Douglas Emmett Inc (DEI) 2008 Q3 法說會逐字稿

Welcome to Douglas Emmett's 2008 third 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 will now 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 that this call is being webcast live on our website and will be available for replay within the next 90 days and by phone for the next seven days. Our press release and supplemental package has been filed in Form 8-K with the SEC and both are also available on our website. 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, and 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 incorrect. As a result, our 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 current SEC filings, which can be accessed in the Investor Relations section of the Douglas Emmett website at www.douglasemmett.com. Please know that the market data [services] referenced in management's prepared remarks are CB Richard Ellis for the Honolulu and Los Angeles office markets, REIT for the Los Angeles office market, MTF Research for the Los Angeles multifamily market, and Property and Portfolio Research for Honolulu multifamily market. With that, I will turn the call over to Jordan Kaplan, President and CEO of Douglas Emmett.

Thanks, Mary. Hello everyone and thank you for joining us. I would like to begin with a short summary of the opportunities developing in our markets and the company's current operating position. Bill will then provide a more detailed account of our third quarter financial and operating results.

To state the obvious, the condition of our global economy and financial markets are dramatically different today from last quarter. Declines in consumer spending and tourism, constrained credit availability, slowing international trade, and the overall pessimistic business climate in our country will most definitely have an adverse effect on our business. While these substantial negative forces will not leave us unscathed, we believe that we are well positioned to resist the downward pressure.

The uncertainty and fear dominating our nation's financial landscape is a comfortable operating environment for Douglas Emmett. We feel that the greatest acquisition opportunities usually arise during these times and that strong real estate operating platforms are appropriately rewarded. For example, during the early to mid '90s, when capital for commercial real statement was also highly constrained, Douglas Emmett seized many extraordinary estate opportunities that today form the core of our portfolio. We believe that this new period of financial distress will once again provide us with opportunities to substantially enhance our portfolio at very attractive long term pricing.

As you may know, in recent months, we have been highly focused on raising an institutional closed end fund to increase our capital availability without putting too much stress on our balance sheet. The initial closing of Douglas Emmett Fund 10 was on October 7, and the six office properties that we acquired in March were contributed to the fund on October 29. The fund commenced with $300 million equity commitments which includes the company's $150 million commitment. The first closing is particularly gratifying since it occurred in October -- the capital markets' worst month in decades. As previously announced, the fund is expected to range in size from $509 million to $1 billion in equity commitments. We believe that we are on track to reach that goal. The fund will be focused on opportunities within our core markets using the same disciplined underwriting and leverage principles that have governed acquisitions at Douglas Emmett for more than 20 years. It will be the company's exclusive investment vehicle and will have an investment period of up to four years followed by a value creation period of up to ten years.

In addition to the capital available through the fund, our $370 million credit line was a further source of substantial liquidity. Our credit line had approximately $40 million outstanding as of October 31, and its maturity date can be extended to October 2011. We also have no term debt maturing until June 2012. Interest on all of our term debt is effectively fixed by swaps to an average rate of approximately 5.14%. Douglas Emmett's core business strategy is designed to both maximize the trends in an upcycle and to be resilient in a down cycle. We own many of the highest quality properties, concentrated in the strongest, most desirable submarkets in Los Angeles and Honolulu. We have a highly diversified tenant base of over 2,000 office leases, representing a broad mix of vibrant industries.

Tenant diversification provides us with a consistent lease expiration schedule during the next five years. Large size tenant expirations can be damaging in a soft market. Our smallest size tenant base is resilient to downsizing and has historically maintained high renewal rates. While we do have a few relatively large near-term expirations, generally they are with small tenants. For example, we have 448 leases averaging less than 4,000 square feet due to expire in 2009. Our submarket and diversification strategy has proven to be effective in prior downturns. At the bottom of the last cycle, rental rates within Douglas Emmett's submarkets were over 30% higher than the other Los Angeles submarkets. Occupancies within our portfolio also remained relatively high.

While history does not necessarily predict the future, there are reasons to suggest that this down cycle may be milder in our markets than previous market declines. Over the last 30 years, all prior market declines had been accompanied by two dominating factors -- a significant amount of new supply and the collapse of an industry with a major presence in the Los Angeles office market. In the early '90s, the aerospace industry contracted following the end of the Cold War. In the early 2000 we had the dot com bust. Conditions today are very different. Almost no new office supply was delivered in our submarkets during the last several years, nor is there any significant amount of new space coming online in the foreseeable future. While the contraction of the nation's financial industry will have modest impact on tenant demand in our markets, unlike New York or Charlotte, we do not have large financial tenants that are drastically downsizing. Los Angeles continues to maintain its diverse economic base including the growing entertainment industry, a robust healthcare sector a strong university system, and international trade in the developing Asian markets. The recent housing declines in California, which are concentrated in the outlying portions of the county and the related unemployment from the construction industry, have a very marginal impact on office demand in the submarkets where we operate.

This is a time when the expertise and experience of our operating management group and leasing team is most evident. I should note that as a result of M&A activity in recent years, there are not many real estate companies with integrated operating platforms left in our market. We feel having one of the few remaining seasoned management groups will provide us with a tremendous competitive advantage in running our portfolio and in buying properties within our core markets. Now I'd like to turn the call over to Bill Kamer, who will provide specific details on our third quarter operating results. Bill?

