Alexandria Real Estate Equities Inc (ARE) 2014 Q2 法說會逐字稿

Please stand by, we are about to begin. Welcome to the Alexandria Real Estate Equities, Inc. Second Quarter 2014 Earnings Conference Call. My name is Jessica, and I will be your operator for today's call. (Operator Instructions) Please note today's conference is being recorded, and I will now turn the conference over to Rhonda Chiger. Ms. Chiger, you may begin.

Thank you, and good afternoon. This conference call contains forward-looking statements within the meaning of several securities laws. Actual results may differ materially from those projections and forward-looking statements. Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements as contained in the Company's Form 10-K Annual Report and other periodic reports filed with the Securities and Exchange Commission.

And now I'd like to turn the call over to Mr. Joel Marcus. Please go ahead.

Thanks, Rhonda, and welcome, everybody, to the second quarter call. With me are Peter Moglia, Steve Richardson, and Dean Shigenaga. As all of you have seen from the press release, we are pleased to have reported our second quarter FFO at $1.19 a share and an increase in the midpoint of our narrowed 2014 guidance range $4.74 to $4.80.

In the second quarter, we've witnessed the very positive convergence of really more of key cyclical as well as structural factors, which have resulted in an exceptionally strong environment for our unique collaborative science and technology campuses in our great urban innovation knot clusters.

In point, we actually see exceptional opportunities, very strong tenant demand, increasing rents and occupancy, and Alexandria is able to drive earnings and NAV growth therefore. We will, at Investor Day in December, set expectations for growth in 2015 as well as how our value-added growth pipeline should evolve over the next two to three years. We'll also detail our funding approach to our capital allocation in 2015 as the Company continues to have the full range of capital sources available to it. And if you look at -- take a glimpse of 2015 can be seen on page 50 of the supplement.

Other macro comments, let me share with you. We see continuing strong improvement in the Life Science Industry's ecosystem participants to the urban core clusters. Peter will talk about this in a minute. Presences in, really, tertiary cluster locations outside of the key core urban clusters are really declining even if you've got a second tier academic or university nearby. And Pfizer's sale of three facilities and their move to the heart of Cambridge, which, again, Peter will comment on in detail in a moment really is a prime example.

We've witnessed this strong biotech and pharma capital market's performance over the last many months and solid profitability and lots of cash. As you know, record high FDA approvals of new drugs are with us plus the FDA review time is down from about 23.8 months as a high in 2008 to, right now, about 9.4 months in 2013.

When combined with the new breakthrough therapies' designation and the new-era precision targeted medicines to treat serious life-threatening illnesses and diseases, it's pretty clear that we've got substantial improvement over existing therapies and better targeting of medicines with fewer side effects and of the six breakthrough therapies approved by the FDA four are Alexandria tenants, Roche, Gilead, and Novartis and GlaxoSmithKline.

In the first half of 2014, in fact, 143 Digital Health companies raised $2.3 billion, 168% growth over 2013, so another good factor.

If you look at the July 25th Wall Street Journal, they did a feature article on Google X, an important tenant of ours in the San Francisco Bay region. And Google's so-called new moon shot project, "The Human Body," was kind of elucidated in that article and, simply stated, it's focused on not being restricted to specific diseases using new diagnostic tools to collect a broad range of samples using Google's massive computing power to find biomarkers and patterns and then using these biomarkers to detect diseases much earlier than we ever have. So we're on the new frontier of some pretty dramatic breakthroughs.

You move to operations and internal growth, and both Steve and Dean will talk about this. We're certainly beating our occupancy in rental rate increase estimates, and we're in a strong environment given our urban locations. Leasing by region has been driving internal growth with 752,000 square feet leased this quarter. Greater Boston contributed 58%, San Francisco 13%, and San Diego 12%.

On external growth, you've seen the disclosure on the acquisition of 500 Townsend Street in the SoMa District of San Francisco in April adjacent to our Mission Bay cluster and, really, over time, we think integrated well will help drive our continued growth in the city of San Francisco where we've successfully developed over 1 million square feet.

I also direct your attention to page 27 of the supplement. Our near-term value-add pipeline is the strongest it's ever been in key multiple urban innovation clusters, and we're very pleased about that. I'll leave the balance sheet comments this quarter to Dean and maybe finish up on the dividend. The Company will continue its policy to share increasingly strong cash flows with shareholders as we continue to maintain a low payout ratio, 61% this quarter.

So I'm going to turn it over to Peter for some comments.

Thanks, Joel. Good afternoon. This quarter I'd like to highlight one notable Life Science trade that provides some clarity on cap rates in Torrey Pines San Diego, one of Alexandria's largest sub-markets; trades of office property in San Francisco and Manhattan that illustrate continuing cap rate compression in the core urban markets that Alexandria invests and operates in. And then highlight the sale of a Life Science portfolio by Pfizer in West Cambridge not so much for its financial metrics but because it offers further support that the transition of large pharma and biotech companies from siloed research campuses to centers of innovation anchored by academic institutions is continuing.

First I'd like to discuss the sale of 11099 North Torrey Pines Road by Angelo Gordon to HCP. The asset is 93% occupied, 92,479 square-foot multi-tenant laboratory office building on the northern edge of the Torrey Pines sub-market. There were about a dozen tenants in the facility that are a mix of large company earned institutional credit with some early-stage private biotech.

The sale price was $43,750,000, which would indicate a low 5% cap rate on in-place income, but after allocating value to excess land, it was reported to be at 5.67%. So this is a solid building, but we believe our overall portfolio in this sub-market is of higher quality and, therefore, this comparable should support low 5% cap rates for our higher-end Torrey Pines property such as our Nautilus and Spectrum projects.

