Douglas Emmett Inc (DEI) 2011 Q2 法說會逐字稿

Welcome to Douglas Emmett's quarterly earnings call to discuss it's 2011 second-quarter financial results. 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 on the call are Jordan Kaplan, our President and Chief Executive Officer; Bill Kamer, our Chief Financial Officer; and Ted Guth, our Executive Vice President. Please note that this 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 7 days. Our press release and supplemental package have been filed by Form 8-K with the SEC and both are also 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, assumptions made by and information currently available to us. The actual outcome will be affected by known and unknown risks, trends, uncertainties and factors that are beyond our control or ability to predict. Although we believe that our assumptions are reasonable, they are not guarantees of future performance and some will inevitably prove to be incorrect. Therefore, 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 the current SEC filings, which can be accessed in the Investor Relations section of the Douglas Emmett website.

Please note that the market data sources that may be referenced in management's remarks are, CB Richard Ellis for the Honolulu and Los Angeles office markets; Reese for the Los Angeles office market; M/PF Research for the Los Angeles multifamily market; and Property and Portfolio Research for the Honolulu multifamily market. Once we've reached the question-and-answer portion, we request that all participants limit themselves to one question and one follow-up per person. This is in consideration of the others who are waiting. I will now turn the call over to Jordan Kaplan, President and CEO of Douglas Emmett. Jordan?

Thanks Mary, and good morning, everyone. I will start with a brief update on our leasing fundamentals and financing program. Ted will review our second-quarter financial results and Bill will conclude with additional comments on financing and our advised FFO guidance for this year.

In contrast to recent headlines about national and Global economic uncertainty, we continue to see a steady recovery in our markets. Fortunately for us, job creation within California has been improving and it is concentrated among highly educated people in professional services and technology who live along the California coast, where our properties are located. We have seen this improvement reflected in the steady progress that we are experiencing in our leasing fundamentals. In our multifamily communities, the leased rate remains over 99% and revenues are increasing at an accelerating pace. We expect that this trend will continue.

During the second quarter, our office portfolio had 15 basis points of positive absorption; this is our second consecutive quarter of positive absorption, and our office leasing volume remains strong. During the second quarter, we signed 204 leases, the largest number in our history. Of the almost 700,000 square feet of new and renewal leases we signed in the quarter, over 263,000 square feet came from new leases.

Overall, our office leasing program during the first half of 2011, was somewhat better than we initially expected. We now anticipate that our office portfolio occupancy at the end of 2011 will be slightly positive when compared to the end of 2010.

Before I turn the call over to Ted, I want to say how delighted I am that we have completed our term loan financing program. Since September of last year, we closed 6 term loans, aggregating more than $2.5 billion at a weighted average rate of 4.07%. Our property level debt structure is very labor-intensive and takes time to complete. But it was clearly worth the wait. We have locked in historically low interest rates, while retaining a debt structure with exceptional flexibility and staggered long-term maturities. With that, I will turn the call over to Ted.

Thanks, Jordan. Good morning everybody. Our funds from operations and our adjusted funds from operations include -- increased in both the second quarter and the first half of 2011, compared to the same periods in 2010. For the second quarter of 2011, FFO increase by 24.5% to $0.37 per diluted share. For the first half of 2011, FFO increased by 29.3% to $0.77 per diluted share. AFFO increase by 32.7% to $0.29 per diluted share for the second quarter of 2011, and by 25.6% to $0.59 per diluted share for the first half of 2011.

As we mentioned last quarter, the amortization related to the swaps we turned in last December has no impact on either FFO or AFFO this year. For the second quarter, GAAP interest expense was increased by $4.48 million as a result of that non-cash amortization, which was then in calculating FFO offset by an equivalent $4.48 million, leaving a net zero impact. FFO was only affected last year at the time the swaps were terminated, when their full impact was recorded for FFO purposes. In the third quarter, there will be a final similar add-back covering one month of amortization.

G&A totalled $6.8 million for 4.7% of total revenues for the second quarter of 2011, and $14.3 million or 5.0% of total revenues for the first half of 2011. Our same-property metrics for our office portfolio were slightly down in the second quarter, while our multifamily same-property metrics continued to improve. Overall, same property net operating income in the second quarter of 2011 decreased 3.9% on a GAAP basis, and 2.3% on a cash basis when compared to the second quarter of 2010. Same property total revenues in the second quarter of 2011 decreased 1.6% on a GAAP basis and 30 basis points on a cash basis when compared to the second quarter of 2010.

We continue to see improving demand from tenants in our sub-markets. Santa Monica and Olympic Corridor showed the most improvement in the quarter followed by Honolulu. Of course, occupancy in any specific sub-market in any given quarter can be affected by the decision of 1 or 2 tenants. On a blended basis, annualized tenant improvements, leasing commissions and other capitalized leasing costs in the second quarter averaged $3.94 per square foot compared to $3.63 per square foot in the first quarter. Most of this increase related to a single lease where we are converting retail space into traditional office space. Excluding this one transaction, our annualized tenant improvements, leasing commissions and other capitalized leasing costs in the second quarter averaged $3.71.

