Cousins Properties Inc (CUZ) 2003 Q3 法說會逐字稿

Good day, everyone, and welcome to the Cousins Property, Incorporated, conference call.

Today's conference is being recorded.

At this time, for opening remarks and introductions, I'd like to turn the conference over to the President and Chief Executive Officer, Mr. Thomas Bell.

Please go ahead, sir.

Thank you, good morning.

I'm Thomas Bell, president and CEO of Cousins.

With me today are Joel Murphy, who runs our retail division, and Tom Charlesworth, our Executive Vice President and Chief Financial Officer and Chief Investment Officer.

I'd like to welcome all of you to our third quarter conference call and, at this time, I'll turn the call over to Tom Charlesworth to review the third quarter financial results.

Tom?

Good morning and thank you for your interest in Cousins Properties.

First let me point out that certain matters we'll be discussing today are forward-looking statements within the meaning of the federal securities laws.

Actual results may differ materially from such statements.

Please refer to our filings with the Securities and Exchange Commission including our Form 8-K filed March 9, 2001, for a discussion of the factors which may cause such material differences.

I would also note that certain items we may refer to today are considered non-GAAP financial measures within the meaning of Regulation G as promulgated by the Securities and Exchange Commission.

For these items, comparable GAAP measures and related reconciliations may be found through the quarterly disclosures and supplemental SEC information links on the Investor Relations page of our website at www.cousinsproperties.com.

Let me start off with a brief discussion of the financial highlights for the quarter.

But first let me mention change caused by our preferred stock offering in July of 2003.

When we now speak about net income available and FFO, we are referring to net income available to common stockholders and funds from operations available to common stockholders.

Net income available per share increased 396% in the third quarter of 2003 as compared to the third quarter of 2002.

This increase in net income available per share is largely due to the sales of two retail centers -- Presidential Market Center and Perimeter Expo, which generated a combined gain, net of applicable income taxes, of $49.4m.

During the nine months ended September 30, 2003, we have sold four properties and generated combined GAAP gains, net of income taxes, of $93.4m and combined tax gains of $107.2m.

A schedule titled "Summary of Gains on Sales of Investment Property" is included as the last schedule in our quarterly information package and summarizes the sales price, the value created, and the related GAAP and tax gains for each of the property sales.

Note that the value created from the development of these four properties; that is, the net sales prices, in excess of the cost of the projects before any depreciation and straight-line rent receivable, exceeds $76m.

This being approximately 43% of the total un-depreciated property costs.

FFO per share decreased by 16% in the third quarter of 2003 as compared to the third quarter of 2002.

This decrease is primarily due to the loss of rental property revenues from the property sales and from tenants who effected early terminations of their leases in previous periods.

As mentioned earlier, in July 2003 we closed a public offering of 4 million shares of Series A cumulative redeemable preferred stock.

The net proceeds to the company from the offering were approximately $96.5m.

The proceeds were used to pay down the credit facility and for general corporate purposes.

In September 2003 the company declared and paid a special dividend to common stockholders of approximately $100.5m, or $2.07 per share.

The amount distributed is a portion of the tax gain incurred on the property sales we have made this year, and when combined with the applicable regular dividend distributions, should equal our REIT taxable income for the year.

As such, we should meet our REIT distribution requirements for the year and should not be subject to any REIT level income tax.

All of the special dividends, except approximately $14m is expected to be subject to the 15% federal capital gains and income tax rate.

The $14m portion is expected to be subject to the 25% federal recapture rate.

Adjusted debt-to-total-market capitalization was 32% at the end of the third quarter.

While recourse debt-to-total-market capitalization was only 1% at the end of the quarter.

Before I conclude the discussion of the highlights for the quarter, let me address the impact of Financial Accounting Standard Number 150, accounting for certain financial instruments with characteristics of both liabilities and equity.

FAS 150, among other things, requires companies to mark-to-market the book value of any minority interest and entities with finite lives.

The standard was issued in May of 2003; however, the applicability to minority interest was not determined until late September, leaving many companies scrambling to determine the impact on their financial statements.

We have concluded our assessment of the minority interests on our balance sheets and have determined that book value approximates fair market value at July 1, 2003, and at September 30, 2003, for the two affected minority interests.

Accordingly, the application of FAS 150 has not impacted our statements of income or FFO.

In addition, I would note that we have revised or will be revising the operating agreements of the two relevant entities so as to convert them from limited lives to indefinite lives.

As a result, we do not anticipate that we will have future adjustments to minority interests under FAS 150.

