Equity Commonwealth (EQC) 2012 Q3 法說會逐字稿

Good day, and welcome to the CommonWealth REIT third quarter 2012 financial results conference call. This call is being recorded at this time for opening remarks and introductions. I would like to turn the conference over to the Vice President of Investor Relations, Mr. Tim Bonang. Please go ahead, sir.

Thank you. And thank you for joining us at an earlier time than originally contemplated. 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. We would also note that the recording and retransmission of today's conference call is strictly prohibited without of prior written consent of CommonWealth REIT.

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 other securities laws. These forward-looking statements are based on CommonWealth's present beliefs and expectations as of today, November 7, 2012. 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, 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 our 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 shortly with the SEC, and in our Q3 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.

Thank you, Tim, and good morning, and thank you for everybody for joining us on today's call. For the third quarter of 2012, we are reporting fully diluted normalized FFO of $0.83 per share, compared to $0.86 per share during the same period last year. During the quarter, we signed 141 individual leases for 1.3 million square feet, with 71% representing renewals and 29% representing new leases. The average term for leases entered this quarter was six years, and the weighted average rental rates were 2% below prior rents for the same space. Capital cost commitments associated with leasing activity this quarter was $12.79 per square foot, or about $2.13 per square foot per lease year.

As of September 30, 2012, our consolidated occupancy rate was 84.5%, which was flat with consolidated occupancy at the end of the last quarter. Our occupancy rate for our wholly owned property, which excludes results from our majority owned subsidiary, Select Income REIT, was 79.7%, or about 20 basis points lower than June 30. Generally, our CBD office properties, which represent 54% of our wholly owned portfolio NOI, continued to perform better than the suburban office properties. The metro Chicago market represents the Company's largest market area with 12.6% of our consolidated NOI, followed by our metro Philadelphia market representing 10% of our consolidated NOI.

In our Chicago and Philadelphia markets, almost 90% of the NOI comes from downtown office properties. Within our other market segments, the stronger leasing areas are Australia, Austin, Texas, Seattle, Washington, Pittsburgh, Pennsylvania, Boston, Massachusetts, and northern California. About 17% of our consolidated NOI was generated from these six market areas in the third quarter. On a consolidated same-store basis, our occupancy declined 80 basis points to 83.3% and NOI declined by 2%. The decline in same-store NOI primarily reflects the decline in occupancy in our suburban office portfolio, including some expected declines in occupancy in our Denver and Washington, D.C. portfolios. Through year end 2012, we have 1.9 million square feet scheduled to expire, and our current estimate is that year end consolidated occupancy will remain flat at 84.5% for the Company. Also, our expectation is that same store NOI and occupancy will continue to be negative through the end of the year due to the softness in the suburban office market.

Looking forward to 2013, we have almost 5.7 million square feet scheduled to expire next year. Almost two-thirds of this expiring square feet is located in our CBD office portfolio and our industrial and other portfolio. We feel confident that we can renew or lease the space in the CBD and industrial properties at rental rates that are equal to or higher than current in-place rents.

As most of you know, for the last five years, we have been aggressively repositioning CommonWealth's portfolio into high value CBD office properties, with a focus on top performing downtown assets and secondary markets, and second tier CBD office properties in gateway cities. Since September 30, 2007, around the time the most recent recession began, we have acquired $3.8 billion worth of property, and the majority of these acquisitions have been high quality CBD office properties. During the same five-year time period, we have sold $1.5 billion worth of properties, largely consisting of suburban office properties, leased to medical related tenants and to government lease tenants.

Over the last several years, the most challenging part of CommonWealth's portfolio has been on multi-tenant suburban properties. When the recession began five years ago, we knew that this segment of our portfolio was going to be difficult for the next several years. We also knew that there was little to no market to sell these properties for fair value, given the depressed fundamentals in the suburban markets. The business strategy we embarked on five years ago was to largely grow our way out of the problem that existed in our multi tenant suburban properties. And to do it partially by selling some of our good performing suburban properties and replacing them with just as good, if not better CBD office buildings.