Thank you, Jordan. For the third quarter, the company reported FFO of $51.1 million or $0.33 per diluted share, an increase of 9.6% compared to the third quarter of 2007. For the third quarter the company's AFFO was $36.8 million, an increase of 30.8% compared to the third quarter of 2007. Year-to-date the Company reported FFO of $156.1 million or $1 per diluted share, an increase of 10.1% compared to the same period in 2007. Year-to-date, the Company's AFFO was $110.9 million, an increase of 26% compared to the same period in 2007.

Our same property results for the third quarter continued to be strong. Same property net operating income increased 4% on a GAAP basis and 9.2% on a cash basis. Same property total revenues increased 2.4% on a GAAP basis and 5.5% on a cash basis. Breaking out the office and multi-family portfolio, same property office revenues increased 3.1% on a GAAP basis and 5.6% on a cash basis. Same property multi-family revenues decreased 1.8% on a GAAP basis and increased 4.4% on a cash basis. As we discussed last quarter, the GAAP decrease is due to a decline of approximately $1 million in FAS 141 income. This decline resulted from the second quarter expiration of approximately half of the multi-family FAS 141 amortization that commenced at the time of our IPO. FAS 141 multi-family income should total slightly less than $900,000 in the fourth quarter.

Moving away from same property statistics, total revenues for our entire portfolio increased 15.7% to $153.2 million in the third quarter 2008 compared to the third quarter 2007. Office rental revenues increased 19.2% year-over-year to $112.8 million in the third quarter. Office parking and other income was 21% year-over-year in the third quarter as a result of higher rates and validation. Our total FAS 141 income for the third quarter was approximately $10.6 million.

On the expense side, for the three months ending September 30, office operating expenses increased 17.1% compared to the third quarter of 2007. Multi-family operating expenses for the third quarter were $4.2 million and G&A in the third quarter totaled $5.2 million. Interest expense in the third quarter of 2008 increased to $52.6 million from $41.5 million in the third quarter of 2007. The increase is primarily explained by the new loan that we obtained in 2008. In addition, the non-cash amortization of our preIPO swaps totaled $5.6 million in the third quarter compared to $3.4 million in the third quarter of 2007. We expect that we will continue to have significant volatility in our quarterly swap amortization interest expense until preIPO swaps are amortized to zero. If the preIPO swaps are amortized on a straight line basis, the amount would be approximately $4.6 million per quarter going forward.

Recurring office capital expenditures average $0.32 per square foot year to date and $0.12 per square foot for the third quarter. Recurring multi-family capital expenditures average $293 per unit year to date and $101 per unit for the third quarter ended September 30. We are still estimating that annual recurring capital expenditures for office portfolio in 2008 will approach $0.50 per square foot. However, we now estimate that annual recurring capital expenditures for multi-family portfolio in 2008 will be less than $500 per unit versus the previously estimated $600 per unit.

Now I'd like to turn to our debt position. The Company has followed a focused debt financing strategy for many years. We have avoided securitized loans, preferring instead to develop and maintain ongoing relationships with lenders in the bank and insurance companies syndicated market. The Company typically obtains nonrecourse loans and LIBOR floating interest rates which we fix with swaps. Our loans provide considerable financing flexibility and generally we may prepay our loans with little or no additional cost and without the fees and maintenance. We do not have any ongoing financial covenants in our loan documents. We do not have any corporate level debt, and thus do not have the covenants and other restrictions that typically accompany corporate debt.

In August, we obtained a nonrecourse five year secured term loan in the amount of $365 million to replace the bridge loan we obtained when we acquired the six office property back in March. The term loan bears interest at a floating rate equal to LIBOR plus 165 basis points. Interest rate swap contract effectively fixed the rate at 5.15% in the first four years. Our financing request was substantially oversubscribed at this favorable pricing by nine different lenders, including a few lenders with whom we have not done business previously. Clearly, the financing market has tightened considerably in the past month. However, we continue to maintain excellent relationships with our lenders, which positions us well for future financing. As previously announced, we have transferred $365 million loan to the fund in connection with our recent property contribution. To reiterate Jordan's earlier remarks, none of the company's term loan debt matures until 2012 and the interest rate on that debt is fixed by interest rate swaps at an average rate of approximately 5.14%. The Company's only other loan obligations are a $370 million secured revolving credit facility whose maturity can be extended by the company until October 30, 2011, and an $18 million secured acquisition loan whose maturity can be extended by the company until March 1, 2011.

Turning to the operational side. Within the 10 submarkets where Douglas Emmett office properties are located, the percent leased declined sequentially by approximately 30 basis points to 91.3%. Rents within the ten submarkets where office properties are located increased 1.6% from the second quarter. During the third quarter, we entered into approximately 115 new and renewal office lease transactions totaling approximately 514,800 square feet of office space, up from 396,000 square feet in the second quarter of 2008. Our office portfolio was 94% leased at September 30, down 80 basis points sequentially, and was 93.3% occupied, down 50 basis points sequentially.

