Douglas Emmett Inc (DEI) 2008 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to Douglas Emmett's 2008 second quarter earnings conference call. Today's call is being recorded. At this time all participants are in a listen-only mode. A question and answer session will follow management's prepared remarks. At that time instructions will be provided to queue up for questions.

I would now like to turn the conference over to Mary Jensen, Vice President of Investor Relations for Douglas Emmett. Please proceed.

Thank you. With us today are Mr. Jordan Kaplan, President and Chief Executive Officer; and Mr. Bill Kamer, Chief Financial Officer. Please note this call being webcast live on our website and is available for replay for the next 90 days and by phone for the next seven days. Our press release and supplemental package have been filed on Form 8K with the SEC and both are also available on our website at www.Douglas Emmett.com.

During the course of this call, management will be making forward-looking statements. We caution investors that any forward-looking statements are based on the beliefs of, assumptions made by, and information currently available to us. The actual outcome will be affected by known and unknown risks, trends, uncertainties, and factors that are beyond our control or ability to predict. Although we believe that our assumptions are reasonable, they are not guarantees of future performance, and some will inevitably prove to be in-correct. As a result or actual future results can be expected to differ from our expectations and those differences may be material. For a more detailed description of these risks, please refer to the company's press release and the current SEC filings which can be accessed in the Investor Relations section of the Douglas Emmett website. Please note that the market data sources that are referenced in management's prepared remarks are CB Richard Ellis for the Honolulu and Los Angeles office markets, [Freece] for the Los Angeles market and F. Research for the Los Angeles market and Property and Portfolio Research for Honolulu multi-family market.

With that I would now like to turn the call over to Jordan Kaplan, President, and CEO of Douglas Emmett. Jordan?

Thanks, Mary. Hello, everyone, and thank you for joining us. We are pleased with our second quarter and six-month operating results. The national economies, substantial negative headwinds blowing from the East have not left us unscathed, but generally our portfolio is performing well due mostly to the strong supply demand leasing fundamentals of our submarkets and the strength of our operating platform. There are virtually no new supply coming on line in the foreseeable future in our submarkets, and modest amounts of new supply in the peripheral competitive areas. In fact, our portfolio experienced positive absorption during the second quarter of 2008. Our stock of smaller tenants that are well diversified across several vibrant industries provides a further buffer to the macroeconomic headwinds.

General speaking, our tenant businesses remain strong as evidenced by our low default rate during the second quarter and the fact that about 20% of our tenant renewals included additional expansion space. However, the national economy has had an impact on our markets. Asking rents have pulled back from the extraordinary rental increases of 2007. Tenants are seeking shorter lease terms, and it is taking longer to complete lease negotiations. The conservative posture we took regarding new acquisitions and our balance sheet during 2007 has put us in a good position to take advantage of acquisition opportunities in this more capital constrained environment, and we are very pleased with our 2008 acquisitions to date.

Notably during the second quarter we not only had positive absorption portfolio wide from a healthy combination of new and renewal leases, but our leasing team was able to produce 140 basis points of net positive absorption in the newly acquired office portfolio since our acquisition at the end of March. That recent acquisition is now 87.9% occupied and the capital rehab program for the new properties is well under way. We continue to expect that a number of large, attractive, acquisition opportunities will develop in our core submarkets. We are focused on increasing our capital availability, without putting too much stress on our balance sheet.

Much of my time during the second quarter was spent on raising money for the prospective closed end fund that we have discussed in recent months. The total equity in the fund including Douglas Emmett's contribution should be between $500 million and $1 billion, and we anticipate the closing will occur during the third quarter of this year. The recently acquired six property office portfolio will be contributed to the fund and the fund will become the primary acquisition vehicle for the REIT.

I would like to update you on the Los Angeles and Honolulu market statistics. During the second quarter, office asking rental rates within Los Angeles county increased 6.1% year-over-year, but dropped 1.7% sequentially. Honolulu county asking rents increased 5% year-over-year but dropped 68 basis points sequentially. Asking rental rates, within the 10 submarkets where our office properties are located, increased 6.9% year-over-year but dropped 4.5% sequentially. Office occupancy in Los Angeles county at June 30, 2008, was 90.2% compared to 90.8% at the end of the first quarter. Office occupancy in Honolulu county remained flat at the end of the second quarter at 91.8%. Within the 10 submarkets where Douglas Emmett's office properties are located, occupancies declined sequentially by approximately 80 basis points to 91.6%.

As I have mentioned in the past, these asking rent and occupancy declines are within the expected normal course of any real estate cycle. To date we haven't identified any one economic trigger that would significantly impact the health of our particular portfolio or our markets. This is the point in a real estate cycle when the expertise and experience of our operating management group and leasing team is most evident, and I am gratified by their performance to date. Our management team in general has worked together in these markets for more than 20 years through many real estate cycles. We will use our past experiences to guide us through this next cycle. It is my hope that as we have in the past we will turn this cyclical downturn into a growth opportunity for the Company as a whole.

