Franklin Street Properties Corp (FSP) 2009 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Second Quarter 2009 Franklin Street Properties Earnings Conference Call. My name is Shantalay and I will be your facilitator for today's call. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session toward the end of this conference.

(Operator Instructions)

At this time I would like to turn the call over to Ms. Barbara Fournier, Chief Operating Officer. Please proceed.

Good morning, everyone, and thank you for participating in this call. With me this morning are George Carter, our Chief Executive Officer, and John Demeritt, our Chief Financial Officer. Before I turn the call over to John Demeritt, I must read the following statements.

Please note that various remarks that we may make about future expectations, plans and prospects for the Company may constitute forward-looking statements for purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those discussed in the Risk Factors section of our annual report on Form 10-K for the year ended December 31, 2008, which is on file with the SEC.

In addition, these forward-looking statements represent the Company's expectations only as of today, August 5, 2009. While the Company may elect to update these forward-looking statements, it specifically disclaims any obligation to do so. Any forward-looking statements should not be relied upon as representing the Company's estimates or views as of any date subsequent to today. At times during this call, we may refer to funds from operations or FFO. A reconciliation of FFO to GAAP net income is contained in yesterday's press release, which is available in the Investor Relations section of our website at www.franklinstreetproperties.com.

Now I will turn the call over to John Demeritt, our Chief Financial Officer.

Thank you, Barbara. Welcome to our earnings call. We're going to be talking with you about our second quarter 2009 results, and we'll start with a short overview. Afterwards, George Carter, our CEO, will further discuss the quarter and FSP.

I'm going to be brief and will be referring to our earnings release, the supplemental package and the 10-Q that were filed last night. I'd like to start with our balance sheet, which continues to serve us well and will enable growth as we move ahead.

As of June 30, we had cash of $24.5 million and $126 million in availability on our line. This liquidity will help operate FSP and fuel future growth. Our property portfolio is well diversifed geographically and has no secured debt. Properties with secured debt can have property-specific issues at debt maturity that could cause a sale when the market is not right for it. Since our debt is unsecured, it's viewed more like one property and mitigates this risk.

At the same time, our low leverage ratio provides a terrific loan-to-value for our bank group on our unsecured loans. Our interest rate coverage ratio is also very high compared to our peers, currently at about 11 times.

We finished the quarter with our leverage or capitalization ratio at about 19.2% with $199 million in debt outstanding and shareholders' equity of $836 million. Our shareholders' equity is held by our common shares only, as we do not have any preferred shares or other equity instruments; it's just those common shares.

The $199 million in debt, as I said earlier, is unsecured and consists of our outstanding line of credit balance of about $124 million and an unsecured term loan of $75 million. Our line matures in August of 2011 and our term loan can be extended to October of 2013.

I think this balance sheet paints a solid picture of FSP at a time when there continues to be general concerns about the availability of debt from financial institutions and debt levels at many companies. We may see some issues with leasing and investment banking as we move through the down part of this cycle, but we have the strength of our balance sheet as ballast.

On the income statement, we measure our performance with three key drivers, which are real estate operations, investment banking, and gains on sale of real estate or GOS. The real estate operations driver is our ongoing net leasing or rent revenues from our portfolio of properties, which is a recurring business. By contrast, the latter two, GOS and investment banking, are transactional in nature. And even in normal markets, the quarter-to-quarter results from them can be very choppy.

First with GOS during the second quarter and first half of 2009, we didn't have any sales of properties so there wasn't any GOS. Second, our investment banking profits continue to be impacted by the financial markets. Investment banking profits come from the fees earned on the value of shares of securities we sell as private placements. The sales of these private placements are what we call gross syndication proceeds, and the fees we earn are based on a percentage of GSP.

The income derived from this is essentially syndication and transaction fee revenues on our income statement less the impact of direct expenses, which are commissions, some G&A and related income taxes.

Gross syndication proceeds generated a relatively insignificant $375,000 of sales in the second quarter of 2009 compared to $49.9 million for the second quarter of 2008. In the second quarter of 2008, we had significant proceeds from two syndication transactions we were working on at the time. And that was just before the markets began having the issues that they faced last year. In the last four quarters, our investment banking has been fairly slow and we've talked a lot about that.

We measure performance of real estate operations and investment banking by FFO, which for the second quarter was $17.4 million or $0.25 per share. And that's fairly flat compared to our first quarter this year, which was $17.3 million in FFO or also $0.25.

