Equity Commonwealth (EQC) 2011 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the CommonWealth REIT second-quarter earnings conference call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will be given at that time. (Operator Instructions) As a reminder, today's conference is being recorded.

And I would now like to turn the conference over to our first speaker, Vice President of Investor Relations, Mr. Tim Bonang. Please go ahead.

Thank you. Joining me on today's call are Adam Portnoy, President and Managing Trustee, and John Popeo, Chief Financial Officer. The agenda for today's call includes a presentation by Management, followed by a question-and-answer session. I would also note that the recording and retransmission of today's conference call is strictly prohibited without prior written consent of CommonWealth.

Before I 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 other Securities laws. These forward-looking statements are based on CommonWealth's present beliefs and expectations as of today, August 3, 2011. The Company undertakes no obligation to revise or publicly release the results of any revisions to the forward-looking statements made in today's conference call other than through filings with the Securities and Exchange Commission, or SEC, regarding this reporting period.

In addition, this call may contain non-GAAP numbers including funds from operations, or FFO, normalized FFO, and cash available for distribution, or CAD. A reconciliation of FFO, normalized FFO and CAD to net income is available in the supplemental package found in the Investor Relations section of the Company's website.

Actual results may differ materially from those projected in any forward-looking statements. Additional information concerning factors that could cause those differences is contained in our Form 10-Q, which we expect to file in a few days with the SEC, and in our Q2 supplemental operating and financial data package found on our website at www.cwhreit.com. Investors are cautioned not to place undue reliance upon any forward-looking statements. And now, I would like to turn the call over to Adam Portnoy.

Thank you, Tim. Good afternoon and thank you for joining us on today's call.

For the second quarter of 2011, we are reporting fully diluted normalized FFO of $0.91 per share compared to $0.92 per share during the same period last year. The decline in normalized FFO per share primarily reflects a decline in consolidated same-store occupancy and NOI during the quarter. As of June 30, our consolidated occupancy rate was 87.5%, which is flat with the occupancy rate we reported at the end of last quarter. As we've stated on previous earnings calls, we continue to believe that our consolidated occupancy rate for year-end 2011 may remain flat with what we reported at year end 2002-- 2010, excuse me, which is 87.7%.

During the quarter, we signed leases for almost 1.3 million square feet. 56% of our second quarter leasing activity were renewals and 44% were new leases. Leasing activity this quarter resulted in a 2% roll up in rents and $15.71 per square foot in capital commitments. The average lease term was 6.2 years, and the average capital commitment per lease year was $2.53. Capital commitments per square foot this quarter were higher than in recent historical averages because of the higher percentages of new leases versus renewals in the second quarter particularly in major market CBD locations.

For the 3 months ended June 30, 2011 about 37% of our consolidated NOI came from 40 CBD office buildings, and about 42% of our NOI came from 279 suburban office buildings, and about 21% of our NOI came from 180 industrial and other properties. Also about 43% of our consolidated NOI comes from 6 major market areas -- which include Philadelphia; Oahu, Hawaii; Denver; Chicago; Australia and Washington D.C. The remaining 57% of the NOI comes from close to 60 individual market areas located across the United States.

Overall, our CBD office properties are performing better than our suburban office and industrial properties. For example, during the second quarter, same-store occupancy for our CBD office properties increased 10 basis points and same-store NOI increased by 2.2%. Suburban office properties experienced same-store occupancy declines of 200 basis points and same-store NOI declined by 10.1%. Industrial and other properties experienced same-store occupancy declines of 160 basis points and same-store NOI declined by 9.6%. Also, all 6 of our major market areas are performing well, with roughly flat to increasing same-store occupancy and NOI in each of our major market areas. The general area of weakness in our portfolio continues to be our suburban office and non-Hawaii industrial properties. And these properties largely contributed to the decline in consolidated same-store occupancy by 130 basis points to 86.7% and the 5.8% decline in consolidated same-store NOI.

As of June 30, we have 3.6 million square feet scheduled to expire during the remainder of 2011. On average, the leases scheduled to expire through year end have in-place rents that are around 1% below market. Nevertheless, we continue to expect that same-store NOI may decline further until the economy begins to show sustainable growth and the unemployment rate starts to decline significantly.

In part because of the strength of our CBD office properties, the focus of our acquisition activities over the last couple of years has been on CBD office buildings, and we have been largely buying these CBD office buildings at well below replacement cost. For example, in May 2011, we acquired a 1.1 million square foot office tower in downtown Chicago for $162.2 million, or about $152 per square foot. This property is currently 85.4% leased to 60 tenants for a weighted average lease term of 6.6 years, and the going in cap rate was 9.2%. Also, in July 2011, we acquired a 515,000 square foot office tower in downtown Birmingham, Alabama for $68.5 million, or $133 per square foot. This property is currently 76% leased to 14 tenants for a weighted average lease term of 8.7 years, and the going in cap rate was 9.7%.