Now I would like to turn the call over to Bill Kamer who will provide specific details on our second quarter operating results. Bill?

Thanks, Jordan. First of all, I should say that we have survived the shaky environment quite well. Of course by shaking I am referring to the earthquake that rolled through the Los Angeles area last Tuesday. Seriously, the 5.4 magnitude earthquake was the largest quake in Los Angeles since the north ridge earthquake that occurred in January 1994. We are happy to report that there was no damage to any of our properties, and that we're confident that the quality of our portfolio makes it resistant to future shocks be they seismic or economic.

I will now provide details on our quarterly, financial and operating results, and I will conclude with updated guidance for the year. For the second quarter, the Company reported FFO of $51.6 million or $0.33 per diluted share, compared to $48.7 million or $0.29 per diluted share for the second quarter of 2007. For the first half of 2008, the Company reported FFO of $105 million or $0.67 per diluted share, compared with $95.1 million or $0.57 per diluted share in the first first half of 2007.

As you may have noticed from the earnings package that was sent outlast night, we have begun to report same property operating results. Comparing the second quarter of 2008 to 2007, same property net operating income increased 6.1% on a GAAP basis and increased 11.5% on a cash basis. Same property office revenues increased 5.2% on a GAAP basis and 8% on a cash basis. Same property multi-family revenues decreased 2.4% on a GAAP basis and increased 3.6% on a cash basis. The GAAP decrease is explained by a decline of slightly less than $1 million in FAS 141 income for the second quarter of 2007. This decline resulted from the expiration during the second quarter of approximately one half of the multifamily FAS 141 amortization that commenced at the time of our IPO. Going forward, FAS 141 multi-family income should total slightly less than $900,000 per quarter for the remainder of 2008 gradually decreasing thereafter.

Moving away from same property statistics, total revenues for our entire portfolio increased 17.7% to $149.4 million in the second quarter of 2008 compared to $127 million in the second quarter of 2007. Office rental revenues increased 20.8% year-over-year to $132.4 million in the first quarter. Our total FAS 141 income for the second quarter of 2008 was approximately $11.5 million. On the expense side, for the three months ended June 30, 2008, office operating expenses increased 16.7% to $36.6 million compared to the second quarter of 2007. Multifamily operating expenses for the second quarter were $3.8 million, down 2.9% compared to the same period in 2007.

G&A in the second quarter of 2008 totaled $5.7 million which was 11.9% higher than the same period last year. We are maintaining our previous estimate that total G&A in 2008 will be between $23.5 million and $24.5 million. Interest expense in the second quarter of 2008 increased to $51.8 million from $38.3 million in the second quarter of 2007. This increase is partly attributable to the noncash amortization of our pre-IPO swaps, which totaled $5.5 million in the second quarter of 2008 as compared to $3 million in the second quarter of 2007 and $1.8 million in the first quarter of 2008. We expect that we will continue to have significant volatility in our quarterly swap amortization interest expense until the pre-IPO swaps are amortized to zero.

Recurring office capital expenditures averaged $0.20 per square foot for the first six months of the year and $0.13 per square foot for the second quarter. Recurring multifamily capital expenditures averaged $192 per unit for the first six months of the year and $100 for the unit for the second quarter. Due to the timing of CapEx projects within our portfolio, we are still estimating that annual recurring capital expenditures for our office portfolio in 2008 will approach $0.50 per square foot and that annual recurring capital expenditures for our multi-family portfolio in 2008 will approach $600 per unit.

Now I would like to turn to our debt position. At June 30th, we had an outstanding balance of $74 million under our $370 million secured revolving credit facility. We do not have any debt maturities through the end of 2009 excluding the bridge loan that we obtained in conjunction with the six property office portfolio acquisition at the end of March and our revolving credit facility, which matures on October 30, 2009, but has two one-year extension options that is we have the right to exercise. We are currently in the advanced stages of obtaining long-term financing to repay the bridge loan and anticipate that we will have further information to announce concerning this debt within the next few weeks.

On the operational side, we had positive absorption during the quarter. Excluding the six property office portfolio that we acquired at the end of March, our office portfolio was 95.5% leased and 94.5% occupied at June 30. On both counts up 20 basis points sequentially. Including the six property office portfolio that we acquired at the end of March, our office portfolio was 94% leased at June 30, up 20 basis points sequentially and 93.8% occupied, up 40% -- 40 basis points sequentially. Our multifamily portfolio was 99.2% leased at the end of the second quarter of 2008, down from 99.6% at March 31. We entered into approximately 114 new and renewal office lease transactions totaling approximately 396,000 square feet of office space.