As Jordan mentioned earlier, we had another quarter of healthy leasing volume. During the quarter, we signed 204 new and renewal office leases, totaling almost 700,000 square feet; compared to 185 new and renewal leases, totaling 709,000 square feet in the prior quarter. During the second quarter, we signed 86 new office leases totalling 263,000 square feet; compared to 81 new leases, totaling 261,000 square feet in the first quarter.

These new tenant leases resulted in 22,000 square feet of net absorption in the second quarter. The lease percentage for our total office portfolio increased again to 88.8%. The occupied percentage for our total office portfolio remained flat at 86.7%. Our multifamily portfolio was 99.4% leased at June 30, 2011, compared to 99.6% at March 31, 2011.

During the second quarter, the mark-to-market and rent roll metrics for our office portfolio were as follows; on a straight line basis, our average rent from expiring leases was 7.2% higher than the average rent from new and renewal leases signed for the same space. On a mark-to-market basis, our in-place cash rents were 11.4% higher than our asking starting rents. This percentage is unchanged from last quarter.

On a cash basis, our ending cash rent from expiring leases was 15% higher than the beginning cash rent from new and renewal leases signed for the same space. This largely reflects built-in growth from the 3% to 5% annual rent escalations contained in almost all of our office leases. With that, I'll turn the call over to Bill.

Thanks, Ted. I will now provide an update on our financing activities and share our current thinking about our future financing activities. A lot has occurred since June 30. To help you understand our current debt structure, page 13 of our supplemental package includes an updated debt schedule as of August 1, reflecting our new loans, associated loan repayments, and interest rate swap expirations.

In July we closed 2 loan transactions totaling $885 million. The first loan is a secured non-recourse $355 million, 7-year term loan, which matures on August 5, 2018 and bares interest at a fixed rate of 4.14%. The second loan is a secured non-recourse $530 million, 7-year term loan maturing on August 1, 2018. We have effectively fixed the floating annual interest rate on this loan to an interest rate swap contract at 3.74% until August 1, 2016.

Since September 2010, we've obtained 7 term loans totaling approximately $2.55 billion. Of this amount, all but $16.1 million is fixed at a weighted average annual interest rate of 4.07%. When we first announced our refinancing program last year, we had loans maturing in 2012 totaling approximately $2.7 billion. We now have only one remaining loan with an outstanding balance of approximately $522 million that matures on August 31, 2012. Related to this loan, we have interest rate swap contracts that fixed the rate on $322.5 million until August 1, 2012.

Since our earnings call last quarter, we used our ATM program to raise over $61 million in gross proceeds from the sale of 3 million shares at an average price of $20.35 per share. It is our current thinking that we will repay the $522 million loan, utilizing a significant portion of our cash on hand, which is over $300 million, as well as proceeds from a new secured revolving floating rate credit facility, which we would put in place at some point in the next several quarters. Based on this strategy, we currently expect to terminate the $322.5 million swap before the end of 2011. Our preliminary estimate is that terminating this swap would reduce 2011 FFO by approximately $10 million, although the actual cost will depend on future events. In any event, we are still evaluating our options, including the decisions concerning a potential credit facility and the swap termination.

Now turning to guidance. We are increasing our full-year 2011 FFO guidance to a range of between $1.32 and $1.36, the new midpoint is $1.34. In providing this guidance we are assuming the total interest expense affecting 2011 FFO will be between $148 million and $150 million, representing lower interest on our debt, which is largely offset by the $10 million of costs that we would incur if we terminate our $322.5 million interest rate swap. A minor change to the weighted average diluted share count for 2011 to 160 million shares as result of the 3 million shares that we sold under our ATM program. No change to total FAS 141 income, we still estimate that it will range between $20 million and $21 million. No change to straight line income, it is still estimated to range between $7 million and $8 million. A small decline to G&A, we now anticipate the G&A will range between $27.5 million and $28.5 million, instead of $28 million to $29 million. No change to recurring capital expenditures in our office and multifamily portfolios. We continue to estimate $0.25 per square foot for our office portfolio and a range of $425 to $475 per unit for our multifamily portfolio.

This guidance excludes any impact from future acquisitions, dispositions, equity issuance's or repurchases, debt financings or repayments, recapitalizations or similar matters. As stated above, we have revised our guidance to include a $10 million reduction in FFO, resulting from the anticipated termination of our $322.5 million swap before the end of 2011. With that, I will now turn the call over to the Operator so we may take your questions.

(Operator instructions)We request that all participants limit themselves to one question and one follow-up question per person. This is in consideration of others. Your first question comes from the line of George Auerbach with ISI Group.

Great, thank you. Jordan, just a clarification on your comment about occupancy guidance for the year. You're saying that occupancy would be higher at the end of the year than it was at the start of the year. Is that relative to the 86.9% overall office lease rate or the 88.1% excluding the JV properties?