I should also note that the reason why the relevant minority interest book values approximated fair value at the beginning and end of the quarter is that we had marked up to fair value the book value of the largest of the two minority interests at the end of quarter 2 as a result of our Mira Mesa [sp] sale and the related distributions.

The other minority interest was not material.

Those are the highlights of the third quarter.

Now I'll discuss details of the third quarter's net income available and FFO, which you can follow beginning on page 2 of the Net Income and Funds from Operations Supplemental Detail and Reconciliation schedule.

Consolidated rental property revenues less rental property operating expenses decreased approximately $500,000 from the second quarter of 2003.

Some of the significant fluctuations by property are as follows: 333 North Point decreased by approximately $200,000 due to expiration of Altel's [sp] lease in May of 2003; 555 North Point and 333 John Carlyle [sp] decreased approximately $1.8m due to termination fees received in the second quarter of 2003 and the related loss of rents following the terminations; 101 Second Street increased by approximately $1.3m mainly because of a termination fee received in the third quarter;

Avenue of the Peninsula increased approximately $260,000, primarily due to legal fees incurred in the second quarter of 2003 with no corresponding amounts being incurred in the third quarter.

These fees related to the settlement of a lawsuit.

Discontinued operations reflects the results of Presidential Market Center and Perimeter Expo, the two retail centers sold in the third quarter.

Also reflected in the third quarter are some trailing operating costs from Mira Mesa, which was sold in the second quarter of 2003.

Residential land division results for the third quarter of 2003 increased by $2.3m over the second quarter of 2003, primarily as a result of sales of two tracts of land, one of which generated a gain of $1.9m.

The company's share of lot sales, net of cost of sales, increased by approximately $600,000 over the second quarter of 2003.

This is largely attributable to the increased lot sales at River's Call.

The company's share of lots sold in the third quarter was 93 as compared to 87 in the second quarter.

Compared to the third quarter of 2002, the company's share of residential lot sales, net of cost of sales, increased by approximately $1.3m.

The schedule titled "Inventory of Residential Lots Under Development" contained in the quarterly supplemental information shows two new residential developments -- Manatee River Plantation in Tampa, Florida, and McKinney Village Park in McKinney, Texas.

These will be developed by CL Realty, our joint venture with Lumbermens [sp] Investment Company, a subsidiary of Temple-Inland.

These two new developments are projected to yield approximately 1,000 lots.

The company's share of remaining lots to be sold for all residential lot development activity as shown on the Inventory of Residential Lots Under Development schedule, including lots and inventory and lots to be developed is about 4,900 lots.

Development income and leasing and other fees decreased from the second quarter of 2003, largely as a result of decreased leasing and development activity and from the recognition of a termination fee of $100,000 on a third-party development contract in the second quarter of 2003.

Management fees increased, in part, due to an increase in the management fee for 10 Peachtree Place.

Interest income and other for the third quarter decreased by $133,000 from the second quarter of 2003 largely due to the recording of the initial fair value of Athrogenics [sp] warrants in the second quarter of 2003.

This decrease was partially offset by recognizing an un-amortized discount in interest income resulting from prepayment of the 650 Mass Avenue note receivable, which was scheduled to mature in December of 2003, offset by interest income foregone due to the prepayment.

General and administrative expenses for the third quarter of 2003 decreased from the second quarter of 2003 primarily due to the reversal of a general accrual for legal expenses, which was made at the end of the second quarter.

The actual expenses were subsequently determined to be associated with the company's preferred stock offering and have now been charged against additional paid-in capital.

Consolidated interest expense decreased by approximately $1.8m from the second quarter of 2003, primarily due to an increase in capitalized interest on projects under construction and to the paydown of the credit facility with the proceeds received from the preferred stock offering and the 650 Mass Avenue note receivable prepayment.

The total other expenses decreased from the second quarter of 2003 largely due to a decrease in pre-development expense.

This decrease reflects capitalization and pre-development costs on projects that are deemed probable.

Prior to a project being considered probable, costs incurred while pursuing new development opportunities are expensed in accordance with GAAP.

Total share of joint venture FFO decreased by $354,000 in the third quarter of 2003 from the second quarter of 2003 primarily due to recognition of a full quarter's interest expense on the Emory [sp] Crawford Long Medical Office Tower mortgage note payable.

This note payable closed in May of 2003.

While on this section of the schedule, I would like to mention what is, in effect, change in the definition of FFO that occurred during this past quarter as it relates to impairment losses.

In September of 2003 the SEC shared with NAREIT its position that impairment losses should be excluded from FFO.

