Franklin Street Properties Corp (FSP) 2015 Q2 法說會逐字稿

Good morning and welcome to the Franklin Street Properties Corporation second quarter 2015 results conference call. All participants will be a listen-only mode. (Operator Instructions). After today's presentation, there will be an opportunity, to ask questions. (Operator Instructions). Please note this event is being recorded. I would now like to turn the conference over to Scott Carter. Please go ahead, sir.

Good morning, and welcome to the Franklin Street Properties second quarter 2015 earnings call. With me this morning are George Carter, our Chief Executive Officer, John Demeritt, our Chief Financial Officer, Jeff Carter, our Chief Investment Officer, and Janet Notopoulos, President of FSP Property Management. Also with me this morning are Toby Daley, Vice President and Regional Director of Houston, and Will Friend, Vice President and Regional Director of Denver.

Before I turn the call over to John Demeritt, I must read the following statement. 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, 2014, which is on file with the SEC.

In addition, these forward-looking statements represent the Company's expectations only as of today, July 29, 2015. 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'll turn the call over to John Demeritt. John?

Thank you, Scott, and good morning, everyone. Welcome to our second quarter 2015 earnings call. On today's call, I'll begin with a brief overview of our second quarter results, and afterwards, our CEO, George Carter, will discuss our performance in more detail and provide an update on our operations and overall strategy as we look ahead to the second half of 2015. Janet Notopoulos will then discuss some of our recent leasing activities, and Jeff Carter will then discuss some of our investment and disposition activities. Then after that, we'll be happy to take your questions, as usual.

As a reminder, our comments today will refer to our earnings release and our supplemental package and also the 10-Q, all of which were filed yesterday and, as Scott mentioned, can be found on our website.

We reported a decrease in funds from operations, or FFO, of about $1.1 million, to $27.2 million, for the second quarter of 2015 compared to the second quarter of 2014. The decrease was primarily from lower property income as a result of the property dispositions we've been talking about and also some single-asset loan repayments we completed in the last 12 months, and also from lower occupancy, which you can see the drop from that in some of our same-store comparisons in the supplemental.

These decreases were partially offset by property income from the acquisition of Two Ravinia that we completed in April. We also benefitted from lower interest expense. As a result, our FFO per share was $0.27, compared to $0.28 per share for the second quarter of 2014. These results were in line with our expectations.

Turning to our balance sheet and current financial position at June 30, 2015, we had approximately $920 million of unsecured debt outstanding, and our total market cap was about $2.1 billion. From a liquidity standpoint, we had a cash balance of $15.8 million and $200 million available on our $500-million unsecured line, so we had about $260 million of liquidity at the end of June.

During this past quarter, we used the proceeds from the recent dispositions and also borrowed from our revolver for the acquisition in April that I mentioned earlier. We also completed the disposition of Park Seneca in Charlotte, North Carolina. We received about $8.2 million in proceeds for that and recognized a gain of about $950,000.

We remain comfortable with our leverage. Our debt-to-total market cap ratio was about 44.8% at the end of the second quarter. Our debt-to-service coverage ratio was about 5.1 times. And for Q2, the debt-to-adjusted EBITDA ratio was about 7 times. We remain an unsecured rated borrower, with about 74% of our outstanding debt effectively fixed or not affected by changing interest rates.

As we continue to execute our asset recycling program, we believe our balance sheet position enhances our ability to opportunistically sell non-core assets and then reinvest those proceeds to execute our growth strategy.

Before I turn the call over to George, I'd like to provide an update on our guidance, which you probably saw in the release last night. We're updating our full-year FFO for 2015 to be in the range of $1.04 to $1.08. And as a reminder, that guidance excludes the impact of future acquisitions, dispositions and capital market transactions.

With that, I'll turn the call over to George. George?

Thank you, John, and good morning, everyone. Thank you for taking the time to listen to Frank Street Properties' second quarter 2015 earnings call. My prepared remarks today will generally follow my written commentary in yesterday's earnings press release. After my comments and others from FSP executives, we will open the call for questions.