This is Bill, hi, George. Relative to our year-over-year occupancy, so we are saying now, as you know, our guidance has been flat for year-over-year, December 31 2011 over December 31, 2010 for the entire portfolio. And we've now seen, as Jordan indicated, performance so far this year has been somewhat better than we anticipated. So we think it's going to skew to a slight positive instead of flat.

Great. Also just on the JV page 10, the line equity allocation in basis difference of around 1.3 million in the quarter, what does that relate to?

I think that relates to a priority distribution -- that primarily relates to a priority distribution that we're entitled to receive from the fund.

That's why your share of FFO seems disproportionately large relative to the overall?

That's correct.

All right, thank you.

Your next question comes from the line of Alex Goldfarb with Sandler O'Neill.

Yes. Hi, good afternoon. Jordan, if you were listening to one of the office conference calls yesterday, there was some discussion about companies entering different markets and Westside LA was mentioned. I know that you guys in the past have mentioned about new people coming in and what that's done to values. But seeing as your market remains one of the focal points for outside investors, curious how that's changed your underwriting and if that means that there may be less opportunities for you? In a sense maybe, Douglas Emmett needs to explore going to new markets? Or in fact, there's still enough opportunity in there, despite all these others who want to enter that you still see staying in your existing markets?

Let's see --

Before Jordan comments, Alex, I just wanted to mention in having listened to some of those calls, I think one of the other takeaway's from the calls was the comment that it's difficult for people to come into the markets and acquire any significant position, because of effectively our existence is the dominant landlord in our market.

You're talking about Mark's comment?

Yes. I guess my question is, with people looking who want to come in -- (multiple speakers)

Let me say this, it's a market where there's always people looking to get in. I don't feel any difference in pressure, from whether -- I mean, VXP is trying to buy here or if [Arnayto] is trying to buy here or some sovereign fund or just other big funds. Or the whole group of billionaire's, that just like buying buildings here, all cash. So there is always plenty of competition for us when we are bidding to buy buildings. I don't feel any change in that, if that's the question you're asking.

Yes, that was my question, if you felt any pressure, that maybe it is my more difficult to acquire now and therefore maybe it is worth exploring entering other markets?

No. Let me just say, buying a building is just, especially a marketed building, it's always a painful process, bidding. The reason you get the building is you're the highest bidder and there's always other bidders. But I still feel like because primarily because of that, like this is the best market for us to operate in because this is where we have the most edges. Whereas going to somewhere where maybe the grass looks greener on the other side of the fence, it's always risky because there, you're an outsider coming into that market, that's why we win the bids here. That's why we end up with the buildings that we want, is because we have a better feel for cost structures and rent and what could be achieved in these buildings and someone coming from the outside that isn't as confident in their assumptions.

And we also have the critical mass that I think that they were talking about on their call, that's a problem for them coming out here.

Right. Okay. Thank you.

The next question comes from the line of Michael Bilerman with Citi.

Hi, it's Josh Attie with Michael. When you look at market rents and then you also look at the rents that are rolling in your portfolio over the next 12 to 18 months, do you think that spreads are close to a bottom at down 15% this quarter?

I think what our feeling was, that we were going to do with that spread for the next couple of quarters and it would start recovering. And it starts recovering basically because we're trailing behind us the anchor of the fast rise-up of '06 and '07. And then when the market started dropping again at the end of '07 and into '08, then you have leases that were signed at lower rates as compared to the rates that we're signing in today. So then the spread starts collapsing and within some quarters after that it will flip itself back around again. And you could just do a backwards look five years, look at the environment that we're comparing against. Because today, our feeling is rents are flat, maybe they have a little bit of even an upward look, but it can't overwhelm the fact that we're having a steep rising period from five years ago that we're still facing. You just look backwards five years, see what's going on, and you'll see how the comparison will move going forward.

Right, you'll be rolling more difficult rents over the next 3 or 4 quarters; so unless the market rents improve, your spreads will be worse than 15%?

I don't think they move a lot worse. And I think they turn on the themselves relatively quickly, the same way you saw us go into the recession relatively quickly.

Right. And remember that because we have these built-in rent escalators in the portfolio, the translation of those roll down and rents doesn't affect our NOI. So NOI from the rental rates in the portfolio has actually continued to be slightly positive throughout this period. It's because the rent-bumps of 3% to 5% affect a much larger percentage of leases.

Okay. Thank you.

Your next question comes from the line of Brendan Maiorana with Wells Fargo.

Thanks, good morning out there. So a question with a bias to pay down the remaining debt maturities with cash and then on the line. It seemed like, I'll call it, the bias to do that may be driven by what you see as less acquisition opportunities that are out there, so less ability to use that cash in the near-term? Or maybe a view that interest rates are going to stay low for an extended period of time? Am I reading that correctly and what's the rationale to pay down the debt as opposed to keep that cash on the balance sheet?

