Douglas Emmett Inc (DEI) 2012 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to Douglas Emmett's earnings call for its 2012 second-quarter results. Today's call is being recorded. At this time, all participants are in a listen-only mode. After management's prepared remarks, you will receive instructions for participating in the question-and-answer session. I will now turn the conference over to Stuart McElhinney, Vice President of Investor Relations for Douglas Emmett.

Thank you. Joining us on the call today are Jordan Kaplan, our President and Chief Executive Officer, and Ted Guth, our Chief Financial Officer. This call is being webcast live from our website and will be available for replay for the next 90 days. You can also find our earnings package at the Investor Relations section of our website or that of the SEC.

During the course of this call, we will make forward-looking statements. These forward-looking statements are based on the beliefs of, assumptions made by, and information currently available to us. Our actual results 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 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 some potential risks, please refer to our SEC filings, which can be found in the Investor Relations section of our website.

When we reach the question-and-answer portion, in consideration of others, please limit yourself to one question and one follow-up. I will now turn the call over to Jordan Kaplan, President and CEO of Douglas Emmett.

Thanks, Stuart. Good morning, everyone. Thank you for joining us. Our leasing fundamentals during the second quarter exceeded our expectations. With a tough 2011 comparison quarter, our same-property cash NOI grew by 2.8%. We leased more new office space last quarter than in any other quarter since our IPO. We achieved our sixth consecutive quarter of positive absorption, netting 52,000 square feet of additional leasing, and have not seen any slowdown, despite well publicized national and global economic concerns. Our total office leased rate now stands at 90.1%.

I am pleased to say that we now have four sub-markets with increasing office rental rates, as Century City joined Santa Monica, Beverly Hills, and Encino/Sherman Oaks markets. Our multi-family portfolio remains fully leased, with continuing strong rental rate increases. We believe that our multi-family portfolio still has significant additional running room. As a result of our improving fundamentals, we are increasing our 2012 estimates for same-property NOI and occupancy growth, although, as we have said before, both measures are subject to quarterly variations.

As we announced a couple of weeks ago, we closed a seven-year 3.85% fixed-rate loan. We believe that the long-term benefits of locking in historically low rates outweigh the negative impact on short-term earnings. We continue to work on a variety of potential office and apartment acquisitions. A few sellers have begun to bring product to market, although it remains to be seen whether those properties will actually trade. We still hope that this part of the cycle will provide real opportunities for external growth.

Before I turn the call over to Ted, I want to mention one more thing, even though it may be old news at this point. After our first-quarter call, the Los Angeles Times published an article about our property tax appeals following the market crash. The Times said it looked at 3,000 buildings in Los Angeles County that traded during the five-year period between 2005 and 2009 which it assumed were similar to ours.

They calculated that the average reduction in appraised values for those buildings was 16%. Because that was somewhat less than the 27% reduction we got on a few properties we purchased in 2007 and 2008, the article implied that we must have received special treatment. Their story is just wrong. They inflated our average by exceeding over half of our appeals, by excluding -- I'm sorry, they inflated our average by excluding over half of our appeals that resulted in smaller or no reductions.

At the same time, they drove down their calculated average for comparable properties by including properties with base values set in 2005, which missed the three years of price run-up prior to the crash, and properties with base values set in 2009 after the market crash had already occurred. In addition, their choice of comparable buildings seems debatable, since they included 3,000 in sales from a period with less than 100 class-A office -- a period when less than 100 class-A office buildings actually traded.

In reality, the reductions we received were less than the actual peak-to-trough declines in our markets that independent experts such as Moody's, CoStar, and many of the analysts on this call estimate to be between 30% and 40%. I will now turn the call over to Ted.

Thanks, Jordan. Good morning, everyone. After beginning with our second-quarter results, I will address our office and multi-family fundamentals and provide a little color on our recent financing and give an update on our 2012 guidance. Compared to the same period in 2011, our second quarter 2012 FFO increased 5.7% to $61.6 million or $0.36 per diluted share, after treating debt interest rate swaps as fully terminated in the quarter of termination.

The increase in our FFO was more than accounted for by two items. First, lower interest expense, largely as a result of our lower outstanding debt. And second, improved revenues in both our office and multi-family portfolios. Compared to the same period in 2011, our AFFO increased 12% to $50.9 million or $0.29 per diluted share, as our tenant improvement and leasing commissions declined to more typical levels from the unusually high numbers last quarter.

