Duke Realty Corp (DRE) 2016 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Duke Realty Quarterly Earnings Conference Call. (Operator Instructions). And as a reminder, today's call is being recorded.

I would now like to turn the conference over to the Vice President of Investor Relations, Mr. Ron Hubbard. Please go ahead.

Thank you, Art. Good afternoon, everyone, and welcome to our third-quarter earnings call. Joining me today are Jim Connor, President and CEO; and Mark Denien, Chief Financial Officer.

Before we make our prepared remarks, let me remind you that statements we make today are subject to certain risks and uncertainties that could cause actual results to differ materially from expectations. For more information about those risk factors, we would refer you to our December 31, 2015 10-K that we have on file with the SEC.

Now for our prepared statement, I'll turn it over to Jim Connor.

Thank you, Ron, and good afternoon, everyone. I'll start out with an update on the overall business environment and then transition into our third-quarter results.

Nationally, the industrial market's momentum continues to be very strong. Demand outpaced supply for the 25th straight quarter, new supply in substantially all markets is in balance, and demand for modern bulk space year to date continues to beat everybody's expectations.

Net absorption for the third quarter was 77 million square feet. That's the most since the fourth quarter of 2005. Almost 40% of this absorption was in five of our markets. Those markets include Southern California, Houston, Dallas, Chicago, and Pennsylvania.

On the supply side, new supply in the third quarter totaled 53 million square feet; the most since the fourth quarter of 2008. Yet speculative deliveries were down 15% from the previous quarter.

The net result was another 20 basis point drop in the overall vacancy nationwide to approximately 5%. Just for historical perspective, the 10-year average is about 8% and the recession was about 10%.

These positive fundamentals continue to drive strong rent growth. 40% of all markets nationally are expected to post double digit rent growth in 2016. As we've stated on previous calls, demand has been broad based, even in the relatively slow 2% GDP growth environment. Containerized traffic flow, transportation indices, and consumer confidence are all trending in a positive direction with regard to demand for industrial product.

We're seeing similar strength in our own portfolio with the completion of 4.4 million square feet of leasing for the quarter. This drove our in-service occupancy to 97.3%, a 60 basis point increase from the second quarter, which achieved another record high occupancy in the Company's history.

Rents on new and renewal leases for the quarter grew by 19%, reflecting continued strong supply/demand fundamentals and our solid pricing power.

Of particular note was our continued success in leasing recently completed speculative projects. One notable transaction executed during the third quarter was a 615,000-square foot lease for 100% of the space in our speculative project at our Camp Creek business center in Atlanta. This lease was signed by a major consumer products company for a term of 10 years.

Overall, demand for space continued to be strong from traditional customers of industrial distribution space, and of course the powerful direct and indirect demand forces of ecommerce. We believe our platform is in a very strong position to continue to capture this growth. The strong supply/demand dynamics help contribute to same property NOI growth for the 12 and 3 months ended September 30, 2016 at 5.1% and 5.7% respectively.

On the development side of the business, momentum continues to be very strong as I've alluded to on the last few calls. During the third quarter, we generated $183 million of starts across 6 industrial projects and 2 medical office projects, in aggregate totaling 3 million square feet at about 50% pre-leased.

The industrial development projects were spread across markets such as Chicago, Baltimore, Tampa, Indianapolis, and Savannah. Many of you may recall hearing about the Savannah project was in the news recently. The 1.4 million-square foot build-to-suit with a national retailer floor and decor was for a lease term of 15 years.

On the medical office side, we started two 100% pre-leased projects in Raleigh and Dallas totaling 72,000 square feet. Both transactions were with existing healthcare system clients of ours, and both were for lease terms of 15 years.

I'm also pleased to share with you that we have started 3 fully leased build-to-suit industrial projects after quarter end in early October with an expected cost of $113 million and in aggregate totaling nearly 1 million square feet. These deals were all executed with major brand name tenants - these were all executed on our land. These October starts are consistent with our increased 2016 guidance for development starts, which I'll expand on momentarily.

We continued to see strong activity in our development pipeline, and are confident we'll close out 2016 in strong fashion, and are optimistic about 2017 as of today. Our overall development pipeline at quarter end has 21 projects under construction, totaling 7.2 million square feet, and a projected $575 million in stabilized cost at our share. We are 58% pre-leased in the aggregate.

We'll continue to closely manage pre-leasing levels on new development start opportunities as noted numerous times in the past. While our Company has an excellent track record at competing for build-to-suit projects, we'll also continually continue to strategically allocate capital to speculative developments. In fact, since the fourth quarter of 2014, we've delivered 24 spec industrial projects that were initially 14% pre-leased. These projects are now 85% leased with strong prospects for the remaining space.

