Brandywine Realty Trust (BDN) 2018 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Brandywine Realty Trust Third Quarter 2018 Earnings Conference Call. (Operator Instructions)

As a reminder, this conference call is being recorded. I will now like to introduce your host for today's conference, Mr. Jerry Sweeney, President and CEO. Sir, you may begin.

Joa, thank you very much. Good morning, everyone, and thank you all for participating in our third quarter 2018 earnings call.

On today's call -- today with me are George Johnstone, our Executive Vice President of Operations; Dan Palazzo, Vice President and Chief Accounting Officer; and Tom Wirth, our Executive Vice President and Chief Financial Officer.

Prior to beginning, certain information discussed during our call may constitute forward-looking statements within the meanings of the federal securities law. Although, we believe, estimates reflected in these statements are based on reasonable assumptions, we cannot give assurance that the anticipated results will be achieved. For further information on factors that could impact our anticipated results, please reference our press release as well as our most recent annual and quarterly reports that we file with the SEC.

So we had a very productive third and now going into the fourth quarter and as part of our third quarter earnings release and 2019 earnings guidance, we also announced 2 significant transactions that change our company's growth trajectory. By way of quick background, over the last several years, we've been on a track to improve our growth profile, control capital cost, create value-driving, long-term, mixed-use development opportunities and effectively manage our balance sheet.

And as a consequence, we substantially eliminated revenue contributions from slow-growth markets like New Jersey, Richmond, the fringes of the Pennsylvania suburbs and October properties in Northern Virginia. In the process, we reduced our same-store properties, improved our capital ratios, growing cash flow and strengthened target submarket positioning. That process has resulted in about a 24% increase in our same-store net effective rents over the last several years. We are also, as part of our 2019 business plan, anticipating about a 5% growth in net effective rents over 2018 levels.

So we believe that the announced Northern Virginia-Austin revenue swap builds on that track record and accomplishes the following key objectives. First, it increases our revenue contribution from Austin on a wholly owned basis from 5% to 18% of overall revenues. It transfers revenues from a submarket with an average 2018 minus 3% cash, plus 3% GAAP mark-to-market and moves that into Austin, where our mark-to-market on a cash and GAAP basis have been 10% and 16%, respectively in 2018.

It also moves our tenant improvement and commission dollars from a market with close to 20% average capital ratio to Austin where we have an average 2018 capital metric of 12%. It does reduce our D.C. net operations to 8% of total company revenues. And I think, from our perspective, the Toll Road Corridor has good, long-term growth potential, hence our desire to stay engaged, but our wholly owned focus will really be on our Tysons Corner portfolio, the development parcels and a couple of redevelopment candidates, one of which is in Herndon.

It's a market though that's characterized by slower-than-Austin growth rates and higher concession costs. So our retained 15% stake in the NoVa assets results in a much better return on our invested capital by creating a different capital stack in a promote structure.

By way of example, through this transaction, we'll be increasing our return on invested capital from the low single digits to the high double digits over the next several years and over 10% including our fee revenue. We have found that assets in these slower-growth markets can deliver the best value through a noncore capital structure as evidenced by the 25% plus return we're currently realizing on our investment of $25 million in the MAP portfolio.

We did, on Pages 5 and 6 of the supplemental package frame out more detail of each of these transactions. And we really are pleased to have delivered such a great rate of return to our shareholders in DRA, and we thank DRA for their great partnership. And we are also delighted to launch our partnership with Rockpoint, where our 15% stake will be a retained interest with a promote structure, and we'll provide property-level services.

We have signaled all year that proceeds from any asset sales will be deployed to create earnings momentum and maintain balance sheet neutrality, and we believe that the structure of these transactions are consistent with that approach.

So with that important revenue shift as a key backdrop, we're also announcing 2019 earnings, key highlights, FFO growth, which is adjusted for the accounting policy changes that were in some analyst estimates, and Tom will talk about, the FFO growth rate of 5% at the midpoint. Our CAD growth rate again adjusting for the accounting policy change is of about 2%, which does interestingly bring our 2-year average annual growth rate on CAD to the top end of our 2018 to 2021 business plan range, as outlined on Page 8 of the SIP.

Cash same-store NOI growth will be a midpoint of 2%, which does not include the performance of any of these DRA assets that are now wholly owned. Spec revenue of $31 million is already 65% achieved, which is an improvement over the last year's levels at this time. Occupancy will be between 94% and 95% by year-end with leasing levels at 100 basis points above, at 95% to 96%. We do anticipate a below-average retention of 57%, primarily driven by KPG's -- KPMG's anticipated move out. Our cash mark-to-market will be between 2% and 4%. GAAP mark-to-market will remain in the high single digits between 8% and 10%, and capital will run about 14% of revenues, up slightly from our 12% in 2018. But 2018 was at that level primarily due to a large note capital renewable. Debt-to-EBITDA, which Tom will touch on, will range between 6.0 to 6.3, really depending upon the level of and the financing plans for development starts that we anticipate in 2019.

So the upshot is the 2019 forecast grows FFO, grows CAD, keeps the balance sheet strong, our capital ratios remain on track with strong mark-to-market. The 2% percent same-store midpoint is at the bottom of our long-term range. So we'll remain focused on trying to improve that during the course of the year. We also do expect at least 1 development start in 2019.

So with that 2019 overview, just a couple of moments on our 2018 business plan, which is totally on track in all of our metrics with the exception of those requiring adjustment due to the DRA and Rockpoint transactions are on track. Some specific data points. We ended the quarter at 93% occupied and 95% leased. Mark-to-market, on a GAAP basis, very solid 11.4% and 14.4% for the year, both in excess of our targeted range and our mark-to-market on a cash basis was also above the upper end of our range. Retention, 75%, ahead of our targeted 67% range for the year. And as we anticipated and we've talked about on a couple of previous calls, our same-store numbers for the quarter were almost 14% on a cash basis and 3.4% on a GAAP basis and that did include the addition of some of those other assets coming into the same store for this quarter.

Leasing capital remained well within our targeted range of 10% to 15%, with a 12% posting for the quarter. As a result of the transactions that we anticipate closing in the fourth quarter and given the continued progress in our '18 business plan, we did narrow our 2018 FFO guidance to a range of $1.36 to $1.40 per share.

