Elme Communities (ELME) 2008 Q4 法說會逐字稿

Welcome to the Washington Real Estate Investment Trust's fourth quarter 2008 earnings conference call. As a reminder, today's call is being recorded. Before turning over the call to the Company's President and Chief Executive Officer, Skip McKenzie, [Kelly Shiflett], Director of Finance, will provide some introductory information. Ms. Shiflett, please go ahead.

Thank you, and good morning, everyone. After the market closed yesterday, we issued our earnings press release. If there is anyone on the call who would like a copy of the release, please contact me at 301-984-9400 or you may access the document from our website at www.writ.com.

Our fourth quarter supplemental and financial information is also available on our website. Our conference call today will contain financial measures, such as FFO, NOI, and EBITDA that are non-GAAP measures. And in accordance with Reg G, we have provided a reconciliation to those measures in the supplemental.

Please bear in mind that certain statements during this call are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements involve known and unknown risks, uncertainties and other factors that may cause actual results to differ materially.

Such risks, uncertainties and other factors include, but are not limited to, the effect of the current credit and financial market conditions; the availability and cost of capital; fluctuations in interest rates; tenant's financial condition; the timing and pricing of leasing transactions; levels of competition; the effects of government regulations; the impact of newly adopted Accounting Principles; changes in general and local economic and real estate market conditions; and other risks and uncertainties detailed from time to time in our filings with the SEC, including our 2007 Form 10-K and our third quarter 2008 Form 10-Q.

We assume no obligation to update or supplement forward-looking statements that become untrue because of subsequent events.

Participating in today's call with me will be Skip McKenzie, President and Chief Executive Officer; Sara Grootwassink, Executive Vice President and Chief Financial Officer; Bill Camp, Executive Vice President and Chief Financial Officer-Elect; Laura Franklin, Executive Vice President and Chief Accounting and Administrative Officer; and Mike Paukstitus, Senior Vice President, Real Estate.

Now I'd like to turn the call over to Skip.

Good morning, and thank you for joining Washington Real Estate Investment Trust conference call today. The fourth quarter was a difficult one for the US economy. While we in the national capital region typically outperform the country in times like these, we are not immune to the financial distress affecting every sector of the economy. Leasing velocities are down significantly; investment transactions and opportunities are few and far between; and the ability for our tenants to finance business expansion is difficult, to say the least.

In our portfolio, while we are generally well leased at 94%, we continue to see signs of distress in our tenant base. Office and industrial tenants are reluctant to assume more business risk by leasing additional space or extending lease terms. Retailers are struggling with the consumer, who now saves rather than spends, and residential occupants are doubling up or moving in with mom and dad.

Having said that, the good news is that the Washington region continues to add jobs, albeit not at the rate of the past five years. The unemployment rate is low at 4.7%; the overall vacancy rate is manageable at 10.5%; and we believe the Washington region will lead the nation in recovery as the newly appointed financial capital of the world, and as a major beneficiary of the financial stimulus plan.

While the engine of the federal government is a slow moving one and will not dramatically improve real estate economics in 2009, critically, we believe the initiatives undertaken by the financial stimulus plan will begin to break the crisis of confidence, which is the root cause of the malaise affecting each sector we operate in.

In addition, our region will become ground zero for the regulators, vendors and counselors to the expanded governmental agencies these new programs will create. Throughout the region, while recent activity has been slow, our core markets have not been overbuilt, and once activity rebounds, we believe recovery should be expeditious.

In the fourth quarter, we completed several transactions of note, improving our portfolio significantly and strengthening our balance sheet. In December, we completed the previously announced acquisition of 2445 M Street, an exceptional D.C. office building. To finance the purchase, we used the proceeds from the sale of two industrial properties, the Sullyfield Commerce Center and the Earhart Building, which were sold in the second quarter of 2008. We assumed $101.9 million loan and borrowed from our lines of credit.

In addition, we purchased $16 million of our convertible debt at a discount of 25%, reducing our exposure to 2011 refinancing and achieving an attractive return on investment.

While we expect 2009 to be a year of transition, WRIT is well-positioned to take advantage of the investment opportunities we believe will begin to develop in 2010 and beyond. WRIT only has 9.3% of rental income rolling in 2009. Our liquidity position is sound, with only $67 million out on our lines at year-end and with only $50 million multi-family portfolio mortgage maturing in 2009.

We have no material exposure to significant development expenditures and commitments, and our properties are currently well-leased at 94%, with average in-place rents generally below market.

There's been much discussion in the REIT world regarding dividend policies and the IRS pronouncement allowing the issuance of REIT common shares in lieu of cash. I would like to reiterate, our current commitment to paying a cash dividend, and our belief that maintaining and ultimately growing dividends are an important component of the REIT story and a major reason for Washington REIT's long-term success.

Last but not least, I would like to thank Sara for her seven years of superb performance as WRIT's Chief Financial Officer. As previously announced, this will be Sara's last call with us, as the transition of her duties will be complete upon the filing of the 2008 10-K. Sara has been a tremendous asset to our organization, and her managerial skills and financial acumen contributed significantly to WRIT's success over her tenure.

