Elme Communities (ELME) 2018 Q1 法說會逐字稿

Welcome to the Washington Real Estate Investment Trust First Quarter 2018 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, Paul McDermott; Tejal Engman, Vice President of Investor Relations will provide some introductory information.

Ms. Engman, please go ahead.

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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 25 of our Form 10-K for our 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; and Drew Hammond, Vice President, Chief Accounting Officer 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 first quarter 2018 earnings conference call. We achieved strong first quarter results across multiple fronts. We grew core FFO per share by 4.5% on a year-over-year and sequential basis, driven by strong revenue growth. We delivered solid internal growth momentum with 2.4% GAAP and 2.9% cash year-over-year same-store NOI growth.

We grew year-over-year same-store cash NOI by 5.3% for offices and 3.7% for multi-family by driving occupancy gains and rental growth -- rental rate growth. We amended and expanded our credit facility and refinanced an existing term loans to increased liquidity and provide greater flexibility to make optimal capital allocation decisions. And finally, we plan to move forward the sale of 2445 M Street from September to June, to accelerate the continued strengthening of our balance sheet.

While Steve will detail the drivers of our first quarter operational and financial performance, I would like to provide an update on our 6 key NOI growth drivers and discuss the long-term strategic growth opportunity for Washington REIT within the context of our outlook on DC Metro real estate.

Let me begin with the Office portfolio and our lease-up opportunity at Arlington Tower in Rosslyn, Virginia. Following the close of the acquisition on January 18, we have experienced nearly 220,000 square feet of demand for the approximately 70,000 square feet of availability at Arlington Tower in 2019. We are implementing a spec suite leasing strategy, focused on creating flexible space solutions with shared amenities to provide an increased speed to market where tenants are willing to pay a premium for such conveniences.

As an example, we have had tremendous success with our leasing strategy at 1600 Wilson where our spec suites have achieved an 8% net effective rent premium to market and 100% occupancy. We feel confident that this strategy will work at Arlington Tower because there are a limited number of Class A small suites in Rosslyn that offer rents in the $51 to $55 gross range, and among those, Arlington Tower is the only building with scenic views according to CoStar data. Additionally, we expect to achieve a 7% to 10% premium on the TI investment of approximately $80 per foot for our flex product.

At Watergate 600, the lobby renovation is now complete and we are trading proposals with active prospects, totaling approximately 213,000 square feet with another approximately 350,000 square feet of future prospects predominantly for the top 3 floors that are currently leased to Blank Rome and have a lease expiration date of December 31, 2019.

We have received interest from law firms, tech companies, associations and co-working providers. We are also in negotiations with restaurant operators and other service providers for the ground floor retail space. Watergate 600 is 1 of only 3 Potomac River front office buildings in DC, and like Arlington Tower in Virginia, it enjoys panoramic river and monuments views.

To recap, both Watergate 600 and Arlington Tower are the result of our office recalibration over the past 12 months. We are upgrading our Washington DC and Northern Virginia office portfolios without materially increasing our overall of office exposure. In Washington DC, Watergate 600 replaces 2445 M Street, which is held for sale. In Northern Virginia, Arlington Tower replaces Braddock Metro Center.

In essence, we are replacing commodity, single-tenant office assets with 2 iconic, well diversified metro centric office assets that possess unique attributes such as spectacular water views which enables us to create a truly differentiated value proposition. Views remain the one of many needs that can't be replicated and assets with waterfront views in the DC Metro region command double-digit rent premiums, on average, according to JLL data. Our capital reallocation in office has reduced our single-tenant exposure from 26% to 13% of the office portfolio square footage. Today, 97% of our office NOI is derived from assets located within 1 mile of Metro.

In retail, we continue to see strong activity at our new development at Spring Valley Village where we are approximately 50% pre-leased, after signing 2 strong food service operator brands for the ground floor, and we are seeing demand from a variety of personal and business services users for the second floor. The Spring Valley Village development is expected to add an incremental $0.5 million of stabilized, annualized NOI.

We have signed an LOI for the 28,000 square feet of HHGregg vacancy at Hagerstown with a major grocer that will be of significant value to the center as we believe it will generate higher traffic and provide better credit. The 23,000 square feet of HHGregg vacancy at Frederick continues to receive interest from discounters in the 12,000 to 15,000 square foot range and we also have single user prospects showing interest in taking the entire space. We are in active negotiations and continue to expect both vacancies to be re-leased this year with leases commencing in 2019.