As John said, for the second quarter of 2015, FSP's profits, as represented by FFO, totaled approximately $27.2 million, or $0.27 per share. Our directly-owned real estate portfolio of 36 properties totaling approximately 9.6 million square feet was 90.6% leased as of June 30, 2015. And again, as John said, we did update our 2015 FFO guidance range to $1.04 to $1.08 per share, and that just brings up the bottom side one penny.

I thought I would just try to quickly take a step back and reiterate on this call what we are doing and why. A lot of analysts and institutional investors hear this (inaudible) meetings and so on, but I think repeating it once in a while, briefly, makes sense for new investors and people trying to get to know us.

So Franklin Street Properties is very positive on US economic growth, and we are very positive about the office sector and property to participate in US economic growth. We are bullish, but we believe that this cycle of growth that the US is in now will be a much longer and slower growth cycle than many other traditional cycles that occurred sort of over the last generation.

And while there are many, many things that go into our view of this that you could talk about for hours, delevering and some of the new rules and regs on capital and other things are certainly a part of our view of this longer, slower growth cycle, again, with muted spikes and muted down parts of the cycle.

And as part of that cycle, or in addition to it, the other change that has really sort of come front and center since the financial crisis and subsequent recession is the realization by us and a lot of people in the market about the real change in US demographic sets, the aging millennial gen-X's. A lot of things are changing in US demographics.

When you combine it with our view of a long, slow growth cycle, we feel very strongly that urban office properties will do better over the next 10 to 20 years than our older, traditional suburban office properties, from which we really built the Company, and so we have been working steadily and methodically to transform our portfolio from suburban commodity to urban infill -- much more vertical, much more multi-tenant office.

At the same time, we have been working to reduce what was in our suburban portfolio a very geographically diverse mix of properties across the country into a more urban office building located in one of our five core markets that we believe have real significant and meaningful infrastructure and macroeconomic drivers that will make them powerhouses over the next 10 to 20 years. Those five core markets are Atlanta, Dallas, Denver, Houston and Minneapolis.

And so when you look at FSP and its potential growth and how we execute that, the two primary ways is accessing external capital and growing with additional net assets and properties or to stay within yourself and do it organically. Now, 2015 may not be a very good time for us to access outside capital relative to its cost and its potential investment return, but it is a very good time for us to work on our organic growth, and that is what we are doing.

And the two primary avenues for organic growth for us are leasing, which Janet will talk about in a few minutes, and recycling of our suburban properties into the urban infill properties that I've been talking about.

This recycling program is what is causing a step back in the growth line of our FFO. Over the last four years, right up until 2015, we had very steady and strong FFO growth as we leased our portfolio out of the, again, financial crisis and recession and did some acquisition. But when you're in an organic recycling mode like we are, moving from suburban to urban, this step back in FFO during 2015, again, was expected.

And the two big issues -- there are many issues that go along with this, but the two big issues are you're selling suburban commodity-type assets, more commodity-type assets, at probably a cap rate, on average, of 200 basis points above what we are then purchasing our urban infill assets for, and that really is initially, as we take a step back.

Again, most of our infill assets that we have purchased -- most of them have a significant value add component that, when we execute that value add component, will bring NOIs on those properties to an effective acquisition plus cost of leasing cap rate right back up to or in excess of the suburban office properties that we are disposing of.

And over a 10- to 20-year period that we really looking at this long, slow growth cycle to be the main symbol of, we believe that our FFO growth with these properties that we're transforming into will be much, much higher than if we would have stayed with our suburban properties, so taking one step back to take many steps forward is really the way we are looking at what we are doing right now.

There's also a timing aspect to all of this between dispositions and acquisitions. If we want to acquire ahead, unless you want to issue equity, which, again, we don't think makes sense right now in this market for us -- you have to borrow, and so you're going out on a risk spectrum ahead of dispositions, and, again, risk-reward adjusted, that tends not to be our model in most cases.

And so there's a timing aspect between disposing of the suburban office and losing that NOI for the period of time until you can dispose of enough of them to have the capital to acquire what normally is a far more expensive urban asset.

But, again, we feel we're right on track, and again, we feel that -- and of course (inaudible), but we feel that the FFO growth potential over the next 10 to 20 years based upon our transformation of this portfolio now will really be stellar, and we're very excited about it.

