奇異 (GE) 2005 Q3 法說會逐字稿

Good morning, ladies and gentlemen.

Welcome to the Arden Realty third-quarter 2005 earnings conference call.

At this time, all participants are in a listen-only mode.

Later, we will conduct a question-and-answer session.

Please note that this conference as being recorded.

I would now like to turn the call over to Mr. David Swartz, General Counsel.

Mr. Swartz, you may begin.

Thank you.

Good morning, everyone.

Everyone should have a copy of our third-quarter 2005 earnings release and supplemental information.

If not, this information can be obtained from our website at ardenrealty.com in the Investor Information section under Annual and Financial Reports.

Additionally, we are offering a live webcast of today's call, which can be accessed at ardenrealty.com in the Investor Information section under earnings conference call webcast.

This called may contain forward-looking statements based on current expectations, forecasts and assumptions, and involve risks and uncertainties which could cause actual outcomes and results to differ materially from our expectations, forecast and assumptions.

These risks and uncertainties and uncertainties include the national and Southern California economic climate; the effects of recent acts of terrorism on our operations and the operations of our tenants;

Southern California real estate conditions; perceptions of prospective tenants of the attractiveness of our properties; our ability to manage and maintain our properties and secure adequate insurance; potential increases in operating costs, including real estate taxes and utilities; changes in applicable laws, including tax laws; and interest rate levels and the availability of financing.

For a further listing description of such risks and uncertainties, see the reports we file with the Securities and Exchange Commission.

We disclaim any intention or obligation to update or revise any forward-looking statement, whether as a result of new information, future events or otherwise.

Also during this conference call, the Company may discuss non-GAAP financial measures as defined by SEC Regulation G. A reconciliation of each non-GAAP measure to the most directly comparable GAAP financial measure can be found in our press release and on pages 27 through 29 of our supplemental information package.

I will now to call over to Richard Ziman, our Chairman and Chief Executive Officer.

Thank you, David.

Welcome, everyone, to our third-quarter 2005 conference call.

On this call this morning her Victor Coleman, our President and COO, who will give you a detailed update on our leasing and marketing activities;

Rick Davis, our CFO, who will discuss our financial results.

Also with us are Robert Peddicord, Executive Vice President of Leasing and Operations;

Howard Stern, our Senior Vice President and Chief Investment Officer; and David Swartz, our General Counsel, who introduced this call.

I'm very happy to report that Southern California's third quarter continues the strong performance that we anticipated.

We have now rounded the corner.

In most markets we are rapidly approaching the tipping point into a landlords' market, with fundamentals for a strong economic recovery well in place.

A prime example is the West L.A. market, which has experienced a 22.7% decline in vacancy from third quarter a year ago.

Overall, there is a strong momentum across the entire region that supports our strategic focus.

Increasingly, we are reaping the benefits of our geographical concentration as the region's economic fundamentals strengthen and as our leasing markets continue to tighten.

Supporting business and ultimately office demand is job growth, which, while not aggressive, is continuing to improve.

Southern California's unemployment rate was 4.2% in September, down over 1%.

In the year-to-year comparison -- excuse me -- in a year-to-year comparison, non-farm employment increased by over 230 jobs, over a 1.6% gain, with gains in most industry sectors such as financial and business services, trade, transportation, health and education and information and entertainment.

Personal income also rose 1.5%.

In addition to job growth, there's a tremendous economic vibrancy the across the region, with a wide range of major projects that are virtually changing the physical and economic landscape here in Southern California.

UCLA is nearing completion of a $1 billion medical center that is part and centerpiece of a $1.5 billion project, including several new research, education and medical buildings.

Kaiser Permanente alone is spending in excess of $1.5 billion on new facilities.

A 1.2 billion retail and entertainment complex surrounding Staples Center just broke ground September 15th that includes an 1100-room hotel and a 7000-foot (ph) seat theater.

The $1.8 billion Grand Avenue project, a massive residential, retail and office development downtown with a 16-acre public park, has been announced and is under design development.

Construction is underway on a $180 million project in North Hollywood that includes residential, retail and restaurants, as well as a $206 million hotel, spa and conference center that David Murdoch is building in Westlake Village.

Construction on major transportation lines are underway, including a 324 Metro project in the San Fernando Valley, an $869 million extension of the Metro Gold Line into East Los Angeles, and a $680 million light rail transit from downtown L.A. to Culver City.

The Los Angeles Unified School District is making inroads in a $4 billion initiative, with the opening of 17 new schools in the past 24 months and many more to follow.

In Southern California, we are experiencing both a migration of technology companies from Northern California, as well as expansion of the existing software in game technology firms in this region.

This is just a part of the significant growth occurring that is making this an exceptionally exciting time to be doing business in Southern California and positively impact the economy and quality of life here for years to come.

Victor will detail our leasing performance in specific markets a bit later.

But from a regional perspective, Southern California has now posted its 14th consecutive quarter of positive net absorption, with over 2.2 million square feet in the third quarter alone.

Year-to-date, in excess of 7 million square feet have been absorbed in what continues to be one of the country's most active leasing markets -- in fact, 500,000 square feet more than in all of 2004.

The traction that we are now experiencing has brought the majority of our markets below 10% vacancy and virtually eliminated rent concessions.

In fact, we are now seeing multiple offers for space, with rates moving up considerably, especially in West Los Angeles, Orange County and Ventura.

In all markets in which we have a presence, we see an average rate increase last quarter of between 1 and 4% and an average increase of 2% for all markets, and encouraging trends that we are now experiencing spillover into our secondary markets as primary markets tighten.

As many experts have noticed, another key component that has accelerated our economy and should provide an advantage over other major markets in the future is the continued constrained supply of office space in Southern California.