Just the simple economics of it is I'd much rather use the cash particularly on a credit line to reduce our interest expense, so I like that process. And we still have the flexibility in the credit line and access to it, but we're using the money to reduce our interest expense. I'm not giving an indication and I don't think that we'll be able to buy properties or anything.

So if acquisition opportunities do kind of move up, the decision is, as opposed to maybe taking refinancing that debt at what you've done pretty attractive rates today, the outlook would be if you could do that in the future you still think rates are going to be pretty low?

Okay, you are asking two questions. You're asking our outlook of what we think rates are going to be and then what will we do if acquisition opportunities come up? So first of all, we are buying stuff in the fund right now so we have the capacity of the fund. We have a lot of capacity to buy. And built into the fund -- I don't know, what do we have, $150 million, $200 million left?

$300 million to $400 million of buying power still left.

In terms of outlook for interest rates, we are no better at it than you guys are or your economists are. But in terms of putting your money where your mouth is, you just saw us do a ton of debt and fix it going out. So we like where rates are today and didn't make a bet and do a bunch of floating rates.

Brendan, let me say very simply, the consideration in terms of our current thinking is, we have a large and growing amount of cash that, based on rates that are available in deposits, or you're getting basically nothing for it, and that's growing. And to reduce leverage and reduce interest costs is just, as Jordan was saying, is just a better economic proposition. But it is neutral to our ability to access the funds by putting it in place with a credit line and that's what our current thinking is. Having said that, as we said a couple of times in our prepared remarks, for some of the reasons you're mentioning, which is credit markets and interest rate environment certainly has been changing over time. And we are going to monitor that going forward and we are going to wind up making what we think is the best execution. But we are sharing with you what our current thinking is.

Okay, that's helpful. And just a quick follow-up. Jordan, maybe a year ago -- I don't know maybe it was a little more or less than that -- I think you mentioned that your goal would to de-lever by $300 million. You have roughly $300 million in cash on the balance sheet, so is this assuming that, that's the effective amount of de-levering? Or do you think that there is more to come via ATM usage or some other form?

I would say this, I like the extra bonus we're getting by first of all using cash found on our balance sheet to reduce our interest expense, and also it does de-lever us. Beyond that, as Bill said, we're going to make decisions going forward. And you're right, I said that I would like to have less leverage, and this does result in us having less leverage.

Okay, thank you.

Your next question comes from the line of James Feldman with Bank of America.

Great, thanks. I was hoping you could talk a little bit about fundamentals. Jordan, in your commentary you had mentioned that tech and media are kind of keeping things pretty strong. As we've seen in New York, it seems like things are starting to moderate. What gives you comfort that those sectors are going to stay strong here and what should we be watching?

Bill probably has a better answer for this than I do, and I'll let him answer it. But the one thing I want to say is, I'm not just relying on tech and media. I feel like, and this is almost a broken record, but I think we have five, six, seven major industries that are going to support us going forward. You're talking about markets that TARP had a huge impact on that were dependent on the financing, the finance world. And that they got to speak in fusion, a very rapid run-up even in the face of the recession the rest of the country was in. Our industries, whether it be healthcare, tourism, entertainment, the big education infrastructure we have here and healthcare research, import, export, whatever, that mix, all of which are great strong industries, are what I'm relying on long-term, not just the two that you mentioned and why I feel good about our future prospects.

And the thing that I would add to that is, we see these commentaries that come along. I think mostly they're comments by people that just can't avoid a perspective from where they are located. So people tend to view our markets with a focus that's very New York centric. And as we've commented before, New York, because of all of the government money that went into necessitating the financial services industry, saw a much earlier and more robust recovery. Now we're reading and hearing that there may be some slowdown in that, as those programs ease off and things settle out in the financial services industry. So people then come and look at our markets and kind of try to put a same viewpoint on it. As we've been saying all along, our recovery from industry sectors is not coming that way. It is from a broad group of tenants.

It has been tech and media and other entertainment. But for example, in the past quarter almost a quarter of all of our new -- so new marginally additive leasing activity came from law firms. Accounting and consulting firms were extremely strong too; I think between those two sectors, it was over a third of our new activity. So we're are seeing a very broad-based set of demand. Again, our view of the market profile is that we are on track with where we thought we'd be at the beginning of the year as we see this recovery, but elevated somewhat. And we see it as kind of a steady progress along the way.

Okay. And then can you talk a little bit about what you're seeing so far, in terms of leasing velocity in the third quarter? And also the San Fernando Valley?

It's too early other than anecdotally. But I think anecdotally we're continuing to see the same factors, the same forces in terms of strong volume across our market. I will say that if you are asking for some differentiation in the sub-markets, Santa Monica has been, and followed by the Olympic Corridor, have been our strongest markets. Santa Monica, the phrase that's been used in the business press of the Santa Monica and other markets on the coast being referred to as Silicon Beach, has been very strong. And then we're also seeing a lot of that strength as well in Sherman Oaks Encino, where we've seen, as we talked about in prior quarters, a number of entertainment and tech companies locating there. Of our sub-markets, those would be the strongest ones.