Our multi-family portfolio was 99.6% leased at September 30, which was up 40 basis points sequentially and up 30 basis points year-over-year. Our office tenant improvements, leasing commissions, and other capitalized leasing costs during the third quarter totaled $14.30 per square foot, compared to $13.66 per square foot for the second quarter of 2008 and compared to $19.05 in the third quarter of 2007. Our mark-to-market and rent rollup metrics have declined, but remain at healthy levels. On a mark-to-market basis, the spread between our in place cash rents and our asking starting rent is 28.8%, down from 27.7% in the second quarter, and down from 37.2% at the end of the third quarter of 2007. 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 third quarter 2008 was 37.5%, down from 43.4% in the second quarter and down from 53.1% in the third quarter of 2007. On a cash basis, the ending cash rent from expiring leases compared to the beginning cash rent from new leases signed for the same space decreased to 20.1%, down from 26.8% in the second quarter and down from 29.7% in the third quarter of 2007.

Before I conclude with an update on 2008 guidance, I would like to address an issue that has received some recent scrutiny in the REIT industry -- margin stock. As many of you know, the executive officers at Douglas Emmett own a significant portion of its stock. None of the Douglas Emmett stock owned by our executives is margined or pledged to securities for loan.

Now turning to guidance. We are providing a fourth quarter guidance range of between $0.32 and $0.34. As a result our full year 2008 FFO guidance range has been raised to between $1.32 and $1.34 per diluted share. The previous 2008 FFO guidance range was $1.30 to $1.32 per diluted share. This guidance excludes any impact from future acquisitions, dispositions, additional equity purchases, debt financing, recapitalization or similar matters. With that, I will turn the call over to the operator so that we may take your questions.

Thank you, Mr. Kamer. (OPERATOR INSTRUCTIONS) Our first question comes from the Anthony Paolone with JPMorgan. Go ahead, please.

Thank you. Can you talk about your sequential occupancy declines in Santa Monica and Beverly Hills in the quarter and what may have driven that?

Sure, Tony. This is Bill. The main driver in the occupancy decline really in the portfolio but would happen to be in Santa Monica was that we had a long scheduled move out of a 62,000 square foot tenant in Santa Monica. We backfilled 22,000 feet of that and the remaining 40,000 feet which we just got back in September -- we are now remarketing that. We're taking one of the floors and we are building out what we call spec suites and some other companies call as-built suites, which is a product that is very attractive in Santa Monica. The other floor, we are actively marking for a full floor tenant. So this is part of the trend that we've been moving the portfolio in, particularly in the submarkets like Santa Monica of moving from relatively larger tenants to smaller tenants. From a timing standpoint, we wind up with the 40,000 feet that were not leased as of the end of the quarter. So that was -- that accounts for the entirety of the decline in Santa Monica as a big portion of the overall portion of the overall decline. Beverly Hills -- handful of smaller tenants where we happen to have a lot of roll in the quarter, and we are in the process of backfilling that as well.

Okay. Can you talk about what Health Net's intentions are -- they have part of their lease coming due this year?

It's 50,000 feet of the overall space that comes due at the end of the year. They've decided they are going to consolidate that space -- that need in some other space that they have not in our portfolio. The 50,000 foot lease will not be renewed. As we've been saying for some time, we've been expecting to see some increase in vacancy in the Warner Center market over the next several quarters in that we have some relatively larger -- for us, relatively larger lease expirations coming up in the next couple of quarters, and I think we would reiterate that we would expect to see some increase in vacancy there in the next couple of quarters.

Okay. And then finally, with respect to the fund, can you talk about how conversations have gone with prospective investors in say the last few weeks or months or maybe how they've changed either with respect to the hurdle rates or the view of putting money towards more or less a blind pool at this point?

Let's see. This is Jordan. Generally it's hard to raise money, and continues to be hard. I don't know -- it was so hard before that I don't know if I can tell it's any harder now, but it's hard. We've always dealt with investors that were used to going into a fund, and so if we are talking to them, they must have some interest in the fund. But it is true that many of them are saying to us, well, I'm coming into the fund, but maybe I have more money I want to put into LA -- there be an opportunity to do a joint venture?

One of the things while we're on the road trying to raise money for the fund that's relatively apparent is for large investors that want to just generally have money in the United States, there's -- if they have focused on having money in Los Angeles, there are not a lot of ways to get equity into the better markets in Los Angeles other than through us. There's not a lot of access points. So we can have a little better success than let's say most do just because -- we don't have a lot of competition in terms of being a good gateway into the best markets in west LA and have an operating platform set up, et cetera. Which helps us to encourage them to come into the fund at first and then if they are too large for the fund, that means it's VJV, then maybe they would have an opportunity to do that. In terms of hurdle rates, I don't think for the last 20 years we've been doing this. There hasn't been pressure on hurdle rates to raise them. I don't sense that the pressure is any greater now than it has been in the past.

Okay. Thank you.

Thank you. Our next question comes from Ian Weissman from Merrill Lynch. Go ahead please.

Good afternoon. Can you talk a little bit about the product that you are seeing that might be suited for the fund right now?

It's some of the stuff that we saw trade or not even a trade in '07 and earlier that people are trying to get back out of that traded more on a portfolio basis. There's also individual buildings that traded in '05 and '06 where the people need to get their equity out for something else that is going on. There's also situations where people are looking for some liquidity and this is still a market where you can get liquidity out of your building, maybe some other markets they have no buyers at all. As a result of what is driving the sales, we are seeing some pretty nice buildings come up. Nice, down the center line Douglas Emmett classic high-rise office buildings.

Where would you say pricing has come from the beginning of the year to now?