Couple of moments on development. The land bank remains within our targeted 3% to 4% of assets. Development capacity remains about 15 million square feet with about 50% of that square footage being targeted for office, life science and related spaces with the balance being mixed use.

Our Broadmoor complex in Austin and Schuylkill Yards in Philadelphia provide an outstanding opportunity for us to grow our earnings base significantly by effectively executing these multiyear master plan developments, obviously, as warranted by real estate and capital market conditions.

We did outline our development activities on Pages 15 to 17 of the supplemental package. Pipeline right now stands at 832,000 square feet with a total cost of $271 million, of which $105 million remains unfunded. Bottom line, we're 93% leased with an average yield -- cash yield on cost of 9.2%.

Couple of project specifics. 500 North Gulph Road has turned out to be an outstanding renovation success story. Project will be completed and stabilized by the end of this year. Cost of slightly less than $30 million will generate a projected 9.3% initial return on cost and will generate an average return just shy of 13% on a cash basis over the tenants lease term. At Garza, which is our mixed-use development in Southwest Austin, we've generated almost $31 million of land sale proceeds and recognized a $2.8 million land gain. We are underway on our 250,000 square-foot build-to-suit for SHI. That building will be delivered by year-end '19, and we do anticipate earning development fees approximating $2.6 million over the next 6 quarters. In addition at Garza, we have another land site that can do a 150,000 square-foot office building. We are heavily into the design development process and based on market activity, plan to be in a position to start that building by year-end 2019.

Similar story at Four Points, our other development underway in Austin, 165,000 square-foot building, 100% leased. We anticipate delivering that project in the first quarter of '19 at a projected 8.5% return on cost. Similarly, we have a 175,000 square-foot building at Four Points and like Garza, based on market conditions, could be in a position to start that by year-end '19. Broadmoor, we pretty much wrapped our 906 renovation. That project is 96% leased with a initial cash return on cost at just below 10%. 405 Colorado in Downtown Austin is ready to go. Construction pricing in just about finalized. Active marketing is underway. The pipeline is excellent and building, and we do plan on breaking ground there once we secure a prelease. We're targeting 8.5% cash return on cost on an estimated budget of the $110 million.

During the quarter, we also completed construction of our second building for Subaru of America. They took occupancy in that building a couple months ago and will be purchasing the building during the fourth quarter. We expect to record a $3.5 million gain at closing. Our total profit thus far at Knights Crossing development in Camden has been over $13 million. Design development for Schuylkill Yards Stage 1 is well underway. We're evaluating the final product mix and also actively exploring a range of equity-financing alternatives. The objective remains, as we mentioned in the last call, which is to finalize the design, identify a tenant pipeline, select equity financing partners and then commence on the start of the first project hopefully by the end of 2019. Master plan-related work is underway and done as of the last quarter at Broadmoor. We're now into the site planning process for Phase 1, which will consist of office and multifamily. And if all goes well and subject to the market conditions, we could be in a position to also start Phase 1 by year-end 2019.

Since resting on Broadmoor, with our baseline approvals in place now for an incremental 5 million square feet. With an investment base per square foot of less than $2 per buildable foot, we have tremendous embedded equity value in that landholding and are frankly quite pleased with the level of interest we're seeing from both tenants and potential partners.

Before I wrap up, a couple of our estimation point in the '19 forecast. We are expecting, as I mentioned, below average retention rate of 57%, primarily driven by KPMG in the fourth quarter of 2019. The blended GAAP mark-to-market will be between 8% to 10% and cash mark-to-market between 2% and 4%. Same-store numbers, again, will be between 1% to 3% on a cash basis.

We do expect our leasing capital to be around 14% of revenues. We're not programming any further acquisition or sales activity during '19, and as we identified in the supplemental package, we do anticipate at least 1 development start in a range between $50 million to $110 million occurring during the course of the year.

So with that, let me turn over to George for an overview of third quarter operations and some color on our '19 business plans.

Thank you, Jerry, and good morning. It was a busy third quarter, and the 2018 business plan was virtually complete. More importantly, our continued leasing momentum has the 2019 business plan off to a great start.

During the third quarter, we generated 114 space inspections, up 14% from last quarter. The amount of square footage inspected totaled 942,000 square feet, up 22% over the last quarter. The Pennsylvania suburbs were the leader from a number of tours perspective, while Philadelphia CBD saw the biggest gain in terms of square footage. The pipeline excluding development and redevelopment properties remains at 1.8 million square feet. Approximately 450,000 square feet of this pipeline is in advanced stages of lease negotiations.

The third quarter of 2018 activity still has to achieve its minimal. Based on the contribution of our 8 Toll Road properties into the Rockpoint joint venture, we did adjust 4 of our 2018 business plan metrics.

Spec revenue decreased $1 million to $25.3 million; tenant retention increased from 67% to 72%; GAAP same-store NOI growth declined 75 basis points at the midpoint; and GAAP mark-to-market increased from a previous range of 8% to 10% to a range of 13% to 14%. All other metrics will perform as previously guided.

Turning to our markets and the underlying assumptions contained in our 2019 business plan. For CBD Philadelphia, we're now 98% leased, having leased the last full floor at 1900 Market Street during the quarter. We've also executed an 85,000 square-foot lease to backfill 4 of Comcast's 5 floors, which will be vacated December 31, 2018 at Two Logan Square. This backfill lease will take occupancy in 2020. The next largest rollover in the city for 2019 is a 27,000 square-foot tenancy, with a renewal notice due on or before January 31, 2019. All expectations are that this option will be exercised.

Mark-to-market for leases in Philadelphia will range 2% to 4% on a cash basis and 11% to 13% on a GAAP basis. In the Pennsylvania suburbs, we're 93% leased with the majority of our leasing still to be achieved in Radnor. We have 3 larger blocks of space totaling 93,000 square feet available. Activity and touring levels remain encouraging. We have proposals out for 70,000 square feet ranging from 5000 square feet to 35,000 square feet. 2/3 of this available inventory is assumed to be leased in our 2019 plan.