Moving on to multi-family, we were pleased that several investors were able to tour our unit renovation program at the Wellington and appreciated the positive feedback we received afterwards. We expect to ramp-up the unit renovation program at the Wellington and Riverside in the second half of 2018.

At quarter end, we had 287 units left to renovate at the Wellington and 415 units left to renovate at Riverside. The Wellington unit renovation program is now 58% complete while Riverside is 52% complete. 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 through 2018 and into the first half of 2019. Combined, these 2 unit renovation programs are expected to add an incremental $1.8 million of stabilized, annualized NOI.

And finally, we are progressing on schedule with the construction of the Trove, a ground-up development of 401 additional units on site at the Wellington. We expect to deliver Phase 1 of this project, which consists of 226 units in the third quarter of 2019. The Trove creates a value Class A offering at the eastern end of Columbia Pike in South Arlington, a sub-market with limited Class A deliveries. Units at the Trove will maintain a healthy $300 to $400 gap [elevated] to the renovated B units at the Wellington, and it is consistent with our strategy to offer multiple price points and value propositions on the same site.

Overall, we remain committed to our multifamily strategy. Since Washington REIT began its asset recycling program in 2013, we have net sold approximately $370 million of office assets and net purchased over $400 million of multifamily assets. Since the first quarter of 2013, we have grown our multi-family unit count by 76% and significantly increased that portfolio's contribution to overall NOI.

Multifamily offer stable cash flows and value-add multifamily offers us the opportunity to meaningfully grow rents. Our research has proactively identified a targeted list of Class B multifamily assets that meet our value add criteria and that are located in sub-markets with solid long-term rental growth prospects. Our acquisition team is working to originate these future off market opportunities and will evaluate all funding sources to determine the most prudent, leverage-neutral path to growing our value add multifamily exposure.

Let me conclude with the long-term growth opportunity for Washington REIT within the context of our outlook for DC Metro real estate. Following over $1 billion of strategic asset recycling over the past 4 years, we have positioned our portfolio in the path of growth within a challenging DC Metro real estate environment.

More specifically, there are 3 key segments within DC Metro real estate that have, structurally, solid fundamentals and Washington REITs portfolio offers the greatest public REIT exposure to all 3 of them. These are value-add multifamily Class B office in Washington DC and our other assets located in outperforming sub-markets in Virginia.

Starting with value-add multi-family, which continues to generate mid-to-high teens return on renovation capital, approximately 76% of our Class B units are in sub-markets with greater than average affordability gaps between Class A and Class B multifamily. Overall, our Class B portfolio has a weighted average rent gap that is nearly double the market wide A versus B gap.

Furthermore, the average rent to income ratio or renter burden in our B portfolio for the first quarter of 2018 is 24%, which is an optimal level from where to grow rents further, especially given average hourly earnings growth in the DC Metro region is now tracking at 2.7% on a year-over-year basis. Rent growth is correlated with income growth, which appears to be accelerating this year.

The second market segment is Class B office in Washington DC where conditions continue to remain strong, as vacancy is dropped below 8% and rents have grown by 7.3% over the past 24 months, according to JLL data. Class B office vacancy is projected to continue to decline to 6.8% in 2020 according to JLL estimates as demand for DC Class B office remains healthy and redevelopment creates incremental supply constraints.

Leasing trends continue to be positive in our DC Class B portfolio where cash and GAAP rents on both new and renewal leases rolled up in the first quarter. Class B net effective rent growth is driven by lower concessions with rent abatement declining by 15% on 5 to 7 year deals according to JLL.

For leases at or below 10,000 square feet in our DC Class B office portfolio, we have seen a 21% drop in tenant incentives, a 6.5% drop in free rent, and a 12% increase in cash base rents from April 2015 through March 2018 compared to the prior 36-month period.

Finally, only 10% of the value office space in Downtown DC is REIT owned with the vast majority, approximately 72%, being privately held, according to CoStar data. We believe the well amenitized, Class A service and experience that Washington REIT provides tenants in our Class B office assets remains a key competitive advantage for our portfolio.

While some commodity Class A assets have dropped rates from their mid-$70 pro formas to attract large tenants, it is important to note that the greatest volume of leasing in the Washington DC core takes place at the $40 to $55 gross price range. Furthermore, 75% of the leases signed in this pricing sweet spot are at or below 7,000 square feet.