We don't have very many data points. From the beginning of the year, that from a different point. Most people have been asking from the high point in the middle of '07, early '07. From the beginning of the year to now, I'd say -- I would say what I've been saying in the past. Frankly I think in '08 prices are just -- they went down, and the only reason that people still feel like they are declining is that there weren't any trades and therefore you didn't put the pen in the board to see that the pin was already down there because there were no transactions happening. There were deals that came in the market in early '08 and they failed. They were failed bids. They didn't sell. So where do you mark that? Because then they come back again in six months or eight months and maybe they sell now, but they are probably selling now for the price they would have sold for then.

You bought the Arden portfolio in the beginning of the year. Did you take a haircut putting it into the fund?

No. We told you before. That was an extraordinary deal which we we're telling the fund investors we won't be able to duplicate. The deal with the Arden portfolio going into the fund, which we described earlier, was that the fund got all the income from the Arden portfolio, and we got 8% on our, only on our net invested equity, which is exactly how it worked when it was contributed in. In fact, if you offset those two, there wasn't a very extraordinary difference. We did tell you guys that that deal generated a lot of income and when we contributed into the fund that we would feel the loss in the REIT, which we [aren't] going to.

Okay. And finally last question. You have about 40% of your roll next quarter in Warner Center Woodland Hills, which is one of your weaker markets. Can you talk about the leasing dynamics in the market -- what is the opportunity to lease that space? Is that where you are going to see a pickup in the vacancy and what are rents doing there?

As I've said earlier and we said this previously, we do expect to see a pick up in vacancy over the next few quarters. There's no doubt that the market overall has been declining. It's been addressed in his opening remarks, and it is coinciding with expirations of a few for us -- small by national standard, and by New York landlord standards, but large for us ten expirations that are coming up next several quarters. So we do expect to see a tick up in vacancy in the next few quarters. In terms of rents overall, rents overall in our markets have declined somewhat from the peak period at the end of '07 which had that huge run up which 30% run up in the LA submarkets, which we always felt and said on prior calls we thought it was unsustainable. There's no question there has been a correction there going along with the market softness conditions. We think that rents now are stable, but that's not to say that on a selected basis on deals as they come up in markets to renew tenants in markets that have some softness that we wouldn't have to meet those markets on those deals to get those deals done.

No specific comments on Warner Center Woodland Hills in terms of the weakness in that market and what you expect?

Other than what we've said, which is the last -- let me put this in a historic content. We've been given a forward look at what we saw softness in that market for a few quarters coming up, getting everybody used to the idea that we thought would see some of that. What has happened so far is last quarter in our portfolio, our occupancies increased in that market and this quarter, second quarter even though we had some overall declines particularly as I addressed earlier -- in Santa Monica and Warner Center Woodland Hills has been pretty flat. It's the quarters coming up, next couple of quarters where we expect the thing that we've been discussing that will start to be reflected in our numbers.

And we still have good activity there.

On a gross basis, we are certainly filling up and as we -- hitting a lot of singles and doubles and the activity is good.

Okay. Thank you.

Thank you. Our next question comes from John Guinee with Stifel Nicolaus. Go ahead, please.

John Guinee, how are you?

Hi John.

Nicely done. As you know, when you're refitting these spaces it goes anywhere from paint and carpet to guiding down the studs and starting again. What are you dealing with on these major rollovers? Is it paint and carpet or gut to the studs?

On the major, when we say major, we are not talking about eight contiguous floors -- like in Santa Monica as I mentioned we had three floors that came back from First Fed's move out and we leased one floor there on expansion. There is higher level of TIs involved there than you would for a smaller tenant. One floor as I mentioned we are building out smaller spec suites, which are great small product again for the reason you are saying. Our whole focus is on having the portfolio continue to evolve in even more so into a smaller tenant market and one of the big advantages of that is to keep your capital costs low and have a standardized product. So we are, on those buildings, and those large leases we would expect to see larger TI packages than we do in the smaller ones. Overall we've said since the third quarter of '07, so a full year now, there's been variations quarter to quarter in our capitalized leasing cost, and there were some declines in some prior quarters and we said don't believe it, they're sort of aberrational -- and that what we've seen overall is a pretty level situation where TI costs have been pretty steady overall. Obviously larger tenants, larger TI packages.

Thank you.

Thank you. Our next question comes from Michael Knott with Green Street Advisors. Go ahead please.

Hey guys. A quick question on the fund. What would be the timeframe that we should think about in terms of either seeing additional closings or getting more clarity whether you would be closer to $500 million or $1 billion?

At this point what happens is we have structurally within the fund, we have nine months. I'm hopeful that we do it quicker than that and we have some good activity that gives some reason to that hopefulness. Now with that said and the economy we are in, it could take the whole nine months. It would be reasonable to expect it to take the whole nine months. In terms of closing, as people commit, they sign subscription documents. We can do an even up with them at that point or we can wait until a later time. Really all that is meaningful going forward is that even a process because people can just keep signing up as time rolls on their own schedule now. I don't know that -- there might be some odd stuff going on that would cause us to want to do this but I don't know why we would have another even up until January. But maybe we will. It depends on how things work out.

