Douglas Emmett Inc (DEI) 2008 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to Douglas Emmett's 2008 fourth 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 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 that the call is being webcast live on our website and will be 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 8-K with the SEC and both are available on our website at douglasemmett.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, the assumptions made by, and information currently available to us. The actual outcome will be affected by known and unknown risks, trends, and certainties in factors that are beyond our control or ability to predict. Although we believe 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 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 the market data sources referenced in management's prepared remarks are CB Richard Ellis for Honolulu and Los Angeles office markets, REIT for those Los Angeles market, MTF Research for Los Angeles multifamily market, and Property & Portfolio Research for Honolulu multi-family market. With that, I'd 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. My remarks today will center on our overall view of the company's current position and future prospects during this period of extraordinary economic turmoil. I will then turn the call over to Bill Kamer, who will provide a detailed account of our financial and operating results for the fourth quarter of 2008 and FFO guidance for 2009.

First, in an effort to put the current economic climate into perspective, it is important to note that Douglas Emmett entered this down cycle in a stronger position than it did at the beginning of every prior downturn over the past 40 years. Each prior downturn was heralded by the completion of excessive new supply and an active pipeline of additional supply under construction and nearing completion. This time, very little new office supply was delivered in our 10 submarkets during the last several years and almost no new space will be coming online in the foreseeable future. As a result, and unlike during prior soft markets, we are not facing competition from building owners armed with construction loans containing large tenant improvement allowances in an effort to lease up new projects. We have a highly diversified tenant base of 2,100 office leases, representing a broad variety of businesses. Therefore, we have a limited vulnerability to the collapse of any one tenant or industry. That being said, this recession is notable for its breadth and depth across virtually all businesses and industries.

As we have suggested in the past, we are seeing an increase in tenant defaults. We lost 15 leases, representing 63,000 square feet of occupied office space, due to tenant defaults during the fourth quarter of 2008. This compares with 27,000 square feet of tenant defaults in the third quarter, but it's slightly less than the 64,000 square feet of defaults that we incurred in the second quarter of 2007, which was the highest quarter of default since our IPO in October of 2006. While future occupancy losses from tenant defaults are very difficult to predict, we are assuming that throughout 2009, the default rate will remain at or above our fourth quarter level.

We are also experiencing a decline in new leasing volume. Businesses are deferring long term commitments for new space and existing tenants are holding off renewals until closer to their expiration dates. Renewing tenants are also showing a preference for shorter lease durations. In addition to having a fully integrated operating platform, we have an extremely well seasoned and experienced operations and leasing team who have worked together effectively in prior downturns. We have implemented proactive programs to minimize the adverse effects from tenant business reversals. With these measures in place, we are confident that we will continue to outperform others in our markets.

We also remain optimistic about the inherent strength of our portfolio. We own some of the highest quality properties concentrated in the strongest, most desirable submarkets of Los Angeles. We believe that our submarkets will provide superior performance in coming years to those markets where the transformation of major industries is fundamentally altering the landscape for tenant demand. Our submarkets are characterized by relatively short-term leases, typically about five years. The higher lease rollover schedules that result from shorter lease terms will likely cause published vacancy rates to rise more quickly in the near term than in other gateway markets across the country. We expect that our diverse economy, the absence of new supply, our small tenant profile, and the small number of large blocks of vacant space will permit our submarkets to improve rapidly as soon as the national economy stabilizes and begins to recover.

Before I move to the balance sheet discussion, I would like to mention that at the end of December, we purchased the remaining land interest under our 1 Westwood office project that we did not already own. You may recall that we previously owned a one-sixth interest in the land and an option to acquire the remainder.

In terms of our balance sheet, we have maintained ample liquidity with our revolving credit facility. Our credit line had approximately $49.3 million outstanding as of the end of 2008 and its maturity date can be extended to October 2011. Of course, we also have our fund where we remain hopeful that we will have in excess of $500 million in equity commitments. We have no term loans maturing until June 2012 and the interest on all of our term loans is effectively fixed by swaps to an average rate of approximately 5.12%. In addition to the absence of any near term debt maturities, we are in the enviable position of not having major development or other capital funding requirements. As a result, we should be able to meet all of our capital spending needs in the foreseeable future from cash generated by operations and without the need to obtain any additional financing.

I would like to conclude with a comment concerning our dividend policy. Much has been said and written recently about the pros and cons of REITs significantly cutting their dividend at a time when, as is true for Douglas Emmett, they are strongly capitalized and have ample liquidity to meet their near and midterm needs. We will continue to study this subject in advance of our quarterly dividend announcement next month and will make that decision based on what we feel is in the best long term interest of the company and our shareholders. On that theme, I should mention our recent announcement that none of our 2008 dividends are taxable for United States federal income tax purposes. So if we should decide in the future to cut our dividend, we will have considerable flexibility to do so without the need to incur the expense and dilutive effect of issuing stock.

Now, I'd like to turn the call over to Bill Kamer, who will provide specific details on our fourth quarter operating results. Bill?

Thanks, Jordan. For the fourth quarter, the company reported FFO of $55.6 million or $0.36 per diluted share, an increase of 15.2% over the fourth quarter of 2007. As we have discussed in prior quarters, our pre-IPO interest rate swap contracts are net assets on our balance sheet that are amortized as non-cash interest expense until the swaps expire. Over the remaining life of the interest rate contracts, the amount of non-cash interest expense that will be incurred is a fixed amount of $42.9 million. However, in order to conform to applicable accounting standards, we are unable to report this amortization on a straight line basis. As a result and as we have previously advised, we have seen and expect to continue to see significant quarter to quarter fluctuations until our pre-IPO interest rate swap contracts expire. In the fourth quarter 2008, our non-cash interest expense from pre-IPO swap amortization totaled approximately $1.3 million. If the amortization had been calculated on a straight line basis, the amount would have been approximately $4.6 million and FFO for the fourth quarter would have rounded to $0.33 per diluted share.