This limited supply persists, not only because of the lack of development land in the region, the time-consuming and expensive costs of new entitlements and the ever-increasing cost of new construction, but also because of regulations that circumscribe growth and new development.

We don't see construction costs easing or the restrictions abating, except for perhaps mixed use, vertical housing and retail developments and medical facilities, as I mentioned earlier.

With that, third quarter showed stabilized office construction activity at less than one-half of 1% of the Southern California market, and with only approximately 1% of that total scheduled for delivery this year.

This completed inventory has had no impact on our current leasing environment and we are confident that the lack of significant supply will continue to increase investment and rental values well into the future.

We have been able to take significant advantage of the heated investment climate in Southern California by successfully executing our strategic capital recycling plan over the past 2.5 years.

Since 2003, we have sold 28 assets, almost 2.9 million feet of office space in non-core markets.

At the same time, we have acquired approximately 1.8 million square feet of outstanding, high-quality assets in our prime core submarkets that strengthened our operational efficiencies and concentration.

It's interesting to note that since 2003, we have recycled 15% of our portfolio as we successfully pursued investments that are more accretive to the overall value of our portfolio and support concentration in each of our strong, improving markets.

We have consistently weighed new acquisition projects against the performance of our existing properties in the markets in which we do business.

We are confident that in this heated markets, our measured but consistent approach will result in the most strategic and accretive investment scenario for our shareholders.

We will continue to look carefully at investment opportunities in our major markets and sell assets which have outgrown their optimum value or present problems and other issues in our portfolio.

In the interim, we are also clearly focused on our core activities of leasing and operations, and we will maximize every aspect of this increasingly strong regional market as we pursue occupancy retention and operational efficiency and other goals.

With that, I would now like to call over to Rick for more financial detail.

Thanks, Richard.

Our fully-diluted funds from operations for the third quarter was $0.63 a share.

Fully-diluted net income was $0.62 a share, primarily due to 34 million in gains on asset sales recognized during the period.

Excluding those gains, operating earnings were $0.11 a share.

Our FAD payout ratio for the quarter was 113.9%, down from 120% in Q2 and about what we expected.

As we've discussed on prior calls, our payout ratio continues to be impacted by earnings dilution from capital recycling, higher velocity of new leasing as we stabilize our portfolio, continued higher transaction costs and higher than normal CapEx due to several large elevator renovation projects underway this year.

Transaction costs for new deals were 21.92 (ph) a foot, and at 4.23 (ph) on an annualized basis, were the lowest we've seen in the last two years.

Renewals were at just under $8 a foot in Q3 or at $1.90 on an annualized basis -- again, the lowest levels we've seen in some time.

Recurring CapEx was $0.20 a foot in Q3 and was $0.64 a foot year-to-date, compared to $0.20 a foot for the same period last year, primarily due to the elevator renovation projects.

Through September 30th we are about 75% complete on these renovations and expect to complete them by year-end.

We expect our payout ratio will run a little higher in the fourth quarter and end up around 120% for the full year.

Our non-recurring CapEx totaled $0.11 in the third quarter, which is higher than normal, primarily due to a large CapEx project at our 707 Broadway Building in San Diego.

This capital project was part of our underwriting when we acquired this asset last January.

Turning to our operating results, our same-store NOI increased by 1% on a GAAP basis and by 1.6% on a cash basis compared to Q3 of last year.

The increase from 2004 was driven mainly by a 60 basis point gain in average occupancy and about $600,000 in higher lease termination fees in the third quarter of this year.

These increases were partially offset by higher repair and maintenance costs this past quarter.

R&M increased due to higher contractual maintenance costs, including janitorial, engineering and security.

Excluding lease termination fees and nonrecurring items in both periods, same-store NOI increased by 20 basis points on a GAAP basis and by 70 basis points on a cash basis for the third quarter.

Year-to-date, NOI increased by 50 basis points on a GAAP basis and by 90 basis points on a cash basis, primarily driven by a 1% gain in average occupancy this year.

Rent growth was up 1% on a GAAP basis and down 5.9% on a cash basis for the quarter.

As Richard will discuss later, we saw another strong quarter with overall average market rents increasing by 2% in our markets in the third quarter and by 4% year-to-date.

Assuming rent growth of another 2% in the fourth quarter, the change in our cash rents would be flat to down by 3% and would roll up by 3 to 5% on a GAAP basis for the full year.

Continuing the trend over the last few quarters, free and reduced initial rents continue to decline in Q3, with no free rent concessions in the quarter and minimal reduced rents on a handful of deals.

Our portfolio occupancy increased by 80 basis points over Q2 to 91.3% and was just over 93% leased at the end of the third quarter. 30 basis points of this increase in occupancy came from our acquisition and disposition activity, with the remaining 50 basis points from the rest of the portfolio.

We signed 119 new leases for approximately 510,000 feet in Q3 that broke down as follows -- 100,000 feet in July; 135,000 feet in August; and 275,000 feet in September; and we have signed 290,000 feet of new leases so far in October.

Our retention rate in the third quarter was 73%, which was above the trend of the last few quarters and was positively impacted by a 112,000 square foot tenant in San Diego who renewed during the quarter.

We expect retention in the fourth quarter and for the full year to be in the mid 60% range.

Q4 expirations represent a little over 3% of our total leased square footage and are spread fairly evenly throughout the portfolio, with a little higher concentration in the West and North Los Angeles markets.

Now looking to our operating results on page 9 of our supplemental.

First on the revenue side, cash rents were up 1.6 million compared to Q2, primarily due to increases in occupancy and scheduled rent bumps throughout the portfolio and from our acquisitions.

Straight line rents declined by about 450,000 from Q2, primarily due to the turnover of older leases throughout the portfolio and the elimination of free rent on new leases.

Tenant reimbursements increased by 1.2 million from the Q2 levels, primarily due to seasonality, with higher utility costs in the third quarter.

