Duke Realty Corp (DRE) 2003 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by. And welcome to the Duke Realty quarterly earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session and instructions will be given at that time. If you should require assistance during the call, press zero then star. As a reminder, this conference is being recorded. I would now like to turn the conference over to our host, Mr. Tom Peck, Senior Vice President of Investor Relations. Please go ahead.

Thank you, Lois. Good afternoon. Welcome to our first quarter conference call.

Got a full group with me today, including Tom Hefner, our Chairman and Chief Executive Officer, Dennis Oklak, President and Chief Operating Officer, Gary Burk, Vice President and Executive Vice President of Constriction and Bob Chapman Executive Vice President of our southern region, Howard Feinsand, Executive Vice President and General Counsel, also the newest member of our team, John Guinee, Executive Vice President and Chief Investment Officer. Bill Lynnville, EVP over the mid-west region, Gene Zinc, Vice Chairman and Chief Financial Officer, Matt Cohote, Senior Vice President and Corporate Controller, Donna Huvvy Vice President of Marketing Services and also Shona Bedwell Manager of Investor Relations.

I'd like no to you point out that as we make forward-looking statements today, they are subject to certain risks and uncertainties that could cause actual results to differ materially. Most factors that could cause actual results to differ from expectation, include our continued qualifications as REIT, general business and economic conditions, competitions, increases in real real estate construction costs, interest rates, accessibility of debt and equity capital markets and various other risks inherent in the real estate business. We have more risk factors on file in an AK that we published December 6th, 2001.

With that, I will turn it over to Dennis Oklak for our prepared statements.

Thank you, Tom. Good afternoon.

At our December investor conference, and again on our January conference call, we predicted first quarter 2003 FFO would be down in the 5% to 8% range from the fourth quarter of 2002 or 54 to 56 cents. In fact, FFO of 57 cents was one cent ahead of the high end of that range.

A company as large and complex as Duke, that positive variance could be attributed to a number of factors but of particular note in this quarter was the fact that we exceeded our budget and termination fees on one hand but operating expenses due to snow removal were $6 million over budget on the other hand. The snow removal costs will be recovered over the next three-quarters through billings through our tenants. We have said for several quarters that the corner stone of FFO growth was occupancy growth. In that regard we made solid progress this quarter.

Overall occupancy increased by 52 was is points to 86.84% to 87.36%. The total in service portfolio increased by 47 basis points and the property under development increased by 291 basis points. Not surprisingly, the weakness remains in the stabilized office occupancies which were down 212 basis points due primarily to the termination of two large tenants which were expected and stabilize office show room occupancies which were down 112 basis points.

The good news is we have only 8% of our rental stream to renew during the balance of 2003 and 70% of that is industrial. Bulk renewals for the quarter were steadily within our 70% to 80% comfort level at 77%. Unfortunately, weak renewal activity in the office and office show room drug down the overall percentage to 62%. That is not acceptable and our entire team is focused on improving the office renewal rate.

Same-store growth for the quarter was down 3.12%. Normalizing that number by taking out the lease buy-outs and adding back the excess snow removal costs which will be recovered over the balance of the year, the same-store results would have been a negative 1.75%. Again, we had projected last December a range of negative 1 to negative 2 1/2%. Value creation pipeline was up in all categories and totaled 374 million at the end of the quarter up 41% from its low on June 30th of last year. Third party construction starts were particularly strong with nearly 60 million of new starts for the quarter. Since the first quarter is usually a slow one for construction starts, we feel these development and construction starts are a positive sign.

Termination fees were unusually high at 9.5 million. Most of that was known and was in our guidance but as I mentioned earlier, a one cent was not anticipated and therefore contributed to out-performing our guidance on FFO. This large amount of lease termination fees should not be considered a run rate. We projected last December that lease termination fees would be between 5 and 15 million for 2003 while the pace of these fees will slow over the last three quarters with the large number recognized in the fist quarter will probably exceed these parameters with terminations fee for the year now estimated to be in the 15 to $20 million range.

Acquisition activity continues to be slow, although, we did close on two 100% leased office buildings totaling 35 million. The cap rate was 10%. On the disposition side, we sold 42 million of assets at a 9.5% cap rate. Most of the disposition activity was related to our efforts to exit the south Florida market as well as some one off sales to existing tenants. The [inaudible] ratio was unusually high this quarter at 103% as we said in the last two calls it's a good thing if fad remains high over the next several quarters as we lease up the vacant space. Once we reach more normalized occupancy levels, fad should return to the trend line of around 80%.