Margins on the pipeline are expected to continue in the 20% range. We believe our strategy will continue to represent a solid risk-adjusted value creation engine for our shareholders.

Turning to dispositions, we closed $227 million of transactions during the quarter at an overall average in-place cap rate of 7.4%. The largest component of these dispositions was the sale of an 8-building, 1.2 million-square foot office park in Indianapolis that included our corporate headquarters facility.

Another notable disposition that I alluded to on our last call, was the closing of a user sale on the 936,000 square foot speculative industrial building in Indianapolis that had been placed in service but was yet unleased.

A few other notes on this industrial sale. First, we sold this building for more than a 20% gain to a major retailer for its dedicated Midwestern regional ecommerce facility. If we exclude this sale from our third quarter dispositions, the reported aggregate in-place cap rate would be 8.2%.

For the remainder of the year, we expect $140 million to $260 million of dispositions, reflecting a small reduction in the previous midpoint of our guidance. Part of this reduced guidance relates to an office park sale in Indianapolis that we had to put on hold until after an M&A transaction involving the primary tenant in the park is completed late in 2016 or early 2017. In addition, there are a few other assets that we expect to close late in the year, but could ultimately spill over into the first quarter.

Overall, we are very pleased with our results for the year, and we are still progressing towards our target of completely exiting the suburban office business by year end - or shortly thereafter.

Even with these dispositions, we continue to have -- we continue to be confident at our ability to grow our AFFO just as we've done for the last 5 years. With this continued steady AFFO growth outlook, and with what we believe is a very defensive portfolio to handle cyclicality, we are very pleased to announce a 5.6% increase in our regular quarterly dividend.

Now I'll turn it over to Mark to discuss our financial results and the capital transactions for the quarter.

Thanks, Jim. Good afternoon, everyone. Core FFO per share was $0.31 for the third quarter of 2016 compared to $0.30 per share for the second quarter of 2016 and $0.29 per share for the third quarter of 2015. The increase in core FFO per share is due to our continued improvement in key operating statistics that Jim just touched on, as well as lower interest expense that resulted from our deleveraging activities over the last several quarters.

AFFO for the quarter totaled $103 million, which was a 7.6% increase from the $95 million in AFFO reported last quarter. Our high quality portfolio continues to produce positive AFFO growth, and we're still comfortable with our original full-year guidance of AFFO growth on a share adjusted basis of approximately 5%.

In the equity capital markets, we issued 3.7 million shares under our ATM program in August and September for net proceeds of $103 million at an average issue price of $28.07 per share.

And considering our share price relative to net asset value, the increases in our development pipeline that Jim previously mentioned, along with our growing list of future prospects, we determined it prudent to use our ATM to pre-fund this development. We now have raised all the capital necessary to fund the current pipeline, as well as the next couple quarters' worth of expected development starts from a few others on our prospect list, and have less than $80 million of debt maturities through 2017.

Our recent delevering transactions have significantly strengthened our balance sheet and result in ongoing reductions to interest expense. Along these lines I'm pleased to note that in early October, Fitch Ratings upgraded our senior unsecured credit rating from BBB to BBB+ with a stable outlook. All of these capital transactions, coupled with our operational performance, resulted in improvements to our key financial metrics during the quarter.

We expect to see further improvement during the remainder of the year resulting from disposition transactions and highly leased development properties being placed in service. This is reflected in our revised guidance.

Now I'll turn the call back over to Jim.

Thanks, Mark. In review of the year-to-date results and outlook for the remainder of the year, yesterday we raised the low end of guidance for core FFO by $0.02 per share, narrowing the 2016 range to $1.18 to $1.20 per share, and effectively raising the midpoint by $0.01.

Given the strong outlook on our development pipeline, we raised the development guidance to a range of $650 million to $750 million, up $125 million from the previous midpoint.

Also due to continued overall strong operating fundamentals, we raised our same property NOI growth guidance from a range of 5.2% to 6.0%, up about 70 basis points from the previous midpoint.

Finally, given our capital recycling activities and recent debt pay downs, we changed the guidance from all three leverage metrics in a positive direction. We believe these improved leverage metrics put us firmly in position for continued ratings upgrades in the near future.

As noted in yesterday's earnings release, the full details on revisions to certain guidance factors can be found on the investor relations section of our website, as well as on the back page of our quarterly supplemental.