For the year, the company reported FFO of $211.7 million or $1.36 per diluted share, an increase of 15.7% compared to the FFO per diluted share for 2007. AFFO for the quarter ended December 31, 2008 was $34.6 million, an increase of 25.7% compared to the fourth quarter of 2007. For 2008, the company's AFFO was $145.4 million, an increase of 25.9% compared to 2007.

Turning to our same property results, same property net operating income increased 5.7% on a cash basis and decreased 1.7% on a GAAP basis in the fourth quarter of 2008 compared to the fourth quarter of 2007. During the fourth quarter of 2008, we increased our straight line rent reserves by approximately $2.4 million, which we believe was prudent in view of the potential for future tenant defaults in this economy. Excluding the addition to reserves, same property NOI increased 0.8% on a GAAP basis for the quarter. Same property total revenues in the fourth quarter of 2008 increased 3.9% on a cash basis and decreased 0.8% on a GAAP basis compared to the fourth quarter of 2007. Breaking out the office and multi-family portfolios, same property office revenues in the fourth quarter of 2008 increased 3.9% on a cash basis, decreased 0.5% on a GAAP basis, but increased 1.5% if the additional straight line reserve is excluded from the GAAP calculation. Same property multi-family revenues in the fourth quarter of 2008 increased 3.5% on a cash basis and decreased 2.6% on a GAAP basis. As we've discussed over the last several quarters, the GAAP decrease is due to a decline beginning second quarter of approximately $1 million of FAS 141 income generated as a result of our IPO. FAS 141 multi-family income should total approximately $3.5 million in 2009.

Moving away from same property statistics, total revenues for our entire portfolio increased 11.9% to $155.6 million in the fourth quarter of 2008 compared to the fourth quarter of 2007. Office rental revenues increased 12.9% year-over-year to $110.5 million in the fourth quarter. Office rental revenues included only $110,000 of lease termination income. Office parking and other operating income rose 9.9% year-over-year to $17.7 million in the fourth quarter.

Our total office and multi-family FAS 141 income for the fourth quarter was approximately $10.6 million and was $42.9 million for the year-ended December 31, 2008. We anticipate the total FAS 141 income will decline to approximately $33 million for all of 2009. On the expense side, for the fourth quarter, office operating expenses increased 17.7% compared to the fourth quarter of 2007, primarily due to the new office acquisitions. Multi-family operating expenses decreased 5.3% fourth quarter when compared to the same period in 2007. G&A in the fourth quarter of 2008 totaled $6.4 million and was $22.6 million for the year-ended December 31, 2008. We expect the G&A in 2009 will range between $24 million and $25 million.

Interest and other income totaled approximately $3 million in the fourth quarter of 2008. This primarily relates to the transition into the fund of the six properties that the fund now owns. As additional capital is drawn from the fund investors and as the company's ownership percentage in the fund changes, we anticipate that the company will recognize additional income during the first and second quarters of 2009. Interest expense in the fourth quarter of 2008 increased to $48.1 million from $42.5 million in the fourth quarter of 2007. This increase is primarily explained with the new loans we obtained in 2008. As I mentioned earlier, non-cash interest from the amortization of our pre-IPO swaps totaled $1.3 million in the fourth quarter, which is $2.4 million less than the fourth quarter of 2007. Interest expense for all of 2008 totaled approximately $193.7 million

Recurring office capital expenditures totaled $0.14 per square foot for the quarter and $0.46 per square foot for all of 2008. Recurring multi-family capital expenditures totaled $254 per unit for the fourth quarter and $547 per unit for 2008. We expect that both of these amounts will be lower in 2009.

Turning to the operational side, the office percent leased for the 10 submarkets where Douglas Emmett's office properties are located declined 60 basis points sequentially to 90.7%. Market rents for the 10 submarkets where our office properties are located declined 3.1% sequentially. During the fourth quarter, we entered into 96 new and renewal office lease transactions totaling 323,000 square feet, compared to 515,000 square feet of office space leasing done in the third quarter of 2008.

Our office portfolio was 93.1% leased and 92.4% occupied at December 31, 2008 -- in each case, down 90 basis points sequentially. I should note that taking into account leases that fell out of occupancy on January 1, 2009, we began 2009 with office occupancy at 91.7%. Our multi-family portfolio was 99.1% leased at December 31, 2008, which was down 50 basis points sequentially. Office tenant improvements, leasing commissions, and other capitalized leasing costs during the fourth quarter totaled $18.28 per square foot compared to $14.30 per square foot for the third quarter of 2008.

Our mark-to-market and rent roll up metrics during the fourth quarter are as follows -- on a mark-to-market basis, the spread between our in place cash rents and our asking starting rents was 14.6%, down from 20.8% at the end of the third 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 fourth quarter of 2008 was 32.9%, down from 37.5% in the third quarter of 2008. 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 was 16.8%, down from 20.1% in the third quarter of 2008.

