Elme Communities (ELME) 2017 Q2 法說會逐字稿

Welcome to the Washington Real Estate Investment Trust Second Quarter 2017 Earnings Conference Call. As a reminder, today's call is being recorded. Before turning the call over to the company's President and Chief Executive Officer, Paul McDermott; Tejal Engman, Vice President of Investor Relations will provide some introductory information.

Ms. Engman, please go ahead.

Thank you, and good morning, everyone. Please note that our conference call today will contain financial measures, such as FFO, core FFO, NOI, core FAD, and adjusted EBITDA that are non-GAAP measures as defined in Reg G. Please refer to our most recent financial supplements and to our earnings press release both available on the Investor page of our website, and to our periodic reports furnished or filed with the SEC for definitions and further information regarding our use of these non-GAAP financial measures and a reconciliation of them to our GAAP results.

Please also note that some statements during this call are forward-looking statements within the Private Securities Litigation Reform Act. Forward-looking statements in the earnings press release along with our remarks are made as of today and we undertake no duty to update them as actual events unfold. Such statements involve known and unknown risks, uncertainties and other factors that may cause actual results to differ materially. We refer to certain of these risks in our SEC filings. Please refer to Pages 9 through 24 of our Form 10-K for a complete risk factor disclosure. Participating in today's call with me will be Paul McDermott, President and Chief Executive Officer; Steve Riffee, Executive Vice President and Chief Financial Officer; Tom Bakke, Executive Vice President and Chief Operating Officer; Drew Hammond, Vice President, Chief Accounting Officer and Controller; and Kelly Shiflett, Vice President, Finance and Treasurer.

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

Thank you, Tejal, and good morning, everyone. Thanks for joining us on our second quarter 2017 earnings conference call. Washington REIT raised full year 2017 same-store NOI growth projections across all 3 asset classes and raised 2017 core FFO guidance for the second time this year. Second quarter core FFO of $0.48 per fully diluted share grew 4.3% year-over-year, driven by strong same-store NOI growth of 8.8% year-over-year. We increased same-store economic occupancy by 470 basis points year-over-year and ended the second quarter 93.3% occupied. In addition, we drove solid leasing momentum in the second quarter with the signing of a 131,000 square foot, 15-year lease with the United States Department of Agriculture at Braddock Metro Center. We also continue to drive high levels of activity at the Army Navy building, which is now approximately 71% leased with an additional 10% under LOI.

Finally, we've received strong levels of interest for the proposed disposition of Walker House apartments in Gaithersburg, Maryland, and expect to close on the sale of this asset in the third quarter. We delivered robust year-over-year same-store NOI growth for the second quarter in a row, achieving 14.8% office, 4.6% retail and 2.6% multifamily growth in the second quarter. While Steve will address our key performance drivers later on the call, I would like to, specifically,, acknowledge our expense management initiatives and our continued ability to work with our tenants to drive operational improvement as key factors that have contributed to our second quarter performance.

Beginning with our largest lease signed this quarter, we are pleased to have secured a major tenant, the USDA in a long-term lease that is expected to commence in the second half of 2018, contingent upon completed renovations of the asset and the lease space. The USDA is in a hold over on its existing space and is working with us to stay on schedule with a desire to commence as soon as possible. For us, this lease achieves a goal of backfilling, Engility's lease that expires in September of 2017 with minimal downtime. Combined with our recent large long-term renewals, this lease effectively addresses all of our large near term office lease expirations, while still maintaining low overall GSA exposure. Including the USDA lease, on a pro forma basis, federal government tenants would comprise approximately 3% of our annualized based rental revenue.

Moving on to our most recent value creation project. We closed on Watergate 600 at the beginning of the second quarter at a going in cash cap rate in the high 6s, which included an estimated year 1 spend of approximately $10 million of the $18 million renovation program. The lobby renovation is currently underway and we are already seeing early answers for the top 3 floors of future vacancy from a number of significant users that place a premium on views and ease of access. Watergate 600 is one of only 3 waterfront office buildings in Washington, D.C. that offer panoramic views of the Potomac and Monuments.

In addition to being walkable to the Foggy Bottom Metro station, the asset enjoys excellent commuter access to I-66, the White House freeway and Rock Creek Parkway. This advantages excess enables computers (sic) [commuters] from Virginia and Maryland to shorten their commuting time, relative to a CBD or East-End location. Ease of access, like amenities, is becoming a key real estate differentiator in our region as traffic congestion continues to increase. Let me now detail our leasing progress at the Army Navy building, where we are seeing strong levels of activity from tenants across a variety of sectors, including financial services, energy, infrastructure, health care advocacy, government consulting and media. Tour activity remains robust and we expect to be stabilized in the first half of 2018. Leasing has met our underwriting expectations, and in a few cases, has even exceeded them. With an approximately $4 million redevelopment project, we've taken market rents at Army Navy from the mid-50s full-service to the mid-60s on average. We are achieving a high return on cost because our market research and cost-effective design enable us to meet demand from small and midsized tenants for a highly amenitized product at a competitive price. Our value adds success at Army Navy, follows on similar strategic office executions at 1775 Eye Street and Silverline Center. Additionally, we are also realizing our value-add strategy through ongoing multifamily unit renovation at the Wellington and Riverside. These successes are driven by Washington REIT's core competencies of combining research with prudent capital allocation to deliver desirable space and amenities at competitive pricing levels for an underserved tenant and renter demographic.