We also currently have 4 CBD office buildings with about 2.9 million square feet under agreement to purchase for a combined total purchase price of approximately $531 million. We are currently subject to an agreement to acquire 2 office buildings located in downtown Chicago with a combined 1.6 million square feet for $390 million, which includes the assumption of $265 million of mortgage debt. These properties are 97% leased to 49 tenants for a weighted average lease term of 8.4 years. We expect to acquire these properties during the third quarter, pending the assumption of the existing mortgage debt.

As of today, we also have 1 property located in downtown Portland, Oregon, with about 107,000 square feet under agreement to purchase for approximately $34.1 million. This property is 100% triple net leased to 1 tenant for about 11 years. We expect to acquire this property during the third quarter. In addition, we have 1 property located in downtown New Orleans with about 1.3 million square feet under agreement to purchase for approximately $107 million. This property is 88% leased to 61 tenants for a weighted average lease term of about 5 years. We also expect to acquire this property during the third quarter. Of course, all these pending acquisitions are subject to customary closing conditions and no assurance can be given that they will occur.

We also currently have 27 non-core office and industrial properties listed for sale with third-party brokers. All these properties are older suburban properties located in tertiary markets with high vacancy rates. We continue to work toward selling these properties and hope to sell the majority of them prior to year end 2011.

Before turning the call over to John Popeo, I would like to discuss some of our recent financing activities. In June 2011, we issued 11 million shares of series E preferred stock, which carry an annual dividend rate of 7.25%. And in July 2011 we issued 11.5 million common shares at $24 per share, raising the combined net proceeds of approximately $530 million. Since the beginning of 2008, CommonWealth has acquired $2.8 billion worth of properties, and the majority of these acquisitions have been CBD office properties. We have partially funded these acquisitions to the sale of $1.4 billion of largely suburban office properties. And the remainder of these acquisitions have been funded through a combination of both equity and debt financings.

Although our recent financings have been expensive, we believe that they were necessary because of recent uncertainties in the capital markets and because they were financing the transformation of CommonWealth into a higher quality portfolio of properties, which would benefit all stakeholders in the Company in the long term. I will now turn the call over to John Popeo, our CFO.

Thank you, Adam.

Looking first to the income statement, rental income increased by 13.5% reflecting rental income from properties acquired since April 2010, offset by the $6 million decline in same-store rents and 15 properties sold between June and September 2010. Total expenses declined by 1.6%, primarily reflecting $21.5 million of impairment losses recognized in the prior year. The 22% increase in general and administrative expense reflects property acquisitions and sales activities. Current quarter EBITDA increased by 4.9%. Interest expense increased by 8%, reflecting the issuance of $250 million of 5.875% unsecured senior notes in September 2010, and a 5-year term loan for $400 million entered in December 2010, carrying interest at LIBOR plus 200 basis points.

These financing activities were offset by the prepayment of $182.4 million of mortgage debt in August 2010, the repayment of $50 million of senior notes in August and October 2010, the repayment of the $168 million of floating rate notes in March 2011, and the repayment of $29.2 million of 7.4% mortgage debt in June 2011.

Since its IPO in June 2009, our investment in GOV has been accounted for using the equity method of accounting. Under the equity method, we record our percentage share of net earnings and normalized FFO of GOV in our financial statements. Our percentage share of GOVs net income and normalized FFO for the second quarter totaled $2.9 million and $5.2 million respectively. We received over $4 million in GOV dividends during the second quarter of 2011. The $1 million of losses from discontinued operations reflects operating results from 7 office properties and 20 industrial properties classified as held for sale as of the end of the second quarter.

Net income available for common shareholders for the second quarter of 2011 was $9.1 million compared to a net loss of $2.7 million for the second quarter of 2010. Normalized diluted FFO available for common shareholders was $0.91 per share for the second quarter of 2011 compared to $0.92 per share for the second quarter of 2010. Year-over-year per share results primarily reflect the decline in occupancy and the issuance of new common shares in 2010. In July 2011, we declared a dividend of $0.50 per share which represents 55% of our second-quarter normalized FFO. This dividend is expected to be paid on August 25.

