Brandywine Realty Trust (BDN) 2004 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Prentiss Properties Trust third-quarter 2004 earnings conference call. At this time, all participants are in a listen-only mode. Following today's presentation, instructions will be given for the question-and-answer session. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded today, Tuesday, October 19, 2004.

I would like to turn the conference over to Claire Koeneman from Financial Relations Board.

Thanks. Good morning, everyone, and welcome to the conference call. Yesterday, you should have all received a press release and supplemental package of information. If not, those documents are available on Prentiss's website at www.prentissproperties.com in the Investor Relations section. Addition, we're hosting a live Webcast of today's call which you can access in that same section.

At this time, management would like me to inform you that certain statements made during this conference call which are not historical may be deemed forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Although Prentiss Properties believes the expectations reflected in any forward-looking statements are based on reasonable assumptions, it can give no assurance that its expectations will be attained. Factors and risks that could cause actual results to differ materially from expectations are detailed in the press release and from time to time in the Company's filings with the SEC.

I would now like to introduce management. With us today, we have Mike Prentiss, Chairman of the Board, who is in Prentiss's Washington office; Tom August, Chief Executive Officer and President; and Mike Ernst, Chief Financial Officer, are in Dallas.

And without further ado, I will turn the line over to Tom for his opening remarks. Tom?

Thanks, Claire. Good morning, everybody, and thanks for listening to our third-quarter call. The format today will be similar to quarterly calls we have had in the past. We're going to give an overview of sort of business conditions and the environment and how it is affecting the real estate business and Prentiss Properties, specifically. Mike Ernst and I will then discuss our quarterly results. I am going to finish our prepared remarks with an outlook and guidance for the balance of 2004 in 2005, and then Mike Prentiss, myself, and Mike Ernst are all available to answer any questions you might have.

Let me start with sort of an overall assessment of the economic environment and how it is affecting real estate. Now obviously, I realize that this is something that other people are much better at than we are. But it appears that the economic recovery, while discontinuing, the growth has really slowed considerably from certainly the way we were looking at things at the end of the second quarter.

I think the best example would be the slowdown and job growth. In the March, April, and May period, we averaged nearly 300,000 new jobs a month. In the last 4 months, that average has dropped to 101,000. There are still a number of companies that are downsizing in mergers that are occurring, which are reducing payrolls. And the best example of this would be -- recently, I guess, where AT&T and Sprint continued to talk about reducing payroll. And Chase and B of A are obviously cutting jobs because of the respective mergers that they are going through. We are also looking at, for example, Delta Air Lines, which is cutting back on a number of its hubs, including Dallas. So the direct and indirect effect of all of this is that it has really slowed down, I think, or will slow down the office market recovery.

I thought in our last call that based on data available at that time, that we would see a noticeable pickup -- and by that, I meant tangible increases in our revenues and earnings in the second half of '05. Based on where we are today -- and clearly, this could change tomorrow. The elections could change a lot of things -- I think '05 is going to be pretty flat to '04. I don't think you're going to see a noticeable improvement. I think it might be more towards '06. And of course, the only reason I'm saying '06 is because I can't see out that far. But I really don't see a big improvement overall in '05.

You know, let me give you -- I want to quote from a recent article in the Wall Street Journal which I think reflects how we at Prentiss Properties feel. I'm not saying the article is right or wrong. I'm just saying I think it accurately reflects our feelings about where we are.

The headline of the article -- and this was printed sometime in the first week of October. The headline says, "Office space demand increases in positive signal for economy. Companies take more space in the third quarter than in any quarter in nearly four years."

And you read that, and to me, that's a pretty darn optimistic headline. And the problem with optimistic headlines is that it raises everybody's expectations -- I think beyond what they should be. But if you get into the details of the report, I think it's a little bit more sobering.

For example, vacancy went from 16.8 percent to 16.6, and is projected to still be in the mid 15.5 range by the end of '05. So while, yes, it's an improvement, it is still very high. It is still a tenants' market. And it's a long, long way from the 7.7 percent vacancy rate that existed 4 years ago.

Rental rates -- and I think this is an improvement. But it says asking rental rates did not decline this quarter. They were flat to the second quarter. This was the first time there was not a decline in more than 3 years. Actual rents did decline by 2 cents, and were off more than 20 percent from the highs achieved in the first quarter of '01. And by the way, I think this 20 percent decline does not factor in the extra concessions, tenant improvements, free rent, etc., that that landlords are forced to give tenants. So the real net effective rents were off a lot more than 20 percent.

So I think it confirms that -- probably I think the market has stopped the declining. But the recovery is going to be more gradual than we had hoped as recently as 3 months ago. And as I'll point out in a minute when I talk about our different markets, I think the recovery will not be smooth, or certainly not consistent from market to market. And as I said, I think it'll probably be '06 before this translates into a noticeable improvement in the Company's existing portfolio -- I think all companies' portfolios, but I'm just talking about Prentiss for the moment.

Let me spend a minute on our specific markets. And I don't want to going into every one in detail, but just hit a few of the more important ones. Both our west coast markets, which would be the Bay Area and down in North San Diego County, are doing well on a comparative basis. Vacancies are in the low double digits and are trending lower. And in certain submarkets, I think -- like at Del Mar, for example, we're having a little bit of pricing power -- maybe not so much in rental rate increases, but with a reduction in the concession packages we have to offer tenants.

So we're not anywhere near where we were 2 or 3 years ago. But when you look at the entire country, I think the west coast is one of the better markets certainly that we are in.