We have not seen commodity A office building break rents for smaller tenants, and for a 7,000 square foot tenant spending $10 to $15 more per foot for commodity Class A office space is a significant outlay for an investment without any tangible returns, especially if you're an association or not-for-profit. As a result, the demand for DC Class B office remains solid.

And finally, the third market segment is well located Northern Virginia real estate across office, multifamily and retail. Office real estate fundamentals in Northern Virginia are recovering, predominantly driven by Rosslyn and other Silverline markets. Properties within a 0.5 mile of Metro have enjoyed greater absorption, lower vacancy, and a 34% rent premium relative to properties located further than a mile from Metro, according to JLL.

These submarkets continue to be the biggest recipients of private sector office growth in Northern Virginia which experienced nearly 970,000 square feet of positive net absorption in the first quarter, its biggest leasing quarter since 2010 or pre-sequestration, according to JLL. Rosslyn registered among the largest occupancy gains of all submarkets in Northern Virginia and was able to attract new tenants, according to CBRE. For Northern Virginia at large, technology and business service sectors were the main source of net demand in Q1, 2018, while government contractors accounted for nearly half of the leases above 20,000 square feet in the first quarter, according to CBRE and JLL.

The $1.3 trillion fiscal year 2018 Omnibus Spending Bill signed on March 23, has increased the Defense base budget by $61 billion, according to JLL data. With only 6 months left in the fiscal year to award the money, contractors in Northern Virginia expect to start seeing contracts flow soon, a move that should boost 2019 job growth which will positively impact all 3 of our asset classes. Approximately 54% of our overall portfolio and 74% of our multifamily portfolio pro forma NOI is derived from Virginia.

To summarize, approximately 75% of our overall portfolio pro forma NOI is directly exposed to 1 or more of these structural growth areas within the DC real estate, which leaves Washington REIT well positioned for the future.

Now, I would like to turn the call over to Steve to discuss our financial and operating performance in the [first] quarter.

Thanks, Paul, and good morning, everyone. Net income attributable to controlling interest was $3.3 million or $0.04 per diluted share, which was lower than the $6.6 million or $0.09 per diluted share reported in the first quarter of 2017. That's mainly due to higher depreciation and amortization, real estate impairment, and the interest expense.

Our first quarter operating results outperformed our prior expectation by approximately $0.01 of core FFO per share, driven by higher occupancy in multifamily and lower operating expenses across all 3 asset classes than our prior forecast. On a year-over-year basis, core FFO per share was $0.02 higher due to the same-store NOI growth and the contribution of acquisitions of Watergate 600 and Arlington Tower more than offsetting the sales of Walker House and Braddock Metro Center, as well as higher year-over-year weather operating related expenses and real estate taxes.

Same store office NOI grew 4.8% year-over-year, driven by 200 basis points of average occupancy gains due to new lease commencements and tenant expansions across several assets; including the Army Navy Building, 1776 G, 2000 M, 1140 Connecticut and 1901 Pennsylvania in Washington DC and the Silverline Center and 1600 Wilson Boulevard in Northern Virginia.

Notably, the same store office portfolio delivered strong year-over-year growth, despite approximately $400,000 of lower termination fee income compared to the first quarter of 2017, as well as higher operating expenses. Multifamily first quarter same-store NOI was up 3.7% year-over-year as average occupancy increased 120 basis points on a unit basis. We drove year-over-year occupancy gains and rental rate growth at over half of our multifamily assets including the Wellington and Riverside.

Overall, we grew multifamily rental rates by 200 basis points year-over-year and average monthly rent per unit by 110 basis points for Class A properties and 220 basis points for Class B properties. As a result, we outperformed the DC Metro regions rental growth rates for both Class A and B multifamily in the first quarter.

And finally, retail same-store NOI declined 2.8% due to 300 basis points of year-over-year average occupancy declines, mainly related to the former HHGregg spaces which are currently in lease-up. On a related note, the sequential decline in retail occupancy was due to lower specialty leasing in the first quarter of 2018 compared to the fourth quarter of 2017 due to the normal seasonality of holiday specialty leasing.

Moving on to office leasing in the first quarter, we renewed 71% of our office square footage expiring in the quarter. And given we have only 3.6% of rentable square feet expiring for the remainder of the year, our focus remains on leasing our 2019 and 2020 lease expirations, particularly at Arlington Tower and Watergate 600. We expect leasing volumes to be lumpy as we deliver on these key leasing opportunities.