There were no other Life Science trades to report this quarter, but we would like to note that last week an article in The Registry noted that 405 Howard Street in San Francisco is being acquired by Norges Bank Investment Management and TIAA Cref for $350 million, which is estimated to be $750 per square foot at a cap rate of between 3% to 4%. This asset is located within 1.5 miles of our 500 Townsend project and the northern edge of our Mission Bay holdings.

We believe Mission Bay is on course to be every bit of a desirable location as SoMa and the Financial District as it moves towards full buildout aided most recently by the announcement of the development of the new Golden State Warriors stadium and supporting next uses on the east parcels.

Because of this, we believe that cap rates for our Mission Bay asset should closely resemble those of assets trading in SoMa and the Financial District. Adding to Mission Bay's terrific location and close proximity to SoMa and the Financial District is that our Mission Bay assets are relatively new with an average age of 5.8 years and are leased to high-quality tenants such as Pfizer, Selgene, UCSF, the VA, and Bayer under long-term leases.

We would also like to note that both 5 Times Square and 920 Broadway traded in Manhattan at $1,361 and $1,091 per square foot, respectively, showing that investor appetite for New York City assets is not necessarily being governed by price per pound limitations.

No cap rate was reported for 920 Broadway, but the 5 Times Square cap rate was reported at 4.35%, and we'd like to note that it was a leasehold transfer.

Lastly, Pfizer recently sold vacant assets 87 and 200 Cambridge Park Drive in West Cambridge totaling 280,000 square feet to King Properties for $192 per square foot. But what is really interesting about this is that they signed a lease with MIT at 610 Main Street South in Kendall Square for 280,000 square feet and are rumored to be looking at taking another 140,000 square feet at MIT 610 Main Street North project.

A June 15th article in the Boston Globe references that Pfizer will consolidate employees from West Cambridge, 620 Memorial Drive, and some employees relocated from Groton, Connecticut, to 610 Main. Although only 4.5 miles away from their new location, Pfizer decided to sell fully improved, owned research assets in West Cambridge and materially increase their occupancy costs by leasing space in the heart of Kendall Square because to quote the article, "While the Company has historically deployed the standard pharmaceutical industry model on in-house silo drug discovery, the new research center here has stolen a page from the collaborative culture in open architecture of the entrepreneurial startups that dot Kendall Square."

They obviously see that the value of the location will vastly outweigh the increase in operational costs. Michael Dalston, Pfizer's President of Worldwide Research and Development, was quoted as saying that Pfizer's decision to consolidate into Kendall Square's location "is a real recognition of our confidence in Cambridge, Massachusetts, to become one of the leading hubs of biomedical research for us in the future."

Examples like this continue to validate our cluster model, and we expect more in the future as they result in new product pipelines and lower overall cost of drug development.

So, with that, I'll pass it over to Steve.

Good afternoon, everyone. At the outset, I'd like to first commend our best-in-class regional teams for a truly exceptional operational performance year-to-date as we're hitting on all cylinders. The level of expertise and commitment to excellence in all facets of the business is truly unique and unparalleled in the industry.

Today I'll touch on two key aspects of our operations in my remarks. One, the ongoing and sustainable solid performance of our core and, two, as we forecasted earlier this year the increasing actual and imminent deliveries from our significant $1.1 billion current value creation development pipeline.

First, the core is performing very well as we reported cash and GAAP increases of 6.3% and 13.6% year-to-date and 3%, 9.9%, respectively, this past quarter for renewals in releasing a space.

We are seeing now more broadly as a trend the clear and compelling sense of urgency towards Alexandria's Class A facilities and operational teams and its irreplaceable cluster locations as tenants with 2015 and even in some cases, with 2016 rollovers, engaging our regional leadership teams to renew leases and lock down space.

This is a very noteworthy and powerful market dynamic that we really haven't seen in a decade or more. The stability provided by our Class A facilities and AAA urban science and tech campuses populated by investment-grade tenants with a high bar 96.9% occupancy rate for North American properties is also impressive, as this is the second consecutive quarter we've been greater than 96.5% occupied. Probably no better metric for the return to stability theme we outlined at our December 2013 investor meeting.

The rollovers remaining to resolve in 2014 are very manageable -- 150,958 square feet or just 1% of our operating base. We'll take a closer look at each of Alexandria's urban science and technology innovation clusters and the very positive fundamentals for each.

In Cambridge, we're seeing demand remaining very robust and increasing with more than 4.3 million square feet of demand from both Life Science and tech users. Our mark-to-market on rollovers for the balance of the year is targeted at 14% on a GAAP basis, and the region has hit a high-water mark of 98.5% occupancy.

The clear scarcity of both large blocks and smaller blocks of space is maintaining rents at the new level of the high 50s, low 60s, triple net for existing product and Binney Street build-to-suit prospects are anticipating rents in the low 70s triple net.

Direct office vacancy rates in East Cambridge remain very healthy at a low of 6.8%, and lab vacancy rates remain unchanged at 10.7%, although it's important to note that the bulk of this lab availability is really B quality leave-behind space from Vertex and Pfizer and, as such, the desirable direct spaces are experiencing competition from multiple users creating a clear landlord's market.