Thank you.

Your next question comes from the line of Rob Stevenson with Macquarie.

Good afternoon, guys. Can you talk a little bit about your approach these days to apartments? Is it a situation where you're looking at some of the acquisitions that are going on and it's just too pricey? Are you guys sort of out of the apartment buying mode, at this point?

No, we would like to buy apartments. We are in the apartment buying mode. Now, I don't want to talk about individual deals, but I mean we are interested in buying, but I would say we are picky (laughter).

What's the sort of profile of the stuff you're interested in at this point?

It's the same profile that we look for in office buildings, which is in high-amenity markets that are supply constrained, that are near kind of the prime office corridors to say in reverse, because when we talk about office, we say near prime executive housing. So there's synergies for us. We need the high-amenity, high-quality units because we run a very high-service operation. But we are still very interested in adding apartments to our portfolio.

Okay. Then secondary, there's been a bit of a pickup in transaction volume on the office side in the Valley. Is most of what's coming down the pipeline sort of lower quality stuff? Or is there starting to be some higher quality stuff that from a pricing standpoint is more comparable to yours?

There's a lot going on so I don't know exactly which deal you are talking about and trying to compare it to ours. But when something comes up that is comparable to ours, in general you're seeing us buy those buildings. Because we are happy to add. And if it is in our markets, we're happy to add them.

Okay. Thanks guys.

Your next question comes from Rich Anderson with BMO Capital Markets.

Good afternoon. The comment, it was emphasized, in-place cash rents were 11.4% higher than asking rents, and that was no change to the quarter. Can we infer that to be in what could be an inflection point in operations? I know you're talking about better occupancy, but can you give a little bit more color on what your view is about a potential inflection point in operations and any specifics behind that, regarding your larger tenants and the pushback you've seen in the past?

We've said all along we think that to really move rents, we're going to have to see somewhat of an increase of 100 or 200 basis points of occupancy. That being said, I think that we do feel like rents have moved to a bottom and that there is now some light towards moving that out. But how fast that happens and where, that will be to see in the future quarters.

So none of that -- all the guidance increase was almost entirely interest expense related and the offset being the swap charge and that's it?

No. Let me give you the components of the guidance change. We have lower interest expenses than we anticipated for the year of, call it around, $0.05 more or less. And that came as a result of having a longer period of floating rate loans than was in our original guidance coupled with the fact that we have been achieving lower interest rates on the deals that we've done than we anticipated as well. It is a combination of those two factors. That amount more or less $10 million, more or less $0.05, largely offset by the fact that we have changed our guidance now and are anticipating as we discussed in terms of our likely financing strategy for the rest of the year, that we will terminate our 2012 swap expiration this year in connection with repaying the remaining loan and that will be an additional $10 million. So that's more or less offset. That gives you a net $0.03 difference. That net $0.03 change in guidance from where we were a quarter ago is driven by a number of factors, higher NOI both on the residential side and on the office side and various miscellaneous things including the lower G&A that we mentioned in our assumption, all of which adds up to about $0.03.

Okay, great. Thank you. And then on the multi-family site, you mentioned and you've been saying this for a while, the CapEx of 420 to 475, which understandably a different type of multifamily product and the multifamily reach generally owned, but is there any issue there in terms of deferred maintenance or whatever that you might have to go back there and start spending more on those properties over time?

No. As Jordan mentioned before, given the clientele we have in the bulk of our units, it is a very high service oriented clientele so the properties are maintained at high levels to reflect that, reflect the people who are staying. So no, it doesn't.

Okay, great. That's all I have, thanks.

Your next question comes from the line of Michael Knott with Green Street Advisors.

Just wanted to go back to the recently seen velocity question, just a little bit. Just curious what you may have seen even towards the end of the second quarter and so far early in this quarter in terms of, are tenants willing to take new space and continue with prior existing business plans irrespective of kind of the negative headlines we've all been seeing?

That's why Jordan tried to address that at the beginning of his comments. We have not seen in terms of tenant behavior any indication that relates to the headlines or government -- (multiple speakers)

I don't think our tenants were getting ready for the government to shut down. They just kept rolling forward assuming they'd make a deal. So they called it right. We haven't seen the velocity slowdown.

Okay. And then any comments on sort of tenant expansions within your portfolio? Is that picking up at all?

Yes, I think the fact that I mentioned before about the large portion of our new leasing volume coming from law firms and accounting firms as being new, does reflect the fact that we are seeing some levels of re-hiring among the tenants and we are seeing marginally -- I wouldn't say it is a huge differential -- but marginally greater number of renewals with expansions and renewals with contractions at this point. But again just pulling back from this, I think the important thing -- because I think this is ultimately where all your questions are coming from -- which is are there dramatic differences that we are seeing either negative or positive in the profile of leasing. And what our current thinking on this area and what we are experiencing is the steady pace that we saw at the beginning of the year somewhat elevated from our initial expectations. That's just continuing whichever version of this you're looking at.