Now turning to guidance. We are providing a guidance range for full year 2009 FFO of between $1.24 and $1.30 per diluted share. This guidance excludes any impact from future acquisitions, dispositions, equity purchases, debt financing, recapitalizations, or similar matters. This guidance also assumes that our 2009 non-cash interest expense relating to the amortization of our pre-IPO interest rate swap contracts will conform more closely with straight line amortization and will be approximately $18.5 million. With that, I will now turn the call over to the operator so we may take your questions.

Thank you, sir. (Operator Instructions). Our first question comes from the line of Michael Bilerman with Citigroup.

Good morning, it's Irwin Guzman for Michael. You talked a little bit about how the supply picture is different this time from how it was in the last cycle. Can you give us a little more color on what you're seeing in terms of the difference in the demand structure relative to last time around?

Well, in demand -- the supply side, I guess, you understand -- on the demand side I would say that -- what I said in the script is that this economy is hitting everybody equally. So all industries, all tenant sizes, everybody is getting hit. So we're not seeing any one sector. We obviously don't have any one tenant that is really failing for us. But I guess last time, I don't know, I mean I would compare them both by just saying that this time, people are shrinking a little bit, but still seem to be staying in business, whereas last time we saw just the combination of the vacancy and the ability of guys to move with all of the extra dollars because it was much more of a tenants market. It's a tenants market this time, but much more of a tenants market last time. I don't know if that answers your question.

Let me just add to that, Irwin, that in terms of -- I mean as Jordan mentioned in his remarks, some of the other markets are going through a fundamental remaking of their economies and tenant demand. We in Los Angeles went through a similar phase in the early 90's when the aerospace defense industry at the end of the Cold War scaled down dramatically and their whole economy had to be reinvented. That's the noticeable difference this time is that we're not seeing one industry in LA that is suffering greatly. On the other hand, as Jordan said, this recession is so broad and deep that it's affecting just about everybody. So there's impacts across-the-board.

That's helpful, thank you. And Bill, just one other question. Can you tell us what kind of rental spreads and what kind of occupancy loss gets you to the high and low end of your range or what we should be expecting?

It's hard to do that. If you notice, we have a little bit wider band this year than we have last year. We're still trying to get our hands around it, so we put in a fairly wide band. Obviously we're seeing that the direction in occupancy if trends continue is down throughout the year, at least modestly. But I don't want to, I think I don't want to get into speculating beyond that.

Okay, thank you.

Thank you. Our next question comes from the line of Anthony Paolone with JPMorgan. Please go ahead.

Thank you. Have you all tried to proactively look at your 2012 ish maturities and tried to push those out or work with lenders to maybe flatten that maturity schedule a little bit?

Yes. We almost got laughed out of the room. I mean, we obviously talk to our lenders all the time, stay in touch, not only for our existing debt but because we want to always have a good feel for what kind of debt is available for new acquisitions that we may make and because we would need debt for that. And when we started bringing up with them the idea that maybe we would be willing to do something and to extend out some of our 2012 stuff, they would say to us things like, you've got to be kidding. You have great loans, you have a huge amount of time. We're dealing with people whose loans are coming up in the next three to six months. You're not even on our radar. I mean, and frankly, they didn't even want to deal with us. So it's just too far out and the loans are in very good shape, current great coverage. There's no loan to value issue. They are just in great shape. So you can't get their attention for something that's 3.5 to four years away. So we stopped pressing on that front and have focused more on what people are willing to do for new acquisitions that we may make in the fund, which we've gotten pretty positive feedback on.

Okay. And in terms of just going back, you gave some color as to the portfolio and you being better positioned versus prior downturns. Can you give us some color as to maybe where your markets or some of your assets may have trended from peak to trough in the late 80's to early 90's, during that downturn?

Well, it was a very different portfolio then. I would say in the worst of it, we lost about between 400 or 500 basis points of occupancy, from peak to trough going into that. We had one building that we are in the process of leasing up that we had built. So that was quite a struggle although we did get it leased and got that dealt with in the middle of that market, not dissimilar from the way we got our fund closed in the middle of one of the toughest capital raising markets. We've got great operating platform. Our operations in markets like this always come through, and I don't want to say save us -- but it's really where you see that when you put money into your operation side, this is where it really pays off. And we didn't, as I just told you, the hit in the last downturn was not that severe. We -- the same as this one, we skidded through it with some scrapes and stuff but we were able to focus as we are this time on raising funds, buying properties, taking advantage of some of the distress that other people in our market were having. And we're seeing something similar now. But we also aren't in the middle of having to lease up, let's say new construction, and some of the other stuff we were going through then when we were a much smaller company.

Okay. And last question, on the dividend. It seems like if you don't pay one or you wouldn't necessarily have to pay one given your taxable and you might be able to retain upwards of $150 million of capital. I mean what would be the case to continue to pay a dividend if you don't have to?

Well, we've been listening to the REIT debate on dividend cutting both in what people have been saying and the debate and the press. And there are certainly I feel like strong arguments on both sides of that question and it is very tough. I mean, I've got to tell you, I'm thinking about it every day. We're reading about it and thinking about it every day. As I said in the prepared remarks, if you look at our capital structure and our near and immediate midterm needs, we're in very good shape. But then an argument similar to the one that you just made might argue in the other direction of cutting and saving cash. We're reviewing it and we'll make a decision, as I said that we think is best for the company and our investors. But we're still just going through it.

Okay, thank you.

Thank you. Our next question comes from the line of Ian Weissman with Banc of America. Please go ahead.

Good afternoon. Just a follow-up on the questions about fundamentals. Your markets have witnessed vacancy pick up several hundred basis points and one thing you didn't talk about was rents. In peak to trough, where would you see rents coming through 2010? Are we talking high teens in terms of coming down, or 20% to 25%?