Today, we believe these combined core competencies are becoming even more critical in the D.C. Metro region, where we can see an increasing supply of Class A office and multifamily product, alongside reduced availability of affordable leasing options for value conscious office tenants and multifamily renters.

In the district, developers are adding high levels of new trophy and commodity Class A office, and multifamily supply, despite relatively static demand from the end users of these products, which are primarily large law firms within office and renter households earning in excess of $150,000 per year in multifamily. In downtown D.C. office, the supply-demand imbalance is further amplified by the fact that over the past 24 months, more than 2 million square feet of existing product priced in the mid-40s to mid-50s per foot full-service has been converted into commodity Class A product, priced at or above $70 per square foot with a further 1.6 million square feet slated for conversion this year. As a result, according to JLL, second quarter of 2017 vacancy for D.C. office product priced at $50 gross, on average was 8.5%, while vacancy for Class A supply was approximately 16%. While the supply of affordable office product has shrunk in the downtown core, tenants seeking more affordable offerings, which include technology, nonprofit and professional business service firms, are showing steady growth. As per regionwide JLL data, 71.4% of tech firms, and 20% of nonprofits grew in the second quarter, while banking, consulting and professional and business services firms signed deals for a net 90,672 square feet of increased space.

Washington REIT is strategically positioned to benefit from the supply-demand imbalances as our same-store D.C. office portfolio offers product in a segment with below-market vacancy and rising demand. A combination that has led to greater landlord leverage. As a result, from new leases, below 10,000 square feet in this portfolio, our tenant improvements per foot per year of term have fallen by approximately 17%. Our free rent has dropped by approximately 10% and our net effective rents have risen by approximately 7% for the 24 months from June 2015 to June 2017, compared to the June 2013 to June 2015, 2-year period. Similarly, in multifamily, we see a supply-demand imbalance as the Class A development pipeline in the district continues to grow with more than 10,000 units projected to deliver over the next 2 years. Developers are adding expensive Class A multifamily product to a market where the proportion of housing-burdened renters is higher than in every major market in the country, except L.A., San Jose and San Diego.

As per a July 2017 regional study conducted by the Fuller Institute, rental housing in the Washington region costs 69.1% above the U.S. average and ranked second to San Francisco with New York now in third place. Moreover, the cost of living in the Washington Metro region is the third highest, following San Francisco and New York. We believe our focus on product can address this issue with quality apartments at a moderate price point, is a winning formula in a market that continues to get more expenses. We see evidence of our research-driven capital allocation strategy, working in our same-store multifamily portfolio.

Our second quarter same-store effective rent renewal rent trade-out was 3.3% and new lease rent trade-out was 5.6%. We attribute this strong performance to our strategic capital allocation to the right assets in the right submarkets. Approximately 71% of our overall multifamily NOI is derived from assets located in Northern Virginia and approximately 80% of our multifamily portfolio is Class B. As a result, our portfolio doesn't directly compete with the aforementioned wave of Class A deliveries that are largely hitting specific sub-markets in the district, such as NoMA, and the Navy Yard and the waterfront areas of Southeast and Southwest D.C. Our growth in same-store new lease trade-outs also reflects our successful unit renovation strategy at The Wellington.

Today, the majority of our multifamily portfolio is located in submarkets with wider than average gap between Class A and Class B rents. In addition to the unit renovations at The Wellington and Riverside, we've already begun smaller scale unit renovation programs at 3801 Connecticut Avenue and The Kenmore.

Finally, our rental growth is also driven by our focus on increasing pricing around stabilization benchmarks that are closely monitored for each individual asset. Our strategy is to press pricing between 94% and 96% occupancy and the -- thereby, optimize the portfolio's rental income growth potential. Year-to-date, we've driven higher rent trade-outs at all of our multifamily assets.

Moving on to ground-up development, our pipeline consists of 2 value Class A multifamily projects as well as 1 small retail project. We believe the size and scope of our development pipeline is appropriate, given where we are in the current real estate cycle. We have commenced construction on the Trove, a 401-unit development on-site at The Wellington and South Arlington. Located at the eastern end of Columbia Pike in a submarket with limited new supply, the Trove is designed to provide a class -- provide a value Class A offering. Units will be priced competitively, while the asset will offer an amenity package that is unique for its submarket. We're able to offer competitive pricing at the Trove because we are developing on land that has a low cost basis, given it was acquired as excess surface parking for The Wellington.