But I'm optimistic, and I still feel like we'll get to the mid-point of the $750 million. The reason why we have the range of $500 million to $1 billion is in the market we are in today, which quite frankly we had a very strong fund machine. We have done nine funds before this, and we were very good at raising the money and getting a place, and we sidelined ourselves when we didn't like what was going on with the market, combined with the fact that we went public, and getting back into it now and seeing, the economy that we are in, I think I misestimated how tough it was going to be to raise the funds and it taking longer than I expected. But with that said, I still expect us to be successful. I'm still hoping and believe that will get somewhere in the mid-point but there's a reasonable -- may be reasonable to also feel that we could -- could be as low as $500 million. We still have a shot of getting up to $1 billion.

You said before the fees are going to be 125 basis points on the equity. Did you experience any diminution there or is that still -- ?

Well, a couple of things. We haven't finished -- some other big guy can come in and negotiate. Things can always change. That has always been the case and we've been very good at holding on to the fees that we thought were fair, which tend to be at the low end of the market to begin with as we already told you guys. We don't make a lot of income on the fees. There's not an acquisition fee. There's not a disposition fee. It's just 1.25% management fee on equity. But essentially the deal that I described, maybe it was two calls ago, in all aspects of that deal it was exactly the way that the fund had its first closing. I'm happy to answer the questions, any questions you guys have about the fund. But going forward, until we really just close the fund, we are going to try not to get ourselves in a position where every quarter, unless we tell you things are close, we are with a company with a big thermometer where every we ask quarter how much did you raise this quarter, how much did you raise this month? I want to just go about the business of finishing up the fund. Of course we'll tell you guys about acquisitions or any type of capital transactions that happen related to the fund, but I want to go about the business of finishing raising the fund and let you know where it ends up. But my estimate today is that we make it to the mid-point and I hope that we make it above $500 million and we would cut it off ourselves at $1 billion.

And can you just comment on the strength of your legal tenant base? Some of the other peers in the group had some problems with some legal tenants. Can you just comment on that portion of your tenancy?

That's the other side, another aspect of the small tenant focus. Pretty much the law firm -- and we have, from our industry diversification, legal industry is the highest industry concentration with a diversified portfolio -- but since the law firms are small, they don't -- we haven't seen really any negative impacts at all from that. We don't have the law firm size that is coupled with the type of business where you would see the major layoffs. That's generall true. We don't have -- one of the main ways in which our portfolio is resilient in a downturn is we don't have those large tenants where they do major downsizing of their office space. They tend to be rightsized through the down cycles.

Okay. Thank you.

Thank you. Our next question comes from Chris Haley with Wachovia. Go ahead please.

Good morning.

Hi Chris.

What color can you provide on the fund -- the commitments you receive, how many of those are repeat from the prior nine and how many are new?

I think there's a lot of repeat and a couple of new. The new ones are the ones that just take longer. We actually have a lot of good lead on some new guys and new investments that I think are like minded to us and will be good investors in the fund, but the process -- not only is the process slow, but with what's been going on in October and -- let's say periods earlier, but particularly in October, has even slowed it down more. Has slowed the slow process down even more, and a lot of our regular investors have done so much with us and been through so many funds with us that all the noise in October wasn't as hard on them and they are like, yes, we've known that you invested in markets like this and they are comfortable with us in these types of markets, so they were able to go forward and make commitments to move on. So whereas if you had another $100 million or $150 million or $200 million guy, they keep saying we are good to go. This is what we are going to do -- but then something like October hit, that we just had hit, and they are like -- we are still good to go, but now we are very distracted because we are figuring out what our exposure is in other sectors of our portfolio to whatever may be, the finance industry or dogcatchers or whatever because that is the latest thing that everybody is worried about. You get thrown off the game and you get refocused back on and we get close. So it's a slower process of new people, and many of the new people are larger.

You may have just scared the dogcatching industry. But what are the things that were -- we are appreciative of is keeping the eye on the ball, operating in an investment standpoint particularly for the local sharpshooter that you are. And one of the things that we are a little nervous of is depth of the personnel in your organization to continue to go down this fund path, recognizing that you will work with your advisors and also continue to record top decile operating and investment metrics. Can you give us a sense as to what you've been doing or what you might be planning on doing over the next 12 to 24 months regarding fund and external communications to these fund investors?

Well, in terms of communications to them, they get a quarterly report that's not dissimilar to the types of reports that you guys get on the REIT, including the activity, any capital transactions that happen and the other operating metrics of the fund. Are you saying you would be distracted by operations within a fund as opposed to keeping focused on reoperations and fund operations?

I guess that's a related question, but I want to understand how you feel your infrastructure is internally to handle additional funds whether they get done possibly next -- might be necessary at the corporate level.

Okay. That's easier to answer. In terms of the big structure to handle funds, we are in good shape there. Remember before we went public, we were operating nine funds, but let me just tell you structurally how it works. The only area where we have segregation is in accounting, which each fund has a separate accounting team because many investors have separate needs and questions, et cetera. But other than that the properties are operated on a geographical or regional basis. So if you for instance -- we own a lot of property in Santa Monica in the REIT, and maybe the fund owns properties in Santa Monica. The people, the portfolio manager, the managers there, the leasing guys, they are all rewarded and focused on Santa Monica. They don't differentiate between one fund building versus rebuildings. So to them we just added a building. As a matter of fact, they don't really see it because of the way the signature box works.