G & A was lower than expected due to higher than expected leasing and construction activity. Our guidance in December was 20 to 30 million dollars for 2003, annualizing the first quarter would put us squarely in the middle of that range.

As Tom Hefner said in our press release yesterday, we're optimistic conditions are improving barring a significant reversal in the economy, we believe our first quarter FFO would be the low point for the current economic downturn. At this time, we see no reason to change our previous funds from operation guidance for 2003 of $2.40 to $2.55 cents per share.

Prior to turning the call back to Tom Peck to describe conditions we made this quarter to the supplemental information package, I would like to introduce you to the newest member of our executive committee. As Tom mentioned, John Guinee is with us today. John has joined us to head up the acquisition team disposition team as Chief Investment Officer. John has had a distinguished career in the real estate industry working with Heinz, ABKB LaSalle and more recently Charles Smith. We're pleased to have John on board with us.

Now ill'll turn it back over to Tom Peck.

Thank you, Denny.

As most of you know, we continually strive to make our financial disclosures as useful and transparent as possible. This quarter we added two pages to our supplemental package. Which by the way, if you don't have it, it's available on the investor information section of our web site at Dukerealty.com.

On page 12, we added a schedule that reconciles funds available for distribution to the cash flows provided by operating activities line on our statement of cash flows. We are doing this in order to comply with recent SEC rulings to reconcile non-GAAP financial measures back to the most relevant measures. The second addition to our supplemental information is the additional income statement and balance sheet provided on page 13 for discontinued operation. We think that this disclosure is becoming a best practice for the industry and among other purposes, it could be helpful to those of you who calculate net asset value.

So with that we are now ready for your questions. Lois if you could please explain the Q&A procedure.

Sure. Ladies and gentlemen, if you wish to ask a question, press one on your Touch-Tone phone. You will hear a tone indicating you've been placed into queue. If you pressed one prior to this announcement, we ask that you do so again at this time.

You may remove yourself in queue at any time by pressing the pound key. If you are using a speak are phone, please pick up your hand set before pressing the number. Once again, if you have a question or comment, please press one at this time. One moment for our first question. And we do have a question from Steve Sakwa from Merrill Lynch. Please go ahead.

Good afternoon.

I don't know if this question's for Tom Hefner or maybe for Denny. Could you maybe just help us understand sort of the sequential improvement? Obviously, you know, 57 cents in the first quarter annualizes out to about $2.28. I realize there were a couple of kind of positives and negatives in the quarter but help us walk through, you know what's going to drive you up to close to a quarterly run rate of 61 cents in the second, third and fourth quarter?

Sure, Steve.

I think if you look at our guidance that we've given as we look through all of those things as we progress through the year that will help us have an increasing trend each quarter. We do have in that some modest improvement in occupancy as we go through to get into that range. Obviously, to probably get to the top end of the range, we need some maybe slightly more than modest increase in our occupancy percentages. But at the low end of the range, it's modest on the occupancy.

And the other things like new development and acquisitions to be within the range that we've given you. Then we think we will get to those numbers that you are talking about on a quarterly basis.

Okay. Just kind of follow up.

It looked like this quarter on the renewals, you actually had a rent rolldown, which looking back to last year, you actually were able to kind of actually keep kind of a rent rollup on renewals. And I'm just wondering, you know, what your thoughts were there and then also, I just noticed that the lease terms look like they were a little bit shorter in the first quarter.

Is that something you are consciously doing or is that something tenants are asking for?

First of all, on the renewal, the rental rate increase on renewals, we had success all the way through 2002 on rental rate increases. That has slowed. I think there was about, if you look at our deals, we were at just slightly below break even on the renewal rate. I think if you look at it on a deal by deal basis, it was also that there were slightly more that had rental rate decreases as far as number of deals with rental rate decreases. So we are seeing that right now.

We would anticipate that that is towards the bottom of the cycle, also. I don't think we anticipate that getting a lot worse. But it might be a while before we start seeing more increases there. And then on the lease term, that is probably as much consciously on our part right now when tenants are coming in and wanting to -- knowing market rates and playing hard ball on market rates, they want to do long-term leases. We're obviously with rental rates near the bottom of the cycle, we'd just as soon do short-term leases. It's really a deal by deal basis.

That's how the average came out this time, Steve.

And could I just ask one last question? What is your -- at the low end of your range what is your estimate for occupancy at the end of the year?

The low end of our range, we would anticipate we need a slight increase from where we are today in the range of about 40 to 50 basis points and increase in occupancy is all we need to be at the bottom end of the range.