NAREIT had previously adopted the position that impairment losses, like gains and losses on sales of property, should be excluded from FFO.

NAREITs position was based on the premise that impairment write-downs are primarily the result of early recognition of losses on sales of property, and these are not includable in FFO.

The SEC has now disagreed with this position and is requiring companies to include impairment losses in FFO.

NAREIT has now issued new guidance acceding to this position.

In the first quarter of this year, Wildwood Associates contracted to sell previously depreciated property at a loss with the closing to occur in the second quarter.

As a result of this contract, Wildwood Associates and the company recognized an impairment loss in the first quarter.

Under then-current rules, we excluded this impairment loss from FFO.

Consistent with the new guidelines, we have, in effect, reclassified the 2003 quarter-one impairment loss so as to include it in FFO.

You can see this on line 2 of this page, the line entitled "Wildwood Associates Impairment Loss on Depreciable Property."

The $551,000 loss is reflected in the 2003 quarter-one column.

If we had contracted and sold the property within the same quarter, this loss would not have been an FFO.

Next, on page 5, our preferred stock dividends, of course, reflecting dividends that have accumulated from the date of the offering in July 2003 through September 2003.

That brings us to FFO available to common shareholders.

Below that are the reconciling items needed to derive net income available to common stockholders.

First is Gain on Sale of Depreciated Investment Properties Net -- Continuing Operations.

Most of this is the recognition of the CP venture, deferred gains discussed in the second quarter conference call.

Discontinued operations is shown on the next line and in the 2003 third quarter column reflects the gains on the sales of Presidential Market Center and Perimeter Expo.

Also included in this amount for the third quarter of 2003 is an additional gain from the second quarter sale of Mira Mesa.

This additional gain approximating $960,000 resulted from adjusting estimated reserves to cover anticipated expenses associated with the sale.

Because these gains relate to the sale of previously depreciated operating properties, they are excluded from FFO and are considered reconciling items in determining net income available to common stockholders.

Depreciation and amortization of real estate decreased in the third quarter of 2003 from the second quarter 2003 by approximately $600,000 -- about half of which relates to the sales of Presidential and Expo.

Depreciation ceases once a property is determined to be held for sale.

The remaining decrease is due to increases in previous periods that occurred as a result of writing off un-amortized tenant improvements and related costs associated with tenants who terminated their leases early offset by accelerating the write-off under the same costs associated with lease terminations in the current period.

That concludes my discussion of the details of the third quarter's net income available and FFO.

Before turning it over to Tom, I would like to make some general comments.

Recently there have been a number of developments in accounting and financial reporting that have caused many of us to scratch our heads.

The short list includes FAS 150 mentioned earlier, which mandates an expense charge for the increased value of a minority interest, while no credit or recognition is given to the much greater increase in value for the primary interest owned by the reporting company.

FAS 141, which requires leases in place at the time of an acquisition to be recorded at the fair market value with the difference between fair market value, book value being amortized into net income and FFO, is another example.

The SEC has used un-impairment mentioned above as yet another such matter.

The AICPA proposal on accounting for property, plant, and equipment cost capitalization would require exhaustive recordkeeping for asset components in an effort to improve depreciation, the great irony being that current reported depreciation, at least for most real estate, is of little value in determining true economic depreciation of the asset.

In the last decade we have sold many properties and, without doing an exact tally, I can say, in the vast majority of these cases, these properties sold for more than their un-depreciated cost.

Reported GAAP depreciation expense was not representative of what was really happening.

We all have been facing a difficult environment in the last several years, and much effort has gone into trying to improve accounting reporting, but results have been somewhat mixed.

It may be the right time to step back and reassess our overall approach.

In the interest of furthering a discussion on this subject, I would offer the following: Consistent with interest and fair value accounting and international accounting practices, let's consider fair value accounting for both sides of the balance sheet.

If real estate properties are mark-to-market, we would have meaningful information for the investment community; we could eliminate arbitrary depreciation and amortization expenses and methods for real estate and components of real estate; we would be consistent with fair value accounting for liabilities; and we may even consider whether the FFO concept is still needed.

Variations of fair value accounting for real estate assets are used in other countries and, indeed, by some funds in the U.S.

So there are certainly some workable examples out there.

It seems to me that some such structure would provide much more meaningful information to investors and others users of financial statements.

With that, I'll close my remarks and turn it over to Tom.

Thank you, Tom.

Looking back over the first three quarters of the year, I must say I feel pretty good about what the Cousins team has accomplished -- completed $260m of asset sales at very good prices; realizing book gains, as Tom said, in excess of $93m.