As part of this strategy, we also anticipate that suburban markets would recover within a reasonable period, and that the recovery would benefit our suburban properties with better leasing fundamentals and increased property values. Our plan has partially worked; CommonWealth has 37% more total assets as of September 30, 2012, as it did five years ago, and the amount of cash flow generated from suburban office properties has decreased substantially. During the third quarter of 2012, suburban office properties generated 36% of CommonWealth's wholly owned portfolios NOI. Five years ago, suburban office properties generated almost 50% of our consolidated NOI.

Unfortunately, the economy did not recover nearly as strongly as we anticipated. We did not forsee that five years after the recession began, unemployment would still be hovering at around 8%, job growth would be weak, GDP would be only growing about 2% annually, and as a result, the suburban property markets would still be very weak. All this brings us to where we are today.

During last quarter's call, I mentioned that it might be necessary to consider adjusting our dividend rate because we were not seeing any sustained improvement in the office market, especially the suburban office market, during the summer months. From our perspective, things were steadily improving during the first six months of this year, but began to slow down in late June and into the summer months. Since our last call, office market fundamentals have remained weak, and as a result, in October, we declared a new dividend rate of $0.25 per share per quarter, which represents a 50% reduction from our previous quarterly dividend rate of $0.50 per share per quarter. We decided to lower our dividend rate in part because we felt that retaining more cash flow would enable us to more aggressively lease space and increase occupancy in the current difficult market environment.

As of quarter end, CommonWealth's consolidated portfolio consisted of 526 properties, with about 77 million square feet, that generate about $149 million of NOI during the third quarter and had a combined net book value of $6.8 billion as of September 30, 2012. Of these 526 properties, we have currently identified approximately 275 wholly owned multi-tenant properties located in suburban markets which we have classified as challenged in our opinion. These challenged properties have approximately 8-point --18.7 million square feet, and were as a group 60% leased for an average of 3.8 years as of September 30, 2012. These properties generated approximately $17.1 million of NOI, or about 11.5% of our consolidated NOI during the third quarter, and they had a net book value of approximately $1.5 billion as of September 30, 2012. Most of these properties are suburban office properties, and many are located in business parks in second tier markets. Also, if you removed all 275 properties we currently identify at challenged, our wholly owned portfolios occupancy rate would increase by over 10 percentage points to 91% as of September 30, 2012.

It's important to note that the current group of properties which we currently identify as challenged is not a static portfolio, and this portfolio changes regularly over time as individual property market conditions change. Nevertheless, we wanted to give the market a sense of how it may further breakdown our portfolio at of September 30. Also, it's important to note that not all of our suburban properties are classified as challenged. There are many suburban properties which we own which are performing well. None of the properties which we currently characterize as challenged consist of CBD office properties. Said another way, if we had not embarked on our repositioning strategy five years ago, this group of properties would represent a far larger percentage of our overall portfolio than it does today, and CommonWealth's operating performance would be much worse than it is today.

Over the next several quarters, our business plan is to more aggressively address our challenged properties. Part of this plan may involve selling some of our most difficult properties in the short term to remove properties from the portfolio with high vacancy and negative NOI. We have already started this process. Since the beginning of the year, we have sold three suburban office buildings, with almost 300,000 square feet for a combined $11.7 million. While these sale prices may seem small, all three of these properties were 100% vacant and were producing negative NOI. Also, we sold these properties at deep discounts, at about 29% of their original gross investment amounts of almost -- of approximately $40 million, which is calculated as before impairment charges or depreciation.

Over the next six months, we plan to more aggressively explore selling some of our worse performing properties. Over a longer period of the next one to two years, we plan to aggressively invest in the remaining properties we currently characterize at challenged in order to lease them to tenants. The increased cash flow generated from our recently lowered dividend enables us to more aggressively lease space and increase occupancy, especially in our multi-tenant suburban property.

In broad brush strokes, we estimate that about 20% of the portfolio of properties that we currently characterize as challenged may be considered for sale in the short term in order to improve the Company's overall occupancy and cash flow. Up to a further 50% of the properties we currently characterize at challenged may be sold over the next one to two years, after we lease them. Said differently, there is a much healthier market to sell suburban properties if they are well leased, and part of our strategy is to consider selling many of our challenged properties in the future after we get them well leased at prices we hope will be at or exceed the current net book value. We also expect that some of these challenged properties may be held long-term after they are well leased because of improved market conditions in the future.

