First Industrial Realty Trust Inc (FR) 2004 Q1 法說會逐字稿

Good morning and welcome to the First Industrial Realty Trust conference call. At this time, all participants have been placed in a listen-only mode. It is now my pleasure to turn the floor over to First Industrial. Please go ahead.

Good morning everyone and thank you for joining us today. Before we discuss our results for the quarter, let me remind you 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 market 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 GAAP policies and guidelines applicable to real estate investment trusts.

For further information on these and other factors that could impact the company and the statements contained herein, reference should be made to the company's filings with the SEC. I will now turn the call over to Mike Brennan, President and CEO, Mike.

Thank you very much, and welcome everybody to our first quarter 2004 earnings conference call. I would like to begin by introducing the members of management that are here today. Jo-Jo Yap, our Chief Investment Officer who will discuss our investment performance and our outlook for the balance of '04, David Draft, Executive Vice President of Operations who will discuss our portfolio performance, Mike Havala, our Chief Financial Officer who will take you through the balance sheet and discuss the guidance for the balance 2004 and you just heard from Mike Daly, our Director of Investor Relations.

For those who are new to the company, First Industrial is a nation-wide acquirer and developer of the five industrial facility types that most commonly found companies supply chain networks. This allows us to capitalize on what we regard as the three key characteristics of our industry, the first one being size -- the domestic market is 26 billion square feet. So the greater our capabilities and the greater our geographic reach, the greater our opportunity.

The second characteristic is ownership. In the industrial market place, 65% of that 26 billion square feet is owned by corporations and to serve that market, an infrastructure, a well-developed infrastructure is critically important.

And the third characteristic of our business is that we deal in a commodity product, but it's one where superior returns are possible for low-cost acquirers. I am pleased to report that in the first quarter we are very much on track to meet our objectives.

First quarter FFO was 81 cents a share, coming in at the higher end of our range. Our portfolio registered its fourth consecutive quarterly increase in occupancy. The economic gain component of our earnings from capital recycling resulted in net profits of $16.2 million and produced an absolutely outstanding internal rate of return of 20.8%. We owe much of our good fortune in that regard to our decision to focus on the corporate real estate market and that continues to deliver benefits for us.

In this particular quarter, three-quarters of our acquisitions came from corporate America, they were corporate real estate acquisitions. And as you will recall from February, we mentioned that one-third of all of our investment activity came from corporate America for the full amount of 2003. So this continues to be a very important part of what we do.

Looking beyond the first quarter, the stage is set for us to harvest the opportunities for growth that we've outlined in the past. If you take a look at the economic outlook, clearly that's very positive. The ISM index has remained above 60 for five months and that's the longest span over 60 since 1983, so that is clearly positive for us.

As you'd expect, the first quarter corporate profits will be up, and they're estimated to exceed '03 levels by double digits and following that profitability, business investment spending was very strong.

Consensus predictions on the increase in business investment spending is in excess of 12%, and if that happens, that will be higher than any single year in all of the 1990s. And all of that is important because as business spending goes, so goes industrial absorption.

And again because we had strong business spending, we had another quarter of positive absorption in the first quarter of '04. However, as we've mentioned in the past, despite those good things we see, we'll still need to get through a double-digit vacancy number and see that vacancy rate go down before pricing power returns to the landlord.

But this economic outlook clearly, an improving economy is going to help our occupancy. And as I've mentioned in the past, every 1% rise in our occupancy adds approximately 8 cents per share in earnings to our bottom line and it's worth noting that for seven consecutive years from 1994 through 2000, our occupancy ranged from a low of 95% to a high of 98%.

But in addition to the earnings potential that we have from occupancy gains, and also as we've pointed out in the past, the company currently has nearly $300 million in what we call low-income producing assets, that being land, developments, cash, and mortgages and our plan in 2004 is to reduce those by $100 million and invest the proceeds in income producing assets. And with that, I'd like to pass the discussion to Jo-Jo.

Thanks, Mike. In terms of economic gain performance, we had a good quarter, posting $16.2 million in net profits. This represents a 36.8% increase over the first quarter of '03.

Now, the first quarter of 2004 marks our sixth year of recycling and reporting our economic gain results. Now these results reflect the success of our versatile disposition tactics with our one-off sales capability.

In particular, we took advantage of the robust market for industrial product by all types of buyers. In fact, in the first quarter, we sold $112 million of properties and land in 19 separate transactions.

We owe the consistency of our gains to the strength of our pipeline, which remains strong with approximately $746 million of properties we could harvest in the next 18 months. Specifically it includes $243 million of existing buildings, $402 million of merchant development and redevelopment properties, $90 million of build-to-suits and $11 million of land.