I greatly valued her intellect, good judgment, and friendship over these years, and all of us at WRIT wish her the best of luck, as she struggles to adapt to a perfect climate 12 months per year, leaving the six months of ice and six months of humidity in D.C. behind her. Sara, thank you for all you have done for WRIT.

Now I'd like to turn the call over to Bill, who will discuss our financial performance.

Thanks, Skip, and good morning, everyone. For the fourth quarter, funds from operations were $30.9 million or $0.59 per diluted share. This compares to FFO for the same period one year ago of $27.5 million or $0.59 per diluted share. Funds available for distribution were $0.46 per diluted share in the fourth quarter.

For the full year, FFO was $104.4 million or $2.12 per diluted share versus $106.6 million or $2.31 per diluted share for 2007. The $2.12 per share include a one-time gain of approximately $0.07 a share related to the repurchase of the convertible debt, and a one-time loss of approximately $0.17 per share related to the extinguishment of the MOPPRS.

Fourth quarter core cash net operating income decreased by 4% compared to the same period one year ago. Although rental rate growth was 3.1%, core occupancy decreased 150 basis points to 93.8% compared to the same period one year ago, but was essentially flat compared to the third quarter of 2008 results.

By sector, our performance is broken down as follows -- office properties core cash NOI for the fourth quarter decreased 2.6% compared to the same period one year ago; core economic occupancy decreased 180 basis points to 93.5% -- however, we continue to see core rental rate growth; office core rental rate growth was 2.9%; medical office properties core cash NOI for the fourth quarter decreased 1.1%.

Compared to the fourth quarter last year, core economic occupancy decreased 220 basis points to 95.9%, while core rental rates increased 3.3%. Multi-family properties core cash NOI for the fourth quarter increased 2.1% compared to the same period one year ago. Rental rate growth was 1.8% and core economic occupancy increased 200 basis points to 93.2%.

Retail properties core cash NOI for the fourth quarter decreased 7.8% compared to the same period one year ago. Rental rate growth was 4.2%, despite a core economic occupancy decrease of 120 basis points to 94.7%. Industrial properties core cash NOI for the fourth quarter decreased 9.5% compared to the same period one year ago. The decline was driven by 350 basis points increase in core economic occupancy to 92.2%, even though the core rental rate growth was 3.3%.

While our portfolio statistics I just highlighted are moderately weaker than they were last year at this time, it is important to reiterate that our overall economic occupancy remains relatively stable at 93.8%. We believe this is a function of having a well-diversified portfolio in one of the better real estate markets in the country.

Much of the decline in the occupancy in each sector happened earlier in the year. Sequentially from the third quarter, office core economic occupancy is up 80 basis points; retail is up 40 basis points; multi-family declined 150 basis points; industrial is down 40; medical office is down 60. Mike will discuss more specific surrounding property type in a few minutes.

From a capital markets perspective, WRIT is well-positioned. In 2008, we took several steps to strengthen our balance sheet, including raising over $190 million of equity, decreasing the outstanding balance in our lines of credit, and repurchasing a portion of our convertible debt, which has a 2011 put date. As a result of our continued focus on our capital position, Moody's reaffirmed our Baa1 senior unsecured credit rating last October, and S&P reaffirmed our BBB Plus rating a few weeks ago.

In 2008, we raised equity in three separate tranches, totaling $190 million at a weighted average price of $35.14. We used the proceeds to reduce the line of credit balances and other general corporate purposes. Essentially, the transactions helped us fund the equity portion of the acquisitions we made last year.

As for our 2008 debt activity, we had previously reported that we expanded the capacity on one of our lines, completed the extinguishment of our MOPPRS, refinanced the debt at more favorable interest rates, and refinanced short-term debt by entering into three mortgage loans at a rate of 5.71% with an eight-year maturity.

Continuing with the activity on the debt side of the balance sheet, in December, we repurchased 16 million of our $260 million senior convertible notes at a discount of 75% at par or approximately $12 million. In conjunction with this repurchase, we reported a gain of approximately $3.5 million or $0.07 a share.

This quarter, we repurchased an additional $19.5 million of those same convertible notes. Also, this week, we closed a 10-year, $37.5 million loan on the Kenmore Apartments at a fixed rate of 5.37%.

In the fourth quarter, WRIT paid a dividend of $0.4325 per share, achieving its 188th consecutive quarterly dividend at equal or increasing rates. Last night, we issued a press release announcing our first quarter 2009 dividend at the same rate.

Looking forward, our only debt maturity in 2009 is a $50 million residential property mortgage due in October. This loan encumbers five multi-family properties, and we estimate the current loan to value is approximately 25%, leaving us alternatives to either refinance the $50 million while encumbering only two of the five assets, or refinance all five assets and generate proceeds well in excess of the $50 million, depending on our need for capital at the time.

In 2010, we have a $100 million term loan debt matures. We have already had discussions with our lenders about refinancing or extending the maturity of this loan. We currently expect to be able to refinance or extend this loan successfully. In 2011, we have $150 million of bonds maturing and $224.5 million of our convertible bonds, which can be put back to us at par.

