Highwoods Properties Inc (HIW) 2002 Q2 法說會逐字稿

Good morning. My name is Lisa. I will be your conference facilitator today. At this time, I would Luke to welcome everyone to the Highwood Properties 2003 second quarter earnings conference call. All lines have been placed on mute to prevent any background noise.

After the speakers' remarks there will be a question and answer period. [OPERATOR INSTRUCTIONS] Thank you. At this time, I would like to turn the call over to Ms. Tabitha Zane.

Good morning. Welcome to Highwood Properties second quarter conference call. On this call today is Ron Gibson Chief Executive Officer, Ed Fritsch, Chief Operating Officer, and Carman Liuzzo, Chief Financial Officer.

If anyone on this call has not received the supplemental financial package, visit our website at www.Highwoods.com Or, call 919-765-7171 and we'll fax it to you. Before we begin I would like to remind you that this call will include forward-looking statements concern it is company's operations and financial condition, including estimates of asset dispositions and contributions to joint venture, the reinvestment of disposition and joint venture proceeds, discussion of share repurchase activity, the cost and timing of development projects, roll over rents, occupancy expense and revenue trends and funds from operation.

Such statements are subject to various risks and uncertainties. Actual results could deliver materially from those currently estimated due to a number of factors, including those identified in the company's annual report on form 10-k for the year ended December 31st, 2002. The company assumes no obligation to update or supplement forward-looking statements that become untrue because of subsequent events. During this call we will discuss non-gap financial measures such as FFO. A reconciliation of FFO and other nongaap measures to the directly comparable gap measure is available in the investor relations section of our website I will now turn the call over to Ron Gibson.

Thank you, Tabitha and good morning, everyone. The second quarter was a solid one for our company as we continue to face a very challenging real estate environment. We're tracking well against our forecast on all metrics and holding our own in each of our markets in what are clearly extremely competitive conditions. Probably most important activity remains strong with the majority of activity being renewals. We leased a total of 1.7 million square feet of which 1.1 million are 66% was office space. And this doesn't include 167,000 square feet of First Generation space.

Through the 23rd of July, we have leased 4.9 million square feet with '03 start dates, which represents 83% of the 5.9 million square feet that was set to expire this year. There is still work to be done but we are very, very please with our progress with this leasing to date.

In the aggregate the markets reported positive net absorption of just under one million square feet, reversing what has been a nine-month trend. We're feeling the full impact of U.S. Air way lease rejections and reductions this quarter. This wear alone we've lost 1.1 million of revenue, from this customer, 75% of that amount occurred in the second quarter.

FFO per share this quarter was 66 cents, which I believe was in line with published estimates. We're leaving our previous guidance of $2.60 to 2.70 unchanged. However, based on our asset disposition schedule for the remainder of the year we are more comfortable with the lower end of the range. And again, this assumes occupancy of 82% to 84% and flat straight line rents.

Our CAD (ph) pay-out ratio this quarter was 100%. As I'm sure you're aware, the payment of second generation capex can be very lumpy and can have a significant impact on CAD so this quarter we paid $13.2 million of nonrecurring capex as compared to $11.6 million for the past five quarters. So using this normalized amount, our CAD pay-out ratio would have been 94% of this quarter.

Another highlight for the quarter, the closing of our $250 million unsecured credit facility, which was announced a few weeks ago. It replaced a $300 million facility that would have expired in December. This gives us increased financial flexibility and sufficient borrowing capacity to execute our business plan going forward.

On the capital recycling front, we completed asset sales totaling $83.6 million, includes $30.8 million during the second quarter and $50.4 million this months. The average cap rate for these dispositions year to date is 9.5%. We have $143 million currently under contract or letter of agreement. And we're using the proceeds from this program to fund the Miller transaction, and to pay down debt.

Now, let me move on to the Miller Highwoods joint venture transaction. We've acquired Miller Global for 80% interest in our joint ventures in Raleigh, Tampa, and Atlanta. In addition, we signed an agreement that gives us an option to purchase the remaining assets in the Orlando joint venture, with a scheduled closing of March 2004-- if that option is exercised.

Now, for those of you new to our company, let me give you a little background on how this partnership originally evolved. We formed these joint ventures with Miller Global in 2000. We contributed assets in return of approximately $300 million in liquidity, which significantly enhanced financial flexibility and enabled us to repurchase our stock, fund our development projects and reduce our debt.