The obvious question I know will be asked is, why not sell all of the challenged properties today and get it behind us? The answer to this question is that we would seriously consider selling the entire portfolio if we felt we could get a price that was anywhere close to their fair value in the current market environment. With regards to acquisitions, since announcing second quarter results, we have acquired three previously disclosed CBD office properties with a combined 1.4 million square feet for an aggregate purchase price of $255.5 million, including the assumption of $156.3 million of mortgage debt. These three downtown office buildings were placed under contract in the spring, and it took a long time to close these acquisitions because of the process of assuming mortgage debt. We have also not entered into any new agreements to purchase property since May 2012. Going forward, I expect that the level of our acquisition activities will be less than in the past few years, and any acquisitions in the foreseeable future will be focused on CBD office properties and will likely be funded with proceeds from asset sales.

Finally, before turning the call over to John Popeo, I want to point out that as of today, we have $535 million of availability under our $750 million revolving credit facility and no near term debt maturities or committed acquisitions. We also own about $785 million worth of marketable securities in government properties, income trust, and our consolidated subsidiary, Select Income REIT. This liquidity provides us with more than adequate financial flexibility to fund future capital requirements. I'll now turn the call over to John Popeo, our CFO.

Thank you, Adam. Net loss available for Common Wealth REIT common shareholders for the third quarter of 2012 was $122,000 compared to net income of $14.7 million for the third quarter of 2011. The decline primarily reflects asset sales in investment gains recognized in the prior year. Rental income increased by 8.2%, reflecting rental income from properties acquired since July 2011, offset by the decline in occupancy and same store revenue from our suburban office properties. Property operating expenses increased by 7.5%, primarily reflecting property acquisitions. Other operating expenses decreased by 3.7%, reflecting impairment charges and higher acquisition costs in the prior year, offset by increases in depreciation and amortization and increase in general and administrative expense related to SIR operating as a separate public company. Current quarter EBITDA was flat compared to the prior year. Interest expense increased by 3.5%, primarily reflecting acquisitions that took place over the past year.

Our percentage share of government property income trusts, or GOVs net income in normalized FFO for the third quarter totaled $2.6 million and $5.4 million respectively. We received over $4 million in GOV dividends during the third quarter of 2012. We recognized gains on issuance of shares by GOV totaling approximately $11 million in the prior year, representing our proportionate share of the difference between GOV's equity issuance price and the carrying value of our GOV shares. We recognized a $5 million loss on the redemption of all 6 million of the 7.125% Series C preferred shares during the quarter. Net income in normalized FFO attributable to the noncontrolling interest in Select Income REIT, or SIR, totaled $4.6 million and $6 million respectively during the quarter. Today, CommonWealth continues to own 22 million, or 70.4% of SIR common shares, and because our retained interest in SIR exceed 50%, we continue to consolidate SIR's financial position and results in our consolidated financial statements.

Normalized diluted FFO available for CommonWealth REIT common shareholders was $0.83 per share for the third quarter of 2012, compared $0.86 per share for the third quarter of 2011. Year over year per share results primarily reflect the decline in occupancy, property sales, the SIR IPO in March 2012 and the issuance of new common shares in 2011, partially offset by acquisitions. During the quarter, we spent $29.7 million on recurring capital expenditures, which include tenant improvements, leasing costs and recurring building improvements. We generated $33.5 million of cash available for distribution, or CAD, during the third quarter, resulting in a rolling four quarter CAD payout ratio of about 119%, based on the old dividend rate of $0.50 per share per quarter. After giving effect to our recent dividend reduction, the rolling four quarter CAD payout ratio would have been about 60% at September 30, 2012.