Okay. Thanks.

That's providing obviously that we meet the other pieces of our business.

I would just add, I wanted to make sure everybody was here. It's Tom Hefner.

I would just add to extend Denny's comments in our management meeting a couple of days ago or two months ago, depending on the energy level, our team felt that clients were trying to do one of two things.

They were either indecisive and wanted short-term leases or they were out-thinking the market and wanted long-term leases. There didn't seem to be anybody in between. And clearly, we're going to do the deals that are best for us long term. We aren't going to outthink the market. If somebody wants short term and they'll pay for it, we'll do it. If somebody wants long term, we'll get as much as we can and we'll do that to a reasonable level. And so, I think it's the mood of the clients that are sort of split right now between indecisive, therefore, wanting short-term and thinking the market's attractive and wanting long term. And remember, all that data is produced open a square foot basis, so it's skewed by the size of the deal. And there was a lot of industrial deals done in the first quarter, and so, you know, you have to sort of look through the data a bit.

And the next question will come from the line of Greg Weiss from Morgan Stanley. Please go ahead.

Good afternoon, guys. I guess a couple of questions.

The fist one may be for Denny or Tom or Gene. You know, you've made what some might argue as a silly brazen comment about conditions actually improving. And I suspect that you are sort of experiencing a number of anecdotal things that give you confidence to say that. And I just wondered if there was any other things you could share with us to make that argument a little more convincing?

Well, I'll start out.

I think we do seem to be bucking the rest of some of our peer group in this, but again Greg, comes back to what we're really seeing. If you look at our leasing activity in the fourth quarter of 2002 and the first quarter of 2003, we really did about 8.4 million square feet of leasing in the fourth quarter and 6.7 million square feet of overall leasing in the first quarter. Those are our two largest quarters since the end of 2000. So that makes us believe still that the activity is there.

Then also, the development in both of those quarters also were the two greatest quarters since the end of 2000. So we are still seeing activity. We're not seeing -- we believe it's good activity. We're not seeing it consistently across the board. There's still some markets that are pretty slow, but overall, we still have a sense that activity's picking up. As you can see, this quarter we did have some increase in our overall occupancy. And our anticipation now based on the level of activity we're seeing is that that's going to continue.

Greg, I just want to say on behalf of the team here, we appreciate you using the word brazen rather than stupid.

I would add, Greg this is Tom Hefner. I can look out my window and see real trees and I can see real grass and I can even see a pond with some geese in it. And, you know, we live out here just in the midwest, in the southeast in the real world, and that's one.

Number two, we've got our balance sheet and our portfolio in good shape, so we aren't chicken little running around with our head chopped off trying to engineer some numbers to make something work. And I'm not implying by that that others are. You can take it for what it's worth.

Number three, we know who we are and what we're doing, so we're out talking to clients every day. Don't get me wrong, we're doing everything from crummy deals to mediocre deals to okay deals but we're doing them because that's what the market is. And, you know, we're positioned -- and number four, we keep saying this, but I don't think people really hear us, but we have lots of ways to make money.

In the last quarter, we sold a piece of ground called Breckenridge in Atlanta, which we were going to build on back office office. And we concluded it wasn't the right thing to do, so we sold the ground for a substantial profit to a residential developer. You know, this is not a one dimensional company that does -- that sits around and worries about an occupancy point. It worries about making money and dealing with clients' needs. I think we're separating ourselves from all those companies that have none of that. And I don't mean to be -- but we believe, you know, there's a world out there and we're going to operate in it and we're going to make money doing it. And I think, Frankly, you guys because you are analyzing all these different companies are having trouble, I mean, I think there's a little bit of bunker mentality out there, and I don't mean to be negative of anyone on the phone, but in the real world, we're out meeting demand and our 16 business heads are figuring out a way to eke out money in lots of different ways.

And Tom, I don't mean to be presumptuous, I'm assuming that you guys are at the rock face, so it's not an ingenuous sort of question, but can you tell us, I mean, obviously you're talking to tenants all the time. Are you sensing a slightly different sentiment amongst tenants? Are their businesses doing better? Is that some of the other factors you are seeing?

We came away from an all-day management meeting two days ago. And the opinions are the office is still tough, the industrial is sticking their head out of the bunker and looking around and seem to be actually thinking about doing some business. If you want through our 16 business heads, a few of them think there is a backup of business opportunities. Others think there isn't. But clearly, they all believe industrial's getting better and office isn't showing any sign of getting any better.