Let me reemphasize once again how proud we are to have the Company repositioned with a rock solid balance sheet, a low AFFO payout ratio, and position to support raising the regular quarterly common dividend by 5.6%.

Now, we'll open the lines up to the audience. And I would ask the participants keep the dialogue to one question or perhaps two very short questions. And you are of course welcome to get back in the queue. Thank you.

(Operator Instructions) And our first question comes from the line of Kyle McGrady. Please go ahead, you're open.

I'm going to get back in the queue. Let me ask -- let me get my ducks in a row. Call on us in 15 minutes.

Thank you, Kyle.

And we have a question from the line of Tom Catherwood. You're open. Please go ahead.

Just a quick question. Page 22 of the supp, you reported effect - growth and net effective rent slightly differently this quarter where you wrapped up both the new and renewal leases for medical office and bulk industrial. What was the breakdown by those different property types for growth and net effective rent for this quarter?

Tom, this is Mark. We -- in our effort to try to provide enhanced and better guidance for everybody, I will admit we inadvertently omitted that. So we'll work on this page for the future and get that back in.

But I would tell you two things on that. The medical office piece is just a small piece of the overall pie. It really doesn't move the needle. So if you look, for example, at the third quarter number of 19.3%, that's right about what the bulk was. We only had just a few thousand square feet, 23,000 square feet of medical deals signed in the quarter compared to 2 million on the industrial side. So, the medical's just not moving that overall number.

So the overall number's pretty close to the industrial. I would tell you the medical is probably slightly lower than that, and it was just a mix, but nothing out of the ordinary there.

Completely fair. And then just one more quick one from me. Acquisition guide was bumped up for the full year. This is kind of bucking trends we've seen from other companies in the sector. Everyone seems to be slightly taking down their acquisitions just based on pricing for core assets being still very strong. What was it about what you guys see in the market right now that led you to bump up the acquisition guide?

Yes, we're probably seeing the same things most are overall. But I would tell you the reason we have ours -- that we raised it is really related to a joint venture transaction that we plan on executing here. So, it's an existing relationship we have. We already have a part ownership in these assets, and we're just going to take our partner out this quarter. So, that's where most of that fourth quarter activity is going to come from.

Got it. That's it for me. Thanks, guys.

(Operator Instructions) And we have the line of Manny Korchman. Please go ahead.

So Jim, if we go back to your comments on spec building, you said over the last couple years you've done a bunch of projects. If I had to rank your confidence now in starting a new spec project today versus if we sat here two years ago, so in October of 2014, where would you be more confident in getting a spec project off the ground?

Well, I think we'd be more confident today, just given the surprisingly strong numbers that we're seeing year to date from both the demand and the supply side. I think it was particularly interesting that spec deliveries in the quarter were actually down quarter over quarter by about 15%.

And there's been some speculation that the fed has tightened the reigns a little bit on the money center and regional banks on construction lending, so that was perhaps going to put a crimp in some of the local developers that were developing spec projects. I don't know if we've really seen that come to pass.

But I would tell you sitting here today, we're very confident given the track record we've had at getting this space leased. And I think you see that by the fact that we announced four spec projects last quarter.

Great. And then Mark, on that, I guess the JV buyout it sounds like that you're thinking about, what would a cap rate be on that? Is that pre-negotiated?

Yes, it's a pre-negotiated cap rate, Manny. I won't disclose it individually, but I would tell you that we believe it's a cap rate -- or it's at a yield that's in excess of the cap rate. So we think that there's some good value there that we're buying.

So if we're just even modeling, your total acquisition pool, where would that be at now?

Total acquisition pool's probably going to be close to 7%, I would say.

That's it for me. Thank you.

Sure.

And our next question comes from the line of Jeremy Metz. Please go ahead, you're open.

I was just wondering, your industrial occupancy's over 97%. So I was just wondering how you're thinking about this in terms of are you really pushing rents hard enough? And then as we think about it going forward, should we expect to see that occupancy actually start to tick down as you push rents here?

Well, Jeremy, that's -- we're in a really interesting time. I would tell you that I see the final terms of all of the major deals that we're doing, and I would tell you I'm comfortable. I think that's backed up by 19% rent growth for the quarter.

So yes, we're comfortable where it is. I think it's reasonable to expect that that's going to come down. I think we could come down 100 basis points and we'd still be in a very, very good spot. I don't anticipate that that's going to happen, because given the volume of leasing that we're seeing out there, I just think it's very unlikely that we'll have an off quarter or two where we'll bring a bunch of spec projects in that aren't substantially pre-leased.