Rollover exposure in the Pennsylvania suburbs during the year is only 7%, which is manageable. Only 3 tenancies over 20,000 square feet, and each of them are currently entertaining renewal proposals. King of Prussia's revenue contribution will increase beginning in the fourth quarter of 2018 with 500 North Gulph Road coming online.

Shifting to Metro D.C. In Tysons, we have 1 known and 1 potential large move-out during 2019. AT&T will vacate 83,000 square feet next August, relocating to corporate-owned facilities. At 1676 International Drive, KPMG has the ability to terminate their 183,000 square-foot lease effective September 30, 2019 with notice by year-end '18. We anticipate receiving notice shortly, and our business plan assumes they will terminate early.

Our comprehensive redevelopment planning continues to make progress at 1676. This plan entails improving vehicular access to the property, upgrading existing common areas, both indoor and out and upgrading amenities within the building. Our plans have been well received by a number of brokers and prospects to date. Inquiries about the building have been numerous, with the prospects ranging from 25,000 square feet to 175,000 square feet. Demand for product in the Tysons submarket provides a great opportunity to increase rents by 10% with a 20% return on our contemplated incremental capital investment.

In Austin, we're 96% leased and are currently renovating Broadmoor Six building. Layering in the 12 assets being acquired, our Austin portfolio is 95% leased. Rollover for 2019 is less than 4%. Rent growth in Austin continues to be robust. We'll see leasing spreads between 13% to 15% on a cash basis and 20% to 22% on a GAAP basis.

In terms of the operating metrics for our 2019 business plan, it's worth noting that previously mentioned Comcast, AT&T and KPMG move-outs account for 250 basis points of occupancy and 230 basis points of same-store cash NOI. It's also worth noting that the acquired Austin properties will generate cash NOI growth between 9% and 10% for 2019. These properties are not part of the same-store mix for 2019 but would have a 70 basis point impact on that metric.

And at this point, I'll turn it over to Tom.

Thank you, George. Our third quarter net loss totaled $43 million or $0.24 per diluted share, and FFO was $63 million or 35% (sic) [$0.35] per diluted share.

Some general observations regarding our third quarter results. Our third quarter net loss was generated by an impairment that was a result on an announced joint venture in Northern Virginia, which generated an impairment charge of close to $57 million or $0.32 per diluted share. The impairment includes unamortized straight-line costs of almost $16 million and estimating closing cost about $5 million. Our quarterly operating results met our expectations, and an incremental improvement is expected in the fourth quarter. As George outlined, we have adjusted our 2018 business plan metrics to reflect anticipated sale in the Northern Jersey portfolio into a joint venture and current operating trends.

Our balance sheet continues to improve with the fixed charges and interest rate coverage ratios being 3.5 and 3.8, respectively, a 9% improvement on both metrics as compared to our third quarter of 2017. Our net debt-to-EBITDA remain constant at 6.2 and depending on the timing of the announced transactions, we anticipate our normalized ratio to be lower at year-end.

Property level income totaled $78.5 million, which was in line with our projections. Looking to the fourth quarter, we have the following assumptions. Property level operating income will total about $79.5 million and will be flat compared to the third quarter. This -- up annually, up a little bit from the third quarter by $1 million. The increase is primarily due to improved occupancy that we expect to occur in our core portfolio.

As George mentioned, we are 96% done on spec revenue. The remaining is roughly of $1 million, so less than $0.01 of FFO per share, so minimal impact on guidance.

Subaru, we will recognize about $1 million of interest income that will be from the Capital lease this quarter. We do anticipate them buying the building during December of 2018. We do not expect any income beyond 2018 a result of this transaction.

FFO contribution from unconsolidated joint ventures should be about $6 million. G&A will increase from $6 million to $6.3 million primarily due to some timing on expenditures. Our mid -- our year-end number is still at $28.5 million. Interest expense will remain steady at 95.5% with fixed-rate debt being 98.6%. We expect capitalized interest to be about $1 million for the quarter. Termination and other will total approximately $0.5 million, and NOI from our management fee and developments will be $3.5 million with no additional activity, either in ATM or buyback.

Additional financing activity, in October, we do plan on closing on term loan C. We expect that loan to be recast from a 7-year loan to a 5-year loan with no change in maturity date or the amount of the term loan. The loan is already swapped to a 3.7% rate. By recasting it, we will decrease our spread by roughly 50 basis points, resulting in interest savings of about $1.3 million on an annual basis.

Looking at our capital plan for this year, we still expect to keep our range of CAD. Including in our uses is about $460 million, including $333 million from the Austin asset acquisition and related mortgage payoffs with one of the mortgage payoffs occurring in early '19 when it becomes open for prepayment. We have $65 million of capital spend, roughly $32 million of dividends. Our revenue maintain is roughly going to be $15 million for the quarter, with revenue create about $10 million. Term loan and financing costs will be about $5 million, mortgage amortization of $2 million.

And on the sources side, we have the net proceeds we anticipate out of the Northern Virginia joint venture and related financings of about $292 million, $50 million from cash flow after interest, roughly $45 million of proceeds from Subaru and using our 75 -- using cash on-hand of $70 million, and we will roughly have $5 million of debt at the end of the year on our line.

We anticipate our net debt-to-EBITDA remaining in the low 6 area and our debt to GAV in the high 30%. In addition, we anticipate our fixed charge ratio remaining constant, and our interest coverage ratings constant at year-end from right now.

Looking at '19 guidance, at the midpoint, net income will be $0.41 per diluted share, and FFO will be $1.42 per diluted share. Based on that, some of our assumptions in that, the first one is to outline our accounting change. We're taking -- we anticipate about a $4.6 million reduction in earnings, primarily due to the internal leasing cost that cannot be capitalized and an increase to our ground rent expense based on the straight-lining guidelines. Of note, we have not yet concluded on 1 particular ground lease that's at one of our joint ventures, and therefore, we have not included that in guidance, and we will update you as that gets to year-end, probably on the fourth quarter call.

Of this according change being about $0.03. In terms of how it was in guidance for a consensus, I believe roughly 20%, a little less than 20% of our analysts had this in guidance, the remainder did not. So for the most part, this was not included in most of the numbers from the analyst community in terms of our consensus.

