First Industrial Realty Trust Inc (FR) 2002 Q1 法說會逐字稿

Good morning and welcome to the first quarter 2002 earnings conference call. At this time, all parties have been placed on a listen-only mode and the floor will open for your questions and comments following the presentation. It is now my pleasure to hand the floor over to your host First Industrial.

_____]: Good morning everyone and thank you for joining us today. Before we review the quarter, let me remind you that this conference call contains forward-looking information about First Industrial. A number of factors could cause the Company's actual results to differ materially from those anticipated, including changes in: economic conditions generally and the real estate markets specifically, legislative and regulatory changes (including changes to laws governing the taxation of real estate investment trusts), availability of financing, interest rate levels, competition, supply and demand for industrial properties in the Company's current and proposed market areas, potential environmental liabilities, slippage in development or lease-up schedules, tenant credit risks, higher-than-expected costs, and changes in general accounting principles, policies, and guidelines applicable to real estate investment trusts. For further information on these and other factors that impact the Company and the statements contained herein, reference should be made to the Company's filings with the Securities and Exchange Commission. I will now turn the call over to Mike Brennan, President and CEO. Mike?

Thank you. And welcome everybody to our first quarter 2002 conference call. Before I begin, I would like to introduce the members of management who are here today with me. Michael Havala our Chief Financial Officer, Johannson Yap, our Chief Investment officer and Mike Daily our new Director of Investor Relations ... welcome Mike to your first quarter conference call. Today, let me just start with an overview of the agenda, I am going to start with outlook for 2002 and also discuss the progress of our plan, Mike Havala will continue with the discussion of our financial conditions and results and also talk a little bit about our 2002 guidance, and Johannson will take both the investment and portfolio performance together with discussing the progress that we have made in our corporate real estate program integrated industrial solutions. Let me begin, as you can see from the press release and the quarter that we have had, the core business performed well in the tough times that we expected to see in 2002. Specifically, the portfolio exceeded our guidance in all key areas, occupancy was a bit higher than our guidance at 90.8%, run rate growth was particularly strong at 6.2% in light of the environment, and our cadre retention was also strong at 68%. Integrated industrial solutions came in with profits of 10.3%, which is a 20% increase over the levels that we had in 2001, the pipeline continues to be strong at about $505 million after harvesting about $87 or 86 million from that pipeline. And I am also to pleased to report something Johannson will talk a little bit more about later, a significant transaction that we did with Maytaq that involved three separate requirements and also we are happy to be say that we did our first assignment with Elborda in this quarter as well. Investment returns continued our tradition of accretive investment, we invested about $66 million at first year returns of 10.5% we sold $97 million or about a 9.2% cap rate for overall aggregate, internal rates of return of 15.9% and nearly $100 million in sales. Our balance sheet continues to be strong. Fixed charge increased to 2.6% and 2.5% and also as Mike Havala will detail greater as we go on in the call, we lowered our costs and we extended the overall maturity schedule of our debt with our $250 million bond offering. So I am very pleased with the performance that we had in our core business. Certain point that I would like to make is that while market conditions have improved and you heard I think some of my pears talk quite a bit about this, we should remember though that the market does remain soft today. Specifically, the vacancy nationally at 10.3%, which is a 60 basis points increase over what we had at the end of 2001. Some other important things I think to keep in mind is that plant utilization in United States are standing about 75% compared to the average over 30 years of 82%. And third I think perhaps even more important is the absence of capital investment spending by corporations. In fact, there is a high correlation between capital spending by corporations and the absorption that we have in the industrial real estate market. So when you combine the effects of all three of these and we talked about these on the last call that we had, these conditions will make for a tough environment. Now, with respect to, you know, the hard evidence that things are improving absorption ... gross absorption has increased in the overall market place as had showings that have increased. Yet a negative absorption was again the case throughout the nation of the United States, which was about 14 million square feet, which marks the sixth consecutive quarter of negative absorption that we have had. Other good news though that we have had in the market was that construction continues to fall. There are different reports on the amount of construction that is out there, but I can tell you that in self markets in which we operate in speculate construction is almost non-existent in those particular markets, and so that augurs well for us. A final point that I think is hard evidence is that manufacturing output rose by about 0.8% in the first quarter, which was the fastest that we have had in 2 years. So, those are positive signs. Last thing I would just like to point out with respect to the market is something that I haven't heard too much about, written about, but it's the high priced acquisition market given the fundamentals and this is an issue that we are particularly concerned about as we go forward in 2002. There is a significant wide bid spread that has limited the amount of properties on the market, yet there are many buyers who are willing probably because of leverage, the kind of favorable leverages you can get and the cost, there are putting upward pressure on prices and also simply because there are no better alternative direct investments. And are making those investments despite the fact that the fundamentals are not where we would like to see them. And so this is a bit of an anomaly where you have soft fundamentals as soft as they were last year and your have crisis affirmed or crisis in some cases arising. Last point that I would like to make before handing it over to Mike Havala is that we have made and we will continue to make decisions that serve the long-term interest of our business even if some of these decisions will cause short-term earnings implications, specifically when we completed our bond offering in this quarter we knew it is going to be dilutive, but it has significant positive effects for us. We believe that we have the bottom market at the right time and secondly and more significantly for the rest of 2000 is that we intend to maintain our investment standards as a total return higher or driven investor even if these results are an short term earnings dilution. There is simply a lot more to loose by over paying then there is by taking short-term dilution and so we intend to stay the course and fool the investment standards and continue, as Johannson will talk to you about finding opportunities in the corporate real estate arena. So with that I would like to pass to Michael Havala.