We have further lowered our development cost by designing the Trove to be a wood frame construction on a concrete podium, thereby, achieving significantly lower cost than a concrete tower construction. We are in the design development phase on our second multifamily ground-up development at Riverside Apartments in Alexandria, Virginia, where we plan to add approximately 550 units of additional density. Riverside is located in a submarket with limited Class A supply and amongst the widest affordability gaps between Class A and Class B rents in our region.

Furthermore, major employers such as the National Science Foundation, MGM, National Harbor Resort and The Patent Trade Organization, combined, are bringing thousands of new jobs within a 3-mile radius of the property. We expect to commence construction on the Riverside new development in the fourth quarter of 2018, contingent upon our validating continued positive market conditions. Finally, we have commenced construction at Spring Valley Village for 14,000 additional square feet and have signed LOIs with a high-quality regional restaurant tour and a café operator for the ground floor of the new construction. We expect construction to be complete in the first quarter of 2018 and for the new space to lease during the remainder of the year. We expect to generate approximately $500,000 of incremental annualized NOI from the new construction.

Touching on the rest of the retail portfolio. We are at LOI for the HHGregg vacancy at Frederick Crossing at higher rents and are seeing good activity on the HHGregg vacancy at Hagerstown. Our watchlist has remained stable after some of the watchlist tenants, such as HHGregg, materialized at the beginning of the year. Despite the general negative sentiment around the retail sector, our retail portfolio is well-positioned and one of the nation's more resilient retail markets. We don't own any malls and approximately 88% of our second quarter NOI was driven by community and neighborhood shopping centers as well as Class A power centers. Furthermore, our neighborhood and community shopping centers are high-performing, well-located centers with an average population density of approximately 156,000 and average annual household income of approximately $122,000 within a three-mile radius.

Based on second quarter NOI, approximately 80% of these centers have a grocery anchor that drives strong levels of traffic. Perhaps, as importantly, many of the centers have been part of their communities for decades and have adapted, over time, to serve their community's evolve needs. Today, they offer an array of food, grocery, medical and personal care services, all of which tend to be relatively less impacted by the growth of e-commerce. Retail in the D.C. Metro area continues to benefit from solid supply-demand fundamentals and has been the most consistent performer of any property type in the D.C. region over the last 5 years.

According to CoStar data, the average market vacancy is 4.1% for all retail types and supply growth, as a percentage of inventory, is about half of the Metro's historical average.

Asking rents have increased 8.2% over the past 12 months and are up 5.4% over the previous quarter. Retail in our region benefits from high average household income levels that exceed the national average by 61%. Buying power in most of D.C. [propers] submarkets has increased by, at least, 25% since the year 2000.

Now let me conclude with some observations on the Washington Metro region, where job growth rebounded in May and accelerated further in June, adding 59,400 jobs on a trailing 12 month basis. This growth represents a 35% increase over the region's 20-year average job growth between 1990 and 2010, a period that excludes the impact of sequestration.

Moreover, forward-looking indicators are pointing to a stronger economic growth in the second half of this year and into 2018. The Washington leading index developed in 1990 by George Mason University in the Greater Washington Board of Trade is designed to forecast the performance of the Metro region's economy, 6 to 8 months in advance. The index measures changes in forward-looking indicators such as durable goods, retail sales and consumer expectations, among others, and has achieved 5 strong increases over the past 6 months. These gains represent the strongest sustained performance for the leading index over the past 3 years and present a signal that the economy is poised for further, stronger future growth than it is currently experiencing.

According to regional economists that track the index, our regional economy appears positioned to accelerate over the balance of this year and to generate a strong economic performance in 2018.

Finally, I would like to highlight that the Washington region is a knowledge-based economy dominated by high-skilled jobs and a highly educated population. Washington ranks first among the country's largest metropolitan areas by educational attainment, with 49% of the population aged 25 and over, holding a college degree and nearly 24% with an advanced degree. It is, therefore, not surprising that The Washington new region has emerged as one of the top 3 destinations in the nation for technology. Cushman & Wakefield ranks the Washington Metro region as the third most tech-centric market in the U.S, after San Jose Silicon Valley and San Francisco. Their research methodology ranks each market on a variety of metrics, such as institutions of higher learning, capital, tech workers, educated workers and growth entrepreneurship. Our region ranks first on the index for growth entrepreneurship by Metro area.

Now I would like to turn the call over to Steve to discuss our financial and operating performance in the second quarter.

Thanks, Paul. Good morning, everyone. Net income of $7.8 million or $0.10 per diluted share in the second quarter of 2017 was below net income of $31.8 million or $0.44 per diluted share in the second quarter of 2016, which have included the recognition of a $24 million gain from the first sale transaction of the suburban Maryland office portfolio. We reported second quarter core FFO of $0.48 per diluted share versus $0.46 in the same prior year period, driven by revenue-led year-over-year same-store NOI growth of 8.8%. Second quarter core Funds Available for Distribution or core FAD was approximately $33.8 million and we continue to target a full year core FAD payout ratio in the mid-80s. Our strong second quarter year-over-year same-store NOI growth was driven by same-store economic occupancy gains of 470 basis points in office and retail as well as higher rental growth in multifamily and retail. Office also benefited from higher periodic settlements of tenant recoveries as well as increased lease termination fees.