Dallas is still a very tough market. We have 25 percent plus or minus overall vacancy. Third-quarter net absorption was about 600,000 feet positive. The last couple of quarters have been slightly positive in that magnitude -- with 20 plus percent direct, and that's on a 200 plus million square foot metroplex market. And I would say probably fair leasing activity. We've e still got a long way to go in Dallas. And certainly, I don't see big improvements in either rental rates or concession packages in '05.

The only positive sign we're seeing in Dallas -- and this is consistent with other markets we're in, which I think hopefully we will benefit from -- is that you see a number of tenants -- while the net absorption numbers are not good, you see a number of tenants migrating towards the higher quality buildings. And I think for us and for most other REITs who do have higher-quality properties, I think that will benefit us. There are some B&C (ph) buildings that are going to take forever to lease in markets like this and maybe Silicon Valley and others.

Northern Virginia -- this is a market where I think over the last six months, and hopefully over the next six months, we have seen the most dramatic turnaround in terms of a change in the environment and the feelings of the people in the real estate business. You can almost feel the improvement happening there on a week-to-week basis. One recent study we looked at showed that the third-quarter net absorption was 1.8 million square feet. And on a year-to-date basis, it was over 4 million square feet. And just by way of comparison, it was 1.35 million for all of 2003.

So this is one market where we should start to see -- and in some markets (ph), I think you already -- submarkets you already have seen increasing rental rates and/or a reduction in concessions. So I think that's a bright spot for us.

I would like to point out, however, that I am really talking about northern Virginia. I think our southern Maryland portfolio, while it is improving, is probably 6 to 9 months behind Virginia in terms of improving.

Chicago -- overall, we had a nice third quarter. We leased 85,000 square feet of leasing (ph) activity in the entire first 6 months in Chicago. And we did 150,000 in the third quarter alone. It slowed down a little bit the last month or 2. We had a nice third quarter.

But I think overall, it's still tough. The vacancy rate has stayed in the mid 17s -- it's about 17.7 today. This is in the Chicago suburbs. Absorption in the third quarter was actually slightly negative.

People are suggesting that the overall net absorption in the suburbs will be 1.1 million square feet positive for the year '04. But most of that is coming from activities that occurred in the first quarter.

So like other markets, we're seeing people to move to Class A space. But I would also tell you, sort of like Dallas, I don't think you will see the reduction in concessions or increase in rental rates at least for the next few quarters in Chicago.

Let me focus on our quarterly results. And the big story for us this quarter was the portfolio occupancy and leasing activity that we mentioned in our last call. We thought office occupancy because of several large, known moveouts would drop by over 100 basis points. Office occupancy actually dropped 140. So kind of in the ballpark -- certainly where we thought it would be.

The major moveouts included Sprint here in Dallas, which eliminated a call center. That was for 171,000 feet. ExxonMobil consolidated some space into a building or buildings that they owned in northern Virginia. And that cost us 150,000 feet. And the expiration of a lease to a startup company that essentially went out of business after our lease expired was for 99,000. Those were the big negative impacts we had in our portfolio.

We had 803,000 square feet of leasing activity this quarter -- expirations, which was almost double our normal. So we got hit pretty hard this quarter.

Let me also tell you that several quarters back, I was a person who was critical of people who looked at gross leasing versus net leasing because, as I said, I'd rather do no leasing and stay flat than a lot of gross leasing but lose occupancy.

So having said that, I will tell you that in looking for a silver lining in this quarter's occupancy and leasing activity was the activity we had. During the first half of the year, we had about 350,000 square feet per quarter of leasing activity, whereas in this quarter, we did nearly 600,000.

So while leasing activity was good, it was not enough to offset those expirations. And in addition, some of these leases we signed because of the time it's going to take to build out the space do not legally commence or start up until into the first quarter of '05.

A lot of our other numbers really were a direct result of increased vacancy. Same-store was off 2.6 percent, most of which was a result of the increased vacancy. It was slightly greater than the 2.5 percent negative that we have averaged for the first half of '04.

Renewals and retention, as you would expect, were horrible this quarter, basically because of those moveouts. It was 28 percent for the quarter.

G&A was 3.4 million. That was I think 6, $700,000, maybe higher than normal. I think we were in a 2 6 to 2 8 average run rate. And it was due mainly to increased liability, because of some KEYSOP liabilities we incurred. I'm going to let Mike Ernst go into that into a little bit more detail. But other than the KEYSOP, there was nothing really extraordinary in the G&A number.

Rental rate were off 10 percent on a GAAP basis, consistent with where we thought it would be. And if you look at our supplemental package, you will see the relative strength of the coastal markets versus the weakness in the central U.S.

On a year-to-date basis, our rental rates were off 6 to 7 percent on a GAAP basis. But they were 15 to 16 on a cash basis.

CapEx was 2.52 per square foot per year. That is versus 2.75 for last quarter and about 2.50 on a year-to-date basis.

On a cost per square foot per year basis, I am pleased because I thought we would average closer to $3. On an absolute basis because of early renewals etc., etc., the absolute dollars we're spending are still pretty significant. And obviously, they're affecting our dividend coverage. And it's something that Mike Ernst will also cover.

Dispositions -- we sold two properties this quarter. One was the last building we owned in Houston. And the second was an R&D building in southern California. The southern California sale is the beginning of what I would call the second phase of our disposition activity strategy. And that is to sell properties in core markets which result in the improvement in quality or earnings power of our remaining portfolio.