Thanks Mike. There are two areas I would like to go through today. First, I will provide some more detail on the first quarter numbers then second I will talk about our guidance for 2002. With respect to the detail on our first quarter numbers, let me first give you a quick snapshot of our balance sheet - this is as of March 31st. We have 1 billion 355 million of debt and that's broken down into 1 billion and 49 million of unsecured notes, 87 million of markets debt, and 219 million drawn on a line of credit. We also had 350 million of preferred stock and 1 billion 584 million of common stock. So our total capitalization as of the end of the quarter was just under 3.3 billion. I should also mention we had $63 million of cash on our balance sheet as well. And talking about the balance sheet one thing I want to underscore is the strength of our balance sheet and I say that from both a quantitative point of view and a qualitative point of view. When you look at some of the numbers in our ratios ... our debt to asset value is about 38%, interest coverage 3.6 times, fixed charge 2.6 times ... these are very strong ratios especially in these tougher times, but when I look at it from even a more qualitative point of view, I think you will see some additional benefit, additional strong points to our balance sheet. For example with our debt, 100% of our permanent debt is fixed rated debt. We have longer staggered maturities and we have a very little secured debt ... less than 3% of our total capitalization is in secured debt. Let me now move to capital markets, in April we closed a $250 million bond offering and there are really two [crunches] to the bond offering. First crunch, we did a $200 million on a 10-year note, and then the second was we did a $50 million, 30-year note fees. I am very pleased as far as the execution and the pricing and so forth with respect to the bond offering and we are also, I should say, very happy to be able to execute on a 30-year note ... something that hasn't been done by recently in almost a year. The purpose of the bond offering really is to refinance other capital and what we are going to do with the $250 million is pay down the maturing unsecured notes, we are going to redeem our series B cumulative preferred stock, and then we are going to also pay down some secured debt, which we have that we can get at later in 2002. As Mike mentioned and it is worth repeating is that one of the results for the bond offering is that it helped increase our weighted average debt maturity. Our weighted average debt maturity right now is 12.3 years, I should say that's not only the highest among our peers, it is about double of the average debt maturity of our peers. With respect to the bond offering and the earnings impact we will see some short-term dilution as a result of it, but in the long term that will be very accretive to our earnings. In the second quarter, we anticipate about $0.02 a share dilution as a result of bond offering. And that is simply a result of ... we completed the bond offering in April yet we cannot get to the capital that we are going to refinance until May. We have about 30-day period whereby the funds from the bond offering are simply going to paydown our line of credit and as, you know, that's negative arbitrage on that. So, $0.02 a share dilution in the second quarter for all of 2002 as you go up for the year, we expect about a total of $0.01 a share dilution as a result from the bond offering. When you look forward into 2003, you have a meaningful amount of accretion and a positive impact of earnings as a result of the bond offering. That will about $1.8 million positive benefit to earnings in 2003 and that's about $0.04 a share. So as Mike mentioned before even though there is a short-term payment with respect to that from the long-term point of view this is a very, very good thing that we did on the bond offering. Next in capital markets let me talk about where we are in the Kuwait Finance House fund or the KFH fund. In December, as you remember we closed the first part of properties of $70 million. In the first quarter 2002, we closed another $34 million of properties into the fund therefore bringing the total upto $104 million of properties. And just as a reminder, this fund serves primarily as a forward purchase commitment for our merchant development business. Next, let me talk about some other items with respect to quarter. At [same store], as you saw in the press release, our same store decreased a little bit down 0.7% during the quarter and the component of this are [same store] revenues went down 1.3% mostly because of occupancy, same store revenues went down 2.8%. I should also emphasize that we are still comfortable with where we expect [same store] in the year and that is in the flat range. Regarding development, we had under construction at the end of March $209 million. Of the $209 million, $165 million has already been funded, therefore leaving only $44 million left to fund. Next, let me talk about our guidance for 2002. As you saw in the press release, we provided guidance for 2002, for both EPS FFO. And we have included the numbers in the press release and the key assumptions and drivers and so forth, so I don't want to repeat those here, but what I do want to spent time on is to talk about the reasons for our change in our guidance and if you look at the midpoint of our prior guidance versus our new guidance, it is about $0.15 a share change in guidance and the reason for change in guidance is simply because of dilution and the dilution comes to us in three parts. The first part is that we anticipate being a net seller of properties during the course of 2002 in the $50 million-$100 million range and that would cause about $0.05-$0.10 a share in dilution. The second part is because we are seeing slower release upon our merchant development; we obviously would see slower sales, and a slower subsequent reinvestment into income-producing assets. So this dilution, which in a sense is a lack of accretion, we expect it to cost us in the $0.05-$0.10 range in 2002. And the final part of the dilution is what I mentioned before the bond offering that should be $0.01 a share during the course of 2002. The good news, if you will, the silver lining is that this dilution is not permanent, and these all can turnaround, when we use the proceeds for being a net seller and become a net investor that will have a meaningful positive impact on earnings. When we lease up the merchant development, monetize it, and reinvest into income-producing assets that will have a meaningful positive impact on earnings and then finally with the bond offering, as I mentioned before, starting in 2003 that should be accretive to our earnings by about $0.04. One housekeeping item, just to mention our supplemental information package will be available on our website midday today and with that let me just conclude and say the first quarter was a very solid quarter for us and from a financial point of view and a balance sheet point of view we were in very good shape. We continue to make the right long-term decisions for the company and we are very exited about the future and with that let me turn over to Johannson.