Reimbursements should run between the Q2 and Q3 levels for the fourth quarter.

Parking income was up by 670,000 over Q2, driven mainly by occupancy and rate increases and from our acquisitions.

Included in other rental operations was 1.9 million in lease termination fee income compared to 350,000 last quarter.

We expect termination fees for Q4 to run between 1 million to 1.5 million.

Now moving on to the expense side.

Repairs and maintenance increased by 600,000 over Q2, primarily due to our new properties and increases in the contractual maintenance costs that kicked in during the second quarter.

Utility costs were about 2.9 million higher than the second quarter due to seasonality.

Utility costs should run between the second and third quarter levels in Q4.

Property taxes decreased by about 325,000 from Q2. primarily due to refunds received on property assessment appeals that partially offset higher taxes from our acquisitions.

We expect the fourth quarter amount to remain consistent with Q3, as we finalize several additional property tax appeals that we expect will result in further refunds.

G&A expense decreased by about 450,000 from Q2, primarily due to lower compensation costs, including the timing of our annual contributions to a deferred compensation plan that we made in Q2.

We continue to expect G&A expense for the full year to run between 6 to 7% in total revenues.

As you'll note on page 7 of our supplemental, we had gains of 33.9 million on asset sales totaling 123 million during the third quarter. 54 million of these proceeds are currently deposited in an escrow account with 1031 Accommodator, and are included in the restricted cash on our balance sheet.

Our balance sheets at March 31st and December 31st contained 12.5 million in 1031 and escrow deposits that were included in the other assets section of our prior balance sheet.

We have reclassed those deposits into restricted cash to conform to the current presentation.

Now moving on to the accounting treatment for our Q3 acquisition.

The FAS 141 adjustment for the net below-market rents for the Agoura Business Park project is approximately 700,000, which will amortize as additional straight line rent over the next five years.

Included in our operating results for Q3 is approximately 2.1 million in GAAP NOI, including 165,000 in straight line rent from our 5670 Wilshire and Agoura Business Park acquisitions.

On the capital market side, as we mentioned on our last call, in July we completed the renewal of our $310 million unsecured line of credit led by Wells Fargo, which was scheduled to mature in April of 2006.

We extended the maturity until April of 2009 and amended various other provisions, including the interest rate.

Based on our current unsecured debt rating, the line is priced at LIBOR plus 85 basis points and like the old line includes a 20 basis point annual facility fee.

All in, the new line is 5 basis points cheaper than the old facility and we have the option to increase our borrowing capacity to 400 million.

We also improved our financial flexibility under the new line by amending several of the financial covenants, including valuation cap rates and leverage and coverage ratios.

In addition, during the third quarter, we also extended our $20 million unsecured line of credit with City National Bank to August of 2007, and entered into a $25 million bridge loan with Wells Fargo that matures next January.

We executed this bridge loan to add flexibility for short-term cash management, as we worked through acquisition candidates for potential 1031 exchanges.

Both the CNB line and the Wells Fargo bridge loan have similar interest rates and financial covenants to that of our Wells Fargo unsecured line.

Also, as we mentioned on our last call, we've entered into 143 million of forward starting swaps in anticipation of the November 2007 maturity of 150 million in 7% unsecured notes.

These forward interest rate locks carry an effective rate of 4.32% on the 10-year Treasury.

Now looking to guidance for the rest of the year.

Based on our current forecast, we expect FFO for the fourth quarter will range between 61 to $0.63 a share, which would put us at 2.43 to 2.45 a share for the full year and within our earlier estimates.

These estimates assume that any additional acquisitions or dispositions would close late in the quarter and would therefore have minimal earnings impact this year.

In looking at earnings for 2006, we are still completing our corporate model and will not be providing guidance at this time.

The areas we are still looking at include estimating the earnings impact from our capital recycling activity, including any charges that may result from prepaying debt.

As we gain more clarity on these issues that could have a significant impact on earnings, we will be in a better position to provide 2006 guidance and plan to provide such estimates on our next call.

With that, I will turn it over to Victor.

Thanks, Rick.

Hello, everybody.

I'm going stick with the usual format and cover a few global issues regarding the Southern California marketplace.

Then I'm going to drill down to our portfolio.

The market information I am going to cover is going to be from various published reports, including the market data from CB Richard Ellis, as usual, and obviously our own market knowledge.

And for everybody's information, all the rates I am going to be covering here are going to be on a full-service gross basis.

Overall, we saw another quarter of solid improvements in fundamentals, with most of our major submarkets at or nearing stabilization.

We continue to see strong activity with multiple proposals to choose from in most markets.

We also saw continued rate increases pretty much across the board over the past three months.

On average, market rents are now within 1 to 2% of where they were at the peak of the mid 2001.

And transaction costs continue to level off and new supply remains extremely limited.

Our portfolio's occupancy was up 80 basis points in the third quarter to 91.3%, and with 93% leased.

Our West Los Angeles assets, the largest concentration in our portfolio, are nearing stabilization with over 94.5% occupied and just under 96% leased.

In Orange County, our occupancy increased by 4% during the third quarter to 91.5% with another 3.5% leased and being built out.

Our highest vacancy is in San Diego, where we had a large tenant default last quarter and where we purchased vacancy at our Sorrento Mesa projects earlier this year.

During the quarter we backfilled half the space we lost from the default, with a 55,000 square foot lease scheduled for occupancy in December.

And in October, we signed a lease for 75,000 feet at our Sorrento project that also scheduled for occupancy in December, and a lease for an additional 45,000 square feet at the same tenant that is going to occupy in Q1 2006.

At 93%, we have now less than 10 blocks of space that would accommodate a 20,000 square foot tenant.

And including that, there are two blocks for a 50,000 square foot tenant.

Now moving over to some specific information in the markets.

First, let me touch on net absorption and vacancies.