Portfolio operations, GAAP NOI will increase roughly $28 million for the year. Austin acquisition will generate about $34 million. FMC should generate an incremental $5 million, One Drexel Plaza and 3000 Market should generate about $3 million. Our redevelopments and sale of 500 North Gulph Road and our development of SailPoint should generate about $8 million. The sale of the D.C. assets will reduce GAAP NOI about $21 million.

Then looking at our FFO contribution from our unconsolidated joint ventures, we have about $17.5 million of that this year, a $7.5 million decrease from 2018, primarily due to having a 50% interest sale in the Austin joint venture offset by our new 15% interest in the Northern Virginia asset.

In G&A, we expect to be between $30 million and $31 million, the primary increase is due to the accounting change, which will generate $1.6 million of additional expenses due to capitalization. On the investment, we have no set acquisitions or dispositions, and we have one development start. Interest expense will increase to approximately $81 million to $82 million. This will include about $4 million on our line of credit, as we do expect to have borrowings throughout the year.

Capitalized interest will be between $2 million and $3 million. Land sales and tax provision will be a net $1.5 million positive. We expect term fees and other income to total about $5 million, which is approximately what we're running in 2018. And net management fees will total about $11 million, which is somewhat consistent with the numbers for '18 also. No change in our quarterly dividend and no anticipated ATM or buyback activity.

As we look at capital, it's a $360 million plan, $120 million of development and redevelopment, common dividends of $130 million. Revenue maintain of about $50 million, revenue creating about $25 million, mortgage amortization of $7 million and mortgage payoff for the Austin portfolio related to one mortgage that won't be paid off till early '19 of $28 million.

Primarily, sources are cash flow after interest payments of $230 million and using the line for about $130 million throughout the year, which will bring our line balance to roughly $135 million by year-end. We anticipate that net debt to EBITDA will be reduced and stay around 6 to 6.3. The main variable will be how our developments are done during the course of the year and how much money we spend on those and whether we find financing activity or JV partner equity to lower those ratios. We also remain -- believe our fixed charge and our interest coverage will be in 3.7 and -- 3.4 and 3.7, respectively.

I'll now turn it back over to Jerry.

Great. Tom and George, thanks very much. So to wrap up, the third quarter business plan -- 2018 business plan is essentially completed. And the 2019 plan that we outlined, we think, represents a good earnings, continued cash flow growth, good balance sheet and really a steady pipeline of development and redevelopment opportunities that we hope to actually doing during the course of the year.

So with that, we would be delighted to open up the floor for questions. (Operator Instructions)

So Joa, we can open up the line to questions now

(Operator Instructions) Our first question comes from Jamie Feldman with Bank of America Merrill Lynch.

I was wondering if you guys could talk more about Downtown Philadelphia. You know we know you got the McQuarrie move-out coming, you got the Standard Reliance (sic) [Reliance Standard] move out coming. Just how do you guys think about the prospects to backfill those spaces? And just -- I know there is a differentiation between a trophy market where you guys are all out of your assets and the rest of the market. So just kind of big picture of how you think that market looks over the next couple of years and your prospects?

Yes. Sure, Jamie, this is George. I'll take first stab at it. I mean look, McQuarrie and Reliance are both examples of tenants who have opted to move into new space. McQuarrie is 150,000 square feet net. We did go direct with one of their subtenants in 70,000 square feet beyond McQuarrie's expiration. They have the top 8 floors are Commerce Square. I mean, you can't ask for better space and better views there. They are about 30% of our 2020 rollover in the city, about 12% of the company. But they are expiring at a rental rate that is kind of below market, so we do see an opportunity to move rents, and I think -- look, the likely backfill of that space will ultimately be someone who makes a similar move. Reliance is almost a year later. They expire with exercising their early termination that is 12/31 of '20. They are 5 floors in the middle bank of Two Commerce Square. Markets are probably plus or minus 10% below market today. So we see a good opportunity. And I think, quite honestly, that then gives us a nice mix of inventory when we kind of get into late '20, early '21 of kind of middle-bank trophy space, top-of-the-bank, top-of-the-structure space and then most likely, some new development and all at varying price points.

And Jamie, Jerry. Just to add on to that. Thanks for that, George. I mean, look, the -- you never want to lose a tenant, period. If you can keep them. With that being said, what we have here is a combination of time and great inventory. So our leasing teams are already well on top of identifying backfills for that. As George touched on the McQuarrie space, we've already put away a big piece of that with the tenancy of the -- the permanent tenancy of the sublet. But I think we have already seen really good upticks in activity. And frankly, we have not had larger blocks of space on west market for a number of years and have been out of play on a couple of tenants moving along that quarter. So these 2 spaces give us that opportunity with a positive mark-to-market and in addition, gives us that price point differentiation that we really do like. We have the Logan, the 1900 product now at Commerce Square competing -- being in the game with the different price points with all of our marketing activity at Schuylkill Yards and University City.

Okay. And then, after the Northern Virginia-Austin trade, I mean, how do you think about your portfolio positioning today? Any markets you think you'd still like to be smaller or greater in, going forward?

Yes, I mean, this was a big move, and I think we're really looking forward to kind of generating the returns that we think we get out of Austin. Yes, look, we've kept a good footprint in the Dallas Toll Road. Of course, We think that market has some good long-term upside. We have indicated that over time, suburban Maryland and a couple of pockets out in the Pennsylvania suburbs will probably be a feeder properties for generating some additional capital to fund our development pipeline. But I think fundamentally, we look back over the last couple years, the company's operating platform is in really good shape, and we're always going to have rollovers that impact one metric or the other. And certainly, we were going through the roll-up of numbers, we are hoping for a higher same-store number, but, yes, we have these rollovers within the same store. But we take a look at that same-store metric juxtaposed with the positive cash mark-to-market between 2% and 4%, the good cap -- GAAP mark-to-market in the high single digits up to 10% and keeping our capital cost within that band of 10% to 15%. We think that's a great prescription for generating growth going forward. But I think you'll see it's always, Jamie, kind of fine-tune the portfolio, particularly to make sure that we're always mindful of making the right real estate decision and also being very mindful of the capital constraints that are there with us every day in -- with public market pricing.