Moving over to the San Francisco Bay, it's also continuing its strong demand cycle as we are maintaining our strong occupancy level at 98.4% in the operating and development asset base. We're tracking 750,000 square feet of Life Science demand, and a pretty amazing 7.9 million square feet of tech office demand. We recently note Google's lease of approximately 250,000 square feet and purchase of an adjacent 90,000 square-foot building in SoMa, further contributing to lease rates for new products now in the mid-50s triple net.

The mark-to-market for 14 rollovers is anticipated to be nearly 14% with lease rates increasing again to the low 50s triple net in Mission Bay, mid-30s in South San Francisco, which could pop if Amgen's rumored plans to reoccupy space that they've had on the market for sub-lease transpires, and mid to upper 40s in the Stanford cluster.

The market, overall, continues to tighten, as vacancy rates drop 50 basis points in the lab market from Mission Bay to Palo Alto to 6.3%. A sense of urgency is clearly evident with a December 2015 and a December 2016 tenant completing the early renewals.

Moving down to San Diego, the core is performing very well with 97.2% occupancy, up 300 basis points from Q2 2013 and the market, overall, is similarly enjoying continued strong demand with 1.3 million square feet of Life Science requirements, up significantly from the 800,000 square feet earlier this year.

A number of transactions along the Torrey Pines Bluff had been recently completed in the range of $40 triple net for a high-quality product, which is now becoming even more scarce as the direct vacancy is just 10% and all current negotiations are now reaching into the mid to upper 40s triple net. UTC's direct vacancy rate has dropped 30 BPS to 6.1%, and although the remaining rollover is small, it's important to note the mark-to-market will be significant as a legacy lease expires.

Finally, Seattle will provide mark-to-market gains in the mid-teen range for the balance of 2014. Vacancy rates are also tight in the South Lake Union District at 4.9%, and demand continues in Seattle with fresh requirements for nearly 500,000 square feet in the science and tech sector.

Finally, our current value creation development pipeline remains on track with an additional 110,000 square feet delivered and placed into service during this past quarter. We're on track to deliver and place in service significant and fully leased facilities during the second half of 2014 and Q1 2015. These projects represent the highest-quality class A assets in core urban science and technology innovation clusters -- Cambridge, Manhattan, San Diego, and San Francisco and are another testament to the acumen of our fully integrated regional teams.

With that, I'll hand it off to Dean.

Thanks, Steve. Dean Shigenaga here, good afternoon, everyone. I have four important topics to cover. First, I want to provide an update on our balance sheet, including our recently highly successful issuance of unsecured notes; second, I'll provide a key update on land sales for the second half of this year; third, briefly touch on interest expense for the second quarter; and, fourth, provide a summary of key drivers of growth in our guidance for 2014 FFO per share and confidence in our ability to deliver solid growth in cash flows, net asset value, and FFO per share in 2014 and beyond from our Class A buildings and land parcels in AAA locations in urban innovation clusters.

Starting with our bond offering -- in July, we completed our third highly successful unsecured bond offering and increased the strength and flexibility of our balance sheet and capital structure. Our $700 million dual tranche offering focused on 3 primary goals. First, transitioning variable rate bank debt to longer-term fixed rate unsecured bonds; second, prudent laddering of debt maturities considering our outstanding bonds with maturity dates in 2022 and 2023; and greatly increasing flexibility as we focus on several high-value build-to-suit development projects.

Our bond offering consisted of $400 million of 2.75%, 5.5-year unsecured notes due in 2020; $300 million of 4.5% 15-year unsecured notes due in 2029 blending to a weighted average rate of 3.5% and a maturity of 9.6 years. And to put this pricing into context, a 10-year deal would probably have priced with an interest rate around 4%.

This highly successful transaction also extended our average maturity of outstanding debt to 6.3 years, up from 5.1 years; increased our liquidity to $1.8 billion; and reduced our unhedged variable rate debt to 7% of total debt.

Briefly, on a few other balance sheet matters, the high-value projects that we have leased, completed, and delivered over the past several years, along with deliveries scheduled over the next few quarters, really highlights the solid demand for our Class A assets and high-value urban innovation clusters.

Our target net debt to EBITDA for the fourth quarter of 2014 annualized is on track with our plan at 6.8 times, and is relatively consistent with leverage at the beginning of the year of 6.6 times. Additionally, our target net debt to EBITDA of 6.5 times is expected to occur by the fourth quarter of 2015.

Non-income-producing assets will decline to 15% by year-end and to 12% by March 31, 2015, primarily through the completion and delivery of pre-leased Class A development and redevelopment projects. These forecasts include a very conservative assumption for construction spend related to new projects and includes the land sales targeted for 2014.

We also anticipate significant EBITDA growth for 2015 when compared to 2014, plus solid cash flows from operating activities after dividends, which, in aggregate, will provide funding for growth of approximately $500 million to $600 million in 2015.

Briefly, on our second topic on land sales for the second half of the year, we remain comfortable with our range of guidance for land sales of $145 million to $245 million for the full year of 2014 and approximately $115 million to $215 million to complete for the remainder of the year.

Moving on to our third topic, I briefly want to touch on interest expense for the second quarter. Interest expense declined approximately $1.7 million driven by a $2.4 million reduction in gross interest expense offset by an approximate $700,000 reduction in capitalization of interest.

Gross interest expense declined primarily due to the repayment in January of 2014 of a $209 million secured loan with an interest rate of 5.6%. Additionally, we had $200 million of notional and swap contracts that ended on March 31, 2014, which fixed LIBOR under the contracts at about 5%.

Capitalization of interest was lower this quarter primarily as a result of the weighted average interest rate required for capitalization at 3.41%, down from 3.88% as of the first quarter. This temporary dip in the interest rate was caused by the higher proportion of variable rate debt outstanding under our line of credit, which, obviously, has a lower interest rate.