Overall, net absorption in Southern California in the third quarter was a positive 2.2 million feet.

Year-to-date, over 7 million feet of space has been absorbed, or about 0.5 million feet more than all of 2004.

Los Angeles County posted its seventh consecutive quarter of positive net absorption with 150,000 feet in the third quarter, bringing year-to-date net absorption to 2.8 million feet compared to the 2.5 million feet of positive absorption for all of last year.

West Los Angeles alone had a positive absorption of 1.2 million feet so far this year, about double the absorption for all of last year.

Orange County had another strong quarter, posting its tenth consecutive quarter of positive net absorption with a 1.5 million feet, mainly in the airport and South County submarkets.

And since the beginning of the year, 3.3 million feet has been absorbed in Orange County, or about 0.5 million feet more than all of 2004.

San Diego had its 12 consecutive quarter of positive net absorption with 550,000 feet in Q3 and with 1.1 million feet absorbed year-to-date.

Overall, the direct vacancy in Southern California decreased by 40 basis points to 9.8% in the third quarter, and the direct vacancy for the markets we are in also declined by 40 basis points to 9.2% compared to our portfolio vacancy of 8.7.

Los Angeles County's overall direct vacancy decreased by 10 basis points to 11.3% in the third quarter and was 10.8% in our markets compared to our vacancy of 6.7%.

At 10.8% the overall vacancies in the L.A.

County markets are now comparable to the end of 2001 before the fundamentals started to weaken.

Vacancies in North Los Angeles have improved the most, now standing at 7.8%.

And even South Los Angeles, the softest market in Southern California, showed continued improvement, with 200,000 feet of positive absorption and an ending vacancy of 18.7%, down 50 basis points from Q2.

Vacancies in West Los Angeles remained relatively flat at 9.9%.

Orange County's overall direct vacancy decreased 150 basis points to 6.8%, which is the lowest level of all major markets in the nation.

Our Orange County portfolio's vacancy stood at 8.4% at the end of the third quarter, with an additional 3.7% leased and currently being built out.

San Diego's overall direct vacancy increased by 30 basis points to 9.6% in Q3, the fifth lowest of all major markets in the country.

This slight increase was mainly due to a 750,000 feet of new office product delivered in Q3.

In terms of rent, the average market rental rates for the markets we are in increased by 2% in the third quarter to 26.5 to $27.5 a foot.

And year-to-date, the average rates have increased by 4% in our markets.

In L.A.

County, rental rates in our market increased 2% during the third quarter to an average of 27 to $28 a foot, and rents in West and North Los Angeles County increased by 2% in Q3 to 33 and $34 a foot in West LA and 26.5 to $28 a foot in North Los Angeles.

Rents in South L.A. were flat at 21 to $23 a foot.

In Orange and San Diego counties, rental rates increased by 2 to 2.5% during the third quarter to 25.5 and 26.5 a foot, and year-to-date rental rates increased by 5% in Orange County and by 10% in San Diego County.

In terms of supply, it continues to be limited, with one of the lowest projections for scheduled deliveries in the nation.

In the third quarter, a million feet of new supply was delivered, split between San Diego with 750,000 feet and the rest in Orange County.

Approximately 2.7 million feet of new supply scheduled for delivery for the full year represents less than 1% of Southern California's 320 million square foot inventory.

LA and Orange Counties are expected to add a combined 1.2 million feet of new space and San Diego is fixed to deliver 1.5 million feet for the full year.

Turning to concessions, TIs and leasing commissions in the third quarter were down from Q2 levels and in line with the average of last several quarters for new deals, but were significantly down on renewal transactions to $1.90 a foot on an annualized basis.

As I mentioned before, even though we have improving fundamentals, the stabilization of transaction costs will continue increase as the materials and labor cost, but will most likely remain as part of our ongoing cost structure in the near-term.

Turning to the investment market, as Richard mentioned, over the last 2.5 years we have been extremely active repositioning our portfolio and we have extremely effective as well this year.

Through September, we sold 8 properties comprising over 1 million feet for just under $150 million in proceeds.

Trade these assets were all below average quality in secondary markets or had higher CapEx requirements going forward.

The average cap rate in these sales was at 7.2%, and a portion of the $40 million gain has either been deferred into acquisitions or deposited with a 1031 Accommodator.

With these sales, we have another 50 million to hit our estimate of 200 million in total sales for the year.

Although currently we're not marketing assets, we're accepting several unsolicited offers and have identified a pool of assets in the 100 to $150 million range that we do plan to sell.

We are also in the process of unencumbering and devising a leasing and marketing plan for these assets.

We anticipate any additional sales this year will have minimal or no impact on our '05 earnings, because they would most likely close at the very end of the year.

In August, we purchased a 115,000 square foot Class A building in Agoura Hills submarket of West San Fernando Valley for 23.2 million.

This project is 90% leased to a solid roster of tenants, including IBM, Prudential and Toyota.

The initial goal in cash yield for this asset was 6.4%.

Agoura Hills is located just west of the Woodland Hills Calabasas submarkets and is proving to be a favorite alternative as vacancies in these markets continue to tighten and as population moves further west along the 101 Freeway.

Finally, finishing up on our Howard Hughes project.

We are wrapping up the final design and bidding process and obtaining city permit approvals for our next development, the 160,000-foot 6040 Center Drive Building.

We are still on schedule to break ground this quarter, with shelf completion targeted for mid-2007.

We are continuing to market the 6040 building.

The remaining office entitlements at Howard Hughes Center are being marketed to build-to-suit users.

At this time, I'm gong to hold off on any more details for now until we complete the final design and bidding process and discussions with prospective tenants, because that would obviously impact our cost structure and expected yield.

That wraps up our prepared remarks.

But before moving onto Q&A, as there have been for several other companies, there have been rumors recently in the market about Arden.