Starting with office, same-store NOI grew 14.8% over second quarter 2016, driven by 870 basis points of economic occupancy gains. Approximately 60% of our year-over-year economic occupancy gains were driven by the Silverline Center, with the remainder spread across the portfolio with news of lease commencements at 1776 G Street, 1775 Eye Street and Fairgate at Ballston as well as tenant expansion at 1600 Wilson Boulevard. Our economic occupancy also improved 80 basis points sequentially due to new lease commencements by tech and healthcare-related users at Silverline Center, 1600 Wilson Boulevard, Fairgate and 2000 M Street.

Office-ending occupancy declined by 10 basis points sequentially due to a tenant move-out at Monument 2 at Herndon, Virginia, that has been backfilled by a cybersecurity company and its lease is expected to commence in the third quarter. With regard to office expenses, although, real estate taxes have increased, as Paul mentioned, we have driven operational improvements across the portfolio that have resulted in lower utility costs. We leased approximately 214,000 square feet of office space in the second quarter with new leases rolling down 14.2% on a GAAP basis and 20% on a cash basis, largely due to the 131,000 square foot, 15-year new lease signed with the USDA. Large leases are not very common for our office portfolio, where the average new lease deal size for the 12 months ended June 2017, excluding the USDA lease, was approximately 4,900 square feet. Our objective in signing the USDA lease was to minimize the downtime at the asset and to derisk our cash flows by signing a long-term lease with U.S. government. That said, when we factored in the term we've received on this lease, the tenant improvements and leasing commissions for all new office leases were a reasonable $6.67 per foot per year of term, the lowest in several quarters. As a result of this lease and our recent large office renewals, we have now addressed all of our large near-term office lease expirations. Office renewals were 14.8% on a GAAP basis and 7.3% on a cash basis, with modest tenant improvements and leasing commissions of $21.65 per foot. We believe these are representative office lease economics for quarters where we don't have large tenants rolling and are renewing small and midsize tenants, who represent the majority of our tenant base. Office tenant retention in the second quarter was approximately 63%.

We continue to generate leasing momentum in our office portfolio. We have activity and prospects for 3.5x the total square footage of our current vacancies in 2017 lease expirations. Our same-store Washington, D.C. office portfolio continues to outperform the region with occupancy approximately 7% above overall D.C. market occupancy. Our office portfolio is also significantly outperforming in Northern Virginia, where our same-store occupancy is over 13% higher than the market's.

Moving on to retail. Same-store NOI grew by approximately 4.6% on a year-over-year basis, primarily driven by 110 basis points of year-over-year occupancy gains and 90 basis points of year-over-year rental growth. Although, occupancy declined on a sequential basis due to HHGregg, one move out was related to OfficeMax, leaving Gateway Overlook, which is being replaced by Aldie. Aldie has taken possession subsequent to quarter end and it rents that are rolling up significantly. Our retail portfolio was 93% leased at quarter end with good activity on vacancies and the opportunity to grow occupancy in 2018. We leased approximately 152,000 square feet of retail space predominately through renewal leases, which achieved an average rental rate increase of 11.1% on a GAAP basis and 8.7% on a cash basis. New leases were 66% higher on a GAAP basis and 57% higher on a cash basis.

Finally, multifamily same-store NOI was up 2.6% over second quarter 2016, driven by 180 basis points of rent growth. On a per unit basis, the same-store portfolio ended the second quarter 95.4% occupied with overall occupancy at 95.1%. Paul detailed the key drivers of our strong rental growth in multifamily, and I'd like to provide you with further detail on our unit-renovation programs at The Wellington and Riverside.

In the second quarter, we renovated 49 units at The Wellington and 97 units at Riverside. In total, we have renovated 313 out of 680 planned units at The Wellington and 275 out of 850 planned units at Riverside. We continue to generate a mid-to-high-teen return on cost on the renovation dollars that have been invested at these 2 assets to-date and expect these programs to continue to the end of 2018.

Now turning to guidance. We are raising the midpoint of our 2017 core FFO guidance range by $0.02 for the second time this year and tightening the guidance range to $1.80 to $1.84, from a previous range of $1.76 to $1.84. Our 2017 acquisition and disposition assumptions continue to reflect the acquisition of Watergate 600 and to assume asset dispositions of $70 million to $100 million, which includes the sale of Walker House in the third quarter. We expect to bring another office asset to market after Labor Day and close in the fourth quarter. We continue to look for further value-add opportunities and we'll update you on future calls to the extent that we execute on such opportunities.