Thank you Mike. Lets first discuss portfolio operations that cover the spirit of the market and provide an outset in portfolio performance. I will then cover investment performance followed by any great industrial solutions. Market conditions in the first quarter were both challenging and encouraging. Challenging in that it will take time before we see meaningful improvement in occupancy and our run rate growth. Encouraging in that activity is getting stronger both in terms of number of prospects we are seeing and in terms of transactions being consummated. In addition, suble space and new construction are clearly down from the prior quarters. Our lowest occupied markets include Cincinnati at 75%, Columbus at 81%, Indianapolis at 84% and Tampa at 86%. The highest occupied markets were Philadelphia at 98%, Southern New Jersey at 97%, Harrisburg at 97%, and St. Louis at 95%. The ratios of our leases on a portfolio wise basis averaged 5.3 years, which is well within the historic norm. In terms of our accounts receivable it shows no significance variance from historically low levels. Finally, in terms of improvements of leasing commissions, they are all in line with historic levels. Regarding portfolio ultimate most of our markets are slightly more positive than three months ago. We anticipate meaningful occupancy increases in both Columbus and Indianapolis in the near future. One of the reasons for this is an increase in activity and part of it is due to our extensive marketing and execution of our leasing initiatives. In the markets of New Jersey, Philadelphia, Denver, and Los Angeles our well-located and diverse products should continue to deliver strong occupancies and run rate growth throughout the year. In Chicago, the activity here has been steady, but as we pointed out in the last call it is a competitive market, as most prospective tenants have multiple option. If you take all of these things into consideration, we think we will see a gradual increase in occupancy over the remainder of the year averaging 92%. We see just like Mike Brennan and Mike Havala have mentioned [same store] analog growth at above level and finally we see run rate increases to be in the area of 3%-5%. In summary, performance over the portfolio of these levels slightly exceeded our expectations and are well within the parameters of our own plan and guidance, those and my comments on the portfolio, I will now discuss our investment activity and conclude with integrated industrial solution. Regarding sales, we achieved a 9.2 cap rate and 15.9% IIR by using the same tactic we have used for a long time by just selling each property to the most strategic buyer. Let me give you a breakdown on the type of buyers. Users represented 30%, 1031 exchange investors 1%, private investors 34%, and institutional investors 35%. In terms of cap rate, the buyers who accepted the lowest yield and therefore paid the highest price were 1031 investors at an 8.1% cap rate followed by users and institutional investors that even in the prior quarter were at 8.5% cap rate, and lastly private investors at a 10.5% cap rate. In retrospect, we continued to validate the benefits of selling to the most aggressive buyer for each property. In terms of selling conditions, industrial properties remain the preferred property type especially in the economic environment because of its stable cash flow. Interest rates like in the last quarter continued to stay low to make both leverage buyers and users to actively buy from the markets place. Also in addition to that there is not enough product to satisfy investor demand. With regard to acquisitions we invested $41.7 million at approximately 10.6 cap rate and expect a 12% un-leveraged IIR. These returns, I would want to point out, are exclusive of value creation tactics that we employ in every acquisition, let me give me an example to explain what I mean. We acquired a $39 million 15 building high-quality portfolio in Exton county Philadelphia. This is Philadelphia's most historically active and best-performing industrial submarket. We expect an initial yield of 10.5% and project an un-leveraged ILR of 12.5% if you just buy and hold the property for 5 years, but our plan is different. Our plan is to create more value by selling 5 buildings earlier on a one off basis to users or 1031 exchange investors who would pay more that we did. We are also planning to develop or sell 5.7 acres of land that we basically got for free. In summary, these value added activities can add the 125 basis points in return over the basic buy and hold scenario. Going forward, despite the challenging acquisition environment we are focussing on using our white product criteria, our national reach, our local full service regional offices, and our IIS initiatives to try to get a leg up on the competition. Concerning development we place in service $24.1million in the first quarter with a projected yield of 10.2%. I want to know that we made positive strides in leasing our speculated development pipeline. At the end of 2001, we had 5.1 million square feet to lease. In 2002 alone we leased 1 million and 88,000 square feet bringing the occupancy to 28%. Our $200 million current pipeline is 15% occupied today as we sold off fully leased properties in the first quarter. I just want to remind everybody there our development pipeline still remains diversified across product type and across 42 projects in 13 cities. Based on our ProForma we still expect to achieve a 10.8% cap rate, which should provide us with an 8% margin over our costs. This implies a $215 million gross value and a potential $40 million gross profit. Our venture with Kuwait Finance House ads certainty and cost efficiency to the monetization of our merchant development program as can be seen for the prior two quarters. Of course needless to say we remain very focussed on leasing the rest of the vacancies. I will finish up my presentation with a discussion of integrated industrial solutions. For the quarter we delivered $10.3 million of IIS it self. Notable merchant development transactions up in the quarter included the sale of a 527,000 square foot building leased to Maytaq Corporation and 182,000 square foot distribution building leased to Maytaq. These buildings with investment great tenants were both sold to our venture with Kuwait Finance House. I want to remind you that this Maytaq lease was part of a multiple service type requirement wherein Maytaq Corporation also needed the state-of-the-art 390,000 square feet building to serve as a distribution centre for the Northeast. We won this on count because we were able to lease to, built for, and acquire surplus assets from Maytaq Corporation. Due to the quality of this episode I just mentioned and the investment grade income associated with that building, we were able to pre-sell this facility and remained as fee developers for the project. This quarter we also sold a portion of very successful re-development project in Harrisburg. The subject property was a former manufacturing facility for Fuller Trader Corp. We consolidated our operations and this resulted in a surplus property opportunity. We bought a total of 718,000 square foot of property with approximately 46 acres of excess land for approximately $8.7 million well below our replacement cost. Since then we have redeveloped, developed, and fully leased $1 million 600,000 square feet of property across five buildings. Our net profit margin on this particular portion of this redevelopment project exceeds 20%. Regarding about our IS pipeline as in the past it remains diversified and we generated for merchant development and redevelopment sales, development fees, single tenant user sales, and land sales. The break down is as follows: merchant development and redevelopment is approximately $300 million, $250 million comes from our expected development pipeline that I just mentioned and $50 million are development and redevelopment projects that are already completely leased and in our balance sheet. The bill to suit pipeline is at $70 million, this pipeline represents four Build-To-Suits wherein we have lease agreement with our customers including the Maytaq Build-To-Suit that I mentioned that we are a fee developer on. In terms of single sales and user buildings we have identified from our current portfolio $80 million of single tenant buildings and $45 million of user buildings that we will sell. Finally, we have identified land sites that are valued at $10 million that are already in the market for sale. So for 2002 in terms of IIS income composition as a percentage we expect approximately 60% will come from merchant development and redevelopment sales and development fees, roughly 39% from single tenant and user sales, and the remaining 1% from land sales. Notwithstanding the pipeline that I have just mentioned we are actively bidding and pursuing numerous Build-To-Suit, sale lease bags, and surplus properties from numerous companies nationwide. These transactions are fairly larger, take quite a bit of time, but offer based on our experience relatively higher total returns. So in summary we are very pleased with our portfolio and investment results for the first quarter especially given a challenging economic environment. But I just want to bring you all back that we were able to deliver these results as in the past because we stuck to our core strategy I-N-D-L and IIS. Rest is assured that we will stay on course, as this will provide us with the more stability in growth and earnings. At this point, I will turn it back to Mike Brennan.