In our press release we also placed on the market, the properties in our first venture with Kuwait Finance House. With respect to our development properties under construction, the occupancy is at 70% today. Build-to-suits and fee developments in process, includes a total of nine projects totaling 2.3 million square feet.

Customers include Mary Kay Cosmetics, Ford Motor, Caterpillar, Maytag and Mobile Carpets. As the economy continues to strengthen, we are in better position to capture more build-to-suits going forward even though we control 1700 acres of land. This would allow us to construct approximately 30 million square feet.

About two-thirds of this land is controlled primarily through options and no-cost marketing agreements. To secure this minimum cost option agreements in late 2002 and early 2003 at the low end of the development cycle, and they should serve us well as the market improves.

Regarding our reinvestment performance, we continue to identify and execute on transactions at projected yields of 10.1%, which is 160 basis points higher than our sales cap rates of 8.5%. We achieved this by investing $72 million in property acquisitions and new developments. The deal sizes ranged from $2.8 million to $31 million in the first quarter.

The last critical factor in our ability to source reinvestment opportunities, is the growth in our corporate real estate business. As Mike mentioned, about three-quarters of the acquisitions in the first quarter were closed directly with corporate America.

Companies we worked with in these transactions included: YKK Fasteners, APYS Incorporated, a French conglomerate, Square D, Procter & Gamble Logistics and Ingram Book Group.

From time to time we get questions about the real estate quality of corporate acquisitions. I just want to say, in most cases, real estate owned by corporations is built and maintained under spec classifications that are generally of a higher quality than those typically found in generic merchant developments.

These assets were generally not built with a real estate profit motivation, but instead were built to satisfy long-term operational needs. And that typically results in a higher level of construction such as thicker floors, more power, stronger columns and roof structure. And usually in conjunction with this, these assets usually come with excess land originally purchased to ensure their expansion needs are met.

Now, this additional land feature now serves to increase the functionality in the value of the assets. Bear in mind multiple factors drive the growth and sustainability of corporate real estate transactions. This includes a need for supply chain efficiencies, pension liability issues, mergers and acquisitions, and increasingly the need for expansion space as business improves.

Corporate real estate transactions also can come in the form of multiple property transactions or in a series of transactions over the course of a relationship. The common ingredient though in meeting the customer's needs in all of these transactions is certainty and speed of execution.

Finally, in terms of our reinvestment pipeline it’s encouraging. We anticipate we'll invest anywhere from $150 to $175 million in acquisitions and developments in the second quarter. Of that, $99 million is already under agreement. With respect to our net lease fund with Kuwait Finance House, our total transactions under agreement and under serious consideration exceeds $100 million.

In summary, we're pleased with our investment performance, and our sales pipeline remains strong and deep. We expect to be able to reinvest our sales proceeds into higher returning investments as we continue to lever our platform and take advantage of our increasing corporate business. I will now turn the call over to David.

Okay, well thank you JoJo. I will start with the key first quarter statistics. Occupancy came in at 88.5%, that's a 10 basis point increase over the last quarter of last year, and as was stated, is the fourth consecutive quarterly increase in occupancy.

Our highest occupancy came from southern New Jersey, Los Angeles, Dallas, and Philadelphia. Lowest occupancies were reported in Tampa, central PA, and due to a couple of recent downsizings, Chicago as well.

Highest occupancy levels in terms of product type, came from warehouse and light industrial type buildings and lowest occupancy in R&D/flex product, which I would just note is less than 10 percent of our portfolio on a square footage basis.

Same-store results. With Amazon termination fee taken out of the comparison, we were minus 2.9% in the quarter. If we compare that to the average of 2003, that minus 2.9% is a 110 basis point improvement. Cash on cash rental rate changes came in at minus 3.7 percent. And then just also for a comparison, 2003 average, at 3.7 betters it by about 200 basis points.

Rental rates were the strongest in our warehouse and light industrial type product, and that really lines up consistent with occupancy as well.

In terms of the length of our lease terms, very consistant again in the quarter. Five years on average, which compares to a 2003 average of 5.1 years. Leasing cost, down again moderately, they came in at $1.97 per square foot. And again, comparative to 2003, we had $2.06 in 2003, so $1.97, we're better there as well.

Land and building expenditures, we analyzed that number. It would be 5 cents per square foot, which is at the low end of our range, we're happy to see that.

And finally, tenant retention, again, very solid. 64.2% based on square footage, and 76.5% based on the number of leases. So a very strong level there, and what we relate that to primarily is, the level of satisfaction with our properties and our services.

So really, then, across all of those key areas of performance, we remain very much on track with the with 2004 plan.