Turning to the balance sheet, on September 30, 2012, we held $73 million of unrestricted cash. During the quarter, we redeemed $191 million of our 6.5% senior notes. We used the net proceeds of our $175 million offering of 30 year, 5.75% senior notes in July to redeem all $150 million of our 7.125% Series C preferred shares in August. Rents receivable includes approximately $220 million of accumulated straight line rent accruals as of September 30. Other assets include approximately $153 million of capitalized leasing and financing costs.

On September 30, we had $1.2 billion of floating rate debt, including the $350 million SIR term loan, and $92 million outstanding on SIR's revolver. At the end of the quarter, we had $842 million to mortgage debt and $2.1 billion of fixed rate senior unsecured notes outstanding. The weighted average contractual interest rate on all of our debt was around 5% at the end of the quarter, and the weighted average maturity was around 5.5 years. Our senior unsecured notes are rated BAA2 by Moody's and BBB-minus by Standard and Poors. The undepreciated book value of our unencumbered property pool totaled about $7.6 billion at the end of the quarter.

At the end of the quarter, our ratio of debt to gross book value of real estate assets and equity investment was 48%. 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. In summary, despite a challenging market environment, we continue to make meaningful progress towards repositioning our portfolio, to be more heavily weighted to high value CBD properties. With a strong balance sheet and $535 million available on our revolving credit facility as of today, we are positioned to grow cash flow as the economy improves. That concludes our prepared remarks. Operator, we are now ready to take questions.

(Operator Instructions)

We will go to the line of John Guinee, please go ahead.

Okay, wow. Well, Adam, I have to say this. You spent a lot of time blaming the problems on others, and I guess it worked very well for someone yesterday who just got re-elected. Your leverage is up, debt plus preferred is now over 80%. Your G&A quarter over quarter went from $12.7 million to $14.6 million, you're on a $58 million run rate for G&A. You have concluded that greater than 50% of your assets are challenged, and CommonWealth's year-to-date performance is down 14.7% versus the RMZ, which is up 11.2%. I don't have any questions. Thanks.

We will now go to the line of Josh Attie, please go ahead.

Thanks. The strategy that you outlined of selling and leasing up some of the challenged suburban office properties seems to make sense, but the environment that you described of weak leasing fundamentals and little demand for assets that have vacancy, that environment doesn't really seem conducive to executing on that strategy. What do you have in the works, and what gives you the confidence that you'll be able to execute on any of that plan over the next 6 to12 months?

Sure. Over the short term, I think what we've been talking about is we're going to be selling some -- we're going to be looking at selling some properties that are currently vacant --100% vacant or have significant vacancy. And what we'll be doing there is doing something we've been trying to resist doing for last couple of years, and we'll probably have to sell them at pretty deep discounts. That's why I mentioned the properties we've sold to date, although not a lot of numbers in terms of gross sales, $11.5 million, we have sold the properties at about 29% of what we originally had invested in them.

So, there is a market to sell vacant buildings in difficult buildings, it's just you're going to have to sell them at a pretty steep discount. I think that's what we are going to do with part of our portfolio, a small part of it. The goal there is, as we talked about, to try to just stop -- get the occupancy up and get rid of some of the negative NOI in some of those properties. That's not a majority of what we classify as challenged. It's what I talked about before, which represents -- again, what I described and outlined before as challenged only represents about 11% of our consolidated NOI, and about 20% of our net book value. So, I don't think it's, as John said before, half our portfolio. But within that portfolio, as I said, about 20% of that -- so call it 4%, 5% of the entire CommonWealth portfolio -- we'll be considering just short of selling at, maybe, distressed prices.

Then the remaining, call it part of our challenged portfolio which, let's use round numbers, maybe it's about $1 billion of net book value -- when I talk about turning those around, we're talking about very aggressive leasing. And what I mean by that -- that means entering leases that might be upside down, meaning, as many people on the call probably recognize, that's doing a deal that is far below market but gets a tenant in the building. And then if you cap out the NOI two years out, you can get a value that's close to what we've invested in the building. And so doing things a little differently than the way we've done it before in trying to sell some of those buildings. Now, I don't think we'll sell all those buildings that we have classified as challenged, I think some of them, we've been very -- for this first time that I've ever dissected and sliced and diced the portfolio this way for people, we were pretty liberal.