Our office TIs leasing commissions and other capitalized leasing costs during the second quarter totaled $13.66 per square foot compared to $12.54 per square foot for the first quarter of 2008 and compared to $14.93 in the fourth quarter of 2007. In general our capitalized leasing costs have remained relatively flat since the third quarter of 2007. Our mark-to-market and rent rollup metrics remain at healthy levels. On a mark-to-market basis the spread between our in place cash rents and our asking starting rents was 27.7%, down from 33.9% at the end of the second quarter of 2007 and down from 32.4% at the end of the first quarter of 2008. On a straight line basis the average rent from expiring leases compared to the average rent from new leases signed for the same space in the second quarter of 2008 increased to 43.4%, up from 38.4% in the second quarter of 2007 and up from 38.2% in the first quarter of 2008. On a cash basis the ending cash rented from expiring leases compared to beginning cash rent from new leases signed for the same space increased to 26.8%, up from 16.5% in the second quarter of 2007 and up from 21.4% in the first quarter of 2008.

In conclusion, I would like to now turn to guidance. We are revising our 2008 2008 FFO guidance range to between $1.30 and $1.32 per diluted share. The previous FFO guidance range was $1.28 to $1.32 per diluted share. This assumes the first closing of the Company's closed end fund which is anticipated to occur during the third quarter and excludes any impact from future acquisitions, dispositions, additional equity purchases, debt financings, or recapitalizations. With that, I will now turn the call over to the operator so that we may take your questions.

(OPERATOR INSTRUCTIONS) From the line of Michael Bilerman with Citi. Please go ahead.

Irwin Guzman is on the phone with me as well. Jordan, you talked about how you spent most of the second quarter in planes going around looking for capital. Can you give us a little bit more color on some of those discussions and sort of what the appetite was and how you're sort of dealing with trying to raise capital in this sort of environment, specially given at least a lower initial yield you're going into some of these acquisitions?

I will answer the first part of the question first which is it is people are generally have some trepidation about investing. They're worried about the market continuing to go down. So it isn't easy to raise this type of money, so we are having a lot of discussions, and it hasn't been easy, but I still feel like we're going to be successful and we've had very many good discussions, so I think we're generally on track there.

In terms of the returns, when you say lower return environment, I am not sure lower return environment compared to what, it is a higher return environment compared to last year.

I am just saying from the perspective of trying to get people over the goal line in a core type product where they're being faced with going in on these assets and 4s, low 5s, a difficult financing environment and rent growth which is going the opposite way. I would assume it is a more difficult thing to raise that capital today.

I think it is generally hard. It is just generally hard to raise capital. Whatever your story. I agree with I guess like the premise of what you're staying which is that I talked to a lot of people that their ears just sort of shut down if I am not talking about distress this, distressed equity. People are really looking to invest in distressed situations right now which means they're chasing some very high returns. Our history is that we have not operated at that sort of higher risk, higher return end of the curve, so but we have still been able to produce pretty solid returns, and I am comfortable that we in what we're doing now and in the deals we're working on now we will continue to be able to produce the pretty good returns we have produced without having to take those what's called distressed or higher risk, make those higher risk bets.

I don't think unless someone is highly focused on the concept of only distressed deals, that hasn't really been much of a problem for us. I think more what we're facing is people that are -- that have found themselves as a result of what they call the "denominator effect" essentially in many cases over allocated or over committed, and so they're more saying to us at times when I am surprised that some some is not coming in, it is more because we're just tied all the way around and looking for ways to generate cash, not make more commitments right now because they've been so surprised by how quickly the market whip sawed around. You have a guy that's maybe investing in funds for many years and is used to a certain level put money out and money coming back with their various fund investors, fund managers, and now all of a sudden they're getting bad news and very little money being returned, and so it it has changed, has changed the way they look at things, and they've become concerned just like in any type market or tough market, people shift to a little more liquidity. It is human instinct, and I see that happening across the board. I still think we're -- our track record and our story is good enough we're going to succeed in raising this fund, and we would tell you guys if we thought this wasn't going to happen, but we're feeling pretty good about it.

How much are you thinking about raising in the first go around in the first closing?

We're in the middle of trying to get a bunch of people circled up, so I don't want to commit to anything, but I think we'll have a healthy first closing, but I also think we'll take months through the end of the year to really fill out the fund.

You will have enough capital in the first closing to take down the $600 million portfolio you purchased which would be about --

Yeah, yeah.

And then just a second question. You talked in your opening comments about your renewal activity and 20% was expansion. You said 20% of the tenants took expansion space.