Comparing the second quarter of 2009 to 2008, FFO was $2.9 million lower or about $0.04 lower per share than last year. The decrease was primarily from the impact of slowness in the investment banking in this environment that I was just talking about, which was about $3.7 million lower in Q2 '09 than in Q2 '08. And the decrease was just partially offset by performance of our real estate portfolio, which was up in that about $800,000.

The real estate performance was greater primarily from three properties we acquired in the last 12 months. One property in Houston we acquired in May 2008 so it was only in part of Q2 last year and the full quarter this year. And two properties we acquired in December 2008, one was located in Virginia and another one was near St. Louis, Missouri. Both contributed to our second quarter '09 and obviously we didn't have them in the second quarter of '08.

During the second quarter of 2009, late June 26 and June 30, we acquired two more properties, one in Minnesota and the other in Virginia. So, their contribution to this quarter was pretty insignificant but will definitely impact the third quarter and beyond for us.

That covers our financial performance. The earnings release supplement and 10-Q filing go into further detail about our results. I also wanted to add one thing, that in early June we attended NAREIT and went to an investor conference there and had a number of meetings. I had two takeaways from the meetings. One, although we don't provide guidance, we could provide more property level detail in our supplemental reports. So, we added that this quarter and that was filed last night.

And the other was based on repeat questions about FAD. We added that to our supplemental. And our FAD for this quarter was $0.24 per share, which is about a penny below our FFO. And the definition and quarterly calculation of FAD is in the filing, if you're interested.

That concludes the financial highlights. And at this point our CEO, George Carter, will tell you more about FSP, the results, and where we are. Thanks for listening. George?

Thank you, John. And thank all of you for taking the time to listen to our second quarter 2009 earnings call. As John has said, our FFO for the second quarter of $0.25 per share was sequentially flat compared to our first quarter. On the surface of it, a static quarter with no property sales, no investment banking, no contributing new property acquisitions, and no big occupancy change in the property portfolio.

In general, that's about what happened. More specifically, the property portfolio occupancy for the quarter averaged about 93%, but at the end of the quarter it ticked down a notch to 92%. Again, for like type office properties in the national market, that 92% compares to about an 84% national average.

No properties were sold in the quarter because none were for sale. It'll probably be a while before the cycle looks right again for selling property in any quantity. And certainly, available financing will be critical to that process. Right now it is not -- as I mentioned before, just the absolute price you can potentially get for a property being sold in the market but it's the liquidity and the competitive pricing. I think it's important for all public companies to sell properties to try to get the best pricing. And of course, without liquidity and competitive pricing that's hard to gauge.

As John said, we only did $375,000 of investment banking for the quarter. It was still a quarter on our investor side of watching. There certainly still is some skepticism about whether in fact this broader economy has bottomed. And more specifically on commercial real estate, the quarter was just more and more bad press about the future of commercial real estate. It seems to be a dominant theme and that certainly affects psychology.

On the buy-side for our syndication business -- the buy-side has evolved over a while of the profile of the syndications and investments that have evolved, particularly since we've gone public in 2005. And one of the elements of that evolution is a shorter time horizon before potential sale of the properties in a down economy like this. In a down market, those time horizons get much longer and very fuzzy. So, broadly speaking on the acquisition side, we still are challenged to find properties that fit our prototype for syndication at this point.

We did close one of our ongoing sponsored REITs, a private placement offering called FSP Grand Boulevard. Franklin Street purchased the remaining preferred stock in that offering, about $15 million investment. That particular single asset REIT owns a 28-story, class A, multi-tenant office tower in the Crown Centre section of Kansas City. This is FSP's third sponsored REIT that we have an interest in. We purchased about 27% interest in Grand Boulevard. So, that's three out of our outstanding 12 single-asset REITs that we have an interest in.

It is important to remember that when we purchased shares in our sponsored REITs many times, most times we are effectively converting an acquisition loan which could service monthly into shares which pay dividends quarterly and in arrears. So, there's usually a quarter lag between return on that capital investment.

Finally and most important, two new properties were purchased, as John said, directly into the FSP portfolio for a total cost of about $51.6 million. However, both acquisitions were closed in the last week of the second quarter, and actually, one was on the last day of the second quarter. Both acquisitions are in areas of the country where FSP or its affiliates have been active owners and managers of office property.