WRIT has two credit facilities. One expires in 2010 and one expires in 2011. We have the sole right to exercise an option to extend these lines for an additional year, pushing the maturities to 2011 and 2012, respectively.

Last night, we announced 2009 FFO per share earnings guidance of $1.95 to $2.15. This guidance takes into account approximately $0.10 per share interest expense adjustment related to the new convertible debt accounting rules, and the fair value accounting treatment for the loan on our 2445 M Street acquisition.

Additionally, our guidance includes increasing our estimated bad debt expense in anticipation of continued deteriorating economic conditions in the real estate markets; taking a more conservative projection for vacancy by assuming lower retention and longer lease-up of vacant or expiring space; assuming our overall cost of capital will rise throughout the year, given rates on our lines of credit currently hover around 1%; increasing cap rate assumptions on approximately $50 million to $70 million of planned dispositions and a nominal amount of acquisitions; and finally, accounting for the full year impact of the additional shares that we issued last year.

Before I turn the call over to Mike to discuss operations, I want to say thank you to Sara. For those of you who do not know, I met Sara in 1999, when she was with Corporate Office Properties. Sara came to WRIT in 2001 when I was an analyst at A.G. Edwards covering the Company. She made an immediate impact here.

In my opinion, Sara's integrity, strong work ethic, great relationships with the investment community, and the ability to comprehend all the operational details that change every day within a real estate company -- particularly as it relates to the capital markets -- made a tremendous positive impact at WRIT. She has been a valuable member of the senior management team. She has welcomed me to the Company and has made my steep learning curve much easier to overcome.

Sara, I wish you the best of luck in your future, and thanks. Now I'll turn the call over to Mike.

Thanks, Bill, and good morning. As Skip indicated, leasing velocities in the market are down significantly, and many companies are delaying leasing decisions, due to the current economic climate.

We had executed over 307,000 square feet of commercial lease transactions in the fourth quarter. The average rental rate increase on leases signed this quarter was 9.1% on a cash basis and 19.9% on a GAAP basis. Tenant improvement costs were $15.33 per square foot.

Residential rental rates increased 1.8% in the fourth quarter compared to the same period one year ago. Rental rates for new and renewed leases in each sector ranged from an increase of 4.6% to 20.2% on a cash basis, with $3.37 to $27.56 per square foot in tenant improvement costs.

In the office sector, we executed leases for a total of 128,000 square feet and an average rental rate increase of 4.6% on a cash basis and 15.9% on a GAAP basis. In total, our office portfolio is 94% leased. Generally, we continue to perform well in all our submarkets as compared to the overall market metrics. For example, our Washington CBD portfolio was 3.5% vacant at year-end, compared to a 5% market vacancy.

In Rosslyn, Virginia, our 166,000 square foot office tower at 1600 Wilson is at 100% occupancy, compared to the 5.6% market vacancy.

In the medical office sector, we signed leases for a total of 62,000 square feet at an average rental rate increase of 8.7% on a cash basis and 26% on a GAAP basis. Our medical office portfolio is at 97% leased. This sector continues to perform extremely well, with some of our properties realizing rents equal to Washington CBD rents.

In the retail sector, we executed leases for a total of 32,000 square feet with a rental rate increase of 17.4% on a cash basis and 14.4% on a GAAP basis. Our retail portfolio is 97.8% leased and we achieved a 91.5% retention rate in this quarter. We do have a 28,000 square foot Circuit City store in our 332,000 square foot center at Hagarstown. The impact of this bankruptcy has been reflected in Q4 2008.

In the industrial sector, we entered into leases for a total of 86,000 square feet with rental rate increases of 20.2% on a cash basis and 26.3% on a GAAP basis. The industrial portfolio is 91.3% leased in total. On average, our industrial portfolio is performing in line with the submarkets in which we operate. There are several of our submarkets will remain challenging in 2009.

Thus, our 2008 commercial leasing activity totaled over 300 lease transactions comprising 1.5 million square feet with total revenue potential of $185 million over the next five years, over the average five-year terms of these leases. In the aggregate for 2008, we had a rental rate increase of 7.7% on a cash basis and 19.4% on a GAAP basis.

Leasing activity at our development projects are steady. Last quarter, we announced two lease executions at our 180,000 square foot Dulles West project. The property is now 86% leased to IBM and National Student Clearinghouse, who will occupy a total of 154,000 square feet. We now have one 20,000 square foot floor left for leasing in the building, and we currently have a 5,000 square foot lease transaction in negotiation.

Bennett Park, a 224-unit Class A apartment complex consisting of high and mid-rise buildings in Arlington, Virginia, was 78% leased at year-end. Clayborne Apartments, consisting of 74 units in Old Town Alexandria, were 64% leased at year-end. Most of these residential projects experienced a slower absorption in Q4, but activity has picked up in the new year and stabilization is projected for mid-2009.

This quarter, WRIT acquired 2445 M Street, a Class A office building with a two-level parking garage in downtown Washington D.C., for $181.4 million. 2445 M Street is located in the established West End neighborhood between Georgetown and the Central Business District. The property measures 290,000 square feet and is 100% leased to the Advisory Board Company, and Patton Boggs, LLP under long-term leases.