At the outset it was anticipated this partnership would be relatively short term in nature, and the answer action we announced yesterday was the culmination of this ultimate goal. Getting back to the agreement, let's go over the details for just a minute. In the aggregate, the transaction implies a valuation of the properties of $138 million and a value for other net assets of 2.9 million. We will pay Miller Global $28.1 million in cash, which represents their 80% interest.

And we'll pay down $41.4 million of the debt and we'll assume $64.7 million in debt. The properties we're acquiring include 15 buildings, encompassing 1.3 million square feet. They're high-quality assets, a number of which we, ourselves, developed. And these assets are currently 80% occupied.

Now, this is a very good transaction for Highwoods. One of the most significant positives is that enables us to efficiently execute 65 million (ph) of 1031 exchanges. As most of you know, in today's environment, with property selling at a premium, we're acquiring great assets at below replacement cost. And at the end of the day, on a leverage neutral basis, it should be slightly accretive to FFO, which will help us offset to some extent the volition of asset dispositions.

As we move into the second half of the year it's clear that our recovery is not likely to occur until the second half of '04 at the earliest and with unemployment still high, the demand for office space still remain versus weak. In fact, many analyst reports indicate that there's at least two-year supply, if you include vacant sublease or shadow space. That would need to be consumed before, on a national basis, commercial property owners could see any meaningful increase in occupancy rates.

With that background, I think Ed and his team has done an outstanding job throughout this very, very difficult cycle, to focus on occupancy and customer services has really paid off and strong leasing activity and a very high ratio of tenant renewal.

In closing, before I bring Ed on I just want to reiterate that I think our company is in great position to weather the storm. Our balance sheet is strong. We've got access to capital. Dividend is at a level that we can comfortably support. And just let me remind you that our yield is still above the average of our peers. With that, Ed, I'm going to turn it over to you.

Good morning. As Ron mentioned, we had another quarter of strong leasing activity, particularly in our office portfolio. We signed 266 leases for a total of 1.7 million square feet of second generation space. We also leased 167,000 square feet of first generation space, which obviously had a positive impact on the leasing in those products that were placed in the service since January of '02. Leasing has increased 69% in the first quarter to the 82% this quarter.

All of this activity increased our in-service occupancy from last quarter's 83.2% to 83.4% as of June 30. For the quarter we signed 1.1 million square feet of office space. Approximately 10% above our rolling five-quarter average. Ten improvements in leasing commissions remain high although well in line with expectations. For the quarter these costs average $1.92 per square foot per year of lease time.

Total dollars committed for sign office leases for the quarter equaled $8.13 per square foot. Net of a ten-year, 73,000 square foot renewal with the federal government in Atlanta, total dollars committed were $7.22. Consistent with what we stated on our last call, we expect TIs and leasing commissions to run between $8 and $9 per square foot for the remainder of the year.

On the straight line or gap rank average office rent over the life of the lease for new deals were nearly a full percentage point higher than the rent paid under the prior lease. In fact, our office straight line rents have increased 2% year to date, on average, which means that on average leases we are signing today, will bring us more rental revenue per square foot than expiring leases.

We attribute this positive metric to our leasing team's ability to secure sound base rent escalations in virtually every lease.

On the industrial side we leased approximately 541,000 square feet. First care cash rents declined by 15.5% and capex on the industrial transactions was 40 cents per square foot, per year--below the rolling five-quarter average of 46 cents.

Same property net operating income declined by 8.6% from a year ago, primarily driven by the decline in average occupancy to 84.6% versus 88.2% a year ago. Well over half of this NOI (ph) decline was attributed to the WorldCom and U.S. Airways lease rejections.

As shown on Page 13 of the supplemental, occupancy in our Richmond, Piedmont Triad, and Kansas City portfolios remain our best markets with occupancy at or above 90%.

The improved occupancy in the Research Triangle was heavy driven by the sale of four properties encompassing an average occupancy of 76%. From an overall market perspective, Atlanta, Research Triangle, and Tampa remain the softest markets, although we were encouraged that these three markets each reported positive net income this quarter for combined total of over 1 million square feet.

Market reports continue to say that Florida and the state and the City of Tampa is one of the country's brightest and best markets with regard to job growth. It's these type of accolades that support our optimism regarding the long term prospects of our Highwoods Preserves campus. Just to give you an update on that we did sign an exclusive leasing agreement with Cushman and Wakefield to market this property. We feel that by working in partnership with the Cushman and Wakefield folks we are certainly expanding the company campuses' exposure throughout the country.