This temporary decline in the rate was reversed in July upon completion of our bond offering when we repaid almost all of our outstanding borrowings under the line of credit. We expect the weighted average interest rate for capitalization of interest to return to its prior run rate in the range from 3.8% to 4% for the second half of 2014.

Lastly, on guidance, our core operations continue to benefit from one of the REIT industry's highest quality tenant basis with about 52% of our total ABR from investment-grade rated tenants.

Additionally, high-quality science and technology entities continue to drive strong demand for our Class A assets in urban innovation clusters including build-to-suit opportunities on our land parcels. This high-quality demand for continued improvement in our outlook for 2014, our guidance for FFO per share this year was increased $0.02 at the midpoint to a range from $4.74 to $4.80.

We increased the range of our occupancy for year-end up to 97.2% after hitting the upper end of our prior occupancy guidance well ahead of schedule. We also increased the range of guidance for same property and alike growth to a range from 3% to 5%, up 1% on both ends of the range.

Additionally, we increased the ranges in rental rate increases on renewal and re-leasing of space to a range from 11% to 14% and a range from 4% to 6% on a cash basis, again, both up 1% each on each end of the range.

Most importantly, the strong demand for our high-quality buildings in urban innovation clusters will allow us to monetize several land parcels through development in the near term.

As we look back to Investor Day in December of 2013, our outlook at that point for 2014 was very solid. Now that we're seven months through the year, it's very clear that demand for space in our buildings has meaningfully improved. Again, this demand and the strength and the performance of our core operations drove the aggregate $0.07 increase to date in our midpoint guidance for 2014 FFO per share.

The key drivers of this $0.07 growth came $0.04 from core operations, $0.01 from value creation deliveries earlier than anticipated, $0.01 from acquisitions, and $0.01 from other items including our recent bond offering.

In closing, we are very pleased to be in a solid position with our balance sheet with continuing solid core operations and demand from high-quality science and technology entities to drive stable growth in FFO per share and net asset value in 2014 and beyond.

With that, I'll turn it back to Joel.

Operator, we're open for Q&A.

Thank you. (Operator Instructions) Emmanuel Korchman, Citi.

Hey, thanks, guys. Do you know, if we just look at your income statement, there was no other income in the quarter? Typically, you've had some amount in there attributable, at least, to marketable security sales. Could you tell us what's going on there?

Yes, I'd say we had a one-time decline in other income. Typically, you see other income in the $3 million to $4 million range, and that's our outlook for the remainder of the year. In the quarter, we did have a lower amount of investment income; in fact, it was a small loss in aggregate during the quarter. So that was the driver there.

And then given the strength you spoke about in terms of assets, sort of, next door to you selling at good cap rates, have you thought about selling more core assets into that type of market rather than just the non-income producing ones?

We did go through a recycling of assets that we wanted to lighten up in certain sub-markets in latter 2012 and part of 2013, and I think that was completed. At the moment, we're reviewing things constantly, and you may see us do some of that but, at the moment, we don't have anything particularly to target.

And then in terms of the non-core sales, the 50, 60, 100 JV is still planned to happen this year?

We're certainly on target to do that, yes.

Jamie Feldman, Bank of America Merrill Lynch.

Great, thank you, and good afternoon. So I guess sticking with the disposition market, can you talk a little bit more about the types of buyers you guys are seeing for your asset class?

Hey, Jamie, it's Peter Moglia. We've seen a lot of domestic and foreign capital private equity. We've had a lot of pension funds interested in both buying our product and in joint venturing with us. So I would say that pretty much every class of investor has looked or purchased Life Science product now. Maybe that wasn't the case seven years ago, but it is now.

And I think that's a good thing, because it's become more mainstream and, certainly, cap rates have reflected that.

And then in terms of operating the -- I mean, it's a little bit of a differentiated asset class -- do they operate it in-house, or there's just specialized third parties? Or do you guys maybe retain more of a stake?

I think most of the things that have traded to those types of buyers have been long-term leases that they'll likely, probably, need to sell maybe within three or four years of those leases burning out. But they haven't got to that point where someone needed to operate something yet.

Okay, all right. And then shifting to the development pipeline, can you talk a little bit more about your leasing prospects at 3013 Science Park Road, and then New York?

Yes, I'll speak to New York. Do you want to talk about 3013?

3013, we've got the existing building that we're saving the steel frame with. We've got that 25% leased to a top-tier Life Science company in that market. And then for the other project, we actually have a letter of intent for the entire 65,000 or so square feet for a long-term lease there. So all we have left will be about three floors on the building that we're redeveloping.

And then in New York we have four floors left, and we have some reasonable activity on some of those floors. We don't have anything that's moved to the stage of LOI, but we're very active, and we think that over the coming couple of months we'll have some news ahead of our internal projections. So I'd say stay tuned for that.

Yes, and, Jamie, let me just add from a modeling perspective, our guidance only assumes we deliver about 60% of the project by the end of this year for the West [Tower].

Okay. So I guess just thinking about leasing and just kind of an interest in New York, I mean, is there anything that's changed, or is it just slower than expected? I guess not than expected because you said you're in line with the guidance, but just how -- ?

(multiple speakers)

Well, actually, ahead of --

-- just actually how the tenants are reacting to the market and to the (inaudible).