We raised $100m of attractively priced preferred equity, and we distributed $100m special dividend to our common shareholders.

Throughout the year we have seen solid performance from our retail properties and our lot sale activities, and we've held our own in the difficult office side of our business in terms of occupancy and leasing.

And perhaps, most importantly, we have positioned our land and retail divisions and, ultimately, our office division for solid future growth.

If the economy can get going at a respectable pace and begin creating some real jobs, we may yet enjoy the upside of a new business cycle initially with increased levels of retail and land activity and the stabilization of our office tenant base.

Ultimately, we will expect to see all three divisions creating significant value through the development process as the economy recovers.

There are at least some signs that real recovery may be in the offing -- consumer spending continues to be quite healthy and, for the most part, earnings reports are good, and we are seeing some indication that business spending is finally picking up.

As I've said before, I've been concerned about the widespread reluctance in my fellow CEO's to spend and hire, and while they continue to hold back somewhat, there seems to be some positive momentum on both of these fronts, and the CEO community seems to be slowly developing the view that the economy's growth prospects are improving.

We continue to hope, now with some supporting evidence, that the considerable monetary fiscal and exchange rate stimulus that has been applied to our economy will ultimately prevail to bring forth a real recovery.

This morning I'd like to spend a little time focusing on our land business.

We've been building up this business the last couple of years, both in terms of adding projects and adding some very talented people to our group.

Cousins Land Development business goes back over 40 years to the beginning of our company, and we see land development as a long-term core competency of our company.

We are exceedingly good at identifying promising land tracks, tying them up with minimal carry, structuring venture transactions, land planning for a whole variety of uses, and getting our projects entitled.

Our most productive efforts in recent years have been in North Point in northeast Atlanta, Wildwood, and northwest Atlanta in Pullman [sp] County to the west of Atlanta.

As we have discussed in prior calls, we have recently expanded this part of our business to our CL Realty venture with our partners Temple-Inland, and we have taken significant positions in residential lot development projects in Texas, Georgia, and Florida.

These are, of course, shown in our quarterly package on the schedule entitled, "Inventory of Residential Lots Under Development."

A very good recent example of our successes in the land business is the rezoning of our 216-acre tract at North Point on the west side of Georgia 400.

Last night we obtained approval of our new master plan for these 216 acres, and this is a very significant event for our company.

It means that as soon as the 30-day appeal period runs, we can begin to close on contracts for the sale of various parcels within this tract.

I would comment that although there are no guarantees, at this point we expect the 30-day appeal process to pass without incident and our zoning to become final.

The approved master plan calls for townhomes, apartments, senior living, office condos, office retail, live/work environments with ground-floor retail and office and second-floor townhouses, a traditional restaurant and traditional retail and community facilities such as a performing arts theater and amphitheater, a community center, and a university education center.

We currently have under contract for sale in the fourth quarter, 42 acres of this property with contract prices totaling about $8.2m.

We estimate that our profit margin will be between 65% and 75% on these sales.

Assuming the zoning appeal period lapses uneventfully and the buyers honor their obligations to close, we would expect these sales to occur in the fourth quarter of this year.

Our plans call for us to sell parts of this project to other developers, and currently we are negotiating other contracts for sale.

Although one or more of these additional contracts could close in the fourth quarter, we expect most of these closing to be in 2004, 2005, and beyond.

We expect the average selling price for the land to be between $150,000 and $350,000 per acre.

And, finally, I would note that we have been able to maintain the right to develop between 900,000 and 2 million square feet of commercial office space within the rezoned West Side project.

Of course, we would not pursue this office development until the office demand in the sub-market recovers.

Hopefully, this discussion gives you an idea of the importance of not only this project but of our land division's potential for ongoing contributions to our company.

The importance of the land division will also be demonstrated by the additional revenues in following years from the increased number of residential lot development projects now underway and by other land development activities.

And while I will not forecast residential lot sale profits, I can point out some important statistics.

If you look at our prior public reporting, you can see that our share of average total estimated lots developed or to be developed in our residential projects at the end of each year of the last five years was approximately 2,500 lots.

And as you can see from our current quarterly package, our company's share of estimated lots developed or to be developed is now almost 6,000 lots.

So that figure has more than doubled.

If you look at the remaining lots to be sold at the end of each of the last five years, you can see that the average was approximately 1,250 lots.

This compares to approximately 4,900 lots reported on our current quarterly package.

I must emphasize that these are not fully built-out lots in inventory.

These are total potential lots and, in some cases, even though we control the land, we have not yet taken the land down.