We have one additional disposition in a core market that we should close this year. It's for about $20 million. It should close by the end of November. And it should give us a pretty significant gains on sale.

In terms of the acquisitions, as you saw in our press release and 8-K the other day, we acquired a 459,000 square foot office building in Oakland. We are pleased with this acquisition for number of reasons. It was an off-market deal at a significant discount to replacement cost. I don't want to spend too much time on how we got it. But it was, I think, kind of interesting. And that is, Dan Cushing our regional manager out there, was speaking to a gentleman who was very old and he was talking to him about maybe selling us the property for estate planning purposes.

The individual died during our discussions. Dan picked up the discussions with the executor of the estate. They were not in the business of owning and managing income-producing properties, and felt if we gave them a fair price, that they would sell it to us. We did, so we were able to pick it up sort of in an off-market transaction.

There's still some leasing to do. So I think there's a little bit of upside left. Part of the transaction was we were forced -- not forced. Part of the deal was that there was a piece of land next to it that we bought for $1.8 million that can accommodate about a couple hundred -- 250,000 square foot addition, which clearly we have no intention of starting tomorrow morning.

But just by way of comparison, and I realize these weren't exactly the same, but we sold our site that we owned in Lake Merritt to the church last year for approximately $50 an FAR foot, and this one we bought for somewhere between 8 and $10 an FAR foot. So I think it was an excellent buy.

And by the way, because of the development aspect of this acquisition, ADP will not be in this deal. This will be 100 percent Prentiss Properties.

Finally, we have one other acquisition that we plan on making between now and year-end. It is in a core market. It's a pretty stable deal. ABP will be part of it, and it's in the 30 to $35 million range. It should close by the end of November.

Mike, do you want to continue?

Great. Thanks, Tom. We had a busy quarter on the financing front. During the quarter, we closed 4 new loans that totaled about $160 million. And we paid off expiring debt totaling approximately 103 million.

The most significant of the financings was an $85 million loan. It was a 5-year floating-rate loan secured by a number of our ABP venture assets. The loan was priced at LIBOR plus 85, and we swapped 70 million of that and resulted in an all-in cost of the borrowings of about 5 percent.

That rate is quite a bit better than what we had projected in our original deal with ADP. So we're real pleased with that. I think it increases the likelihood that we will see some value in the promote at the time that we unwind these transactions.

The other financings were detailed in the press release. I'm not going to going into a lot of detail on them. They averaged LIBOR plus 128. We also retired $33 million of debt right after quarter end. There was a 6.92 percent fixed-rate. And we paid off a $70 million floating-rate at 137.5 basis points.

And if you look at sort of the improvement in rate on these debt paydowns, plus the fact that we had the $110 million swap that fixed LIBOR at 6-1/4 that expired at the end of the third quarter. Now on a going-forward basis, that brings our quarterly interest cost down by about 2 to 2.5 cents per share per quarter, starting this quarter, the fourth quarter.

During the quarter, we reduced our overall level of debt by $37 million as result of the sale of Westchase and Shadowridge, which was offset by about a $15 million acquisition of some land in the Del Mar market in North San Diego County.

As a result of this debt reduction and the increase in our stock price during the quarter, our leverage declined from 41.4 percent of the end of the second quarter to 38.9 percent this quarter. And since we have been generating cash from selling assets and we have not had substantial levels of new investment, we did not issue any equity during the quarter under our Dribble Plan. And at this point, even with the Oakland deal that Tom discussed and the other deal that's in the pipeline we do not anticipate issuing any new equity under the Dribble program during the fourth quarter.

During the quarter, our credit experience continued to show improvement. As you remember, last quarter, we sold Natomas. With the sale of Natomas, we have no exposure to WorldCom anymore, which is pretty significant, since they were once our third-largest tenant -- 250,000 square feet. And notably, we have released all the space that they vacated. So we're pleased with that.

We were also able to restructure 1 large lease during the quarter. And we replaced 58,000 square feet of a tenant that is on our watch list (ph) with a new tenant. So we're pleased with that. Nobody else was added to the watch list during the quarters.

Term fees were unusually high this quarter as a result of the lease restructure that I just discussed. They were 3.2 million, which is well ahead of our normalized run rate of about 750,000. Tom also mentioned that G&A, which was probably about 700,000 higher than our normal run rate.

And I talked about this before, but it's sort of an odd accounting treatment. In our deferred comp plan, we have a fair amount of property stock that people have deferred their bonuses and invested in Prentiss Properties stock. What you see is in a quarter where Prentiss Properties stock goes up noticeably, as it did this quarter, that causes the value obviously of those shares to increase. And any increase in the value of those shares shows up as compensation expense in G&A. So notwithstanding the fact that obviously, the share price appreciation and the asset value are there, it still shows up as an expense.

Anyway, okay -- moving on. One thing on CapEx -- you will notice it was particularly high this quarter; a little over $10 million on non-incremental. The Hyperion -- not the Hyperion -- there was a couple of large leases that were in there. But I think we are going to continue to see CapEx at a relatively high level for a while now, especially given the high level of leasing we did during the quarter.

If you'll notice also, the incremental leasing cost was up pretty noticeably this quarter. The incremental was primarily comprised of the Hyperion lease. We paid, I think, not only the commission, but a fair amount of the tenant improvements on that deal this quarter. There was also a pretty noticeable amount for the GMAC expansion in Cityplace, which was vacant space at the time we bought that building. And also, we did quite a bit of leasing at our Willow Oaks III deal, which was a development deal that had had a fair amount of vacancy for a while. We leased the rest of the building up. So that was shelf space that had never been developed.