Well, peak to trough on rents is a much tougher number than occupancy when we're looking at our portfolio, because there's I think a lot of weak information about where rental rates are in the various markets that we're in when you use market rents, which is people's asking rents. If you look at -- especially in this market that we're in right now, I think we saw a wider spread from asking to what was really happening in the submarkets than we've ever seen in the past in a strong market. And as a result of that, you probably are looking at a bigger fall, but from a number that I don't think we were ever really at. If you take a look at where we felt the real economics of the regular leasing that we were doing with that, and obviously this varies in submarkets and you compare it to where we think we're ending up in this whole thing, you're off anywhere from 15% to 25%, and it just varies in submarkets.

Given the reserves that you've taken so far, and what you I guess comment on for 2009, is it safe to assume A) that your occupancy ticks below 90% and that your low end of the guidance assumes negative same-store NOI growth?

I think it's safe to say that we're conservative guys, as you've seen over the last couple years, and we've made some conservative assumptions with regard to all of the items that you just mentioned.

Okay. And finally, while many people are not in the acquisition mode, there are a number of assets which have hit the market. I guess Broadway is being forced to auction off a property and I understand that Lantana is on the market or coming to market. What does pricing look like today and how much capital is out there to buy real estate in your markets?

Well, good knowledge of our market about what's coming up. There are a couple deals that we are really, I don't want to say involved in, watching, closely watching, whatever. And so far, it's been a little surprising first of all in terms of the number of bids the assets are getting. There's still quite a few people out there that are bidding on good assets, that's number one, or taking hard looks at them at least. And the second is that, maybe this is still a habit, but the pricing hasn't moved as dramatically as we had expected. And there is some deals right now going on where I'm very surprised by the pricing. I mean much higher than I thought it would have otherwise been. And obviously they aren't done and they need to play out and we'll watch and see what happens with Lantana and see how it plays out. But there's still a pretty good level of interest in those sorts of assets. I'm talking about better than 10 strong players and maybe as the year goes on, the number, the bid and ask will get closer together. But let's see what happens.

What type of capital is out there now looking at these properties?

A lot of, well I seen funds, I've seen individual foreign investors, I've seen even some domestic JV partnerships going after individual assets. I mean I'm not seeing any of the big hedge funds or anything or Blackstone Fortress type companies.

Care to give us a range of cap rates you're seeing or price per square foot for assets like the Lantana or the Broadway property? Can you do that?

Do you want me to jinx? It's not Rob anymore, it's Nelson.

I just want color.

I'm sure Nelson is going to get a great number for that project. It's a great project. I don't have that detailed information on those deals. I don't want to handicap those deals.

Okay, all right. Thank you.

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

Hi, good morning to you guys.

Good morning.

I guess going back quickly to the dividend, I wonder why you would, despite the attraction of saving $150 million annually, I wonder why you would even consider it -- considering you guys are in no way, shape, or form in my mind at least in a distressed situation and that a dividend cut would maybe send a signal of distress. And I guess if you could just expand more on the thought process and the dividend in light of that?

Well, think about this -- the first way I was asked that question about two minutes ago was how could you not be cutting your dividend, and you're asking the question, how could you consider cutting your dividend. Well, that combination is why we're just studying it very carefully. And by the way, it's closer to $120 million than $150 million.

Okay. I guess I was listening to the answer, not the question. Bill, I think you gave some guidance about interest and other income that to me suggests that your expectation for some near term fund activity in the first half of 2009 -- did I connect those dots correctly?

What I was referring to Rich is that in the transition into the fund, there's cost recoveries that we have that are shown in that $3 million other income item. Those incomes, the way we recognize those amounts is based on drawn capital in the fund and as ownership changes, we're in a transition -- as you know we're in a transition period and in the fund until the fund or ownership settles down and the money is drawn -- which happens, the date for that is June of this year. So we have this interim period. So we'll be recognizing those amounts sequentially until that settles down and the number gets finalized in June. That's why I referred to those amounts coming in first and second quarter.

Okay. In terms of the guidance, you had a low level of lease termination income in the fourth quarter, maybe surprisingly low. Do you expect that to ramp up in 2009?

There's no real way of predicting it. It comes when it does. We've always had very low lease termination income. And the number this past quarter was right in the zone, maybe actually to tell you the truth a little on the higher end of where we've been over the last several quarters. But it's always been very low. And given the nature of our tenancies, it's unlikely you'll see any large amounts of lease termination income in any quarter and we always could have the outlier situation, which occurs from time to time where we get that, but unlikely.

Okay. You mentioned some occupancy loss during January. Can you provide a little bit more color on what that was?

We mentioned I think in last quarter that there's a very small tenant profile and are relatively for us our relatively larger leases are in the scheme of things nationwide feel pretty small. But we had a HealthNet lease as we discussed before of 51,000 feet that we've known as non-renewing or consolidating in other space. And that hits in terms of falling out of occupancy -- it happens to hit right on New Years Day, January 1. So it's in our year-end numbers as occupied and then at the beginning, we wanted to give everybody some clear visibility of a starting point of where our occupancy was going into '09.

Okay, and then the last question I guess, maybe conceptual more for Jordan possibly or whoever. Your tenants are asking for shorter term leases, which isn't a surprise but is that potentially a blessing in disguise? I guess if you have shorter term leases and the market recovers in 1.5 years or the economy recovers in 1.5 years or so, that maybe it gives you an opportunity to tap into some more of that untapped growth say 2010 to 2011? Are you looking at it that way at all?