Okay, if I could just ask a follow-up. I know I am only allowed 2, but your guidance shows 2% AFFO growth, if you look ahead, forward years beyond that, I mean, do you think that number can rise with some of these big move-outs, or are you kind of stuck in this AFFO?

No, I think we would expect that to rise, and I think when we look -- took a look at the numbers for this year, we were coming off kind of an extraordinarily strong year in '18 where actually it's going to be north of the 11%. And just then taking a look at where we think some of the capital deployment opportunities over the next 12 months, we felt that it was a little overweighted, based upon our historic run rate. So we certainly do believe that we're going to be able to, with this portfolio, get that portfolio back to the targeted range on our 2018 to '21 business plan.

Yes Jamie, I think it's -- as we look at that long-term growth rate for CAD, which is -- it has been above our FFO. We still think that trend long term, over that -- over our business cycle will be higher, continue to go on.

Do you think in '20?

'20, it's not -- I mean, '20, it will be probably a little positive. I don't think, it'll be very positive, but I think as we look at '21, as we get some of the leasing done, we will be within the 5% to 7% range we've outlined.

Our next question will be from Manny Korchman with Citi.

Jerry, just as you thought about the Dallas transaction, retaining 15% of it and collecting the fees and potential promotes versus -- weighing that versus selling it all, cleaning up the structure, getting out of that market completely, why did you choose to retain the 15%?

Yes, it's a great question. Here's how we thought about it. I mean, fundamentally, I think this was a capital allocation decision. We do like the Toll Road market long term. We think there's some good things going on there. We also think we have an absolutely fabulous local team who's really very adept at identifying value points for us. But we really did feel like kind of bottom line, moving from a lower-growth market where we have a smaller platform to a higher-growth market where we're market leader made a lot of sense. And fundamentally, we thought makes -- it makes the company more valuable. I mean, I think with -- on -- being on a path to increase our revenue contribution from Austin to 25% of revenues. And then in this quarter supplemental we also broke out our revenue differentiation between CBD, Philadelphia and University City, where we have about 20% of our revenues coming from University City. We think that now 25% coming from Austin with all the great attributes that market has, 20% coming from University City, which is one of the top performing urban submarkets in the country with tremendous catalyst for life science, academic and residential expansion, we thought creates a great value platform for the company. And as we looked at kind of trying to figure out how to bridge the long-term potential we see in the Toll Road with kind of a near-term capital allocation decision process we go through and bridging ourselves to when that market recovers, I think we felt that the 15% promote provided a good upside if the market improves, as we hope it well, and during that market transition, provided a well-capitalized smart partner to help us work through both the capital-sharing arrangement and also potentially providing a more effective return on invested capital mechanism to grow a platform in that market. It does give us the ability to really focus our wholly owned activities in Tysons where we do think we have a great opportunity between 1676 and 1900. We know they're near-term disruptors to same store, but we think we can get a great return on incremental invested capital in both of those buildings and create some strong rental rate growth. And we also kind of kept a proxy out in the Herndon market with our 2340 property, which right now is fully leased. But that's a 250,000 square-foot building that if that tenant would decide to vacate, we would have a development opportunity out there as well. So the 15% is a proxy for us to maintain some growth and a better return on invested capital metric coming out of that marketplace, because we still do believe it has good, long-term viable tenancies and the continued movement of the Silver Line out to the airport.

And then in Austin, can you just frame for us how that deal came together? Was it something that they approached you on? Did they want to sell their stake to somebody else? Or is it something that you wanted to increase your exposure to and you approached them?

Well, we -- the DRA venture was formed a number of years ago. Gave us a tremendous opportunity to acquire almost $800 million dollars of assets we wouldn't have been able to acquire before. We did sell, Manny, the first tranche, you may recall a bid ago, and we view the assets remaining in the venture as higher growth, really well-positioned assets we would like to have stayed involved in. So with the partnership approaching kind of this 5-year life cycle, I think both DRA and Brandywine thoughtfully evaluated how we could optimize market pricing for all the assets. So there were a number of discussions that involved a lot of third parties to kind of assess independently what we thought market value would be on those assets. Certainly, Brandywine knowing those assets as well as we do, plus the promoted structure we had built into the deal I think gave us an opportunity to completely meet our fiduciary obligation to DRA and deliver great returns to our shareholders.

Our next question comes from John Guinee with Stifel.

Couple questions. I guess, the first one would be noticeable change in your dividend policy. Can you walk through your thinking on that?

John, there's no change in our dividend policy. I think the board will continue to evaluate that with the 2019 business plan just coming out. I think the board will certainly to continue to evaluate what to do with their dividend. I mean, I think from a coverage standpoint, both on an FFO and a CAD standpoint, we are very well covered. The board continues to maintain that we want to continue delivering increasing returns to our shareholder. So I'm sorry if any of the comments would lead you to allude that we've changed our dividend policy, quite opposite I think. We're pretty excited about the level of cash flow growth we've had over the last 24 months that would provide an opportunity for the board to evaluate the dividend as the 2019 plan has a higher level of execution. I think in Tom's comments, he was indicating that 2019 business plan did not include any ATM purchases, any acquisition or disposition activity or any increase in the dividend. This is a framework for all of the analyst models.

Correct, John. I wasn't -- I was just implying what kind of cash flow was going to be coming out of the '19 plan. And at this point we haven't -- last year, as you recall, we did include a dividend increase. This year it was just stating that we haven't included one as a plan item.

Got you. Okay. And then follow up, a couple, a and b. One is, where do you think -- clearly, JV capital is advantageous to issue in common equity right now. At what point in time, at what level do you think your share price needs to be where you think that issuing shares is a more attractive cost of capital than entering into these large joint ventures? And then just more of a curiosity question, it looks like you're going to be expensing leasing cost to the tune of $2.2 million into property operations. How does that work?

