Equity Commonwealth (EQC) 2005 Q3 法說會逐字稿

Good day and welcome to the HRPT Properties Trust third quarter 2005 financial results conference call. This call is being recorded. At this time, for opening remarks and introductions, I would like the turn the call over to -- to the Manager of Investor Relations, Mr. Tim Bonang. Please go ahead, sir.

Thank you, Kevin. Good afternoon everyone and welcome. Joining me on today's call are Adam Portnoy, Executive Vice President; and John Popeo, Chief Financial Officer. The agenda for today's call includes a presentation by management followed by a question and answer session.

Before we begin today's call I would like to read our safe harbor statement. Today's conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and federal securities laws. These forward-looking statements are based on HRPT's present beliefs and expectations as of today, November 8, 2005. The Company undertakes no obligation to revise or publicly release the results of any revision to the forward-looking statements made in today's conference call, other than through filings with the Securities and Exchange Commission regarding this reporting period. Actual results may differ materially from those projected in these forward-looking statements. Additional information concerning factors that could cause those differences is contained in our forms 10-K and 10-Q filed with the Securities and Exchange Commission and in our Q3 supplemental operating and financial data found on our web site at www.hrpreit.com. Investors are cautioned to not to place undo reliance upon any forward looking statements. And with that, I'd like to turn the call over the Adam Portnoy.

Thank you, Tim. Good afternoon, everyone and welcome to our third quarter 2005 investor conference call. For the three months ended September 30, 2005, HRPT's reporting FFO of $0.32 per share, which is flat with last year's result for the comparable period. In general, the third quarter was largely business as usual for HRPT, we signed leases for close to 1 million square feet and closed on the acquisition on $117 million of properties during the quarter. We continue to remain an occupancy rate of about 94% with long-term leases to strong credit tenants. Overall, HRPT continues to experience modest improvements across its portfolio with regards to office fundamentals. Within each of HRPT's major market areas, there is positive net absorption, little new development activity and increasing occupancy rates.

During the third quarter, although we experienced rent rolldowns of about 5%, we are continuing to see reductions in up front capital commitments. Up front capital commitments for leases signed during the quarter were about $14 per square foot compared to over $30 per square foot at the end of 2004. More importantly, up front capital commitments per square foot per average signed lease term were about 30% less in the third quarter than they were at the end of 2004.

In summary, when looking at both changes and rental rates and up front capital commitments, overall net effective rents have generally improved since the end of 2004, but have remained basically flat during the last couple of quarters. We continue to have among the highest occupancy rates in the office reit sector. We were 93.9% leased as of the end of the quarter compared to 93.1% leased at the same period last year and 94.1% leased at the end of the second quarter of 2005. Even though we signed leases representing more square feet than expired in the quarter, the slight decline in occupancy between the second and third quarters is a result of some acquisitions in the third quarter which were less than 90% leased.

On a same-store basis, occupancy increased by 60 basis points to 94.9% at the end of the quarter, compared to the end of the comparable period last year. Same-store NOI also increased 4.2% during the quarter. However, after excluding lease termination fees, same-store NOI gross -- growth was less than 2%. This indicates that even though our occupancy rate continues to improve, we are still experiencing modest rolldowns in rents across our portfolio.

With regards to our major market areas, Washington, D.C.; Oahu, Hawaii; and southern California continue to be our strongest markets. Our portfolios in these three markets are very well leased on a long-term basis and have experienced increases in same-store NOI during the quarter because of rising occupancy rates coupled with increasing rental rates. Austin continues to be a growth market for HRPT with an increase in occupancy of almost 10% during the last year. As of the end of the quarter, our Austin portfolio was 88.6% leased, compare to 79% leased at the end of the same period last year. In addition, for the first time in many years we are operating at well above market occupancy rates in Austin.

Despite the increase in occupancy, Austin's same-store NOI declined this quarter because of rent rolldowns. Atlanta's also one of HRPT's growth markets. As many of you know, Atlanta is a new market for HRPT that we entered with the acquisition of Hallwood in July of 2004. Since then, we have made four additional acquisitions in this market. We are primarily attracted to the Atlanta market because of its long-term growth prospects. Starting in the fourth quarter of 2005, we will begin reporting same-store data for this market.

Even though both Philadelphia and Boston have difficult market conditions, our portfolios in these markets are stable and well-positioned. Because we significantly repositioned our Philadelphia portfolio during 2004, we -- we will continue to see declining same-store operating results from this portfolio through the end of the year. However, as a result of our activities in 2004, today we are the best-positioned commercial office owner in downtown Philadelphia. We have above-market occupancy rates, all of our leases are currently equal to market rates, and we have limited lease expirations over the next several years. Our Boston portfolio had flat same-store NOIs during the quarter, which was the result of increasing occupancy offset by rent rolldowns. Today, we are very well-positioned in Boston with above market occupancy, modest lease expirations over the next years and limited exposure to the more difficult downtown market area. In other markets throughout the country, our portfolio has generally experienced modest increases in occupancy offset by some lease rolldowns.