There's a lot of little detail on what's going on, on the leasing but the number that, if you want to talk about them, inflection points or something like that, it's the fact that we finally turned a positive absorption. There's a lot mixed in there, expansions and less defaults and things like that. But at the end of the day, those all come together and either you're getting positive or negative absorption and that's going to give you the best directional evidence of where people are headed. Now we are on our second quarter of positive absorption. That's better than good news. That's great news.

I agree, thanks a lot for that. Just one more question. Jordan, why do you think there hasn't been a lot for sale yet in your markets, and has the pace been disappointing to you, and you expect that to pick up in terms of investment opportunities?

It is always disappointing to me that more is not for sale that we can buy. And I have to say, I feel like from what I expected it has been slower and I spent a lot of time trying to think, why aren't these guys getting this done? Maybe I'm wrong or it is just, it seems like the summer, more than past summers -- maybe people were on more alert past summers, I don't know, or more nervous. This summer it's just been much harder to get peoples' attention, people don't want to start things until after August.

It is just been a slower summer than I would have otherwise expected. And I'm hoping that's all it is. And that people get back in the game, because I know deals out there where people are saying, yes, we're at the point where we're going to get something done here, but they are just not getting it done, done. They get it out and get it marketed. We are still following a good amount of stuff. But I hope it is just longer summer vacations. But I don't know the real answer.

Thanks a lot.

Your next question comes from the line of Ross Nussbaum with UBS.

Hi, guys, good afternoon. I'm wondering, in light of the comments on the market from a transaction point of view, have you looked at divesting some assets, perhaps things like Warner Center, as a source of funding going forward from a capital perspective?

I can't say that considering -- let me say this. Considering that in the markets we are in we still think it is a good idea to buy more buildings in those markets, it would be odd to sell what we think are some of the best buildings in those markets, which we already own, to buy other buildings in those markets, since it is all the same pricing environment that we are dealing with. So I can't say we're thinking that hard about selling buildings in what I think are great markets to buy in, in order to buy more buildings in those markets.

And remember before the IPO, which was not that long ago, that the Company did go through the portfolio and look at the various buildings that were in the portfolio and to the extent that any of those buildings did not seem to make sense going forward, had disposed of them.

We sold a bunch of buildings.

That's fair. I was just looking at your sub-market portfolio and thinking ultimately when you run down the occupancy rates, is Warner Center going to be challenged perhaps more so going forward of the next few years than your other sub-markets and would this be an opportunity to take advantage of it?

That's a good point and that causes you to look at Warner Center but it means that the opportunity to outperform is more in Warner Center than anywhere else. I wouldn't want to sell one of my markets that I think has good long-term perspectives when it's down. You want to sell it when it is doing particularly well and people are ascribing a very high value to it. So we are still willing to buy there.

Okay. And then lastly, obviously you had a great quarter on a gross leasing perspective and were positive on the net absorption but it would suggest that you still had quite a few tenants who were churning out of the portfolio. The tenants who aren't renewing, where are they going?

Before I say that, the point you're making is really the point that we were trying to make in terms of the idea of there being steady progress, which is the volumes now for a number of quarters have remained very consistently at extraordinarily high levels on the gross leasing side. And what's been happening, as we anticipated it would, is on the outflow side, it has been decreasing. And so the lines crossed. Now we are seeing positive absorption and we anticipate that, that trend of greater positive absorption as we maintain high leasing volume and as the outflows further decrease, will continue.

Mainly the outflows come from consolidations and down-sizings that are still layoffs that occurred at some point before leases come up for renewal. They want to use their space more efficiently and so they down-size. Or different units that are consolidating. Sometimes there are moves that tend to be within our sub-markets and it tends to be specific to the tenant. You may have a tenant who they were on two floors with us and they down-sized. They've had some layoffs and now they are fitting in a floor and half, but they're at a size where on another building with another floor plate, they can fit more efficiently all on one floor. So they make that kind of move. It is that sort of thing. It is not moves that are occurring where they're moving to other buildings or other sub-markets.

You think we are in the seventh or eighth inning of that?

Of the down-size?

That's something that's always going to occur. If you don't have the right fit for the guy and he's made a change in the way he's operating, then he's going to go where it is the right fit. The things that cause you to lose tenants are, they move to a new space, they shrink or they default. Defaults are down and shrinking is down and we don't tend to lose many to just the fact that they are moving unless there's some structural reason why we can't accommodate them in one of our buildings and that's always something that's going on.

Where I'm going is, does the occupancy rates start going up because the gross leasing activity is going to be improving or is it going up as you're maintaining that gross leasing, but you've got fewer tenants turning out?