Yes, I think we're ahead of our own internal expectations, so I think that's reflected in the model that Dean just referred to, but I think you have to look at New York, again, always in New York we're building a cluster there, and so there is not -- it's not like Cambridge or San Francisco. But I'm very comfortable. We've got a number of tenants, both big pharma and one very interesting entity that's a nonprofit that are looking at good blocks of space, and we'll see. But it's a great market and -- yes, and I'd say rental rates are exceeding what we hope to get, so we're, I think, feeling pretty good about that.

Okay. And then, finally, can you talk about your largest expirations in the back half of the year and then in 2015?

Jamie, it's Steve. The expirations in 2014 are really marginal. As I was saying, it's 150,000 feet total, just 1% of the asset base. So I think the largest block is potentially in Maryland, and it's probably about one-third of that. Otherwise, it's pretty well distributed in either Cambridge, San Francisco, really.

And then for 2015, it's really split among quite a number of regions. It's about 1.1 million square feet, which generally takes us about two quarters to lease or sometimes even one quarter. The largest is a suburban property out in Route 128, and we're well on our way to working on a re-tenanting plan. We've got one or two tenants already in tow.

So we feel pretty good about that. There's some space that could be significantly up in Tech Square, and kind of varied by region. I don't know, Steve, any other color?

I think that's right. I mean, as you look at these roles that are in the core markets, Tech Square, San Francisco, a piece in UTC in Towne Center, so, you know, the larger blocks in 2015 are all in good core locations.

Okay, and do you have a sense of the mark-to-market on your expirations?

Yes, certainly, in 2014, as we touched on as we closed the year out, those are all on a GAAP basis in the mid-teens. So I think that will continue to support the guidance we had at the beginning of the year.

Yes, and I would expect, directionally, on the rental rate steps on our leasing activity for 2015, I think, generally speaking, you're going to be in the general ranges of both GAAP and cash steps. So I think the performance we have this year or at least our expectation for 2014 should continue into 2015.

You're saying the leasing spread should be about the same or your rent (inaudible)?

(multiple speakers)

Yes. The leasing spreads.

The leasing spreads.

So the rental rate increase is there.

Gabriel Hilmoe, ISI Group.

Thanks, just maybe following up on the last question a little bit, but just on the expansion and the leasing spread guidance. Steve, you talked a little bit about the current mark-to-market in the portfolio, but can you talk a little bit about where things are maybe tracking ahead of where you thought they would be, maybe, three or six months ago by market, I guess?

Yes, Gabe, it's probably -- certainly, Cambridge, San Francisco, and San Diego. I think, overall, we just see demand has not only continued, but it strengthened in those areas. People are locking down space so that's enabling us to drive rents in those, kind of, key core markets moreso. So it's probably those three markets that are driving it primarily.

Okay, and then I realize this is still a strong number, but it looked like the occupancy dipped a little bit in San Fran. Anything in terms of progress and backfilling some of those smaller moveouts in the quarter?

Yes, we did have one legacy tenant at one of our mid-Peninsula properties that ultimately rolled out. We're actually working with the group right now, so a temporary dip from 99.9% occupancy there.

Okay, and then maybe, lastly, for Joel, I may have missed this, but any update on the plans or progress for the north parcel in New York or is the West Tower leasing still kind of the priority for the time being?

Well, both. The West Tower is still the priority with four floors left, and some under active discussions but no paper trading yet. And then we are in discussions with the city on the north parcels.

Any idea of any type of timing around that -- the north parcel?

Too early to say at the moment.

Dave Rogers, Robert W. Baird.

Yes, hey, Joel. You're 97% leased, I think, in the operating portfolio, 77% leased or negotiated in the development portfolio. What should we expect to see coming out of the ground in terms of new development? I mean, obviously, you want to get more product out there, so maybe give us a sense on starts, maybe, over the next six to 12 months? And then, also, where those starts might be located? Where do you feel the best about kind of getting new projects coming out of the ground?

Yes, I think in my prepared remarks, I mentioned if you go to page 27 of the supplement, this is kind of the best way to visualize it. And if you go to the second half, the bottom half of that spreadsheet, if you will, we've signed a LOI with Illumina working on finalizing the lease. That will kick off here pretty quickly, and that will be delivered next year.

We're in active discussions with two significant tenants in 6 Davis Drive, and my guess is that will probably kick off here in the second half of the year. Townsend -- Steve can give you a quick update on that.

Yes, we're making real good progress. The team on the ground with advancing the entitlements there and perfecting the entitlements. We're engaging tenants in the market in a series of serious conversations, so we're encouraged there as well.

On Campus Point, we have a letter of intent with an existing tenant to take most of the new buildings, and we expect that will move forward here over the next few months. Lake Union, we've got two parcels in play with multiple users -- don't know how that's going to go, but we think we have a shot. So I'll reserve judgment on, kind of, the starts there. And then on 50, 60, and 100 Binney, we've got a lot of activity on those parcels.

Would you feel comfortable going spec on any of those? Or pre-release then continues to be the focus?

When you say "any of those," meaning any of these on the whole list or any -- ?

Yes, the bottom half that don't have that pre-leasing component or the negotiating component already underway.

It's possible. I think the strength of the Cambridge market might move us to go forward. We're doing site work right now, so I'd say stay tuned there.

Okay. And then, I guess, with 50, 60, and 100 Binney, maybe -- I don't know how much you can talk about this, I know you're in negotiations, but talk about maybe the cost and return terms -- two years. Do you think about maybe what you might be giving up, and I guess the only reason I ask that is your cost of capital has come way down with the bolted bond offering and where the stock is, and I think that the returns continue to improve given where rents are going in those markets.