Both properties are newly constructed within the last three years, are 100% net leased to excellent credit tenants. Considering cap rate and price per square foot, replacement costs and a number of other metrics, we believe these acquisitions represent outstanding values.

The acquisition dates, as I mentioned, of the assets did not allow them to contribute meaningfully to our second quarter results. But both properties will be on for the full third quarter. These two property acquisitions are our first in 2009, and along with three property acquisitions made during 2008, are now fully contributing to FSP's revenue.

Again, while a static quarter of profits compared to the first quarter of 2009, FSP was not just marking time. This is a very exciting time for FSP. And the strength of its business model which has, at its philosophical core, the recognition of commercial real estate is a very cyclical asset class. We believe we're in a wonderful position to take advantage of this part of the commercial real estate cycle and to meaningfully grow our longer-term profits, dividends, and company value.

The second quarter of '09 continued in a conservative, patient, and disciplined way the execution of our business plan to achieve those growth goals. And while we never have given forward profit guidance primarily because of the unpredictability of our transactional business components, I thought it might be useful at this time to take a little more time on this call to talk about some of the dynamics that are likely to affect us going forward at this point in the commercial real estate cycle.

And when I say going forward, I really mean the balance of '09 and 2010. And when I say at this point in the real estate cycle, obviously, it's just our opinion on where we may be in the cycle. I'll try to give you these dynamics quickly in the extra time here. And I'll try to give you both the positive and the negative sides of these issues.

The first big dynamic factor that is affecting us is the on-ground economic fundamentals of commercial real estate. And when I'm talking about commercial real estate for the balance of this call, I am really talking about office properties and specifically suburban office properties, which is our primary product type.

The negatives are pretty well known and they're pretty big. Vacancies are rising. Rents are falling. Vacancies nationwide, depending on what research you read are 16% plus. Rents nationwide vary quite a bit, and obviously from lease to lease, quite a bit, depending on when you signed the original lease. But rent drops of 10% to 35% nationwide in this asset class are fairly common.

Our existing portfolio averages five to 10 year leases. Most suburban properties have tenants that are in the five to 10 year lease range, maturity range, so that when you see 10% to 15% lease roll per year on a portfolio like ours, that's very, very normal. In this market, the result of any lease roll is generally longer vacancies and lower net rents than you could get obviously in a good market.

Continuing on with negative news, the macro look is not that good, either. Unemployment continues to rise. Many companies, as most of you know, that are reporting earnings in the second quarter are beating on the bottom line estimates of those earnings but are missing on the top line. Most of the beat is because they're reducing expenses.

And in case there is any confusion, rent is still an expense. And rent is an expense which is generated by another expense and that is people. There is probably no greater connection in the asset class than office and employment. So, you are not likely to see occupancies rise and rents rise until when and if you start to see employment rise.

And bankruptcies can still surprise you. Our big surprise was in '08 with Land America, which has been pretty well publicized. But unless the economy gets sort of a double dip down here, we're probably through the worst of the bankruptcy play. So, it's a fight every quarter. Quarter-to-quarter occupancy and FFO can move around quite a bit with a company like ours.

On the positive side of this really awful economic fundamental economy that we're in for commercial real estate and office properties, FSP really does have what it takes to be very, very competitive in this environment. We have good properties. They're in diversified markets with diversified tenant bases. They're in excellent local locations within their markets. They're up-to-date, immaculately kept, and physically well cared for.

Our property management team is on top of it. We have local property managers that have lived in those areas for long times. They have lots of deal-making flexibility. They know the tenants in the building and they know the tenants from the marketplace that are looking for space.

And most important, when we are talking about FSP's ability to compete, we're really talking about our financial condition, our balance sheet, our capital position, our liquidity. Today it takes dollars to make deals. I'm sure you've heard it from every other REIT that you've tuned into.

Tenant improvements, TIs, and leasing commissions for those tenant reps -- and most of the tenants have commissioned reps to look for space for them -- are very, very important to making a deal. The tenant reps will not even call on you unless they know you've got the money to put together a competitive TI package and most important, to pay them their leasing commission.

The tenant reps, the potential tenants in our markets, they know us. They know we have the capital. They know we have the liquidity. We see deals. We see virtually every deal that is competitive for the modern space that we might have available in the market and get to compete on those deals.

Our unleveraged property portfolio is very helpful here. We have, as John said, no property secured debt. We have low corporate unsecured leverage of about 19%. And tenants today, more than ever before, are very concerned with the property stability. And they will demand finances on the property. They are very concerned with landlord stability. Again, this makes us extremely competitive in our markets.