Thank you JoJo. Just a few quick summary comments and then we would love to open up for question and answer. Number 1, I think is you know our view that market conditions while improving remain soft and remember that I mentioned that we have got a high vacancy, we have got low plant utilization, and we have the absence of capital spending. So when you have the combination of all those three, even though we are at the bottom and even though it does seem like we are coming out, we have to operate in that environment, which is about 300 basis points on a national basis in terms of vacancy where we were only a year ago. So I think it is helpful to keep those things in mind and so as we price acquisition and we make assumptions about how the markets is going to perform, we don't want to dilute ourselves and prematurely conclude that we are out of the woods. Yet despite these market conditions I think that our core business did perform well. In 2002, we have no change in terms of how we see the portfolio performing, no change in terms of how we see IIS performing, but you know our confidence that we can quickly make acquisitions is really at the heart of some of the things we see a little bit differently today. So again we will continue to do this and as we said in the last 60 days all eyes were on portfolio leasing, we intend to maintain our value investment standards and really not change our course. So with that I just want to say that I think you can expect us to make the right long-term decisions for the business and we intend to fully stay on the course with our strategic direction. We will make no change. We will continue with our strategy of being just a diversified industrial investor and stick within the 25 continental markets in the United States. So with that, I would love to open it up for question and answer, moderator?