Indeed, as we have often said, we are careful incurring land and other costs, limiting our built-out inventory and investments in order to maintain as much flexibility as possible to deal with changing market conditions.

But, in any event, these total buildable lots represent a solid base of profit potential, which we expect to realize in coming years.

The average term of our residential land development is approximately 6 1/2 years.

In addition, we do see additional lot development projects in our Shadow pipeline and would expect to add a number of these over the coming quarters.

On the office side of the business, it's more of the same -- not much worse but not much better.

There is still high vacancy in our markets, there is still weakness in our tenant base, and there is still little or no job growth.

Obviously, an improving economy will help the situation but only over time.

Under these circumstances, I am extremely pleased that we have maintained our office occupancy above 90%, actually increasing it in the third quarter to 91% from 90% at the end of the second quarter.

On the office development front, we do not expect much activity in the near future.

While we do have several projects at various stages of pre-development, when these projects are launched will largely depend on the pace of the recovery.

As we have discussed before, Marant [sp] is the single biggest question mark in our office portfolio.

We have a 50% interest in their 362,000 square foot headquarters building in Atlanta.

Marant recently announced that they were looking at alternative space and were considering rejecting our lease, and they have now approached us seeking concessions from us on our lease.

We will attempt to work out a satisfactory arrangement with them while also actively pursuing other uses for the property with our partner.

As creative developers with strong development and leasing capabilities in Atlanta, we feel we are well positioned to maximize the value of this property, going forward.

Our retail business is looking very good at this point.

Our operating properties have been doing quite well with good traffic, tenant sales, and high occupancy.

New development opportunities are also looking very promising.

The Avenue West Cobb, which has just opened with 88% of the space being leased at opening.

Now, we've never had an Avenue project open at this high rate of the leasing level.

The sales reports from our retailers during this first month of operation have also been exceptionally strong across the board.

We were fortunate to exceed our going and rent projections and bring the project in on time and under budget.

It's a great tribute to our team, our retail team, and an indication of retailers' appetite for new stores in our Avenue projects.

Yesterday was a good day in another respect.

We commenced another Avenue project -- the Avenue Viera, and the Viera master plan community in Brevard County, Florida.

This will be a 415,000 square-foot Avenue project with potential for an adjacent power center.

We currently have commitments for about 50% of the avenue portion of this project, including signed leases and a theater pad sale for 38% of the total square footage of the Avenue segment.

We expect this to be another outstanding Avenue center with an opening currently scheduled for October 2004.

Our very talented retail team is also making great progress at deepening the Shadow pipeline with a good number of potential new retail projects now being worked on.

As we have said many times before, our primary goal is to maximize total shareholder return, over time.

We do this by creating value through the development process and real estate investments by actively managing our property portfolios, capturing or harvesting the value we have created through sales and other transactions at opportune times, and by actively managing our capital base.

During the first nine months of this year, we've been fortunate enough to have an opportunity to demonstrate all of the above and will continue to be proactive on all of these fronts.

I've already commented on development prospects in our various businesses concerning active management of our portfolio properties.

I can say that we continue to look over our portfolio, particularly the office portfolio, to determine if the property markets are offering sufficiently compelling prices to cause us to consider selling or otherwise capturing the value we have created.

As far as the capital base goes, we are in exceptionally strong financial position, as evidenced, for example, by our low adjusted debt-to-market cap of 32%.

We have sufficient financial resources to found our future development activities to the extent that we might generate excess funds from future sales or financing transactions, we have certainly demonstrated we are not afraid to turn the excess capital to our stockholders, an action that would tend to enhance shareholder value.

All in all, I believe we have excellent flexibility and are well positioned on all fronts to successfully execute our business strategy as the economy improves.

That concludes my remarks for the quarter.

Please ask any questions that you may have.

Thank you.

The question-and-answer session will be conducted electronically.

If you do wish to signal for a question, you may do so by pressing star 1 on your touchtone phone.

Once again, that is star 1 on your touchtone phone to signal for questions.

We will take questions as they come to signal and will take as many questions as time permits.

We will pause for a moment.

Our first question comes from Greg Whyte with Morgan Stanley.

Hi, good morning, guys, a couple of questions maybe for Tom Charlesworth first.

Tom, can you just reconcile a little bit -- when I look at the margins on the rental property, operating side, it looks as the expense as a percentage of revenues rose this quarter from a year ago, and I just wondered what caused that and whether it's merely a reflection of the portfolio composition?

Greg, I think what's going on has to do more with the volatility of termination fees.