So at this point, I'd just like to look at the portfolio as we see it performing over the next two to three quarters. The summary comment would be it's a positive outlook, shaped, of course, by the improving fundamentals of the economic recovery. We expect to see improvements in occupancy and market rental rates. The moderating factor, of course, will continue to be the national availability rate, which at this point at least is still at a historical high, though we see that gradually reducing here as time goes on.

Same store, we think the average decline in 2004 will be modestly less than in 2003, and that's consistent with what we projected on the last earnings call as well.

And then just looking at our remaining rollover here in 2004, as I stated earlier, our Q1 renewal rate was solid, and we've so far, renewed approximately 35% of our 2004 rollover. So a very strong start. And additionally, discussions with our remaining rollover, they're going very well.

The amount of remaining rollover, I'd just like to note, at this point is very similar to the same point last year, in 2003, though there certainly is a difference in the leasing activity overall. We feel very good about our renewal position given where we are in an increasingly strong environment.

Leasing costs, we project they'll be right in line with the run rate of around $2 a square foot, that we've announced on the last call as well. And, of course, given the economic improvement, we see that gradually decreasing as the year goes along.

I'd just like to finish up with a comment on the increase and activity that we're seeing from prospective customers. We're definitely getting more inquiries from signage and our other marketing efforts.

Our brokers and our leasing directors are showing space more frequently, and I would also tell you that, that's happening geographically in a very broad way. It's across most all of our markets.

Clearly, the focus is returning to future space needs within the context of the improving economy. We started to see the early effects of that in Q1. We certainly look for that to continue and the momentum to grow as we move through the year here.

So that concludes my report for today. At this point, I will turn the call over to Mike Havala.

Well thanks, David. First I'd like to talk about our balance sheet.

Regarding the strength of our balance sheet, our debt to asset value was 42% as of the end of the quarter. Our interest coverage for the first quarter was the 2.8 times and our fixed charge coverage was 2.3 times, very solid ratios - which, by-the-way, should improve over the course of the year as fundamentals improve and our income increases.

With respect to the qualitative features of our debt, we have as you know, one of the longest debt maturities in the entire REIT industry. In addition, we have very little secured debt, as 97% of our assets are unencumbered by mortgages.

Next, let me talk about earnings and guidance. As you saw in the first quarter, we are very much on track with our 2004 plan. In fact, in the first quarter we were in the higher part of the range of our guidance.

Also, I should note, as we had in the press release, if you remove the Amazon lease termination income from the first quarter of '03, that is the comparative quarter, our FFO per share actually grew by 20% in the first quarter of '04.

With respect to guidance for the whole year, 2004, we reaffirmed our guidance for FFO in the $3.35 to $3.55 range, and then with respect to GAAP EPS, we actually increased our guidance by a little bit. That range is now $2.15 to $2.35.

We outlined the key assumptions for our guidance in the press release, and just to go through a couple of key points here. Our same store, we expect to be slightly negative this year, and that's calculating it excluding the 2003 Amazon lease termination fee.

We anticipate having about 89% occupancy during the year, which would mean that there would be a small increase during the course of the year. That's what we expect. We also anticipate the monetization of at least $100 million of our low income producing assets. And most of this would happen in the second half of the year.

And then with respect to economic gains, similar to what we have seen in prior years and then also based on some known transactions that we're currently working on, we anticipate that these will be somewhat back-end weighted.

And then with respect to the EPS and FFO guidance numbers, they do not assume any impact from refinancing existing debt or the redemption of callable preferred stock.

The last thing I want to mention with respect to our earnings guidance is that we did give the second quarter guidance in our press release, so that's laid out for you there.

The next thing I want to talk about is interest rates. As everybody has seen, interest rates have moved up pretty significantly over the last month. And there's two quick points I want to make about this. First of all, all of our permanent debt is fixed-rate. The only floating rate we have right now, is of course, our line of credit. The second point about this is in March, we decided to lock in interest rates via an approximately $150 million swap in order to hedge against rate increases.

Well, this has proven beneficial, as we did this prior to the April 2 jobs report and so interest rates have moved up about 75 basis points since our locking in. So we're very pleased about that.

The last thing I want to mention is the two significant opportunities that we have. The first opportunity rests in assets which are on our balance sheet that earn a below normalized return. We call these our low income producing assets. Specifically, these are cash, land, construction in-progress, and mortgage notes receivable. As of the end of March, we had $305 million in these assets. And if you look at what we actually earned on these assets versus what we could earn on this capital, a normalized return, say 10%, that incremental return or that difference is about $24 million a year.