As mentioned, we are making great headway with the 2003 lease expirations. At the beginning of the year we had 5.9 square feet expiring. As of July 23 we had signed leases representing 4.9 million square feet. This equals 83% of the 5.9 million that was expiring, so we are 83% signed—60% of the way through the year.

Looking ahead, in order to maintain current occupancy and excluding the impact from future dispositions we need to lease an additional 1.5 million square feet with 2003 start dates, or an average of 300,000 square feet per month, for the next five months. Through July we have leased an average of 650,000 square feet per month so we feel confident we'll be able to meet this goal. I want to thank all of our personnel for their diligent efforts throughout the quarter and I turn it over the Carman.

Thanks, Ed. I would like to start with the balance sheet.

First, we'll discuss our recently amended and restated credit facility. We put into place a $250 million unsecured three-year facility. With that facility we sought and obtained increased flexibility, particularly in the fixed charge coverage and the restricted payment covenants. The fixed charge coverage which in this facility takes into consideration a certain level of recurring capex and principal amortization, as well as the leverage at our JVs, was lowered from 175 times to 155 times. And the restricted payment test now considers asset sales in the calculation.

Pricing increased modestly, 10 basis points up--from 95 over to 105 over. And I just wanted to say we set out to obtain a $200 million facility. We were able to get $250 million from an excellent group of Banks, who are very, very supportive of the company.

Next I'd like to move to our refinancing that will occur in the fourth quarter of this year. As you all probably know, we have $246 million of bonds with an average coupon of 7.5% that will mature in December. We continue to evaluate all options, which include secured debt, unsecured debt and asset sales. We are considering a refinancing a portion--up to, say, $125 million on a 10 year term with a balance likely in five-year and shorter periods. We may use short-term floating rate to match up with the proceeds from asset sales. Secured debt today is available in the 160 to 200 over range, depending on leverage, while our unsecured spreads are wide--north of 300 over.

We are currently running parallel pass on this and will expect to make a decision on the financing in September and we plan to discuss that in some detail on our next quarter call.

We are hedged on a portion of the expected 10 year financing at a 3.20% 10 year treasury today. As Ron mentioned, with respect to the Miller joint venture, the impact on the balance sheet, considering the funding with assets sales, will be leverage neutral. And also, just to reiterate that we expect it to be slightly to FFO as well.

On to the income statement, our operating margin, the ratio of operating expenses to revenues, the trend year over year increased. That was due primarily to lower revenues, due to declining occupancy and the lease rejections of WorldCom and U.S. Air, combined with fixed expenses staying in place on those leases, as well as higher fixed expenses across the company. Property taxes up about 3% and insurance up 54%.

G&A costs were up over last quarter due to higher variable compensation charges and restrictive stock amortization. Also, in last quarter we had the benefit of recovery of certain legal expenses, which amounted to $500,000 which reduced that line item. We expect a $6 million to $6.2 million run rate for the G&A expenses for the balance of the year.

Termination fees for this quarter return to a normal level of about $1 million, up from $800,000 over last quarter, and below the prior year levels on a year to date basis which totaled $2.6 million. Also if you focus on the equity and (in) earnings or loss of unconsolidated affiliates you will see that we recorded a loss this quarter of $485,000. We took a charge of $2.4 million, a noncash impairment charge related to our 20% share of the $12 million impairment that was recorded at the mg HIW partnership due to the transaction that Ron described, which is essentially the difference between ironclad purchase price, and the book value of the asset at the partnership level.

With that, I will open up the call to questions.

[OPERATOR INSTRUCTIONS]

Your first question comes from Lee Schalop with Banc of American securities.

You take us through the specific markets and talk about any markets that you think are improving versus markets that you think are getting worse?

Lee, this is Ed. I'll do that. The market debt seems to be showing some trends -- some traction from our perspective as Nashville. We have seen some descent leasing there and we're leased well above what the market is.

Ironically, that's -- that market itself had negative absorption in the second quarter but the prior four quarters were all positive absorptions. So the five-quarter run there was 390,000 square feet of positive absorption.

Atlanta, on a vacancy basis, remains the softest with about 18% of the market vacant and then another 3%, 3.5% of market available for sublease. It did turn positive absorption this quarter of about 700,000 square feet. But that market, as you know, is pretty sporadic. In the three quarters, prior there was significant negative absorption.