So the place where you mean -- certainly we have a management structure that is scalable and as we buy buildings it scales up and maybe we have a portfolio management, divisional, et cetera, but that whole structure is already in place. The only place where a separate group has to be developed each time is accounting group of two or three people for each fund for accounting for the fund and preparing the fund reports, which is really a completely different task because of the way the accounting has to work. And then the reports we prepare for you guys even though it contains a lot of the same information, those reports are just the way accounting requires -- they reported it a different basis.

Thank you. My last question has to do with the organic expense levels year-over-year or decrease in multi-family expenses. One is anything extraordinary in there or therefore looking towards 2009, what would be a reasonable assumption to use for organic expense growth?

Well, we are working right now, we intend to give 2009 guidance in the next call. We are working now through our budgeting process. It's premature to give you a lot of visibility on what the 2009 expenses look like. I think the short answer is in the multi-family side as you know it's a small part of our overall portfolio. So smaller absolute moves create a percentage impact than you see on the office side, but I don't think that there's anything extraordinary in terms of what's going on in the ground in terms of expenses. I think it's timing, how different accrual type things work. I wouldn't view the event of a decline as significant. I think if you look over both of the years we've operated and put them together and average the two and look at it as a baseline to grow forward, you are in the ballpark.

Thank you.

Thank you. Our next question comes from Michael Bilerman with Citi.

Hi. Erwin Gossman is on the phone with me as well. Are any of the $150 million that you raise from third parties contingent on getting up to $500 million of total equity?

No.

And so if everything shuts down, you just keep the fund as is 50/50 and these investors will be rewarded when you sell these assets down the road?

Are you trying to jinx me?

I want to make sure -- ?

That is correct.

Worst case scenario, you own these assets you like them whether you bought them 100% or 50%, you enjoy the return, so share the net.

That's correct.

And then looking at the $150 million that you raised, can you talk a little bit about the size of maybe the largest or the couple larger commitments in there and the totality of number of investors?

I don't want to get -- I mean, exact details -- I don't want to get into the details of the investors. I want to finish raising the fund as I said, and then I'll be happy to give you a good description of what is going on out there, but I will say it's around 12 to 15 investors, something like that.

What was the largest commitment?

I am not going to get into that. We were the largest commitment.

I'm thinking more so about the third party.

Let's wait and see how it plays out.

Okay. On the income statement, Bill, there was -- what's the other income expense that was negative this quarter? I don't know if there was a charge or something in there that was written off?

There was a charge off there as you know when we bought that little Honolulu Club property in Hawaii, within like two months later, we wound up leasing the building to a third party health club -- or leasing part of the building to a third party health club operator and transferred the assets of the health club over to them and there was a chargeoff in connection with that.

And what was the size of that? Of the charge off?

I don't have that handy. It's under $100,000.

Just a clarification. On the lease expiration schedule on page 20, the expirations that you show, is that reflective of the leases that you've already renewed in terms of the footnotes or that is the stuff that you haven't been able to renew yet? Or release yet?

It reflects -- it's the current situation as of September 30. To the extent we already renewed leases they are not on the schedule.

They are not on the schedule any more.

That is reflected in the footnotes on that page which talks about what the original amounts were and gives you an idea of what was already renewed.

I was looking at fourth quarter 2008. The total went down by 10,000 square feet but your -- you renewed 125,000 more square feet. I was wondering what happened sequentially.

Well, the renewals in the quarter are not necessarily, it could be for future periods. So the activity in the third quarter, renewal activity, their lease expirations covered multiple quarters.

I'm thinking your 4Q expiration last quarter was $396 million in the fourth quarter, and as of June 30th, you had renewed $126 million. In today's disclosure you have 380,000 square feet scheduled to expire in the fourth quarter, but as of September 30 you had been -- ?

In the renewal there is some short-term extensions.

That happened in the third quarter?

Right. The two numbers don't tie.

So about 100,000 square feet that you push 3Q to 4Q?

I think so. Yes.

Michael, just thinking about your question while you were asking it, what you were worried about is we have one large investor and a bunch of little ones -- that is not the case at all. It's a mix of -- not dissimilarly-sized investors.

And then just returning back to that, is -- did any of those investors say, look we recognize the environment. Let's put in $15 million to $25 million, whatever it is and then come in '09 we may tee up for another $25 million or $50 million? Or do you view the guys who came in they are in and done?

It's hard to know. I mean, like one of the things that happens in this kind of environment is people start out at a higher number and then they get frustrated with their own process. I'm going look, I can approve such and such. Maybe the started out at -- I am making this up. The guy started out at $70 million and he said look, I can improve myself $40 million because I've had it with this [process]. That thing is happening now so it slows the whole thing down. What happens next year does he decide I am going to go back and get my rest -- who knows. But one little side thing here is we definitely have plenty of people that have done the work, are doing the work and saying -- but it has to be an '09 deal for us. It can't be an '08 deal, so we can't sign a subscription til '09. That wouldn't necessarily be something that is already invested.

Interested in buying back any of your stock at all?

It's quite interesting to be in a blackout during the wildest time I have ever seen the stock market in action over October which I guess is the case for most everybody in the REIT industry or most everybody where we can't trade in our stock. In terms of specifically for the company, it's the same thing. There are great deals out there. [VEN] is buying the stock. And that's a great deal, and you have to look at the two as alternatives. The only one negative that goes along with buying the stock is it has a double impact towards stressing your balance sheet at a time where liquidity and having the strong liquidity that we have acts as a good support for the company and the stock price for investors that are already in your stock. I don't know. It's something that takes a lot of thinking, and which we haven't had an opportunity to do since this all happened until I don't know five days after this call or something.