At the end of the third quarter, HRPT is still very well-positioned in the marketplace. We continue to have one of the most secure revenue streams in the industry with 64% of our annualized rents coming from the Government tenants, medically related tenants, long-term leases, leased lands or other investment grade rated tenants. Our largest tenant continues to be the U.S. Government which represents about 15% of our annualized rents. We were 93.9% leased at the end of the quarter and have one of the longest average remaining lease terms in the industry at 10 years based on square feet and 6.6 years based on annualized rents.

With regards to acquisition activities, during the quarter we purchased four properties with 1.3 million square feet. The total purchase price for these properties was $117 million and the weighted average going in cap rate was 8.8%. The largest acquisition during the quarter was the purchase of a multi-tenant office park in suburban Pittsburgh for $69.1 million. The purchase price equals a 9.2% going in cap rate and $81 per square foot which is significantly below its replacement cost. We were attracted to this property because of its high asset quality, strong credit tenants and its location in one of the strongest performing submarkets of Pittsburgh. Although the property was about 78% leased at closing, we are optimistic about the prospects of leasing the remaining space if the future.

In addition, we purchased two properties located in the Atlanta market during the quarter. One property is a multi-tenant office park with 244,000 square feet, which was purchased for $25.1 million, or a 9.4% going in cap rate. The property was 87% leased at closing. The other Atlanta property that we purchased during the quarter is a 96,000 square foot multi-tenant office building for $6.15 million. On the surface, this may to -- may appear to be an unusual investment for HRPT given that this property was 30% leased at closing. However, the primary reason for the purchase is to accommodate the parking needs of an existing tenant that is located in a building owned by HRPT next to this property. In addition, the building was purchased for significantly below its replacement cost and with some modest capital investments, we are hopeful that we'll be able to increase occupancy at the property in the future.

We also purchased a 144,000 square foot multi-tenant office building located in Milford, Connecticut, for $17 million. We purchased this building at a 9.1% going in cap rate and the building was 91% leased at closing. After the quarter ended, in October, we had purchased one additional property with 100,000 square feet for $13.4 million, which we will discuss in more detail during our fourth quarter investor call.

As of today, we've acquired $328 million of property in 2005. Overall, the acquisition market remains very competitive, but over the last couple of months, there are signs that the market may be improving in some parts of the country. Specifically, cap rates seem to be modestly increasing in some second and third tier markets. I will now turn the presentation over to John Popeo, our Chief Financial Officer, to provide some more details regarding our third quarter results.

Thank you, Adam. Looking first to the income statement, rental income and operating income increased by 15.8% and 13.1% respectively during the third quarter of 2005. The year-over-year increase in rental and operating income reflects over $1 billion of properties acquired between July 1, 2004, and September 30, 2005, plus the 4.2% increase in same-store NOI. In addition, G&A expense increased 31% reflecting properties acquired since July of 2004 plus management incentive fees. Average G&A expense in relation to total revenues was around 4.5%, which is better than the peer group average. Current quarter EBITDA increased by around 13.2% over the same quarter last year. Interest expense increased by 13.4%. This increase primarily reflects amounts drawn on our revolving credit facility to acquire properties during 2004 and 2005.

Net income available for common shareholders for the third quarter of 2005 was $26.8 million, a 7.6% increase from the third quarter of 2004. This increase reflects property acquisitions in 2004 and 2005, offset by an increase in interest expense from additional debt. FFO available for common shareholders was $0.32 per share which was equal to the prior year amount. Current quarter FFO includes around $3 million of lease termination income received from a tenant in one of our non-core markets. We had 209.9 million actual and 201.5 million weighted average, common shares outstanding for the quarter ended September 30th. In October of 2005, we declared a dividend of $0.21 per share, which respects 65.6% of our third quarter FFO. Our board considers the dividend level on a quarterly basis and they are comfortable with this current payout ratio.

During the quarter, we spent $32.4 million on tenant improvements and leasing costs which include costs related to deals signed in 2004 and the first half of 2005. As of September 30, 2005, we had $72 million of total committed, but unpaid tenant improvements and leasing costs related to leasing that took place last year and during the first nine months of 2005. We expect to pay about $40 million of this amount during the fourth quarter of 2005. Leasing costs for leases signed during 2005 averaged approximately $15 per square foot, almost half the amount for leases signed during the fourth quarter of 2004. As a result, we expect that capital expenditures related to tenant improvements and leasing costs in 2006 may be significantly less than 2005. During the third quarter, we paid $7 million or $0.13 per square foot for recurring building improvements including lobby renovations and elevator and other systems upgrades throughout the portfolio.