In Raleigh, it continues to be a very soft market. Deals are very competitive. It did turn positive absorption, albeit anemic, at 30,000 square feet. But it was a positive indicator.

In Richmond, we're well ahead of the market there and we attribute that to where we are in Richmond--mostly the West End Inns Brook area, we're some 800 basis points better with them than what the market is. But that market isn't as bad as most of ours, particularly those in our top five.

Then in Tampa, we are seeing, you know, good job statistics there just like we are in Orlando. It did have positive absorption of almost 300,000 square feet this quarter. Our challenge there remains if Highwoods Preserve Campus.

What type of tenants are signing leases these days? Is that something that can be categorized?

Ed Fritsch It can. We're not -- we're not seeing a tremendous amount of migration into our markets, but there have been announcements like General Dynamics going into Charlotte, new Rubber Maid (ph) into Atlanta, R.H. Donnelly into Raleigh. So there's some of that but most of the customers that are signing leases today in that better than three quarters of what we're signing are renewals are our existing customer base that are renewing in their existing space. The amount of new deals in the market is only representing about a quarter of what we do.

Thanks. Dan has a follow up.

Hope you could talk me through your views of '04, as you're saying the markets probably won't recover until late in the year in terms of leasing activity, and how you then think about the uses of proceeds from dispositions over that time and funding dividend, the dividend if the markets remain difficult?

This is Carman. I'll start with if end of the question with funding the dividend. Weed like to reiterate what we stated ton last quarter call, we don't see a significant shortfall. We're at the trough with occupancy. Capex is at a relatively normal level in the $10 million to $13 million range. So we see very little if any, of the assets of proceeds necessary to fund a shortfall. And we are, as we outlined on this call, using most of the proceeds to fund the Miller transaction. We will evaluate paying down additional debt as well as possible redemption of some of our preferred stock with you know, incremental proceeds from this program over the next, you know, six to nine months.

Okay. Thanks.

Your next question comes from Lou Taylor of Deutsche Bank Securities.

Yeah, thanks. Good morning, guys. Ron, can you talk a little bit more about the Miller Global deal with regards to-- Was this a right that was pre-existing in the contract or was this just some conversations between the two partners? I mean, how did the transaction or the buy-outcome about?

This was mutually agreed-upon transaction. The timing worked well for them and for us. It was an opportunity for us to bring what we view to be very high quality assets in our core map marketing back into the portfolio. From their perspective, they had met their investment hurdle and it gave us an opportunity not only to buy the properties back below replacement cost but, as he indicated earlier, we have significant 1031 needs and this allowed us to address that. So it was a meeting of the minds and it was mutually beneficial transaction to do what we're doing.

Okay. Now, on your supplemental Orr on the balance sheet there's $340 million of assets here. How much will be left after this deal?

Approximately $200 million, between $200 million and $210 million.

All right. So this value is fairly close to book?

At the partnership level, what we're paying for the transaction that was announced in this press release is about $10 million -- excuse me, $12 million below book value.

Okay. Now, can you talk about the accretion and especially given the fact that you're presumably going to lose the management fees for this portion of the assets? And, I mean, what's your sense accretion or dilution?

Lou, it's very small, over a course of a period, it will be 1 to 2 cents. We will lose management fees which average approximately $700,000 on an annual basis. There will be some leasing fees that have run maybe 200,000. So you're a little bit over a penny a share there.

We're looking at these assets to return 9.5% or so on cost, over the next 12 months. And, given that we have sold some assets that were single tenant that don't have growth in them-- that's where the accretion will come from.

Okay. What does this do to your balance sheet? This venture was levered with a fair amount of floating rate debt. What's the nature of the debt that you're going to bring on your balance sheet?

We're assuming, you know a portion of the debt we paid off some, you know. It's floating rate debt which mature in '06. It's a little bit more expensive than our credit facility, is 200 over.

But there's higher leverage of secured debt but there's a higher level of leverage based upon value. We will evaluate that.

But overall, given the debt that we paid down with assets sales and if you worked through beyond the quarter with a transactions that were completed post-quarter, it will be essentially leverage neutral.

I mean, our debt as a percentage of assets, maybe went from 47 to 47.1%.

Okay. The last question, Ron, you had talked about how your leasing progress this year with about 83% of the expirations done. Can you talk about the expirations in the second half?

It looks like you've still got about 10% of the overall portfolio expiring in the second half. And, you know, how much of that has been put to bed so far?

I'm going to let Ed address that for you, Lou.