For the second quarter of 2012, our G&A totaled $6.7 million or 4.6% of total revenues. Comparing the results for our combined office and multi-family same properties in the second quarter of 2011 to the second quarter of 2012 -- of 2012 to the second quarter of 2011, revenues increased 0.7% on a GAAP basis and 2.2% on a cash basis. Expenses increased by 1%, both on a GAAP basis and on a cash basis. And net operating income increased 0.6% on a GAAP basis and 2.8% on a cash basis.

Now, turning to office fundamentals. During the second quarter, we increased the lease percentage for our total office portfolio by 30 basis points to 90.1% and our occupancy rate by 30 basis points to 88.2%. During the second quarter, we signed 829,000 square feet of office leases. As Jordan said, we set a Company record for new tenant leasing in the second quarter, with over 320,000 square feet of new deals.

Our leasing spreads continue to show the impact of the rapidly rising rent environment five years ago. Although our average rent on executed leases increased from last quarter, the average rent on our expiring leases -- I'm sorry, I said that wrong. Average rates on executed leases increased from last quarter. The average rent on our expiring leases grew even more.

On a straight-line basis, our average rent on executed office leases was 8.3% lower than the average expiring rent for the same space. On a cash basis, our beginning cash rent on executed office leases was 17.9% lower than the average expiring rent for the same space. Most of this decline reflects the impact of our annual rent bumps. The negative impact on our office revenues and roll-downs, which affect approximately 11% to 14% of our office portfolio each year, continue to be essentially offset by the positive impact on the annual rent bumps in our remaining leases.

On the multi-family side, our 2,900 units were 99.8% leased at June 30, 2012. We continue to see strong residential rent increases, with average asking rents last quarter 6.2% higher than in the second quarter of 2011. Recurring capital expenditures for our apartment communities during the second quarter averaged $85 per unit.

Now, turning to our balance sheet, as Jordan mentioned, after the end of the second quarter, we closed a seven-year non-recourse $285 million term loan with fixed interest at 3.85% per annum. As a consequence, we were able to further push out our debt ladder at historically low interest rates. At the same time, we reduced our next consolidated maturity in 2015 by $100 million without any pre-payment penalties.

We left the related swaps in place until their expiration at the beginning of 2013 to fix the interest rates on some of our outstanding floating rate debt. Overall, our net leverage remains at the same reduced level, and we have ample liquidity for potential acquisitions and other working capital uses. Page 13 of our earnings package includes a summary of our outstanding debt after these transactions.

Finally, turning to guidance. We estimate that our new loan will adversely affect our FFO in 2012 by about $0.03 per share. However, we expect that this impact will be largely offset by improvements in fundamentals. Accordingly, we are updating our full-year 2012 FFO guidance to between $1.33 and $1.37. In providing that guidance, we are increasing our estimate for the growth in our same-property cash NOI by 100 basis points to between 2% and 2.5%.

We are also increasing our estimate of office occupancy growth by 0.5%. We now expect that occupancy at the end of 2012 will be about 1.5% higher than at the end of 2011. We still expect that our multi-family portfolio will remain essentially fully leased.

Given our new loan, we are increasing our estimate of interest expense after adjusting for terminated swaps to between $137.5 million and $138.5 million. We still estimate that our G&A will range between $27.5 million and $28.5 million. We estimate that our FAS 141 income will range between $17.5 million and $18.5 million. We continue to estimate that our straight-line income will range between $4 million and $6 million.

We continue to estimate that our recurring capital expenditures for our office portfolio will be approximately $0.25 per square foot and that our recurring multi-family capital expenditures will range between $400 and $450 per unit. We continue to estimate that our weighted average diluted share count will range between 172.5 million shares and 173.5 million shares.

Our guidance excludes any impact from future acquisitions, dispositions, equity issuances or repurchases, debt financings or repayments, recapitalizations, or similar matters. With that, I will now turn the call over to the operator so we can take your questions.

(Operator Instructions)

Your first question is from Chris Caton with Morgan Stanley.

Hi, Chris.

Hi, how are you? Good morning. Was hoping you could speak for a minute on the rents. You talked about the effect of rapidly rising rents at the peak of the market. When do you think you begin to see easier comps on kind of the same-store basis in the rent trend and replacement rents begins to get easier for you?

If you look at the rent on expiring leases it will be sometime in 2013 based on the expiration date, but that number actually moves around a lot each quarter, based on early renewals of space. So that we don't -- excuse me, we can't project exactly when that will happen, because it is effected by some factors. But if you just look at the expiration dates, you can see and you could expect that 2013 will be the transition year.