We -- there are properties in that group that I think we will be able to lease up and we will probably end up holding long term. But they are currently challenged in the sense that they have a high amount of vacancy, and the market's weak. But the fundamentals of the building are fine, the fundamentals of where it's located are fine, it's just that we're in a weak market. And so that's how I think we'll execute on it. We're going to have to be very aggressive in terms of getting rid of some of the portfolio that is just bleeding, and then being very aggressive on another part of the portfolio, to lease it up with an eye towards selling some of them over the next few years.

And how do you think about that in the context of the leverage? As John mentioned, it's close to 80% with preferreds. Where do you want leverage to be and how do you plan to get there?

80% is on a market value. Obviously, if you look at a book basis, it's far less.

Right. You mentioned that a lot of these assets are going to be sold for less than book.

Not a lot, not a lot. Remember the numbers we're talking about. I talked -- be very specific, I said there's $1.5 billion of net book value with the properties that we characterize as challenged. I say maybe 20% of that, so let's say $300 million? I'm using round numbers, an estimate, so around $300 million. On a portfolio, remember, our total assets are $8 billion, total assets for the Company.

So, keep in mind what I'm talking about. If we sold -- and I'm just using, again, round numbers, we sold that $300 million, I don't know, as what we've sold the last group of properties, $0.30 on the dollar. Then we're selling them for a couple hundred million dollars less than what their gross book value was. Our Company can withstand that. Our hope is over the next one to two years that, as we turn around some of the more challenged properties with aggressive leasing, we'll be able to sell them at or close to their net book value so we won't be taking a write-down or a loss on the sale. That's the strategy we're going to be deploying over the next couple of years. Does that answer your question?

Yes. And you mention in your prepared remarks, it sounded like acquisition, I just wanted to clarify your view on acquisitions. Are acquisitions completely on hold until you recycle capital, or is that not the case?

I never want to say never, but I can tell you we've not put anything under agreement, and we virtually have looked at nothing in the last six months. And I expect that we're very -- it's very hard for us to fund any acquisitions other than through asset sales at this time, so for all effective measures, acquisitions are virtually on hold. But does that mean I don't look at anything? Sure, if a building happens to come up that is right next to a building we own and adds a lot of synergies and just makes a lot of sense that we would own that building because it's right next to a building we may already own, then, sure, might look at it. But, again, we haven't looked at anything in six months. I think there's going to be very far and few acquisitions over the next, let's say, at least six months to a year until we straighten out and get the portfolio stabilized.

Okay, and then you mentioned in your prepared remarks that you feel good about the CBD expirations next year. Can you specifically address Glaxo in Philadelphia? It's a big expiration, it's earlier in the year, it's a big building, what are your plans for that asset?

Sure. Glaxo, right now, we are currently talking to potential tenants about leasing Glaxo. Our hope is that we will be able to make a very positive announcement about that, hopefully by next quarter. Nothing's done yet, but we hope -- we are cautiously optimistic that we can lease it.

The full building?

At this time, the full building, yes.

Okay. All right, thank you very much.

Yes.

We now go to the line of Michael Carroll. Please go ahead.

Hi, good morning guys. It's Rich Moore, how are you?

Good, Rich.

Actually, Adam, sounded like a pretty decent strategy to me to do what you're trying to do with the asset sales, so I was a little taken aback by the disappointment expressed so far. My curiosity is, the $300 million, roughly, that you want to sell, should we throw that into our 2013 numbers? Is that a reasonable thing to do?

I can't guarantee it, but it's -- that's not an unreasonable number to look at. Maybe it's $200 million, maybe it's $350 million. It's somewhere in that ballpark that we are looking to sell over the short term, somewhere around there.

Okay. And if I were to put a cap rate on that, I'm guessing most of this stuff is vacant, so it doesn't have a lot of NOI. Would I put a low cap rate when I sell it? Or is some of it actually leased up and you just don't want to keep it anymore?