Now, we probably won't monetize all these assets of course, but certainly we anticipate monetizing a good share of it. The second opportunity lies in occupancy. As Mike mentioned, between 1994 and 2000, we were anywhere from 95% to 98% occupied. And if you just calculate the difference between 95% occupancy and 88.5% occupancy, that computes out to about $35 million in additional annual NOI. So I wanted to share these two opportunities with you, that is the low income producing assets and the opportunity that we have in increasing occupancy as it's something that's significant to our future potential and, by-the-way, it's something that we have within our existing capacity. So with that, let me conclude and say that our financial position is strong, it is, in fact, improving. We have a solid balance sheet and strong and diverse sources of cash flow. So with that, let me turn it over to Mike Brennan.

Thanks, Mike. Hopefully it's clear from the comments that the company's running game and passing game are both on track. The passing game, what we refer to as the passing game are economic a gain profits, as developed a profitable niche in corporate real estate, and our running game, our earnings from portfolio NOI, is grinding out steady improvements as the leasing market improves.

The second take-away point is that the economy's improvement is going to help both aspects of our game. The increase in business spending has increased base absorption, and that's helping our occupancy and the improvements in fundamentals will eventually lead both to new development opportunities and faster lease-ups of existing assets, both of which should lead to greater economic gain.

So the combination of the two, good execution on our running and passing game combined with now having the economic wind at our back, rather than facing a headwind, gives me every confidence that the opportunities that we outlined for growth here today and also in February will actually manifest themselves and eventually manifest themselves in growth and shareholder value.

So with that, moderator, could we take questions at this point?

Thank you. The floor is now open for questions. If you have a question, please press star one on your touch-tone phone at this time. If at any point your question has been answered, you may remove yourself from the queue by pressing the pound key. We do ask that while posing your question to please pick up your handset to provide optimum sound quality. Once again, that's star, one on your touch-tone phone to ask a question at this time. One moment while we poll for questions. Our first question is coming from William Acheson from Prudential. Please go ahead with your question.

Thank you very much. Good morning, gentleman.

Hi, Bill.

Some questions on the KFH portfolio that you have agreed to sell. What's the un-depreciated book value of the real estate assets there?

Yes, Bill. As far as that sale goes, we're really not going to comment on the specifics of it at this time, as you know. This is a sale that has just been put on the market, and we really don't want to go into the economics of that transaction now. Also, I hope you appreciate that we want to respect our partners' desire for confidentiality.

Okay, I'll try to limit the questions so I don't violate your disclosure. Your percentage interest in KFH, could you refresh my memory there?

Yes. It's a 15% interest.

Okay. And the size of the portfolio, it's been reported at 6.2 million square feet; is that correct?

That is correct.

And we're not going to talk about pricing or cap rate assumptions. Does your full-year guidance for FFO and 18-month sales include an allocation for that sale?

Yes. With respect to our earnings guidance, let me just say this. The expected profit from the sale of that portfolio is included to an extent in our guidance numbers. And, again, let me explain this further. When we develop our guidance, we look at perspective transactions, we estimate probabilities and handicap them accordingly, and so the sale of the properties owned in the venture really is no different than how we approach it with sales on our balance sheet and in our pipeline. So, you know, it's included at a level that we're very comfortable with and hope to be conservative at the end of the day.

Okay, I just want to make sure, you know, I'm approaching this from an intuitive modeling sense whereas you guys have the real numbers, I want to make sure I'm looking at it the right way. If it's 6.2 million square feet, just to throw a number out there, $50 per square foot, call that $300 million, your portion of that sale would be $45 million. Would you include the $45 million figure in your guidance for sales as opposed to the larger $300 million?

In our guidance for sales, what we show for the 18-month pipeline, that does not include that. That's just on balance sheet assets.

Okay. That's helpful. Profit margins have been averaging pretty close to 15%. Do you have any reason to expect it to be different on this sale?

Again, we're not going to comment on the economics of that. The other thing I should also mention is that with respect to our guidance, really our guidance for the year would be the same with our without the transaction, just to clarify that.

Okay. In terms of motivation, did you and the Kuwaiti organizers just decide it was a good time to sell or did they want to leave? Could you go through the genesis of that, perhaps?

Yes, I mean it's very simple, we believe now is a good time to sell the portfolio. Remember, we're now in the third year of what was originally designed to be a five-year venture. So at some point, we were going to sell anyway within the first five years of the venture. The venture being started in 2001 of course. So we believe that we have created a substantial value for First Industrial and KFH, and now is the right time to harvest that value.

Do you see -- I might be crossing the line here a little bit, but do you see any opportunity for earning a promote on the sale as is standard with joint ventures?

Again, we're not going to comment on the economics of it.

Okay. Now, in terms of the overall picture, it does appear that you're confident enough to be able to deploy capital quickly enough to maintain a respectable coverage of the dividend, you don't see that changing, and how do you see the percentage of dividend - the percentage of regular FFO covering the dividend over the next year or two? Can we expect to see regular operations cover a greater percent?