Thanks. And then a follow-up on one of your sub-markets. In Honolulu, the occupancy moved backwards in the quarter. I wonder what you're seeing on the ground there? Some of the hotel data has been positive there, and I wondered if you could share your perspective on the office side?

I think we see the Honolulu -- I mean, you saw this happen in Brentwood, and now it snapped back in Brentwood. And I think we see the underlying fundamentals in Honolulu being good. As you say, the economy over there seems to be doing fine. So at this point, we would just see this as one of those things where we have a little fluctuation quarter to quarter.

Thank you.

Your next question comes from Brendan Maiorana with Wells Fargo.

Thanks. Good morning out there.

Hey, Brendan.

Hey, guys. So, question, can you give us a sense of the magnitude of how much you guys are pushing rents in the four sub-markets that you mentioned?

It varies from building to building, but I would say that on a year-over-year basis, it is someplace between 5% and 10% up.

Yes, it doesn't show up if it is not in that range. It is not worth mentioning.

Sure. So let's call it roughly half of your portfolio, and you're pushing it up 5% to 10%. And Ted, you have talked about that relationship where your expiring rents, the rent spreads, the negative rent spreads are being offset by the in-place bumps. But if I look at -- and you guys have been clear that next year is that peak year, so your expirations get a little bit harder to comp against next year. But at the same time, this year, your rent spreads have gotten worse as well, a little bit in the first half of the year, relative to where were you last year. So is there a point in time when the rent spreads become so negative that they -- the in-place bumps won't be able to offset that and your same-store NOI growth might be challenged a little bit, even if you move occupancy up?

I don't expect it to be a significant impact on any individual quarter. Depending on a lot of different factors, it could move somewhat negative or somewhat positive. But I again, it will -- the majority, maybe even the significant majority in any quarter, I would not -- I would expect to be offset. So there is a little bit of headwind there, but it is not going to be a big one.

Yes, it is noise below what you see, because if we keep having positive absorption, you might just see a little less of positive NOI comparison. So it is not -- I don't think it could become a number that eclipses the other things that we're doing, whether it is slightly negative or slightly positive.

Okay. Fair enough. And the last one, it is this negative 18 spread that we saw in the quarter and negative 15 that we saw in Q1. Is that a reasonable expectation for the back half of the year as well?

Again, because of the -- because we're getting into sort of the noisy area, that is, we're now starting -- we will be seeing increasingly over the next year, some of the leases will be after the crash and some will be before. And because we don't know on any given quarter when people are going to actually renew. So even if you got somebody who is a lease that is going to be expiring in, say, 2014, which might be a post-crash lease, they may come in and renew early. So you -- that number really is hard for us to get a handle on, to be fair.

Okay. Fair enough. Thank you.

Your next question comes from Rob Stevenson with Macquarie.

Good afternoon, guys.

Hey, Rob.

Can you talk a little bit about the Brentwood market? There has been some stuff in the press that you guys signed a big lease after the end of the quarter. And what you're seeing there in that market?

It is a very strong market for us. And when we talked about it on our last call, when the market looked like it was off, we said, we think this is not a -- this is just a quarter-to-quarter fluctuation which obviously it was, and now it is strengthening. I mean, I would look for many of those Westside markets to -- I feel that they're all strong and recovering well. I don't think there is anything special there.

Does that bring you to over 90% leased in that market now?

My recollection is it puts us to like 88% or 89%.

It is 88.5%, is our thing there.

That is of June 30. Did the RBZ lease execute?

Yes, RBZ is included in our June 30 numbers.

Okay, perfect. And then, can you talk about to what extent in that market -- I mean, the construction on the 405, is that still a problem for you guys, and when that starts to abate?

Well, we're hoping it will start to abate sometime over the next year, although their projections of when they will finish, there is still a sign near my house that says that construction would be done through November of 2011. And they haven't bothered replacing that sign.

I can tell you from personal experience also that during the summer, it has abated a little just because of school. School is out. I suspect when school is back in, it is going to be just back ugly again and backing up real far.

But hopefully in the next year. The other thing to remember in the Brentwood market is that that does include the building we bought out of bankruptcy, which continues to be repo -- being repositioned now. So it has significant less -- we bought it with a lot of vacancy and the expectation it would take a little bit of time to renew that.

Okay. And then, Jordan, any thoughts on the recent Wall Street Journal article on EOP, on Blackstone selling some of the EOP assets?

Well, I mean, I hope they do. I mean, they had a quote from two years ago from me, and they did a big press release that sometime in the next two years John is going to do something. I don't know if that deserved that much fanfare. But every time I see something saying that they're going to selling, it puts me in a good mood.