It's the second one. You've got, really, fewer defaults and fewer guys shrinking and staying in the portfolio but shrinking. Less of those two things, which are I think direct symptoms of the recession, and our leasing velocity has stayed the same, and therefore in terms of inflection, those lines have crossed now, and now we are getting positive absorption.

The room for that improvement is large. We are already into positive absorption for a couple of quarters, but we don't need -- as a matter of fact, it is hard to even imagine having higher gross leasing activity than we've had over the last number of quarters because it's just been so huge. But there's a lot more room for the outflows to continue to decline, because normally at this pace of inflow, we would be seeing huge increases in occupancy, and we are heading in that direction and making steady progress to getting there.

Not to belabor the point, but do you have numbers behind your renewal percentages, what you're renewing now versus maybe a year or two ago?

In terms of retention, it is more or less the same. That's not really tremendously different.

It is also a very misleading number. It is not a good number to use to figure out what direction things are going. And in the best of markets, in the worst of markets, those numbers still stay sort of similar.

Appreciated. Thanks.

Your next question comes from the line of John Guinee with Stifel Nicolaus.

Hi, this is just, Jordan, a curiosity question. When you got -- [couple of them] has an incredibly focused investment strategy and my guess is that you do a bottom-up approach which means you sit down with your deal team and you have a list of all the buildings in your focused sub-markets. You toss out buildings that don't fit the certain quality standards, and you come up with a certain number of buildings and a certain number of square footage, amount of square footage that you are interested in. And whether it is Honolulu, West LA, Century City, San Fernando Valley, does your total target list that you are tracking total 50 buildings and 5 million square feet or does it total 200 buildings and 40 million square feet?

You know, first you're exactly right and we actually have a list and I'm not remembering the numbers, but I had -- we had to do that exact analysis when we were raising that last fund. So we've done it and the number is closer to what you gave, your first guess. It's not 200 buildings, it is more -- it is less than 150, 75 buildings. I don't remember the number but we actually have them all listed.

Would you mine forwarding that list to me? (laughter)

As soon as we complete the final purchase on that list I'm going to send it to you.

Thanks a lot.

You have a follow-up question from the line of Michael Bilerman with Citi.

Bill, in terms of the $0.06 swap termination charge, when are you expecting that, the third quarter or the fourth quarter?

Fourth quarter.

So thinking about quarterly guidance for the back half of the year, so the back half of the year you've basically got $0.55 to $0.59, just backing up the $0.77 from the $1.32 to $1.36. So from a trajectory standpoint 3Q versus 4Q., what else is going on that would alter that quarterly guidance?

I don't have in front of me broken down -- first of all, we haven't given quarterly guidance, but other than the big number that you are talking about which is, we're anticipating guidance, $0.05 hitting in Q4 for the swap termination in Q3. I don't have all the other differences. Obviously your seasonality differences in Q3 and Q4, that would come along. Normally you would have higher expenses in Q4 than Q3, just normal course. But I don't have it allocated between quarters.

$0.05 or $0.06?

Excuse me?

You said $0.05. It is $0.06, right?

I think about $0.055, or so.

$0.055. Then I guess the other impact is if you take the loan, which is swapped out at 5% and go floating, that's going to have a bigger effect on 4Q relative to 3Q?

It depends -- in terms of the interest effect going forward, it would depend on when in queue [four] it terminates. (multiple speakers)

I'm saying you're carrying it at 5% now in the third quarter. In the fourth quarter, 5% is going to drop down to a pretty low rate. That's going -- (multiple speakers)

Depending on when we do it in the fourth quarter.

Depending on what the rate is, depending on how much we pay down, what the rate is for an replacement financing. But yes, the swap otherwise expires on August 1 of next year, so from the date of termination to the August 1 scheduled maturity date, there would be lower interest expense than you'd see with the 5%.

Now the assumption is, you're going to take the 330 cash. How much of that cash are you going to use to pay down the loan? Because that's going to go the other way, right? Because your earnings [about just] on the interest today, and you're going to pay down so that's going to have some effect as well. How much of the cash is being used?

That's what we said before. Here's the thing, just to step back a second. We've been running a sprint in the form of a marathon for the last -- since September to get seven term loans done and refinance everything and reschedule it and we just completed that. We are now saying, okay, that activity is completed. Now we are saying, okay, what's this cleanup activity we have and how do we get the best results from it? So we are going to take time because we have the time now to focus on the best options, so that mix of how much did we pay down, how we structured exactly, we're going to start working on that and get there over the next several quarters but that's exactly what we don't have nailed down yet.

I'd asked at the beginning of the year as you looked out at all the refinancing activity that had planned, given the fact that it was going to be dilutive to your numbers, where would you end up? And now that you're passed the sprint, you got through it and everything is done and you'd got it done at unbelievable rates, where does that quarterly run rate take you into 2012? Because if you're at this, let's call it, low 30s number, 31, 33, excluding the charges based on your guidance -- (multiple speakers)

Michael, you've been very consistent the last couple of quarters in asking for that. And actually when we were going through and made the decision to put in the August 1 debt schedule that we put in, going forward on -- page 13 of the supplemental that gives all that, I was actually thinking of putting a ribbon around it --

That's why Bill put your picture next to it, on the thing.