And everything we look at since we formulated our opinion about a slow growth economy and changing demographics of the US, all the things that go into our thinking, which really got formulated in 2008, 2009, 2010 -- everything we're seeing in the markets today lead us to believe that that thesis still holds water. We believe it more strongly now than we ever have.

That's a little sidebar, but I thought it might be worthwhile. Continuing with my written remarks in yesterday's press release, I would say that during the first half of 2015, we continued to lease vacant space totaling approximately 547,000 square feet in our property portfolio. The largest lease we completed right at the end of the second quarter, on June 30th, at our Timberlake property in Chesterfield, Missouri, for approximately 117,000 square feet to Centene Corp.

This lease brings the entire three-building Timberlake complex, which includes Timberlake East, to the 77.2% lease level. However, our overall portfolio leased percentage remains relatively unchanged at approximately 90.6% quarter over quarter -- or sequential quarters, primarily because of our $78-million purchase during the quarter of the 442,000-square-foot Two Ravinia office property in Atlanta, Georgia, which, again, is a value add opportunity we purchased approximately 80% leased.

So when you just stop a minute and, again, think about this recycling program and our leasing program, the two ways we are organically working this year, we are effectively selling existing, full-occupancy suburban properties. We are buying existing vacancy in new, urban properties to replace those suburbans that we are disposing of. And then, of course, we are leasing vacancy in our longer owned, established existing portfolio, such as Timberlake.

So selling full occupancies, buying existing vacancies and leasing the vacancies in the established portfolio is really what's the dynamic that's going on, and for us to be able to take an overall portfolio leased rate of 90%-plus we think is doing very well in that scenario, and we anticipate continuing to do well during the balance of the year.

Also, as John said, we, on May 13th, did complete one more disposition this quarter of a property we call Park Seneca, a 109,000-square-foot suburban office building located in Charlotte, North Carolina, for $8.2 million. A total gain of about $900,000 was realized as a result of the sale.

Park Seneca had been owned by FSP or an FSP affiliate since 1997. We continue to actively pursue further potential dispositions of other suburban office assets that we believe are no longer part of our long-term strategy of acquiring larger, multi-tenant urban infill, CBD or town center office properties. Janet will talk about that in a minute. And we remain very, very positive about our prospects and opportunities for the balance of the year and into 2016.

So with those remarks, I will turn it over to Janet Notopoulos, the president of our property management company. Janet?

Thanks, George. As George noted, the biggest lease for the quarter was with Centene Management at the Timberlake property in St. Louis for 117,618 square feet. Centene will occupy the entire second building of the project that was formerly occupied by RGA Reinsurance Group. The lease is for 91 months and is expected to commence around December 1st. The rent is approximately $24 a square foot, which is higher than the expiring gap rent for RGA, and higher than the Energizer deal that was announced last quarter at the Timberlake East building.

In the six months since RGA moved out of approximately 197,000 square feet, we have leased approximately 162,000 square feet of that vacancy, or close to 82% of the RGA vacancy, and there are several strong prospects waiting for the remaining vacant space, which is now primarily in the Timberlake East building. The portfolio as a whole ended the quarter at 90.6% leased, and only 2.3% of the portfolio's square feet expire during the rest of 2015.

The next large scheduled lease expiration will be in January of 2016, when the TCF lease in Minneapolis expires. As a reminder, the TCF lease includes two buildings. The first is a 17-story tower, which we have just completed repositioning. TCF leases approximately 90,000 out of approximately 305,000 square feet in that tower. We expect the 90,000 square feet of (inaudible) space in that tower to start leasing as soon as TCF moves out, similar to the leasing pattern that we saw at Timberlake in St. Louis.

TCF also leases approximately 165,000 square feet in the adjacent low-rise building that we refer to as 801 Marquette at only $4.75 per square foot, net. This low-rise building, 801 Marquette, is the one that's being considered for redevelopment, and if a redevelopment scenario is pursued during 2016, there will be no rent from that building during the construction period, and the rent loss would be approximately $805,000 net per year. However, the potential future rent gain from the new structure will obviously be much greater because of the low in-place rent.