We have assumed the $101.9 million loan with an interest rate of 5.619%, and the remaining balance was funded with proceeds from the sales of Sullyfield Commerce Center and Earhart Building, and the balance from our credit lines. WRIT expects to achieve a first-year leverage yield of 6.7% on the cash basis and 7.2% on a GAAP basis. 2445 M Street is an excellent downtown asset that will provide WRIT a stable long-term cash flow.

Now I'd like to turn the call over to Sara.

Thanks, Mike. I just wanted to let all of you know what an honor and pleasure it has been to work with you over the last seven years. I greatly appreciate all of your generous support as we have navigated these capital markets. I'm confident I'm leaving you in good hands, and I believe that you will enjoy working with Bill as much as I have.

Now we'd like to open up the call for questions.

(Operator Instructions). Mark Biffert, Oppenheimer and Company.

Skip, I was wondering if you could start off by trying to figure out the timing of this stimulus impact in the D.C. market and how that plays into your guidance. It seems like you've pulled down your occupancy assumptions and increased your percentage of bad debt in revenue. How did the two tie out?

Yes, I mean, I think as I mentioned in my comments, I mean, we don't think it will have a material impact on real estate dynamics this year. In other words, I don't think there's actually going to be leases hitting the streets that you'll actually see income from this year.

What I do think the most important part is, it's going to really sort of free up the crisis of confidence that's out there. The problem that we're seeing and really the fundamentals really across all sectors is that everybody is playing defense right now. And it's extremely difficult for any tenant, even the good performing tenants, to take additional space, to sign a five-year -- extend their lease for a long period of time.

Everybody wants to go one-year extension, two-year extension. And it's because they don't know what's going to happen next. I think the financial stimulus plan -- the impact of that in 2009, will really begin to just re-establish confidence in business. And I really -- and I think our guidance reflects the fact that we're not expecting any juice from that to really impact real estate economics in 2009 in our region.

And then what about -- have you seen any kind of increase in traffic in your apartments related to the new administration and seeing more people move in as a result of that? And how is it impacting retail tenants' view points as well?

Nothing immaterially, with respect to the election traffic.

Okay. And then what are your cap rate assumptions that you're using on the planned dispositions that you have $50 million to $75 million for?

I believe we have mid-7's; something like that.

Okay. And then what are your occupancy assumptions?

For?

Across each of the property types?

For next year?

Yes, how much have you pulled them down? Or how much are you assuming they decline?

Okay. It's kind of a range. We're just looking it up.

Okay. Well, if you want, I could ask another question to Mike while you look that up. Mike, I was wondering if you could talk a little bit about the retail performance in the fourth quarter. You had mentioned that Circuit City was included in that number. Was that the largest percentage of that decline in NOI that we saw?

Yes, it was. And that number approached $900,000 as a result of not only cash but FFO adjustments.

Okay. And then in terms of the rents that you have in place, I mean, where could we see -- I mean, would you expect to see in '09 some type of inflection point where your in-place rents -- or your market rents fall below your in-place rents?

On the retail front?

Yes, or any of the sectors, even the industrial side.

Well, I think the retail front is probably where we're looking at it very closely, where we could have the most exposure. The others I would identify more as a flat, and that's pretty much what's forecasted for the market in general. But as you know, retail is under pressure and discussions of reductions or holidays are in the dialogue daily, as we talk to those tenants.

Okay. Anything on the occupancy? I can jump -- the last question I had was just related to Sunrise. We're hearing discussions that there -- that could lead to them giving back the space potentially in terms of a bankruptcy. Have you guys had any talks with them? And have you talked with any tenants that could potentially -- of your replacements for them?

Yes, I mean, that assumes Sunrise -- I mean, they've been a great tenant for us. They are, in fact, in the market attempting to sublease some of their space. I believe two of their floors are not occupied right now, which are about 60,000 feet. And we're working actively with them to attempt to sublease the space. In other words, we've told them to the extent they would need some help from us on the back end, that we would consider that.

Now, obviously, we've made no commitment specifically. But they've been a great tenant so far. I mean, we've read all the information that everybody else has in the public arena. But that's pretty much their status.

So what could be the potential impact if they do file for bankruptcy? Is there any kind of impact in terms of FFO?

It really depends -- it depends obviously on timing, because rent-wise, they're somewhere on a full year basis. I think they're somewhere around a $0.10 number. So (multiple speakers) --

$5 million.

Yes, $5 million.

Yes, it's $5 million. So, on a full year basis, around $0.10 plus there would be some kind of straight-line adjustment that we would have to take if they actually go away. But it's all dependent about timing. Right now, they keep paying rent, so.

And as a practical matter, I mean, I don't think it's a situation where they could just vaporize and leave that building. They have just -- it's a huge management company for a lot of different investors. And we think it's an extremely unlikely scenario that they're just going to leave the building completely, even in the event of a bankruptcy.

So, it's something that we keep an eye on. We're as concerned as anybody. We try to keep tabs of all the news and we're watching it very closely.

Okay.