So you said you're still on track with that, and certainly understand the capital component of it, but maybe can you talk about the cost in return terms to ARE?

Yes, I don't think we're ready to talk about anything. But I would say, in general, that we feel that we've got, as I use the term "exceptional prospects." I don't know that I've ever used that before in all the conference calls I've done. So I think that, with that, clearly, we want to keep our balance sheet in great shape. I think Dean's report on the balance sheet is very comforting.

So for us to be able to look at exceptional prospects and have another major source of capital to do things that we want to do in our great urban clusters gives us, I think, a big advantage. And so I think just stay tuned. But we don't think we're -- I wouldn't characterize it as giving up anything. I think we're gaining something very valuable, and we can move a number of projects ahead much more quickly than maybe we could on our own. And we are focused on, again, keeping both the NAV growth moving and, very importantly, our earnings growth moving not only this year but well into next year and 2016.

Michael Knott, Green Street Advisors.

Hey, guys, good afternoon. A question for you, and this has been asked a little bit but I just wanted to take a slightly different tack. Your 2015 releasing spread sounds like it will be similar to 2014. But, just curious, given the strength of the tenant demand you're seeing, if you think that you might see, at some point, the cycle releasing spreads exceed what look to be at a peak from last cycle of about 8% on a cash basis on an annual basis?

Michael, Dean Shigenaga here. Yes, I gave you some baseline assumptions to think about for 2015, but, no doubt, the strength of our core markets and the demand in the marketplace for quality space that exists in our asset base or space like the quality of our asset base, I think is going to provide opportunities both in capturing new requirements but also as we work through early renewals, I think we have an opportunity on both sides.

But I guess I want to give you some baseline assumptions as we think well ahead of Investor Day six months from now or five months from now.

Okay, that's helpful. And do you guys think about where your overall portfolio is on a mark-to-market basis today? It sounded like the 2015 expirees are in pretty good markets and is sort of in line with the spreads you're seeing this year. But just curious if the overall portfolios may be a little better than that or sort of similar to that sort of up 5% on a cash basis?

Yes, I think on a cash basis, we're probably in the 2% to 3% range and then 8% on a GAAP basis on a mark-to-market overall operating portfolio. Keep in mind you've got long-term leases, you have annual cumulatively compounding increases with some pretty great tenants. So I think it's important to really look at the GAAP metric as well.

And so would try to be conservative so that it makes sense.

Got you. And then Joel or Dean, just curious how much development you're comfortable with carrying it at any one time as a percent of total assets. Just curious how you think about that and, obviously, the list of projects you have going is pretty appealing at this point, but just curious how you think about it from an aggregate standpoint.

Yes, I can ask Dean to comment from an aggregate. I think, though, the most important thing is that we try to cover the vast majority of our capital spend with both free cash flow and the generation of EBITDA from projects. And so to the extent that we can do that, Dean laid out, I think, a pretty nice slide on that.

Page 44 has a really nice depiction of --

So I think that's how we think about that at the same time we're bringing down non-income producing assets as a percentage of total gross assets funding our construction spend. Really, our spend on growth is really, if you -- and this is just our own current capital plan. Nothing is definitive yet until we give for-sure guidance in December, but this is, I think, a handy way to think about it.

Okay, thanks for pointing that out. And the last one for me, on that debt-to-EBITDA target of 6.5 times -- first, thanks for providing that. Not enough companies are thoughtful enough to do that, so thanks for that. But my question is, just curious, is that your long-term target or is that more just sort of where you're going to end up in the near term? And then also, just curious, how you arrived at that target as opposed to something else?

Well, I think 6.5 times has been a bogey for us for some time, so it is near-term by the end of 2015, and I think we'll always look for opportunities as we grow EBITDA to possibly improve that. But, for now, that's our bogey. And, really, most of our EBITDA growth is providing the opportunity to manage the growth of our business without moving leverage in the wrong direction.

Sheila McGrath, Evercore.

Yes, good afternoon. Joel, I noticed that Longwood had a little bit of pickup in leasing in the quarter. I just wondered if the level of tenant interest is continuing there and how the velocity of leasing you expect?

Yes. As I said -- thanks, Sheila, for the question -- as I said last time, and we've made comments at [May Read] and other places. Of all the markets and all the segments, the one that I think is most disappointing, in a sense, when we had the current vacancy rate in Longwood is about 1%, but I think there has been this weird overhang of NIH not increasing the budget. It was cut a little bit under the budget axe from Congress and then it got restored, and it's kind of current run rate is about $30 billion-plus, although I note that I think Tom Harkins from, I think, Iowa, just introduced a bill in Congress to raise it over, I think, a five-year period to $46 billion. Don't know where that's going to go, but that would be good.

But I think the institutions got a little bit frightened. They are also a little bit nervous about where Obamacare is headed because nobody really has been through that process. So I think their operating spend has been more conservatively managed while their capital spend, certainly, is going forward. So we've had a lot of interest in buying floors for condominiums. We've kind of put that off for the moment. We may return to that at some point if we decide to. But we do have some -- we do have current demand for two floors, which we hope to resolve over the coming, maybe, quarter or so. And then beyond that, we've got active discussions with a bunch of people but nothing to show up on the scoreboard yet.

There is some pharma interest in Longwood, although the main pharma interest does tend to be, as Peter pointed out, Kendall Square. So we'll see what happens. But as I say, that's the one area with such a low vacancy rate, our view back a couple of years ago when we proceeded on this process, we thought this would be much more efficiently leased than it is, but we're still comfortable. We don't deliver until the end of the year, and I think we'll be well over 50% at that point, which will meet our internal projections, and we hope our rates stay at what they are pro forma-wise, which, to date, have been the case. So we'll see where that goes. Keep in mind, we have a 27.5% interest in that joint venture.