Okay. That's helpful. Just a couple of other small things. In the text in your release, you suggested you'd be recouping or recovering some of the weather and snow-related costs during the balance of the year. I just wondered, is that just a recapture in terms of billing from tenants or was there something else that I'm missing?

Greg this is Matt. You're right. It's recovery from the billings of the tenants throughout the course of the year.

Okay. And just one final question maybe for you, Tom. On corporate governance and stuff. Pardon me if I've got this wrong, but did I read correctly that you guys were thinking of expanding the board?

Greg, I think you're referencing, we put together, I think we had seven proposals to vote on by the shareholders at yesterday's meeting. We're a little unique in that none of them were brought by anybody that us. I read a lot of proxies and there were a lot from other people.

There's something in the water in Indianapolis.

The one I'm referencing is the one where we wanted to mandate. We've always had a majority of independent directors. From day one we have had a majority of independent contractors. We're propose to set the bar higher at a 75% minimum requirement of independent directors. Beginning in '05. The reason for the '05 date is I made a gentleman's agreement with John Nellly about how long he could stay on the board, and I wasn't going to renege on that, and therefore, that's the '05 date. That received an 84 or 85% vote, so it passed.

So beginning with the '05 after April of '05, we'll have a 75% of independent director mix. That did not speak to the number of people on the board. We have authority limit because we hold sort of the wrong charter off the shelf when we went public way, way back that we can only have up to 15 members of our board. We have as of today, we have 14 with the election of Jack Shaw from ENY, who is the Indianapolis head of Earnst and Young, who joined the board at the annual meeting.

Thats helpful. I appreciate it. Thanks, guys.

Tom, you might also mention that the other proposal passed,, too the stagger board.

Yes, the elimination of the staggered board also got 85% of the vote. So I want to re-emphasize this. The ISS ranks us in the 99th percentile of all the companies in the Russell 3,000 index and everyone in the REIT industry. So our company from a shareholder standpoint on corporate governance ranks in the 99th percentile which we're very proud of.

And our next question will come from the line of Don Fandetti from Wachovia Securities. Please go ahead.

Actually Chris Haley. I'm calling from Baltimore and I'm looking at an office building. [ laughter ] I wanted to congratulate you on getting those things approved in your meeting yesterday. Gary had a question for you on the construction service business. Know that the pre-tax margins move around a little bit, but now we're in the single digits on a pre-tax basis. Can you give us a sense as to what's driving that number downward or what's the composition of that backlog and what are your expectations over the, you know, economic recovery and business recovery?

Well, Chris, I think it's really not that tough. There's really a couple things.

Number one, we've increased our percentage of work we're doing outside our company's envelope. In other words, on ground we don't own. And because of that, those margins have always been kind of low. And they've gotten much, much tougher.

Other aspect of it is basically, we've always carried the profit from our land sale in our third party. And since we're no longer the mix has become disproportionate more outside to in, if you will it's overall lowered the percentage.

So when you look at your volumes historically and where you expect these volumes to go, is this a fair run rate?

I don't think so because I think that this fist quarter had a high percentage of business outside of our land, if you will.

All right.

So, you know, that's likely not to stay the case. In fact, we had one like half of our first quarter was made up of one job that was for an outside client.

And the backlog with regard to specifically trying to get on the backlog? And how's that look in terms of expectations for return or margin?

I think our backlog right now is as good as it's been in a little while for third party business, but right now it's heavily stacked with people outside of our portfolio. The current backlog we have will probably stay at the margins you are seeing maybe inch up a little bit, because we're picking up a few jobs with the a little bit better percentage, but it will really start picking up when we do more deals on our land.

Are you going out of our existing market universe, Gary?

We certainly have. We've got outside it a little bit. Probably better than half of the first quarter volume that you're seeing was outside of our core markets, if you will.

I'm assuming they're with existing customers?

They are.

My last question is, Tom was -- Tom Peck was kind enough to go through the roster of the Bevy of professionals on the call. What is John Guinee going to be doing now that he's on in terms of the disposition or refocusing the disposition or recycling business?

Before Denny answers that question, I want to bow back to your point. There's a good chance we'll be at the high end of the construction range we referenced at the last investor conference. And the fees will be slightly lower but they are not going to be at the run rate that you saw in the first quarter.

So construction volumes will be up but margins will be a little suppressed?

Well, I didn't say they would be up. I said they would be in the mid range or upper range of what we gave you.

Okay, great.