Ed Fritsch Lou, we're about 5% to 6% right now for the what's going to start year end.

And, I guess what's your retention or renewal percentage?

Well, about 76% of the leases we did were renewals. And as far as economic retention, customers that stayed in the space that they were in was about 65%.

Great. Thank you.

You're welcome.

Your next question comes from John Lutsias with Green Street Advisors.

Good morning. Who initiated the Miller Global? You said it was mutually agreed to. Was it Highwoods or Miller Global that came first?

John, it was sort of a mutual agreement that came to a point concurrently. We had suggested to them that we had some 1031 needs. It made sense for us to reacquire properties with which we had familiarity in our core markets, rather than us having to go scout out properties, given prices where they are to date.

And as I said earlier, they were at a point in their investment that they had reached their objectives and were ready to move on as well.

The quality of these properties run relative to the average quality of a Highwoods office asset?

John, I would say they're truly representative, maybe a little bit up on the higher -- higher end. They're located within the research triangle park. And some of our newer developments here in Raleigh, moving to Tampa, it's at the high end of the quality range within our portfolio. And Atlanta would be a development project. So they're relatively new.

I'm taking your $138 million gross value for the deal, dividing it by 1.3 million square feet and coming up with a value per square foot of about 106 bucks?

It's just above $100 a foot, yeah.

To what extent, Ron, is that a good comp for your portfolio in terms of value? Or was there some leverage that you brought to the table against Global?

John, I think we bought those properties at a 10% to 15% discount predicated upon replacement cost.

Would it be that much of a discount predicated on current market value?

No, I don't think so at all. As a matter of fact, most of the sales we've done have been able to accomplish-- have been at pricing that's significantly above replacement cost.

So you're selling things, in your view, above replacement cost and then buying this at below?

Exactly. And the sale that we've accomplished, John, were more to financial buyers, financial engineering as operators, and it's been a very high demand for that, particularly in our markets. So we continue to see that.

You need to keep in mind that these assets that we brought are currently in an 80% occupied. And we're pretty confident that we're buying them at below replacement cost predicated upon the lease up and excited about the growth opportunities that we have here.

Do you remember roughly the value per square feet of these assets, at the value when the deal was first put together?

Yes. John, this is car man, it was about $115 to $116 per square foot.

And how has Miller. Global in terms of their returning on the deal?

You know, John, that's something that I don't know. They seem to be satisfied with their investment and the relationship that they have with us, so I assume they've done well.

Okay. Just a couple of questions for Eric. Ed, you talked about your roll over on new leases in the quarter on a straight line rent basis. Can you talk about what the rent change was on a cash to cash basis?

Sure. That's in the supplemental on Page 18.

It says that by market, it really, it varies depending upon what particular lease is rolling out. I wouldn't want to draw a conclusion that the cash basis is a direct indicator of the market.

For example, we could have a lease that had low escalators in it that was rolling versus a lease that had very strong escalators that were signed some five or seven years ago rolling.

I stick with my comments that I made earlier with regard to which markets are softer than others.

Okay. In your comments there you emphasize some positive there with respect to the gain versus straight line. But it's still going down with respect to cash.

Right. But we're still able to negotiate in virtually all of our leases these base rent kickers that enable us to grow over the term of the lease.

Okay. what's your view on what's happening to market rent? Not roll over rent but what's happening to rents in the market on a net effective rent basis?

I think the rate of decline in certainly slowed, but it's still an 8 to 10% decline.

I'm sorry. 8 to 10, would that be in the full year?

That's right.

So -- and sit still declining or have we bottomed out?

We're bouncing along the bottom. You know, it's our opinion based on what we've seen over the last seven months now that -- that the rate of decline has slowed and we think we're at the bottom.

Okay. Last question for Carman. On a year to date basis, Carman, pro forma for the. Miller Global deal and other deals that are known, what's your pro rata (ph)share of acquisitions and dispositions?

Our pro rata share?

Yeah, like the Miller Global, I prefer to look at it on a pro rata share.

That's about 110 -- that equates to about $110 million acquisition.

John Lutsias Okay.

So our dispositions totaled $83 million and some change year to date. And then we've closed some or had some under Letter of Intent that had recently closed. So it's about a push today. It's a little bit over $100 million and the Miller Global acquisition, our proportionate share, they're 80% that we bought is about $110 million.

Okay. Okay. Thanks a lot.