Mark, on the occupancy or vacancy, whichever way you want to look at it -- we're using for most of the sectors somewhere in the 95% down to about 92% or 90%, depending on the sector. Obviously, industrial is probably the weakest in there, but it's also -- it's kind of already the weakest. So, that's kind of the range. We haven't given out specifics on each property type in terms of budgeting to anyone.

Okay. All right, I appreciate it. Thank you.

Dave Rodgers, RBC Capital Markets.

Related to your comment that the open regarding acquisitions and other opportunities likely to open up in 2010. And I heard your comments about the overall economic environment and what's going on with the stimulus package. But is that a function -- originally that was 2009 everybody had expected these opportunities; now it's another year out. Is that more a function of wide bid/ask spreads and not much coming to market? Or is that a Wash REIT specific function today of how you feel about your capital position?

There's very little on the market right now. Are there some things? Yes, but given -- we don't think the pricing is where it needs to be in the current market environment for the very few assets that are out there. And it is extremely thin in terms of investment offerings out there -- for anybody. And I think you'd time that -- there's nobody making major acquisitions in Washington right now.

And as a statistic, I mean, we're 75% off -- I mean, last year's transactions.

Yes, the fourth quarter was -- if you read any of the major brokerage house's numbers, I mean they're -- those poor guys didn't do much in the fourth quarter even, of '08.

Okay. And then on the financing opportunities, comment, I guess, what you're seeing on the commercial side versus what you're seeing on the residential side, from maybe Fannie or Freddie. Do you continue to feel that there's access out there on both sides of that coin? And dovetailing into that, how do you feel about your controlled equity offering program at this point?

Well, I think, in terms of the debt side of the equation, obviously Fannie and Freddie are still in business, so we are -- that continues to be probably the cheapest cost of long-term debt capital. As I mentioned, we closed this week a loan on the apartment building, Kenmore Apartments that we bought last year. That was a ten-year loan at 5.37%.

It seems to -- since we locked in that rate, we actually locked that rate in, in December. And that was kind of a low point in the market for Freddie -- that was a Freddie loan. And since that time, I think they both, both Fannie and Freddie, have kind of implemented quasi-floors. I don't think there's any public statement out there, but it sure seems like no matter what treasuries do, those rates kind of hover in the 6.25 to 6.5 range right now.

On the commercial side, there's certainly availability from some of the life insurance companies in terms of rates in loans, but they're typically shorter. They're typically a lot lower loan to value. And so you can't get as many proceeds and the cost is --

Another 100 basis points or more --

Yes, 7.5% -- somewhere in the 7.5% to 8% range on many properties. But they're out there. I mean, so there's opportunities out there.

In terms of the equity programming that we have in place, we'll continue to use it opportunistically as we see fit. But right now, it's been very nominal.

A final question on the acquisitions. Is it this quarter that you were expected to close on the Kenmore Avenue Medical Office building? Do you have any pre-leasing done there? And should we expect dilution to come from that or will that be capitalized for the first year?

Yes, Dave, that was the Lansdowne, not Kenmore --

Oh, yes, you're right. I'm sorry.

-- out in Loudon County. We're still waiting for the building to be completed and then we have 30 days after substantial completion to close. I would say -- where you're sort of that borderline of potentially the very end of the first quarter to the very beginning of the second quarter. We have some leasing activity; we don't have any actually executed leases. So, it would be fairly dilutive initially.

But it's -- I don't know if you've been following the news out here -- one of the issues was that HCA was going to build a competitive hospital also in Loudon County. And their application to do that was rejected. So really it is a monopoly out there for Loudon Inova Hospital and our MOB. Our perspective MOB would be directly across the street from that hospital.

So we actually think that the interest in that building is going to pick up significantly, since it's really the only new building out there. And although initially -- we don't have any leases at hand right now, but we have some interest. We do think it's going to pick up expeditiously -- but with build-out space and the whole processes -- you know, you can't really expect significant income till much later in the year in the best case scenario.

Well, that's a good point, Skip. I mean, there were many prospective tenants on the fence, depending upon what was going to happen with those hospitals. And now there's clear indications that we have an advantage there.

In terms of the budget, we budget that dilution that Skip mentioned into our estimates.

John Guinee, Stifel Nicolaus.

John Guinee here. Thank you. I did a little bit of -- we've been covering you guys for a long time, so I just did a little bit of research here. And it looks like your FFO in 2005 was $2.07 a share, and your guidance for 2009 at the midpoint is about $2.05 a share -- does that make sense?

Sounds somewhere in the neighborhood.

And then if I look at 2006, you signed 1.6 million square feet at a 12.8 GAAP rent increase and a 2.8% cash rent increase. And then if I look at 2007, you signed 1.8 million square feet at a 17.3% GAAP increase and a 6.4% cash increase. Then you look at last year or 2008 is 1.5 million square feet and a 19.4% GAAP increase and a 7.7% cash increase. So if I average those out over the last three years, you're signing leases, a million and a half square feet a year at, according to your numbers, a 16.5% GAAP increase and a 5.6% cash increase.

On the other side of the equation, your cost of debt during the last three years has gone from 5.9 down to 5.2%. And I guess what I can't figure out is -- how do you have such incredibly good renewal rents, a decreased cost of debt and not get any juice in the FFO?