Our guidance is supported by the following assumptions. Overall, same-store NOI growth expectations are raised to a range of 5.75% to 6.25% from a previous range of 4.75% to 5.25%. We assume office same-store NOI growth is now higher at approximately 9% to 9.5% from a previous range of 7.25% to 7.75%. We are raising our assumptions for retail same-store NOI growth, which is now expected to range between 2.5% to 3% from a previous range of 2% to 2.5%. Stronger retail growth, despite absorbing the impact of the previously disclosed HHGregg and Offenbachers bankruptcies, reflects our stable tenant watchlist as well as our region's resilient retail fundamentals. Our office non-same-store NOI range now includes Watergate 600 and has been revised to $18.5 million to $19.5 million from a previous range of $9 million to $10 million. Multifamily non-same-store NOI is expected to range between $13 million to $13.5 million from a previous range of $13 million to $13.75 million. Our interest expense is expected to range from $47.5 million to $48 million, considering the acquisition of Watergate 600 and the anticipated timing of the assumed dispositions. G&A is protected to range from $22 million to $22.5 million. Our capital plan for 2017 continues to focus on maintaining our strong balance sheet strength and flexibility to realize our development or redevelopment plans and to pursue further value-add growth opportunities. As already mentioned on our last call, this year, we have opportunistically raised approximately $65 million of gross proceeds through our ATM program at an average price of $31.44. As a reminder, we have unencumbered our assets and now have approximately 3% secured debt to total assets and have no debt maturing this year or next year. We expect our net debt to adjusted EBITDA to end the year within our target range of 6 to 6.5x.

And with that, I will now turn the call back over to Paul.

Thank you, Steve. Our same-store NOI and core FFO growth in the first half of this year is the result of our research-based strategic capital allocation to those sub-markets and product types in our region that have strong rental growth prospects. While our growth is apparent in our quarterly operational performance, the relatively low risk that underpins it, is also a key differentiator for Washington REIT and one that we work hard to maintain. Over the past 3 years, we have strategically allocated capital out of low barrier suburban office assets and into urban infill Metro-centric assets in locations with strong demographics and walkable amenities. We're focused on targeting small to midsize office tenants and have further minimized our risk by offering specs- [tweaked] solutions that reduce downtime and leasing capital.

Moreover, we've allocated capital to value add multifamily assets, thereby, increasing the stability of our cash flows, while decreasing overall portfolio risk. In addition, we have a resilient retail portfolio with a large majority of neighborhood and community shopping centers. Our overall operating portfolio has low submarket and tenant concentration risk, and therefore, low cash flow volatility. On the development front, given where we are in the cycle, we have built a small and manageable pipeline that enables us to increase density at existing NOI-producing assets located in submarkets with limited new supply.

And finally, we have strong financial metrics and a deleveraged and unencumbered balance sheet, providing us with greater capacity and flexibility to capitalize on future growth opportunities. Now I would like to open the call to answer your questions.

Operator, please go ahead.

(Operator Instructions) Our first question comes from the line of Bill Crow with Raymond James.

Couple of questions. You have, in the past, indicated that you'd be happy to add more retail to your portfolio, if you could find it. Has that perspective changed, given some of the dynamics in the retail space?

I think we've (inaudible) built probably tempered a lot of people's enthusiasm. I think both from a buying and a selling standpoint. We still have not seen a tremendous amount of retail product come to the table, although, there are 2 opportunities right now on the market that we think are going to be a good litmus test for updated retail pricing in mid-2017.

Two more quickies. Just on the economic growth, and I appreciate your comments about the leading indicators, but we have heard reports that job growth did stall with some of the early failures of the Trump efforts. You didn't see any of that? Or it's -- it did and it's reaccelerated, just talk about the job growth itself?

Sure. So I think we came out of the blocks pretty strong at the beginning of the year in January and February. Had good job growth. Admittedly, it cooled in March and April with April being a low point. I think it rebounded sharply in May and then we just got the new June numbers and we're, as I said, we're in excess of 59,000 for the trailing 12 months. That is a 35% increase over the 20-year average of 1990 to 2010 and the reason we stopped 2010 because that was a bellwether moment for this region where sequestration kicked in. If you added sequestration, that 35% increased number would only accelerate. So at this point and at mid-year, Bill, we feel pretty good about the jobs numbers.

Finally for me, Paul. We've seen some really high-profile asset sales or transactions in the D.C. office market. Can you talk about any change in competition in your type of assets?

I'd say the -- let's start with what you're seeing. I definitely agree that there has been, maybe, a bit of an overzealous underwriting approach to the super core. And we have, I think as we've seen, Bill, we've set records recently at $1,250 a foot for downtown core assets. I think that people will continue to pay up for that uber quality in the CBD. We haven't seen that really change. In terms of the value-add product that we like to go after, targeting affordable gaps on multifamily or targeting repositioning opportunities like 1775. We want to make sure that we lead with research and we want to make sure that demand is going to be there. Right now, I think, the multifamily opportunities that we are executing on currently, are probably a little more prevalent than the office opportunities that we're seeing. I'd say people are pushing through underwriting on the vacancy. And I think there's a bit of risk rationalization going on, but I also think that there's a tremendous amount of capital out there and some people have a gun to their head to try to push the value-add envelope.

Our next question comes from the line of Jed Reagan with Green Street Advisors.