As far as the dividend goes, on October 8, we paid a 56-cent quarterly dividend. Our payout ratios were 72.6 percent of FFO and 105.5 percent of FAD for the quarter. If you look at FAD payout, year to date, it's been about $3.2 million shortfall of funding the dividend. And while this is probably a little bit more than we expected, it's relatively close. And we think that as far as going forward, we're going to kind of be in the same range for awhile, which is we may have some quarters where we're right at breakeven, and we may be a million or 2 short in some quarters. But that seems to be the outlook for the next 2 to 3 quarters.

Lastly, I just wanted to quickly touch on Section 404 of Sarbanes-Oxley. This is the provision of Sarbanes-Oxley that requires our auditors to certify in our 10-K this coming spring that they agree with Management's assertion as to the effectiveness of internal controls. This sounds like a fairly simple concept. However, it's evolved into the full employment act for accountants at this point.

We estimate that this 1 provision of Sarbanes-Oxley is probably going to cost us about $500,000 this year in out-of-pocket cost. related to increased cost for our auditors and the fact that we now have to go out and hire a separate set of auditors to do internal audit work. And that doesn't count the thousands of hours that are our guys have spent internally doing all the documentation and testing required to comply with this.

You know, I think at this point in the year I feel like we're in reasonably good shape as far as getting that certification. But I will tell you that the interpretation and implementation of 404 is a moving target, with new issues being surfaced it seems like weekly. And I don't think that any company can be that confident at this point that they're going to get a clean opinion as to this specific issue, and probably won't be confident until the day they get it sometime in March of next year. With that, I will turn it back over to Tom.

Thanks. Before I go into the balance of '04 and the guidance for '05, I would like to summarize, if I could, our feelings about sort of our performance this quarter.

And overall, I think it was a very mixed bag. The lease expirations and the drop in occupancy were a big disappointment to us. While we knew they were coming and we had identified them I think to all of you, at least last quarter if not even before that, the fact that we've dropped is disappointing. The activity level looks good, but -- to improve upon that in the next year. But that was a big disappointment for us.

The CapEx on an absolute basis as Mike just finished talking about continues to be very high -- a lot of it not only because of cost per square foot per year, but also because we are quote-unquote addressing a lot more leases, as a lot of companies are, before the stated maturities that you might see in the supplemental package.

And as you look out to '05, if we're hoping to increase occupancy, it's still going to be an issue that we really need to focus on, certainly for the next year. Hopefully, some markets are improving, but there are a couple that are still very, very difficult.

And the lease-to-lease declines -- you know, for the last few quarters we have been in the 10 percent on a GAAP basis and noticeably higher than that in the cash basis. And when I get into talking about '05 in the effect, what you see is just this compounding effect of the rolldowns -- is just like a bigger and bigger rock on your back that you have got to carry to sort of break even. So a tough quarter from those respects.

On the positive side, we had some good leasing activity. We leased more space than we have ever leased before, I think, in a quarter. It was nice to see Chicago -- and Larry Krueger up there has had a couple tough years -- for him to lease as much space as he did, and he has got some good activity, even today. So that's a bright spot for us.

The continued disposition of assets that I think are in the long-term great assets for us to be selling so that we can improve the quality of the portfolio -- that is continuing. It continued this quarter; it will continue next quarter. And I think the Oakland acquisition and the little story behind -- just like the 3Com deal a quarter ago -- I think continues; was kind of unique, and shows the value of our regional offices.

Okay, let's get into '04, '05. Based on current projections, I think 75 to 76 cents for the fourth quarter is probably a good number. As I said, while we did a lot of leasing, those leases aren't coming to effect because of the time just to build them out in the fourth quarter. So I think there will be a slight dip even though we had this leasing. So you are looking at 3.05 or so for an adjusted FFO for the year, and that seems pretty reasonable -- maybe there's a penny of upside, but probably not much more.

So as we look into '05, I'd like to be a little conservative. So using a 75-cent run rate you're talking about $3 a year run rate. And I think that when I look at our same-store portfolio, and I would adjust it only for the acquisition, the 1 acquisition and the 1 disposition that we have yet to make this year that I referred to earlier in our portfolio -- other than that, we don't do any acquisition -- I say will be pretty flat for '05.

And there are a whole bunch of factors that go into that number. But let me give you 5 to 6 that I think -- which are most important. And the first and the biggest issue is these rolldowns. They start to just have a cumulative effect.

So what we're showing in our numbers is a 10 percent rolldown next year on a GAAP basis. And we are assuming we do more leasing than our supplemental package would indicate, because that always seems to happen. So if a 10 percent rolldown would result in about a 1.2 to 1.5 percent reduction in revenue, that equates to about $5 million or negative 10 cents. So that alone brings us down 10.

Termination fees. We are projecting term fees to decline by $5 million from what we achieved this year. You know, we had a couple of big ones, certainly in the first quarter with Regis (ph), the executive suites, was over $3 million. And EarthLink, which was a company that terminated, which was part of the Sacramento portfolio we sold, was over 1 million. So we are expecting term fees to be down by $5 million -- that's another 10 cents.

So, on the negative side, that's minus 20. Now how do make that up? We're looking for over 100 basis point average increase in occupancy and that should be anywhere -- depending upon what market those leases are signed that will be 6 to 8 cents positive.