Well, I think, John, as you look over those years, I think there's a few things in there. You see some development activity that is still slow to lease up, that cost -- that we used a lot of equity to finance, so the share count on dilution is there. And the development yields are not quite above the current dividend yield. So you're going to have cash flow and FFO per share and certainly dilution on that activity until those properties lease up. That's probably the major difference.

What's that, about $200 million of development?

You're probably in the neighborhood there.

Well, you have a $2.9 billion company -- $200 million of development coming in at slightly below cost of capital shouldn't cause you to have no FFO growth over four years, while you've got a 16.5% GAAP rental rate increase, 5.6% cash rental rate increase, save 70 bps on your cost of debt.

John, I think the other point is, is that you have to look at the quality of the portfolio. If you look at what was sold over those last three years versus what was purchased over the last three years, you obviously improved the quality of the cash flow and the tenant base. But in those transactions, you're selling at higher cap rates and you're buying at lower cap rates. So, not only do you have development activity lower yields but you also have lower yields on the acquisition disposition transfer.

Okay. Yes, I would maybe double check your rental rate increases, but okay. Second question is you're obviously not going to raise capital at $20 a share. And what you guys have done, which I think has really helped your stock price in the last couple of years is keep your leverage low. How much further will you lever up in 2009?

The only thing that is even in the horizon that we're talking about is obviously we have to pay for the acquisition of Lansdowne, which is roughly a $20 million purchase. And then it's really a trade of debt, it's not a leverage up from there.

It's really a situation of refinancing this $50 million apartments. And like I said in my prepared remarks, if you look at the $50 million, it only -- you can replace the $50 million by encumbering two of the properties. It's a five-property pool, so we have a choice of just doing the $50 million and replacing the $50 million, and unencumbering three assets, which is always a good thing; or we can lever those five properties up and use those proceeds to pay other debt away -- either repurchase debt that expires out in the future or repurchase more converts, like we've been doing in the past.

So there's options out there, but I don't anticipate really having any more leverage, if more at all, at the end of the year.

Michael Knott, Green Street Advisors.

Sara, good luck to you. Hey Mike, can you -- a little bit on the CapEx on the office leases signed in the fourth quarter? It looked like it was fairly high and jumped up a bit. I didn't know if it was a mix issue or a location issue. Can you just comment on that?

Guide specifically?

Well, the combined TI and leasing commission. It looked like it was over $5 per foot per year.

I'm trying to think of any sort of major leases that would skew that number.

Are TI's increasing in your [mix]?

As a general rule, I'd say TI's are actually coming down to a degree now. To the extent you have development properties, that sort of skews numbers. I don't think any of the Dulles Station leases -- I'm sort of paging through the leases -- were in there.

I think they're out.

We did have a transaction in 1 Central, Skip, that required a lot of retrofit.

That's right. We did a 20,000 square foot lease at 1 Central Plaza that had a pretty big TI number that we did a ten-year lease on.

Additionally, we brought in a major state, Montgomery County -- I'm sorry, it was Montgomery County that came into 51 Monroe, but it looks like that (multiple speakers) --

There was a couple of large transactions -- I'm just paging through --

I'm looking at about $2.6 million worth of TI's on 127,000. We did have also a Crescent, Skip. We brought in a major tenant out there. So, yes, I mean, there were some situations where we had some challenged space that required some retrofitting on those projects. And the primary one being that one central location where we lost a major tenant, out in that space earlier this year -- I mean, in 2008.

But to answer sort of your basic question, I don't see tenant improvement cost going up dramatically right now. As a matter of fact, just because of the economic climate, you could drive generally better bargains with general contractors. It's just a matter of what the condition of a specific space was. And in the particular case that Mike just mentioned, those tenants signed extended term leases.

And the one tenant at One Central Plaza, that space was not left in the greatest condition by the prior tenant, so it required a lot of retrofit.

Okay, thanks for that color. As far as the office lease expiration schedule for '09 and '10, it looks a little more -- a little heavier in 2010. So I was curious if you can just comment on -- A, how much of that you expect to maybe get a head start on in 2009?

Yes. 2009 -- actually, 2009 is kind of a soft year in terms of lease rollover. With respect to 2010, which sort of is the big number, is World Bank -- a good portion, not all of it -- but a good portion of the World Bank space is coming up. And we are actually in preliminary discussions with World Bank.

It's -- almost 150,000 square feet of the World Bank's space, at 1776 G Street, which is probably -- I'm just thinking out loud now, probably our highest rent per square foot building in the portfolio, certainly office building. So it's a big number as a contributing factor to the rollover expense. And we're actually in preliminary negotiations with them. We're very confident they're going to renew. It's a matter of selecting the lease terms.

And Michael, that's 20% of the rollover in 2010.

Okay, thanks. And then lastly, it sounds like there's a good chance that you won't do any acquisitions in '09, given the [possibility] of opportunities in the market currently and also your view on pricing. But if you were to pursue acquisitions, how would you think about where to add to your portfolio, both geographically and by product type going forward -- update us on your thoughts there?

