we'll be right at 7 or so next year, very close; and I think as we see getting into 2014, we can easily gravitate I think into the 6.5, with the major on-boarding of projects. I don't know that we need to go out and create a radically dilutive, $0.25 dilutive event, when we think from the sources we've described we can get there in a logical way. That's how our thinking is. But, others may have different views.

I'm just curious because you mentioned 2014 of construction spending coming down. But then when you start to layer in the Binney Street project and the eventually of the North Tower, if the West Tower is indeed successful in being --.

That's quite a ways downstream. I think that --

it would seem as though there's enough in the hopper to have another $600 million of spend -- you talked a lot on this call about redevelopments, going into land inventory, so it doesn't seem like that spigot is going $600 million over each of the last two years, going down significantly. Seems that that's going to be a consistent pace in terms of development.

Yes, I don't think so. I think, again, remember too that we've got kind of a cushion as Dean described it, future development projects in one or more of the buckets. So we've tried to be conservative in this, with some cushion in the 2013 numbers.

And I think 2014, I think really looking forward, the only really big project we would have would be Binney. I don't see us doing any more large-scale projects in the very near future. I think we see there's some interesting opportunities potentially for selective redevelopments, buying locations, maybe with some stabilized income and some we could convert as opposed to large-scale development.

So I think we see that as probably more the business model matrix for 2014. I think we're pretty comfortable on this glide path where we think it's working pretty well. You know, we had a lot of feedback from Investor Day last year and certainly over the past couple of years and so we've sought to try to, again, minimize that equity dilution.

I think Dean and his team have done a fabulous job this year of managing it and I think he's given you and will give you great granular detail on December 5. If you look at what we've got next year, we think it's a pretty manageable number and obviously if we can get our NOI run rate up and our earnings projections going into 2014 to look at nice, reasonable growth in a no growth environment, we feel pretty comfortable with that.

That's very helpful. Joel, you talked a little bit about the dividend in your opening commentary about seeing what would be a solid increase. How should we think about that level and then also how it would impact free cash flow. I think Dean had talked about $100 million of free cash flow as a source of equity for deleveraging and to fund the developments into next year.

Well, I think the key is to share the increase in cash flows, not just suddenly move it obviously all to a dividend category because clearly it's the cheapest form of capital that we have. But I think if you look at this past year or so, what we've tried to do at the Board level is kind of restore a predictable step-wise increase in the dividend, again, sharing on-boarding of cash flows and I think that's probably a similar run rate you'll see and that still leaves us with at least about $100 million of free cash flows for the coming year.

Beyond that, in 2014, don't know. But I think that's the Board's discussion for 2013.

Sort of if this year's a 10% increase, that's what we should be thinking about for 2013 at this point?

Probably somewhere in -- I don't know that I've looked at it instantly but I would say, somewhere in the 5% to 10% range.

Okay. And then just last question, just in terms of understanding compare and contrasting 409, 499 and your confidence level when you bought that asset vacant or half the asset vacant and the confidence level here in New York about going vertical on the second tower. And you talked a little about this previously, but how should we just think about those two situations, because when you bought 499, 409, you were really confident about leasing that up pretty quickly. I guess how should we view the ability in New York about going vertical?

Well, I think on 499, I think our view is actually -- we tried to provide and we're still, as Dean mentioned, we're still sticking with our yield projection, but at the lower end. I think what that shows is we still feel like we put adequate cushion into that lease-up. We never thought it would be simple, day one, but we thought that with the hospital's momentum it would go faster than it actually has, and it sucks that it didn't. I don't think we've changed our view that, as Steve said, it's high quality and that we'll be successful. The Street will judge us by not what we say but obviously by what happens, but I feel pretty good about New York.

I think Roche has been a big plus. We've got some pretty great current tenant interest. One tenant has stepped forward. We know that there's one or two others that are in discussions internally about expansion space. That could even be as many as three current tenants which would be pretty amazing.

We have got two biotech companies that have high probabilities. We're in negotiations, specific dollars and provision negotiations. And then we've got pretty active showings with a whole range of -- I did a trip last week to the headquarters of one major Company. They're very interested. Don't know where they'll end up but I almost -- my personal view is they'll come to New York.

So we see a lot of activity, but again, you know, we only want to be judged by how we succeed, not what we say, but we feel comfortable pulling the trigger on that incremental spend because we own, as I say, a lot -- we own the steel, the curtain wall. We just go vertical and we think it's a good time in New York to do that and that's been another reason we felt pretty comfortable with that. So I guess my level of confidence is pretty solid. Time will tell.

I mean, if we did build the East Tower through the Lehman fiasco and the cliff of almost disaster before TARP kind of came on and so forth. So we managed to get through that and had a -- from delivery date to full lease-up took a year which was two years' faster than we had gathered. I don't know, It's a hunch, It's an instinct, It's a feel, based on all the people we're talking to and I hope we're right and if we're wrong, then the Street will make that judgment but we feel pretty good about it.

But I think having Roche as the anchor has been a huge plus from the quality and the efforts they're going to put forth in New York. So I think if we had no anchor, we never would have pulled this off.

Thank you so much.

Yes, thank you.

We have no further questions at this time. Mr. Marcus, do you have any closing remarks?

Just to say thank you. We'll talk in February, and again, stay safe over the next day or two. Thanks, everybody.

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.