I guess a couple points there, John, a and b. So we'll try to pack it. But yes, I think from a share-issuance standpoint, I think when the stock price earlier this year was north of $18, we were selectively using ATM to both create some financial capacity as well as to recharge the balance sheet. I think we're far, far away from that given the existing stock pricing. So I think from our perspective, we need to be incredibly disciplined about how we can create long-term growth potential by focusing on every dollar's return on that incremental investment. So certainly doing transactions like we have done over the years by, call it, privatizing portions of the portfolio through these JV structures to create a better return to our public equity base is a very viable alternative. I -- we're -- I continue to be very impressed with the level of private capital that is looking to invest in real estate operations with great operators. So as we went through the process for the Northern Virginia transaction, for example, the pricing differential between a wholly owned sale and a venture sale was really all at a point of indifference, so we felt we had the opportunity to create some great upside momentum for our company both in a near term and long-term basis by retaining an equity stake in that. As we've done over the years, we've sold an awful lot of real estate directly without retaining any ownership stake. So it's really kind of a price point discussion with each asset trade and then also kind of our market assessment of where we think that asset fits long term into our desire to generate some growth.

And John on the capitalization, I guess we have -- the capitalization affects 2 areas of our income statement. So the general rule is that if you have direct commissions, whether they be external or internal, those are allowed to be capitalized, but with our internal -- there's certain personnel that receive both a base, a bonus and a commission as a blend. Any portion that's not a direct result of the lease such as a salary or a bonus, those will be expensed going forward. That's the new rule. Whereas before we saying, as long as those were below market rate commission, you could capitalize all of that. Those personnel are in 2 different places, so we have some cost that are running through G&A, which a certain personnel they were in the G&A or either were being -- were part of a leasing process. And then we also have people that are brokers that are in our third-party management business that are -- going to be seeing less capitalization against that revenue. So from that standpoint, you'll see an adjustment to our operating income for the balance of it.

Our next question comes from Craig Mailman with KeyBanc Capital Markets.

Just curious here, how you think buyers are underwriting Amazon right now in Northern Virginia. And kind of maybe give us some insight as to why the transaction had to be now versus waiting for an announcement?

Yes, it's a great question, Craig. I mean, certainly something that we've labored over quite a big and it's intriguing in its possibilities. We think there's certainly some more interest in that corridor because of the potential of Amazon locating there, which is why I think we're happy with the auction process on the pricing that we got for these assets in the low-6% cap rate range, we thought that was very good. And I think as we evaluate our position, a couple of things. It's a good window into what might happen in that market and from our perspective to the extent that there is a big updraft in that market, we think our retained position with our promote, but more importantly our position in Tysons Corner with the buildings we have there, the property we're retaining in Dallas Corner and potentially grow this venture with Rockpoint can provide a really good proxy for us to participate in market recovery. And I guess on the other sides to the -- of that discussion is -- yes, well, Amazon would clearly benefit any market they go in. Just like we're seeing Google benefit Austin and some of the growth -- any time a major tenant goes into market, it's good news for everybody. Northern Virginia, the reality, the ground, a little bit more intriguing or stark. I mean, in the Reston to Tysons Corner corridor out to Herndon you really have about 14 million square feet of new office that can be planned as part of the Silver Line expansion. Herndon itself has over 2 million square-foot pipeline with some more behind that, that could drive that pipeline higher. And when we're assessing that marketplace, there's no doubt that Amazon Web Services, which is in a market now for requirement, an expansion by defense contractors, forays by Apple and Google, could really create some significant demand and that's, frankly, what we all are hoping for. The counterbalance is that -- to that potential demand is that the size and location of the pipeline could just as easily have the impact of creating a lid on effective rent growth near term in some of these existing product. So I think we were really trying to evaluate how to look through that window and really create the best opportunity for our company, and we concluded that selling a portion of over Toll Road assets, retaining a stake in those assets that we were partially selling and retaining a portion of our Northern Virginia portfolio as wholly owned created a great opportunity for us to benefit if that market really does take off. But certainly, over the intermediate term, gave us the ability to take advantage of what we thought was a wonderful opportunity to bring in some assets wholly owned into our company in Austin, Texas.

Right. So it sounds like you're hedging yourself a little bit, which makes sense. I guess part of what I'm getting at is, you guys said you like the market long term. You're kind of bridging yourselves here for potentially some more -- a couple more years of weakness outside of what Amazon may or may not do. But do you think we're here in 5 years as the Rockpoint JV kind of matures and we get another DRA situation where you guys kind of sold low and buying back high, similar to what you did in Austin?

Well, I think when we sold the assets in Austin, I think we got great market pricing at that point. There wasn't a selling low, the markets moved dramatically. But more importantly, and it kind of dovetails onto John's question on private equity, we're always looking at the best way to allocate capital and create the growth -- the best growth rate. What can't be forgotten with the Austin JV was that we were able to, again, move from a fairly small market position in Austin and through that JV acquire a number of really high-growth targeted assets that generate great rates of return to both DRA and to Brandywine during the whole period, and Brandywine then had the opportunities. We see some opportunity to further accelerate growth in those assets by buying them in. I mean, interestingly, of the assets we bought in, of the 3 positive assets we bought in, only 1 was one of the originally contributor assets. The other 2 were new with Riverplace and Four Points, which we've been able to demonstrate that we create value in both of those locations by leasing up the portfolio. So if the marketplace in 5 years in Northern Virginia is tremendously stronger and we can harvest a lot of money by using a bridge financial structure and generate great returns to our shareholders and then we view that some of those assets and the venture that we're contributing now have better long-term growth potential as wholly owned. I think we'd certainly want to retain that flexibility.

Okay, and then just separately, on your '18 to '21 kind of same-store outlook of 2% to 5%, you guys are 2% in '18 and '19 and you have some bigger move-outs again in 2020. I mean, do you think you guys need to reevaluate whether you can top the midpoint of that range?

Well, I think the benefit we have with -- look at the numbers in the third quarter view with us bringing new properties online. I mean we -- the numbers on the same store in the third quarter, as George has been articulating all year, I mean, is a great pop because we're bringing some high-performing assets into the portfolio. They'll be transitioning in again and generating good growth with very low capital cost for the period from, call it, '19 to '21. We certainly will have some rollovers, as George talked through in '20. The reality, they're not that big in the scheme of where our overall portfolio is and whereas the 1676 project as they hit the same store this year, we'll lease it out next year to be a tremendously strong performer in '21. I mean, one of the challenge with the same stores is it's a point in time snapshot that doesn't necessarily take into account the true push through the portfolio. So no, we look at our forward model and we think that those numbers get progressively better, which is why I was kind of touching on the point -- if we're generating same or good cash mark-to-market, good GAAP mark-to-market, keeping our retention rates in pretty good shape except for in '19 with the 57 with KPMG, that's a prescription for good, sustainable, accelerated growth. And when you overlay that with the development pipeline we have, some assets will be 26 to 30 months to build, some assets will be 12 to 18 months to build. We have a tremendous opportunity over the next few years to really start to generate some growth rates foreign ex we've been generating over the past with the older portfolio.