Well, let me make a couple of comments about that. We anticipate, if you look at our guidance for 2004, that our FAD payout ratio will be lower than 100% but will clearly cover our dividend. In fact, even if you take the low end of our guidance for the year, we would still more than cover the dividend.

And that's including the economic gains?

Sure, that's including all cash flow generated by the company, yes. Okay, any -

Gentlemen, this is Mike Brennan. You know, I mean obviously, as I said, our running game, or our earnings from our portfolio NOI, that's going to be going up at a greater rate in all the probability than will earnings from economic gain profits. So the composition of what contributes to the earnings is going to be -- you know, we anticipate as we move into the balance of '04 and '05 that the running game will contribute to a greater extent than it has in the last couple of years just because of the improvements in fundamentals and the reinvestment of low-income producing assets.

How about a trend in lease spreads? It appears that things are firming up out there. Do you see them turning positive by the end of the year?

Bill, this is David. You know, in terms of our - first of all, let's look at it in two pieces, I guess. In terms of our rolling rents, we turned in on a relative basis, at least, a good first quarter, though it was negative. We would just restate our probably 5 to 10% rolldown yet on our existing rents on a market-to-market basis, declining as the year goes on however. And also it might be helpful if I just comment on market rents overall. We think there is a lot of stability there generally speaking, and that we shouldn't see a lot of movement up or down in market rents generally.

Okay.

Does that answer your question?

Yes, sir. And occupancy. You say that the negotiations are going well with the rest of your expiration schedule. Did I hear -- I don't think I heard an occupancy forecast for the end of the year.

Yeah. What Mike Havala said was that we expect to average 89%, which is, again, consistent with what we projected on the call a couple of months ago. And, obviously being at 88.5 today, we're going to average more than 89% over the next two to three quarters.

Okay, thank you very much, that answers my questions.

Thanks, Bill.

Thank you. Our next question is coming from Lou Taylor from Deutsche Bank. Please go ahead with your question.

Thanks, guys. Good morning, guys.

Hey, Lou.

Let's see, can you guys just talk a little bit about that first quarter leasing activity and maybe some of the activity you have in the pipeline. Are tenants expanding, contracting, keeping the same square footage? What kind of trends are you seeing in the leasing activity?

High, Lou, it's David again. Let me try to answer that in the context of, you know, maybe where the activity came from in the first quarter and where we're likely to see it in the next couple of three quarters. And I'll give you -- you know, I'll give you just a few industry categories as well that might be helpful.

We're definitely seeing continued activity, strong activity in the import and export business. Whether it's in LA, obviously due to the port activity there, or in our properties in the San Diego, Otey, Mesa market, where we're getting a lot of cross-border activity as well.

Healthcare and medical, we’re seeing good momentum there, in Denver, Dallas, and Salt Lake City, in those areas where we tend to have product that appeals to that type of a user. Consumer products and food service in particular continues to be strong. We're seeing that in Nashville and Chicago as well.

Even in some of the general warehousing and logistics business. Not as much in the large bulk storage, that's a little bit more inactive but, for example, in Houston in Q1, we leased three spaces totaling over 300,000 square feet, actually, to logistics providers. So we're starting to see a little bit of pick-up there.

Decision making process is I wouldn't say significantly different from where it was in prior quarters, though the level of interest in expansion space and new locations as well, is picking up, Lou.

But in terms of the net activity of the guys that are active, are they taking more square footage or are they just taking same square footage - different location or same square footage in the same location?

No, It's generally more square footage. I mean, and often in the same location, I mean it's preferred, typically at least, to expand in a current location rather than a second location. Or obviously, logistical efficiencies connected with that for most companies. So I would answer that by saying expansion would be number one, taking additional space when not available immediately adjacent to existing space would be number two. But it's definitely space growth.

Okay, thank you.

Thank you. Our next question is coming from Lee Schalop from Banc of America Securities.

Hey guys, this is Christie McElroy here. I was wondering if you could go into a little more detail on your plans for reinvesting the proceeds from your low-income producing assets and other asset sales.

Yes, with respect to our plans there, if you're asking about where we're going to reinvest those funds into, basically into income producing assets.

Hi. Again, this is Jojo. Part of the low-income producing assets are of course construction in progress, and one of the things that we're going to do is we're focused to leasing that up. Basically, as I said in my presentation, we have currently $99 million of acquisitions and developments under agreement. We would expect to deploy any and all of the monetization of those low-income producing assets to those investments, identified investments and hopefully more.

So no plans to repurchase stock?

Well, that's always a possibility. We still have significant authorization left on our stock repurchase plan. So that's always an investment option, depending on the price of the stock and other investment alternatives.