In retail, we retained 100% of our retail square footage expiring in the quarter and achieved 3% cash and 12% GAAP rental rate increases on approximately 45,000 square feet of renewals signed in the quarter. Of the remaining 197,000 square feet of retail lease expirations in 2018; 95000 square feet is leased to Kmart with an expiration date of November 30, 2018.

While the Kmart lease is significantly below market and re-leasing the space would represent a long-term NOI growth opportunity, currently there is a higher probability of the tenant exercising their right to renew than to terminate. Kmart remains at the top of our tenant watch-list, which closely monitors the tenants that we believe posts a high risk of vacating prior to their lease expiration dates.

Currently, that entire list of such tenants represents less than 1% of overall retail GAAP rental revenues. Having renewed 100% of expiring retail leases, there was minimal new leasing in the first quarter and spreads were negative due to a new lease on 21,000 square feet of space that had been vacant for nearly 2 years and skewed the numbers.

Now, turning to guidance. We are reaffirming our core FFO guidance which remains projected to range from $1.82 to $1.90. We've made 2 changes to our guidance assumptions. First, we now project multifamily same-store NOI growth to range from 2.5% to 3.5%, up from 2.25% to 3.25%. And second, we now expect to complete the planned sale of 2445 M Street in June, instead of September of this year for approximately $100 million and have therefore revised our non-same-store NOI guidance to range between $34.5 million to $36 million.

We continue to negotiate moving this sale forward with the buyer to strengthen our balance sheet sooner. We expect to mitigate the negative impact of approximately $0.02 of core FFO per share from selling this asset nearly 3 months earlier with the $0.01 of core FFO per share outperformance we achieved in the first quarter and another $0.01 of core FFO per share from the non-same-store portfolio relative to our previous forecast.

While we do not provide quarterly guidance, we expect our second quarter 2018 same-store NOI to be lower, partly due to higher second quarter 2017 lease termination fees and expense recovery settlements that together represented approximately $1 million of higher NOI than expected in the second quarter of 2018. We expect our same-store NOI growth to rebound in the third and fourth quarters, and thus, expect our overall full year growth to be weighted accordingly.

Moving on to the balance sheet. The planned sale of 2445 M Street in June will improve our annualized net debt-to-EBITDA and we project to be within our target range of 6x to 6.5x by June 30. Our balance sheet is unencumbered and healthy with secured debt to gross assets at 3% and a debt service coverage ratio of 3.6x. With further deleveraging expected from the planned asset sales we've guided to this year, we would like to retain the flexibility to prepay debt.

To that end, while amending and expanding our unsecured revolving credit facility, we've also refinanced an existing $150 million, 7-year unsecured term loan, expiring in July 2023, with a $250 million, 5-year unsecured term loan having the same expiration date. The term loan continues to fit well within our debt maturity ladder and provides us with greater flexibility to accelerate legacy asset sales if appropriate, as there are no prepayment penalties associated with the term loan.

With regards to the $250 million refinancing, we've been able to re-price our prior 7-year $150 million term loan with a 5-year term loan without changing its maturity date, thereby saving 55 basis points over 5 years. We've also fixed the interest rates for the entire $250 million to manage interest rate risk.

Let me conclude with core funds available for distribution or core FAD. We delivered $32.6 million of core FAD in the first quarter, representing a payout ratio of 73% and are targeting an approximately 80% core FAD payout ratio for full year 2018. We have grown our core FAD from approximately $70 million at year-end 2014, when our programmatic asset recycling began, to $119 million on a trailing 12-month basis to March 31, 2018.

One of the biggest drivers of that improvement has been an annual reduction in tenant incentives every year for the past 4 years. Our planned sale of 2445 M Street is yet another decision that reduces future capital requirements and supports the long-term returns we aim to deliver to our shareholders.

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

Thank you, Steve. The 2 questions we are most frequently asked on the road these days are regarding the DC Metro region's prospects for winning Amazon HQ2 and whether or not we have seen a pick-up in leasing activity following the passage of tax reform in December, the Bipartisan Budget Act of 2018 in early February and the fiscal year 2018 Omnibus Spending Bill at the end of March?

At this time, any comments that we or others make on HQ2 would be largely speculative. However, we and the brokerage community are seeing a definitive increase in our office tour activity in the region, especially in Northern Virginia and our multifamily portfolio has also outperformed our occupancy and renewal trade-out expectations in the first quarter.