All right. Thanks, guys.

Your next question comes from Josh Attie with Citi.

Thank you. On the FFO guidance, it seems like to hit the low end of $1.33, you would have to decline to $0.31, $0.32 a quarter from $0.35, $0.36 in the first half. And I know the refinancing is a little bit dilutive, but when you look at the numbers, what are the largest unknowns or risk factors that you see that could put you toward the low end?

Boy, that is a loaded question. Because we spend a lot of time staying in the range going through, because it is kind of bottom-up budgeting. So we go through and take each thing that can be impactful, we give that a range, and then we calculate out the sum of the highs and lows. And that's how we get the range that we give to you guys. I mean, it would take going back through that.

I mean, there is a lot of things in operating, like utility costs moving. We had obviously a big change in the Honolulu utility costs last year, which went from $0.23 a kilowatt hour to $0.33 a kilowatt hour.

A lot of leasing. We do range to leasing. We do range to defaults. Most of this is driven probably more by the revenue side. But there is ranges for each of those things. There is ranges for how fast something is going to lease up and when it is going to hit income and how fast -- whether someone is going to default or not default. There is a watch list. So I can't say that there is one thing that we're looking at that we're saying stretches the range down to the $1.33. It is a sum of -- gosh, I feel like there are 12 things on that page.

Yes.

So it is a pretty good amount of things.

Let me ask in a different way. Are there any large expirations in the portfolio that you don't know which way they're going to go that maybe would cause the FFO to roll down by $0.02 to $0.03 sequentially?

No.

Okay. And can you -- I know you spoke a little bit about this on the last call. But can you discuss the AIG expiration for next year? Is there any update on your discussions of them, and do you feel any better or worse about that risk going into next year than you did three months ago?

We're really not in a position to make any announcements yet on AIG.

Okay. Thank you very much.

Your next question comes from Jamie Feldman with Bank of America Merrill Lynch.

Great, thank you. I don't know if you guys have calculated lately, but do you have your thoughts on the current mark-to-market in the portfolio?

Yes, the current mark-to-market is about 8.2%. It is down from last quarter, which I think was 9.9%. So it is improving. We're not really big fans of that statistic, so we think it's got a lot of noise in it, because asking rents are kind of funky anyway. But in any case, it is improved from 9.9% to 8.2%.

Okay. Thank you. And then, Jordan, back to your comments, you're just not seeing leasing slowdown, even though there is bad news out there. Can you talk about what has changed in terms of the leasing market? It sounds like maybe even for the positive. Who were the new types of tenants that were active this quarter? What does your pipeline look like that kind of gives you conviction that it is going to keep powering through here?

Well, I think -- I mean, last quarter, I think tech was our third largest group that came in for new leases. I think that still there is a lot of -- of course, legal, accounting, finance that is in there. But you said it really after that question, which is that the pipeline still seems strong. And there is a lot of deals out there. And all the way from showings to deals in negotiation, et cetera, you can just walk through the thing. And that is what -- we have a little forward vision as there is all of that, right, because we do so many transactions. Now, we can't see super far, but we can see far enough to say we don't see the slowdown that you might be expecting from reading the papers, basically.

The other thing that we'd say is that compared -- when we went through the same summer slowdown in 2010 and then again in 2011, neither time did we see anything in our sub -- in our markets that reflected that, that on the ground here didn't seem to have much impact. But we will see.

Okay. And then just a follow-up, as you think about the leasing pipeline, how much of it is focused on the markets you -- the sub-markets you mentioned as having ranked growth? And how much of it is on some of your lower occupancy sub-markets?

Well, there is always going to be -- in terms of our focus, we're very focused on lower occupancy markets. The pipeline, I think, is mixed across the board. But it is hard for -- it is hard to see real movement in somewhere like Warner Center, where you have so much big vacancy. Still, there is good activity there, which is why we feel like we're -- just let me say this. When we were going to into the recession, we were saying to you guys, hey, we're seeing problems. And that's because we saw our pipeline looking bad. And now, we're saying we're seeing it looking good. And I'm also saying, as we've been saying about Warner Center for a while, because that's one of the lower occupancy place, it is really the lower occupancy place for us, frankly. Everything else seems to be getting up into some pretty good territory. We're seeing some good activity out there. So we're still feeling like that market can make a good -- will make a good comeback for us.

Okay. Thank you.

All right. Thanks.

Your next question comes from Jordan Sadler with Keybanc.