Turning to the balance sheet, on September 30th we held $21.5 million of unrestricted cash. The book value of our equity investments and former subsidiaries was $205 million compared to a combined market value of $336 million. The $21.4 million increase in rents receivable reflects over $21 million of straightline rent accruals during 2005. The $28.4 million increase in other assets reflects leasing commissions paid during 2005, financing fees related the our January revolver amendment and prepaid operating expenses. The changes in our revolving credit facility reflect $314 million of property acquired during the first nine months of 2005 and the repayment of $185 million of debt during the same period. These activities were offset by proceeds from properties sold during the second quarter and the issuance of common shares in March and September of 2005.

On September 30, 2005, we had $696 million of floating rate debt, $352 million of mortgage debt, and $1.3 billion of fixed rate senior unsecured notes outstanding. The weighted average contractual interest rate on all of our debt was 5.7% at the end of quarter and the weighted average maturity was 7.3 years. Our senior unsecured notes are rated BAA-2 by Moody's and BBB by Standard and Poor's. The book value of our unincumbered property pool totalled almost $4.5 billion at the end of the quarter. Our secured debt represents less than 7% of total assets and floating rate debt represents less than 30% of total debt. At the end of the third quarter, our ratio of debt to book capitalization was about 47% and debt to total market capitalization was about 43%. EBITDA and fixed charge coverage ratios improved during the quarter to 3.3 times and 2.5 times representativity. As of the end of the third quarter, we were comfortably within the requirements of our public debt covenants.

Subsequent to quarter end, in October 2005, we issued $250 million of unsecured senior notes due in 2015. Net proceeds from this offering were used to repay amounts outstanding on our revolving credit facility. As Adam mentioned, in October we also acquired one property for $13.4 million. We funded this acquisition with cash on hand. As of today, we have $98 million outstanding on our revolving credit facility with $652 million of additional borrowing capacity. In addition, our unencumbered property pool has increased from $4.1 billion as of June 30, 2005, to almost $4.5 billion as of September 30, 2005.

In summary, we completed $117 million of acquisitions in the third quarter with notable additions to our Atlanta and Pittsburgh portfolios. We continue to maintain one of the industry's strongest occupancy rates at approximately 94%. And TI costs have decreased by more than 50% from the $30 per square foot level that we reported last year.

Overall, we believe HRPT's strong tenant base, limited near term lease expirations, strong balance sheet, and current annual dividend yield of over 8% make HRPT a logical choice for long-term investors. That concludes our prepared remarks, operator, we are now ready to take questions.

Thank you. (Operator Instructions) We'll go first to the site of Brett Johnson with RBC Capital Markets.

Good morning, guys. Here with Jay Leupp.

Hi, guys.

A couple of quick questions. If I'm reading your supplementals correctly, your same-store NOI grew 4.6% in the quarter and 9.7% for suburban properties? Is that correct?

Sounds right?

Can you talk a bit about what's driving this kind of growth in improvement in a still relatively but improving office market?

It's primarily -- well, it's largely being driven by our -- the markets, Washington, D.C.; southern California; Oahu, Hawaii, and some of our other markets that are we would characterize maybe as our core markets, but what we're seeing is in those markets rising -- not only are we seeing increases in occupancy, but we're actually able to push some rate. Specifically in San Diego, Washington, D.C., and especially in Oahu. That's been -- that's largely what's driving it. In other markets throughout the country, even though same-store NOI, you look at it and you're right, it's about 4% -- a little more than 4% as what we're reporting, but if you take out the lease termination fees, it's a little less than 2% and given the increases in occupancy, I think what's going on is generally we're still seeing sort of in our portfolio modest roll downs across the board on a -- on a macro level of rents. And you can see that in some of our leasing sta -- statistics. With that being said, net effective rents sort of after you take into consideration TI dollars and other -- and other factors, I think they've been pretty much flat for the last couple of quarters. They're definitely better than they were at the end of the year.

So I think it's largely the reason what's driving our growth is, the -- the -- where our properties are located. Maybe some of the asset qualities of our property. One of the strategies of HRPT, and we've been criticized about this in the past at some times, is that sometimes we focus on some of our other markets on other markets largely make up what you people might consider second and third tier market areas, like St. Louis, or Kansas City, or an Indianapolis, or Pittsburgh, or Seattle. And in those markets, if you look at some of the asset quality we have, we have what I believe to be class A properties. And in a second or third tier market if you have a class A property it's always going to perform well. If the market's doing well, it's going to outperform the market, if the market isn't doing well locally, it's -- it's still going to do better than the average in the market because people will be upgrading from the B and C buildings into your building.

So I think that's what's largely been driving -- driving our growth. But I -- I don't want you to think that we that -- we have have runaway growth in our portfolio. It's -- I -- I would characterize it as increasing occupancy, being largely driven by some -- by some core markets and overall some still rolldown in rents.

Okay. Thank you for that. Also, if -- I know you mention the southern California, specifically San Diego. I don't know if you mentioned it in your prepared comments, but what exactly drove the -- what the 28% same-store NOI growth, was there a lease termination fee there?