And I think we're seeing great renewal activity in our portfolio. So we're not anticipating getting any major vacancies back this year or early next year that we can't handle with our normal leasing volume.

Okay. And then just one on the development front. You mentioned the strong build-to-suit pipeline. I was just wondering, is there anything in particular that's driving that increased activity? And then maybe can you talk about what markets those opportunities are really coming in? How much of it is really ecommerce related?

I'll answer the second question first, Jeremy. Ecommerce continues to be a very big driver of our business, both on the leasing and on the development side. And if you just think about it logically, we positioned the Company, particularly the industrial portfolio, focused on the modern, large, bulk product. And that's what ecommerce users need today.

With the exception of some of the smaller infill last mile, which we're doing a little bit of, most of the fulfillment centers today we're looking at are 800 to 1.2 million square feet. They're brand new, state of the art, 36 and 40 foot clear, and that's really in our sweet spot. So, we'll continue to do a lot of business with the ecommerce companies, and they'll continue to be a great driver of our business.

And our next question comes from the line of Mike Mueller. Please go ahead, you're open.

Quick question. On your GAAP rent spreads, they're running at about 2 times the 2015 level. And I was wondering, in terms of the drivers of the increase from 9 to 10 to the high teens now, would you say it's primarily higher rate driving it, or other dynamics and lease terms changing such as you're getting bigger bumps or longer terms? I was just wondering, could you give us a little more background on that.

I would tell you it's really all of the above. It's just overall better quality leases. We're getting as good or better bumps. We're getting better starting rents. It's really all of the above.

It's not really lease vintage driven, if you will. We're doing about a third of the leases right now that are rolling were what I consider to be in the trough period. That's about the same percentage we were running at last year. The overall amount of leases rolling are getting smaller because their overall expiration schedule is pretty light. But as far as a percentage of the leases rolling, the vintage of them are pretty consistent from 2015 to 2016. So that double the increase, if you will, and that net effective rent growth is really just overall rent growth that we're driving, whether it be starting rent or rent bumps or truly all of the above.

Mike, the only point I would add to that is, and you touched on it in your question, is lease term. Two things -- the more really large deals we do always tend to have longer terms -- 10 and 15 year lease terms -- so that clearly helps there.

The other side of it is with our portfolio, as well leased as it is, we're doing very, very few short-term leases. Historically it's not uncommon to get a tenant to come to us and say, you know, I'm just not really sure what my business is going to do. I want to renew for 12 months or I want to renew for 18 months.

And the truth is, we're not doing very many of those leases. Today, the short term for us is 3 years. And we're really looking to lock tenants up for the longer term while we've got some leverage so we can push rents and escalations. So, I think it's all of those things, but that's one point I wanted to add.

Got it. Okay, thank you.

And our next question comes from the line of Jamie Feldman. Please go ahead.

I guess starting with the guidance, can you talk about -- you did some delevering activity. So if you would just move your guidance on your core operations, how much you would have increased it. And then what was the drag from some of the deleveraging you did?

Jamie, you mean the drag on earnings from delevering?

Yes.

I would tell you that really nothing in what we reported. There may be a little drag in the fourth quarter because we're sitting on cash in October until we can get that redeployed in the bonds that we bought back just last week in our development pipeline. So you may be looking at a penny drag in the fourth quarter, but it really didn't have any impact on the numbers we reported. Nor would I say it would have an impact as we look forward to next year because it'll all be fully redeployed by then.

And then as far as the leverage metrics that we're at, I would tell you that they're a little bit low because of raising the capital that we did in the third quarter to pre-fund. So as an example, that debt-to-EBITDA number, really close to 5.0. As we look out into 2017, we'll probably be closer into the mid 5s. We won't need to raise any additional capital to fund all of this, like I talked about. So that leverage metrics will naturally move up closer to the mid 5s.

But I would also point out that without any additional delevering, fixed charge will continue to get better because we have high coupon debt that continues to burn off. So, fixed charge will get better, and debt to EBITDA will be kind of in the mid 5s.

Okay. And then I guess as you think about next year, big picture activity, any big dispositions you think we might do? How are you guys thinking about MOB now? I'm just trying to think about, your core seems like it's improving, but what other noise might we see next year as you guys continue to make some changes to the business?

Well, Jamie, I don't think we're, at this point in the year, we're not planning to create any additional noise next year. I think the bulk of the heavy lifting will be done. I think we've really positioned the Company to grow. And I think that's really what we're focused on as we start to look forward to 2017.