And actually, we are making very good progress on our leasing. When the Land America lease was formally rejected, we actually started the year with over 16% turnover. We're now down -- and most of this is in the second half of the year. We have now done enough re-leasing to get that down to about 12% for the balance of the year.

And we have a lot of things working; I mean a lot of things. I'm more than cautiously optimistic about our leasing progress for the balance of the year. And again, we're starting at a high rate of about 94% compared to a nationwide occupancy rate of about 84%.

And obviously, our balance sheet allows us to maintain and improve our existing portfolio, keep it in the class A competitive position. And when potential tenants walk in and their reps walk in, our properties look sharp and are ready to go.

The second big dynamic factor is the property sales volume slowdown. And this obviously is on the GOS or Gain on Sale side of our earnings. The negatives here are again well publicized. The sales slowdown nationally is horrendous. And I don't think we're going to get any big turnaround until we start to see some of the fundamentals turn around.

The broad disposition of multiple properties in this market is very tough. But besides fundamentals, the most important thing will be financing. We're going to need competitive and readily available mortgage debt financing to return to the market before sales volume can pick up.

The GOS, gain on sale component of our profit return is not likely to be very prevalent for a while until this happens. But GOS for Franklin Street Properties comes in bunches. In other words, it is very cyclical. We sold about half of our portfolio properties between '04 and '07. And in that period of time, we had bunches of GOS. However, there are and can be some specific property opportunities to sell specific situations, even in this awful market. But again, we'll be very property-specific.

The positives for FSP in this down sales volume are strong. We don't have to sell any properties. We don't have any properties with secured debt on them. We have no secured debt maturities to deal with. And we have, as John said, over 10 times debt service coverage on our 19% unsecured debt.

We've got good cash flows. We have no preferred outstanding so no preferred dividends. No converts that are coming at us. No OP units, just common stock. And after our dividend adjustment in mid 2008, we are currently well covered on the common dividend at about 76% of FFO. And as I've said before, because we have this financial capability we can keep our properties in first class condition, so that when the time is right for sale, they'll look right and be right for that sale and get the maximum dollars.

Third dynamic and factor is our real estate investment banking business. The negatives here have been clearly seen in the last four quarters on our income statements. This is a very, very profitable business when active. But right now, it is not producing any revenue and in fact is causing us money every quarter to maintain.

Our investors, who are primarily high net worth individuals and some institutions, have really been stopped in their tracks now for about a year. Both the fundamental statistics of the asset class continued to deteriorate. And the press surrounding commercial real estate and the investment media is just constantly negative.

As I mentioned earlier, the type of investment product that we have been offering through our investment bank has evolved over time, especially since our listing in '05. And again, finding the right kind of investment opportunity for this business in the last year has also been very hard, again, with the lack of visibility in the future of the economy.

The positives for FSP on the investment banking side, though, are significant. Our cost of maintenance, fully maintaining our investment banking capability, is relatively low. And in fact, we have been improving some technical infrastructure in the bank during this time period.

Our investment banking business is 100% in-house. We use no outside broker dealers. We are completely vertically integrated. We do all dividend distributions, 1099's, et cetera. More and more real estate firms that work in the real estate asset class want to get into this business, but it is very hard to get into. It is very expensive to get into. We've been in it for over 15 years effectively.

Because you really have to do this business correctly, have a securities firm. I mean, having a real estate firm is one thing. Having a securities firm is another. You need Series 24 principals. You need Series 7 brokers. You got net cap requirement, SECs, FINRA. It is not something you can do halfway. As I said, it's very expensive to start but it's very, very profitable once it gets going.

The key for FSP shareholders, in my opinion, is to understand that every dollar of revenue and every dollar of profit from this business goes to our common FSP shareholders. And when we listed ourselves in '05, the profits from this business were really part of our regular dividend. When we adjusted that regular dividend in '08, we really removed the transactional portions of that dividend and adjusted the ongoing recurring part to what we thought would be more than sustainable in what we knew would be a down market.

As the investment bank gets going again and starts to produce profits again, as well as potential future GOS, we view those profits as more likely to be paid as special dividends rather than being added to the ongoing recurring regular dividend.

We currently have about 2,300 active clients in our investment bank and in these 12 real estate syndications. They all -- these single-asset REITs all own individual properties. All those properties have various challenges and opportunities. As I mentioned, FSP has preferred stock investments in several of them.