Our net acquisition activity in '04 -- so net acquisitions over dispositions -- that net looks like it should increase our earnings next year by 7 cents without anything new, just the net acquisitions we had this year. And then we have projected an increase in short-term interest rates next year. But the interest rate swaps we have done on swaps that have matured and we've re-swapped, plus refinancing some longer-term debt we project will add another 5 cents to our earnings.

So the negative 20 is offset by about 18 to 20 cents in positives. So I think were within a penny or 2 of sort of being flat for the year. I would like a little cushion on both sides. And so I would say 2.95 to 3.05 same-store. I'd like to think there might be some upside in our occupancy numbers. But you know, like we have been talking about for 3 years, the recovery is always six months away. So we're not planning on any major improvement in occupancy other than the 100 basis points for all of '05.

And then I would think that the acquisitions that we are looking at and hopefully we will see during the course of the year would add 10 to 15 cents. I would like to say 20 cents, but I think that that's aggressive given we're trying to semi-disciplined anyway, for sure. And we are sharing some of these deals with ABP. So I would say 10 to 15 cents is reasonable on external growth.

When you add it all up, where do you come out? You come out in the 3.05 to 3.20 range for earnings next year. I would like think there's a little bit of upside in that number. But at this point, I'm not prepared to suggest that we should book it yet. So that's sort of I think our outlook for our earnings for '05. And with that, we'll take any questions you have.

(OPERATOR INSTRUCTIONS) Ross Nussbaum.

John Kim (ph) with Ross Nussbaum at Banc of America. Can you comment on capacity utilization at your space leased to AT&T and IBM -- companies that are either downsizing or offshoring? And then what is your expectation regarding the Verizon lease expiring at year end?

John, I'm not sure I understand the first half. How much space our major tenants are using?

Well, basically with AT&T and IBM, are they using the space for --

The IBM lease -- we have a number of big leases with them. We have -- there's a million 1 (ph) square feet down in Austin that they are fully utilizing -- in fact, I think they're bringing more people into that space. And we have 3 leases in Dallas. There's the 150,000 square foot call center that they're fully utilizing; C3 that they're fully utilizing. And then in our C2 lease, which has, I don't know, another 3 or 4 or 5 years to run -- I think there is part of that space that they're not fully utilizing. But I think the utilization on that is pretty high.

The AT&T leases in northern Virginia is their federal systems group. And I believe that's being fully utilized as well.

In terms of the Verizon lease, I don't think we've got a full reading on that yet. But I think the indication, John, is that they may be moving out. So I want to tell you -- in my numbers, I've assumed they moved.

Tom, you also discussed your land position in downtown Oakland. And I apologize because I missed this, but when do you expect to develop on this land? Or is your intention to sell it?

No, it was part of the acquisition. And what will happen over that is hopefully -- I don't know when, but let's say certainly over the next 5 or 6 years, we will build an addition to that -- build an addition on that site which will become part of the 2101 Webster building. We're actually going to tie the two together. That was the way it sort of used to be. And this building that was on that site got destroyed in the 1989 earthquake. And that was part of the overall package that we bought and the understanding with the city of Oakland. But I think we've got until, I think, 2010 or something like that to start a building. And it's got to be in the 200,000 square foot range.

There are certainly no plan to do it immediately, unless we have one of the existing tenants in 2101 expand in need space immediately.

Mike, is there a formula that we can use to model out the compensation expense? Is it every dollar change in your share price equals to roughly 200,000 in G&A?

Well, we had about a $3 change in our share price this quarter. And it worked out to 6 or $700,000. So probably for each buck, it's a couple hundred thousand.

And John, I want to make it clear -- we're not adding -- this is not new compensation expense. This is just an accounting issue of how we have to account for grants and bonuses that everybody has elected to deferred (ph) and the Company's obligation to repay them when they ask for it.

And this is using a quarter-ending stock price rather than an average stock price?

That's correct.

Okay. Final question -- regarding Equity Office, they're officially on the record now that Dallas is an noncore market for them. Can you comment on the quality of EOP's portfolio there and whether or not you may be interested in acquiring these assets?

They've got -- I don't know their portfolio very well. I know several of the buildings. It's good (ph) quality.

But you know right now, Dallas represents 21 percent of our EBITDA. We've got a couple of big buildings in Fort Worth and in Cityplace. We have got a full plate in terms of our leasing for the next few quarters in this market. So I don't see us being the big buyer of EOP properties.

Lou Taylor.

Tom, maybe I missed it. But can you talk a little bit more about the TIs and -- for the leases, I guess, signed or committed during the quarter, what are the leasing costs average on a per square foot per year basis?

Lou, it was 2.52 per square foot per year. And I'm trying to find a page in our supplement if I can. There's a page in our supplement where it actually breaks out -- what page is that? 19 in our supplemental package -- if you go to it, it actually breaks down the cost from renewals, expansions, and new leasing. And it's the same story, which is not new news to anybody. And that is you really should work hard, hard, hard for renewals, because you can see our average cost per square foot on renewals was a $1.17, and yet on new leases, it was $3.19. So what really helped us is -- you really just need to renew a lot of tenants and help keep that number down.

Okay. And then secondly, can you just remind us in terms of your CapEx for the quarter that's in your AFFR (ph) -- FAD (ph) calculation. Is that dollars actually spent during the quarter, or is that for commitments for those leases signed during the quarter?