Okay. All right, that's helpful. Thank you.

And next we have the line of Sumit Sharma. Please go ahead, you're open.

So, thanks for the commentary and all of the disclosure and commentary this quarter. Actually, the GAAP rent spreads had me confused, too, but Ron was instrumental in clearing that up.

But I guess it sounds like NOI's growth is accelerating in the fourth quarter, which is great. And this may be an early indicator that 2017 could look a lot like 2016, maybe get some comments on that?

But more importantly, as an owner and manager of industrial real estate, I guess where are you guys most cautious? Because if you think about the investor mindset, they're all trying to say -- we're all trying to figure out, well, this is a little too good.

Oh guys, it's not too good. It's good. We should enjoy it.

Well, let me take your first question about 2017. Sitting here, kind of towards the end of October, I would tell you we feel fairly optimistic about 2017. There is nothing in the macro drivers of the industrial business, so-called storm clouds on the horizon, that would really give you pause.

We've been in a slow growth market, but that's been really good for the industrial business. Consumer confidence is still up. All the -- as I've referenced earlier in my earlier comments, the transportation indices are a little inconsistent, but by and large, they're all reasonably positive.

I think we look at the, particularly the supply and demand equilibrium in the marketplace. I think that we've had a fundamental change in the industrial business that is here for the foreseeable future, which is ecommerce. And if you look at the pace at which ecommerce is growing, and the amount of space they need to support that business, and most of that is in the form of new big boxes, I think we're positioned very, very well for the future.

In terms of what worries us in the future, I will tell you it's not the U.S. and it's not real estate. I think you've got to go global macro to anticipate anything that could really put the US economy in a bad spot or have some really negative trickle over into our market right now. But thankfully we don't see that right now, so we're fairly optimistic.

Thank you so much. If I may just ask one follow up to that. If you were just thinking about it from -- you mentioned bulk distribution. In fact, you categorize your industrial portfolio as a bulk distribution portfolio. What if in 2018 or going into 2019, it's not about the bulk and it's more about let's say smaller, closer, last mile infill kind of assets. How are you prepping for that, how are you getting into new markets? Any commentary on that?

Sure. I'll give you a couple of data points. First of all, that's a business we are in and we have been in for many years. And it probably doesn't get talked about enough, and that's our fault. But Duke has a long track record of redevelopment, brownfield redevelopment. We've done a number of these projects in major metropolitan areas all over the country. So, we do that. We're doing business with some of our favorite ecommerce companies in some of our transportation and 3PL companies right now. So "A" - we are addressing that business.

The second point is the last mile, which has gotten a lot of attention in our industry of late, is really fairly small. If you look at and do research on Amazon, for example, they have about 2 million square feet of these last mile facilities. They average about 50,000 or 60,000 square feet a piece. They have 70 million square feet of fulfillment centers. And you need the fulfillment centers to drive this huge volume.

This is a company that has 30% market share of the ecommerce business in the US. It is growing at 15% or 16% a year. They're not going to be able to keep up that growth by focusing on 50,000 square foot infill. That's just really small piece of the equation.

You look at the number of projects that they have in the pipeline that are debated out there in the different public forum, they have twice as many of these major fulfillment centers, which average about a million square feet, as compared the number of the last mile. So, it's an important piece of their business and it's an important piece of ecommerce going forward. But quite candidly, it's just not going to move the needle.

Fair enough. Thank you for your comments. We'll continue the conversation at NAREIT.

And our next question comes from the line of Blaine Heck. Please go ahead, you're open.

Just back on the topic of acquisitions. You guys have the best balance sheet you guys have had in a long time. And there have been some pretty significant industrial portfolios on the market. So, if there was an opportunity to expand your presence in target markets with a substantial portfolio acquisition, would you guys consider it, or do you think pricing is still at a place that might keep you from chasing a deal like that?

Blaine, if you got one, call me afterwards. We'll work on the deal. No, guys, the truth is we look at every deal that comes down the pipeline. Every deal. And the ones that were talked about in this last quarter, it's a combination of the quality of the portfolio, the location of the real estate, and the pricing. And all the ones that we looked at we passed on for a variety of reasons.

If the right portfolio came along, particularly if it was heavily weighted into the markets that we want to grow in, we know what a reasonable price is. I think we'd certainly try and be willing to pay up for that. Given where our stock has been trading and our balance sheet, I think our currency's strong and we've got the ability to stretch.

So when we find the right one, I think we'll certainly try and make it happen. We just haven't found the right thing. And it's like you tell your kids; just because you got money in your pocket doesn't mean you got to go spend it.