Maybe just following up on Bill's retail question. Would you say you feel like your -- all your retail assets are longer-term hold at this point? Or could you see looking to maybe monetize some of the more outlying stuff in the coming years?

I think, right now, Jed, we're comfortable with the position that we have in retail. As you know, we have some -- we did have 2 HHGreggs, 2 at the outliers. We feel very pretty good right now. One, we're working on an LOI. I think that our biggest thing is making sure that we're shoring up the cash flows on some of what you term are the outlier. But the infield product, we think, not only offers good diversification for our portfolio, but as you know, probably 3 or 4 of them offered good redevelopment, repositioning opportunities.

Okay. Are there any other major roll downs in the coming years similar to USDA and where would you say your office portfolio in place rents are relative to market, overall at this point?

Jeff, it's Tom. We don't have any other significant roll downs. I think we're looking at our rollover as being fairly manageable and it's rolling, generally, flat to slightly up on a cash basis and rolling up on a GAAP basis and pretty much across the board.

So that's the last of larger roll downs for a while?

Yes.

And that's a kind of second-half '18 sort of commencement and impact?

Yes that is correct.

I guess any update on the advisory board expiration, guess we're a couple of years out on that, now less than a couple of years. I'm just curious if you've given any update on how the plans are coming there? If you're getting any tractions on the marketing campaign and then maybe how much base-building capital you might be looking to spend there?

So as we've discussed on previous calls, we've looked at several of redevelopment options, scenarios there at 2445. What seems -- multifamily was of interest early on. I don't think that the city has been able to push through a significant incentive package for that conversion. That's still out there. I think it's becoming less or a bit more remote. And so we have gone, sort of, aggressively with an office redevelopment to marketing approach and one that has been a little more open to what the users would pay for. And we do have some fairly sizable prospects that want a full Class A rental. And so we're looking at that and we've some others that are looking for a more modest, I think a lot of it is going to depend here on, who bites first in significant size that sort of drives how this plays out.

Okay. Is it realistic to think you might have that space recommitted by the time advisory board expires?

I'd like to think we have it all committed, but that might be optimistic. Certainly, a big chunk of it.

And maybe just last one for me. Generally, how is the tempo of office leasing feeling in the district in Northern Virginia so far this year? Are you seeing any uptick in velocity? And that are you seeing any noticeable changes in asking rents or the concession environment?

So let's see, D.C. Class B is still active, fortunately, that's the bread-and-butter for us. I think, the large tenant market in D.C. feels about the same. Northern Virginia, I think there was, you have the initial defense surge going on out in the northern Virginia suburbs. That really is not affecting us that much, but it seems to have sort of faded a little bit, to be honest with you recently. But we've seen activity in Rosslyn with the Nestlé deal and there's another 100,000-foot deal circling round in Rosslyn. So Rosslyn has picked up a little bit. And I just think the activity feels about flat to me and concessions feel flat, nothing seems to really be changing significantly. Now we've talked on previous calls about Silverline. Most, 65% of the deal activity is hitting along the Silverline and the major beneficiary has been Tysons. We have seen rent growth there. So I think that is the one bright spot where rents, frankly, on the product right along the 4 Metro stops and Tysons, especially, on the 2 primary ones has moved $5 to $10, depending on the asset. So that's probably the biggest bright spot in the Northern Virginia.

Our next question comes from the line of Blaine Heck with Wells Fargo.

Just a follow-up on that for Paul or Tom. Can you just talk about, whether or not you think the high Class A vacancy you're seeing in D.C. office. Is it going to have a dampening effect on rent growth in the Class B market? Or in other words, do you think Class A landlords are going to have to decrease asking rents to the extent that Class B space might have to compete with them to attract the same tenant?

Blaine, it's Tom. I think the gap is a little bit too wide for a huge spillover effect on B. If you talk about the glass box redevelopment model, it's about mid- to low 70s gross rents, and in some cases, higher. The new development is in 80s. And we're in the, let's just call it, $50 for B. That's a big gap. I don't think we're going to have to drop rents. We may see our effective rent growth, which we've seen some nice growth there as concessions have squeezed down. That might slow down a little bit as we move up, but that's just a big gap, I don't see it affecting us too much.

Blaine, the only think I'd add to Tom's spot-on comments would be, you really need to keep going back to people when you -- especially, when you look at other firms that do build the suits and everything. You really need to go back to the size of the tenants in the marketplace. I don't see somebody that's asking out going in the middle. I don't see somebody that's asking $72, dropping to $55 for a 5,000 or 10,000 square foot tenant. It just really doesn't move the needle on the big risk projects that they've taken on. And if you look at the B caliber tenants and look at the average deal size in our portfolio as well as in that particular rental demographic, it's kind of 5,000 to 6,000 square feet. These Class A landlords have made big bets on the repositionings, getting in the mid-70s and having substantial pre-leasing and that's a lot of wood to chop, adding up a bunch of 5,000 and 6,000 square foot tenants.