During the quarter, we spent $21 million on tenant improvements in leasing costs, and $3.7 million, or $0.05 per square foot, for recurring building improvements. We paid $7.9 million on development and redevelopment activities during the quarter. We generated approximately $38 million of cash available for distribution, or CAD, during the second quarter resulting in a CAD payout ratio of 95%. Including the recently completed preferred stock and common stock offerings, we continue to believe that our CAD payout ratio will be below 100% for the full year 2011.

Turning to the balance sheet. On June 30, we held $55 million of unrestricted cash. Rents receivable includes approximately $179 million of accumulated straight line rent accruals, as of June 30. Other assets include approximately $102 million of capitalized leasing and financing costs. As Adam mentioned, in June we issued 11 million 7.25% series E preferred shares, raising net proceeds of approximately $266 million. And in July we issued 11.5 million new common shares, raising net proceeds of approximately $264 million. We used the net proceeds from both offerings to repay amounts outstanding on our revolving credit facility and to fund acquisitions.

In June, we repaid at maturity $29.2 million of 7.4% mortgage debt. And in July, we prepaid $23.2 million of 8.05% mortgage debt due in 2012. On June 30, we had $630 million of floating rate debt, $382 million of mortgage debt and $2.3 billion of fixed rate senior unsecured notes outstanding. The weighted average contractual interest rate on all of our debt was around 5.5% at the end of the quarter, and the weighted average maturity was around 5 years. Our senior unsecured notes are rated BAA2 by Moody's and BBB by Standard & Poor's. The un-depreciated book value of our unencumbered property pool totaled about $7 billion at the end of the quarter. Our secured debt represents 6% of total assets and our floating rate debt represents 19% of total debt. At the end of the second quarter, our ratio of debt-to-book capitalization was 49%. Our EBITDA and fixed charge coverage ratios were 2.6 times and 2.1 times, respectively.

As of the end of the quarter, we were comfortably within the requirements of our public debt and revolver covenants. As of June 30, we had nothing outstanding on our credit facility, and as of today, we have $40 million outstanding. Amounts outstanding on our credit facility are projected to be approximately $300 million assuming we close all pending acquisitions.

In summary, this quarter produced results we expected in light of a challenging market environment. Our strong balance sheet, solid annual dividend payout ratio and $710 million of availability on our revolving credit facility position us to opportunistically grow cash flow.

That concludes our prepared remarks, Operator, we are now ready to take questions.

(Operator Instructions). Mitch Germain with JMP Securities.

Sorry about that. Just curious about the asset sales. We didn't see any progress this quarter. Adam, where do we stand on that?

The asset sales continued to progress. We don't normally report when something goes under purchase and sale, just because we didn't report anything just means we haven't signed the purchase and sale agreement regarding anything.

But that doesn't mean that we don't have letters of intent or aren't in active discussions with parties. I do think we will sell the majority, if not the majority, half the properties by year end. I just don't think we're in position to have any things under contract to report anything as of the quarter end or as of today.

How would you characterize the pricing or the bidding that you're seeing on the properties relative to your original expectations?

They are coming in -- we are seeing 10% of our expectations. That's about the right way to answer it.

Great. And the Chicago acquisition, I know it's been in the doing for awhile, is this [tax] related issues that's delaying it?

Yes that's all it is. We actually expect to close on it within the month of August. And we don't really foresee any issues. I expect we'll close on it once we get through the mortgage assumption process, which is well underway.

And then, just last question with regards to your deal pipeline. You keep on cautioning that acquisition activity will slow, yet it's been pretty substantial year to date. How would you characterize the properties right now that are being underwritten for new acquisitions?

Well, again, keep in mind of the $530 million we say we have under contract only about 100-- well I guess about $140 million of it's new because $390 million of it relates to the acquisition of Chicago, which you've just pointed out, has been pending for a couple of quarters now. I think it's fair to say we have been slowing down, it's just that a lot of stuff has been closing.

We announce things when we put it under agreement and we also announce it when we close it. I hope people aren't double counting our acquisition activity. But there's only basically 2 buildings that are new. We mentioned in Portland, Oregon for about $30 million, and the building in New Orleans, which is new.

So, acquisition activity I think it's fair to say is slowing down. I can tell you that it's very focused on CBD office buildings. That's principally the only thing we are looking at anymore. And I can't tell you exactly where acquisition activity is going by the end of year, but I think it's safe to say that this is a good segway into what we've been doing in terms of refocusing the Company on CBD office properties.

You just look at the results for the quarter, I mean if we hadn't engaged or bought many of these CBD office properties over the last 2, 3 years I think our results would be looking worse than they reported today. I think our results today are actually fairly positive, given the expectations from Wall Street.