No. There's no lease termination fee there. It's basically being driven by -- it's being driven by our Cedar Sinai's Medical Center in Los Angeles and some leases that we signed down in San Diego. As you can imagine, San Diego market's very -- it's very good right now and we were able to sign some biotech leases -- biotech space there at the end of 2004, which is what's resulting in the increase in the same-store NOI when you look quarter over quarter. In addition, our Cedar Sinai space, it's the me -- our two medical office buildings. Those rents just keep going up. It's noth -- we don't even market the buildings and the rents go up. So, it's basically being driven by those two things.

Okay. And then last question. If you could just comment a bit upon your comfort level with your variable rate debt as a percentage of total debt. It looks like it's moved up a bit in the last few quarters and I was wondering if you guys had a target for where you expect that to -- to level off?

Well, it's largely -- John, you can add something if I -- if I don't answer it sufficely. But basically what -- it large enough -- the largest piece of that is the revolving credit facility and we only have $350 million of term loan that's floating rate. The rest of it is just -- is just made up of our revolving credit facility. And so I expect that to move a little bit up and down depending on whether or not the revolver gets used or -- or -- or we start drawing down on the revolver. So, I -- do I have a comfort level? I think -- I don't think we have an appetite for much more in sort of permanent fix -- floating rate debt. I think we're comfortable with our revolver where it is and $350 million of what I'd call permanent floating rate debt. Maybe we have an appetite for a little more floating rate debt on a permanent basis, but not much.

One other thing to note, Brett, is that on October 31st, when we closed the $250 million bond offering we used to proceeds to pay down the revolver.

Okay.

Even though in the prepared remarks we mentioned close to 30% floating rate debt as a percent of total, that number's down below 19% now.

Okay, great. Thanks very much and good quarter, guys.

Thanks.

We'll go next to the site of Scott Subank with A.G. Edwards. Please go ahead, your line is open.

Good afternoon. Adam, can you maybe comment, I know you -- I know you had indicated that there was a couple specific examples of acquiring vacancy in the quarter. Should we read anything into that in terms of maybe you guys shifting strategy a little bit more rather than acquiring fully leased properties and acquiring some vacancy.

Yes, I know, Scott, I appreciate the question. And I -- and I'm glad you asked it. I think overall, no, the str -- there is no shift in strategy. Largely these were one off opportunities. And I think, overall, the Company is still very, very committed to positioning itself as a Company that is traditionally buying properties, long-term lease, the good credit quality tenants. That being said, we've been saying this for the last couple of quarters with meeting with investors and -- and such that we have 65% of what I characterize of our portfolio as really coming the our security portfolio, that's either U.S. Government, long-term leases, with land leases in Oahu, medical-related tenants, or investment-grade rated tenants. And the average long-lease term on square feet is over -- is 10 years. So I think there is a little bit of appetite for us to maybe take a little bit more -- move a little bit up the risk curve in terms of looking at some acquisitions. But from a -- and so maybe there's -- maybe the answer is on the short-term basis, I think there's a little bit of appetite and willingness to look at some deals like that. But, I think long-term, this is in the a shift in strategy. Overall the Company will -- the portfolio metrics will stay largely the same is what I'm trying to say.

Is -- is there any pricing differential? The pricings that you achieved on -- on a per square foot basis appear relatively cheap compared to the market. Even if there was a pricing differential, would you still not really consider the opportunity to -- to do more of a value-added type of oppor -- acquisition?

No, no Scott, you're absolutely right. We -- that -- yes, we will do those type of acquisitions and you're right, we did a little bit of it in the third quarter and I think we have an appetite to do a little bit more of it. But I just -- I -- I'm trying to answer the question by saying we're going to change the long-term strategy of the Company, but, yes, you're right, we have become a lot more comfortable in the last couple of years taking on a little bit more risk. We're leasing now anywhere from 1 million to 2 million square feet a quarter. We've got lot of offices around the country. We've become a lot more comfortable with our ability to do -- to do leasing. I think some of the results, even this quarter in terms of our leasing activities for this quarter and last quarter and throughout this year have given us a little bit more confidence that we know what we're doing.

And so, if we see a building, let's say like in Pittsburgh that's 78% leased and we're able to buy it for $81 per square foot, yes, that is significantly below replacement cost, but we also feel comfortable that we've done a lot of diligence about the market area, we already own some properties in the market so we have some intelligence of our own in that market and we're confident we're going to be able to increase the occupancy there. So, yes, we are willing to take a little bit more risk and we're willing to look at some of -- a little bit what you might characterize as value ad properties, but I would not characterize -- do not think suddenly the shift of our portfolio is suddenly going to shift, lop sided the other direction to be 65% multi-tenant office buildings that are 78% leased, that's not going to happen.

Okay. Last quarter I think you commented, approximately like 50 million of potentially opportunistic sales that you would -- would consider throughout the second half of '05, can you maybe give an update on those?