I'll answer any other questions that you have about leasing or property performance later, but I'll now turn the call over to Jeffrey Carter, who will discuss the redevelopment prospects for 801 Marquette further, as well as other investments and dispositions.

Thank you, Janet. Good morning, everyone. I will review our investment activities for the second quarter and year to date, including dispositions and acquisitions. Then I will, as Janet mentioned, conclude with a discussion about the status of our potential development project in downtown Minneapolis at 801 Marquette Avenue.

On the asset recycling front, and in an effort to continue the evolution of our property portfolios George discussed into a primarily urban and infill orientation within our top five core markets, and also to capitalize on strong national real estate pricing trends, FSP continues our active focus on asset recycling of non-core, mostly legacy commodity suburban assets when and if appropriate pricing is in fact achieved.

We had indicated the potential for dispositions of non-core assets of up to $150 million to $200 million during the calendar year, and so far, FSP has sold three properties for approximately $57 million. We continue to think that our range is a reasonable estimate of our potential asset recycling during this calendar year of 2015.

As mentioned on our last call, asset recycling efforts will consist of sales of directly owned properties as well as the potential repayment of certain outstanding single-asset reloans. We will continue to update the market as greater clarity on potential progress is achieved.

As a reminder, in the first quarter of 2015, we sold the 100% leased Willow Bend office center in Plano, Dallas, Texas on February 24th for $20,750,000 and about a $1.46 million gain. Also in the first quarter of 2015, we sold the 100% leased Eden Bluff Corporate Center in Eden Prairie on March 31st for $28 million and an approximate $9 million gain.

Most recently, as George mentioned, during this past second quarter of 2015, we sold our Park Seneca office building in Charlotte, North Carolina, about 110,000 square feet, on May 13th for about $8.2 million and an approximate $950,000 gain. This property was a smaller suburban non-core class B asset that was originally acquired in 1997.

In sum, FSP has sold three nearly 100% leased properties so far in 2015 for about $57 million and recognized a total gain of about $11.5 million on the sales, and we've reinvested so far into one $78-million infill property in our core Atlanta market at Two Ravinia that was approximately 80% leased at closing.

Looking ahead at our potential future dispositions, we have several properties either in the market or pending their price discovery efforts that have the potential, in sum, to meet or exceed our disposition guidance by year end should acceptable pricing be achieved, and we will continue to keep the market informed.

Moving on to investments, as discussed on our last conference call, FSP intends to be a net acquirer in 2015 and has been targeting between $150 million and $300 million in total acquisitions for 2015, with obviously one $78-million investment at Two Ravinia Drive in Atlanta completed so far.

We still believe this investment guidance to be a meaningful estimate of potential acquisitions for the remainder of the year, with waiting likely towards the end of the year to potentially match funds against prospective dispositions. Importantly, aside from the Two Ravinia purchase, further acquisitions are not in our current FFO guidance. FSP is actively working on several specific opportunities that we believe could contribute meaningfully to our future growth and profitability, and we will continue to keep the market aware of any specifics.

As George discussed, we continue to seek infill, urban and CBB office assets in the strongest, most amenity-rich locations within our five core markets. We continue to favor below replacement cost assets and properties that have irreplaceable locations and a wide range of potential value creation opportunities associated with them.

These can include assets with significant vacancy, in the plus or minus 50% to 75% leased range, as well as more stabilized assets that likely have below-market rents and the ability to create value in the near and intermediate term upon lease renewal. Our underwriting criteria is dependent upon the nature of the investment in question, with variance between larger value add and more stabilized assets.

FSP continues to have a healthy array of potential investment opportunities that we're looking at, and we also continue to see a number of potential off-market properties that we're considering as well. The majority of our most promising prospects and underwritings at this time are in our Atlanta and Dallas core markets, as well as in downtown Minneapolis with the potential development at 801 Marquette Avenue.

Two Ravinia was acquired, as we reported on our last call, during the second quarter, on April 8th, for $78 million and $176 a foot. Two Ravinia is a 17-story, 442,000 approximately square foot class A multi-tenant office tower with an attached parking garage, that was approximately 80% leased at closing.