Thank you. Just wanted to follow up on the debt raised during the quarter. I'm curious what your cash balance is today. It looks like in the mid threes. And the thought process of warehousing that much cash today and if the decision to pull the trigger this quarter was a function of where you thought the capital markets might be going and rates looked real attractive. Or are you seeing activity on the acquisition or investment front?

Well, I would more say this. We essentially are following the debt markets very closely, and the debt markets in general are at great rates. So as the opportunity came up, and we're constantly evaluating credit lines, fixed loan, how we deal with our cash, how we keep the liquidity that we want, having the great hope that there will be some good acquisitions that come up. When this loan came up and when we saw the kind of pricing we could get, we all talked about it and thought, you know what, that is something that we -- that is something we should just do. And when you look at that deal, we should just do that. I know it has created a lot of liquidity for us. And we're very hopeful that we will be able to now put that liquidity to work in a very good way. So that's something that we're playing -- we're literally playing through. It is not a sign that I think -- that we think that interest rates are necessarily about to spike up or anything like that. It was just that was the deal that was there that we could make, and we thought this has got to turn out to be a very good move to create liquidity through this deal.

So it sounds like it is a little bit -- it is not about interest rates, it is a bit more about having the liquidity available to do whatever you want to do, in terms of investment activity and just fortifying the balance sheet. But last quarter --

I'm sorry. Go ahead.

I was just going to say, last --

That's exactly right. We had to create liquidity some way. And that seemed like a great way to create it. We looked at credit lines. We looked at all sorts of ways, and when we saw that, we thought it was a great way to do it.

And last quarter, you talked about the acquisition landscape actually slowing in terms of dead deals, not seeing anything really in the market. How would you characterize it today? Are you seeing anything?

Yes, as I said on the written part, I said there are deals that have come to market and that have been listed. And so we're going to see -- that's happened before, of course, and they haven't traded. But there has been a little bit of a new crop that have come out. Actually, some have come out and look like they are actually already are vanishing again, but others have come out. So, we're following through on those and hopeful.

Okay. That's helpful. Thank you.

Your next question comes from John Guinee with Stifel.

Hi, John.

Hi. I tell you guys, all of your conference calls and the questions seem to be very similar. Congratulations.

Thank you.

It looks to us like you're on a pretty solid run rate for FAD, which is clearly a more relevant number for you guys than FFO, because you have the $0.10 to $0.11 a share in FAS 141. If you're running at $0.95 to $1.00 a share in FAD, what is the appropriate dividend level for you in the next two or three years?

Boy, that's a loaded question. I will say this. And we have -- obviously, everyone cut their dividend. We then, in the last 18 months, we dramatically have increased our dividend to try and get back up to a good altitude. We know that we are still have a very low dividend payout rate compared to our FAD or AFFO, probably one of the -- said the other way, one of the best coverages in our comp set. We also don't want the dividend to ever act as a drag on the stock price in terms of yield. At the same time, we don't want to run ahead of the market in terms of paying dividends, and we also have the goal to get back on a schedule that we had originally wanted to be on when we went public, which was to give people a reasonable expectation of a regular annual increase. So bringing that all into play, we're going to obviously sit with our Board and try and make some decisions about giving some stability to that number and hopefully achieving those goals. I don't know, and I hope we do achieve those goals. So that's about all I can say on that.

Okay. And then a follow-up question. Basically, the stronger markets you're in are doing well. It is a 190 million square foot market, all in L.A. County. What do you think of some of the secondary markets where you aren't a participant? For example, downtown L.A.?

Well, there is as big of a variety -- frankly, Los Angeles County is huge. And there is as big of a variety of market in Los Angeles County as there are in the United States, literally. I mean, there are markets where I drive through there and I think, who ever had even thought to build an office building here? And there are other markets where I feel like I can see exactly what is happening and things are progressing out here. And then there is the core of the L.A. County universe, which is where we are. And I have a whole variety of expectations for those areas. There is -- I don't know, I'm just picking this randomly, but I think Pasadena is doing a great job in terms of their old town area, and they have some very good industries there, between Cal Tech and then a bunch of engineering firms which seem to be coming back and aerospace. So I go, hey, there is an up arrow on that market. And so we're going out and looking out there, you know.

So there are markets out there that seem like, as the economy recovers, they're going to benefit from that. And then there are also markets within L.A. County, frankly, that I feel like they need a whole new plan. I don't know how this becomes any kind of reasonable percentage leased for sure office market, much less just all commercial and retail. And even, there's tons of unoccupied housing that though now is starting to turn over a little more quickly, because the capital markets are getting in. We're seeing people -- I know people that are putting together funds and they're starting to buy those and manage them, and they're being recycled back through the system. But that is totally different from what we're dealing with, as different as talking about a market in Arizona or in Texas. So I'm not sure that they play a relative or cousin-style impact on us the way you might expect because they're in L.A. County.