Yes, there's -- there's nothing to announce as of today. You're still looking at -- at -- at possibly doing some dispositions throughout -- through the end of the year. We've got some stuff that we're -- there's a couple -- there's probably about three or four properties that we're actively looking at -- at selling. And we mi -- they may -- we may decide not to -- we may decide to actually sell them, we may not decide to sell them because we're not happy with the prices, and if we actually sell them, I don't know if it's going to happen in the fourth quarter.

And are those just non-core older assets or what -- what type of properties are they?

It's pretty easy. If you just go to our web site start poking around on our map and try to figure out where we have one asset sitting by itself in let's say in an area, it's -- that's one criteria. And, so, it just means it's on a sitting -- it's sitting there, we don't think we're going to be growing much we have -- haven't been able to grow much in that market. And the other criteria, it's sort of characteristics, would be represented by what we did in the second quarter where we sold some properties here in Boston. Is a market -- it -- it's -- it's one of our core markets, but it was sort of an older asset which is going to take significant amount of CapEx to reposition it. We took a look at either spending the money to reposition it or selling it. We made the sell -- the decision to sell it. So, it's either one of those two criteria.

Okay. And then, John, I just have a quick question for you. I know you're up at 4. But, in terms of your supplemental package. Can you reconcile the tenant improvement and leasing cost for me. On page 23, it indicates like $32.5 million. I guess those are the committed TIs in -- in leasing cost and then the -- the ones that you guys reference of like $14.5 a foot are the ones that were actually used?

Okay on page -- if you go to page 30, that represents TIs and leasing commissions on deals signed during the quarter. If you flip back to page 23, in the 9/30/05 column, that $32 million, I can tell you, almost half of that is represented by payments for leases that were committed to in the prior year in 2004. That's actual dollars spent, is what's disclosed on page 23.

Okay, so that's the $72 million that you're referencing before?

That's correct. It's -- it's the same type of expense. Correct.

Okay. Thank you very much.

We'll go next to site of Steve Swett with Wachovia. Please go ahead, your line is open.

Good afternoon. Hey, John, could you just provide a little bit more detail on the G&A? It looks like it moved up a little bit as a percentage of assets and revenue. Is there anything one time in there?

Yes. Well, actually, what -- what we're booking this year is an estimated incentive advisory fee and the way that works is, it's -- it's an incentive fee based on growth in FFO. Last year the --

FFO per share.

FFO per share. Correct. Last year FFO per share ended up at $1.22. So far this year through nine quarters at $0.32 per quarter, it's looking as though there will be an incentive fee that will be paid at the end of year. So that's what you see -- that's what you see in the G&A expense.

And -- and so you'll kind of book the same kind of accrual in the fourth quarter?

No, not necessarily.

It would depend on what the fourth quarter FFO is?

That's correct. That's correct. This is just an estimate based on year-to-date.

All right. But if -- but if I --if I look at your full year number, I can -- I can sort of figure out how much you've -- you've booked of that incentive fee?

That -- that's correct. It'll be easy to figure out what the incentive fee is at the end of the -- .

And then next -- next year when you -- when you go into first quarter, you'll lose that portion of the -- of the -- the G&A effectively, at least at the first --the start of the year, and you'll go back to -- to more a normalized percentage?

That -- that's very likely, yes.

Okay.

We get a handle on what our growth rate for 2006 will be on FFO per share basis.

Okay. And then the -- on the acquisitions, is there any material difference between the GAAP and cash yields?

It's about, you know, the -- the -- the 8.8 on a GAAP basis, it's about 50 basis points less on a cash yield.

Okay, thanks.

Yep.

We'll go next to the site of Philip Martin from Stifel, Nicolaus. Please go ahead, your line is open.

Thank you. Good afternoon.

Philip

A couple things. First off, with the acquisitions here, the $81 -- or $88 a foot combined for the acquisitions in the third quarter, does that include CapEx?

No, that's just -- that's just the acquisition cost.

Okay. What -- what -- what would you expect the average CapEx per foot to be on those -- on those assets?

On most of them except for the small Atlanta property it's $6 million, that you saw there -- that's in that -- if you're looking at that page, it's going to be running normal course. We run -- we run somewhere on a year around 60 per -- $0.60 a foot and I'd imagine that they'll probably come in around there. I'm tal -- I'm talking building improvements. In terms of that one building that the $6 million, they might -- it might be double that.

Okay. Okay. And in terms of replacement value -- how far below replacement do you think you got these?

The ones is Pittsburgh,, you know, replacement cost is a fun -- it's -- it's all generalities, it's soft science, and, and our -- and our metrics internally have been changing just in the last couple of months because we're trying to factor in rising construction costs. But, generally about $150 a square foot I think for that property in Pittsburgh.

Okay. And Atlanta, similar type of --

Similar.

Okay, in terms of where you bought it relative to replacement. Okay. The other thing, in terms of just opportunities there on the rent side, leasing side, et cetera, can you characterize some of the upside and even talk as much as you can about the timing of when some of that upside could -- could be recognized?