Well, it's not a disguise. I mean it could be a blessing, but it's your view on the economy. If you think in the next two years things are going to recover in any reasonable way, then I will tell you that we have a very strong springing board that we're launching off of here. Because when I look at the last couple times, whether it be '89 to '90 to '91, that recession, or the one that hit us in the 2000 range, we had all this space that had to be reabsorbed and digested. And maybe in the dotcom one we had these large guys that had to go out and had be turned back into space for little guys. In the early 90s, we had all that new constructions -- I mean, we had whole buildings with nobody in them, totally vacant buildings, new office buildings. Okay, so we don't have any of that now. So what we expect to have happen over the next year or so is just like creepy crawldown, just chipping away. So if the economy turns, we don't have that redigesting absorption thing to go through that we've had the last few times. And it should turn very sharply, because remember, on a relative basis, the rents, whether you want to take the lower rents or you want to take the slightly higher rents we were at last year, they are all low rents relative to the cost structure of the tenants that we have. So the next time things turn if we can get a good run out of it, a good healthy turn out of it, we should have years of a real good ride where we adjust up pretty dramatically, since we're very cheap relative to everything and every other major gateway market, not only in the US but around the world.

Great, thanks for the color.

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

Thank you very much. On the last call, you guys did a good job of telegraphing the HealthNet lease and what was to come at the Warner Center. Can you give an update on the '09 roll, some of the big box that you feel may not be occupied?

Yes, let me try to do that. We've got, I think at this point -- as you said we did try to telegraph that one. Coming up in first and second quarter this year, I don't think we have a similar situation of relatively large tenant that we know is going out that hasn't already been discussed. And I think we're at this point expecting our larger tenants -- and I don't think there are very many of them, but larger tenants rolling in that time period to renew.

And then in the back half of 09?

It's out far enough and as Jordan said earlier, one thing that you have to -- I guess we can't emphasize this one too much is in the current economy, one phenomenon that we've really seen is tenants -- even relatively larger tenants, they are going right up to the wire now on expirations before they are showing their cards and are willing to make a commitment. I'm sure from the feedback that we get a lot of these companies have their own lack of visibility in the future of their own businesses. So they are just not willing to even give a good picture on what they are going to be doing other than that they aren't willing to make a definite commitment early on.

And then the other submarkets where you seem to have the biggest occupancy hit were Honolulu and Beverly Hills. Can you give a little color on vacancy there?

Sure, Jamie. The issue there is the markets, the numbers in quarters are pretty sensitive to the defaults that we incurred and where they fall out. And it just happens that in the fourth quarter that a large percentage of the 64,000 square feet of defaults happen to fall both in Honolulu and Beverly Hills.

Okay. Which actually leads to my final question. The reserves that you've taken, it sounds like it's a straight line reserve, but is it also an assumption that that space will go vacant? I guess the question is what's your policy on reserving?

Well, we have, this is in connection with -- the main portion of the $2.4 million increase in reserves was a general increase in reserves which is just based on as Jordan is saying -- culturally, we tend to be pretty conservative, but on the other hand with the economic uncertainties we think conservatism is warranted right now. So we have increased our general reserve just because we think that the levels that we saw in the fourth quarter, we think that and maybe a little bit higher levels are probably where we are going to be this year. But it's just uncertain, so we've taken a little bit higher reserve. And this is again straight line, so it's amounts that have been booked into income on a non-cash basis and straight lined and that's where we want to show the conservatism.

And then that reserve flows through top line revenue?

Yes. It goes through rental revenue.

Okay, and then do you have an assumption for the '09 guidance?

Assumption on?

Additional reserves?

No. We'll revisit it from time to time, but we're not anticipating changing the policy.

Great. Thank you very much.

Thank you. Our next question comes from the line of Chris Haley from Wachovia Securities.

I love the Boris the Spider reference.

You mean the creepy crawling down in occupancy?

How you doing, Chris?

A question on dividend, just to make sure I clarify. You said from a taxation perspective, you would not have to pay it out, correct? And then you also would not be inclined to issue or use equity to pay it?

Okay, that's a good question and I'm happy to clarify it. First of all, I'm not trying to give tax guidance on next year, but last year, we had our entire dividend was quote unquote a return of capital, so there was taxes associated with it. So you would expect this to be somewhere in that range this year, right? It went public a few years ago and we got a big book up in the assets and they are creating a lot of depreciation. So we have a very low tax related to our dividend. In fact, it's 0% tax related to our dividend. So this year if we're similarly situated, which I expect we will be, there is no requirement for us to issue stock in order to cover -- in order to maintain our REIT status and to cover the REIT role that requires us to distribute 90% or 95% of our earnings, which is the basis under which I suspect most of these other organizations are issuing stock. So the point we were just making is one thing you won't see us do is we won't say well, we're cutting -- we're not cutting the dividend, we're changing its nature. We're giving half of it in cash and half in stock. We won't be doing that. So if we cut the dividend, it just means we're giving out less cash. But we're not doing anything dilutive with stock and we certainly wouldn't issue any additional stock. That was a long answer but to get it all in there why it's so clear that we're not issuing stock.

On this debate though, the Company is paying out the dividends with the stock, it is treated -- you're getting the stock at fair market values. So at the end of the year, the taxation of the dividend is still largely a function of what you as the REIT, what your tax structure looks like. So one of the things we're interested is how far down the road have you gone in terms of looking at -- but if that's the case, then it doesn't really matter whether you paid out in stock or cash, if it's all going to be return to capital, generally speaking, really the only issue becomes whether or not you're comfortable issuing it below current whatever the perceived value of the business is.