This property was highly attractive to FSP, as we own the immediately adjacent One Ravinia Drive that we acquired in 2012 and which was brought up just from over 80% leased to over 90% leased currently. FSP has now increased our total footprint in our core Atlanta market to approximately 1.8 million square feet, with over 800,000 square feet in the prime central perimeter submarket.

Moving on to development activities, potential development activities continue to be vetted at 801 Marquette Avenue. We believe that 801 Marquette Avenue represents one of the premier development sites available in downtown Minneapolis, and we wish to maximize the site for potential value creation. We do not wish to settle or rush on any possible development that falls short of maximizing value at the site.

With this in mind, we continue to favor a mixed-use development that could contain residential, hotel, retail and office, or some combination thereof. And under this vision, FSP would be the owner of and responsible for the costs of the office portion only, which we still believe would be most likely in the 200,000 square foot range. Initial estimates for costs are between roughly $325 and $400 a foot, or $65 million to $80 million in total potential exposure to FSP.

With FSP taking on the office portion of any potential mixed-use development, we have interest in the site from a premier national residential group and are now working on finding the right sponsor for a hotel portion. We view the potential participation of a hotel group is significant, because it would add a further potential amenity base to the whole development that could further stimulate respective rents and demand from tenant customers. There are no formal agreements, though, to report at this time.

Now, at this time, I'd like to turn the call back over to George Carter to close. George?

Yes, let's open the call for questions.

We will now begin the question-and-answer session. (Operator Instructions). John Guinee, Stifel.

A couple just sort of small questions. I notice that you have the one acquisition of $78 million and one asset sale of $8 million, so a net use of proceeds of $70 million, but your debt only went up by $60 million. What's the difference? And then the second question is it looks to me like you extended $53 million worth of loans for a couple of years. Can you walk through that rationale?

John, this is John Demeritt. The debt went up $60 million, because we used some of the Park Seneca proceeds to acquire that property, but also used some operating cash generated to cover that, so that's why the debt didn't go up as much as the asset acquisition. On the loan expenses for the single asset reloans, we have a property in Houston that we have a loan on called Energy Tower, and we extended that loan for a couple of years, so we're working on some lease ups. In fact, we have the asset manager here who works with that, if you have more questions about that.

I guess from a strategy point of view, if I was thinking totally as a shareholder fiduciary, I'd rather have that $53 million back as opposed to having it lent to a third party at less than 6% interest. Wouldn't that be a better use of the capital?

John, it's George. These loans are, first, mortgage loans secured by properties, so they are a real estate investment. They're really not lent to a third party, per se. They're really a real estate investment secured by the property. And from a pure cash flow point of view, when you consider cash, not necessarily NOI, you can get 5% of 6% cash flows. So when you think about AFFO versus FFO and all of those sorts of things, these are actually wonderful, wonderful investments, and we think they are absolutely great investments for the FSP shareholder and right where we should be.

Again, we know these properties. We've been managing these properties. We originally acquired these properties. We are not lenders, in effect, to the broader marketplace of other people's properties. These are properties that we found, bought, managed and know whole. And as you know, they're slowly being disposed of at the right times, and my guess is that eventually all of these properties will be disposed of and we will be effectively out of the lending business.

Okay. Thank you.

You're welcome.

Dave Rodgers, Baird.

Maybe, Janet, I'll start with you, and I wanted to ask a little bit about lease economics in the second quarter. It looked like lease economics definitely dipped on the leasing that you did. I was curious if that was a function of maybe some PI at the Centene space or if that was just a broader trend that you noted during the quarter.

Could you just refer me to what numbers you're actually looking at to be asking the question about the lease economics? Are you looking at the leasing activity spreadsheet that gives the six months --

Well, I think we were just trying to look at it as probably the combination of the all-in economics on the leases, so the spread, the TIs, any free rent component. It looked to us that it kind of dropped in the second quarter, but I guess I'd be interested in your commentary on that.