Well, for those specific acquisitions in 2 -- in this quarter, the build -- small building down in Atlanta, that's going to take us through 2000 -- it's -- that's going to be sometime late 2006. The building in Pittsburgh, that could be first half of 2006, maybe sooner. The other building in Atlanta -- I mean, the -- the building in Atlanta, the -- the -- the park that we bought down in Atlanta with the eight buildings, that has, it's 80 so -- it's 87% leased but we -- we're marketing the space today. It could -- it could -- it could be something between now -- it could be -- it could be very soon or it could take some time in 2006. The property that's going to take a little bit longer is that property down in Atlanta that we primarily bought because it's next to an existing building we owned that had -- has short fall parking. This building had excess parking. The tenant in the building next to it wa -- was -- was actually already subletting parking from this -- the owner of this building. We decided it was a good way maybe to make that tenant more comfortable and within our properties, so we decided to buy the building next to it and then we looked at what it could take to spend money on to try to get the occupancy up a little bit. It's -- we're going to have to spend the money through the first six months of next year.

Okay. Okay. That's -- that's fair enough. In terms of the --just your acquisition pipeline, can you characterize where -- where that is? Is it -- is it about same as it's been in terms of your outlook towards your acquisition pipeline, is -- is the outlook pretty much the same as it has been, is it better, is it a little worse? I -- it sounds like cap rates are firming to slightly rising in some markets from what you're saying.

That -- that's correct, Philip. I think they are firming to slightly rising in some markets. I would say our outlook for acquisitions has gotten a little bit more bullish in the sense that I think that -- the markets definitely -- we -- we're definitely having more serious discussions with more groups of people now than we were six months ago. There's no question about it, in -- in lots of different markets. And it's been characterized by -- to give you an anecdote, what's going on is, second, we're losing -- we would -- we've been lo -- we would lose a bid let's say three months ago, and we found in just the last month or two, properties coming back to us because they couldn't close with the buyer that had a lot -- a financing contingency. And what I think is going on is people that have been using a lot of -- a high amount of leverage with floating rate debt, they are -- they're unable to close so then they're coming back to buyers like HRPT which they know has a certainty of execution, even though our price will be lower, they know it's going to close. So that's sort of what's been happening. That's -- that -- that's sort of the -- the anecdotal infor -- , sort of what's been happening the last couple of months. That's what's giving us the sense that something must be changing out there. And just given the level of time -- now we're getting after the second round bid in some properties. We did -- we're even getting there six months ago. So, I think it is a little bit more bullish now than it was six months ago.

Okay. And last question. In terms of leasing costs, TIs in particular, certainly it looks -- they're -- they're ob -- they've obviously declined year-over-year, but can you tell us what costs you're still having to pay for, what's gone away, et cetera, specifically, just to characterize that for us to -- and how that's changed within your own portfolio with costs that you're not paying that you were a year ago?

Well, the things -- leasing commissions are pretty much the same. For most of our -- mo -- more the majority of the renewals we're still paying leasing commissions. The costs that are really coming -- changing are the TI dollars and it's -- and it's -- it's in markets like Wa -- southern California, Washington, D.C., there are no TI dollars in Oahu, Hawaii, so -- because it's land leases. So, generally I would be saying that it's -- it's -- it's basically TI dollars.And if you -- if you look at the average length of the leases we're signing, they have come down a little bit. It's more like six years now compared to maybe eight or nine years that you saw last year. But we -- we don't just look at gross dollars per square foot. We look at it -- internally we look at it at gross dollars per square foot per lease term to get a sense on an apple's to apple's basis. And what's encouraging is that's even coming down by about 30%, even though we're signing shorter team -- term leases. Now that's -- that's -- there's an offset there. I think they'd be coming down even further, but what's the offset is that construction costs are going up. And so to do the same build out -- the same finishes you would do let's say 18 months ago to do today can cost anywhere depending where you are in the country 10 to 30% more. So, if the constructions cost weren't going up, I think you'd see TI dollars even dropping further.

Okay. So, and -- and -- and really it -- it sounds like the southern California's -- you've seen TI dollars go to virtually zero and so there's --

They're not going to zero, they're just dropping.

They're just dropping considerably more than certainly other markets like Boston, Philly at this point.

That's correct. And even Austin still requires a lot of TI dollars. At least in up the portfolio but it still takes -- you still got to spend money to do it.

Sure. Sure. Okay, I thank you for the answers.

Thanks.

We'll go to the site of John Guinee with Legg Mason. Please go ahead your line is open.

Hi, guys. Can you hear me on this connection?

Yep, we can hear you.

Okay. Well, the market is -- is clearly not a 9-yield for institutional quality real estate, it's much closer to -- to 6 or 7. So you're taking some risks to execute the strategy. It's either a bad sublocation or a functionally challenged building or above-market rents or some hidden near-term expirations, but you simply can't buy at a 9 cap and acquire good institutional quality real estate in this market. Where -- what risks are you guys taking with this acquisition strategy?