Steve, one for you. Obviously, you guys did a great job on same-store basis during the quarter, but I did notice, of the same-store expenses, we're up from about 7% year-over-year. Is that just increased taxes or expenses associated with Silverline occupancy or was it something else and how long should we expect that year-over-year expense growth to continue?

I think your biggest driver is we are now fully occupied at the Silverline Center. So this time a year-ago, that space wasn't fully occupied, and therefore, we weren't incurring all expenses. You have natural increases in the real estate taxes that we also talked about, some great work that's been done to drive down the utility cost. So I think they moved in and we started organizing income in the third quarter. They weren't fully occupying, because they were still building out in their space, so I think that the comparisons for the expense at Silverline will begin to normalize over the next couple of quarters.

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

Just as an educational exercise, can you walk through, how it is to work with the GSA on, for example, the USDA lease at Braddock Place? Aligned RFP process, ability to negotiate, who else was in the fray? Would they consider our non-metro locations such as Skyline? Do they go up as far as Rosslyn-Ballston or Crystal City or was it primarily an Alexandria requirement?

Good question. And like you said, it's an educational process anytime you do a GSA deal. I think it's an educational process for our team as well. We had an experienced GSA brokerage team on the assignment. And when we knew Engility was going to depart, we knew that being on Metro and in Alexandria, it is a, generally, a highly scrutinized GSA type of asset for the price point. And so we had a good team that got us plugged in to the ERP process. Yes, there is, in general, very specific defined geography, Metro, correct, and a lot of it has to do with the workers and commuting patterns and things like that, that go into, how they write the ERP. And so that USDA fit our asset well and I think that's why we were successful in winning the deal.

It looks like it's maybe a $30 gross rent, $18 net rent deal. Is that a good way to look at it? And what did you have to pay in terms of base-building dollars in addition to the TI package?

Yes, so you're at -- your economic pictures, plus or minus, in the ballpark. I think, the typical GSA deal requires a fairly standard TI package, but they also needed some additional security-type requirements in the -- but when we totaled all the concessions up, they were totally in line with a typical large deal even in the commercial market. The one thing you don't get on a GSA deal of course is the ramp-ups. Other than that, the deal lined up very competitively in the marketplace.

And then switching a little bit to The Wellington. When you look at that deal, and essentially, you have to build a lot of structured parking to replace the surface parking and that, essentially, provides your land basis. Paul, what do you think your all in cost per unit is going to be to develop that? And then, refresh our memory. What's the closest Metro stop? Is it Pentagon City? And how far away is it?

I'll start with the construction cost. So as you know, we contributed that land, John. And I think that land was in the -- probably the mid-30s a door and dirt. And I think at the end of the day, we're probably in the 325-ish range per door for construction. In terms of, I believe, Pentagon City is the closest. We're running a shuttle and it's one-mile.

325,000 per door all in, including land costs per parking?

That's correct.

Our next question comes from the line of Dave Rodgers with Robert W. Baird.

I wanted to ask really quickly on multifamily. Clearly, this is the time seasonally where you'd expect to see lease percentage up and rents up. And so not to take anything away from the strategy, which you guys have evolved and done a good job executing, but do we expect that to continue or would we expect 2 steps forward, 1 step back, as you still see more construction coming online and maybe more pressure in the B market? How do you feel that, that unfolds here over the next 12 months or so?

I think, I'll start now and I'll ask Steve or Tom to jump in. I mean, B, right now, in the region, I believe B rents increased 1.5% in the second quarter. I think the vacancy rate for B is 2% region-wide in 2Q. I look at where a lot of the supply is delivering and it's really D.C. based NoMA, Southeast and Southwest Waterfront in D.C. So I don't really feel like Dave, we're competing with that project head-on -- those products head-on. And we're also -- when I look at where our capital is allocated, we still got pretty wide gaps between the new Class A that's delivering and the B that we have right now and that's why, quite frankly, we're adding additional renovation programs like a 3801 Connecticut in the Kenmore because we can capture more value there. We still see enough of an affordability gap to capitalize on it. But I don't see the $2,500, $2,700 a door cannibalizing the B space at $1,850 to $2,000 a door.

And Dave, I think you mentioned how we've done so far. So in our other answers in our prepared remarks, we talked about our ability to focus on driving and maximizing cash flows by focusing on the rent pricing strategy, when we get to the 94% to 96% range, asset by asset. So the first half of the year, I would say, we've really focused on pricing and you've seen the good rent increases in the trade-outs in our portfolio. I think it shifts just a little bit because we've now got a really strong occupancy when you start to go into the lower seasonal part of the year. And so I think our strategy has been tactically planned out sort of for season of the year. So I think we will focus on occupancy when we get towards the last quarter of the year. And then when you think about our same-store growth, so year-to-date, we've -- it's been 3.3% growth in multifamily and we've talked about a lot of that being pricing. We think we're starting the second half of the year with a really good strong occupancy point and we've upped our guidance for the year to 3% to 3.5%. So we're basically saying, we're expecting our same-store performance to be just as strong in the second half of the year as it has been year-to-date.