I think we are going to continue to try to look at CBD office buildings, but I think it's fair to say the pace is slowing and we'll see where the market goes. I mean, we've had what 8, 9 days of the Dow going down. I mean if this continues for the foreseeable future, it's going to be hard to imagine much transaction volume at all occurring, not just here, but among most companies.

Great. And just actually I had 1 more question for John. In terms of pricing for unsecured, what could we expect if you went to the market today for an index sized deal?

That's a good question. I mean our hope is at least below 6%, maybe even around 5%.

John Guinee with Stifel.

Hi. We've been covering you guys for a long time and while you were giving your introduction, I look back at 2004 to get a good sense on the last 7 years. 2004, on a split adjusted basis, the stock was $51.50, it's $21.75 now. That's a 58% drop. Dividend got cut from $3.36 to $2. That's a 40% drop. And FFO went from $4.88 to $3.64. That's about a 25% drop. What kind of comfort can you give us that you've got it right on this go around?

Well, John, as you know you're talking about a period of time especially in the last few years where many office REITs have had a difficult time. We're not the only REIT that had to cut it's dividend a few years ago. And we're certainly not the only REIT that it's stock is below where was in the mid-2000s.

But that all being said, I think the result -- I think when you say are we getting it right this time, I think the results are starting to prove themselves out. I mean, I think -- we made a point in our prepared remarks to really spell out where -- what comprises the portfolio.

The amount of CBD office properties has doubled over the last few years and it is largely contributing to any of the growth that we're experiencing in the Company. The NOI growth on a same-store basis was positive 2.2% on our CBD properties. Our same-store occupancy was up. Most people think of us as a suburban office REIT, and I can't criticize them for that because we're still -- the plurality of our properties are suburban office.

But my goal over the next foreseeable future is to try to get the Company to be -- I'd like it to be over 50% CBD office properties, if I could get it there. We may not be able to, given just the cost of financing and the market generally, but I think it is helping.

If we do not engage in the activities that we have engaged in, in the last 2 to 3 years, I think it's fair to say that our results, I can't comment on the stock price, but certainly our FFO and our occupancy, and many of the metrics that people use to value the Company, would be coming in much worse than where they are today if we had not sold many of those suburban properties and bought the CBD properties. So, I think it's-- I think that's the best proof to say that we got it right is to look at the short and medium term results which are starting to show up in our numbers.

Okay. So, it looks like you're on track to acquire another $531 million worth of assets against assets for sale of maybe $100 million, how should we model in coming back to the preferred market or coming back for common equity? And how should we factor in the fact that the last equity offering was at, I think, what, $23 or something.

$24.

$24, $23 net which is sort of a high, 9/8 implied cap. So, anything you're-- when you're investing this money you're doing it on a diluted basis. So, 2 questions. How should we factor in your next equity offering or your next preferred offering? And how should we rationalize that these things continue to be dilutive?

Well, John, these are all good questions. Look we knew when we engaged in that equity offering earlier in July, it was going to be an expensive equity offering, and at the same time, as John reported in his remarks, we still think even though it was a dilutive, our payout ratio is still going to be below 100% for 2011. I think you had to keep that in mind, as well as in the context of the idea that we're trying to transform the Company and buy higher quality assets, which is resulting in better performance or better results for the Company.

Now going forward, how are we going to continue to finance these acquisitions? I think it's fair to say, and we've been talking about it for a couple of quarters, we have a couple options in our tool chest. We could sell assets, we could sell our shares in Gov, which I consider may be selling assets or we could go back to the equity markets or debt markets or preferred markets.

We've now tapped the preferreds, we've now tapped the equity. I think it's fair to say that maybe the first thing on our list of things to do is to think about maybe monetizing some of our investments or assets that we have to help us finance some of the acquisitions we want to do. That, or acquisitions are going to slow down greatly.

Because at some point, as you point out, I don't want to just keep issuing equity that's dilutive. That's not I come to work to do, it's not what I want to do, I don't think it helps -- it's very painful to do and we knew this equity deal that we did in July was going to be painful. But, again, we had to weigh it versus what we were going to gain by doing it from the Company long-term.

And would answer your question directly, how do you model growth going forward. It would be very hard for us to do another very large equity deal today based on where we're buying properties at and our pay out ratio would not go through 100% on a stable state basis, and I think that's a governor for us.

You know how all these Republican Presidential candidates are signing no tax increase pledges? Will you sign a no dilutive equity offering pledge?

No, John, I won't. But--

We thought so.

But, I'm telling you that I'm not-- I mean the math is what the math is. If I do -- I can't do dilutive equity deals continuously, I know that. If I do that, it will destroy shareholder value. I did the deal in July because I felt we needed to.