It's dollars spent, which may or may not relate to the leases we signed this quarter. As a matter of fact, a lot of this money is for leases with signed the last couple of quarters as we are actually spending those tenants improvement dollars.

Lastly, were some of the longer-term bigger leases that you signed in this quarter -- and if you have more of those in the future, what is a typical buildout for that? Is that work that can be typically done in 2 or 3 months, or does it take more like 4 to 6 months?

Well, in some of these bigger leases, it can take 4 to 6 months. A couple of the bigger leases that we signed in northern Virginia -- I think we signed one for 90,000 feet. And it's taking us 4-plus months to build out the space. And of course, once we sign the lease, we've got to do the plan -- it's just the process takes 4 to 5 months.

Yes, and it depends, too, on what jurisdiction it's in, Lou. I think northern Virginia, in particular, the approval process takes you another couple of months beyond where you would, say, in Chicago.

Some in other words, the lease is signed, say, in the third quarter. We should really -- if we wanted to really model it very, very closely, we would say those are really dollars, maybe the bulk of which is spent, say, in the first quarter of '05 and into the second quarter of '05.

That's probably good. Lou, just so that everybody is aware, I just want to make sure that everybody understands leasing and occupied and rent-paying. If we lease a space, we will show it as leased, which means it's no longer available for our leasing people to look at. But the difference between leased and what is occupied and rent paying is usually about 75 basis points on average in our portfolio.

Lou, one other thing on that it is while the TI dollars may well be deferred, a big chunk of the cost is obviously commissions. And typically in the market today, that's all getting paid at the time the lease is signed. But we had for instance this quarter 1 million 6 was in that lease in Chicago for National-Louis University -- primarily commission. So that part of it is front-end loaded.

John Stewart.

John Stewart here with Jon Litt and Andrew Calderwood from Smith Barney.

Tom, if you are assuming that Verizon moves out in the fourth quarter, what is your occupancy forecast for the end of the year?

We are assuming that our occupancy is approximately -- I'm looking -- do you have that stuff? 87 point something percent, John -- probably low 87s.

Okay. And do you have any lease termination fees baked into your fourth-quarter forecast?

500,000 that we think we've sort of identified -- I mean have pretty well identified.

Okay, Mike touched on it briefly in his comments. But can you give us a bit of color on the $50 million of land that you took down in Del Mar during the quarter and what the plans are for that?

We think that certainly in our portfolio, Del Mar is probably one of, if not the best submarkets we're in. We only have one site that is now under construction that is 60 percent leased. And we have got a couple of tenants we're working on that.

So we just wanted a little bit more inventory. It seems like that's the best way for us to create value. We would begin to think about a second development in Del Mar once we get some more leasing done on our first one.

By the way, our first one -- we're just putting up the steel (ph) now. We have got 9 months ago. So we're pretty optimistic about that.

I'm sorry, Tom; did you say that one is 60 percent leased? I thought it was 50 at the end of the quarter.

I'm sorry, I'm sorry -- you're right. It's 50. (multiple speakers)

The $20 million disposition in the fourth quarter -- is that an office or industrial property?

It is an office property.

Okay. And on your last call, Tom, you mentioned that you would be shifting your disposition program to more of an emphasis on exiting non-core assets as opposed to non-core markets. Does that still hold true, or --?

Yes, that's why, John, this one that we disposed of in southern California was a non-core asset in a market that we really liked. And the second -- this one we've got coming up this quarter we just talked about is also in a core market. It's just an asset we think has sort of peaked. And from a quality perspective, we need to move on.

Right. But to your point, it is kind of striking on the leasing activity page -- the rent rolldowns and the dichotomy between the coastal markets and (multiple speakers)

Absolutely, absolutely. And I think that's just the way it is.

David Harris.

Lehman Brothers. Tom, I've got some questions for you. Can you give us an idea -- you may not want to be specific about this -- the cap rates that you achieved on the sales of the two assets in the quarter?

Yes, I think Westchase was about an 8 (ph). But it's hard to really use that as a number, because there's rollover happening and there was some vacancy. And then the Shadowridge one was in the 6's somewhere -- that was a pretty --

Okay. Is it fair to say that you would characterize the investment market as still very flushed with funds, and it's very competitive in terms of seeking any attractive property? On the flip of that, obviously, this is a terrific time to be a seller still.

It's a terrific time to be a seller. There is a ton of property -- a ton of money coming in.

I think what you see, however -- you see a lot of great quality, good quality assets being sold. Let me tell you -- I think if you were selling an asset that had significant vacancy or leasing risk in a tough market, there would be a lot of bidders, but it would reflect that risk.

I think that just -- in some of the better markets, where there's little leasing risk going forward, it seems like, who cares if there's leasing risk? You can't even factor that in. But if you're in the mid-part of the country, I would suggest that -- and you have big leasing issues, you will have a lot of money chasing it, but it will be at a different level.

What's your thinking in terms of giving out the guidance for next year of the 10 to 15 cents of external activities? I know you have mentioned that you expect interest rates to rise. Are expecting some of the fund flow into real estate to ease back, for there to be a better acquisition environment? Or do you think we're going to be still in pretty much the same environment as we have been in through '04?

David, we have not suggested or don't think that there's going to be a dramatic change. We are assuming that it will still be very tough.