I also think, Craig, as we look at the same-store grouping, this year will not benefit from a -- to your -- from the assets coming out of Austin because they don't hit same store till next year. So we would hope as we look at going out in 2021, we now start to benefit from the strong mark-to-market and having close to 20% of our revenue coming from Austin, which is really not helping our same store this year for '19 coming up.

So do you think by 2020, even with the move outs and everything going on, that you could be at that high end of near 5%, given what's rolling in and then you rolling out Northern Virginia?

Well, no, we just announced '19 guidance. We're not going to postulate on '20 guidance at this point.

Our next question will be from Michael Lewis with SunTrust.

I wanted to follow up on a question about the lease accounting. I was just wondering how much leeway you have in deciding that what goes into the property OpEx and what goes into the G&A? Because we were one of the analysts that did have the adjustment in our model. We put it in G&A. We thought maybe companies would want to shift it there because in this example, if you take that 2 2 of your NOI and you cap that, you lose 1% of NAV for something that really has nothing to do with the business. So just curious about that?

Sure. As we look at that, Michael, we basically for right now just put the people -- we put the expense where it was in. We -- the property, the operating expenses that we are hitting since they're running through where those people are, which is in the management area, which is -- those leasing agents aren't at the property level such that they would hurt same store. The ground lease will, which we did have as a piece also. But in the overall -- on overall NOI for the company, yes, there will be an adjustment that would affect our cap rate. But most of those other people are sitting in our management arm and will affect same store. But certainly, we will look at those people and decide where we want to locate them for '19. But for right now, we're leaving them in the places they are. So we do have leeway that -- look at where they're performing and do we want to move some of those people into G&A. I think we have flexibility there. I do not think that the new rank is telling you where it needs to be located and where your people need to be classified.

Okay, great. It'll be interesting to see what other companies do with that. And then the second question just, I just wanted to ask about EQC reportedly selling 1735 Market Street. It sounds like that could be maybe the biggest single asset sale in the city. Just wanted to get your thoughts on that, and if you think there's any read-throughs from how that turns out to maybe values in Philly?

Well, they do have it on the market and it'll be interest to see what the pricing comes in at and who the bid list is. I mean, certainly, we were continuing to see almost on a weekly basis more investors expressing interest in Philadelphia, which is something we've really hoped for a number of years. So the expansion of the targeted investor list and who are valuating high-quality assets in Philadelphia we think is a very good thing for the -- for our inventory base and certainly our hope is that EQC does very well what they're trying to do as well. So I think that dynamic and the motivation is moving in Philadelphia's favor. The read-through will be a function of kind of who buys and what they're looking for. I mean, the property is pretty well stabilized. I think it's got some -- a minor amount of leasing to do. But I think, certainly, we've always viewed that as part of the trophy class in the city and so the valuation range that comes in at should have some level of read-through to some of our existing portfolio, at least the Commerce Square buildings on Market Street.

Our next question will be from Daniel Ismail with Green Street Advisors.

Appreciate the color on the Austin-NoVa swap, but can you guys give us your current thoughts on where disposition starts to make more sense into being recycled into stock buybacks versus recycled into the portfolio?

Yes, great question. And look, share buybacks are always on our radar screen and management and the board review that. We still haven't authorized buyback plan in effect and we could certainly expand that as well. I think from -- when we look at the deployment of capital, I think as we evaluate the Northern Virginia-Austin swap, we felt that the growth potential and -- out of that portfolio, plus preserving some additional financial capacity to ensure that we could fund future developments, was primary in our mind. And as we were thinking through that, we took a look at current pricing levels, incremental $100 million of share buybacks will increase our earnings between $0.03 and $0.04 a share, but also increase our net debt-to-EBITDA by 2 turns. And from our estimate, only add about $0.16 per share in NAV. So we use that as kind of a guiding point on what we should be doing. But certainly, from the company's standpoint, share buybacks in this type of market pullback environment are always clearly on the radar screen.

Our next question will be from Mitch Germain with JMP Securities.

Jerry, if we're thinking about development starting next year, any specific market that comes to mind?

Well, I think we take a look at our near-term development starts. I mean, certainly, we're actively preleasing -- I'm sorry, premarketing, Mitch, 405 Colorado, Four Points and our last piece at Garza. Garza, we're completing the common area by the end of this year. Tremendous momentum with the site we sold to Trammell Crow Residential on the apartment side, the hotel's under construction. So we think that will be an incredibly sought-after site in 150,000 square-foot range. So in Austin, we think that the higher probability starts would be either 405, the Garza or Four Points. We are, as I mentioned in the comments, with the approvals at Broadmoor in place, we are on a pell-mell pace to finalize the site planning for Phase 1, which will be an office building and probably a residential for rent project as well. So as that process unfolds over the next couple of months, the marketing on this one -- on those sides will ramp up dramatically. So Broadmoor could be in that next for start next year as well. Then up in the Northeast, we're very, very focused on wrapping up the design development for the 2 building at Phase I at Schuylkill Yards, 1 will be some office and residential, the other will be office and life science. And we're working with our development partners on those premarketing campaigns as well. And frankly, we're seeing a pretty good level of activity. I think we're very pleased that with some large tenants we're talking to as well as some smaller tenants that with the completion of the public park early next year, you may have seen the press release, I mean, Spark Therapeutics has leased the entire bulletin building from us and they'll be staging over the next 24 months. That renovation project kicks off by the early part of '19. We're really creating a dynamic platform to accelerate leasing activity at Schuylkill Yards. So I think that's one of the things that I think the entire company is very excited about, which is with these development opportunities, let's complete the design development, let's get the marketing pull together, let's -- certainly, in a capital-constrained market, let's just make sure we stay in touch with and build new equity financing relationships. So we are in a position to really move with alacrity as we see market demand being there.