Great, that's helpful. Mark, you guys have seen very strong same store NOI performance over the past several quarters. And it looks like guidance implies another good one in the fourth quarter. Seems as though occupancy has been a big wind at your backs this cycle, but given that you guys announced 97.3%, it'll be pretty hard to maintain the year-over-year increase.

So I guess given where rent spreads are and where rent bumps are right now, what kind of level same store NOI growth do you think you can achieve without the benefit of increasing year-over-year occupancy?

Blaine, obviously we'll give a little bit better color on that in January when we give our guidance for 2017. But I would tell you that if you just look at where we are today and where we think we're going to be closing out 2016, about half of our same property growth is coming right now from rent bumps and rent growth on rollovers.

I think that is very sustainable, as we look forward because we've got rent bumps built into really all of our leases. I think we're very bullish on our ability to continue to drive rental rate growth on rollover. So that half of what we get, or are getting right now, I think we feel very comfortable about that going forward.

You're exactly right on the occupancy piece. If you look right now, the remaining half of that same property growth, a good chunk of that is occupancy related. And it is going to be tough to continue to drive occupancy up. And like Jim even mentioned, I think if we were to bet something right now, we may bet that it may tick back just a little bit, at least early in the year next year. So let's just call that flat. And then you got to look at just efficiencies in your portfolio and where you can drive those.

So, that's a long winded answer for saying I think we're still very positive in our ability to drive same property growth, maybe not at today's level. But I will caveat all of that by reminding everybody that we don't put properties in our same property pools until they've been in our population for 24 full months.

So we believe we have just as much NOI upside, if you look at total NOI growth, on all the properties that we've delivered, and are going to deliver, in our development pipeline. So I think that overall NOI growth can continue as we look forward at about the same levels that we're driving today.

So can I push a little bit and ask whether it's kind of between 2 and 3 or 3 and 4?

I'll let you know in January, Blaine.

Sounds good. Thanks, guys.

And next we have the line of Eric Frankel. Please go ahead, you're open.

Obviously everything is in great shape, and you're commenting on the demand picture nationally, and specifically in some of the biggest markets -- Houston, Dallas, Chicago, Pennsylvania, and Southern California.

Are you seeing any supply -- I know obviously supply and demand's been in balance the last couple of years, or demand's outpaced supply. But are you seeing any big supply issues on the horizon in those markets? I think just from the local reports we've read over the last couple weeks, I think certainly Chicago and Atlanta supply has picked up immensely. And I think it would, at the current development volumes, it would probably match what demand has been the last couple of quarters.

Hi, Eric. I would answer that in a couple of ways. We've seen over the last few years a handful of markets get what I would call maybe slightly overbuilt. And the beauty of the markets today is how efficiently they're operating. And you can look at, we've talked about over the last number of quarters, we've talked about Indianapolis, we've talked about Houston, we've talked about Columbus. And anytime those markets got slightly out of balance, all the developers took their foot off the accelerator. We waited for demand to come back, which it has in all of those instances. So I think from a macro level, the market is operating very efficiently.

You look at some of the numbers. We were having the same conversation probably a year ago about Dallas when Dallas was pushing, I don't know, 25 million square feet of speculative. Dallas is on track to do 20 million square feet of net absorption this year.

So, Chicago and Atlanta has kind of joined that club, but they're both having really strong quarters of absorption. And the amount of activity that we've got, as evidenced by that 600,000-foot lease in our Camp Creek Park, is very, very strong. So, I don't see any real warning clouds. There's a lot of activity out there to cover this spec development.

Okay. That's helpful. Switching to the build-to-suit side, I'm not sure about the cost basis for what you started this quarter. But what you just announced in terms of your 3 build-to-suits starts in early October, I guess that comes out to roughly $113 per buildable square foot. Can you comment maybe on the nature of the leases? That seems somewhat expensive for industrial.

There might be one of those in there that's got a little bit higher basis and a little bit more infill specialty use to it. Obviously it's early, we can't give you specifics on each individual deal. I think we'll get into more specifics next quarter when we announce everything. But there is one project there that's probably skewing the other two a little bit.

Okay, that's helpful. Thank you.

And our next question comes from the line of Kyle McGrady. Please go ahead, you're open.

Jim, if you guys -- Mark, if you guys have answered this, let me know because I missed the first part of the call. But we noticed that the service operation expectations are declining while G&A is rising. Anymore color on what's actually going on there?

When you say --

Page 32.

I'm sorry, John?