And Chris, John has joined us with -- as I mentioned, a wealth of experience in the real estate industry and particularly on the acquisitions and disposition side and several of his previous stints. So what we're looking at now obviously, we're focusing on acquisitions even though the market's tough. We're still looking for good bargains out there. John's working a lot on that.

We're also looking at doing some strategic dispositions and, you know, sort of pruning the portfolio with times are good and we'll look at that and John has been with us for about two months now and is very much immersed in all those projects.

The success of your past recycling efforts has shown itself. How can you improve -- how does John propose to improve upon the record you've established?

I'll let John try that one.

I think the disposition strategy for the next couple of years, Chris, is really to try to prune the portfolio in terms of some of the second tier assets. What we're going to do there is bulk them up into portfolio sales because we see portfolio sales is getting a significant premium to one off transactions. To date, we are very, very exciting about the pricing that we are seeing. On the acquisition side, as you know this is a value-added company, this is not a core acquisition company. We have always seen core pricing as being out of sight, but we think value-added pricing particularly in the markets where we're strong is being better than core but not great.

Thank you.

Our next question will come from the line of John Litt from Smith Barney.

Good afternoon it's Gary Boston here with John Litt.

Quick question, you guys made great progress in terms of occupancy during the quarter. It looks like one group of assets that continues to be stubborn is the '01 deliveries which is still sitting at about 67% leased and the state-wide return that you guys projected has come down a little bit. I was wondering if you could comment on that, if it was anything in particular in that pool that is making that a difficult batch of things to get leased up?

Yeah, I would say a couple things. There's really the one thing that I would point out, there's two projects in Atlanta industrial that comprise a million square feet. Bulk buildings that we built at the tail end of, you know, our speculative building. And we still have not -- we've had very little activity and we still have close to a million square feet vacant in those two buildings. Everything else has had, you know, some amount of activity and a little bit of lease up. Albeit some of it slow. It's really been those couple projects in the Atlanta industrial that are felt overall that that's down.

Is there anything -- I mean,it locational issue or type of asset?

Bob Chapman, why don't you make a comment on those properties.

Well it's not a locational problem. It's lack of demand in the Atlanta bulk market. And we are seeing some increase in activity in the south side. We're going to sign a lease next week for 200,000 of the 500,000 feet. But it's not locational. It's really a market situation.

Right.

I'll give you an example in Plainfield near the airport in Indianapolis, we built 600 square foot building and it sat vacant for nine months to a year, and I could be off a number of quarters. We not only leased it up, but we have a deal made to lease it all up and potentially put a 200,000 foot addition on it for the client who's taking the building. We just happened to have two of those in Atlanta that skew the numbers and the activity has perked up. Then if you look through it, it's a whole bunch of little of this and a little of that, you know?

We're as dumbfounded by it as your question. But we actually see activity picking up a bit. But Atlanta, our experience is that the Atlanta bulk industrial market has been the weakest of, you know, when you think Chicago, Atlanta and Dallas would sort of all operate together and Chicago's held up, Dallas is held up and for some reason Atlanta has done nothing.

Fine.

The other question I had was regarding the space vacated schedule that you put in the supplemental. You spoke to the lease buyouts and those are running sort of higher than you might have thought going into the year. The other number that stood out to me was the contractions at about 400,000 square feet was almost twice the quarterly pace of what it looks like it's been the last couple of years. I was just wondering if it was anything unique or something you are seeing ramping up. I know it had been a problem for most people, you know, last year, but I wanted to see if there was a trend there.

Gary, this is Denny. I don't know if its with a trend. Most of that was one deal customer down in one of our industrial properties in Cincinnati. Had a fairly significant contraction. I think that was the bulk of any increase there. So I don't think it's any particular trend on contractions. We're still seeing some as we always do, but not anything significant.

Great. Thanks a lot.

Thank you. Our next question will come from the line of Kevin Lampo from Edward Jones. Please go ahead.

Yeah. First question to follow up on the snow removal costs. Are those shown as revenue this time as part of your tenant reimbursement and then showing up as a recovery on your balance sheet then?

Could you repeat that question, please?

Yeah, the snow removal cost of the $5.5 million. Is that show up in this period as a revenue item and then showing on the balance sheet as receivables from the tenants?

No.

So that's going to impact revenue in the future then?

Yes.

Okay. Second. Gene, you've talked about in the past about the kind of the borrowing ability that Duke has. Where do you kind of see that today?

Kevin, we think we have comfortably a billion dollars with the capacity in this environment.

Okay. I mean, I noticed the coverage ratios did come down in the quarter. Is that just a reflection of just, I guess, the difficult -- hitting the bottom in the first quarter?