Thank you the floor is now open for questions. If you do have a question or comment, please press 1 followed by the 4 on your touch-tone phone at this time. Please hold while we poll for questions. Thank you. Our first question comes from [Bryan leg] from Merrill Lynch.

BRYAN LEG]: Yeah, hi guys. First a couple of housecleaning items, your G&A has propped up a bit particularly looking at its relative to the third quarter, what is a good run rate number you use for G&A and my other question is about depreciation expense, it was high in the fourth quarter and then it came back down from $24 million in the fourth quarter to $19 million, what also a good number you used for that?

Hi Bryan this is mike. On G&A, I think, on the run rate I look at our first quarter 2002 and that kind of score should be a good run rate for us for 2002. With respect to the second part of your question on depreciation, depreciation in the fourth quarter of 2001 plies up somewhat because in that quarter we had a number of properties which we reclassified out of help for sales and under the accounting rules, if a property is held for sale you don't depreciate it. We put them back, sort of, out of that category of held for sale and so we had some catch up depreciation if you will in the fourth quarter of 2001. We look at that at that as more of a one-time addition to depreciation in the fourth quarter. So, if you are looking for our run rate for 2002, I think, if you take our first quarter that's a pretty good run rate.

BRYAN LEG]: Okay and your IIS income I thought it was going to be more back end loaded and if you take at this quarter and just annualize it, it falls within your range, is it going to be more lumpy over the next couple or few quarters.

Bryan it will probably will be more back end loaded not to a enormous degree, but probably a little bit more back end loaded.

BRYAN LEG]: And with which ... with respect to your timing differential between your property sales and expected reinvestment, I mean, could you give us some idea of how you breakout the $500-600 million of sales versus $450 million-550 million of acquisitions?

Let me answer you in this way Bryan I think it will give you what you are looking for. As I mentioned, we anticipate that we will be a net seller in the $50-100 million range for this year and we would anticipate that differential impacting us in the 6-9 month range for this year, of course that's about what's left in the year. So, from a timing point of view, in the first quarter we are already net sellers to a tune of about $50 million. So, when you look out in second, third, and fourth quarter we anticipate to be fairly balanced just on a quarter by quarter basis in the second, third and fourth quarter between sales and reinvestments.

BRYAN LEG]: And can you talk about the leases rolling over in 2002 what percentages have been the totalled of rent in 2002 and how much of that you have find or committed?

Basically we renewed Bryan about 40% of what's going to roll in 2002. That is where we are at right now.

BRYAN LEG]: And what percentage of rent do you still have yet not tried?

Basic for the leases that are scheduled to expire in 2002, we still have and roughly what is rolling over for the remaining of the year is about 70%. So out of that remaining 70%, we have already renewed 40%, so 50% are remaining out of that 70% of the portfolio rolling. Does that answer for your question?

This is Mike Brennan. If you can limit it to one more question as we have just get a whole line of people there who would like to get in as well.

BRYAN LEG]: Okay my last question is lease term fees, whether there is any lease term fees in the quarter?

Yes, there was [Bryan] about $450,000.

BRYAN LEG]: Perfect, thank you guys.

Thank you, moderator Lou Taylor was next up.

Thank you. Our next question comes from Lou Taylor from Deutsche Banc.

Michael, can you just go over the [same store] breakdown again, the revenue and expense, please?

Sure, [Lou] the [same store] revenues went down 1.3% and same store expenses decreased by 2.8%.

Okay, all right great. The second question is for JoJo, just on the development pipeline, the 200 million you list as under construction, do you have any redevelopment in there or is that all ground up?

Yes all that is ground up.

Al right. And then the $70 million of Build-To-Suits? Is that within the 210 or is that something else.

That's something else.

All right and is that Build-To-Suit, I mean, are those are fee deals or are those merchant involvement deals?

_____] was a fee deal. The other three deals which I haven't, and I would not want to disclose because of our confidentiality agreement with the tenant is one is we own and we sell it and then the other two are other fee deals.

But I guess why you wouldn't you include them with 209?

Because the 209 is what's currently under construction, these are not currently under construction.

Also we defined the 209 as expected development [Lou] and I just specifically separated it, you know, you can look at it from a profit generation point of view, the Build-To-Suit building on our balance sheet is creating a merchant development profit, but for my presentation, I will separate what's expected and what's Build-To-Suit.

And last one Michael Havala just in terms of the dilution from being the slower lease up and slower sales, wouldn't the cost be capitalized from the developments and if you didn't sell them, you know, you wouldn't recognize the profit, but it sounds like you are going to do that and would you be rolling it into existing buildings paying rent or would you be rolling over for new development, and if you went into existing building wouldn't it drag your IIS income down for later this year or next year?