Then just on 50, 60, 100 Binney, it sounds like you're seeing a lot of interest. And given where you have the NOI coming online in 2016, is the interest that you're seeing more Life Science or is it a mix of tech as well?

It tends to be very heavy Life Science at the moment.

Okay. And then last question. Steve, you mentioned in your remarks that the Amgen sub-market space might come off the market. Could you just give a little more detail on how much space that is and maybe the impact on vacancy potentially?

Sure, Sheila. Yes, the vacancy, overall, is probably right around 10% in the market, although if you segment that and take smaller blocks of space, you're probably at just 3% or 4%, so that's why we've been able to be very successful with our projects there in the smaller blocks over the past several quarters.

These couple of blocks, you've got, probably, roughly, a quarter million square feet, and it looks like they may take back one if not both of those blocks of space there. So that's been something they talked about much more intently, I think, as they look at Thousand Oaks in recruiting versus South San Francisco. So we're hopeful the conversation is becoming more serious about them re-occupying that space.

That would drop the overall vacancy rate, probably down, total, that would cut it in half, really, it would be at 3%, 4%, 5%.

Yes, I'd make one footnote comment to that. Amgen, who I used to deal with pretty regularly, and we have pretty close relationships with, approached us recently, and we did a bit of a strategic planning session with them on innovation. And it was pretty interesting, because I think Amgen, similar to one or two of the big pharmas probably hasn't been historically as innovative, say, as Genentech was. Genentech ended up spinning out 75 to 100 companies over its lifespan before it finally got acquired by Roche.

Amgen is just starting to do that, but historically hasn't. So I think what Steve says may come to fruition. They're really thinking about becoming a much more innovative company. They've been highly, highly successful, but it hasn't generated a lot of spinoff companies and out-licensing of technology, which I think they are now under new leadership, really beginning to examine pretty carefully.

Michael Carroll, RBC Capital Markets.

Can you guys give us some color on 124 Terry Avenue and 9950 Medical Center Drive? It looks like you moved those two projects out of the near-term value creation pipeline and moved them into the future one? Can you kind of explain what changed there?

Sure. Maryland, I think, the simple fact is we don't see the demand that would really push us to do development there. We think there is adequate available space there through -- we have some space, obviously, and others have a bunch of space, both local and national folks. So I think that was put down.

And then, although we have been approached a number of times by the NIH, but we'll see where that goes, for some new space. And then 124 Terry -- we think that that's probably likely to go resi. And so that's probably something we wouldn't do ourselves, so that -- stay tuned, we might either sell the parcel or joint venture the parcel, something like that.

Okay, and then how long does it take for 50, 60, 100 Binney Street to do development? How improved are those land sites? And if you start construction, let's say, in the beginning of 2015 would it get done by 2016?

Yes, they're shovel-ready, and they're something in the range of about --

Thirty-month construction timeframes.

Yes.

All right, and then do you expect to start 50 and 60 before 100? Or 100 just takes longer because it's a bigger project?

At the moment, although we have it in the disclosure that it looks like 100 would be started later, it really depends on the demand. The demand in Cambridge is, as I said, pretty large, and so it's hard to say at the moment.

(Operator Instructions) Emmanuel Korchman, Citi.

Hey, it's Michael Bilerman, good afternoon. I echo Michael Knott's comments as well. Thank you for the target debt disclosure as well as a lot of the commentary that you had in the release. And, if I may, I just had a question sort of surrounding it. When you think about getting to 6.5% by the end of 2015 from 7.2% today, what else is sort of in that forecast in terms of capital spend and any asset sales. So we know what's sort of happening in the back half of this year, which I think you have about $380 million left to spend. You have about $16 million of free cash flow that's coming in. And then you have the asset sales you've targeted. But I'm curious -- I didn't know what was factored into 2015 in order to get to that target?

Michael, it's Dean here. I think the best way to think about 2015 is that we have a number of items that bring clarity to what can unfold, i.e., the retained cash flows after dividends and EBITDA growth. So we have tremendous capacity to fund growth for 2015. Hopefully, everybody can appreciate it's a little difficult to predict the exact dollar amount of construction spending related to a number of projects that we've identified, and this goes back to page 27 on the pipeline of opportunities in the near term.

We have a number of negotiations ongoing, the exact starts will likely depend on the pace of those negotiations and lease executions on many of them. So I would say give us some time to come back to you, probably closer to Investor Day, to give you better clarity on the exact mix of what will unfold for 2015, because there's a lot of moving pieces at the moment.

Well, maybe if we attack it from a different level. There are some known factors that I assume are embedded. One is you talked about that other income being very low this quarter. You didn't have a lot of sales, investment sales, you had a loss. Just moving that back towards the average is about 0.2 times net debt to EBITDA. So 7.2 goes to 7.

You'll have same-store EBITDA growth, I assume, next year. And so that's going to add some level, I don't know what you're going to forecast for next year, whether it be 3%, 4%, but probably somewhere within that range. That's going to add to it.

And then you have this large redevelopment platform that has delivered some assets that are not yet stabilized and that are going to be delivering over the course of the back half of this year and next year. Do you sort of have the buckets of that EBITDA from those activities so at least we can get the EBITDA numbers that underlie the forecast and then we can figure out what spend will be?

We'll provide that clarity in December, Michael, at our Investor Day.