Yeah. I mean, this is something Bill has been following for awhile, and we stuck it in here because we thought it was an interesting stat which is people focus a lot on the new and renewal mix a lot of times, and I think it is because in your model you're driving sort of the TI levels. But within renewals, it is interesting to see, you can look at what's happening with people, are they shrinking or expanding. And he followed that staff for awhile, and I was just surprised that in this market which, look, we're we've got the dose of pessimism that we all, everybody has, and I was just surprised to see that still we were 20% of these people renewing were actually taking additional space.

Just for perspective, how had that been trending and your 20% represents 200,000 square feet of renewals, you're saying it was 180 or 160,000 and they took an extra 40?

I don't want to get into that fine line on it.

I am trying to understand what the 20% means.

The 20% is a snapshot in the most recent month that we have some data, and that the full month that we closed the month of June, and in terms of historical -- from an historical basis, it is roughly in line with what we've seen. There have been higher months and lower months over the last year or, so but it is roughly in line. The point of it really was, in trying to get a handle on early indicators of the health -- the underline health of our tenants businesses, it is one measure, that there is still a pulse, business that is are still expanding, and another is the default rate which we alluded to which trended particularly low in this last quarter, well below our trend line. We're anticipating over future quarters it will revert more to the mean which as you recall we discuss this had previously, we've been running for the past eight quarters or so about 25,000 feet of tenant defaults quarter to quarter, and so we were down like at 7,000 this past quarter. I think it is going to revert more higher quarters coming up that will get us back more in line with that long-term trend.

Another metric, which we don't like quoting quarter to quarter because it is a volatile number, when you look at a snapshot which is our tenant retention rate, that was particularly high this past quarter. Again, I don't like talking about the individual numbers, because it is an expectation that we'll bounce around, but what is a little bit better way of looking at it is over the past eight quarters we've averaged definitely averaged in the trend of between 70, 75% retention which is the long-term trend we've talked about, and that trend is continuing on as well, so we feel that the mix of businesses that we have here remain strong on the tenant side, obviously there is some sectors fairing better or worse than others.

I think what you're seeing is we're probably -- we're as or more nervous than you guys, and we're looking for ways to see kind of leading indicators of where things are going with our actual tenant population, and Bill has been working through trying to follow some of these finer things to see if they prove out to be good indicators, and throw of some of them out to you. I think the question before is when we say 20%, is it 20% of tenants or 20% of square footage.

All right. Thank you.

Thank you, sir. Our next question comes from the line of Chris Haley with Wachovia, please go ahead.

Good job on the research side, we have an opening for you.

Thanks, Chris. Happy to work for you.

We're looking at some of the same stats. Any indicators, so actually I would be interested in what you guys are thinking over the next six months, twelve months, on the leasing side? What deal levers term rent capital are you more likely to pull today than where you were six months ago?

You mean where do we see things backing up more?

In terms of the deal, the four or five-deal --

Beyond rent?

If you wanted to use rents, too, that's fine.

Rents is where, it is rental rate flattening rental rates is where you see it the most. We made some gains in this last round, the market is still very strong, but in the last round of sort of tenant fear that they weren't going to get their space, I think we made some gains in terms of the other let's say a little more subjective terms you're talking about, and I don't think -- I think most of for our Company and it varies, and one point you're making which is a very good point, is these other terms can actually dramatically impact a lease, but for our Company we tend to let rent sort of move, and we meet the market, and trying to stay well leased. We try and hold onto some of those other more little more -- I don't know, subjective is not the right term for it, but slightly less economic terms because they make a difference for long-term holders trying to build a good tenant population and get good control over your building.

A point that Ken has made with respect to those terms you're asking about, to us in the past is that because some of the other landlords in the market, maybe their shorter term landlords and trying to show higher face rates, they played a lot of games with some of these other terms. We saw in an extremely strong market we saw some of our co-owners introduce free rent, which is very odd because a lot of times you see free rented in a down market. You don't see it in an up market, and they were doing that because they wanted to show very high face rates, and that has had some interesting benefits because it is so confused the market with respect to rental rates that still I think it is hard particularly small tenants and even the tenant brokers to put their finger on exactly where rents are in any particular submarket or building for that matter, and and it is created confusion that might swing things as much as 50 so a guy can't get a handle on, $0.50 a foot a month, where a particular building or lease should be, and that's helpful to us. We have a wide range of very strong data, so we aren't confused about where things are at, but having confusion on the other side is useful.

I mentioned in my script part that we are seeing a little bit of shortening of terms and that's because I think tenant concern, I mean, there is an attitude more than anything there is an attitude shift in the tenants. It is the fear that we're all having about where the economy is headed, and that causes people to shorten things up, causes people to negotiate a little longer, be a little more nervous about where the rental rate they're signing onto is right or has the market shift and had they don't know it. That's all going on, and that's where you see it.

Is there any positive -- thank you for that. Any positive offset with a short term? Are you able to hold on your either contractual rent bump or a little higher initial rent?