John, I -- I-- I actually, I -- I disagree with our presumption that -- that it isn't institutional quality assets. And I'd be happy to show you some of these buildings that we're buying and show you the quality of the assets and that we're -- we're buying. These are markets -- Pittsburgh has been shunned by many -- of in -- by a lot of institutional buyers. Now this isn't in the downtown Pittsburgh market this is three miles west of downtown. And the Pittsburgh downtown market, even though there's been some acquisitions lately there that people would say are institution quality and they have been in the 7% rates, the downtown Pittsburgh market is not a good market to be buying into because it has a -- a city income tax and tenants are moving outside the city. This submarket that we're buying into, let's say I'm using Pittsburgh as an example, where we're three miles west of downtown. It has the strongest performing submarket, has good -- good demographics tends -- trends in terms of medium in -- household income in the immediate surrounding area.

And we're at places like Atlanta. Atlanta is a market that a lot of other institutional investors have been shunning. And I -- I -- I disagree with your presumption that these are not institutional-quality assets. I think a lot of other, may -- maybe some other reits are telling -- telling the market that you can't buy things at 9% caps because they're only willing to look downtown, but maybe in some of these markets downtown isn't the right place to be and so I don't think we're taking on an exorbitant amount of risk. Now, yes, are we -- are -- are these buildings 95% leased to the U.S. Government for ten years? No, they're not. But do they have -- are they at market rate rents? Yes. Do they -- are they good credit quality tenants that you'll see in those buildings? Yes.

Do they have shorter duration? I'd argue yes, they do have a shorter duration than we typically see, so we're taking a little bit more lease rollover risk, but not in terms of dollars, because we do a lot of diligence to make sure make sure that the rents are at market. It's more in the sense of , okay, this tenants going be up for renewal in three years, what do we think about the prospects of renewing him. If they're not here -- if they don't want to renew what do we thing we're going to be able to do in terms of leasing space here. I think -- I -- I just think that if you look and -- again if you look at where we bought this year, it's been Indianapolis, excluding the Hawaii acquisition we did in the second quarter, but it's been in Indianapolis, it's been in -- in Atlanta and it's been in Pittsburgh. These are -- people could argue these are third tier markets maybe or second tier markets. And they're not in the downtown areas but they are good solid class A buildings in the suburban markets and I think institutional investors for whatever reasons shun these markets.

Okay. Thank you.

Yep.

We'll go next to site of Steve Benyak with Merrill Lynch. Please go ahead your line is open.

Hi. Good afternoon, can you hear me?

Yeah, hi, Steve.

Hi. How you doing? A couple of questions. First of which, what markets do you see the cap rates rising the most, I guess, or not -- not declining anymore?

Well, sort of the markets I've been talking about. Like the second and third tier markets across the country.

But nothing in particular?

Yes, it's ba -- it's easy to characterize the markets that aren't seeing any increase in cap rates because it's still -- it's a very -- it's very fluid. In places like D.C., you're not seeing a rise in cap rates like southern California, you're not seeing a rise in cap rates, in New York City, obviously, you're not seeing it. In downtown Chicago or even downtown Boston, you're not seeing a rise in cap rates. But, even in some of the suburban markets around the Chicago, class A properties you're -- I think you're starting to see possibly a movement in -- in -- in cap rates in those markets. So, it's -- it's pretty -- it's market by market, but luckily given the size of our Company and the way we run it and the focus on diversity and -- and trying -- and trying to -- and operating in many different markets across the country, we do get to see a lot and I would say, anecdotally places like St. Louis and Kansas City and Indianapolis and Atlanta and Pittsburgh and -- and some other markets are -- in -- in some submarkets of those markets you're definitely seeing cap rates move.

Right. And then second. Given the recent weakness in the stock price since probably mid-September or so, what are your guy's views on repurchasing shares?

It's a good question. We -- we have bought shares back in the past, back in 2001, we did a share buyback program. It was modest, it was only about $30 million. but we have done them in the past. Typically, I agree with you, our stock price has definitely been -- has been hurt over the last six weeks, but, we'restill able to deploy capital and I think -- positive spreads where we're able to increase shareholder value. And it would really have to take -- it would have to be a twin storm of we can't put -- we can't find anything else to do with our money that we think would increase shareholder value, and at the same time it'd have to be a prolonged depression in the stock price and six weeks or whatever it has been is not -- is not long enough. And at the same time, I think we're still able to find places to put the money to work at positive spread. So, look, we -- we are not adverse to ever doing a stock buyback. We -- we've done it in the past, we'll do it again if the -- if the mar -- if we don't think we can do anything else with the money if the stock looks cheap in our eyes I guess is the way to say it.

Right. Is there a value at which it seems a better -- a better value to buy the stock back versus invest in certain markets? Or is that something you guys look at?