It's always been our policy not to comment on market rumors and we do not plan to change that policy today.

As we always have, we will be happy to answer any other questions.

Operator, please open the lines for Q&A.

(OPERATOR INSTRUCTIONS) Greg Whyte from Morgan Stanley.

Good afternoon, guys.

You guys talked about an improving market and obviously your vacancy rates have come down a lot.

I guess I'm just a little surprised that you're not seeing more than your sort of 2 to 4% rent increase on the market year-to-date.

Are we in an environment where this is going to be a whole lot slower this time around?

Greg, it's Victor, how are you?

I don't think so.

I think the statistics are across the board are pretty general.

But in main marketplaces, we are starting to see a real pickup right now in our major areas.

I think you're going to see a much greater speed-up in '06 than we have in '05.

And as you can see by the trends in leasing between Q2 and Q3 and currently what we've done in Q4, those rental rates are really starting to move in a fairly expeditious manner.

With that, we mentioned this in our last call -- we are continuing to sort of evaluate it internally.

In specific marketplaces, we are holding off on leasing certain space because we think the impact is going to be greater.

So we are pretty comfortable with the movement, and the underlying movement in rental rates right now is at the levels of expectation that we are feeling pretty comfortable with.

Okay.

I know you gave a little bit of detail on the Howard Hughes thing.

Did I miss here -- you said you are going to start this year?

Is that correct?

Yes.

On our 6040 building, the one we talked about before, we will be breaking ground by the end of the year.

We are in final city approvals right now.

We will start grading probably sometime November and moving forward on that spec building.

I know you said you are talking to a bunch of folks.

I mean, in terms of sort of size commitments, is this single tenant negotiations going on?

With our 6040 Building, we are going to open that up to the average sized tenants that we typically market to, which is 5 to 15.

And that's what we'd be looking at.

With our other building that we are talking about, we actually have negotiations going on right now with a single tenant for the entire project.

On the guidance for Rick, when do you think you might give 2006 guidance?

Right now, our plan is to work through things and give guidance on our fourth-quarter call.

Okay.

Thanks a lot, guys.

Jay Leupp from RBC Capital Markets.

Here with Brett Johnson (ph) and Dave Ronco (ph).

Can you talk a little bit about some other redevelopment activity that you may pursue in 2006 and what you are seeing in the marketplace, and what the difference in going in yields is on redevelopment activity versus new development activity where you are seeing it in the market right now?

Hey, Jay, it's Victor.

On the redevelopment side, we've got a couple of assets in the portfolio right now that we are looking to potentially take out of the normal course of commission in the property in our portfolio and then repossession those assets going forward.

If that's the case, I mean, the ability for us to redevelop our assets and add additional capital is a higher yield than what we're buying at currently in the market today.

I mean, the spread on that is difficult to determine because of the increasing construction cost and capital cost that you have to put in (indiscernible).

But it is probably in the 100 basis point spread to 150 basis point spread of what we're currently buying stuff at today on a stabilized basis.

And then just one follow-up.

In terms of acquisition and development activity, both for you guys and in the marketplace in general, how much dispersion are you seeing across your submarkets?

And has a that dispersion tightened up here over the last year or two?

You know what, there really isn't much.

I mean, virtually across a board in our marketplaces, the limited supply out there is really creating a fairly efficient marketplace.

And what we are finding is the stuff we're looking at or the stuff we've sold, the competitive play out there is really pushing the level of cap rates to the consistent level we are buying and/or selling at with the spreads right now.

I think you can see a shift in quality assets -- middle-level quality assets on the sales side to really tighten up to the high 6s, low 7s across the board.

These are pretty consistent and standard.

We haven't seen enough competition out there right now for Class A stuff to really comment on that stuff.

But what we have seen, it has been in the low to mid 6s all the way down to the high 5s.

All right.

Thank you.

David Fick from Legg Mason.

John Guinee with Dave Fick.

The big debate in the leasing world is always whether a rising tide rises all boats or the best assets recover.

In your markets, do you see the B and the C quality assets recovering concurrently with the A assets or do you see them lagging?

No, definitely is recovering at the same.

I mean, in our marketplace because of the tenant makeup in the Southern California market, you are seeing the growth across the board.

There isn't any quality of asset that is not getting the pickup in the markets that we are seeing currently today.

I can't think of an asset quality right now that is at all slow.

It's equal from C to A in terms of activity.

And what we're finding out right now, as Rick had mentioned in his prepared remarks, virtually every space we have in our portfolio, somebody is looking at it on a multitenant basis.

There are multiple tenants looking at every space.

So I think that is pretty consistent throughout the Southern California market.

Great.

Thank you.

Jim Sullivan from Green Street Advisors.

Thanks.

The disposition cap rates, 7.2, and the acquisition cap rate at least for Agoura 6.4.

How representative do you think those are for your overall portfolio?

As I mentioned, Jim, and you have and I have talked in the past -- I mean, the stuff we sold had capital dollars and/or quality issues.

Not necessarily the quality of the product, but in markets that we were also expanding in.

That is indicative, I think, of the marketplace of the assets we sold.

I think we're looking probably at closer to what we're buying at than what we are selling at in terms of the overall value.

I can't comment on our portfolio in general as to what the value of our portfolio is.

It's not really relevant, our sales cost to the value of our portfolio, because those are the assets were (indiscernible) on.

Overall, I think the market is really telling you right now where cap rate are.

And as I mentioned, you are seeing stuff in the high 5s down to the low 6s on average on Class A stuff, and stuff in the mid 6s on everything else.

That is pretty similar, what you are seeing.

I think the reality is, though, it is more relevant is the fact that there is not that much product in the marketplace.

What you think a stabilized occupancy can be for your portfolio, given the relatively small size of your tenants and the relatively short lease terms you have?