But look at it -- I have been sort of negative a little bit on this call. I want to toot our own horn a little bit. We've got 5 regional people who I think are among the best in those markets. And their job is to find unique, individual, one deal each. And we think we should be able to do that. We think that's what they're good at. That's what they're being paid for. And that is certainly what Dan has done the last couple of quarters with the two acquisitions he's done. So we think we will find interesting deals over the next year from those sources that will add 10 to 15 cents to our earnings.

Okay. I've got a specific question on page 8 regarding the operating portfolio. There was a dip in occupancy in Dallas/Fort Worth. Does that data include the addition of the Cityplace building?

Yes, it does.

And is that the principal reason why there was such a big drop?

Two things, David -- you've got to remember -- we bought Cityplace and you had those moveouts that I referenced in the first part of the call -- you know, the Sprint and the Metro-Optix (ph).

Maybe I missed this, but I know Lou Taylor asked the question related to this earlier on. In terms of tenant retention, it took a big dip in the third quarter. What's the fourth quarter looking like?

Let me tell you -- it better not be as low as it was. But I don't know the answer to that, David.

Jim Sullivan.

Green Street Advisors. Tom, last week, Mission West reported their results. Their CEO, Carl Berg, like you, tends to be very candid about market conditions.

He said a lot of very unsettling things about the Silicon Valley office and R&D market. But the one thing he said that I want to ask you about that was really troubling is he said that virtually every tenant in his portfolio that has a lease renewal needs less space than they currently lease.

You commented before specifically on AT&T and IBM and Verizon but speaking more broadly about your portfolio, is Mission West's commentary Silicon Valley specific, or do you see evidence throughout your portfolio that lots of your tenants still lease a lot more space than they need?

I would tell you -- I shouldn't actually tell you. I don't know. But my guess is that Mission West is probably a little bit more dramatic than the overall market simply because of where he is. I'm going to ask Mike Prentiss, if he would, to comment in a minute, because we were out there last week ourselves. We took our Board out there. But in general, we are still spotty. But I don't see it as widespread as Carl Berg does.

Jim, this is Mike Prentiss. I think that in general, across the country, we're still not seeing -- the reason you don't see occupancies moving up -- you look at some of the statistics Tom quoted -- is tenants are not growing, because most of them are underutilizing the space they have. And that's why we don't see the move up in the rental rates.

And I don't think that's going to change dramatically. I don't think it's as bad as it was -- you know, the Mission West -- I read their report. And we don't see it to that extreme by any means.

But when we were out and toured the west coast last week, we took our Board out. And I think in general, the Board was very pleased with what we saw. And the 3Com deal is a good example. Notwithstanding what Mission West found, we went out and found the Hyperion (ph) deal and created (ph) a situation that works out very positively for us.

So I think the opportunities are there. But the whole reason that Tom is as negative as he is is that the leasing agents we have are not seeing tenants when they come up for renewal wanting more space. We are pretty much holding our own, but they're not expanding. And I don't think they will next year.

Okay, I appreciate that perspective. Tom, last quarter you were asked, gee (ph), what is your year end occupancy going to be? And you said in the 89.5 percent range. Just a few minutes ago, you said that the number is more like low-87.

Yes.

Can you help me reconcile that pretty dramatic change?

Yes. Verizon was one that I think -- we hopefully weren't counting on. And I think the other one was -- my timing was off on the ExxonMobil space. I was hoping we were going to be able to retain them at least for a while longer. And those would be the 2 that I think -- and you know, we bought Cityplace. And that's -- while that one was sort of in there. I think those are the 2 that sort of caught me off guard.

We also had a lot of the leasing activity this quarter doesn't start till the first quarter.

Okay. And with respect to the termination fee you got during the quarter, could you just shed a little more light on the circumstances there? Was that expected; was it something that was in negotiations; did it catch you by surprise?

I would say it was in early stages of negotiations probably at last quarter end. But there were a lot of moving pieces that involved terminating two different leases in our Barton Skyway project in Austin. So we certainly were not clear as to how much the termination fees were going to be, or if we could even pull off the logistics of it. But we were very pleased with the way the deal worked out, because it allowed us to get one guy who was potentially a credit issue out of the space. And it also addressed a couple of leases that would have matured over the next 18 months to 2.5 years, where we knew they would vacate the space. So we're pretty pleased with that (technical difficulty)

Okay, and then finally, you gave the cash rent rolldown on a year-to-date basis. Can you give me the number for the quarter?

It was 19, I think, Jim.

Chris Haley.

Wachovia Securities. Tom, could you give me a sense -- you were mentioning job growth, and you mentioned utilization rates. Could you give me a sense as to why in terms of discussions with the companies that occupy your space -- why they may not be adding jobs?

I think a lot of it, Chris -- this is well beyond my capabilities -- is among other things efficiencies -- is number 1. And number 2, I think that if you look around anybody's space, you can always cram a few more people in there without needing more space.

And I think given all the uncertainties, whether it be terrorism, whether it be the elections, a combination of all those things -- space is the number 2 expense on everybody's income statement behind people. So I think both of those are saying, I'm going to be very cautious. And I think that over the last year or 2, people have learned how to squeeze a little bit more out of all their employees for better or . Worse and that is holding everybody back.

Is there any feedback from your customer visits on what it's going to take? Say (ph), look at the difference between what's happening in northern Virginia versus what is happening in Dallas?

What we're seeing is that the people are relatively optimistic about their earnings. What they're seeing is, you know what? I just don't need as many people to accomplish that. And they're just doing without. If you walk around our floor, if we added 5 or 6 people, we'd figure a way to cram them in without adding more space. And I think that is what people are doing. So you've got a combination of lower jobs being added and people putting more people in less space.