Well, what you have --

32 of the supplemental.

-- service operations essentially was --

So let me try that, John. I think I kind of know where you're going here. So if you're talking about from 2015 to 2016 levels -- not revised guidance, right? I assume that's what you mean?

Yes.

Yes, so really service operations are declining because we're taking all of our development expertise and we're building more buildings for ourselves rather than building buildings for third parties. It's not really directly correlated with G&A either, not saying there's not some correlation; but it's really just a change in focus.

We're now on pace to do $700 million, give or take a development this year, for our own account. We haven't staffed up to any measurable level on our people. So what that means is we're just doing less lower margin third party projects because we can do projects for ourselves, so that's why service ops is going down. That's really just the focus from third party work to wholly-owned.

And G&A is actually, if you look at G&A, it's not up much, we were at $51 million last year. The midpoint of our range this year's $53 million. That's really just the lovely cost of our government and being a public company. It's not really any inefficiencies or anything like that. It's just increase SEC fees and things like.

And then Jim and I always talk about this. What's your long-term expectation for your land inventory, Jim? Are you going to get back up to $1 billion, or what do you think's appropriate?

Sorry, John. I just choked a little bit there. No, we have worked really, really hard over the last four or five years to get the inventory down to the level it is. It's actually under $350 million right now. We believe we can run this business through cycles with between $350 million and $400 million of land held for development.

And it's really we've changed the culture on how we approach land. We're not buying it in 500-acre chunks and controlling it for 10 years. We're buying it in smaller pieces. We're focused on putting it into production much more quickly. So I think it's taken us a while to get there, but we are certainly in no hurry to get back. And I think you'll see us continue to stay in that $350 million to $400 million range.

Great. All right. See you soon. Thanks a lot.

Thanks.

And next we have the line of Rich Anderson. Please go ahead, you're open.

Earlier in the call, even the thought of problems emerging in the industrial space kind of made you chuckle a little bit it; and I get it, you guys are in great shape. No argument.

But in previous past cycle, not so much in industrial but other sectors, REITs did a really poor job of knowing when to walk away from the blackjack table; so, and speaking specifically about development, you're expanding development, what are you looking for, if everything is just track record driven and you're feeling great and you're adding to the pipeline, what are you looking for as a signal to get to be early before it's too late and you have some real problems? I'm not saying that's now, but what are some of the telltale signals that you're looking for this time around?

Well, Rich, I think we could all reflect back on what the market looked like in 2007 and 2008. And there were comparable levels of supply coming on the market. It was much less pre-leased. So the entire market had much more spec risk out there. And I don't have the numbers right off the top of my head, but I would -- going from memory, I think we were 10% or 15% pre-leased as an industry last time, and now we're in the 35% or 40% range. So, I think that's one of the factors that we look at.

The fact that demand has continued to outpace supply. And I think the fundamental difference this time -- and we've been talking about it at the last several calls -- is e-commerce and the changes that that has fundamentally made to our business. You could step back and look at all kinds of projections and forecasts out there for that side of the business. The most conservative ones I've seen have it growing at 8% to 10% a year. The more aggressive ones are 15% to 18% a year. So I think that bodes very, very well for us.

But on the outside, we're looking at the supply/demand fundamentals, both from a macro perspective and a local perspective. And even when you get to a local perspective, we're drilling down into specific submarkets.

And then we're looking at our portfolio. We've committed to you guys and our investors that we're going to keep our development pipeline, whatever size it is, at least 50% pre-leased - we are going to manage our risk much better this time. Some people have from time to time been a little critical and said we might be leaving some opportunity at the table, and if that's the case, so be it.

And we've continued to perform very well at keeping that pre-lease percentage up. Today, the pipeline's at roughly 58%. And I think in actuality, that may go up in the fourth quarter given the build-to-suit volume compared to the timing on some spec projects, but that remains to be seen a little bit. So that's kind of how we're thinking about it and what the things that we're trying to manage.

Okay. So 58% is not quite the floor, but kind of close to the floor. You wouldn't want to see the overall pipeline go much below that before you would get some leasing done and then add to it. Is that the right way to think about it?

Yes, I would say we think the floor's 50%. And in the last I think 3 years, we dipped below that one time. And I made a point of telling you guys a quarter in advance that it was going to happen and why. And in that particular case, it was simply just the timing from one quarter to the next of a number of spec projects.

A lot of the markets that we deal in, you can't build in 12 months a year. You can do that in Texas and you can do it in Florida. But in New Jersey and Pennsylvania and Chicago, you can only build about 9 months a year. So there are some of those instances. But yes, the magic number for us is 50% that we're trying to stay above.