You were saying moreso personally you would be buying the stock rather than the company?

It was aggravating that -- look what happened in the stock price. I don't want to get into this. Let's move on.

All right. Thanks.

Thank you. Our next question comes from Rich Anderson with BMO Capital Markets.

Thanks and good morning. I guess I'm a little confused. The Arden portfolio is $610 million and you have $300 million of equity, I guess with leverage it makes sense, but how did you get compensated for bringing those assets in? How did the REIT get compensated?

Well, what happens was when we started raising the fund, the fund investors are obviously concerned -- one of the biggest concerns of funds investor is cherry picking. They want to know that any deals you do with presumably are good deals -- they are not going to get like you are going to get the good deals and put them in the REIT, and the mediocre deals go in the fund. You have to set a date where you say everything I buy after this date I commit to putting it in the fund. We had hoped to have an earlier closing -- we had set that date. I can't remember if it was March 1st or something. And frankly the date was set because this transaction was helpful in raising the fund, and so we said okay we'll put this in the fund. So the main way that we were compensated for giving a particular good deal to the fund is that allows us to even have the fund. But in terms of the hard economics which I mentioned earlier, basically the deal that was made was on our invested net equity. We made an 8% return fixed, no more no less, and they get all income that was generated by -- we bought the portfolio into an LLC so all we did was transfer the LLC interest over to the fund at the time we -- it was October 29. So we got, when we transferred it in, we got our equity and 8% on it and then they get all the properties and the operations from the properties -- which I've said netted to be pretty close.

I understood. I remember that. With this fund created as it has or at least started with the contribution a couple of days ago, was that contemplated in the previous guidance that you issued in the second quarter? The timing was a little bit off?

The timing -- as Jordan said, we thought it was a little bit earlier and it winds up because Jordan was mentioning before, because the acquisition is strong and accretive. By pushing it along and closing it a little bit later we wind up with some more FFO, a little bit stronger numbers in the REIT.

That's what I was going to say. A little bit later that is why your guidance went up by $0.02?

No. That's a factor. The other factors which we mentioned as well is we had some lower expenses than we were -- one we are conservative. Two we wound up with expenses coming in lower than we anticipated earlier. There are multiple factors, but the delay in the REIT contribution is one of them.

Okay. Jordan, did you happen to see the article in the Journal today on LA?

No. I was practicing.

Read it and they will us what you think about the title being the Worse Is Yet To Come -- it's the title of the article. I assume you will disagree or maybe you won't. I don't know. And last question is Jordan, you sound like you are sounding opportunistic about some things that are out there for you well capitalized organizations -- what is worrying you today? What is the sort of stuff that worries you besides your stock price I guess?

Well, my stock price I want to be strong for my investors on the stock, but it's not something beyond doing a great job of running the company that I have much control over. The things influencing it at the moment don't feel like things that we have much control over. I'm -- I guess in one sense we are watching the global economy and waiting to see if there's some -- going to be some extraordinary impact on our tenants, on the underlying economics of our buildings that we haven't figured in or something that we are not used to because I mean remember the team has been through a number of these, two really significant ones -- the dot com one I mentioned in early 2000 and the one in early '90s. So we feel like we have some way to predict where things are headed and what happens to the portfolio when we get into this. So that's one thing I'm worried about is I mean are we calling it right in terms of the way the tenants are going to react and let's say the default that we are going to have and what's going to happen with rents, et cetera, and vacancy. That's one thing.

The other thing is I don't want -- at the time when the broad consensus of people agree that we've hit the bottom, then the bottom is so far behind us you can't even see it in the rearview mirror. And I don't want to miss some of the opportunities that are coming up soon because we are trying to be so accurate to hit it to the right date or the right month or the right minute or whatever the case may be. So we are working very hard to do all the work we can to understand where the numbers are without a lot of transactions, where we think they can go to, what we think is coming up so that we don't miss those opportunities. So those are the two main fronts concerning or that we are working hard to be particularly good at where it's easy to make a mistake.

Great. Thank you.

Thank you. Our next question comes from Jamie Feldman with UBS. Go ahead.

Thank you very much. I was wondering if we can focus on the fundamentals. Can you talk a little bit about what sectors are driving demand right now in your markets and showing what you're doing, who you're with? It seems through third quarter earnings, a lot of companies have been talking about a real slowdown.

Again because we don't have either a particular big industry focus or particularly large tenants, we don't really see that. One of the points that Jordan mentioned earlier, which is the general business pessimism. That is a pervasive thing that obviously accelerated in October and the trend which we discussed last quarter of tenants being just across the board, being more conservative about their extension commitments for space, in term -- we have seen pull back in term -- shorter term extensions, some -- we have had some lowering of expansions. I think in second quarter we had about 30% of our renewals had an expansion component. This past quarter that number dropped to like 15% to 20%. Frankly I was impressed but there were that many in the current climate that had current expansion components, but it was definitely a drop from what we had seen in the prior quarter. It seems to be that a general pessimism or conservatism across the board and somewhat of a slowdown but we are not seeing any particular impact in one area that is really driving things.

Okay. Have you had any discussions with AIG about the SunAmerican space?