I think typically what we've looked at in our portfolio has been pretty consistent, which is 96%.

Then again, this may not be a typical marketplace.

And I think in our marketplace today, we may see a greater increase in occupancy levels.

The major difference in the past was we had -- some of the assets which we sold had certain space in those properties that were really "unleasable."

We've gotten rid of those deferred type assets, and I think we're seeing more core lease stuff in our portfolio that's going to get you maybe greater than 96%.

But we've always quoted 96 as being our stabilized number.

I think because we have better quality assets now than before, we may see a rise in that, but I don't think -- we're not going to underline that in any type of valuation.

Are you saying 96 is stabilized or that is a point you can hit in a strong market?

We think that is a stabilization.

We're almost there right now in our West Los Angeles marketplace and our North Los Angeles marketplace.

As well, as I said, between the 3.5% that we're building out in Orange County, we are there as well.

Since your IPO, how many quarters have you been at 96% or above?

Do have any idea?

I don't know the actual number.

But you know what?

We have been going in and out because of the type of portfolio we've changed.

We've increased the asset quality, so you can't look at same store across the board at that level.

Our asset quality has changed dramatically since the IPO.

Can you comment on proposition 13 property taxes and the impact that Prop 13 has from the buyers' standpoint on what you've sold and from your standpoint on what you've acquired?

Yes, absolutely.

You know, on Prop 13, our portfolio -- fortunately for us we have pass-through in our leases, virtually all of our leases have documentation on Prop 13 pass-through.

And those that don't have it, we've negotiated with tenants that are pretty much in it.

We have somewhere around -- I think it's around 20% of the portfolio that don't have Prop 13, but there are some of those leases in the 20% that actually have language in it that have a the landlord buy-out provision if we sell.

So it's an obligation of the landlord or future owner of the property who buys the asset, they can actually do a onetime payment to that tenant.

So the exposure is a lot less than I think the Prop 13 vision is in the marketplace.

We've been pretty diligent getting the 80 plus percent of the portfolio when we leased it up because of the size of the tenants -- Prop 13 protection pass through directly to the tenants in the portfolio.

With respect to the rent decline, the cash rent decline on new leases of 6%.

When I combine that with the CapEx reduction, is there any evidence you are trading lower CapEx for lower rent in order to keep your retention and occupancy up?

No, not at all.

I mean, listen, the CapEx is completely separate and above.

We have talked about that in our last couple of calls.

We've got a lot of interest right now in reupping quality in our portfolio, given the fact that we're doing elevator work and stuff like that, and the value of the portfolio is decreasing in the near and long-term basis.

In terms of rolldown on our few leases that we signed in 2000, I think that is really where the impact is right now.

You are seeing this 60-month average lease term rolling.

At this time frame -- 2000 was a time in the marketplace where you had that rolldown.

I think if you looked at 2002 going forward, when the market started to turn and go upward again, in '06, '07, '08, you are not going to see any of that going forward.

On a mark-to-market basis, would you say you're in-place rents are about at market for the entire portfolio?

No.

We're about probably $1.25 below market on an overall basis.

On a gross basis?

Yes.

And on a per-share basis, I think that is close to $0.30 a share for the in-place leases.

And then if you -- so that gets you to around maybe in the $20 million range.

And then if you lease up the rest of the portfolio, add another 4 to 5 million.

Then a final question for Dick.

In your prepared comments you talked about downtown and you talked about the capital investment occurring downtown.

It's the first time I've heard you talk about downtown other then in a bearish kind of mode, with respect to downtown as competitor for your properties on the West side.

Is your view evolving on downtown?

Well, we are still seeing very, very little migration from our marketplaces to downtown.

There's always going to be an isolated tenant that for one reason or another is going to move downtown.

I think we're going to see more and more expansion of satellite office of downtown tenants in our marketplace.

I still continue to feel the suburban environment here in Southern California is the way to go.

Now, there is an awful lot of residential construction going on downtown, an awful lot of residential construction.

And how deep is that market?

How strong is it going to be?

Only time will tell.

Quite honestly, only time will tell.

I hope it is very successful.

I hope the development all around the Staples Arena, the Staples Center is very successful, and all these new developments that are now coming out of the ground, I hope they are successful.

Because it's not going to do anyone any good anywhere in Los Angeles if they don't.

What do you make of Microsoft moving 40,000 feet from Santa Monica to downtown?

Bobby, why don't you answer that?

You probably have more.

Microsoft was looking at the West side and then they decided to go downtown and take advantage of the location for their employee base.

They had employees all throughout the area, Pasadena, some West Side.

So they just felt like downtown was where they should be.

Remember, it's only 40 or 42,000 feet.

Thank you.

David Harris from Lehman Brothers.

Hello, all.

This is probably a question for you, Dick.

It is on the housing market.

Is the state of the housing market a cause of concern to you as an office landlord?

And are you seeing any signs of weakness at all in what obviously seem to be quite frothy markets?

Let me answer the last question first -- is there weakness?

We are still -- I actually talked with half a dozen residential brokers over the weekend.

And each of them -- and very heavily involved in basically the markets from, I guess, mid-Wilshire, Miracle Mile, all the way to the ocean, parts of the valley and down in the South Bay.

They are not seeing significant softening whatsoever.

People are a little concerned about where interest rates are going to rise.

I don't think we've seen prices continuing to increase at the galloping pace that they were.

Some people do say perhaps it has flattened.

There is some -- a little bit of increased -- maybe on the way, way West, closer to the ocean -- Malibu is still on fire.

But that is a much smaller marketplace.

In terms of the impact of the residential market here in Southern California or in Los Angeles, particularly, yes, we need more housing.

There is no doubt about it.

We need more mixed use projects.

And the problem we have here is there is very few development sites, entitlements are very, very expensive.