The sustainability of this improvement will depend upon the speed at which contracts are awarded and moneys are disbursed from the departments and agencies whose budgets have increased. Historically, just having a federal budget instead of a continuing resolution has had a significant positive impact on the metro economy as most continuing resolutions prohibit new starts or the initiation of new activities that weren't funded in the prior year and this naturally inhibits growth.

Prior to the Budget Act and fiscal year 2018 Omnibus Spending Bill, the region had been operating under a continuing resolution for 13 of the 18 past months which created significant uncertainty for a meaningful portion of the private sector in Washington DC. That cloud of uncertainty is now lifting as Congress has passed a Bipartisan Budget Act that significantly increases authorized spending for the next 2 years over levels previously controlled by the Budget Control Act of 2011.

For fiscal 2018, amounts have already been appropriated. And for 2019, amounts have been authorized thus providing clarity to government serving private sector businesses to determine their hiring and expansion plans as they can now be awarded business. With unemployment in the metro region hovering around 3.6%, we believe growth at this stage in the cycle will likely result in net migration into the region, which should provide continued support for multifamily and retail.

Washington REIT remains a secular way to play the DC recovery with a platform that's strategically positioned in segments with the strongest supply-demand dynamics within the DC real estate.

Now, I would like to open the call to answer your questions. Operator, please go ahead.

(Operator Instructions) Our first question comes from Jed Reagan with Green Street Advisors.

Paul, you mentioned the pick-up in tenant activity following the budget passage. I mean is that -- would you say you're seeing sort of -- that translating into tangible results at this point or is it just more towards just kind of a sense of optimism?

Yes, Jed, it's Tom. The short answer is that the activity has definitely picked up. We've seen about a 75% increase in tour activity in our B portfolio DC, which has manifested itself in 3 expansions as well. So I think both new activity and existing growth has shown up. I think Northern Virginia, with our new acquisition at Arlington Tower; we were surprised with how much activity we got shortly after closing on that. And I think that is an indication, as well, of the optimism that's starting to penetrate into a lot of the users in both the defense and government contracting segment as well as just the basic business and professional sector.

And then, Paul, you mentioned in your opening comments that you're talking to co-working groups for the space at Watergate. Just curious to get your general comments on how you're viewing the co-working trend, how you guys sort of approach leasing with that group of tenants, and then if you've considered doing an in-house co-working concept like a few of your peers have done.

I'll start and I'll ask Tom to jump in. I mean, if you look back, Jed, at this last quarter, tech and co-working were the real drivers of occupancy gains in the region. You look at like Facebook, Yelp at Terrell Place. WeWork just opened their 9th location at 7776 which -- WeWork now has a 0.5 million square feet downtown, which is kind of the largest private sector tenant in the city. We, I think, through our flexible spec suites and -- this is where I'll turn it over to Tom. I mean, I think we are looking at various concepts, but co-working is clearly here to stay. People want the flexibility on duration and size, and I think they're willing to pay for that.

Yes, I think that's exactly right. With the -- there is no doubt that tenants demand more flexibility and if you can't address that, I think you're going to lose out on a lot of the demand in the market. And we think it's also going to become almost like an amenity in a sense that you are able to provide a flexible solution for tenants that need to search for various project work or consulting work and that's just something that we think is going to continue to grow over time. That being said, I think there has been a rapid growth in some of the co-working platforms and it's going to take some time for that to sort of get absorbed. And we've heard recently, interestingly enough, that some of the large co-working is starting to compete against landlords, and so I think you've got to be careful with that in how you make decisions on co-working.

In terms of the flexible spec suites, I mean, are you looking to sign shorter deals on those or open to signing shorter deals of 2, 3 years?

Yes, yes. In fact what we've found in our spec suite programs to-date, Jed, is that we can do a 2 or 3-year deal in a spec suite and when they decide to move on hopefully to something bigger and more permanent, which we have found to occur, that we backfill that pretty quickly and with no capital investment. You know, it's a little bit like -- one of the benefits of us being in the multifamily business is we see how that business works and how there are some parallels in the trending changes in the office dynamic.

I think we saw that show up in your numbers a little bit last quarter. Average new lease term was under 4 years, I believe. So is that kind of reflective of some of the leasing you're talking about?