And we strongly believe that the best long-term leverage for this business is to be standing right next to our investors during these tough times, working hard to make sure that their property investments get through this downturn and come up the other side with the best possible returns. It really is times like these that you cement your investor franchise and its longer-term growth potential.

And finally, like all investment businesses, psychology plays a role. The recent moves in the stock markets and bond markets have helped that psychology. The economy's Armageddon scenario has faded somewhat, and the question of real fundamental recovery and what it will look like has taken over.

Opportunities for single-asset real estate investment and investor equity capital to purchase them are looking better than they have in the last year. A restart of our investment banking business may be close at hand for all the right reasons.

The last big factor and dynamic affecting Franklin Street is falling property values. And when I say falling property values, I don't mean the intrinsic long-term value of a property or its intrinsic long-term capability to produce increasing revenue streams and profit streams or rental streams. I'm only talking about current market values.

The negatives here, again, affect the broader market as well as FSP. Rising vacancy and lower rents and a locked-up mortgage market make for rising cap rates and lower current market values. Virtually all commercial property asset market values are falling. And so, the real current market value of our portfolio is negatively affected as well.

The positive to this whole scenario, again, falls back to our balance sheet and the lack of significant debt leverage, and more specifically, the lack of property-secured debt that could be, if we had it, maturing in this tough market. Without property-secured debt, we really do not have any loan-to-value issues on that maturing debt.

We have only unsecured debt, as I mentioned, at about 19% with debt service coverage over 10 times. We have lots of equity. A small amount of debt allows us to focus on the biggest positive opportunity to come out of this deep cyclical commercial real estate downturn and as to acquire existing real estate assets at the best prices we have seen in a long, long time, in many cases from owners that do have to deal with maturing debt and property loan-to-value issues.

Let me close my prepared remarks by again emphasizing our excitement and optimism about our future growth prospects. FSP's business model is designed to take advantage of the real estate cycle. And we believe that a significant difference in the total return or IRR of commercial real estate investing is made at the point in time of the buy. Price paid and value gotten at the point of purchase may be the most decisive factors in determining ultimate return on investment.

The positive property acquisition opportunities arising out of this deep cyclical real estate recession keep getting better and more plentiful. FSP will continue to take advantage of this opportunity for as long as it is available. And consequently, we believe the Company will position itself for exceptional profit growth as the cycle turns up again.

With that, I'd be happy to open up for questions.

(Operator Instructions). Your first question comes from the line of Dave Aubuchon with Robert W. Baird. Please proceed.

Thank you. Good morning. I appreciate the additional commentary and disclosure, very helpful. George, you highlighted that the acquisition environment is pretty attractive for you right now. You just acquired $51 million worth of assets. What are your expectations for volume over the next year and a half, or maybe more appropriately, the balance of this year, considering your immediate sources of liquidity?

It's going to honestly depend on the capital markets willing and price-right to supply us with the capital to continue to acquire. We have obviously been acquiring, Dave, on our line of credit and we obviously have more room there.

But the basic game plan here is to acquire on the line. And if, and I underline if, and when, and I underline when, the markets are right, we plan to go for the first time in our Company's history to the public capital equity markets. I would say we're doing secondary or follow-on but we never did a primary.

So, we know from other REITs accessing the equity markets that those equity markets are open to certain REITs. We anticipate continuing to acquire on the line, accessing the equity markets if and when the time is right, repaying the line and then continuing that sort of stair-step acquisition on the line/ equity repayment approach and stair-step up through this opportunistic environment to acquire really great properties at great prices.

When you talk about equity markets, you'll never know what they're going to give you. If you look at what exists today, and it's only today, our stock price and all of the different metrics that would be accretive or dilutive to a stock issuance today, we would be in a very accretive position to issue stock and acquire.

So, that's a longwinded answer, Dave. But it's the correct one to say, "I don't know how much more we'll acquire. I hope a lot." We plan to acquire a lot. Since we don't need the capital for other things other than acquisition and since we are accretive in the marketplace as we stand today and that marketplace does seem to be open, we will continue to use our line and the public marketplace possibly for the first time to acquire as much opportunistically as we can.

Understood. And do you feel like -- have you investigated terming out some of the balance on the line of credit in another term loan, similar to what you did last year?

You mean, fix what's currently there?

Yes, sir. Taking some balance on the line and putting on it on the term loan to get five-year debt or whatever?