What about geographically in terms of your acquisitions and development plans? Any specific areas of the country?

Certainly, right now, the strength of our investment program is our ability to be selective in 25 different markets, and we will continue to focus on that.

In terms of divestment also, that is one of our strengths. Like I've mentioned to you, we've achieved record-level IRRs because we have had 19 separate transactions in multiple cities. We will continue to focus on those.

As we sit right now, any submarket that we would invest, it has to first satisfy our projected growth requirements for net investment, and basically saying that supply/demand fundamentals in that market have to meet our criteria.

So there's no specific target markets that you're looking at?

Our 25 markets are our target markets.

Got it. Can you go through the difference, the sequential difference, in your 81 cents for the first quarter and lets say the midpoint in your second quarter guidance is 78 cents. What's the difference there?

We expect the sort of big picture, we expect our second quarter to be very similar to our first quarter. The only thing that we're factoring in to that is the fact that we were net sellers in the first quarter. So that could have an impact on the second quarter.

So it's really just gains?

No. It's being net sellers. We sold more than we invested in.

So a little bit of dilution?

Yes.

And then what about your ramp up in the second half of the year? How much of that is gains and how much of that is an improvement in NOI?

Yea, we're not going to provide a detail specifically on that, but let me just say that it's a combination of both. It's a combination of expected increases in NOI, and that's due to a slight improvement expected in occupancy, as well as the monetization of low-income producing assets. We expect that to have a meaningful impact. And then we do anticipate the economic gain numbers to increase in the second half as well. As we mentioned, there's a little bit of seasonality to that, as well as some known transactions that we're currently working on.

Great, and one last question, I was wondering if you could comment on any trends you're seeing in cap rates?

Yes, Christine, Hi - this is Jojo again. Trend -- it's -- right now, as we sit, its pretty much stabilized over the past year, year and a half. Cap rates have, as we all know, have come down a bit. But right now, it's -- we project it to be in the 8 to 9%, Christine. That’s for core, multi-tenant type product throughout the rest of the year, of course, investment-grade net-lease, long-term net-lease product trades lower in terms of cap rate. Does that answer your question, Christine?

Yep. It does. Thanks guys.

One thing that sometimes is helpful to keep in mind on the relationship between interest rates and cap rates is just what's happening with the fundamentals. We would rather -- would rather sell a property at a 9 cap if we got a $4 rent versus an 8 cap if we had a $3 rent. In other words, if interest rates rise, and it's a reflection of improving fundamentals, remember that what you might lose with interest rates you might gain as people look forward to better fundamentals. That's why historically, cap rates have been relatively sticky as it relates to their relationship with interest rates.

All right. Thanks, guys.

You're welcome.

Our next question is coming from Jonathan Litt from Smith Barney.

Hey, good morning it's Gary Boston here with John.

Hi, Gary.

Mike, in terms of the guidance, is there anything in that number to reflect the reduction in fee income that you might get as the KFH -- JV unwinds? And any cone you could add as to how much that is, sort of annualized, would be helpful?

That's factored into the guidance, and I will say it's a small number. A very small number.

Okay. And any sense on -- I mean, do you expect that you will be able to get that transaction completed by year end or is that really going to be more of an '05 transaction?

We don't want to comment too much on the economics and the timing of it.

Okay. I think that's it. Thanks.

Once again, if you do have a question, please press star one on your touch-tone phone at this time. Our next question is from Albert Adriani from Haven Funds.

I was wondering about your guidance as far as economic gains are concerned. Is that range that connection to FFO, is that connected to the volume of transactions you do or is that connected to potential moves in cap rates and resulting change in economic gains?

Albert , Hi - this is Jojo. Our economic gain guidance really comes from the pool of properties that I have discussed, and then applied a probability-weighted factor in those happening. You know, a number of those need to have the asset management plan completed, but out of that probability pool, then we use that to provide guidance.

Okay, the spread you show between acquisitions and dispositions, the cap rates there, are those under the same definition?

Yes. They are.

Okay. In 2003, you show the expected cap rates on your acquisitions of 10.6%. How does that compare to the actual cap rate?

When you say -- what do you mean by actual cap rate?

Well, today, now that we're into 2004, and at the end of the fourth quarter of 2003, that on the 6.6 million square feet of properties purchased, you have an average expected cap rate of 10.6%.

Correct. Let me give you an example. In first quarter of '04, the properties we bought were at 97% occupancy. And the cap rate that we have quoted you reflects that. Does that answer your question?