It's a little bit reflective and then some of it was some shorter-term expansions that we're going to set up to be coterminous for a longer-term renewal.

And then just last follow-up on the topic. Is there a hard cap for maybe the percentage of your rent roll that you are willing to have with co-working?

We haven't -- so you've probably read a lot of stuff. I mean you guys have done some good work on analyzing co-working. I think the penetration to-date, 1% to 2% in a lot of the gateway markets on co-working, then there is some studies that say it could be upwards of 20%. We look at a building like Arlington Tower, 400,000 foot building, and you think if you've got a flexible platform in there that can address these emerging tenant demands that takes up maybe 10% of the building, that feels like the right amount of that product in a given asset of that size.

Our next question comes from John Guinee with Stifel.

Sort of a really, really big picture question. Looks to me like you are at about 53% office and 26% multifamily. If instead of investing in 600 Watergate and Arlington Tower, about $380 million, if you had invested that in multifamily, your ratio, instead of being 53% office, would be about 41% office and your multifamily would have gone from 26% to 38%. So you would have been sort of 50% office -- or 40% office, 40% multifamily, 20% retail. And I realize that probably would have been a $0.08 to $0.10 hit in FFO, but you probably would have changed your peer group in terms of multiples. I'm sure you guys did a ton of analysis on this. What was the sort of big picture decision to invest into office and invest first multifamily and thereby sort of putting yourself in a different peer group in terms of multiples?

Sure, John. Well, first off, I think primarily and I think one of the things that we've tried to articulate on our calls and certainly on our NDRs and at NAREIT and face-to-face was, we had 2 objectives. One was to sell off risk in the portfolio; and the other -- and simultaneously, elevate the quality of the portfolio. So when I look at a trade-out from Braddock to Arlington Tower or 2445 to the Watergate, I think we've sold off risk and elevated the quality of the portfolio. In terms of capital allocation for us, we never said we were going to abandon office, we just said we wanted to improve what was in our portfolio, and I think we've accomplished that. In terms of the multi-family, I think we've increased our unit count by 76%. We've almost doubled the NOI contribution percentage since I've taken over. And I think we are going to continue to pursue value-add multifamily. I think right now for us it's just what is going to be the best capital execution to help us grow that. We continue to recalibrate. We are going to be selling. As you know, as we mentioned, we are selling 2445. We will be selling another office asset later in the year. And I do believe that we are continuing to scrutinize our office portfolio for other monetization opportunities. So the 53% and the 26% is, yes, that's a 90-day snapshot. I just wouldn't hang my hat on those percentages, John.

And then 2 other questions. One is more curiosity than anything. Where is that 95,000 square foot Kmart? And then the second question would be the Trove, the 400 unit ground-up development, if you fully load it up with all your infrastructure costs, all your structured parking costs, to create that opportunity for 400 units, what sort of cost per unit are you looking at and what sort of return on cost are you expecting?

Sure. Well, the lovely Kmart is in Frederick, Maryland and that Kmart, which by the way, we would love to have the space back; that Kmart is currently paying, I believe, $2.50 a square foot in a market that's just over $7. So while we have been hoping that they would -- that would be one of the [shared] stores, it remains open. And we had forecasted them to go out at the end of their lease term this year, and now we're not so sure that is going to happen. So I think that below-market rate that they are paying is an asset for them, candidly. The Trove, the 401 units we're constructing on site The Wellington, I think we are in that for just over $300 a door when it's all in, loaded up and I think that is a low 6 going in and stabilizing in the mid-6s.

(Operator Instructions) Our next question comes from Dave Rodgers from Robert W. Baird.

Maybe a couple questions to start off on office. Paul, you talked about 220,000 square feet of demand for Arlington Tower. I think it's 70,000 square feet that will be available next year for you. Why go into the spec suite avenue with that much demand? Does it just not fit the space? Is there not one large tenant? Little more color on that. And then, can you talk about, at the Watergate, are you in term sheets or deeper negotiations with any office tenants, maybe besides that WeWork that you had mentioned earlier -- or the co-working sorry, in that building?