At the moment we are priced at LIBOR plus one and we have -- which is a pretty favorable pricing with no floor. And we have a couple of years to run before that line of credit matures. So, we thought we'd hold with the line we have and then try to increase it with our bank group in two years and not sort of fix what we have already at the moment.

That doesn't mean to say we wouldn't think about something along that, though, Dave.

Okay. And just going back to acquisitions, George, I believe the last time I spoke to you, you felt like the market was certainly opening up. And just given your acquisitions you've closed in the quarter and your commentary on this call, that sounds like that's still the case. Can you talk about this in terms of how much velocity there actually is? What's the total amount of deals that you may be looking at?

Well, we're looking at hundreds of millions. I don't realistically -- the reality is you never know if you can acquire until you acquire. We have a full plate, and the two transactions that you saw us acquire in June are fairly typical of what we're seeing out there.

These are properties that are fairly new. They are very much below replacement costs. They have cap rates -- and I'm talking about cash flow cap rates, not NOI cap rates. These are effectively triple-net type properties. We've always looked at cash flow. You pay debt service with cash flow, not NOI. These cash flow cap rates are running between 8.5% and 9%. And at 8.5% and 9%, when you really -- and you're talking about leases anywhere between eight and 15 years with steps in the rent every year.

It's really easy, even with low leverage, to get very acceptable total rates of return when you add that kind of cash flow return and appreciation through either static cap rates on high cash flows or, in the best of all worlds, the cyclical cap rate compression syndrome, which we all went through and sold into.

Right. And do you feel like the deals you're looking at now still are bracketed in that 8.5% to 9% cap rate range?

Absolutely. And if you're talking about the kind of deals that we're looking at, they certainly are -- cap rates certainly aren't moving down. If you're willing to do some shorter leases, if you're willing to take a little more risk on credit of tenant, and certainly if you're willing to go multi-tenant operating where you have near-term turnover of, say, smaller tenants, you can do better than that on cap rate.

But I think there [isn't] a natural cyclical nature of the economy and the asset class. There's a sort of a time to buy different types of property. And I think this type of property that you just saw us buying in Minnesota and Northern Virginia are likely to be prevalent at least over the next six months. As we start to see some light at the end of the tunnel, I think you could see us moving away from those properties, doing a little bit more multi-tenant, maybe a little bit more with some lease opportunity, etc.

Okay. And then, can you explain your thought process behind buying the Grand Boulevard building relative to some of the other external deals that you may have been looking at?

It's just a terrific piece of real estate. It's everything that we were looking for. It has a significant major tenant that we're very comfortable with. The building is very well leased. It's great price point per square foot, great cap rate for us. We want to be in that market. We hope to expand in that market over time. It's just as good an investment as anything else we looked at.

So, the yield is -- the cap rate on that transaction is in line with the other deals?

Absolutely.

Okay. Any interest in buying mortgages from banks that may be looking to move loans off their books for whatever reason, assuming that that it's a stabilized building?

I don't think that's us. I think the process and disciplines involved in that are not ones which we have internally or particularly want to develop or particularly think we need to develop.

Okay. Question on the operations -- you mentioned you finished the quarter, I think, at 92% occupancy. You highlighted that the vacancy rate nationally obviously is a lot higher than what your vacancy rate is on your portfolio. You have about 25% of your portfolio expiring through the end of 2010. Can you give a little forward guidance to where you think your occupancy rate may fall in this sort of environment?

I can't, Dave, just because I really can't. I can tell you that, as I mentioned in my comments, the fear that you have when you have lease turnover in a bad economy is you fear no activity. You just fear no one walks to the door. No one wants to consider your space to lease.

That is not the case with us. We have a lot of activity at these properties. We have opportunity, and we can compete for it. I'm pretty bullish about our occupancies. What I am more uncertain about is where the rent levels wind up and the cost of getting those leases, again, the TIs and leasing commissions, rent levels and so on. It's tough out there right now. So, as stuff turns over you have to go with the market to fill the space. An empty space is not a good idea.

One of the things that we have done historically and believe in a lot is not signing big long-term leases for particularly smaller amounts of space in these kinds of markets. If you have to take a lower rent, why not take it on a shorter-term lease and let that space go ahead and turn again three or four or five years out, where you'll have a chance to move that rent up faster than if you lock yourself into a longer 10-year number?