Well, I'm saying more than that. I'm saying if you don't, my feeling is that or our feeling of our company is that if you don't have a tax reason to issue a stock dividend, then there's no reason to do it. So if we're going to cut the dividend, then the amount of cash we give out will be less, but we won't be issuing a stock dividend because we know for ourselves that we probably won't have a tax reason to issue one.

Thank you for that. Could you help me with where do you think your current mark-to-market on the portfolio is in the office?

You mean mark-to-market in value?

No. I'm sorry. Where you think your cash effective rents are?

Well, we had indicated our mark-to-market spread at the end of December was 14.6% and at the comparison between our asking and in place cash rents.

Sorry I may have missed that. So that's the leases that were signed in the fourth quarter or where they are today?

I'll just go through all three again. So the mark-to-markets -- the spread between our asking and in place rents on a cash basis, 14.6% which was down from 20.8% at the end of the third quarter.

Okay, all right.

[Rate] line for leases actually signed in the fourth quarter, the mark-to-market there is 32.9%.

Got it, okay.

And the cash ending cash rent to starting cash rent is 16.8% down from 20.1%.

That's for leases signed in our portfolio -- the last two are for leases signed in our portfolio.

Okay, good. All right lastly, on the capital expenditure side, the concessions offered in the fourth quarter, the ratios were higher than the year-to-date figures through September 30th. I know you haven't commented specifically regarding 2009, but if you could, that would be helpful from your expected leasing costs or concession levels for 2009 as a comparison to 2008.

Well, Chris, in terms of the capitalized leasing cost, we in the fourth quarter as we indicated, we were up a little bit in the fourth quarter to $18 and change, from $14 and change in the third quarter. There is noise in that number. We've indicated quarter to quarter in the past where we've had numbers that were unusually low because we might have had a large as is renewal that skewed the number down. In this particular quarter, we had for us a larger -- it was a 10 year lease which was unusual for us -- and a larger space in our portfolio that hit in the quarter. So that noise pushed the number up. Our overall view is that the TI side of things in our market is very flat and it's been flat for a while. And we're not really seeing that trending up even in the softening market.

Great. Thank you.

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

Hi, thank you very much.

Hi, John.

A question I guess, Bill. Can you walk through the accounting on your fund which closed I think October 7th, particularly where the $57 million other liability and your partners' income offset and where the fees are coming through?

Let me answer it this way, John, and I'm happy to get back to you and go through, I mean, unfortunately with the way all of this accounting stuff works, it's probably a long technical discussion. But let me just on this call let me just say it this way, which is that -- where the fund, as we indicated last quarter, we're showing the fund on the consolidated basis at this point. As I mentioned a little earlier on the call, we're going through this transitional phase as we're raising funds and drawing funds from investors, and until the structure of the fund as it were settles down and is finalized, which we're anticipating in June of the year. So between now and then, we're showing on the consolidated basis, I know it's a little confusing in terms of past presentations and there's a bunch of different ways that that impacts the numbers a little bit. But I think what I tried to do is in the call is to give you some color on the amount of income that was generated as part of that transition and we're expecting to see some numbers in the first and second quarter. But the main point is that we're reporting at this point on a consolidated basis.

So what's the other liability of $57.3 million?

It's drawn capital from the non-REIT investors.

It's because it's consolidated.

Because it's consolidated --

We have to first back out the other guy's investments.

Adjusted by a few things, but basically it's drawn capital.

Okay, and when we're trying to work out an NOI for Douglas Emmett, what should we look at on a cash basis or a GAAP basis the income offset for your fund partners? How should we look at that?

Well, for '09 and going forward compared to '08, there's a dilutive effect of those funds moving from full ownership of the REIT into the fund in terms of the REIT books as we own a lower percentage. And so those numbers again, I think it's hard to give something very precise until again the structure and ownership percentages settle down over the next several months. But suffice it to say in terms of directionally, I think you'd be in the right ballpark if you viewed it as somewhat fairly mildly dilutive in the early stages.

As we own less of the fund properties, the fund properties are a positive. They are very profitable, so as people come into the fund and we own less of them, it's dilutive towards our earnings on a go forward basis. But we have to see how many people we get in and as we settle up where that number ends up.

All right Bill, I'll call you later, thanks.

Okay.

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

Jordan, can I ask about your outlook for raising additional capital for the fund before June?

Well, I mean as I said in the script, we're still hopeful, I think is the word we used, that we will reach our $500 million threshold where we had originally given you a number -- $500 million to $1 billion is where we hope the fund will end up. And we are still hopeful that we'll get there with some positive feeling that we will get there.

It looks like there could be a chance maybe at the low end of that range where maybe this is not an exclusive acquisition vehicle for very long I would wager. Should we think about it that way?

For so long as the fund has money, it has to be the exclusive acquisition vehicle. Now if deals come up and the fund deploys all of its capital, then it's not the exclusive vehicle anymore because it has no money to spend. But then we would most likely start another fund for so long as we think there are opportunities out there. That's a structure we're pretty committed to, and for so long as we're committed to the fund structure, I think that it's reasonable to assume that whichever fund has funds at any particular time will be our exclusive acquisition vehicle.

Okay, and then on the lease rollover side, about half of your '09 roll is in the Valley. What's that number for 2010? Is it a similar, roughly half?

Mike, I don't think we have that for '10 handy broken down by submarkets. I'll have to get back to you on that, unless we have it here?

I'll follow-up on that one. And then on the tenant side, are you seeing tenants ask for rent concessions to help them get through or pay their bills?