And then you have about a 200 basis point drag on same-store numbers for next year, what -- is there anything specific that's driving the offset? I mean, I think you're forecasting 1% to 3%, it seems like a big kind of increase considering all those different items that are out of the portfolio. Is there anything specific I should be considering in terms of what's driving that increase?

Well, I think the increase it -- hasn't set to range we have despite that drag is really the properties that were added to the same store in Q3 of '18 now being same-store properties for all of calendar year '19. So FMC Tower at 1900 Market Street, 933 First Avenue and King of Prussia.

Our next question comes from Manny Korchman with Citi.

Thanks for the follow up. On the page in your sup, I guess it's page 8, the -- it's the walk forward from your Investor Day. It looks like your 2019 leverage is going to be higher than the 6x you guys were targeting or hinting in 2018. Is that a new target or is that a temporary phenomenon? And if so, what's causing that?

Yes, Manny, we expect to keep it low, but I do think that -- and I said in my remarks, I think that 6.0 to 6.3x is that we do plan on, as Jerry has outlined, starting a development but also spending time and money on the work at Schuylkill Yards and Broadmoor and to the extent we -- where that accelerates, that could cause we think our capital spend to go up and therefore net debt-to EBITDA go up, because those costs are going to come on the balance sheet with no corresponding income. So we wanted to leave a range there. Of course, if we end up having a partner come in on like the Schuylkill Yards and they pay down some of our basis that could have a -- benefit us, because we've incurred buying the land and already starting some of that infrastructure work. So we wanted to leave a range where it does take up. And I think it's temporary. I think as we look at spending money on those 2 multiphase sites, that's going to cause us to potentially going up and I guess, that is -- it is dependent on how the development spend comes and what kind of opportunities we see on those development sites?

And Manny, it's Gerald here. And again, the 2019 plan doesn't anticipate any asset sales either. So there's -- we could generate some additional liquidity. So really on the acquisition or disposition activity build into the plan that could also serve to keep that range at the lower end. I mean that 6.0 target is very important to us, but it was also important to be transparent at this point, indicating that there is that upward impact on leverage through the development process and that's the range that we think that frames out the best and the worst case. I mean, basically every $25 million of spend creates a 1/10 of a return for us. So it's -- but the target remains in that -- at that 6% level -- 6.0x level.

On that disposition point though, would that implying that you're going to be selling down lands or other noncore, nonincome-producing properties, because otherwise it doesn't help with leverage much?

No, Manny, just an outright sale. I think we do anticipate hopefully having some land sales coming up, keeping our targets to in that 3% to 4% rate. But then also it could be a combination of a sale and then a better acquisition opportunity that generates more revenue for us could also be a player in that as well.

And next question comes from Bill Crow with Raymond James.

We're all looking at a whole bucket-full of trends that are going on, right? Rework, densification, technology shifts. Many preferences, millennial workforce and scarcity of labor. And you put those all into the bucket and seems like new buildings are aging faster than ever before. And I guess, the question is twofold. How young can a building be today to be considered old? And what does that imply for CapEx as you think about annual inflation of the requirement to shift your buildings to today's preferences?

Bill, great question. Look, I think it depends to some degree on each building's physical plan. I mean, I think what we have found is that buildings with elongated clear stands, column-free floor plates, higher deck-to-deck to give it the potential to kind of create more into your daylight kind of really creates the opportunity to kind of reimagine the building. To give you a great example, we had a -- our 500 North Gulph Road property was a building concrete superstructure that was built in the '70s. We have kind of took that building back to superstructure, new mechanicals, new window lines, new lobby, new laboratories and taken what was a real underperformer in our portfolio and created such a great physical reimagination that we had the entire building leased at a 9-plus return before it was finished. So I think the trick in that algorithm is, can you get a good return on incremental investor capital to justify the investment? Or are you better off just selling the asset? I think we've been done over the years. Where we don't think we're going to get good rate of return, we'll simply sell the asset. 1676 that George walked through is another example. We think that when we evaluate the market window for that block of space, the positioning of that asset physically, it's physical configuration today, what we can do to present a whole different physical platform, we'll get a great mark-to-market and get a close to 20% return on incremental capital. So buildings vary by their design, and I think as we're looking at all the buildings could we either own or looking to build, we're hoping to create some timeless aspect to our new developments by creating a volume of space that to some degree becomes almost indifferent to how that tenant is actually going to use that space. That they've got the physical volume, the tight core, the window lines, the supporting mechanical systems that actual make that building have some durability as workplace appetites change.

Should we expect to see more asset shift from private ownership to public, given the requirements for capital?

Would you say the public ownership...

No, just deeper pockets, right? I mean, if your capital -- and you gave the example of what you had to do to retrofit one of your buildings, you didn't have to do that 10 or 15 years ago. The cost of ownership has gone up pretty dramatically, right? So it requires deeper pockets to be an office landlord today. Is that fair?

Well, I think, certainly, capital cost have gone up for sure. That is fair. Fortunately, in some market rental rates have gone up to provide the appropriate compensation for that. But if you take a look at our perspective, Bill, I mean, we've got our capital cost in that range of 10% to 15% and have a pretty good run rate on that. I mean, that's down because of the portfolio we have today. So either we need to spend, call it, $40 million versus $35 million in TIs. The -- if we're getting a good increase in rents either at -- both at point of entry, but also lengthening lease terms and good rent bumps, the math works well there. Look, there is -- to your broader question, there's a tremendous amount of private capital that is well-capitalized, looking for places to put their equity. The overall debt markets are still fairly favorable, particularly for existing assets. So I -- we view kind of it the capital driving office valuations remaining very positive, and you'll see public companies continue to invest capital where you think it's wanting assets and private companies using a much different leverage model coming in and getting a very high return on their invested capital through either development or repositioning assets as well.

I'm not showing any further questions at this time. I would now like to turn the call back over to Jerry Sweeney for any closing remarks.

Joa, thank you for your help, and thanks to all of you for participating in our call. We look forward to updating you on our business plan progress on our fourth quarter call early in 2019. Thanks very much.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program, and you may all disconnect. Everyone, have a great day.