I'm not sure you can get a whole lot of information out of comparing those two percentages right now.

I know we have had significant variability in termination fees from quarter-to-quarter, and that is continuing.

As we said, we had a termination fee this last quarter in San Francisco.

And if you -- not to be specific about it -- but if you were just to stand back for a second and take the termination fees out, what do you think is happening to the expense margin side just in general?

Well, you know, if you look at the numerator side of that equation on the expense side, I don't think we see cost issues at the property.

The issue is the revenue side, and we don't have that much rollover but certainly to the extent that we do have some leases coming online in a market that has lower market rents, we will have some increase in that ratio.

So there is some of that going on, too, as well as the termination fee.

Okay, secondly, the Texas office building in Austin -- has there been anymore lease up in that space?

Just slightly more than 52% lease there, Greg, today.

We have two other leases that we are in the late stages of negotiation.

You never know whether they're going to get signed until they get signed, but we're feeling pretty good about them, and we've found the traffic in Austin to be increasing.

I think that market, from a rate standpoint, has probably bottomed out.

Okay.

Tom, obviously, yesterday's announcement between B of A and Fleet -- I mean -- I'm sure you've given that some thought.

Can you comment a little bit about that, given the size of your exposure to B of A?

We don't expect, given the geographic diversity of the two companies, which have come together, we wouldn't expect that to have any impact, Greg.

And those leases that we have with our B of A partners, both in Atlanta and in Charlotte, are long-term leases, and I would expect those leases not to be affected by this transaction.

Okay.

On the Avenue concept, you did put a press release about the new Viera One, and you were fairly specific in your press release about having a number in the pipeline.

Without getting -- I'm sure you don't want to be too specific, but can you tell us what shall we expect?

I mean, is the pipeline going to ramp up until we get one a year opening?

Or could it be more rapid than that?

Well, I'll turn it over to Joel to talk about specifically, but I think, yeah, I think you can expect to see that increasing over the coming years.

The overall concept of lifestyle centers and, in particular, our Avenue demonstration of that concept, have really become more popular with retailers.

Isn't that right, Joel?

Yeah, it is.

Greg, it's Joel Murphy.

Hey, Joel.

How are you?

I'm good, how are you?

Good.

Yeah, I think the comment that we were making on West Cobb that we're pleased about is not only it's the highest percentage lease at opening, we also have really got people open, and all of our co-tenancies are satisfied, which means we're rent paying from day one, which is nice.

And so what it means is not only are we getting the people that are interested in it, we're getting their interest, and they want to be on the train when it starts to leave the station at the beginning as opposed to what we were doing when we started the Avenue concept, was trying to convince them about the concept.

So now the idea becomes trying to roll this thing out and, obviously, we could be very specific about the Avenue Viera, our first one in Florida, and our fifth one overall.

But we feel really good about our ability to move those out in other geographies, others that we're working on in Atlanta.

You know, we've always been a sunbelt kind of company, and that's where I think you would see the development.

But we're pleased about that.

Also in Viera, as Tom alluded to in his remarks, we have a ways to go in the Shadow pipeline, but there is an option parcel for an embedded power center opportunity in there, which speaks to the fact that in addition to the Avenue, we also want to be ramping up on the power center side of the business as well.

Okay.

Tom, can you give a little more color on the residential and the parcel lot sales, but can I just get you to be more specific?

If I'm reading this correctly, I mean, volumes have sort of doubled in the last couple of years?

I mean, are we going to continue to see an acceleration of that or have we got the inventory levels already up, and now it's just a question of executing?

Well, I think the answer is yes to both those questions.

I think that we'll probably see slight increases, over time, and it's very market-dependent, obviously.

And, yes, we do have to execute.

We are executing our projects and are well underway, are doing very well this year, running a little ahead of our internal plans.

We think this is a good business, and it's one of the areas where we feel comfortable with investment opportunities with good returns are available to us.

We've been operating now with our partner, Temple-Inland, for several years.

We've become very comfortable with our operating styles, and so we've begun to expand that business into Texas and Florida, and we might expand it into other markets in the future as long as we're comfortable with those markets.

You know, we look at household creation in Atlanta, for instance, was increasing even as job creation was going down, and we feel like focusing our residential development activities in growing markets where we have the deep market knowledge and good experience will work well for our shareholders as we move forward, and we just wanted to spend a little more time focusing on that so that we could give our investors to be better acquainted with this business.

Okay, just one last question, and then I'll yield the floor.

You alluded to the fact that the -- instead of disposition or acquisitions, depending on which side you're looking at the market, remains pretty robust.