In general -- and we are still spread in several markets beyond just our core markets -- the rents in the markets are rising. The leases that we're doing in those good markets are above expiring rents. They're certainly at market. If you look at the leasing activity, one of the things that makes a difference is what the mix is of renewals versus new, so the extent -- if you look at the six-month period and try to subtract and find out what the tenant improvement leasing costs for this quarter were versus the other, a lot of what drives the per-square-foot is what the ratio is of renewals, which obviously are low cost to new.

And so we did -- Centene was a big driver of the activity in Q2, and we have -- it's a new lease with space that needed to be renovated, so that would obviously have a higher TI than the renewals that we were doing in the past at Park Seneca, where we'd have under 1,000 square feet but lots and lots of tenants renew one year at a time. Is that --

Okay, that's fair. Thank you. And then maybe on -- when I look at your lease expiration schedule, next year, Danbury and Fannie Mae both expire, I think about 100,000 square feet each, plus or minus. Any thoughts on kind of where those discussions are today?

Unfortunately, I don't have -- John Donohue was our regional manager for Dallas on the call this morning. He's tied up on another matter. But on Danbury, that property has two properties -- two buildings. They exercised an early termination option on one of the buildings, and that building was completely sublet, so we are in the process of talking to the sub-lessees to see if they're willing to pay what we think is the market rent, but we think we'll either renew those tenants or we will achieve higher rents, depending upon how those negotiations go, so that one is off to the side.

Fannie Mae has been in our building for a long time. They wanted more space, where we believe that -- and they're very dense. We believe that they may move out. We're not willing to make the accommodations, but we'll see how that goes. Stranger things have happened.

Okay, great. Thanks. And maybe for Jeff or George, talk a little bit more about the acquisition environment, what you're underwriting today, how big that pipeline is and how good you feel about being able to close some more deals.

Hi, Dave. This is Jeff. The acquisition environment is as tough as it's been. There is a lot of competition out there for assets, and pricing is strong in a lot of the markets that we're working in. We have and continue to have a lot of opportunities that we're looking at, a number of which continue to be off-market. As George talked about, this environment is an interesting one to operate in, in terms of matching cost to capital and return on capital. We have opportunities in front of us.

We still feel good about our acquisition guidance. My guess is that it'll be likely towards the end of the year, if it materializes, to try to match one against some prospective dispositions that we're working on as well, but I feel good about the guidance that we've given at this point on both dispositions and acquisitions, and I think you're going to see us continue to favor more often properties that have leasing opportunity associated with them, vacancy associated with them.

Again, Dallas and Atlanta are the two that I continue to see the most opportunity in, and, again, some that are just off-market opportunities, but we do feel good about our pipeline and prospects and the guidance that we've given on dispos and acquisitions.

Okay, great. Last one is for John. Any thoughts, John, about terming out debts this year, just given the high line balance, or are you feeling pretty comfortable with the balance where it is?

Well, at the moment, we like having the balance outstanding as we go through this asset recycling program, so probably not in the short term here, but we're certainly keeping our eyes open on rates and where these rates might rise and may consider that as we move ahead.

Okay, great. Thanks, guys.

Tom Lesnick, Capital One Securities.

George, Janet, just a couple of leasing questions. I only had a chance last night to do some cursory research about Centene, but it appears to be a health insurance company that caters mostly to uninsured and underinsured people. In the context of the changing industry dynamic, the Affordable Care Act and the consolidation we've seen among the major health insurance companies recently, how did you underwrite that credit, and how did your approach change at all to underwriting that credit?

(Inaudible) Toby Daley.

Tom, it's Toby Daley, and I'm regional director. I cover that market, and our asset manager who did that deal actually obtained a corporate guarantee from the parent, which is Centene Corp. They're a publicly traded company, and if you look them up, you'll see that their track record and their financials are very strong, so their credit is excellent and we were very pleased to have them as a new tenant at Timberlake.

Okay, fair enough. And then turning to the Ravinia campus in the perimeter submarket in Atlanta, obviously you guys are in One and Two right now, but I believe State Farm has a pretty sizable chunk of space in another building on that campus, not to mention a couple buildings on that side of the perimeter submarket. Given that they're building their own campus in the perimeter submarket kind of on the other side, how are you guys thinking long term about State Farm potentially leaving a sizable chunk at the Ravinia campus?