I also felt and I happen-- I think we proved right, I thought we were going into a period of maybe a lot of instability in the marketplace, which I think has actually proved out to be correct, and were able to actually get into the market, raise the money. We won the last equity deal done in the REIT space there certainly hasn't been much activity in the REIT space in the last couple of weeks in terms of raising equity and there may not be for some time.

And so in hindsight, to be honest with you, I'm actually happy we got it done because it had to be part of the financing to transform the Company. We had to do some equity as part of this. And we delayed it for a long time and we talked about it for a long time, but eventually it had to be part of the equation.

And I think going forward, the math simply stalls out itself. It would be very hard for us to do another dilutive equity deal, because suddenly you put pressure on the dividend and obviously that's a governor for us.

Okay, thanks.

(Operator Instructions) Dave Rodgers with RBC Capital Markets.

Hello, Adam, through the sales of the existing assets that you own currently and the acquisition of the CBD properties, have you revised or do you have a number in mind in terms of what type of long-term core NOI growth you'd like to see. I.e., what's the difference between what you're selling and buying on a basis point spread calculation?

Well, right now most-- again the stuff we've got up for sale today, the stuff that's up for sale today, is stuff that largely is vacant or has very little occupancy, so the cap rates don't mean much. They're meaningless, they're not calculable. It's really a price per square foot. The buildings we have sold in the last few years, the $1.4 billion, John do you--?

The original $562 million that we sold back in 2008 was at around a 7.1% cap rate, the 2010 sales were at around 8.7%, and then later on in 2010, another batch of properties, $470 million, was right around 8.4%.

So, you can see the stuff that's occupied, it's operating properties. When you sell those there is a cap rate spread, where basically it's about 100 basis points versus what we're selling versus what we're buying.

Maybe I can ask a different way, so you're picking up yield on the trade, but I guess, what do you think you're picking up in terms of long-term same-store NOI growth?

Well, I think we are picking up a ton. I mean I think again I'll point again to the second quarter numbers. Second quarter numbers are CBD office properties, increased same-store NOI by 2.2%. Suburban office properties we owned, declined by 10% same-store.

So, we are focused on the properties, the CBD core office properties which we think long term are going to provide a lot more growth in our cash flows throughout different cycles, business cycles. And so, I think we are improving the quality of the portfolio going forward simply on the type of properties we're buying versus the type of properties we're selling.

And with respect to the acquisitions that you discussed earlier, you said you expected the pace to slowdown. Just to get a little more clarity, was that related more to the capital raising that John mentioned or related to the opportunities?

And I guess if it's to the opportunities, yesterday Gov had obviously mentioned maybe seeing an accelerated pace of acquisitions coming to market. If you're seeing a slowdown, what's driving that? I would think the uncertainty might actually take that higher as opposed to take that lower.

Is it just that most of the deals you were closing more distressed debt deals? Maybe the sellers are now out of the market? Can you give some color around why that slowdown may occur on a market wide basis?

The slowdown I think is more specific to CommonWealth than versus the market. We are being incredibly choosy and picky in terms of what we are willing to put under contract. There is not a slowdown in the number of properties that are being offered for sale. There are many.

In fact, I think it has been picking up over the last couple quarters, it continues to be very robust. There's no end of properties to evaluate. I just think that we're being exceptionally picky in terms of what we are deciding to put under contract.

And it partly relates to our capital structure and our cost of capital. We're trying to transform the Company, but we cannot be blind to the fact that we have a very high cost of equity. And so, we have to be very choosy in what we're picking -- what we're deciding to put under contract.

Finally, in your discussions regarding leasing with decision-makers across your portfolio, have you seen any major trend either pick up or slow down since, let's say 6 or 12 months ago? Do you feel any better or worse or do you felt pretty much the same?

I think it's pretty universal that in the last 6 months, things have pretty much stayed stable. I mean, there's maybe a little bit of improvement across the country, a little bit of backing up in concessions, a little bit in the form of free rent. If we look across our entire portfolio, things may-- it might be safe to say that things are getting slightly, albeit slightly, better across the portfolio in terms of our position, our negotiating position with tenants. But, I think it's also fair to say that it's basically been flat for the last 6 months. And I think it's also safe to say that it's not getting any worse, either.

Thank you.

Jamie Feldman with Bank of America Merrill Lynch.

Great, thank you. Can you talk a little bit about your underwriting assumptions on some of the buildings you bought lately? Especially the ones that have the larger vacancy, what you're thinking in terms of lease up and cost to spend to get those leased up?

Sure. I guess the 1 building we have any vacancy, and I think you're referring to is the Birmingham, Alabama building is that right, Jamie?