Lou] as far as the $209 million of development that we have going on that was, you know, as of March 31st ... if you just roll that forward and lets say it was all leased and sold tomorrow, you wouldn't see as greater a number being redeployed into development. Exactly what the amount is, you know, I would say maybe in the $100-150 million range that we redeployed into development, but remember also what you don't see in that 209 or what JoJo mentioned is our Build-To-Suit fee deals, which are done; the Build-To-Suit fee deals, which will also add or be a part of our IIS income. So as long as we have $100-150 million of Build-To-Suit in our development activity going on, it should not negatively impact our IIS income.

But if your development pipeline is going to be smaller in 2003, is your IIS income going to be ... you expect it to be down in 2003 over 2002?

No, [Lou] just to add on, I mean, if you look at the pipeline ... the merchant development pipeline it is quite significant, but you have raised a point that we are all focussed on and that's why we working very hard into working with Corporate America, [Lou] to try to generate sales lease back and surplus redevelopment opportunity. And like I have said, it does take time, but we are hopeful that we would land some fairly decisive ones. So if you look at it going forward what we haven't done in First Industrial and we hope to do is increase our surplus property in redevelopment pipeline and we are very, very excited about that opportunity going forward.

Lou] we would anticipate that the mix could change. So if we take that money from development and we see a great corporate real estate acquisition to make instead of building a new building we would put it therein as JoJo alluded to you we were working on some of that right now. So on the IIS number, we don't anticipate it all going down, but we would see a shift of potentially in the mix.

Okay thank you.

Thank you. Our next question comes from Lawrence Raiman from Credit Suisse First Boston.

Hi, aside from the numbers, I was just curious if there has been any sort of changes people, you know, David often speaks in the conference calls about operations, I was just curious whether there is been any management changes with the new organization?

No Larry not at all. We just started to be more efficient and David has to spend two days preparing for it. So, he said why don't you spend that out in the field leasing, no change at all.

Would you anticipate there being any sort of cost initiative over the course of this year over and above what's you have already done in spite of fundamental trend?

No, no I don't anticipate any.

Okay thanks.

Thank you, our next question comes from Lee Schalop from Banc of America Securities.

Every one here excuse there is two questions. The first, could you talk about if you have made any changes to the way you report FFO in light of SFAS 144 and the new [_____] guidelines that followed that.

Lee, with respect to that we are doing what's consistent with what Maytaq, recommended that we do with SFAS 144 and that is basically calculate your FFO in a sense ignoring the SFAS 144.

So there is been no change Lee.

Great thanks.

ALEXIA HEID]: And then Michael Havala I think that you are projecting a flat sense for growth for the year? Is there is something about the 60% of the remaining roll over this year? Is there something about the composition of the markets it has been etc that will you expect that [same store] growth will reverse the trend and turn positive in the rest of the year?

Alexia Heid] this is JoJo. Right now, based on our own understanding of what the markets rents are and our rents per space on all their roll overs we are right about 5%-10% below ... we are signing leases comparable within the same properties so we expect to increase those in place rents at about the historical level of 3%-5%.

Alexia] this is Mike Brennan and to a bigger question. There are those who take a different view and more optimistic view and perhaps, you know, have concluded prematurely or rather correctly that it is clear skies from here on. So I hope they are right and I hope we are wrong, but yeah there are you know I mean if you listen or if you talk to other people in our business, some of them have a more optimistic view point on. Ours is the pretty much state where we were at 60 days ago. So it could, you know, people that have a different view and some people have been talking about rent and emphasizing rental rate growth instead of occupancy. So there are certainly things that could change it, but we have to see capital spending resume, we have to see plant utilization go up, and we have to work through the vacancy. So, we just maybe take a little slightly more conservative view on it.

ALEXIA HEID]: And JoJo I just want to make sure that I understand the numbers, you mentioned that there has been 5%-10% spread between your in-place rents and market rents and that you expect to grow rents on expiring leases because of your focus on occupancy of roughly 3%-5?

That's correct [Alexia].

ALEXIA HEID]: Okay thanks.

Thank you, our next question comes from [Terry O' Connor] from [_____].

TERRY O' CONNOR]: Yeah I have actually got two questions. One is if I am reading the numbers correctly your development pipeline went from roughly $232 million at yearend to $209 million now, which implies you sold $23 million worth of development properties.

Yes that's correct, most of what will go into the KFH fund will come from the development pipeline but there are certain circumstances where they are interested in some other properties that we own and those will be sold through venture if it mutually makes sense from our point of view and from their point of view.

TERRY O' CONNOR]: Could you remind us what is the threshold before assets can be put in that investment? Do they have to be fully leased up or what has to happen in order for an investment to be sold out of the government pipeline to them?

It has to be 90% leased or more among other requirements, but that is the leasing required.

TERRY O' CONNOR]: One other question is you mentioned in breaking down your property sales that 34% of sales were to individual investors or private investors at 10.5% of cap rate, can I ask you why you would be selling any properties at 10.5% cap rate when you are having the kind of difficulties that you are reinvesting in properties at that same cap range?