Right. As we build FFO back up, coverages will get better.

Okay. And the third, kind of as a general question, I mean, I think everybody's watching the employment numbers. And we have not seen employment pick up at all this year. And I'm just kind of curious where the demand is sort of coming from that you are being so successful in planning new deals?

Kevin this is Denny. I think I would say a couple things. From, you know, sort of our view, the employment numbers really affect the office side quite a bit, and I think we've said we haven't seen a significant pickup. With a couple of lease expirations, we've seen some decrease on the office side in the stabilized portfolio because of that.

On the industrial side, you know, we don't believe that is quite as much tied to employment growth. It's population growth and other things. And I think just people have cut back and as people also try to take advantage of slower times to cut costs, you know, they really look heavily at how to consolidate distribution facilities and make distribution facilities it more efficient. I think we're seeing some of that on our industrial side. That's where some of our activity there has come from.

All right. Thanks, guys.

And our next question will come from the line of Jim Sullivan with Green Street Advisors. Please go ahead.

Thanks.

On page two of your release, you indicate this on the leases that you signed or the renewals that you signed during the first quarter, you had a 1.5% decrease in what you called net effective runs. How are you defining net effective rents?

Net effective rents are basically the same as the straight line rental income. So it's the average rent over the term of the lease less the operating expenses.

So yoe not factoring in releasing costs into that net effective rent calculation?

Correct.

Do you have any sense as to what the decline would have been had you done that?

Well, Jim, I think if you -- I would have to say at least off the top of our heads we don't have like a sense of exactly what that number would be, but I think we also show in here our average capital expenditure per square foot historically. And I think if you look at that separately, you can see that we are having some increase in capital expenditures on a per square foot basis. Particularly on the office side on the industrial side. It's holding pretty steady. On the office side right now, the capital expenditures that we're putting in are probably up 15 to 20% over, say, a normal run rate.

Okay. What about free rent? How prevalent is free rent in the renewals that you're doing, the replacements that you're doing? How do we get our hands around the total releasing costs you referenced TI's and leasing commission but what about free rent and the effect that that's having?

One quick thing before Denny takes that, the free rent is factored into the net effective rent calculation so that's already considered when you are looking at that comparison.

Amortized the free rent over the life of the lease?

Right. Right. But just what we're seeing in the markets, we're not particularly seeing free rent on the renewals I don't think in any particular market or any particular area. There is a little bit of free rent coming in the new leases and maybe new development deals. But it's still generally speaking in a three or four-month range, it's not in the 12 to 18-month range or anything like that. So that's what we're looking at right now. And it's still, that's not like across the board, Jim. That's on probably, again, I would say maybe 25% of the deals or maybe a little less than that we're seeing the free rent creep in.

And geographically speaking, where are you having to offer that or where are your competitors offering that most frequently? Geographically, I guess, and which property type?

Obviously, in the office property type more than industrial. And geographically, I don't know that there's any one place that it's happening more than others geographically. I know Bob or Bill if you would have any comments on the markets you cover whether you see anything specific there?

I don't think, Jim, that it can be tied to geography like a region. It would be tied to geography only in the sense of a soft market. You know, a local soft market.

Chicago is a very soft sub-market right now. Where else do we have soft sub-markets, guys?

Well -- well, the St. Louis industrial market has been softer than historically, it doesn't reflect as much in the occupancies, but it has been a soft market.

You know, Raleigh's soft because of some things. Bob, what other sub-markets?

Raleigh, Atlanta, the Georgia 400 market, a little bit in central Florida. But in terms of trends, I don't -- there's really no change, Jim in the last six months on that free rent category in my cities.

It's not getting worse?

No.

No.

Switching gears. The land sale gain that you had in the quarter, Tom Hefner referenced the situation behind that. Was that land sale gain in the guidance that you had provided for the quarter previously or was it a pleasant surprise?

It was in the guidance?

Denny's got a program where we're trying to reduce our land position by you know, just roughly 30 to 50 million bucks and, you know, we knew that one was coming. And we, you know, feel good about -- I've been impressed. We closed on a piece of ground --

Tuesday.

Tuesday in Cincinnati that reduced our land position by about $9 million and made a million. We'll make $1 million. So we're very focused on that.

Okay. And on the lease termination fees, can you shed some detail on what they were or where they were and just refresh my memory on how much of it was expected and how much was not?

Sure, Jim.