Correct.

Yes, well that building, it's leased for an average of 8.7 years, it's-- many people my call at the Wells Fargo building, it's got its name plate on the building in Birmingham. We made specific assumptions, we took market rents and we took market TI packages. And market rents, I don't have it at my fingertips.

But I can tell you that's the way we underwrote it, the way we look at all of our underwriting, we do both a 5 and 10 year analysis and we run all sorts of scenarios in terms of how long we think it's going to take to lease it up and what it's going to cost to lease it up and what type of confessions we're going to have to run. And we do an IRR analysis, we do a cap rate analysis and we do a replacement cost analysis.

And we do the IRR analysis both on a levered and an unlevered basis and we look at all these things. And so, that's basically how we do our underwriting. It is pretty rigorous underwriting process we go through. And we do it twice. We do it when we initially put it under contract, is a very rigorous process. And then we do our diligence and then we learn a lot of stuff in diligence and we change all of our assumptions based on what we learned in diligence.

And I would say 10%, 20% of the time we end up asking for significant price changes or we end up just not closing on the deal because we have to change our assumptions so dramatically that the economics don't pan out. And so, that's the process by which we go under.

I mean, specifically with that building, keep in mind it's 76% occupied, we bought it at $133 per square foot. I think I'm safe in saying that's well below replacement cost and the existing, in place cap rate on just 76% leased is 9.7%. So, that's how --

So, you basically-- but across your acquisitions you pretty much assume market rents stay flat?

Yes, we say-- yes. I mean specifics on how Argus works, I mean you basically-- there are inflation factors you can put in based on, let's say if a lease rolls over in 8 years from now, guess market rents are flat but they might be growing at 1%, 1.5% or something depending on the assumption you put in the model.

Okay. And then I know you mentioned a little bit about the new dispositions. Can you give us a little more color on the types of buyers that are out there looking for the kind of assets you're selling?

The stuff that's for sale, that we have for sale, it's mostly local developers, people that are trying to think about repositioning the property. It's also owner occupiers, people that are going to buy the building and occupy it themselves.

Okay. Do you sense you'll need to provide financing?

I think financing might need to be provided in a few cases. I don't think all, but in a few.

Okay. And then certainly the market suggesting we're heading towards weaker times ahead. How do you think your portfolio reacts if we to head towards a double dip, or at least kind of much slower GDP growth here from where we're-- what the market -- what we were all thinking recently?

I think our portfolio reacts similar to most of our competitors in the market, generally. I mean I think it will be a tough slug for all office REITs in that environment, if the economy really does go into a double dip. I don't know how else to react.

I guess in terms of the different -- I mean, do you see CBD slowing down more? Do see warehouse versus suburban?

From everything we see, and we've been in the business about 25 years. We have owned CBD properties for a good portion of that time. We've owned suburban office properties for a good portion of that time, we've done a tremendous amount of analysis around this just on our own portfolios, as well as reading a lot of outside research about it and talking with a lot of people and just our own experience personally dealing with it.

CBD office has held up better, and we would expect it to hold up better in a downturn than the suburban office product. Of course, there are times in any business cycles where people want to leave the CBD and they want to be out in the suburbs.

I mean I can give you a good example, there are certain markets for example today, right now, in San Diego, it's 1 of the few markets that I think you might be better off in the suburbs than you are in the CBD. So there are examples where that's the case.

But overall, when you look at the entire country, if you generally own the number 1 or number 2 office tower in a market, regardless of that market, you generally fair well in both good times and you do better than most in bad times. And so I-- that's again, why I've been so focused on-- over the last few years on trying to acquire CBD office properties. And as you can see, we virtually have shut down the acquisitions of suburban and primary focused where we are selling, it's always been on suburban office.

Okay, thank you.

Yes.

Michael Bilerman with Citi.

Good afternoon, Josh Attie is on the phone with me as well. Adam, when you think about the dispositions that you've done, I think you said $1.4 billion the last few years, what percentage of that went to RMR related entities, my thought it was almost 90%, 95%?

About, that's about right. About 90%, yes.

And as you think about the suburban office, your-- put your RMR hat on for a second, I guess you're saying that's a product type that you don't want to own anywhere? You don't want it within the RMR entity.

Well, no, let me say it to you a little differently. We-- for a long time in CommonWealth, we owned at the very, very large MOB portfolio and we owned a very, very large government lease portfolio. And for some-- and in that product type I think it is quite often that you'll find in suburban, you'll find it suburban office, or it's suburban locations.