The property we sold to them is a redevelopment property. As I mentioned, that does not offer us any more higher total returns that we typically get in acquisitions because, you know, there are properties wherein you can buy at 10.5 and not offer your total return higher than 10.5. So we are very, very focussed on total return. The property that we sold we feel has spread out in terms of both run rate growth or it exhibits a flat run rate stream. So, if our target is 12% for the return what we need to look for in those properties that have decreasing at a line and at the same time increasing cash flow and therefore may be even have the arbitrage to buy at a higher cap rate and sell us at a slightly slower cap rate. So the property that we sold [Terry] didn't exhibit that and, you know, we have said in the past that we look at the properties in which we view an opportunity to turn higher or so on all our properties, and if it doesn't meet our criteria it goes on the block.

Terry] this is Mike Brennan, another way of putting it is that if somebody gave us a properties that had a 10.5 cap rate and then we held it for 10 years and sold it at the same price and just got a 10.5 cap rate we would not buy it. We need a better return than that and as JoJo mentioned it is cap rate plus residual equals total return and we are a total return by ourselves. It is a good question. It is not apparent from discussion, but that's what we do. Those are our standards we need a better return than that simply put.

TERRY O' CONNOR]: Going back to one earlier question, it sounds like your development pipeline would be meaningfully smaller if you could start it over today and that you would tend to make it smaller in any case and I am still struggling with how do we get up IIS income if the key component of IIS income gets smaller.

Yes the reason that it can is because IIS has three components. It has development and it has existing buildings, which is development, its redevelopment, and existing building sales. So the way you get it up is by, as mentioned to Louis, by changing the mix. If it was good to develop in the past we would that and if its not the optimal place to put our money in the future then we invest in different things where we invest in a combination of things. Example, if we sold a $5 million development property and we find a very attractive $5 million corporate acquisition, we will sell that corporate acquisition and we will buy it and then sell it and that would become part of IIS income. So you know the development pipeline that goes down does not in anyway mean that IIS income goes down, and again it is just a change in the mix.

TERRY O' CONNOR]: Well, I would say you had a struggle convincing people overtime that IIS should be considered core income and existing building sales are of certainly lower quality and the argument that this is ongoing business for us than development projects are, so what you are suggesting is that there will be mixed shift here to stuff that you are going to be more skeptical about?

What I will also is that of the $209 million of development we are not expecting to sell all that this year. In other words that's not just a one-year supply of profits that go towards IIS. That's more like 18 months or may be 2 years supply of development products. So, that is something I will also just make sure that we are clear on that we are not looking at $209 million being sold this year and those profits going into hitting our IIS numbers.

But [Terry] let me go back and answer your question. I don't care whether it is a development or whether it is an acquisition of a corporate property where I make my money. Money is money to us. If we think 10% on a $5 million development deal and make 10% on a purchase and resale of a corporate acquisition, it makes no difference to me. So, you can see that there are people who have a different view of us, but that's our view on it.

TERRY O' CONNOR]: I guess the other point of view is that in existing building sales, sales of depreciated property is not something you can count on all the time, and that the income shouldn't be capitalized the same way.

You don't necessarily know you can count on development either. So you either can make money on it or you cannot. Development has risks and so does existing buildings. I don't really see too much of a difference and economically at the end of the day, it really doesn't make any difference to us. It doesn't matter where you make money or where you loose money, either you make it or you don't or you loose or you don't.

TERRY O' CONNOR]: It only matters in the sense that if you are paying dividends and distributions based on income from property, lease rentals versus the sale of assets and capital gains in the long run, it will make a significant difference.

I don't know if it is an accounting question, but obviously the base of the operation [Terry] is our portfolio earnings. It is our ongoing rental stream. You know not to beat a dead horse, but if the mix changes from time to time, that's very much a part of our business and if in one year it's good to develop we do it, if one year it is better to acquire that, we do that. These are all surfaces that we try to provide Corporate America with if that's the thing that is most good for us at the time or what they need more that's what you will see us do.

TERRY O' CONNOR]: Thank you.

Yeah, thanks.

Thank you we do have a follow-up question coming from [Bryan Leg] from Merrill Lynch.

BRYAN LEG]: Actually my questions have been answered thank you.

Okay, thanks [Bryan].

Thank you. Our next question comes from [Gary Boston] from Salomon Smith Barney.

GARY BOSTON]: Hello good morning. I was wondering if you could talk about the starts in the first quarter and give us a breakdown of that activity.

GARY BOSTON]: I mean in terms of new development that you started during the quarter, what is the breakdown between, sort of, Build-To-Suit or those types of things that are expected to go into the fund.

Gary], we have not started any buildings in the prior quarter. The $209 million pipeline that you see is basically in terms of shell construction, substantially complete today, and some of the project have commenced in the ... most of the projects have commenced in the first half of 2001. In the first quarter of 2001 was an active year, but we have not any specific project since I would say March or April of 2001.