The bulk of that came in two places in the first quarter. One was a buyout of an entire building here in Indianapolis. It was on a long-term lease to one of our tenants. And we actually when you look at that building, you know, it was, I think the interesting thing on that one is that the buyout number represented on a per square foot basis about 60, 65% of the original cost of that building. And that building's now 55% pre-leased. There's was one existing sub lease that we assumes, and we have signed another tenant and have good activity on that one.

The other one was in an office building in Cincinnati where we had a tenant buyout of some space and that's about 35,000 square feet. And we have not signed any new leases on that, but we have some prospects. But they just moved out on February 15th.

And the other part of his question was, relative to expectations, we were, I think we said in the script about a penny ahead of our guidance that we gave last quarter on lease termination fee.

We were expecting the first one he described. We weren't expecting the second one.

Finally, on page seven of your supplemental, you have a table that shows a return on real estate investments. And the number that you show about 9% year-to-date '03 is much lower than what that number has been historically. And I guess I'm trying to figure out what to make of a 9% return on real estate investments for a company that historically has developed to about an 11% return that historically has acquired in the, I don't know, 9% to 10% range? How come the leverage the figure return on real estate investment isn't more reflective of those kind of returns that you've historically gotten on investment?

Well, John, I think it's an easy answer on them. It's really just the occupancy. Obviously when we develop and get those 11 or 12% returns, that's at, you know, a 95% kind of stabilized occupancy. And as well, when we look at historically when we've looked at our acquisition prospects it's also included the, you know, some level of leasing. And so, I think that's the really the primary reason for that. And you can see that overall, our occupancy is down on the in service down at the 86% range. So that's, I think, the primary reason.

Is that a measure that you in any way use to manage your business or is it just an output based on everything that you do?

Say that one again, Jim? I'm sorry.

Do you manage your business towards a target number here or is this just an output of the various activities that you participate in from an investment standpoint over the course of the quarter or over the course of a year?

We would like to manage this to a higher number, obviously. And what -- but what we do have is a building by building yield analysis that we do and maintain every year. So we're always looking at those on a building by building basis and trying to increase our yields and figure out ways to do that.

The other thing that's also, you know, in this number is this includes in our real estate investment our undeveloped land. And obviously, our undeveloped land is at a higher level right now because we haven't had the development volume we would normally have over the last 18 months. So that is also having the impact of reducing that number.

And, you know, that number only equates to 10% of our compensation scheme. Our compensation scheme is about earnings per share. And remember, this number's carrying $300 million of land. So it's not a pure number, and don't try to make it. That's an average of what we get on the properties. We run lights and heat to.

It's an unleveraged number. I thought I heard you say it was after leverage. It was unleveraged.

No, I misspoke. No, no. We're just still trying to -- we don't manage to that number as much as we manage to our earnings.

Thank you.

Our next question will come from the line of Susan Berdiner from Bear Stearns. Please go ahead. Ma'am, your line is open. We'll move to the line of David Fick from Legg Mason. Please go ahead.

Good afternoon. Good quarter, guys. You've already answered most of my questions. Just one little detail. On this year's dividend return of capital, do you have any ballpark idea as to where your ordinary income versus return of capital and capital gains will be?

I think your question, David,do we have any tax reasons to increase the dividend? And the answer's no.

No, no, no. No, really, I'm try fog get an idea of an anticipation of the value of your dividend, if you will in terms of the taxability versus --

Oh it's way too early for to us have any idea, David, on return of capital.

Okay. Thank you.

Thank you. Our next question will come from Mike Bilerman from Goldman Sachs. Please go ahead.

Good afternoon. I was wondering if you could comment on the activity for the remaining '03 roles and what sort of prospects you have there?

If you look at the roles for the rest of the year, the actually the second and third quarter are lower than both the first and fourth quarter would be. We believe we definitely will improve on our experience in the first quarter. We've said there was two fairly large tenants that we had, clients that we knew going in that were not going to renew and as we've looked through the rest of the year, we believe that we'll have better success, but the rollover in the third and fourth quarter are low and we're already working on a number in the fourth quarter to get them renewed early.

And in terms of the Magellan space, have you had any prospects there in terms of back filling that space?

Bill, you want to talk about the prospects there?

Yes. They vacated 180,000 feet in a tower that we have. It's about 50% of the building. The year prior we had done an expansion for EDS.

That space was filled by city mortgage within about six months. Then when Magellan moved out, it vacated the other half of the building. We've got 65,000 feet of it leased in the last literally, the last six days. And we've got a very good prospect for the balance of 120,000 feet. That's looking at either renewing in a downtown facility or moving out with us. So I would say the activity's been very good given that they vacated just, you know, 45 to 60 days ago.