But nevertheless, you are seeing developments go up here and there -- putting downtown outside of that quotient, because I can't even remember how many units now have been announced or completed or done downtown -- it's probably approaching 10,000, maybe more.

But you are seeing some newer developments.

They are spot developments.

You are still seeing single-family on the outer edges.

So housing is being delivered.

The biggest problem is statewide, quite honestly, where we are chronically 50 to 70,000 units short.

It's not so much right here.

It's going to get worse before it gets better, but I think the City of Los Angeles got their arms around it.

The Mayor just announced that the Los Angeles business council housing summit that he is going to endorse very strongly -- a $1 billion housing initiative for the city, which I think is going to go a long way.

And I think other cities are going to do the same thing right along.

Because there are some 80 some cities in the County of Los Angeles alone.

I was rather more concerned about your thoughts around affordability.

I mean, if the house prices were to fall, then it seems to cast a little bit of a shadow over the outlook for the economy in Southern California.

Alternatively, if they continue to rise, there's a question of affordability and whether people will generate -- employers will choose to put jobs there, given the very high cost of living.

As I said earlier, we haven't seen right now prices rising.

If anything, they are flat.

Is there going to be a bubble here?

That is very, very difficult to predict, because it depends upon interest rates and a lot of other factors.

But quite honestly, even those people that say there is going to be a bubble, they don't see a dramatic downcrease in the value of the homes.

Maybe they will see 3 to 5% is what they are talking about.

Maybe 7%.

But they are not talking 10, 15, 20%.

Okay, thank you.

Chris Haley from Wachovia Securities.

Almost good afternoon.

Victor, if I recall kind of your earlier comments for the 2005 year, you guys were looking for about 5% rental rate growth in your kind of budget.

Is that correct for the kind of the blended number?

Across the board, yes, you are absolutely right.

Where are we year-to-date?

We're just a little over 4 right now going into the fourth quarter.

And as Rick mentioned we're anticipating we're going to be beyond that.

I think we were realistically conservative on our 5% for the year.

It looks like we're going to be over 6.

That is encouraging.

The comments that you made regarding asset sales, could you refresh me in terms of your expectations for the full-year '05, what you have built in for buys and sells?

Yes, we initially had $200 million of sales in '05 that we anticipated.

We are currently at 150 right now.

In terms of the buys, we didn't talk about acquisitions at the beginning of the year; it was not part of our model.

But year-to-date, our acquisitions have increased beyond what we thought, basically because of the main acquisitions we made -- not aside from the one we did in August -- but the two large ones we did, which was Sorrento and then 5670 in mid-Wilshire.

I look at where you guys started out the year in terms of expectations for FFO results.

Your GAAP earnings numbers are lower today for '05 than where they started.

Maybe let's call that -- maybe the analysts, including myself, were maybe a little bit more bullish.

But with more buys and sells and the market rent structure feeling a little bit better -- it's obviously performing so far better than we originally expected -- could you recount for us where would you say the primary variances have been this year?

The biggest variance was when we bought Sorrento.

If you recall, Chris, it was about $180 million that we had -- at the time of the lease-up there was 74% occupied.

And so we bought that -- at the time, it was in the 5 cap range.

With the last two deals that Bobby's team did down there, by Q1 of '06, we're ahead of schedule on lease-up dramatically in that stuff.

We should be in the low 90s.

So we anticipated moving that up around -- I think it's 10 to 12% for the year, maybe 15 at the most. 10 to 12 is what it was.

And we're going to be 20% off (multiple speakers).

If I take the third-quarter run rate and look at where Sorrento deals are being done, what the contribution is to the third quarter, what is the potential adds over the next couple of quarters -- we're looking at kind of a stabilized number for that in '06.

You've got to look-- well, first of all, Sorrento, the main lease was done, as Rick mentioned in his numbers -- it's really in fourth quarter.

So we haven't given you those numbers yet.

We signed the deal actually the first week in October and we signed the additional 45,000 expansion space just two weeks ago.

And so that's going to be really effective on Q1 '06.

So those are the numbers you have.

So you actually don't have those numbers so far.

But I think the impact overall, if you shifted that impact going through January 1 of '06 of where the income would be or in '06 when those guys are taking place, it's probably $3 million impact for the full year.

3 million GAAP earnings?

Yes.

So in terms of capital expenditures, can you give us a sense as to something -- I guess we're dealing with what some of our other companies -- in terms of forward CapEx issues?

On that specific lease, that obviously did not hit your third-quarter supplemental for CapEx commitments.

Correct.

What should we see when you report fourth-quarter numbers regarding CapEx commitments and then kind of a run rate of costs going into '06?

Just specifically for the Sorrento property, the buildout on that is going to be a little bit more expensive because some of the space was raw.

So I think going into probably Q4 and into Q1, we're looking at on probably 100,000 feet a TI number in the 35 to $40 range.

And that money will be spent over what time period, Rick?

Q4 and Q1.

Okay.

And then regarding kind of the normalized concession level, kind of use the more recent run rates.

And what kind of leasing volume would be safe to assume in relation to your expiration.

So if you have 100 square feet expiring, are you typically leasing 120% of that?

You are talking about going into next year?

Yes, just kind of your leasing pace.

Yes.

We are on target, I think.

And the other thing that -- in looking at the beginning of the year, the projections that we had, if you remember, we were about 100,000 feet short of leasing in the first quarter.

And we really haven't picked that up.

We've been kind of on par with what we expected for the rest, so (multiple speakers).

You mean you are just a little bit behind what has expired?

I'm just talking about gross leasing expectations for the year.

We were short.

And I think for the year, we will be right around 2 million feet of new leasing.

And next year, I think we've got 2.6 million feet that is scheduled to expire and our retention is probably going to be a little bit higher than where we were this year.