For those 2 product types, I think it makes a lot of sense to be in the suburban area, we are just not buying or owning that type of product in CommonWealth any more. If I were to own suburban government leased building or suburban MOBs, medical office buildings, I think that's still a very worthwhile investment.

But that's a very tenant specific type of product versus, I think, location type of product, it's not general office. And so for many years, we had of those 2 large portfolios sitting in CommonWealth or what was used to be known as HRPT, and people didn't give us any credit for it. They just hey, you're a suburban office REIT and generally we don't-- the market didn't like suburban office REITs.

And it was-- we told them-- we kept trying to tell people well, the truth is we have these huge portfolios of MOBs and government leased properties that are really worth more than what you are giving us value for as a suburban office REIT, and so they made a lot more sense to be in vehicles that are focused on that product type. And the market, I think, is appropriately valued them in those vehicles for what they are.

And so that's -- I mean that's a long way of answering your question but yes, when I talk about general multi-tenant office buildings, I'm pretty negative on it. If you're talking about buildings that the majority are single tenant leased, or single tenant buildings that are MOBs, or government leased buildings, I think I have a very different opinion.

So, the thought process is, you are not going to entertain -- we're not going to-- 2 weeks find out that you're going to split CommonWealth into 2 CommonWealth suburban, CommonWealth CBD. Your focus to grow out of the negativity that the suburban assets that are weighing you down is 1, to keep on acquiring CBDs so it lowers the percentage. And 2, to sell outright to third parties the suburban product. We should not expect a trade to another RMR entity?

That is the current focus, yes. I have to caveat this 1 -- 1 caveat which is that we still own -- we don't own any properties that are leased to government tenants left in CommonWealth. There are still properties that are MOB properties, they're still subject to right of first refusal they technically could go to S&H

Right, but you're done and how much does that make up at this point?

I am sorry, what?

How much does that make up at this point, what's left?

I think it is 15 properties, around there.

With the value of rough--

Roughly $200 million.

All right, so then the-- so we should be done at this point, outside of those out assets, with other trades to other RMR entities? We should not expect to have any other transactions, spin off, sales at all?

I'm not currently planning anything, Michael. But, I can't tell you for the rest of the existence of CommonWealth that we won't decide to do something with it. I mean, or change -- or do a spinoff or do something. I have no plans to do anything like that, and I'm not anticipating it, but I don't want to go on record saying I'm never going to do it.

Well I'm just trying to piece together. I mean, you're talking pretty negatively about the suburban product and you keep on referencing the-- when you look how bad the results were in the quarter in the suburban product, it's down 11%, we don't want to own it.

I don't want to find out 6 months from now we get -- the way to enhance the value, the perceived value of CWH, is to split out the suburban product and give it its own focus. Which clearly 1 of the markets frustrations, as you know, is that nothing is leaving the overall RMR entities, so I'm just trying to put all that stuff together.

There is no -- yes, there's no plans to currently take the suburban office product and spin it on. Not to bring up totally unrelated real estate company, what General Growth is for example, and try to talk to you about doing this B class malls, to spin that out, there's no plan to do something like that with our suburban office properties, no.

And then if you think about the payout ratio and you're sort of teetering on 100%, I think with our CapEx numbers it's even a little bit above, and you think about the same-store continuing to decline and the capital needs that you have, the CapEx in the quarter was elevated, how comfortable do you feel about keeping that payout ratio below 100%? Because you start adding everything up, it seems that you may-- well a year from now all else being equal, you may eclipse it?

Well, I'm okay -- I think where you're getting is the heart of-- how secure is the dividend. And I think the dividend is very secure. I think there is a good chance that we might go above 100% payout ratio and we might go up above it for a period of time. But I would-- I think the only reason that would happen is because if we're starting to lease up or gain occupancy across the board, or significantly start to grow occupancy. And so, I would see that as a-- as something that's a good thing overall for the Company. It might be a short-term spike in, let's say, the payout ratio, but I would see that as a temporary thing. I would not -- I do not imagine that would be a long-term thing.

And so, if that happens, let's say for example in 2012, if our occupancy starts growing and growing nicely at a good clip, I think it's a good chance our payout ratio will go over 100%. But I would not be alarmed by that and I don't think it would mean our dividend would be in jeopardy.

I think I'd be more alarmed if my occupancy were saying flat. It's consistently running well above the 100% payout ratio. Then I think it's a legitimate question to ask, is the dividend sustainable. But we're not there today. By our calculations, what we report in our public filings, we're currently at 95% payout ratio and we kept occupancy basically flat.

Right. Yes, but you think about the decline in the dividend back in 2000, late 2008, you should have had-- you've effectively gone and rebuilt back up and you should have enough room to grow back into the dividend. Maybe I just want to get some on the lease expiration schedule page 29 of the sup.