Yes. Thank you. Lastly, you guys referred to the potential growth in earnings due to the lease-up of vacant space. And he mentioned, I believe, a number of approximately $35 million of NOI. And I think that ties nicely into your NAV calculation, where you actually show the dollar amount of NOI that would be realized there, which I cap at the 9% -- again, almost $400 million of value there. The question is, in that NAV calculation, what kind of costs to lease the space, if any, are included in that calculation?

That does not factor any -- does not factor in any unusual cost to lease the space. Just a more normalized cost to lease the space. In the NOI number, of course, there is not a cost to lease the space. That's just the rent.

Right, okay. Thank you.

It is, of course, we've kept our NAV calculation based on a 9% cap rate, so we do that for prior period comparisons. Obviously, you know, people -- you can make whatever adjustments you would like to the NAV. Some people say that the cap rates, whether we like it or not, are in the 7s and 8s. Any changes in that is obviously going to change your NAV.

Thank you.

Thank you. Our next question is coming from David Copp from RBC Capital.

Hi, good morning, guys.

Good morning.

Looking at your development schedule on page 24 where you outline your $155 million development in process pipeline. You've got an expected yield there of about 8.5 to 8.6%. Looking back over the last several quarters, it looks like about what your selling cap rate has also been. Can you give us an idea of what your expectation is with regard to selling cap rates on this development pipeline that makes that an attractive investment for you guys?

Sure David, Hi - this is Jojo. One thing that I do want to note is that 35% of that pipeline is build-to-suits, with lease terms, with investment grade tenants with lease terms ranging anywhere from 10 to 20 years. We would expect to sell well below the 8.6.

So if you were to go in and look at the exit values here, we expect to, if you took that out, there would be significant value creation on the rest. Another way of looking at it is that our build-to-suit yields, which represent 35% of that pool, David, has a lower initial yield, and the rest of the non-build-to-suit have a higher yield. Does that answer your question?

Well, somewhat. I mean I guess - so you're looking something like a sub-7 exit cap rate on these? Because it seems like on a risk-adjusted basis, even on a build-to-suit, I mean I know most of your peers aren't dipping into the low 6s on these, the low 8s, rather, I apologize, in terms of yields, especially when you can buy, you know, based at least on first quarter and looking on most of last year, I mean, you're buying at a 10-plus cap rate, it would just seem that maybe your capital and your efforts are better spent on the acquisition side as opposed to the development side.

Sure David, that's a good point -

And I also have to assume on average, as we looked at your sales in '03, those also had some long-term leases in there, and you still wind up with the average as if you do, if you follow my logic.

Yes, I do, I do. And one of the things that I agree with your logic. One of the things that we're not doing right now, is that we're not big on speculative development, that's number one. Second, is we continue to do build-to-suits. And just to address your valuation question, I cannot name transactions, and I would not do that,but on the build-to-suit in the market today, and the major markets, our properties for long-term build-to-suits trade for anywhere from 6.5 to 7 cap rates. And I hope that would somewhat answer a value creation question for you.

Thank you. Our next question is coming from Gary Freeman from GEM Investors.

Hi, guys. Good morning. Two questions. The first one is just a point of clarification. I think you mentioned early on in the call that you have 35% of your rollovers to date taken care of. Was that a year to date number?

That is year to date, Gary.

Through - so through mid-April, basically?

Yes, correct.

And I thought your comments on the dividend early on in the call were helpful, I just wanted to elaborate on that a little bit. Can you give us a sense for when we might expect operational cash flow to cover the dividend?

You're talking about operational --

I'm meaning the contribution from NOI, basically.

Basically, the environment that would happen just if you did the math, would be when occupancy gets back in a normalized range of low to mid-90s. When some of the low-income producing assets are Monetized, and then we're in an environment where rents are not negative, but are actually slightly positive.

Is that a 2005 occurrence, do you think?

I'll say it's anybody's guess a little bit as your going out a couple of years, but certainly, it's probably at 18 months or longer than 18 months.

Okay. Thank you. That's helpful.

Once again, if you do have a question, please press star one on your touch-tone phone at this time. Our next question is from Terry O'Connor from Cedar Creek Management.

I was hoping you could elaborate a little bit with regard to an earlier question about cap rates. I gess I would be surprised about the margin of a 75 basis point increase in the 10 year rate that didn't translate into some pressure upwards on cap rates on these kind of properties. What's your plan in the event that rates spike up again here and then it becomes a lot more difficult to sell properties for economic gain, because under the scenario you just outlined essentially everything has to go right before you can cover the dividend with operations?

In terms of the cap rates - this is Jojo. Yes, an increase in interest rates, you know, you would think would increase cap rates. I do want to say first of all, even if you increase -- two things.

Even if you increase the interest rates quite a bit, what would happen is that today, the debt/interest rate constant still allows a buyer of real estate in the 8 and 9% range have a slightly positive arbitrage.