Yes, that's definitely a product now, because of the breadth of the economy, everybody in all sectors is trying to cut their operational cost. And what we indicated before, Jordan indicated in his remarks about our management group and our proactive programs. One of the principal programs that we have in place is with all of our property managers. And we've set up a lot of procedures that in order to respond to those requests, and the fact is when you ask for tax returns and get into the details of it, you wind up through that approach -- 90% or more wind up falling by the wayside as people just try in every direction to try to reduce costs. There will be some situations, hopefully relatively small, where we have some reason to modify leases for existing leases. But that's the vast bulk of them, by setting up the procedures we do and separating it out, we think we can keep that down to a pretty rock bottom minimum.

We actually, which is something we haven't had to do for many years -- but we took our portfolio managers, put them through additional days of training on how to deal with these kind of questions when they come in, what you ask back, what kind of information you ask for, how you deal with it. We included also role playing for our portfolio managers and when people come in and start asking for concessions so they could get comfortable with how to talk to them and how to deal with it. There's a lot of it == I think we're getting hit with a lot of that, but I think we're dealing with it extremely well. So I think we've taken every step to mitigate that impact and I think it is going to be substantially mitigated throughout all of this year.

Mike, in terms of your other question, we got the information while we were discussing this. It's for 2010, we understand the expiration is down significantly from '09. It's well under 300,000 feet so it's quite a bit lower in 2010 and 2009.

And then my last question, can you just give us a little commentary on sort of your comfort level with your two Valley submarkets as it would compare to your six West LA submarkets?

Well, the one in the middle of the valley along Ventura seems to be doing extremely well. The one out in the Warner Center, Woodland Hills area, that's where there's larger tenants. So that's where you're seeing vacancy. And when we lose one large tenant it creates real problems for us out there. So we've got a lot of focus, an incredible amount of focus out there, even to the extent that Kent has been going out there every Friday focused on holding occupancy up and dealing with actual lease deals and calls that are coming in. So that's probably the market that we're -- in the Valley that we're worried about weakness the most. The one around Ventura -- [Poveda] strip there, Encino, Sherman Oaks, I think is holding up extremely well, very strong. And obviously out in the Burbank Media district, we only have one building and it's leased for another 14 years or something.

Thank you.

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

Thanks, just one question left. Relative to your smaller tenants, do you have much sublease space in your portfolio?

I don't think we have been facing that very much. I know I've been reading about what's going in in New York and the huge concerns about the amount of sublease space that's coming on. But we are not, we're certainly not seeing it in our portfolio and we're not generally seeing it. There's some spots I could look at and say there's sublease or that kind of space available, but not in any of the areas where we're competing or where our buildings are. We're not seeing a lot of it yet.

Just following up on Jordan's point, one thing that's important for you to keep in mind is sublease space in our markets and with our tenant profile is very different than what you are used to with other parts of the country because with the shorter lease terms and smaller spaces, almost without exception, any time we have a tenant that's subleasing, it does not compete with our leasing activities.

Right. They can't afford to give PI dollars, they can't afford to make any changes, so it's not very cost effective for someone to sublease.

I guess what I'm trying to figure out is if you had somebody in your smaller tenant in your portfolio, and typically they would -- a company would have the choice to sublease the space if they weren't going to use it. But if some of your smaller tenants don't exist anymore, does that translate into quicker vacancy in your portfolio versus others for the market?

Yes, well, to the extent they don't exist, that's direct vacancy and you're seeing that in our numbers and that's why we're saying we're expecting that crawling increase in vacancy, but whereas in other markets, a lot of times vacancy is just half the picture and you can find out what sublease is. I don't think that's the case here. Vacancy is telling the story.

And the 63,000 square feet of defaults in Q4 -- those businesses just went away?

Those caused vacancy. Yes, they had some extraordinary problem and contracted or defaults -- that means they had deadly financial problems and now we're dealing with them in some type of collections mode and took back the space.

And you mentioned, Jordan, I think the level of defaults in this quarter was the highest since Q2 '07.

Yes.

Was Q2, was there a bigger lease within that second quarter of '07 that drove most of that 64,000 square feet?

The Q2 '07 number was we had the hurricane force winds that hit a lot of other markets when the mortgage tenants got their blow at the beginnings, the early days -- it seems like a thousand years ago now, the very beginnings of the credit situation. Our very mild version of that was a few mortgage tenants in the second quarter of '07 and that's accounted for that amount. So that's why that was, that's still the high water mark of the falls at this point. Thank you guys.

Thank you. Our next question comes from the line of David Harris with [Arroyo] Capital. Please go ahead.

Hello there, guys.

Hi, David. How you doing?

I've got a question on the fund. You've probably thrown this out in previous calls but just remind me, what return are you targeting?

Oh, 12% to 14% to the investor.

And that's a levered return, obviously?

Yes, leverage range is from 50% to 60%.

You're obviously talking to a lot of these guys today looking for top ups or for some new sources of funds. Could you give us a sense as to how those return expectations are changing from the fund investor perspective if at all?

I think fund investors are more interested how realistic your assumptions are nowadays than they are and whether you're throwing out their huge IRRs. So I don't think that's been an issue for us -- and by the way, this is our tenth fund and those are the same returns we were proffering for all previous nine funds. We haven't changed those numbers.

Is that assuming the same leverage throughout?

Yes.

Which is what? 60%?

Yes. We tend to run 50% to 60%. Usually a particular fund will average around 50%. Although we have a right to leverage up into the 60's, we don't tend to do that.