And just going back to suburban office, you've got about 25% of the rents rolling the next -- obviously the back half of this year 10% and then 16% in 2012. What's your expectation of where those rents are relative to market? They seem pretty elevated right now.

Yes, across the portfolio, mark to market, our rents are about 2.5%, 3% above market. Specifically in 2011 what's left to expire, we're actually a little bit below market. If you mark-to-market the entire probably of what's expiring in 2011, we're about 1% below market. If you look at the entire Company, everything expiring for-- every lease in the entire Company, we're about 2% or 3% above market.

And then I echo John Guinee's point as well on the equity, the more equity you issue at a huge cost is obviously-- I guess that's 1 way to narrow any perceived discount, but it clearly-- it's difficult, right? It's very hard in a position that you're in to have -- to create that value when you have to come back to the market and issue equity at such an expensive price?

I agree with you and I think it's why we wrestled with what we had to do for many, many quarters. I think people were asking us about an equity deal for the last 3, 4 quarters and we worked long and hard trying to get the stock price up so it would be less expensive.

Okay, thank you.

Steve Swett with Morgan Keegan.

Thanks. Adam, can you just update me on your thoughts on Australia and how that fits into your plans to sort of shift around the portfolio?

Sure. As you can see, we haven't bought anything in Australia in many months. I think it's safe to say that we're not actively looking for many new investments there and it is a market that we started thinking about whether or not it makes sense to sell some of our assets down there, just given where currency markets are and given the strength of that economy.

It might make sense, I'm not saying we are going to do, it might make sense. I think about selling some of the holdings down there as we think about that market. But, we're not currently focused on growing the portfolio down there.

Is John still down there?

John Mannix is still down there, yes.

Okay. And then the last question, on the acquisitions that you've completed and are pending, can you just kind of give me a general sense of the difference between the GAAP yields and the cash yields?

Sure. Overall-- let me-- this might be a good way of answering the question. For everything we have bought since the beginning of 2011, our cash yields are roughly 70 basis points below, on average, what we have reported on a GAAP basis. Some of that is less than 70, some of it's more, but on average it's 70 basis points less than what we've reported on a GAAP cap rate.

Okay, thanks.

Yes.

Mitch Germain with JMP Securities.

Adam, a couple of your peers have been clearly stepping up their disposition efforts, and I know you referenced that the transaction markets were pretty robust. I don't know, you've got 27 out of 400 something assets for sale. I mean could we see -- or would you entertain possibly starting to sell some more of your core suburban assets rather than the nonperforming ones?

Yes, that is something that is on the table and we're considering. And in answering Steve Swett's question just prior to this 1 I mentioned that something that's on the table we're thinking about it. So, not all, but maybe some of the assets in Australia. Okay.

Jamie Feldman with Bank of America Merrill Lynch.

Thanks. Adam, you had mentioned thinking about Gov shares as a source of capital. Can you just talk about where that falls into your priorities when you think about your other capital sources?

And then, if you were to sell those off, do you think it would be -- how you would do it, what the process would be? Would it be into the open market or a block trade?

The second part of your questions, I think it's pretty simple we would-- it would likely be a block trade, is how we think about it. And we may not sell, if we did it, we may not sell the whole -- our whole holdings at 1 time.

Where it fits in my priorities, I think we're-- right now where we are thinking about things is, probably we're thinking about generally asset sales and-- if we want to continue to grow. Again, 1 option is we just don't continue to buy anything or we slow down the pace significantly. If we continue to grow significantly, I think that what's on top of the list is asset sales. And when I say asset sales, I guess it's equal between selling shares at Gov or we would think about property sales.

But, again, if we did sell shares in Gov, it would probably be a block trade, it would be through an investment bank and it would likely -- and I'm not even sure we'd sell everything all at once. It right be small-- we might do a small amount or we might decide to look first to selling some properties first and then think about the Gov shares.

But by now-- where the markets are today obviously, I would not be very-- I'm not too enthusiastic about selling. Right today, where the market is, I'd probably be looking to sell assets, meaning properties, before I'd sell the Gov shares.

So, I guess the question is given your strategy to grow in CBD, would you prefer to own Gov shares or more CBD assets?

That's a good -- I guess more CBD assets if I had-- but I'm not sure that choice is mutually exclusive. I think I can maybe do both is what I'm trying to say.

Okay. All right, thank you.

Yes.

And it does appear there are no further questions in queue. At this time, I would like to turn the conference over to our host, Adam Portnoy. Please go ahead, sir.

Thank you all for joining us on our second-quarter conference call.

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