Can you talk about -- has there been much of a shift in cap rates over the last, you know, three to six months?

I think it depends on the product type but, no, I don't think we've seen a real significant change in the last three months.

I think that's probably correct.

We closed -- we actually contracted and closed the retail center sales in the second and third quarters, and those were pretty heady prices.

From that point we haven't been that active in the market, but I think our sense is that those are still holding up fairly well.

Tom, you were actively being solicited on the office side.

Are you still sensing that, or has it pulled off a bit?

Well, we're still hearing a lot about our office portfolio, and we're looking at that portfolio very carefully right now.

Okay, thanks a lot, guys.

And our next question comes from David Shulman with Lehman Brothers.

Good morning, everybody.

First, could we get a little bit more color on Marant?

What you said is you said they've entered into discussions with you to get concessions.

Does that mean exiting maybe half the space and restriking the lease or something on that order?

Marant is not using all the space in the building now, David, and we don't expect that they'll have a need for all the space in the future.

And, of course, they're looking for a rent concession as the market has changed significantly from when they signed their lease.

So I can't predict what they will ultimately want to do, but I think they would like to get their lease rate more in line with market and on a lower volume of space.

Okay.

Are they utilizing their trading floor there?

Yes, they are.

They are, okay.

That's the specialized TI -- I think they put that in, right?

For the most part.

For the most part, okay.

Next question is on maybe for Joel.

In your release, you talked about the Shadow pipeline, and you mentioned something on the West Coast.

Now, I know you guys aren't going to get specific, but could you give us some rough area of what the geography on the West Coast you're looking at?

California.

I mean, Northern, Southern, you know, something?

I'm not trying to be cute, really.

We are actually -- we are looking at opportunities in Southern California.

There is one specifically in Northern California we're looking at that has moved along in a fairly significant way since last quarter.

In Northern California?

Yes, that's correct.

Okay, and that would be new for you then?

It would be new for us in retail, absolutely.

In retail, yes.

But as you know, David, as we talked about retail for us is new in the sense that it's geographically distant but not new in the sense of concept or contact.

It's the exact same people that deal with it in the home quarters of these retailers and typically the same real estate rep that does Southern California or the Southwest will also do Northern California.

Okay, and then let's go down to Southern California.

Can you update us what's going on at Avenue at the Peninsula?

Avenue of the Peninsula -- we are pleased with traffic and sales.

There are some really good sales numbers -- Gap, and the people that are kind of really important to us in that center like Gap and Ann Taylor, the Regal Cinema, Banana Republic, Pottery Barn, Williams Sonoma -- all have positive sales increases for the year and are reporting very good traffic.

The key thing we're trying to do now is we do have a new tenant, the Sharper Image, which is going to sign a lease, which is going to open in the end of November.

We have two new restaurant deals that have signed leases that we probably won't get open this year but may get open closer to the end of the year.

And the space that is not leased is the subject of a lot of discussion on really kind of two different options that we're looking at with retailers that would be new to the project of some type of significance, and those have a long way to go, but we're pleased with that of those options.

And we're also pleased with the fact that there is one particular retailer that we're dealing with for an expansion of their space to an adjacent thing -- so we're -- you know, Avenue of the Peninsula -- our goal, as we've always said, is to make it an operational success, and we feel we're on our way to that.

What is the current occupancy there right now?

Eighty-seven percent.

Eighty-seven percent, and are you okay with respect to co-tenancy with everybody there now?

Yeah, I think we are largely -- I'd have to check for sure -- I think we're largely, with the exception of two retailers, have all the co-tenancy satisfied -- ongoing and opening.

Okay, thank you very much.

Once again, that is star 1 on your touchtone phone to signal for questions.

Our next question will come from John Lutzius with Green Tree Advisers.

Good morning -- John Lutzius.

Just on Palos Verdes -- what's the remaining term of the Saks lease there, and does the Saks lease contain an operating commitment covenant?

Yes.

The operating covenant -- yes, Saks does have an operating covenant, which goes out for an initial amount, I believe, of 10 years from that.

In the primary term of the lease I know was at least 10, John.

It might have been 15.

Okay.

If you need specifics on that, just call Mark, and we'll give you the number -- whether it's 10 or 15.

Okay.

Tom Charlesworth, looking at your same-store calculation, am I seeing this right, that your calculation of same-store is really what we would call sequential comparisons rather than year-over-year?

Sequential, correct.

Do you do a year-over-year calculation?

We have not done it in this package.

Do you have one you can communicate?