That's a good point, Chris. As Jordan was saying, we tend to adjust rent rather than a lot of other terms. And we've even in the recent deals and even with the flattening of the market, we're generally holding on to the contractual rent bumps between 4% and 5% depending on the submarket and building that's held up pretty well as a result, so we're getting that. I mentioned in my prepared remarks that we're not at this point teg a pick up in TI packages, so generally coming back to your initial question, the driver we're seeing adjusting is on the face starting rent, not really on the other terms.

Thank you. Last question. Looked like although you hadn't provided specific details on the San Fernando assets, the lease up assets, looked like there was minor progress made. Can you give us more color on the year-to-date?

This is on the portfolio we thought, the six buildings.

This is on, say, Warner and Warner center, et cetera.

Well, the data that we did give in the Warner Center, Woodland Hills market we're 92% leased at the end of June, and we're on the both the older assets that we own in that which is everything other than the one building we just acquired as part of the six building portfolio, in all of those buildings we're up into the 90s there continuing to make progress. We have positive absorption in the Warner Center, Woodland Hills sub market in the second quarter. The newest acquisition we acquired I think 75% occupied at the end of March, we're in the process of turning that asset around. We made some physical changes to it. We're focusing our leasing and working on that and starting to see a little traction there and.

And Sherman Oaks? Thank you --

Sherman Oaks. We're about 93% lease and had that's been a market that has been for us pretty close to the full occupancy level that we've indicated that we see in our portfolio with the smaller tenant mix, and that market is continued along very strongly.

Great. Thank you.

Thank you. Our next question comes from the line of John Guinee with Stifel Nicolaus. Please go ahead.

Thank you. We usually don't get into this level of detail, and I realize that FFO per share is of limited value here given the amount of FAS 141 income that flows through every quarter, but having said that, it looks to me like you've got a hit, Bill, of about $0.32 a quarter for the third and fourth quarter of 2008, and you were at $0.35 for this quarter if you back out a couple of cents in noncash finance charges, so my question is how do you go from $0.35 to $0.32 a share in the third and fourth quarter?

Right. Your initial part of the question which is trying to avoid getting into that level of detail in this call and obviously we can follow up on detail later, but let me just try to answer your question in a general way. There are two things going on. One is there is some significant noncash income that we reported in Q1 that pushed that number up. One of the big drivers was the significant drop in our noncash swap amortization interest expense. We're down at a million eight versus the call the normal run rate of that 4.6 million a quarter. I hesitate to refer to that as a normal run rate because we're not likely to ever see that actual number because it just as I mentioned in my remarks it is a volatile number that balances quarter to quarter but just straight lining it it is about 4.6 million a quarter, so that pushed it up there. The second big driver and I think I will leave it there is the assumption that we're going to have initial fund closing in the third quarter which there is a lot of moving parts, but the general overview in terms of ongoing FFO is if it reduces down ownership from 100% to a smaller percentage in the fund structure, that reduces the ongoing FFO from those assets, and that's probably the most significant item in terms of impacting the particularly the fourth quarter.

Great. Thank you.

Our next question is from the line of Rich Anderson with BMO capital markets. Please go ahead.

Hello, everybody.

Hi, Rich.

Back on the fund if you could, -- your conversations with potential fund investors, does the conversation ever get to a point where they say, well, I know that this is sort of an open ended type of fund where you can do acquisitions, development, redevelopment, whatever, office, multi-family, do they ever ask you be an investor but could you sort of maybe consolidate the structure or what the fund can actually do? Is that happening in the negotiating process or are you going to stick with an open ended type of strategy?

Well, what we're say to them is the same thing we're saying to you which is the fund is going to execute the external growth strategy that we've been articulating for the REIT, and so as you guys know being analysts, we're probably one of the easiest company to say understand in terms of our strategy in our markets and where we are, and that's the same thing we're telling them we're going to do with the fund, and I have been asked by you guys, and we might get asked by them. Are you going to also start buying buildings in New York, and I always say, no, we're not. I mean, when they ask about our pipeline and what we expect the character and nature of the fund to be, we pretty much expect and we tell them it is going to follow the lines of the Company, and whatever we are, 85% office, 15% residential, a little less than 10% Hawaii, and 90% plus here. We expect the fund similar attributes, and it is along those lines that we are the most confident of our ability to perform.

Okay. Got it. Thank you. And then you're talking a lot about raising equity for the fund, but how is the process or talk about the challenges that might might face you guys when it comes to raising debt capital for the fund.