Most of the stuff we are thinking of divesting over the short term, it's negative NOI. There is no -- it's not going to be sold on a cap rate basis. It's going to be sold to an owner, user, or somebody, a local developer that has some vision that they want to do something different with the property. That's what they're going to be sold for. So, it's really maybe price -- they are going to be sold on a price-per-foot basis. And, again, using the benchmark of what we sold to date, 29% of their gross book value, that's probably a good benchmark -- could be less, could be more.

Okay. Good, I got you, thanks. And then the 50% that you want to lease, is that a '13 activity, 2013? And then we sell all of that stuff in '14, so I've got another $700 million of asset sales in 2014?

Yes, I think -- my hope is it's spread out between 2013 and into '14, and I can tell you that this leasing strategy I've outlined, it's not day one of the strategy. This strategy has sort of been migrating in this direction for several months, but I think we went into full gear with this strategy about after the second quarter. We've been -- it's already started and I expect we'll start to see some of it in the fourth-quarter numbers, but really come into play into 2013. But I think you'll -- I don't think it's just going to be, do all the work in '13 and sell it in '14; my hope is that we do some of it this year and sell some of it in '13, and then sell some of it in '14.

Okay. And then, how are you marketing this stuff? Is there -- are there packages you are putting out that maybe have multiple assets in them, or are you sort of saying to the brokers, here's a whole bunch of assets, go at it, do what you want to do? What's the basic strategy behind getting rid of 200 plus assets?

Right. Again, the 275 identified, I'm not sure we'll get rid of all 275.

I understand.

I was very liberal in what I characterized as challenged. But, first step -- it's a stepped process. First, the properties that are -- you have no -- they have got 100% vacancy and negative NOI. Luckily, that's not a lot of properties, but it's certainly -- as we talked about the numbers we've been throwing around on this call -- about $300 million in gross investment value. Those properties, they're going to be sold in many different ways. They're going to be sold one off, there could be a couple that could be packaged together, but they are really sold at the -- very much the local level. I don't expect that they will be sold as a package, because the type of buyer is really -- again, it's the local owner/user or a local redeveloper or developer that thinks they can do something with it. As you get into '13 and '14, as we think about some of these properties, we -- it could be some packages of portfolios that we put together that we would then take to market in a marketed sales effort. But I think that, before we can do that, we got to do -- we got to execute on some of the leasing. And that's what we have got to do now and into 2000 -- and even into 2013. But it's very different the way we'll be selling some of these properties over the short term versus how we envision selling some of these properties later. I think it will be a little bit more organized, through a brokerage, maybe as a portfolio -- sub portfolios in '13 and '14, but over the short term, it's going to much more one-offs.

Okay, so just last thing on this, if you sell 20% of 250 assets -- so you sell 50 assets over the next year or so -- is it going to be a fair question when we get on the call next quarter to say, hey, Adam, you have 50 assets you were trying to sell, there's only 2 that you sold in the quarter. Or should I expect to see 8 or 10 possibly in the supplemental that say I've sold 8 or 10? Is this really going to progress at this rate where we can monitor it quarter by quarter?

Short answer is, yes, that's what we are currently engaged in trying to do. I can't guarantee --

I understand.

But that's -- it's going to be at a much more robust base than what you've seen in the first nine months of this year.

Great. Appreciate it, guys, thank you.

Yes.

(Operator Instructions)

We will now go to the line of Mitch Germain. Please go ahead.

Hey, everyone. Adam, what's the criteria for determining what's for sale versus what you want to invest and try to lease? What are you -- what are the criteria or the items that -- is it location, is it age of the asset? What specifically is differentiating one versus the other?

The whole -- it's a whole bunch of stuff, Mitch. There are some portfolios that we have looked within the group that we have thought about as a group or sub portfolio because of the geographic location, and I won't disclose it on this call, because I don't want -- because I don't think it's appropriate. But there are certain groups that fit into certain geographies that maybe make sense for us get out of.

There are others that are property type, meaning there's maybe, of these 275, there could be a group of 15 that's a whole business park in what I call a second-tier market. While maybe it makes sense to get out of -- maybe not all 15 of the properties are really struggling, maybe it's 9, and 6 are well leased. So, maybe it makes sense to sell all 15 properties to exit that business park. That's how we think about it. Now, that gives you a flavor, but, of course, it depends on market conditions, it depends on how well leased, it depends on -- how the age of the building, all the things you mentioned do go into the calculus.