Just to clarify your first part, I do agree that in the next few months there isn't going to be anything. Potentially, could there be something toward the end of the year? Yes, possibly. But just to get the engine rolling, to get properties on the market and due diligence and et cetera, et cetera -- even if they came on some great opportunity tomorrow, it would take a while for the marketing process and all the other logistics to close, and have anything happen any earlier towards the end of the year would be a stretch.

As I think we've said over the years, I mean, we try to be opportunistic and not really limit ourselves to any one sector. So I don't think I would limit myself to one area as opposed to another. Certainly, the areas outside the Beltway are a little softer than areas inside the Beltway, so that might be our focus. But I think we sort of keep an open mind to opportunity, as opposed to putting blinders on and limiting ourselves to one particular sector.

Chris Lucas, Robert W. Baird.

Sara, first, thanks for your years of help and support and your responsiveness. It's been very -- it's been a great relationship and I appreciate it.

Just a couple of points of clarification on the guidance, I think specifically. Do you guys have -- rather than a range, is there a specific -- or can you give us the range in terms of the portfolio vacancy increase you're expecting?

Well, as I mentioned earlier, Chris, we kind of budgeted in for every sector somewhere between 95 and 90 with industrial being down at the low end of that range. But the movements -- we're basically taking an approach where a lot of the vacancy, just from a budgeting perspective, not necessarily throwing targeted guidance, but from a budgeting perspective, we're kind of assuming that a lot of the space that we had vacant at the year end, will remain vacant for an extended period of time.

And then just in general, we're thinking that while history shows retention rate actually improved during downturns, we're actually taking a budgeting approach where we're actually thinking retention slides a little bit. And that that any kind of rollover that goes dark would be dark for a longer period of time.

So we've just extended everything out a little bit in our budgeting process to make sure that we have everything we can think of that might happen, we've got it covered.

Yes, I think another big factor there, although it might not be technically a vacancy, is I mean we're really hitting our bad expense hard. So it wouldn't mean necessarily show up in the vacancy numbers, but particularly in the retail sectors and other, and then the industrial sector, we're hitting bad debt expense pretty hard in terms of our projections -- just given where the world is. I mean, we don't know what it portends over the next, I guess, almost 10 months or so of this year, but it's been very difficult in those two sectors.

Okay, so just to follow up on that comment. Can we -- what was the tenant retention for the fourth quarter and what is your expectations for '09 as you budget it?

Fourth quarter retention was right around our norm, I believe it was 62% (multiple speakers) -- it was 60% --

It was high in the retail sector.

Yes. And that was a little bit skewed -- believe it or not, our high was in the retail sector but we had a K-Mart rolling that sector, so it skewed the number up. So we were in that 60% range, which historically were 65% to 70%. So I guess it's down slightly. We were -- to be exact, we were 61% in the -- so it's actually year-to-date.

What was the second part of your question?

Well, and then, what are you guys budgeting for 2009 as far as tenant retention is concerned?

We don't actually do it on an overall portfolio, we do it by property, kind of round up property level. But I would say that we have that inching down; in a year or two projection, it actually goes out further than just '09, that that retention inches down from our historical average of around 65% down to as low as 55% or below in certain instances.

And then just to reiterate on Skip's point about bad debt, historically, this Company has been below 1% on bad debt expense. And for budgeting purposes, those numbers are going up materially -- north of 2%, closer to 3% on average for the portfolio for budgeting purposes. And in certain instances, we've taken -- we've varied that and did sensitivity analysis on it. So we kind of know where we're heading and we're watching all our tenants pretty closely.

And we've tried to be as conservative as possible on that, in the economic climates.

What was the bad debt expense for the fourth quarter? What was the impact there?

I think it was $1.3 million, but I want to doublecheck that. I know we have it here.

Totals including straight-line was $1.7 million, and Skip was correct -- it was $1.3 million on a cash basis.

Yes, so $1.3 million on a cash basis, another $400,000 of straight-line.

And Laura, what was the prior quarter number?

The prior quarter --

Sorry, I'm just trying to understand the trend here.

Okay. For third quarter, we also had -- we have $1 million on a cash basis and a nominal amount on the straight-line.

We're thinking it's going up. I mean, if you're looking at trends, I mean, we think bad debt is going up. We don't know, but given where the economy is, that's our expectation and that's baked into our numbers.

And so, Laura, going back to the -- on a percentage basis then, what was the fourth quarter percentage number then, roughly?

1.3% -- is that what it was, Laura?

The fourth quarter percentage of net potential on a cash basis was actually 1.75%, and overall 2.2%.

Okay. And so from these levels in the fourth quarter, you're expecting continued deterioration?

Absolutely. Carve out one thing -- not expecting duplications of Circuit City's of the world, which was a huge impact. It probably was an extraordinary impact because -- that was actually a 20-year lease, so it had some really significant one-time hits. And we're not expecting instances like that, because as you know, we don't have a lot of 20-year leases. That's actually -- is quite unique in our portfolio. So, I do want to quantify that. We're not expecting a whole lot of those to occur.

That is correct. Because that fourth quarter number, that straight-line of [$400,000] was almost entirely Circuit City. And then also included in the cash amount was another $200,000. We took over all basically a $0.02 hit in the fourth quarter for Circuit City.