GARY BOSTON]: Okay. It sounds like you said the Build-To-Suits that you referenced earlier had not commenced, so I guess those would be second quarter starts.

Okay, now for Build-To-Suit, we did commence the building for Maytaq Corporation.

GARY BOSTON]: Okay, yes. I just wonder when you were speaking about the guidance and sort of the occupancy expectations for the balance of the year, you said 92% was the average occupancy you expected or where you expect it to be by year-end?

That would be the average.

GARY BOSTON]: Okay, in terms of that expectation and 3-5% rent rollover growth, I mean, moving up from 90.8% today to an average of 92% that's a pretty big occupancy pickup combined with positive rent growth, I am not sure how you getting to, sort of, flat [same store] numbers.

Well, because even at 92% occupancy as an average for this year that would be lower than the average occupancy for 2001.

GARY BOSTON]: So sequentially you would see some pretty strong growth that you are talking on year-over-year?

Yes when you get into 2003, yes so as your occupancy rises in 2002 because you had high occupancies in 2001, you see flat [same store], but when you get into 2003, you compare that with 2002 that's where you would expect to see some better [same store] growth.

GARY BOSTON]: Okay, in terms of you know getting to that 92% average occupancy what if you haven't seen this sort of increase in utilization or a real pickup in leasing signed, what are you looking for on the horizon to give a better comfort level with that being a really achievable number.

Well [Gary] it is just that some of our markets like Indianapolis and Cincinnati have actually had occupancies below the market in the quarter before last quarter 2001. So we are just expecting some of our sub markets just to get to market and so, you know, it is not relying on a significantly increase in activity, but just that some of our sub markets like Indianapolis and Cincinnati were weak.

GARY BOSTON]: Okay thanks for all.

Thank you and our last question comes from [David Kopp] from Robertson Stephens.

DAVID KOPP]: Yeah good morning guys. Just a clarification on the $24 million in developments that were completed during the quarter ... all of these were sold in, if I am correct?

Two out of the three, there were three projects in $24 million that were completed during the quarter, two out of those three were sold into the fund. So, the majority of the number, I don't remember the exact total, but it was in the line of a share of dollars.

DAVID KOPP]: And what was the occupancy on those?

Those were both 100%.

DAVID KOPP]: All three of them or were they two in the front?

The two resources of the fund were 100% ...

And the remaining property that was not sold into the fund was at about the 70% level.

DAVID KOPP]: Okay and then at the end of the quarter, what did you have that characterizes as help for sale in terms of assets?

Are you looking for a dollar amount or you looking for?

DAVID KOPP]: Yeah.

David] I don't have that number handy, but I can certainly give you a call back and provide you with that information.

DAVID KOPP]: Okay, thanks.

Thanks [David].

DAVID KOPP]: Thank you.

We do have a follow-up question come from Lee Schalop from Banc of America Securities.

Just following up on [Gary Boston's] question about the occupancy, can you tell us what the occupancy level is today, is it actually already up from the 19.3 at the end of the first quarter?

Slightly yes.

90.8 in the first quarter and we are about the same or slightly up right now.

We don't have time as we have appearance for another call. Lee did we answer your question?

Thank you. Our next question comes from [Jenner Spears] from [Davis Bonds].

Lee if you are still out there, you can come and ask for the follow-up question, I think we got cut off there sorry about that.

JENNER SPEARS]: Michael can you hear me this is [Jenner Spears].

We can [Jenner].

JENNER SPEARS]: Okay great, I just have a one quick question, I don't remember verbatim what you said regarding your 10% return, you know, KFA from acquisition developments or whatever, but could you clarify that comment to the extent that it relates to risk?

Sure, hi [Jenner] I won't talk about our investment threshold returns that we need to have. I just want to tell you that, that is information that we don't release. When we look at returns we in the investment committee try to make sure that the risks are properly analyzed and underwritten in any particular acquisition. So are there risks adjusted rates for returns for different properties? Yes sure there are. We have a certain threshold that we like all acquisitions and developments to need, but when as we go into the detail of the underwriting most of it is implicit there. You know what I mean. So there does exist significant differences between different properties that we have. Re-developments or developments or Build-To-Suit or acquisition are obviously different in terms of their risk parameters. But where we hit the acquisitions and the developments, where we really hit among the underwriting is the assumptions that go into resale, downtime, rental rate growth, capital expenditures, and so for. So, it is implicit in the underwriting of each deal that we look at every particular building, building by building. Does that answer your question?

JENNER SPEARS]: It does, thank you.

Okay, thanks. Lee, I don't know if you still have a follow-up question out there, if you are there you are welcome to come on back, if not we can follow up with you after the call. Okay, I think I that is it. And if there are no more questions, I just want to thank everybody and we look forward to talking with you soon.

Thank you, this does concludes today's teleconference. You may all now disconnect your lines and have a great day.