We can certainly look at putting that into the package -- be happy to do so.

Yeah, the convention on same-store -- you know, it's good to get the sequential, I think that's a great add, but the convention really is the year-over-year.

We can certainly address that.

Okay.

Can you talk, in general, about your capital strategy this year where you've paid a special dividend of roughly $100m, and you've also raised preferred stock of a similar amount?

Is it the case that you did that because trying to do a 1031 on development deals is just something that is difficult to do?

Or was there other thinking involved?

Well, the first thinking that was involved was we really liked the rate on the preferred, and we felt, long term, that was a nice addition to our capital formation at a very good rate, and so we think we're going to like that, and we think you'll like it over the years.

The fact that we paid out a $100m dividend, we raised $100m, was sort of coincidental, though I do think that they have worked to our advantage.

Yeah, and, John, as far as exchanges go, as a developer who likes to create a lot of value, it's rather difficult to exchange into another property at retail and have the same potential to create value on that new property.

So exchanges are typically not going to be used that much by us, and we will sell when we have very attractive prices, and if we need the money, we have, and I think I pointed this out before, some mechanisms to retain the money, including a private letter ruling from the IRS, which basically would let us keep all of the funds except for about 20% to 30% of the income tax gain.

By and large, we're really -- other than unusual circumstances -- we're really not retail buyers of stabilized assets.

When we acquire, it's usually some, you know, significant strategic opportunity for us, or it's a redevelopment opportunity where we feel like we can bring significant value creation to the project.

And there's just not a tax structuring option to take sales proceeds and reinvest them in development in a 1031-type manner?

It's much more difficult to do.

Okay.

Can you talk briefly about two office markets -- the North Point Market and then also downtown San Francisco?

Just general conditions, rental rates, net absorption?

Both of those markets stink.

I think that's the economic term.

I'll start with North Point -- you know, North Point is a pretty amazing story.

I think in 2000 there was no space available in that sub-market.

I mean -- it was 98% leased.

Now I think it's about 70% leased, and we don't see it getting any worse.

In fact, I think there has been some absorption in North Point recently, but it's not getting better very fast, and rates are significantly, significantly decreased in that sub-market.

Now, this is by memory, so don't hold me to the exact numbers.

I think there's a little over 14 million square feet of space in the market -- some 7 million square feet of that space has been built since 1997.

So there's a lot of new space on the market.

It was, you know, thought of, I think, as our technology corridor, and so a lot of that space has gone vacant or is economically leased but not occupied.

So it's going to take quite a while for that market to recover, we think.

Can you give me just a rough sense of where the lease rates are?

John, in that particular sub-market, you're in the low teens on a net basis, and it is the lowest in the city at this point.

The best being probably Buckhead [sp] and even CBD.

So that's a fairly low net rent level.

San Francisco is also a very difficult market.

We have had pretty good success there in backfilling our two big holes -- Arthur Andersen and cable and wireless space.

We've not -- we've leased out most of the Andersen space.

We've not leased the cable and wireless space, although we do have some good opportunities there.

Our team has done a really good job of backfilling that space, but the rates are, you know, significantly down from where we were originally leasing space in those buildings.

I think it's fair to say, Tom, is it not, that the rates in San Francisco are in the low 30s now?

Yeah, high 20s to low 30s, depending upon what -- the particulars for the space at this point.

How worried are you about the recent sale of the Chevron Building there on Market Street?

You know, I think it's something like 12% occupied, some number like that.

It strikes me that's a property in the hands now of an opportunistic investor that is just going to offer very, very attractive rates to potential tenants, and it's a building that's a couple of blocks away from you.

Is that a big deal, not a big deal?

I don't think so.

We've not competed with the Chevron Building in the past.

You know, if -- it's probably unlikely that the same tenant would pick 55 or 101 that would go into Chevron.

I think that there will be a significant -- there would be a significant difference in pricing in those two properties and, of course, you know, the Chevron Building is 20 -- I can't remember exactly -- older, different floor plates.

So I'm not too concerned about that.

Did you folks bid on the Chevron Building?

No, we did not.

We looked at it and chose not to bid.

Okay, that's it for me.

Thank you.

Once again, as a final reminder to our audience, that is star 1 on your touchtone phone to signal for questions.

And we have no further questions standing by on our question roster.

I'd like to turn the conference back to our speaker for additional or closing comments.

Well, as always, we very much appreciate your interest and support.

We feel like we've had a pretty good nine months, and we're looking forward to the fourth quarter, and we'll be talking to you then.

Thanks so much.

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