And I think we all should remember -- and again, I'm sort of way beyond my capabilities -- a mid-5's unemployment rate is probably what used to be considered before the Internet bubble sort of almost full employment. And the 3 percent that we saw in '99 in 2000, we're starting to think maybe was more of an aberration, and we're not going to get there. We don't see that engine to generate all the jobs over the next 18 months. So it's going to be much more slow, much more normal, as it was maybe in the late '80s and early '90s from an employment perspective.

Focusing in on northern Virginia, and we've seen sort of the other data points that you referenced from some other companies in our site visits -- what is your perspective on the debts (ph) of the leasing market in terms of, 1, the type of customers, the businesses; and then 2, is it big blocks, or are you seeing good activity in the 5 to 20,000 square foot blocks, as well?

Mike, do you want to take that one?

Well, I could try, Chris. I think the -- in northern Virginia --first off, you asked the question -- I'll go back to your earlier question, why the difference between northern Virginia and Dallas?

You know, Dallas has historically fed off of relocations. And that's where a lot of the growth has come in filling up the space. And that's something we have been missing for the last 5 years. And talking with some of the business leaders in Dallas now, we've got more activity than we have had in a long time. It doesn't mean they're going to turn into relocations. But that is what we need there.

And as compared to northern Virginia, when you talked about Wiburg and his folks there, just the Homeland Security function alone has had a big impact, because there has been new businesses starting up to support that function. It's a mini-Silicon Valley type situation.

So that has generated a lot of the increase in demand that we are seeing there. And most of the tenants that we are seeing there -- you're not getting big blocks of space. They're not 100,00 foot tenants. But it's the 25 to 50,000 foot range, which are very healthy numbers for us.

Last question, Thomas -- from your leases in the last, say, 6 to 12 months, how often are you offering breakpoints?

What do you mean by breakpoints?

Or early termination clauses?

That is still an issue, but it's not as big of an issue, Chris, as it was. And that number has gone down simply because everybody is realizing that if they are renting space today, they're getting it at a pretty darned low rent. So when you look at what are their priorities -- in the late '90s and into 2000, having some sort of a termination option was pretty important, because they were at the peak of rental rates. Today, when you're 20 to 25 or 30 percent below that, that doesn't seem to be a major issue.

So I don't have the percentage. But we aren't seeing that termination option in current leases are a big problem from us, where, as we're with 20/20 hindsight looking at the termination fees that we and all other REITs receive, and that's because that was a big issue for tenants back in the late '90s and early 2000. So we're not seeing that as a problem today. But I don't have the percentage for you off the top of my head.

(OPERATOR INSTRUCTIONS) Keith Mills.

UBS. Mike, I just had a question for you. You indicated that the 404, you thought, would cost about $500,000 this year in just audit-related fees, it sounded like. What do you think that cost will be on an ongoing basis for Prentiss Properties? And talk about that cost as well as other Sarbanes-Oxley related costs that you're now incurring -- kind of what those are in aggregate in terms of additional costs each year.

Well, I think this year will be the highest year. So I don't think it will be at the same level it is this year going forward. But if you think about all the things for Sarbanes-Oxley, we now have an internal audit group that comes in -- it's an outside group that comes in and is our internal auditor in addition to our external auditor. And those guys are -- I think this year, they will be $300,000. Hopefully, going forward, that number will be 50 to 75 percent of that number. But it's still going to be a significant number.

The audit fees themselves have gone up substantially, both because the auditors have a lot of pricing power and can get much higher realization rates, but also because they are expanding the scope of work significantly to address the internal audit 404 portion of it. I think that's costing us an extra -- I wouldn't be surprised if it doesn't cost 120, $150,000 extra just from the auditor on a going-forward basis.

And then you throw in things like higher D&O insurance costs; legal bills. There are just a whole lot of things that add up. And I wouldn't be surprised if this year, it's $1 million, and on a going-forward basis, it's 7 or $800,000 at least. So I'm not sure I can exactly quantify it, but that would be my best guess.

So going forward beyond '04, it sounds like about $0.75 million in additional Sarbanes-Oxley related fees as well as other fees that may come as a result of that -- does that seem fair?

Yes, I think if you add up the consultant costs and the insurance costs between internal auditors, legal, and then additional insurance costs, I would not be at all surprised to see 2 or 3 (ph) quarters of $1 million.

Now, are those costs all flowing through the G&A line?

I would say for the most part, they are.

Yes, they are.

Gentleman, we have no additional questions at this time. Please continue.

Thanks, everybody, for listening. Obviously, the intent wasn't to throw cold water on everybody's expectation. I guess we had thought with the EOP recent meetings they had, and certainly Mission West statements, that we wanted to convey to everybody that while things may have stopped declining and may be improving gradually, we're still in a very difficult market. And it's going to be a while before we get back to the good old days of 2000, 2001. I think we're in decent position to do that because of our leverage and because of our capability to buy properties. But it's still a difficult market. And we foresee this continuing through '05.

We will talk to everybody in February. Thank you.

Ladies and gentleman, this concludes the Prentiss Properties Trust third-quarter 2004 earnings conference call. If you'd like to listen to a replay of today's conference, you may dial 303-590-3000 or 800-405-2236 followed by access number 11009051. Once again, we thank you for your participation. Have a pleasant day. You may now disconnect.