That's it, either you've got all the rates laid out in that -- (multiple speakers)

We did the August one, because we wanted you guys to be able to figure out an interest run rate and so you have all the new debt costs and everything on that schedule.

The only thing you need to adjust for is, in the $522 million which is -- we've given you all of our current thinking on it -- (multiple speakers)

You just have to make an assumption about it.

You just have to make some assumptions on how much of that debt is left and what you think the interest rate will be on the portion is left. But everything else in the whole debt stack is laid out.

So now with all this free time, because you've been so labor-intensive over the last year, what do you?

Go to Disneyland. (laughter)

But seriously, I guess now there is free time in the Executive Management team. What's the big next project? What's the big focus for Ted, for Bill, for Jordan? It's obviously been an extraordinary amount of time getting this stuff done over the last 12 months. You definitely have a lot of resources that you can throw at something. What is it?

I tend to stay on the capital market side so I'm focused on acquisitions and other financing's that are coming up and all that stuff. And Bill and Ted float back and forth, so Bill will probably float back towards operations for a little while, and then if I'm working and something heats up, he floats back over to my direction. I'm not going to cut his pay or anything now that he's got this done and isn't working as hard.

I will say, I think we all felt we had full-time jobs before last September when we started the program. So I think going back to a pace where we can look forward and spend some more intense time planning and making moves and fine-tuning the machine I think is still a job that we used to think was a full-time job.

The last one just on the March 20 term limit, $350 million, what are those conditions upon which that could be extended from 18 to 20? What needs to be satisfied?

Forgetting what's in that, it is pretty general test. It's probably a debt yield test, but frankly I forget.

Just because, while you did stagger your maturities, you still got a bulk load going from October of 2017 to August of 2018. And God forbid that March 2020 loan goes to 18, you are going to have 60%, 70% of your debt rolling within a 12 month period again.

Right. The anticipation is that, that loan will go to 2020 and the tests are set in a way that makes that highly probable. But beyond that, one of the things in my ample free time, as you're trying to remind me of, going forward is going to be to work on financing's that come along between now and then, so that by the time we get to 2018, we'll have things spread out over a longer period of time going forward from there.

Right, so the idea is, more so when the swap comes off, you'll extend it out rather than wait until the final maturity?

Well, the key thing that Jordan touched on at the end of his prepared remarks to keep in mind with our debt structure is, it is equally achieving very good rates, and -- this is our main focus -- maintaining maximum flexibility, because none of us are smart enough to predict interest rates or how credit markets are going to be in future. And we've been able to achieve that. We have very long windows with each of our loans where we can very -- (multiple speakers)

Inexpensively.

Inexpensively refinance and further stagger maturities. We've made a lot of progress in that direction but the intent would be to make a lot more over the next several years.

We watch spreads and we watch all-end rates and sometimes we refi much earlier than when the loan comes due, because of that and sometimes we wait longer.

Okay. That's helpful. Thank you.

We have a follow-up question from the line of Rich Anderson with BMO Capital Markets.

I was actually trying to get out of the queue, I guess at the risk of repeating -- -- (laughter)

You can just call in as a well-wisher. You don't actually have to ask us another question.

Okay, great. Fantastic quarter. (laughter)

Okay, and we have a follow-up question from the line of Brandon Maiorana with Wells Fargo.

Thanks, just for Bill, I wanted to follow-up on the guidance and the debt. If I look at -- and I appreciate the schedule on page 13; it is very helpful. But if I look at any of your guidance of interest expense at the back half of the year, it is about $84 million compared to -- assuming the $148 million to $150 million for the year versus about $64 million of FFO impact interest expense recorded in the first half. That's around $42 million a quarter versus doing $36 million, a little more than $36 million, in Q2. Included within guidance, does that assume that the repayment of the remaining $522 million just happens at the end of the fourth quarter or is there something else that would drive that number up in the back half of the year relative to where you were in Q2?

No, it is not assuming that we get any benefit from paying, or detriment, from paying that off sooner. That's why the guidance, we indicated in the guidance, it excludes any effect from any refinancing so it assumes -- (multiple speakers)

I didn't follow your numbers, but the cost of swap breakage, an estimated cost of that, is in there so -- (multiple speakers)

But not any savings from pay down of the $522 million loan.

Wait, wait. Sorry, Jordan. I just wanted to make sure. The $6 million is included in the $148 million to $150 million?

Yes.

Yes.

Okay. Got it. That makes my numbers come out a little better. All right, thank you. (laughter)

There are no further questions in queue. Do you have any closing remarks?

Thank you, everybody, and I look forward to speaking with you again. We all look forward to speaking with you again next quarter.

Thank you for participating. This does conclude today's call. You may now disconnect.