So that's -- meaning that right now, even if 10-year treasuries were to go to 6.25%, because of the spreads lenders are willing to do, that would afford the buyers to buy core industrial in the 8 to 9% range.

Second, increases in interest rates usually point to a sign of an improving economy. In most cases in my experience what happens is that buyers of real estate are in a position to ascribe higher rental growth rates, increasing occupancy, and basically, lower down times. Most of the population of investors are still total return, IRR driven. So in one sense what you may lose on the leverage yield, you pick up in the growth rate assumption and we're seeing that today.

Could you just give us an idea of what the average life of your ownership and the assets in the KFH pool is? It looks like it's a three of year thing, so is it crazy to say you've owned them on average a year and a half?

Well the fund on average has owned them in that range, yes. Because the fund was started in 2001 and has invested over time. So with respect to the ownership in the fund, that's correct, yes.

And there's one piece I'm struggling to understand. In a year and a half on average, what's changed here that makes it go from a buyer's environment to a seller's environment? Essentially we've had stable cap rates in that period -- if anything, they're going down. What makes it an -- I guess --

Well, hey - Terry, this is Mike Brennan. First of all, most people know that the KFH 1 fund was buildings that we built. And that s like 95% of those buildings were contributed into the fund. Just got to wait and see. We'll see whether or not we get them sold at the price we want or not. That's the big news in the industrial real estate market today.

Things are getting sold for more than you paid for them a couple of years ago. Every couple of months, we seem to set a new high water mark. Who would have thought that these multi-tenant properties down in Miami that recently sold would sell at a mid-6 cap rate? Who would have thought that properties that were recently purchased by another industrial REIT would go to 6 1/2? These are bulk warehouse buildings and they sold for over $55 a foot. So we have to see what happens what happens. The plans for these development properties were commenced about three years ago, bought when land was a little cheaper, some of it leased when rents were a little better. We'll see at the end of the day whether it sells for the number we want.

Thank you.

Our final question is a follow-up question coming from Albert Aldrani from Haven Funds.

I forgot to ask. What is the average in a lease term of the assets that you buy versus the average lease term on assets you have sold?

What we -- well, it's not much different from our core portfolio. Our average lease-term in our portfolio has been in the five-year range, and the properties that we buy, except for when we engaged in long-term sale lease-backs, typically range in the same, you know, length. And if you -- Albert, if you notice, you go way back for three to four years back, we have bought and sold a number of properties, and proof of that is that our average lease term has not materially changed. So what we buy is basically in terms of lease term is what we sell. Did that answer your question, Albert?

Yeah. I'm just trying to determine - you said that the spread you enjoy between your purchases and sales, if that's due to adding on risk to the purchases versus your sales or if it's just the fact that you're able to do the small one-off transactions which give you sort of a sustained edge and therefore a higher value.

Albert, It's the latter, plus our increasing share of corporate business. It's the latter. You mentioned one off, that is the key. If you follow, we do engage in a lot of transactions, that is the key to being competitive at the local level in a one-off basis.

Thank you.

We actually have one more question. It's a follow-up question coming from David Copp from RBC Capital.

Hello again. I'm just following up on that last question, with regard to lease term, you know without getting any more specific than you're comfortable, can you talk a bit about the lease term in place on the four acquisitions you made this quarter, and also talk a bit about in-place rents versus market rents? You know if I look at least three out of these four acquisitions, they appear to be somewhat big box. I'm surprised that you were able to get those cap rates going in. Can you explain how you were able to achieve those cap rates? These appear anyway to be the kind of assets that would be getting a low 8, high 7 kind of cap rate, and yet you're getting a 10.5.

Sure, I can give you an idea. I will not go property by property specific.

Sure.

But in one of the transactions there, we acquired it from a company as a surplus property during due diligence. We then put a tenant in, in a long of term basis. And that was a very good transaction because we had a motivated seller, and using our local market network, we were able to lease that space. In another transaction --

So one of those, I'm sorry, acquired and leased is in the same quarter here?

Yes.

Okay.

And then on another transaction, it was a corporate seller who needed about 20% of their existing space for a long-term basis, and we then, during due diligence, filled up 80% of the space, and both were investment-grade companies. We were very, very happy about it. Again, it was a motivated seller and we were able to use our local market expertise to fill up the space. So we're very, very pleased about that. And one was a sale lease back?

Okay. I would now like to turn the floor back over to Mike Brennan for any closing comments.

I think, moderator, if we are done with questions and we are done with the call, I look forward to catching up with everybody on the second quarter. Thank you very much.

Thank you. That does conclude today's teleconference. You may disconnect your lines at this time and have a wonderful day.