Hey, Rich, it is Bill. The experience we have probably is the best one to talk about is as I mentioned in my remarks we're close to completing our long-term financing on the re-fi of our bridge loan, so we're in the market with that, and I have to say we have been extremely pleased by the very enthusiastic response that we've had, the benefits in the current marketplace of the long-term lending relationships we have are really paying off plus we've been able to identify and I think we're going to be making some new relationships in this financing with some new lending sources. There seems to be a real stratification in the market right now, and our kind of product, our sponsorship, our leverage level, our asset level, oddly is actually really in demand right now, and because there is a flight to by the lenders to our kind of products, so we're very, very pleased with that, and from a --

I call that a flight to quality.

We're very pleased with that response, and I think it sets us up well for the debt financing we're anticipating doing for the fund.

Okay. Great. Maybe either one of you can respond to this question. If you were to hypothetically take the $200 million investment done by the fund or done 100% on your balance sheet, what would be the difference bottom line difference in terms of your earnings, the earnings power of that investment? I assume the fund with its fees and all the rest would generate more FFO for you, but can you quantify how much more the fund gets you from a pure FFO standpoint?

I think to directly answer your question I am not sure I can do that. To more globally answer your question, what the fund does for us is allow to us continue our acquisition program in a market where I think it is good to be making acquisitions without putting our balance sheet at risk or stressing our balance sheet. That's the primary objective. That's our primary objective for the fund. We want to continue to gain greater control in these markets we think are good, and we want to still be able to make the deals that we think are good, and acquisition that is we think are good, but we don't want to take on unnecessary risks and we have three choices. You can issue stock. You can do debt, or this, and debt puts our equity at risk. Issuing stock dilutes us, and we certainly don't want to do that, so this achieves our goals there and allows us to spread the capital that we have more widely, and --

A good way of looking at it, Rich, is in the short run when the fund is formed and the initial quarters, there is a very modest increase resulting from fees, and that's the way that's always been our philosophy which is we're very light on fees. We like to be well aligned with our fund investors, and our business strategy is to put the emphasis on the back end when we produce the results for our fund investors, and so that's what makes it hard to really talk about this and quantify it because I think what you see hopefully if we make all the right moves in terms of the acquisition and building value through our operating plat form is the returns really paying off down the road as we produce the results, and that's in addition to the diversification and helping out on the balance sheet. That's really where I think you see that impact. It is really long-term value creation.

Got it. Thanks for that. To the Arden occupancy up to 87.9%, is your target the market which I think was 94%, do you think you can get there and if so, what's your timeframe?

I think initially we initially looked at trying to get those assets up to let's say stabilized occupancy within either 18 or 24 months. I think we're really are ahead of where -- I mean, I was shocked. We've only had assets for three months. I was really pleasantly surprised by how quickly we got the ball rolling and got some positive absorption out of those because taking the assets over and getting our brokers in position and then getting deals working, you start cold, it is not like you have a stock of deals that transfer very easily to a new owner, and so these guys were really cooking to make that kind of progress for the first three months, and it is a good sign. I am now feeling very good that we're going to be our pro forma. Our pro formas are very conservative. I am used to beating our pro forma, but I was happy to see that.

Jordan, last time last call you said that you thought property values around town were down 10% or 15%, and that was giving way to some opportunities for you. Is that the same range today or has it deteriorated maybe even a little further since the first quarter comments?

I think I am real comfortable dropping the 10% and staying with the 15%.

Okay , and the last question, I guess I was a little surprised by the 4.5% sequential decline in office rents in your markets. What surprises you more, that sequential decline or the run up in rents you saw over the past few

Definitely the run up of rents. The run up for rent shocked me. We had 25% a year for two years. And for 20 years I didn't even have the guts to dream those kind of numbers. Forget about thinking they would really happen.

If you annualize 4.5%, you get pretty close to 20%, right?

A quarter?

Yeah.

I will tell you something. That statistic is based on obviously asking rents and what we saw I think to be fair built in certainly in the '07 year, not necessarily the '06 year, but in the '07 year we saw the asking rents which I described a little earlier was John that asked that question? What I described a little earlier was we had a hot market and then because of these big portfolio transfers into the hands of guys we're say were instantly sellers again in some sense, we had guys giving free rent to move the face and asking rates way up, right, so when you sell a building you only have pro forma huge numbers, so you try and sort of buy data points at that level, and I think we had super accelerated asking rents that may not have had the typical relationship to where people are truly signing economic deals going on in the previous years, and now I think that's adjusting its way back down, maybe some of these owners are more resigned to longer term hold which over the longer term it is not a good economic move to give a guy free rented, right, because you just increase your credit risk because you're sort of essentially lending the first months of rent, so you wouldn't do that if you thought you were going to own the building through term. And so we saw the 25%, certainly the second 25% wider than it maybe really was because of asking rents having their own inflation index going on, and now we see that contracting now a bit, that asking rent number contracting a bit, so maybe there is a lot of noise right now.

I see. Great. That's helpful. Thanks, guys.