How much of the redevelopment pipeline is -- where is that number for what you want to be delivered in 4Q of next year. How much of that's been leased? So you'd have a very highly leased development platform. What is that number in terms of the projects that will be earning income for Q2015?

Yes, I think if you look at page 28 of our supplemental, which highlights the current development pipeline, it's probably simplest just to go top down on the page -- 75, 125 Binney Street, which is 99% leased to ARIAD, will be delivered contractually here in late March, and rent will commence in late March. 499 Illinois will be delivered over multiple quarters but I think we get to stabilization close to year-end, probably in the 90% range with a little bit being delivered in the first quarter. And, again, that's 100% leased. 2690 [Scran] will be probably an October 1 delivery, 100% leased. Science Park, Peter ran through, 60% leased and negotiating today. Pretty good shape there. We talked about New York being about 60% delivered by the end of this year with upside on delivery through 2015.

On the redevelopment front, on page 30, 225 Second Avenue, it looks like 100% leased with an occupancy in the second quarter of 2015. Florence Canyon, 100% leased, delivery later this year in the third quarter. And then Rosell, it's a mix -- 75% leased, 24,000 square feet has been delivered, we have another 17,000 to be delivered probably in the second quarter of 2015 with a little bit to resolve.

So big picture, to answer your question, Michael, the pipeline of active projects that will be delivered substantially through the first quarter is driving a tremendous amount of the EBITDA growth that's been forecasted, and big picture, I think, same property performance on the cap side, I think, will be solid given the occupancy growth in the portfolio over 2014 would contribute to 2015 as well as nice steps on leasing activity and contractual rent steps embedded in the leases.

So core should deliver strength into 2015, and you've got tremendous value-add that's highly pre-leased that's driving the significant EBITDA growth. So we've got a pretty good ability for internal funding is what we've been trying to highlight. And, again, I think we'll provide more clarity to some of your questions on Investor Day, Michael.

And then just going back to Binney, 50, 60, and 100, you have about $300 million in effective land today. On your schedule, page 32, my understanding is that's going to be where you're going to raise some capital as part of this joint venture capital forecast that you have of $110 million to $210 million. Part of that's going to be put in some of this land into a joint venture. How much of the project are you going to be putting into a joint venture?

It will be a minority interest.

So, 25%, 30%?

Yes. I'm not sure I'm ready to announce any percentage, but it will be a minority percent. It will be less than 50%.

And as you think, Joel, as you think about putting in land and, obviously, getting some mark-to-market on that piece for the value that's been created in the value in Cambridge, how do you sort of evaluate that versus selling at 25% or 30% interest in a core stabilized asset versus putting a lot of money into Cambridge at, arguably, a very attractive yield relative to your land basis. How have you, sort of, wrestled with being able to sell current cash flow at an attractive valuation given how -- where cap rates are versus developing to a higher yield and earning the NAV spread on that?

Yes, I mean, that's always the historical challenge, but I think that because Cambridge is so large and may move altogether that having a capital (audio break) makes a lot of sense, and we look forward to having a more programmatic sense of other things that we have in more the medium term pipeline that aren't necessarily reflected here as far as our thoughts and things that we're going to do. We'd like to have that source of capital available to us to do things that we might not otherwise can do.

I think if we go down the road of we are looking hard at a variety of assets that we haven't made any decision about, we have recycled assets, as you know, but I think in recycling assets, we've got strong cash flows, we've got long-term tenants. We probably would not want to give up what we would consider to be really irreplaceable locations that are already cash flowing at very strong yields out there. But there are a host of assets that we might consider, so I think stay tuned on that score.

Jim Sullivan, Cowen & Company.

Thank you. I just have one quick question. Digital Health as a category has been attracting a lot of startup funding. I see where Rock Health's recent reports for midyear indicates a very, very significant uptick year-over-year in that category. And I know that you've mentioned it once or twice in connection with some of the land acquisitions. And I wonder if you could talk to us a little bit about how you assess the potential for growth in Digital Health demand, number one.

Number two, whether or not there is any regional concentration in demand, so far, or anticipated. And I guess number three, whether there's any specific physical demands in terms of space that they need, i.e., can they take conventional office space or not? And I guess, finally, is there any need for them to be in what you would think about as innovative cluster markets or approximate or adjacent to the innovative cluster markets?

Yes, all good questions. I think it's really an emerging sector, broadly under the IT sector and under the Life Science sector. My sense is, over the next five to 10 years, it will be a very big sector, and it will come into, maybe, some prominence that would be identified as some category under either both of those. The growth is really pretty staggering. The opportunity is huge, but I think it's too early to tell.

I think the main cluster where we're seeing activity is San Francisco at the moment. There is some in New York and in the Boston/Cambridge area, but I'd say primarily in San Francisco, and that's due to the extremely heavy concentration of tech-oriented venture capitalists on Sand Hill Road, et cetera.

Most of those requirements can be accomplished with office, kind of a creative tech office. Some might require some enhanced features, but we view that those people generally will want to be -- at least the ones that we identify now -- will want to be in, kind of, the urban innovation cluster markets primarily for recruitment and retention.

So we're tracking that sector -- emerging sector -- very closely, and I'd say we hope to see it grow in pretty substantial fashion over the coming years.

And this does conclude our question-and-answer session. Mr. Marcus, I will turn the conference back to you for closing remarks.

Okay. Well, everybody, thank you very much for a busy time on one of the earnings days. Thank you for your questions and attention, and we'll look forward to talking to you on the third quarter call. Thanks.

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