Great. Thank you.

Your next question comes from Alexander Goldfarb with Sandler O'Neill.

Good morning out there.

Hey, Alex.

Hi, Alex.

Just going -- continuing along John's questioning, can you give us your thoughts on the [cabby] portfolio, the portfolio that Green is now controlling? Are those assets that would fit your profile? And overall, what is your impression of those assets? Even if they don't fit your profile, what's your impression of those assets?

Well, that portfolio seems to be transferring by way of lender transfers, next year down, next year down. It is a portfolio that was created -- and I'm not -- this isn't my characterization, it was the B properties of the Arden portfolio that they -- the effectively when Arden traded that was split out and sold. And it's -- they are properties that are really -- you're right, it goes with John's question, because they're spread all around Orange, L.A. County. I mean, there is certainly no real concentration in any of the markets that we're in. I actually think there may only be two or three out of all of those buildings that are in any markets that we're in, and they are certainly B or C properties, smaller properties. So, as it pertains to Douglas Emmett, it is probably not our type of portfolio. If you're asking me to just take shots at someone else's portfolio, to value it, I guess I'm not prepared to do that one.

No, I'm not. Actually, what you -- Jordan, what you just provided was good color in and of itself. Switching along similar -- your southern Cal peer has been quite active on the acquisition front. I understand and I get your point that you don't want to go to a new market if you can't replicate your platform, but even still, they bought in -- they just closed on a deal in Hollywood. Aren't there any other sub-markets that are close enough to your existing platform markets where you can buy grow? Or I'm just thinking of your acquisition folks. They must be shooting a lot of rubber bands at each other.

I'm one of those folks. But there are, and like we look at Hollywood stuff, right? So, we certainly knew about the CIN deal. We look at those deals for whatever reason, and there always is a good reason why we don't think that works for us, they don't work. And maybe that is just a fault in us, because we tend to be, unless something really looks right, especially when it is out of your market, even an easy market to add. Like you're saying, you're making a perfect point. Take West Hollywood instead of going all the way into where that deal was done. I would love to buy some of those buildings, and we take shots at that sometimes, regularly, actually.

And why don't we make those deals? Maybe a part of that is because to make those moves, we are too conservative ourselves. I don't actually know. But you're right. There are markets like that. And we do look at properties in markets like that. And I'm hopeful that we will be able to continue to add that way. But we haven't done a good job of it recently. That's for sure.

What do you think is holding you guys back? Is it just culture? Is it Board? Is it -- what do you think is holding you back?

I don't think it is that we're bored.

No, no, no. The Board of Directors. Not you guys.

Oh, our Board. No, it is not the Board. It is a combination of precisely the product that is coming available and our feeling about the way it would fit for us. And it just hasn't come together right. And as I said, speaking quite frankly, we have not quite aggressive enough in terms of how we value this thing. We tend to be -- when we bid on something that is in a market that we're already in, when we bid on something that is in a market that we're in, it is very rare that we don't get that deal. When I say rare, I'm talking, 1 out of 10, we don't get it. When we go outside of our market and we think we should get that and we bid, most of the times we don't get it. And that makes me sense that maybe we're just the ones that are too conservative when we make a move like that, not the fault of something else. But it always gets down to something that is very building specific. And we need to get over that, I guess, in a way.

Okay. Thank you.

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

Hey. What's up, guys?

Hi, Rich.

Just a question, Ted, you mentioned the transition year, 2013, notwithstanding early renewals, which by, the way, I think would make it a sooner process. And early renewal would be a better comp, I think. But putting that -- is that correct?

That's correct.

So let's just forget that for a moment, and if you just look at 2013 and your base, your comp year is off that peak, how long do you think it takes for your rollover to go from negative to break-even or positive? Is that a two-year process beginning in 2013? Or is it shorter or longer?

It is a complex formula, because it depends -- it is a market-to-market thing. But I actually think that once it starts to turn, particularly if we continue to have rent increases, that it will turn very fast. And that it would turn positive -- it could turn positive, significantly positive very fast as well. Again, subject to the fact that if you're looking at the cash rent roll-down which we're not -- we don't think it is good, you've still got in a flat market on an average five-year lease, you're going be looking at somewhat over a 12% roll-down, even in a totally flat market.