That's -- as you know, we have very few, other than our supermarkets, really, a handful of retail tenants, we don't have 20-year leases. And that, under the current accounting standards, we're straight-lining and the FAS 141 adjustments for that was acquired post that. That had a really -- it had a big impact.

And so if I think about the portfolio and going forward, it seems like a lot of the issue last year was related to those -- ex-Circuit City, but in the retail and industrial portfolio, a lot of that was small tenant-related. Is that broadening out to the -- are you expecting that to broaden out into the other areas? Or is that still fairly confined to the retail and industrial portfolio?

The major impact is retail and industrial. I think it's impacting everything, to be quite honest with you. But I do think that the major impact -- let me just give you a little background.

I mean, our industrial, as you know, Chris -- and I don't know if everybody does -- is mostly small bay industrial and it has a very heavy consumer orientation. The smaller industrial in a lot of our buildings have -- the contractors, the marble guys, the kitchen cabinet guys -- all of those guys who are getting slaughtered right now. And that's one of the things that the guys that are struggling in some of our properties. So if you add those on top of the retailers, I mean, that's where we're seeing the material impact.

Less so in the office buildings, although there's some. I mean, obviously, we've had our handful of mortgage companies; but really predominately, it's retail and industrial.

Okay. And then my last question just is on the disposition mix. What can you tell us about what your thoughts are there?

Well, we have one property on the market currently. And that's a residential property, the Avondale Apartments. And we're looking at possibly an office building, potentially.

Okay. Thanks a lot, guys. I appreciate it.

(Operator Instructions). Anthony Paolone, JPMorgan.

Not to beat a dead horse, but just to make sure I understand, on the retail NOI, the $1 million sequential decline -- it sounds like $400,000 of that was what we could think of as being one-time related to the write-off of the Circuit City straight-line. And then -- is that fair?

For the straight-line, yes, but (multiple speakers) --

That's not all.

That's not all of it.

There was also a $475,000 write-down of FAS 141 [mid] rents.

It was closer to $900,000, right? (multiple speakers)

(multiple speakers) It was $900,000 -- (multiple speakers) the $0.02 that Laura mentioned earlier.

Okay. So that's the add-back to get back to get back to the run rate. And then from there, we can bump up the bad debt expense even more. Is that fair?

For '09?

Yes, as going forward.

That's correct.

Okay. And then and following up on the CapEx discussion, if I look at your numbers for 2008, about $11 million in TI's and $10 million in recurring and $6.5 million in the other leasing commissions -- like, should we take your comments to mean that you think those numbers will be lower in '09?

Well, a lot of it depends on our leasing activity. I don't know if on a price per pound basis that there -- I'd factor them in nominally the same, but it's really going to depend on our leasing activity.

Okay. And in terms of the MOB pre-sale, can you just refresh the yield expectations on that and where you think that will pencil out when it stabilizes?

On what, Tony?

The yield expectations for your MOB pre-sale, like where you think that will stabilize?

That's probably in the mid to high 8's. And also, let me clarify -- Bill just mentioned to me -- back to your TI question, we do have a large commitment this year for the IBM TI. So that would be sort of an extraordinary CapEx this coming year. I forgot about that (multiple speakers) --

That's first generations space and if you --

Yes, so both tenants.

What I would say generally, Dulles Station.

Yes, Dulles Station. And so the first generation space, it will be pretty healthy numbers. So absent that, my comments apply. So that will be a pretty big number. So I just wanted to clarify.

But that would have been in the development budget, I assume, and probably not show up in that line item for '09? Is that fair or --?

I think they're going to probably break out first generation (multiple speakers) expense.

Right. It's not going to be in your FAS.

Right. Okay, great. Thank you.

Thank you. There are no further questions at this time. Actually, we have another question that just jumped in, coming from Chris Lucas of Robert W. Baird.

Sorry, just one real quick one on the exchangeable notes impact. Two quick questions, actually. One is on the -- you talked about the $19.5 million you bought. What was the price paid or the gain expected?

What was that?

On the $19.5 million we just -- the converts.

Oh. We're -- hang on, I'll tell you.

Okay. And then the next question that's similarly related -- you combined the fair value adjustment as well as the exchangeable note accounting change impact. I was just curious as to what the accounting change impact for the exchangeable notes by itself represents.

It's about $4 million.

That's right.

About $4 million a year.

It's about $0.08 of that.

Is that $4 million a year on the lower or on the full amount that was outstanding?

That was on the full.

[What we've revised that down.] So that total $0.10, about $0.08 of that is now on the lower amount. The $0.02 is basically related to -- we've got the fair value on 2445 M.

Okay, very good. Thank you.

Bill's got the --

Chris, on the gains for the repurchases this year, we're probably at about between $3 million and $3.5 million, somewhere in there.

Great. Thank you very much. That's it.

Thanks, Chris.

Thank you, everybody, and thanks, everyone -- oh, is that -- Operator? Do you have any further comments or can we make our final comments?

You may make your final comments. There are no further questions.

Okay. Thank you, everybody, for listening to our call last quarter. And we'll be back with you with better news from the first quarter results of this year.

This does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.