Again, Tom, Toby Daley. I'll cover that one. State Farm is at Three Ravinia, which is right next door to our two buildings, and they're on a longer-term lease, as I understand it, through 2021, I believe, so they're there for a good while. And then in the other locations, I'm sure they're going to move out of some of those spaces over the next couple of years as their campuses deliver, but the market has gotten so tight in terms of space. We're below 10% vacancy, so that we feel strongly that space will be absorbed fairly quickly, and our lease role is pretty minimal over the next couple of years, so we're not too worried about it.

Got it. And then lastly, on same-store NOI, aside from the Midwest region, which obviously is impacted by the RGA move out, none of the other regions looked particularly strong this quarter. I'm just wondering when we can start to see that second derivative turn positive in terms of trend there, and what's really driving that? Is it the revenue side? Is it the expense? Is that something you could potentially begin to disclose in future quarters?

This is Janet. I think if you're looking at the numbers in our supplemental, if you look at the six store -- six month same store, you see decreases, which are all due to the vacancies from the fourth quarter of 2014, when we were at the 94% and then dropped, and RGA certainly was part of that in the Midwest, but we had similar kinds of give-backs right in that fourth quarter or January 1.

So I think if you then look at the three months to the three months, you can see that we're picking up, obviously, the first lease that Energizer has kicked in. We expect the Centene lease to start December 1. They may start earlier. So we would hope -- well, we expect that the leases that we've done will start kicking into NOI throughout this year, and we hope that the leasing picks up in these other places where we've gotten vacancy back.

It is not a result of rent. The rents are still pretty strong in all of the places that we're talking about. Houston may be moderating, but we should start seeing it gradually kick in as the leasing commences. As the construction finishes, as the leasing goes.

Okay. So it sounds to me it's mostly the timing of leases coming on or offline regarding the revenue side, and the expense side is still relatively churning as normal?

Yes, and the thing that's a little bit different about the second quarter is that there was a lot of movement on real estate taxes, particularly in the Midwest and the West. We had a lot of abatements and then offsets by other ones that had new tax assessments that we accrue this full amount until we get the abatement, so they're sort of offsetting. So you don't see a big swing in the numbers, but a lot of different changes are working their way through. I expect that that sort of will settle itself out in the next quarter, and then hopefully we get more abatements at the end of the year, but that's what's running through the expenses.

Okay, great. Thank you.

Craig Kucera, Wunderlich.

You've got several assets that have had relatively low occupancy for some time. I think the Baltimore asset's been at 80% or below for a while, and one of your Denver's has been at the 70%, and the Seattle asset's been kind of at the 50% range. When you look at those assets that have been at relatively low occupancy, how do you balance the decision to try to lease them up versus selling, particularly for those where maybe you only have one asset in the market?

This is George. I mean, that is something we look at all the time, and so if you take, for example, the Federal Way asset, which has had tough occupancy for quite a while -- and it's an isolated asset out in the market. I mean, we definitely look at that all the time for potential disposition, but every property is unique.

For example, in that particular submarket, the Federal Way submarket, that was so affected by (inaudible), and the market is starting to come back, and we think the property -- for example, that property is sort of operating profitably, break even or profitably, and the market is coming back, headed in the right direction. There's not a reason just to dispose to dispose of, and we -- that philosophy, Craig, sort of goes through all of our properties, including the ones that -- the few that have had low occupancy.

Again, on the whole portfolio, our occupancies are pretty good, and these isolated ones are just analyzed property by property, market by market -- where the markets are going, where we think we can best generate the best values.

Okay. You mentioned that Houston was moderating a bit. Can you give us a little bit more color on what you're seeing there, and are you seeing any space coming back as sublease space that's maybe currently leased but is dark?

Craig, this is Toby Daley. I'm Regional Director for Houston, and --

As well as Atlanta. Sorry.

Clearly, there have been a lot of new deliveries of space, and there's also been sublease space introduced to that market, but we started with such low vacancy that the fundamentals remain fairly strong, and rents are actually holding firm. They're relatively unchanged from last quarter, and clearly vacancy is up, but it's still in the range of healthy, and our overall lease percentage is 93% at quarter end.