Right. So if you're talking on a GAAP basis, that's when it starts to --

I'm talking about a -- yes, that's right. On a GAAP basis, it will turn fairly quickly, particularly with some rent increases.

Right. So that's less than -- within that year, or maybe like a 12-month period, something like that?

Yes, I would -- within the -- it is certainly within a 12-month period it will turn. And that is where it becomes hard, because there are -- it is a very complex formula, depending on the sub-market each quarter. So it will actually have -- what I really would expect is that you are going to have a period of time of noise. And then after the noise, when you bleed through it and now you've got mostly post-crash leases, then you're going to see it go positive, and I think probably faster.

Okay. And then a follow-up question unrelated to the first. When I look back at what I guys have done in terms of acquisitions actually doing something, I think Bishop Square was the last maybe, the 16% interest in the fund, I don't know which. But you haven't done a whole lot. I mean, those were -- Bishop Square in particular was a big one. But talking a lot about the pipeline, but haven't really seen anything go to the finish line lately. Have you thought about any different strategies like buying debt or anything like that, that might be a way for you to preempt or be proactive about acquisitions or investing?

Before Jordan gets to answering the main thing part of the thing, while it is not a big difference, we did also buy Wilshire Bundy and 150 Rodeo --

I was going to say that too, just to give us a little credit. Yes, I mean we look at buying debt. I got to tell you, there is not debt -- yes, we do, to answer his question. But there are a not a lot of opportunities to buy debt in our market and get to the building. First of all, there isn't as much that's over leveraged. And secondly to the extent something is overleveraged, it is probably in a CMBS pool that would mean buying some tranche in a CMBS pool. But he other things are, to make your point, are we willing to do OP unit deals because people are tax sensitive? Yes, although there doesn't seem to be a great need for that. Most people looking at selling seem to want to pay their taxes this year. Are there other structural things we are willing to do where people want to somewhat stay in the game? We are willing to do all of those things. We are trying to pry buildings loose.

What about redevelopment or even ground-up development?

We're debt -- well, ground, there is not a lot of opportunities for ground-up development, to just buy a lot and build a building in our markets, and that's what makes them great markets. In terms of redevelopment or doing a development that expands one of our projects, yes, we are -- I mean, in the markets we are now, with increasing rents, and especially with what is going on in residential, we are looking at that now.

Okay. Great. Thank you.

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

Hey, guys. Just curious, if you think the West L.A. investment sales market will remain slow until the EOP Blackstone portfolio, something happens with that? Do you think so? Or is there sort of waiting to see what happens with that, to get a better indication of pricing before sales will pick up?

I don't know if sellers are waiting for that -- for an indication. But I think that by the way we grade it, I think it -- it is going to be faster than it has been, because it has been a complete wasteland. So I think there is going to be transactions and I hope -- I mean, literally we've been dealing with almost a zero. So going from zero to five or six or seven in a year, okay, that's going to feel great. That still is not a huge amount. I think that is where we're headed. Now, the Blackstone deal, whenever they do do that, I guess that will be similar to the one last time, where you will see follow-ons and follow-ons and will start to serve a trading thing, because there is just a lot to get out there so it has to spread through the market. But I don't know that --

I think if people are waiting, they're waiting because they're seeing the same improving fundamentals that we're seeing. And so if you're a seller, and as Jordan said, in our markets, there aren't a lot of people who are being forced to sell by debt issues. And so if you're not in that place, I think a lot of them are balancing the desire to sell, which they may have for some period of time against, maybe I wait another six months and the fundamentals get better and I get more money for my building. But I don't think it relates to the -- it's not any particular deal.

Ted's point is real good. Most of the meetings I have, the bottom line for the guy is, hey, my portfolio is going up in occupancy and finally able to increase rents, I think I will wait a little while to sell. I mean, they've been through a hellish time, and so people are feeling good again.

Okay. That's helpful. And then on that point, Jordan, how do you feel about the recovery this time around, compared to prior cycles? Do you feel like this is going to ultimately look just like other West L.A. strong rent spike-type recovery? Or do you feel like that this might be good but maybe a little slower than in the past?

In general, how I feel is that the volatility that we felt from the last recession and the volatility that we're going through is something that we should -- I think we are going to go into a period for a while where there is just going to be more volatility. Now, I don't know whether that necessarily means we're going to have a spike here in the west L.A. market, but it just seems like the way capital moves and information moves and our industry is maturing and the capital markets industries are matured and the global markets have come into play, I just think we're in for a little more volatility than let's say, we're used to some years back. Because of the basics, which is no real new development, a good set of industries, and our portfolio leasing up, I do expect that we have some good days ahead of us, subject to another -- subject to that volatility thing, where there is some big national economic collapse or the fiscal cliff or something in Europe. I would expect that as things start going now, you would start seeing -- you would move into what in the olden days you would say is just a classic landlords market, with a tight market and rent is moving up and you are being able to make choices and have bidding on spaces. Certainly, as we sit here now, we seem to be headed for that.