Okay. And for Mark, if you could just answer a quick modeling question. Maybe we can do this offline if it's not right at your fingertips. But FFO from unconsolidated, it bounces around from quarter to quarter, but you're going to have a deal in the fourth quarter. Can you give me sort of a sense of what the run rate should be on a go-forward basis? And if that's not a question you can answer now, maybe offline.

Yes, Rich, I could probably answer it now, but I may not answer it correctly. So let's try to do that offline.

Okay, no problem.

I kind of think I know, but I'd like to look at my stuff first.

Okay, sounds good. Thanks very much.

Next we have the line of Ki Bin Kim. Please go ahead, you're open.

So, Mark, you actually made a quick mention about how you guys have a little bit less lease expirations going forward - and I would say compared to your peers, more noticeably less just because you have longer leases. So how do you maintain 4% to 5% same store NOI growth when you have less to recoup, even though Mark, rent growths are higher? I know you have probably about 2.5% cash rent step ups, but it just seems like it might be a little bit more difficult to get -- to maintain a high same store NOI run rate just because you have less coming due.

Yes, Ki Bin. Like I had mentioned earlier, we need to finish rolling our budget up for next year before we give guidance for next year on this number. I guess my point there is I'm not giving guidance. I'm saying that I think it is difficult to imagine we can continue this run rate next year. But somewhere half of that give or take, I think we can get there.

There's always efficiencies you can try to drive out of your portfolio as well. We've done a good job of doing that. So that's one top of the rent bumps, that's on top of the rent growth. So it's somewhere in that call it close to 3% range, give or take, I think's a pretty good baseline to start at. And then we'll just when we roll everything up how much north or south of that it is.

Okay. And just quickly on G&A. You're going to exit the office portfolio completely by year end it sounds like. But your G&A is just -- it's actually been increasing over the past couple years, so just curious if there's anything we can expect in efficiencies on that line item.

No, not really, Ki Bin. We've already driven all of the efficiencies out of G&A I think for the most part that we can. Most of the -- any additional, I should say, cost savings that come out of the remaining dispositions we have are really sitting up in property NOI. It'll be property level efficiencies that we have. What I would call the relatively slight increases we've had in G&A the last couple years are just kind of what I call cost of being a public company. They're just rising at greater than inflation.

I would point out that if you look at our G&A load relative probably any of our peers, one of the metrics we look at is G&A as a percent of the gross revenues or G&A as a percent of gross assets. While I acknowledge our G&A's increased a little bit over the last couple years, I would still put us best in class.

And just a last quick one. Are cash lease spreads generally, as a rule of thumb, about half of the GAAP lease spreads? How do I think about that?

No, we don't really calculate that, Ki Bin. I would tell you it's probably less than half. Because the GAAP lease spread, the lease term matters, so if you've got a 5-year lease, you may have to divide that number by 5 even. So it's probably, if you're at 20%, it's probably closer to the mid-single digits, give or take.

Okay. Thank you, guys.

You have a follow-up question from the line of Eric Frankel. You're open, please go ahead.

Thank you, just a follow-up question regarding future asset sales and asset recycling. So obviously you've had this non-core pool of assets you'd be able to sell down and use that to fund development. If for whatever reason your share price isn't quite as attractive in a year or two as it is maybe today, do you have a self-funding formula for funding development or capital allocation opportunities in the future?

Well, Eric, that's just blasphemy talking about our stock price like that. No, I'm just kidding. I think we can always recycle assets. I think, as I alluded to earlier, we like where the portfolio is, we've done obviously all of the heavy lifting as it relates to the office portfolio.

But we've also harvested some gains. We've sold a couple of Amazon buildings, we've liquidated a couple of joint ventures, we've pruned some industrial assets here and there. So if we need to, we can certainly look at that as an opportunity to raise capital.

Sitting here today, Mark will tell you we've got the vast majority of our development and borrowings for the next year pretty well covered. So even if we don't like where the price is from an equity perspective, I think we're pretty well covered next year.

That's it. Thank you.

(Operator Instructions) And speaker, no one else has queued up. Please continue.

Thanks, Art. I'd like to thank everyone for joining the call today. We look forward to reconvening during our fourth-quarter call, tentatively scheduled for January 26, 2017 and hope to see many of you at NAREIT next month. Thank you.

Ladies and gentlemen, that does conclude your conference today. Thank you for your participation, and thank you for using AT&T Executive Teleconference Service. You may now disconnect.