Shifting gears a little to Watergate. I know you are underway with a pretty substantial renovation there. And Paul, you said activity was good on the space, but how do you view the desire to lease that up or the ability to lease that up pretty quickly versus getting through some of the renovation and taking some time over the next year or 2 to put the right tenant in?

Dave, it's Tom. So to answer your question, it typically requires a user -- a perspective user, to touch and feel the final product to make a big commitment. But in this case, because of the unique nature of the views, the access, those are the 2 main selling points. I think we've set up a very nice marketing presentation there on site, that the tenants are able to visualize how the final lobby renovation is going to look and feel and the amenity package. And I think you get them up and look at the views and then up on the roof, and that's generally been effective so far and that's why the activity has been robust and we feel we'll be able to get some commitments even before we're done with the renovation.

Tom, I will be sticking with you on the USDA and the replacement of Engility. Sounded like, they wanted to be in as soon as possible, I think were your words. Are you still going forward with the redevelopment of the asset in total? If you said that, I missed it and I apologize, but can you talk about the scope of that work and is the downtime between Engility and USDA, which it sounds like, could be as much as 9 months or more? Is that just due to tenant work or is there some more going on?

I'll take it. Dave, this is Steve. So as we started the process, we were really going through 2 approaches. One was a potential multi-tenant scope and one was a single tenant. We were working with the USDA, but also getting the other option ready. Fortunately, this deal progressed fast enough that we were able to alter the scope to meet more of their requirements. We still have building work to do. They've got some security requirements and there is still some common area things that we need to do, but we were able to tailor more to them, for instance, how they want to access the conference room versus how we would've had to do it in the lobby for the multi-tenant. So we've got work to do, but it will be a little bit cheaper than if we had multi-tenant. I would say, it's brought the base-building cost down a little bit. I think it's -- we're estimating it to be a little over $5 million. For the base-building cost, it would have been more if we'd done the multi-tenant around.

Our next question comes of the line of Christopher Lucas with Capital One Securities.

Just a few questions here, the call's gone long. But on the transaction market, Paul, you guys have been really successful since your arrival at doing off-market deals. And obviously, 600 Watergate was a limited viewing, if you will, and you had success doing OP unit placements with that particular seller. Are you finding any traction in the off-market, sort of, private own noninstitutional, where OP units would be helpful in the transaction market or are you finding that, that the 600 Watergate transaction is opening some doors for you and are you getting some traction on those kinds of opportunities?

Yes, good question, Chris. Yes, we are seeing more deals. We've actually gotten contacted about deals. I think our biggest challenge is where we are in the cycle, number one. And number two, we preach it till people are nauseous around here about research and we file a research into the submarkets. Not all of the families that we talked to have always made some of the -- placed some of the best bets, and so we want to be cognizant of -- we're not changing our strategy for an asset and so we're trying to lead with research and go into those markets that we are comfortable with. We got presented an office deal down at the Waterfront that we just decided to take a pass on. I think that we're continuing to talk to folks about more than just a one-off deal and trying to involve something that has scale and duration, Chris. So we think that those opportunities are going to continue to present themselves, but the Watergate was kind of a special deal for us and we'd like to see that both translate more, I think maybe a little bit more, we are seeing more of the family type deals on the multifamily side and so we're going to continue to push on that.

And then just shifting over to the multifamily side. On the unit renovation process, that you have been doing at both Riverside and Wellington, returns are certainly, sound like they are within your underwriting it. As you guys look at those units, sort of going through the first churn, are you -- what sort of returns are you getting, sort of rent bumps you are getting at that point after a full year and what kind of renewal rates are you getting with those tenants as it relates to, maybe, the project overall. How is that driven, the business at Wellington and Riverside?

So Chris to understand your question, you are saying that after we've renovated and we've turned it over or come around for a renewal and/or it relates after a year of a renovated unit.

Correct, right.

Yes, I think we're seeing renewal trade-outs in those units pretty much consistent with all of the trade-outs across the board. I think, again, the quality of the renovation is what's driving both the rent and the trade-out on the, whether it's a renewal or a new lease.

Okay. And then just 2 quick ones on the USDA lease, you talked about I guess, GAAP rent commencement, second half of '18. Rent -- cash rent commencement would be roughly when after that?

I think we gave them 18 months of free rent.

15-year deal.

15-year deal.

Okay. And then the last question. You guys jumped the G&A midpoint of guidance a fair amount. What's the driver behind that?

Well Chris, most of it would be incentive [compresses] the second time that we've raised guidance for the year, so that's a pretty good indication that we're ahead of the plan for the year. It is not all of it, but that would be the biggest change.

I'll now turn the floor back over to Mr. McDermott for any final remarks.

Thank you, operator. Again, I would like to thank everyone for your time today and we hope that you enjoy the remainder of your summer. We look forward to seeing many of you on our upcoming non-deal roadshows in the very near future. Thank you, everyone.

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