I think we -- if you look at the fundamentals within the market, I think that there is every reason to say that those fundamentals within the market are at least as good or better than they were as we were recovering from the last two recessions. You've got the same lack of supply. You've got the same good industries underlying the growth pattern. You've got a situation where the people actually, in this case, people actually have paid much higher rents within a very short period of time. So in some ways, in an odd way, as they roll off of leases, they feel better about things. The 3% bump also gives you a way of saying to a guy, you can increase the value of his lease -- next lease by 10% and yet tell him he is getting a rent reduction from his last year. All of those things can tend to be good things. Obviously, the big question that nobody can answer, which goes back to where we started out at the beginning of the question period, which is, what is the impact from the global stuff? And that seems to be a slower recovery than the recovery we had in the '90s or in the early 2000s. Put them together, and as Jordan said, we still see on the ground that potential for a very good recovery, but we will obviously have to stay tuned.

Okay. Thanks a lot.

Your next question comes from Josh Attie with Citi.

It is actually Michael Bilerman. Just on the fund, so the -- just remind me, you still have like $160 million, $170 million of undrawn commitments, which I think expire in October. Is that correct?

That's correct.

And so what's the current plan, if any of these deals that you're looking at come to fruition? Those would be fund investments or on balance sheet, putting any unit deals aside. Obviously, that would go on the balance sheet.

There are a few exceptions like unit deals, but other than that, any deals which we -- we don't have to actually close it by October, but which we effectively enter into before October, are likely to go into the fund.

And I guess what's your -- looking at what you're looking at now, the likelihood is a deal goes to the fund, or the fund effectively expires from a commitment perspective in October. And if it does expire without any deals, would you seek to get those extended or continue to look for that fund capital?

I don't think that we're -- we've talked about this before, that the decision to go with the funds reflected the capital markets at the time that we were going into it, which was stock prices and raising it through equity was really going to be incredibly expensive. At this point in the capital cycle, we have lots of access to capital. And so I don't anticipate that we would be looking to raise additional fund capital. And so any acquisitions that we make after the expiration of the fund would be done by the REIT.

And then, thinking about if you continue to be disciplined, which is a good thing, in terms of deals that you're doing, rather than just going off and acquiring a lot of stuff, just to acquire and get bigger. If you don't find anything and you're sitting on the $350 million in cash, come at the beginning of the year, and you're producing $80 million of free cash flow a year, what can you do on the balance sheet front in terms of buying back any further-out maturities? I don't know, when certain swaps mature. But is there an opportunity that you can put that capital to work on the debt side?

Well, we have -- our next maturity in 2015, there is still $240 million of that, which is -- which could be pre-paid at that point, and we could move forward.

We could apply it to debt.

So -- and that's really the only piece?

Well, that would totally -- we would have a lot of delevered property at that point.

Right.

Right. But that's not a bad thing.

To keep going -- we have very flexible debt, and we could keep reducing it. I hope that is not what we end up having to do. But we have that as an option, if that's all you're asking.

And is there other new debt deals that you said this one came and you tossed it around and thought it was the right thing to do? Is there other transactions, new debt transactions that you're working on to raise additional capital?

We had told that you we were thinking about doing this, between this and doing --

A credit line.

A credit line. So it has actually been in the cards. I think that we're not going to be -- without having additional needs for liquidity, we're not going to be running out very quickly.

No, we still have some unlevered properties, and I'm not going to put loans on them just to create even more cash. We've got a lot of cash now. You called it. All the cash we're sitting on, plus all the cash we're earning. We need to get some good acquisitions done.

Right. And lastly, you talked a little bit about the article that was on the tax front. Is this starting to enter into defamation in terms of what the press is doing?

Well, I feel that way, but I can't tell you legally what's going on. I don't understand why they're after us in this way, but it sort of feels like it is what it is. We certainly, when they call us, give them the information, and they seem to feel they should ignore it. So, they write the articles they want to write.

Okay. Thank you.

I think that's it. Thank you, everybody. That was our last question. Thank you, everybody, for joining us on the call this quarter. And we look forward to speaking with you again next quarter. Goodbye.

That concludes today's conference. Thank you for your participation. You may now disconnect.