Can you guys comment on where you see the mark to market on rents on the industrial and the office side and maybe you can comment on some of the major markets?

Bill, Bob, why don't you start with that, and then I'll jump in.

Mike, was the first part of your question where we see rents going?

See what the mark to market is on the leases that are rolling sorting of over the next 12 to 18 months?

Well, I think generally, and it shows in our new lease analysis we're actually seeing improvement in the bulk and mid sized industrial rents. And in the amount of Cap Ex that's going into them. And I think that's a product of increased demand, but I think it's also because the pipeline stopped. You know, the pipeline can be a lot more reactive in industrial. So there isn't as much supply. The service center is pretty flat, although, I don't think it's deteriorating. As we've said, we'd like to believe we've hit the bottom in office, but the office has the rents have deteriorated.

Do you care to comment on some of your major markets and where you see the rolldown?

This is Bob Chapman. I'd say in Atlanta, on the office side, it's probably a 10 to 12% roll down. On the bulk, probably about the same. But on the smaller spaces, 10 to 20,000 foot service center faces on the Atlanta industrial, it's pretty flat. And in Dallas, it's probably only 5 to 7% rolldown overall.

Okay. One last question on land sales, how much is in your guidance for the year?

As far as net profit on the land sales, we had just over 7 million was sort of the range of guidance. As Tom said, we've had some good successes on that. I think we believe we will be with -- at that range at the top of that range, and if some good things happen to us, we will be able to exceed that range this year.

Okay, great. Thank you.

Thank you. Once again, if you do have a question, please press one. And we have a follow-up from Don from Wachovia. Please go ahead.

Hi. In terms of your occupancy, you had mentioned you were expecting an uptick in '03. Does that include the negative impact from the lost space from termination?

Yes.

Okay. And also, in terms of your increased lease termination fee guidance, is that a function of more tenants coming to you seeking buyouts or your greater willingness to accept these deals based on a better outlook for your markets?

Most of that is from tenants coming to us that they want to downsize or -- and also there have been a few of strategic opportunities that we know that a tenant has come to us in the past and we've not been interested because of market conditions or certain specific conditions in the sub-market that we did not want to take a buyout. And we have on a couple times gone back as leasing activities picked up in a particular sub-market and agreed to do a buyout where we felt good about the prospects.

This is Chris. Would you say -- well, how would you characterize the quality of the companies that are coming to you now versus those that might have come to you last year?

I would say that most -- the bulk of the buyouts as far as dollars have all been from sizable significant clients. And as we've looked at them, Chris, they wanted to downsize so bad, they wanted to give us so much money to do it, we felt we even in light of the occupancy conditions, we were going to take it. But there always are a few scattered in there of tenants that are low quality and you are worried about them anyway. So you go ahead and take the money and hopefully don't worsen your risk.

I'm assuming this is skewed in terms of dollar amounts to the office size? Is that fair?

Yes. Very much so.

Very much so. Okay. All right, great. Thanks again.

Our next question will come from the line of Gary Freemen with [inaudible] Investors. Please go ahead.

Hi. This is really a question for anyone that wants to jump in. I've been listening to some of your comments on the office side and just focusing on that for a minute. You know, you are talking about rents rolling down a little bit on the office side. Free rent maybe being stable. TI's increasing a little bit. How confident are you, really that net effective rents are bottoming? Can you elaborate on that concept a little bit?

This is Denny, Gary. And I think, you know it's just a matter of degree. I mean, right now, we sense, again that they are bottoming. Again, we could have a double dip and something get worse but we've been watching them for a year and a half as they moved down. And looking at where they are and I think a lot of that also is affected by the level of activity. And as the level of activity picks up, which we have seen more people interested and more people talking, and as that picks up, the sense always is that your discounting should be more at the bottom and the rent reduction should be towards the bottom.

And there's just not a lot of new supply coming into the market. We didn't go into this downturn with a whole lot of space under construction that kept overhanging and overhanging. You know, there was a modest amount of it. We can only speak about our markets and now it's a question of the downsizing the occurrence, the people going out of business and the subleased market and how it gets refilled. It's not a continuous pipeline of new product coming.

The other thing is, our rents didn't go up like certain, you& know, downtown markets, and therefore, they don't have to fall as much as certain other locations.

And at this time, we have no further questions in queue. Please continue.

All right. Thank you very much for joining our call today. We will go ahead and plan on having the next conference call July 31 at 2:30 P.M. Eastern time. And have a nice day.

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