Dave, it's Tom. I'll take a stab at it. So we just -- as I mentioned earlier, we look at this flex space demand as a trend that we need to address and that you're going to miss out on demand in the market if you don't really have it. And so I think that is and we proved it out at 1600 Wilson, which is what gave us confidence to expand our presence in Rosslyn as it was, because we just have seen Rosslyn start to really evolve into a 24/7 market that's going to be, I think, a long-term success story. And we believe that having a flex space option in Arlington Tower is going to help us outperform the market; not only demand side, but I think we drive premiums on the rents and we saw that at 1600 as well. So do we have, of the 220,000 k or whatever of activity, we've got some that are, in fact, moving into LOI, but they are small to mid-size tenants and we're going to be breaking up [clause] with those. So I think it works well to have a flexible space option to address these -- what is -- as we know, the majority of the demand in the market is in the small-to-mid-size segment. What was the other question? Was that Watergate? Yes, at Watergate we still have ways to go on the existing lease obligation and the trick there is to ensure that if we're going to sign a deal to start any earlier than the end of '19 we've got to make sure we can get a win-win arrangement with the current lease obligation that ends up being a value add to the project. And so -- we've got some deals, but we've got to be careful that we structure those the right way. So we're still not quite at lease on any of those.

And maybe last on the residential side. Can you talk about maybe what the impact is from the unit renovation program? The return sounds strong, so what impact is that having on your revenue or same-store NOI growth in the residential portfolio?

So Dave, this is Steve. So when we look at incremental, what's already in our run rate are embedded, when we finish the remaining renovations at [Waterside] and Riverside; that should be an incremental of about $1.8 million of NOI. I'm sorry, yes -- Wellington and Riverside, sorry.

And you said you were about halfway through that program or --?

Yes, we gave -- yes, roughly half. I think we threw out different numbers. One is at 52%, one is a little longer.

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

I spoke to somebody recently in the market who indicated that they think pricing may actually be up a bit and perhaps cap rates down a bit in the last, call it 3 to 6 months in the market. Can you, at least for better quality stuff, maybe Paul, if you -- any perspective you might have on, does that sound right to you or maybe just kind of general trends you've seen in the valuation side of things in the DC area?

Sure, Jed. Let's -- since there is a lot involved in that, in investment sales, let's probably start with the capital. There is no shortage of capital either on the debt side or on the equity side. I think, I alluded to this at the last time we met, and I think we did on the call. The debt funds are continuing to be extremely aggressive and that's both for urban and suburban product. Quite frankly, I think the life companies have been trying to do a yeoman's job to compete, but clearly these debt funds have capital to get out and they're going to do it. And frankly, we've even talked to some owners that said, "Look, with debt rates this low we thought we'd risk off and sell but we can now cut a deal and help us carry us through a downturn to when we think some of these concessions will burn off and we can plough through the [re-lift]". On the private equity side, that is just continues to flow into DC. We've seen high net worth funds, state pension funds, big push on foreign capital in terms of -- I'm assuming a defensive play because I can't see value creation like when somebody is paying $12.75 a foot, that's pretty rarefied air. We'd see Middle Eastern capital come in, they recapped the bureau and Tyson through MetLife seem Israeli capital be active. 1440 New York just traded at $4.4 cap for a law firm credit. And that's Munich Re in a JV, I believe with EastBanc. So the capital has been extremely aggressive. I wouldn't say, though, unlike that deal worth $12.75 a foot, you have 6 or 7 buyers. You probably have 1 that really wants that asset and it's a specific asset allocation. The equity that's come to us and that's talked to us, they like the Toll Road, they're chasing technology. They like the Silverline markets where they see development going. One of the things that probably isn't getting a lot of color but should is just been kind of new product rents in downtown Bethesda. Vacancy in downtown Bethesda is around 7%, and we've seen some pretty big tickets, mid-to-upper 60s numbers, full service being recorded there. And so, we definitely have seen people nosing around, going into there. I know there were questions about our acquisition of Arlington Tower, but I like that. I like our basis. We know that there is a partial interest being shopped out there for a product that's about to deliver, that's probably going to have an 8 in front of it. So we like our basis with a 6 in front of it. But I would say, definitely, downtown here, we've seen cap rates decline certainly in the multifamily space, the ones that have traded. The only exception, I would say, where I haven't seen cap rates press down, Jed, is when someone's trying to sell multifamily pre TOPA and those are probably maybe a 25 basis point cap rate expansion. But multi-family value-add has really probably been the most extraordinary, probably over the last 3 to 6 months.

Now, I would like to turn the call back over to Mr. McDermott for a final remark.

Thank you. Again, I would like to thank everyone for your time today, and look forward to spending time with many of you as we get back out on the road next month and at NAREIT. Thank you, everyone.