Thank you, sir. Our next question comes from the line of Michael Knott with Green Street Advisors. Please go ahead.

Hey, guys.

Hi, Michael.

Question on the same store disclosure. Appreciate that by the way thank you very much. Why did the operating expenses go down year-over-year and is that at all related to prop 13 and can you give us an update on sort of how your operating expenses on the income statement, does that include sort of a noncash estimate on your part for the prop 13 resolution?

I would say the operating expenses went down. I don't think there is any particular driver that caused them to go down, didn't go down in a particularly large number. There is some probably some timing effects from one quarter to another. I don't think we viewed the trend in our expenses as down. I don't. I think they were pretty tightly controlling on them. I don't think we're seeing any increases. One thing that you might have expected to see but were not seeing at this point is any significant increase on our utility cost side in L.A. There hasn't been any -- we're not aware of any proposed utility increases by the two local utilities. There was increase in the year in Honolulu, but that is largely picked up by tenants and doesn't impact us, so I think really the answer is the numbers are pretty flat.

Okay. Can you update us on prop 13 around the IPO?

I think the prop 13 thing is largely if not entirely played out, and you know what, we were having to make estimates obviously and what I would call the first real year which is the '07 year, and there might be noise from that, but the noise is draining out real fast, and so fast that only in that comparison I think maybe it is still dusting things up a bit, but there is really not much -- there is really no story left on that one.

Can you just talk about the roll over schedule for the next twelve months? It looks like over half a million feet in.

Yeah. There is some larger for us, as you know we're a very small tenant size focused company with the average size of less than 6,000 feet. For us there is a couple of larger leases that are rolling in that time period and that we're going to be dealing with over that time period, so I think when you factor out a couple of big leases coming out the roll is pretty in which keeping with the size that far market, but we do have a few larger deals we have to address over the next couple of quarters quarters.

Feel okay about that roll over schedule as of now?

Excuse me?

You feel okay about the roll over in that particular submarket even though it seems like from the statistics we have seen on that market it is weakening. Do you have any comments on that and then also just confirm that you do feel okay about that particular roll over schedule?

The market as you said, that submarket occupancy is down somewhat. It is down I think in 86, 87% as of the end of the second quarter. It definitely has been some weakening in that mark market. It is among our submarkets a softer submarket, but the issue, we'll certainly play out the lease negotiations we have with on some of these larger tenants, we're optimistic, but in the current climate we'll know when we get through to the end of that and we'll see what happens, but we're at the moment we're addressing leasing issues out there. We did see as I noted earlier in Q2 we are in our portfolio had positive absorption in that submarket in Q2, you know, clearly our leasing team is putting a lot of focus on that submarket, and when the game gets played out, we'll let you know how the -- what the score was.

Michael, you're right, that that is getting a lot of our attention. All of our attention right now. We would rather have that kind of role in Santa Monica than out in Woodland Hills.

Last question and I will yield the floor. Sounds like you did not do any share buybacks this quarter.

Correct.

How are you viewing that capital allocation opportunity on sort of your menu of opportunities today?

Really no differently than we have the last six or quarters I mean the stock is an opportunity. Buying buildings is an opportunity, and we're still equally open to both.

Thank you.

Thank you, sir. Our next question comes from the line of Jamie Feldman with UBS. Please go ahead.

Thank you. First just a quick follow-up to Michael's question. Sounds like on these big roll overs you're not expecting vacancy, it is just a matter of pricing?

We could have vacancy. I guess pricing plays a huge role in everything we do in this business, but it could be vacancy. We're hoping it is not. We're certainly proactively working. As I said, we're very focused on that market. We realize that market is somewhere where we can out perform and under perform. We have both opportunities there. The other markets that we're in we are very healthfully leased, very full, with not a lot of role and small guys coming up there. We have vacancy. We have a lot of role. We have to do very well there to do well, and we have a chance to do poorly there and we'll do poorly. We're working hard on it.

Okay. The rent question. If you were to say net effective rents, how would you say those changed both sequentially and year-over-year?

The best stats would be to use the stats we've been reporting.

Yeah.

Like same space, same, you know, starting rents and same space average rents. Look at the way those percentages are moving. We give you three stats, and the one stat that goes to asking rents as we said, I think there is a lot of noise there, but if you look at the stats that sort of same space, they're not perfect because they just look at a quarter, but they're probably better to look at directionally than any other numbers I know of.

That's fair. I was looking at the top tenant list, so Health Net is number three on there now? Looks like they've got an expiration in 2008. Can you tell us a little about what's going on there?

We can't talk about individual tenants.

They're on the sedge schedule. It is one of the ones indicated there coming up this year in that marketplace, and we will -- we're in discussions.

Okay. They don't have a renewal option?

I don't know.