Well, the SunAmerica space or center -- the tenant there is SunAmerica Life Insurance Company. They merged with AIG, so the- operation out there is life company and retirement operations, and that lease goes out to 2013. So that situation seems pretty stable for the foreseeable future.

But to answer the question, the answer is no.

But you -- there's no reason at this point?

You are worried about them initiating a conversation or us?

No. Given AIG's status if that has even come up?

No. We are still feeling good about that lease.

Okay. And then in terms of how the competition is acting, are people increasing TIs aggressively or are they dropping rents aggressively? How is the market behaving?

We are starting to see skittishness from our co-landlords and that will add to the noise and how hard it is to run the portfolio well through this period. But I'll tell you that negative in my opinion is more than offset by maybe the landlords that aren't comfortable operating in this environment, which causes them to sell. That just creates a better opportunity on the other side. Creates a little noise for us for a couple of quarters, but creates an opportunity to get a well priced long term purchase, and that is certainly worth it.

Okay. And then I'll take my one fund question. Have you laid out what the restrictions are in redemptions? I know it's early and shouldn't happen for a long time, but just in case.

Well, this is a closed end fund so there's not really redemptions. The way the fund works is we have a four year acquisition period and then we have a ten year value creation period, and what we commit to them is without the investors voting to extend the fund, that we'll sell the properties before the end of ten years. But in particular what we would say to them is the best time to sell the properties -- it's a longer term hold time, but we'll sell the properties when we think is the best time to get the best long term IRR for you. In terms of their particular interest, under certain circumstances, they can trade their interest, but we don't have any obligations to create liquidity for them through activity within the fund.

Okay. All right. Thank you very much.

Thank you. Our next question comes from Mitch Germain with Banc of America.

The question has been answered. Thanks.

We have a final question -- follow-up question from Chris Haley. Go ahead, please.

Jordan, you started your comments referencing the higher diversification in LA, and then also less supply. So therefore that would lead me to believe that there is less downside and at the same time you are saying that there are investment opportunities that are much more appealing today. But the two starting points suggest that other investors also see more diversification, less supply. So I'm interested in your comment that more investment opportunities are coming to you. Fundamentally that doesn't appear to be the case. Is that driven by financial structures of how assets were held or placed in LA? Was LA more aggressive this time around than in the past?

Basically the reason I think opportunities are better is because -- I don't have if I've ever said so on these calls, but my view of the way real estate is valued is it's valued on two basic things. One is the supply demand metric of office space and tenants. So how much supply office space is there and how many tenants want that space. That gives you your rental space and the underlying economics of the building. So that's one metric. That metric I'm thinking will be very healthy, very good going on forward.

The other thing that helps set -- the other big factor in setting the value of the building -- is the supply demand metric associated with the amount of capital that wants to buy the building and the amounts of buildings that are for sale. So the supply building for sale versus the amount of capital that is to buy buildings. So if there's a lot of capital and not many buildings for sale, the price goes up. If there is not very much capital and people become easy about selling buildings, the price goes down.

The best environment for a company like us, an operating company, is good underlying economics and horrendous capital market economics, and that's what I think we are looking at today. So we feel like whereas in the early '90s where we did a lot of buying, and we had significantly more -- we had lost an the industry. That one was the contraction of the aerospace industry as a result of the end of the Cold War and at the same time you had a ton of new supply at the end of '90. From the early '80s through today, we essentially at least on the website doubled the amount of space office from 20 million to 44 million or something square feet. So we had all this office space. We had a pro forma absorbing as well as completely dislocated capital markets. So it was a little bit trickier pro forma and analysis that you are doing, whereas today we feel a lot more comfortable about where cash flow rents, what kind of hits we can take in terms of vacancy or potential vacancy in not only buildings that we own but buildings that we may be buying will be. And so that seems like an easier part of the metric to figure out value. And then the capital marks are so screwed up that we are seeing great value, great depressed pricing related to some still very good -- you are seeing it from our quarterly calls that our properties are a great proxy for the safe stuff that we are buying.

And yes. I think your note actually mentioned that you are seeing the decline, the occupancy decline, you are seeing the occupancy declines, that's right. If you look at everything that is going on, they are not horrendous and we are still releasing for above the rent the previous tenant was at. So we still have a lot of strong things going on and a lot of good industries that we are relying on as opposed to oh my God there is another aerospace guy that is leaving the market. So that's why we feel -- that is a long answer, but that's why we are feeling so good about being able to make accretive acquisitions at pricing that we like in these markets.

That's very helpful. Just to clarify, the [PD] received on the equity, is that on equity committed or equity invested?

It's on equity invested.

Okay. And then are you -- do you have the flexibility to buy sliver interest in assets and debt interest in the fund?

We have a lot of flexibility to do all sorts of things, but it would be very unlikely that we would do -- we have done both. We bought debt and foreclosed. We bought interest as a path of getting the entire project, but we don't do those things as stand-alone investments. So if you see us buying a piece of debt, you can assume we are doing to get the property or if we buy an interest in a deal, it is with the hopes of expanding to control the deal or give us control over the deal.

Okay. Great. Very helpful conference call. Thank you.

All right. Thanks.

Thank you. That concludes our question-and-answer session for today. I would now turn the call back to Mr. Jordan Kaplan for any closing remarks. Mr. Kaplan?

Okay, thank you all for joining us. Frankly, we are looking forward to a less exciting next quarter, and we all look forward to speaking to you again. Thank you.