Sure -- I'm sure theoretically. There's a point in which that happens. I don't think we've hit there yet. It hasn't been there. Not only is it not there yet, but six weeks does not ma -- -- I know some people might think it does, but six weeks -- we're at $13 in September, and it's November and we're down $10.50 or so. So, it's not -- it hasn't been like this for a long time.

Okay. And then just finally, I guess the se -- in the sequential increase in TIs, is that -- is that partially due to the construction costs rising as well?

Yes, it's -- you're saying what we commit to or what we're actually spending?

Oh, I guess the -- the 14.43 versus what was last quarter, I believe at 9.11 or so.

Yes, that has -- yes, it's -- it has a little bit to do with -- if you look at the -- the renewals. It's more rene -- we -- we signed some renewals last quarter that had almost no TIs in them. That's really what you're seeing this. I think this -- I think this quarter is a little bit more normalized. Last quarter we had, if you look at our supplemental, 3 to 5 -- $3 to $4 in TIs for renewals, I that's pretty low and I think that's just more of an anomaly that we had last quarter.

Great. Thanks, Adam.

Once again, if you would like to ask a question today, please press star one on your touch-tone telephone. Again, that is star one if you'd like to ask a question. We'll go next to the site of Eduardo Aboush with Millennium Partners. Please go ahead, your line is open.

Hello, John, Adam. Quick two -- quick questions. First in terms of expenses, operating expenses a lot of companies have came out saying expenses are rising and that's one of the reasons next year they're -- they're seeing actually net -- net rents negative and not positive. Could you give us a sense of where do you see your utilities, insurance, all those costs going and kind of what percentage do you think you'll be able to recover through reimbursements?

Okay, let's see, u -- utilities make up roughly 20 -- 25% of total expenses for the portfolio. If you assumed a 30% increase in utilities, we -- we have a run rate of somewhere right around $70 million or a little over $2 per square foot portfolio-wise. Our recovery ratio is roughly 70% and that's mainly because a good portion of our portfolio is modified gross lease -- government leases. They don't pay a one for one, dollar for dollar increase in operating expenses. They pay based off a CPI adjusted base year amount. So, again, I think a 30% for the entire year may be a worse case scenario, but in either case -- in any case, if you assumed a 30% increase, you're really looking at probably less than a penny a share on a quarterly basis.

In term on -- in terms of wages and any other costs, are those under control?

Yes, wages are under control. Insurance is -- is definitely under control. I mean we -- we had a spike just like everybody else in 2001 and 2002, but we've been maintaining roughly $0.15 per square foot -- $0.15 per office square foot for the past two or three years.

Okay, thank you. And my last -- my last question maybe for Adam, just in referring to a previous question here in the call, do you guys have any sort of, like, internal implied cap rate on your -- on your stock when you're making decisions in term of what's better to buy?

Well, it's a good question, Eduardo. We lo -- we obviously look at our cost to capital, and as part of looking at our cost of capital we look at wha -- our -- the cost of our equity and we look at the cost of our debt and we think about how we're going to financing it -- finance it. And there's many different ways to looking at cost of equity, for a reit. You look at your dividends, you look at what your dividend payout ratio is. You look at -- you look at your FFO yield, you look at your AFFO or CAD yield, so there's many different things we look at. There are some general rules that we apply, but there are so many exceptions to those rules depending on the property and what we think maybe the growth prospects are or whether or not we think it adds a great amount of security or di -- or diversity to the portfolio that things may change or -- so -- I guess what I'm saying is I'm not willing to give -- tell you what -- I'm not willing to give you a hard fast number, but I'm willing to tell you that we definitely are very aware of our stock price, where it is in the calculation of our cost of equity.

Would you, in just ballpark, would you think that that implied a cap rate on your properties would be north of 8%? Ballpark.

I leave -- I -- I leave that to you to figure out what you think our implied cap rate or -- or what I might -- my people might consider our NAV to be. I -- we -- we don't give guidance or talk about sort of where we think the right cap rate is to apply to our property. We're more than happy -- we think we've done a great job, at least I hope you agree with us, to give you a lot of information about the Company to sort of make that assessment on your own in terms of location of every property, description of properties on our web site, a lot of information in the supplemental package. We don't -- we don't do it and we don't talk about it and we -- I --I -- I hope we give you guys enough data so you can figure out or make your own opinion.

Sure. Adam, will you eventually give guidance through Street?

It's not something with playing arou -- it's not something -- I'm never going to say never, but it's not something we're curr -- currently considering. No.

Perfect. Thank you very much, guys.

At this time, there are no further questions, and I'd like to turn the conference back over to Mr. Adam Portnoy, Executive Vice President.

Okay. Thank you for joining our third quarter conference call. We will be presenting at the Wachovia conference in New York in early December and we look forward to seeing you at this event or speaking with you on our fourth quarter and year-end conference call. Thank you, everyone.

Ladies and gentlemen, this does conclude today's conference. We thank you for your participation. You may now disconnect your lines.