And we're expecting with the vacancies and the market that we will probably do as much new leasing next year, so another couple million feet, and with a little bit better retention, we will pick up occupancy next year.

So when we outline our 2006 estimates, we can go into more details.

What would you say your retention is going to run this year?

It will be in the mid-60% range.

Great.

Well, that is very helpful.

Thank you.

Alexander Goldfarb from Lehman Brothers.

Thank you.

First, just coming back to your -- I think you said $1.25 that the portfolio is below market.

That is on a monthly basis or that is an annual basis?

That is an annual number.

Okay.

I was going to say wow.

We would like it to be on a monthly.

Well, you guys in California quote monthly and then you suddenly switch to annual, so I just wanted to make sure.

On the disposition, I think you said, if I understood correctly, there is 50 million potential and then in addition to that is another 100 to 150 or is that 50 is part of that 100 to 150?

For our year -- to recap the year, we had said at the beginning of the year we were going to do up to 200; so we're 50 off of that.

And looking at the 50 that we are doing, because we're taking some out of some of the pool of assets and restructuring the pools so we can release some assets without paying the defeasance, we are looking to include in that 50 an additional 100 million to $150 million on top of that, with total assets up to 150 to 200 this year and next year that we want to sell.

Okay.

So over the next 12 months, another potential 150 to 200 --?

We are not putting a timeframe on it, but that is what we are evaluating right now, which assets are applicable and then compared to the ones we've got unsolicited bids on.

Would any of those include the airport assets?

I don't want to comment on specific assets.

Okay.

Can you update us where you stand on resi at Howard Hughes, when you'd start on that?

Well, we've received some unsolicited offers on what the land there, from a residential standpoint up to -- on a price per-acre basis.

Currently now, as you mentioned before, we've got the ability to do an up to 600 either hotel units or residential units on two different sites.

One is more of a high-rise and one is a mid-rise.

And we are talking right now with other development companies who are interested in venturing with us the residential stuff.

We feel that the market is extremely conducive to build residential there, it's conducive with the park.

But our objective initially is to get this first building, this next building -- not the first building -- 6040 out of the ground and complete the other building that we're working on right now.

So I would venture to say we'll probably tackle the residential question sometime Q2 of '06.

Okay.

Now you said 600.

I thought before you had maybe 350 to 450.

No, that was up to 600.

It's almost split 50-50 on the two sides.

Okay, so it would be two sites with 600 units?

600 total there.

How we configure it, we don't know.

But it's 600 total.

Okay.

Are you seeing any effect on developments from Prop U (ph), I believe it is referred to?

I think the general question is are we seeing any effects on development across the board.

And the reality is there is not that much development in place today in the majority of our markets.

As I said in my prepared remarks, the new space that is coming online is so de minimus, given the size and the vastness of the marketplace.

I think the next wave is really -- it's not a Prop U issue; it's just there isn't a lot of buildable sites available that can be entitled under the current conditions in our markets.

Remember, Prop U was basically downzoning like tens of millions of square feet.

It wasn't an entitlement to build more.

Right, right.

It was just some of the market commentary I had heard coming out of L.A. was that it physically restricted new development, and I just wanted to know what your view of that was.

Massively restricted.

Okay.

So we wouldn't anticipate any, then, major developments coming up in the next few years?

Well, if they do develop, they are going to be -- instead of 20 to 25 stories, they're going to be 2, 3, 4, 5 stories.

Hard to make the numbers work on those, I'm sure.

Especially with subterranean parking.

Thank you.

Lou Taylor from Deutsche Bank.

My questions have been answered.

Thanks.

Rich Anderson from Harris Nesbitt.

Thank you.

The 5-year lease term on new leases, is that an effort to draw out your -- to negotiate longer-term leases these days?

Rich, typically we've been trying that, and I think we made these comments before.

I mean, our average lease term is in the 42 month range -- it's been going up, fortunately, to 46, 48 and now we're getting closer to the 60.

We are trying to, in the tighter market that we are currently in, take longer-term leases with bumps throughout on an annual basis and capture the quality (indiscernible).

I think we're having less resistance now given the tightness of the marketplace than we were 24 months ago.

So we are seeing longer-term, more better economics and we can spread the construction risk over a longer period of time, which is the key.

With regard to the 73% retention, how was your retention for the expiring space just for the third quarter.

You reported it to be 527,000 square feet.

Does that 73% apply to that number as well?

That is the 73%.

Oh, it's not including out quarters that you have done deals with?

Actually, what expired in the third quarter we did a little better than that.

We retained about 78% of what was scheduled to expire in Q3.

Is there in a difference in the TI packages that you are able to get for out quarters that you negotiate before they expire?

Not really.

Again, it's more -- as Victor said, as the market tightens, we're able to dictate the deals better on renewals and new deals.

With regard to the disposition proceeds in escrow, is there any timeframe that you need to put those proceeds to work?

Well, yes, I mean across the board we've got until the end of this year to -- I'm sorry -- until Q6 (ph) to close.

We've got some designation issues in the end of November.

So it's 180 days, so that brings us to some time in March, February or March, that we have to close the deals on.

March 06?

March '06.

Okay.

Last question.

Regarding the recovery that you are seeing in the marketplace, is it following a typical trend or are the improvements that your seeing happening more sort of more rapidly than you've seen in past cycles?

I think it's funny.

I think people have been talking about the recovery for several quarters.

I think we are now hitting strike in the recovery.

Richard's prepared remarks I think were very applicable.

Currently right now, as we said, the recovery is in stride with other market timing aspects.

I think it took us a little while to get to this point, but the supply is just so limited right now that you're going to find that the recovery is going to pick up at a much more rapid pace than at other times in the marketplace.

There's also a perception out there that this is becoming very, very quickly, if not already, a landlord's market.

Thank you.

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Thank you, everyone, and we look forward to seeing all of you at NAREIT.

Thank you.