Again, when you have property-secured debt, that may not work with your lender's point of view. But when you don't, like we don't, that works very well with economic make-money-on-real-estate point of view.

Right, okay. Last question I had is related to tenant credit. Any increase in bad debt reserves or any issues that you see specifically outside of the Land America issue?

No, not right now. We look pretty darn good. I think we've gone through -- you'll never know when something comes out of the left field, and as I mentioned, you'll never know if you get a double dip in the economy, which starts another slide. But as we sit here today, we do not see anything significant that we know about in the portfolio.

We went over the bad debt reserve for the quarter and make adjustments here and there, but really nothing significant as what -- as George mentioned.

Okay. Thank you, guys.

Yes.

Your next question comes from the line of Justin Webb.

Hi, guys.

Hi, Justin.

Hi, Justin.

How are you?

Good.

Doing good.

A couple of just follow-up questions that are more technical, I suppose. Could you maybe talk about East Wacker? I think that KPMG was there and maybe occupancy got wacked, pun intended. Could you really talk about what happened there?

Yes. It is a publicly registered company. And so, we have to be a little careful because we file Qs and Ks associated with it, too. But I've actually talked about this on our previous call. KPMG is the biggest tenant in that property. And they have about three years remaining on their lease with us. They've been a wonderful tenant. We appreciate them very much. They have decided at the end of their three-year lease with us to leave and go to another property.

That's one factor. That really doesn't affect occupancy for three years on that particular property. Some of the other smaller tenants that have left the building -- again, just to be blunt about it, sort of stick guns to your ribs and say we either lower the rent, cough up a lot of TIs and leasing commissions or we're going to cheaper quarters. And that happens in downturns.

Again, that property we own all cash. We actually have cash reserves on that property without any debt on it, millions and millions of dollars to get the right tenant at the right rent with the right TI package with the right lease.

And it is a classic example of what I just talked about with Dave of not knee jerking in the downturn and just making deals to make -- tenants are out in force to make deals right now. They've got the market in their favor. You need to be careful, particularly in a CBD property like Wacker which tends to assign longer leases, I mean much longer leases than suburban, to encumber longer-term value of their property with the lease that in a year or two with the same credit tenant, if the economy starts to recover you'll just do much better on.

So, a lot of these has been our making at Wacker. But it is a calculated making relative to the longer-term value of the property.

Again, that sounds reasonable. And then maybe on the expirations, I know Dave had mentioned the 25% rolling over the next sort of year-and-a-half. They did -- they jumped up in this quarter versus last quarter for just '09. What exactly happened there? When the Land America lease was rejected in bankruptcy courts, did that answer the expiration schedule?

No, there were just a few properties in the quarter that -- the biggest hole came in our Dallas portfolio, particularly at Addison Circle. That was the Jones Lang Lasalle Staubach merger that finally left and went to new quarters. That was the biggest single hole.

But if you're comparing it to last quarter, we did not know what Land America was going to do because they had not accepted or rejected the lease.

Right.

And Land America did have a lease that kicked in on November 1, '09, that matured in '16. So, that just kicked in this quarter.

Okay. So, that explains why it bumped up like that?

Yes.

Yes. We would have been, if we had to put Land America in at the beginning of year, John, and then over 16%?

Yes, it would've been over 16%.

So, we have actually done --

We have had some leasing.

Yes, we've actually done quite a bit of leasing, yes.

Let's see. On real estate taxes, you mentioned the market property values are lower here. As a result, do you guys think that the real estate taxes are going to be able to lower maybe this year relative to other years?

I probably -- most REITs are the same. We're very aggressive on that. We go in for tax adjustments on a lot of our properties, almost all of them yearly. We are always fighting that. And in these markets you fight harder with obviously a little more ammunition.

The other side of that, of course, is states and local municipalities and agencies need money more than ever. So, the battle is engaged but -- believe me, we're engaged.

Okay. And then lastly, just quickly, you talked about the cost of maintenance for the bank and you're losing a little bit here, but then it can be quite profitable when the market is revving. What is that full cost of maintenance?

Less than a penny a quarter. Really, when you go through it, some of the investment banking does suck up some of our G&A costs, and that's really what the loss is. The cost to maintain it is really not that significant.

But it's less than a penny a quarter.

Less than a penny a quarter, yes.

Okay, perfect. Thank you.

Your next question comes from the line of Bob Sarason from [Glenoak Capital]. Please proceed.