And a lot of the deals that we're doing this year, the renewals and some of the new leasing, because we did the expiring leases three, five, seven years ago, even though rents have held flat or maybe a little bit off, we're still getting an increase in rents of 15% to 30% on a case-by-case basis.

So, yes, there's sublease space available. Some of our tenants in pockets are attempting to sublease, but overall we're holding at 93% and we have very little role coming up in 2016, so we remain very bullish on Houston.

Great. And I appreciate the tightening of the guidance, and maybe I missed this, but have you guys disclosed any sort of implied pickup in occupancy or expectation baked into that number, and what is it?

We have not, Craig, no. We have not given guidance that way.

Okay. And then, finally, on the Two Ravinia property, it looks like you've got, going in, occupancy of about 70%. What initial yield was that purchased at, and where do you think you can bring that to eventually once it's closer to maybe 90%-plus occupancy?

Craig, this is Jeff Carter. We did not give specific guidance on that, except to say that it was in the range of what I was talking about for investments on the last quarter's call. We're typically seeing the deals that we're underwriting be in the 5% to 6% going in range, and this property was consistent with that -- bought at about 80% leased with below-market rents. We see upside in there that would be, we think, meaningful, and that's the guidance that we gave on that one.

Okay. Thanks, guys.

John Guinee, Stifel.

Yes, just one quick question. I noticed Richmond is now 100% occupied. Congratulations, because I think that was a deal that was 0% a while ago. Is there enough lease term on that portfolio or that asset to sell it, or is that on the sell block?

There is term. It is a potential candidate for sale, along with, by the way -- it's not for sale now. It's not listed. It is a potential candidate for sale. Timberlake, when we finish the leasing there, could be a potential candidate to sell, all of these noncore ones, John, that we are stabilizing and where the markets are starting to come back and you're starting to get buyers in the markets. Some of these properties have been stabilized for a while, but there are no buyers in the market. When both happen, we definitely test the market for sale to move into more urban in our five core markets.

Great. Thank you.

(Operator Instructions). James Feldman, Bank of America.

I was hoping you could give a little bit more color around the assumptions in your guidance, like in terms of year-end occupancy or what you think same-store NOI might do in the back half of the year.

We actually don't have that, James. We really just work on an annual basis of what we thought the range of FFO would be, so we haven't disclosed that, where we thought we were going to be.

So what are some of the key changes? How do you guys get to the number? What do you assume?

Well, we brought the bottom of the range up from $1.03 to $1.04 this quarter and a range of $1.04 to $1.08. We look at leasing assumptions that we have during the year and what leasing we think we're going to accomplish and factor that into it, and then we look at some of the things that we think might go wrong and some of the things that might move our way, and we make some assumptions about interest rates and things like that and come up with a range of possibilities of where we think FFO is going to land and try to capture that range when we give our guidance.

We don't generally target a particular occupied or leased percentage of it at year end, where we disclose that. We thought -- there may be several assumptions on that based on what spaces we have and what rent rates we might receive, so it's a little bit hard to come up with that in a -- other than in a range, which is not something we've disclosed. So hopefully that's helpful for you.

Yes, so it sounds like you do a bottoms up, which makes sense, but would you say on average -- like do you think the occupancy will be higher or lower or the same when you do your bottoms up?

Well, I think we would expect to have the occupancy go up as we move during the year, and I think when you think at, for example, the same-store comparisons of Q2 2015 versus Q2 of 2014, you can see that it's better than the six month numbers, and I think the Centene lease that we did this quarter is clearly some good news about where we are with leasing, and I think you'll -- the Quizno's space we had in Colorado, we leased some of that up to KPMG, and I think we've got some good stories with that and that's heading in the right direction.

Okay. All right, that's helpful. Thank you.

And this will conclude our question-and-answer session. I would like to turn the conference back over to George Carter for any closing remarks.

Well, thank you for attending the call. I look forward to talking to you all next quarter. Thank you. Have a great day.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect your lines.