Now forgive me for asking this question, as an Englishman [sat] in New York, is there any particular reason that we should be concerned from a landlord's perspective about the current state of the state's finance?

Wow, I mean, we have, we're one of a few states where we wanted to make a little more interesting around budget time, so it takes two-thirds vote of our legislature to pass a budget. So California really likes to shine when it comes to screwing that kind of thing up. We were talking about this. It's funny you ask that because we were talking about it a day or two ago and trying to figure out is there anything there that could get us? I don't think -- we don't have the type of a tenant base. We're not in markets that are very highly dependent on let's say government leases or tenants that are getting a lot of their funding from government contracts. So we couldn't put our finger on anything that in particular would be directly impactful to us, although you like to live in a state that's a little more fiscally sound than the way California seems to be operating lately. But I don't know of anything special, no.

It sounds like the dramas in Sacramento are pretty comparable to what were going on in Washington, I guess, but one final question. If I go back a couple years ago, there was an outstanding unresolved [with the] state taxation question. Is that largely settled now and we can look at the quarterly numbers as being sort of a reasonable go forward number?

Yes.

Thanks guys.

Thank you. (Operator Instructions). We do have a follow-up from the line of Michael Bilerman. Please go ahead.

Hi, Jordan. Just on the apartment side are you seeing anything else on the market today in how you're looking at sizing-up apartment versus office prospects and whether you try to be more aggressive there or not?

I would say we are equally aggressive or interested in both apartments and office deals in our markets. I mean obviously we're really watching to see how Archstone plays out and what happens with those assets, because those are a lot of apartments that could come for sale that are in our markets. And there's, there isn't, I don't see a lot of apartment deals. When we look at the radar of what's coming up, there's not a ton coming up for sale. And apartments are even less than office have not come down as dramatically because the financing of apartments is still supported by Fannie and Freddie.

And what can you do in the fund -- as it stands with the capital that you've raised, today, how much more can you put into the fund assuming no additional closing? Well, we still have the ability to buy -- you asking how much can we still buy? Right.

We still can buy. I mean the fact that we haven't bought anything is that we haven't found a deal as good as that last one that we did. Matter of fact, when you look at the comps post our acquisition, it's a huge outlier because it's so far below where deals happen even after we closed our deal.

On price per pound or on a yield?

Price per foot basis. So what we're doing is -- I hate to do, we're watching, it's hard to do a deal that's worse than that deal. So we're watching these deals come up and that's why I said earlier I'm surprised by the strength of the number of bidders and the type of pricing that these projects seem to still be commanding. But with that said, there's very little activity that you could put your finger on to really peg where the market is.

Right. And what -- you haven't -- on the fund basis, there hasn't been any subsequent closing from the initial round?

Well, as we said earlier, we're not going to do sort of a board on the front of the building that here, we've closed this money today with a thermometer. So we'll -- if our expectations change for when -- for the amount that the fund will be for in total at the end, we'll let you know that. But short of that we'll just let the fund play itself out, and then after June when it closes we'll let people know where we ended up.

And then just a suggestion, Bill. A lot of companies have whether it be consolidated or unconsolidated joint ventures, do show that income statement. So while I know there's a lot of messy accounting things and a lot of different lines, maybe just showing a pro rata beside will help us sort of understand what's going on line by line.

Well, as I said, we're going through a transitional period and we will settle things out on the presentation when we complete it.

Was there anything in parking and other in the quarter that listed that number pretty significantly?

He's asking if there's parking income in the other income line.

Well, just year-over-year it went up $5 million.

Well, year-over-year, it's largely as a result of the -- we share on a consolidated basis, so it's largely the acquisition of the funds properties in March. So it's additional properties that are in that number. That's the primary reason.

So that's more of a stable, that $17.7 million is a more stable number, with more parking revenue?

The increase is not a same property increase.

Okay. That's helpful, thank you.

Thank you. Our next question comes as a follow-up from the line of Michael Knott. Please go ahead.

Hi guys. Can you give a little bit of commentary on the pricing and your thought process on the land acquisition you mentioned in your prepared remarks?

It was very small. We were talking about it and it was I think between $7 million and $8 million, all it was to finish buying the remainder. It was a two appraisal, third tie breaker process where we had an absolute right to buy the property at market and then the way market was defined. So it was a very good deal for us to be able to buy the land in that manner -- but, and it does dramatically reduce the ground rent expense that we'll have going forward which is already figured into our guidance for you guys. But it wasn't a very big number overall in comparison to all of the numbers in the company.

And Mike in terms of the thought process, we've always intended -- matter of fact going back to our IPO, we always indicated back then that we intended that this option, the right to exercise the option, was going to come up in '08 and we intended to exercise it. So we just completed that process.

We sold, before going public, our other ground lease deals. We kept the ones where we knew we had a right to buy the ground.

Okay. And is there a relevant value per foot to share?

No. I don't think it would be comparable to anything. It was its own structure for figuring out that value. It's not like I wouldn't call it a real market comp for anything.

Fair enough, thanks.

Thank you. There are no further questions. Management, I'll turn it back over to you for closing comments.

Okay. Well, thank you, everybody. It was a pleasure speaking with you again this quarter and I'm sure we'll all be speaking again in another quarter.

Thank you. Ladies and gentlemen, that will conclude today's teleconference. If you'd like to listen to a replay of today's conference please dial into 303-590-3000 or 1-800-405-2236 and enter the access code of 11124572 followed by the pound sign. We thank you again for your participation and at this time you may disconnect and have a nice day.