And just describe to me, you talked about investing in some of these properties, leasing them; clearly, some of those leases are going to possibly be underwater on a net effective basis. Why even go through that measure, and why not just try to sell these properties as-is and take an impairment today?

Yes, it's a good question, Mitch. The answer is that there's a just -- being in the market every day, there's a vastly different market for -- buyers are just -- the valuations you get for a vacant building are very -- high vacant building, with low occupancy, it's far different than you get for a building that's got occupancy. Meaning -- so if I can do maybe -- the game worth talking about is a game that a lot of developers do.

They enter into a lease -- they enter into upside down leases or negative net effectives because it gets them two years into the lease a pretty healthy cash flow which they can then cap, and then it gets them almost out or maybe even better than their investment. So, it's the game of, okay, sell a building today that's vacant, maybe you get, let's use just for example, say, $0.20 on the dollar. Versus if I do a very aggressive lease and we get it leased up, it's 100% leased, and two or three years into it, it's going to be cash flowing X. And you put a cap rate on that X, suddenly I can get $0.90, $0.95 on the dollar. That's the game we're playing. It's just -- we -- it doesn't make sense in our mind to just sell all these properties today, because the value we would get in the marketplace would be so much lower than if we try to lease some of them up. But, at the same time, it's a balanced approach.

I am saying to everybody, we are going to do that with some of these properties. There are some properties, not all, but there are definitely some properties that I'm going to take -- we're going to take, we're just going bite the bullet and take the position that you're advocating, Mitch, which is, look, let's get rid of these. They are vacant, it's going to be too hard to lease them up, it's going to be too costly, it's too much of a drag on occupancy and NOI, so let's just sell those. We are going to do that with a portion of it, and we're going to try and do that over the short term. A little longer term, one to two years, we're going to try and turn around some -- get some of those buildings leased up, and then try to sell them what we think would be much better value. We think it's much better for stakeholders in the Company to sell properties 18 months from now, let's say $0.90 on the dollar, $1.00, $1.10 on the dollar than sell it today for $0.20 on the dollar. That's what we're trying to do.

They're also easily financeable, I'm assuming, with occupancy.

You got it.

Last question, Adam. It seems like obviously this is bit of a strategic shift, right? Shifting away from growth in CBD to more, now, pairing down the suburban, if that's a good way to put it. You've skirted around specifically what you're looking to do with some of the proceeds from these sales, right? Maybe if you can get a bit more specific. Is it going to be shifting back to CBD, reallocating that capital? Or, is it going to be addressing leverage, which clearly remains a huge concern with investors.

I think -- well, I'm not sure if we got -- if we sell something at below book value it would take down leverage. I'm not sure we've helped our leverage ratios much, or -- so I think really where we're going to end up -- I think where we're biased towards is try to take the proceeds and, in the majority of instances, reinvest it into CBD properties -- that's what we're going to be doing. I'm not sure if taking the proceeds, we're just going to be shrinking the Company at the same time. We'll take down debt, we're taking down the assets at the same time. So, shrinking the Company and taking down the assets. If I could sell something for $2.00 on the dollar and repay debt, well then, yes, but I'm not sure that's where we're -- that's not what we're talking about doing here.

And just to confirm, when you talk about this bucket of properties, you're excluding any assets that you are currently warehousing or that currently -- SIR has the right of first refusal? Or is that -- are those properties also included in that 275 that are looking to be sold down the road?

No, any properties that -- no, they are not included in the 275, because they are not challenged. Anything that --

It's just the challenged, got you.

Anything that could be sold that could fit in the criteria of SIR is obviously 100% net leased. So, that's --

Understood. Okay, just wanted to clarify. Thank you.

Yes.

And, speakers, there are no more questions in queue. Mr. Portnoy, please go ahead with your closing remarks.

Okay. Thank you all for joining us on the third-quarter conference call. We look forward to seeing many of you at the NAREIT conference in San Diego next week. Thank you.

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