Okay. So that means you wouldn't update your thoughts on Metro City's mortgage either?

No. I don't want to get into individual tenant discussions.

Okay. That's fine. That's all I have. Thanks.

Thank you, sir. Our next question comes from the line of Mitch Germain with Banc of America Securities. Please go ahead.

Good afternoon, guys. I had to skip off for a second so I apologized if I missed it. Jordan, your thoughts on how much you are currently underwriting for investment science.

How much -- you mean what's our pipeline look like?

Yeah.

For investments?

Exactly.

It is pretty strong. We're feeling very good about it. I think there is I think our pipeline and maybe I said this earlier in a little different way but our pipeline really well reflects the demographics of our existing portfolio in terms of the markets where we see opportunities to make purchases, and the product types, you know, whether it be the markets, why, west L.A., valley, et cetera, and then product types office and residential, and that whole mix is holding true in our pipeline and our pipeline is looking very good.

Great. Thanks. All my other questions have been answered.

What was that?

Thanks. All my other questions were answered.

Okay. Thank you. Thanks a lot.

Thank you, sir. Our next question comes from the line of Dave Aubuchon with Robert W. Baird. Please go ahead.

Thank you. Jordan, your portfolio, your current portfolio right now is essentially full. When you think about investments for the fund you just talked about you're seeing a lot of opportunity out there, do you tend to gravitate towards more value add or core product at this point?

If I had my choice between two buildings, I would always take one that had more vacancy where you could pay less and you're just paying for the building and location. Our strategy historically has been to try to buy the best buildings in the best locations and, you know, not focus too much on the particular leases in place unless you have some big above market leases or some large leases where other people might pay more for that credit or that stability because we don't want to pay for that.

I don't know, you know, the difference between core value add, opportunity, I mean historically we have been successful at buying what I think a lot of people would and some have asked us would call kind of almost core type properties because the markets we're in and we buy the higher quality properties, but we've been able to give almost opportunity level returns in our past funds, and I think a lot of that is because we do a lot with respect to the properties operationally, and I mean we've yet to purchase a property where there wasn't some adjustments we made in terms of rehab and then where we reserved over time recharacterized the tenant base and pulled away from being dependent on one or two large tenants, so we're driven -- we're driven in that direction, but of course if someone wants to sell me a full building and cheaply and without me having to pay for the rent, I would be happy to buy that one, too. We're more market and good location and good basic bones focused.

And what you're seeing so far, are you seeing any difference in pricing between those various property types?

Oh, yeah. As a matter of fact, we're now seeing a difference, and I don't think there was much of a difference last year, and now there is a big difference. I mean, if you have a building that takes some real operational expertise, a lot of tenants, et cetera, you have a different stock of people that can even handle it. You need a pretty big and aggressive operating platform when you're dealing with these smaller tenants. You hear the numbers every quarter. We're doing 100 transactions plus a quarter, so a one off guy coming here to buy a building, just depending on more outsiders on everything he does. Third party leasing, third party management, and they're going to have their concerns about how those are going to perform for them, so I think it has given us a real edge that has come about just in this market. I mean, we will no edge last year because vacancy was almost worth more than having an occupied building when people were selling last year because people would pro forma their way into higher returns because there was vacancy there which is not the case any more.

And if you had to, if you had to quantify the difference in the pricing, what would you say is the --

Depends on the difference in the buildings. If the building is 10% vacancy, 15, 20, whether the building needs a lot of rehab or a little, but I do think you're paying for all those things now. You're paid for if a building real needs a rehab, then you get a discount for that. If a building has real vacancy and as a result lower cash flow, as a buyer you get paid for that. If there is lower rents in the building because of the way the financing world works, the building is worth less because guys can't put as large a loan on it and therefore the returns for the equity aren't going to be there, so those things have all come dramatically back into balance, and the other thing that's come back into balance is size. I mean, larger deals which almost anyone can bid on any large deal because they can get the financing to do it, larger deals now have fewer real bidders where the seller is confident the guy out the money is going to be able to close, and so having equity and track record and known ability to make and take over those larger deals as value which it does did not have last year.

Thanks, Jordan. Bill, one question for you. Did you talk about the FAS 141 guidance or any type of comment there for the full year?

Yeah, I did.

And can you repeat it? I am sorry.

I did previously. Do you have a specific or do you want to talk about it off line?

Just the total number you expect for 2008.

Oh, the total -- first half of year?

It is about $38 million to $40 million for the full year. Very good. Thank you.

Thank you. That does conclude our question and answer session for today. I would now like to turn the call back over to Mr. Jordan Kaplan for any closing remarks.

Well, I would like to thank you all for joining us today, and we look forward to our next quarter. See you then.

That does conclude our conference for today. Thank you for your participation and for using ACT teleconferencing. You may now disconnect.