Hi, guys. I have a couple of questions. One is with respect to the Southfield property, I'm crunching the numbers here but I just want to confirm. The IBM renewal, so they dropped their space it looks like from 138,000 to 83,000 square feet so approximately a 40% reduction in space they took. And the net rent dropped from $2.7 million a year to $1 million a year. That should be a rent reduction of about 63%. Is that a fair assessment of what has happened there?

I'm not exactly sure of the numbers you just read back, but the square footage is correct. The lease that they're currently in expired July 31st and the 88,000 square foot kicked in August 1st.

The IBM story is an interesting one. Obviously, the Detroit area is challenged. But IBM had planned to leave that building. There was a new building that was supposed to be built. And that building did not get built, one. Two, they were then going to go to another existing building but they couldn't come up with the TI package.

So, we did a very short extend for them with no TIs for three years. We cut back their space. We got the space back that we wanted. And so, this was a keep IBM for three years, no TIs. I'm not sure your rent number is correct, but your space is correct.

I'm pulling numbers right out of your --

Yes.

Yes, your gross rent number that you're looking at there probably included the TIs in the old leases. So, net cash probably isn't as dramatic as the numbers you just read. It's possible you're looking at an annualized June number, too. Their lease expired in July. So, I'll have to look at that.

But we actually anticipated that space to be vacant.

Yes.

And we're glad to keep IBM for the three years.

Okay. And the Land America situation, let me just clarify. Is Land America -- is it 100% sure that they're vacating the entire building at the end of the year?

No, that is not 100% certain.

Okay. So, you're still negotiating with Land America to possibly keep some of that building?

That may not be sure, absolutely. We had -- they have subtenants in there.

Okay.

So, there were a number of players there. And then they sold part of their business to another entity that has some interest, too. So, the occupants and the buyers that are part of Land of America all are talking with us.

Again, until the end of October, Capital One is effectively the tenant. And we're effectively 100% leased. Where we wind up at the end of October and November 1st is the question. Clearly, Land America and others effectively were subleasing from Cap One. There's parts of those operations still in their property that would like to stay. So, we are negotiating with them as well as others from the outside for that space.

From the FSP perspective, this is going to -- instead of being one big lease would likely be a number of smaller leases. And it's just a question of how many and how much space you have to fill?

I think that's exactly right. There are actually three buildings that make up this -- it's almost like a campus. And each building has a little bit different characteristic in it. And we are showing literally each building to different tenants for different needs right now.

Okay. So, ideally you would segregate the buildings as opposed to making -- possibly one set of a bigger whole building versus multi-tenant space or just themselves?

No, that's certainly possible. And then, it's possible, too, that we multi-tenant a building. But they're ideal for -- the buildings are ideal for a single tenant that's large enough to use all the space.

Okay. And lastly, you made some comments about TIs and lease commissions. Can you give us an idea -- and I know it's varies by market -- just for example, in a market like the Land America market, what kind of TIs and lease commission packages are you seeing being in the market?

Again, that's just a very tough question because the TI package for a five-year lease or 10-year lease, a credit tenant, a non-credit tenant, a tenant that pays a high level of rent, a tenant that pays a low level of rent. I mean, that package moves all over the place.

But if you were just going to pick a general TI number that sort of sits out there right now for an average 5 to 10-year lease for an average tenant, for an average package, average rent, $25 per square foot is a good number.

Okay. And then, one last follow-up. You mentioned in your comments that you're seeing the national averages for rent falling 10% to 35%. Is that what, in a reasonable scenario, you would expect on some of these re-leases?

Well, it's 10% to 35% off of what it was in the marketplace. It may not be 10% to 35% off of what your existing lease roll was. In other words, if you signed a lease 10 years ago that's rolling to market, you might not see much of a drop at all. If you signed the lease in '05 or '06 or '07 in Manhattan as an example, and you were really re-leasing a space today, you might see a huge dropoff. So, it's -- when I say 10% to 35%, it's against where the market was, not where your lease was.

So, do you think your current lease at Land America is at market or below market?

Again, the rent that Land America would have paid had Land America become our tenant effectively today is probably over the market.

All right, thank you.

You're welcome.

At this time, there are no further questions on the queue. And I would like to turn the call back over to Mr. George Carter. Please proceed, sir.

Well, thank you very much for listening. This was a long call. We won't probably do them this long in the future, but I hope it was helpful. We look forward to talking to you next quarter. Thank you.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a wonderful day.