John, just one point, too. On this cash rent, I just want to remind everyone of our calculation and how conservative it is. I mean t prior year deal includes -- or the prior lease deal includes all of the operating expense recoveries. The new rate has the new concession it is they're in the first year.

So it's a -- it's a conservative -- it's a conservative calculation.

Thank you.

Your next question comes from Greg Whyte with Morgan Stanley.

Good morning, guys. Ron, I don't want to flog the Miller too hard here unnecessarily, but I just want understand.

You said that Miller was happy with their investment returns. But when we hear what they paid for the assets and what they sold them for, and you are confirming that there was some sort of diminishment in value because you took a right down in your own share, I'm just curious to know, were their objectives something other than a straight return?

Happiness is a relative emotion. And really what I'm suggesting to you is that we, Highwoods, are more bush on these markets going forward than the Millers may have been. So from their stabbed point, the return that they achieved on these assets may not have been at the top of their return scale certainly they did okay in these assets.

Okay. I want to continue a little bit on pay-out ratio remains pretty tight and I think -- I don't want to put words in your mouth, but I understand you as kind of agreeing or acknowledging that there may not be a pick up in the operating fundamentals in the second half of '04.

And when I look at the trend in your sort of TI capex, leasing commissions et cetera, I'm just sort of curious as to how comfortable you are with that trend and it continuing out for another call it three or four quarters? And what the implication of that means to the pay-out ratio.

Greg, this is Carman, I think the trend you're referring to is a trend that principally our office leasing statistics. Which this quarter we're $8.13 per square foot for TIs and lease commissions compared to last quarter, as we said on the last quarter's call it was relatively a very low number of $5.67.

We're comfortable in the 8 to $9 area. And if you take out a deal that we sign this quarter that was a ten-year deal with the U.S. government, our capex trends for this quarter, those same numbers would have been $7.22, which would be in line with the five-quarter trend. So we're comfortable.

I mean, we think we are at a level that is -- we're probably going to see this $8 number for several quarters, maybe another year or so. But if you take into consideration the leasing activity that's out there, we are we're very comfortable where we're operating with respect to the pay-out ratio.

And as we said on the last call, we didn't expect to be, significantly below 100%. We said there would be, a couple million dollars of cushion over the next several quarters.

And so we're in line with what we said on the last call. We're very comfortable with the dividend level.

Okay. I just -- one last question on the tenant mix. Obviously, you've brought down your exposure to telecom and stuff a little bit. But when you look down that list are there tenants that are of great concern to you today or where you may be having discussions with them?

Ed Fritsch Greg, this is Ed. There aren't any customers on that list that we have great concern with beyond what we all know about WorldCom.

Okay. All right. Thanks a lot, guys.

Thank you.

Your next question comes from Chris Haley with Wachovia Securities.

Good morning, Ron. Good morning, Carman and Ed. Question about your sales and investments.

Our note suggests you indicated about $75 million to $175 million in sales for the full year. And that did include a small amount of land sales in there. Could you refresh me with those numbers and where you stand today? And your expectations for a full year.

Chris, I'll start with the overall fees. I mean, we have with this release, we closed $83 million of dispositions. And we had $142 million and some change under contract or letter of intent. So if you were simply just take the -- and assume we closed on all of $142 million which we feel very good about, but until you get them closed, you never know. We would clearly exceed the $175 million, upper end of the range.

Again, when we set the range, we had not contemplated the Miller Global transaction. So if you take that into consideration, we will likely be in the $200 million range of dispositions this year. We closed some of those that we have under Letter of Intent since the quarter end.

And we're making good progress. As far as the land transactions, I think we stayed at around $15 million to $20 million. And we're in line with that at this point. And we expect to meet those targets.

Converse is acquisitions, so you're providing, you know, a range that could exceed $200 million, I guess, largely because you're now allocating that in the new investment.

So when I look at kind of matching those numbers together, I should use $110 million or $100 million for acquisitions? I'm trying to look at this --

I think you could look at Miller Global as a approximately $110 million acquisition, which is 80% of the implied valuation of $138 million.

Chris Haley Okay. And the -- so when you look at your sales under contract and closed, what is your -- I think you provided this previously. What than cap rate on those?

9.5%.

Okay. And you're looking at a comparable 9.5% for Miller Global, am I correct?

It's pretty close. It's slightly lower today, but with known leasing and we're looking at the last half of the year to be in the 9.5% range, 9.4 to 9.5%.

All right. Okay. And regarding some of the specifics, was there anything -- was there any interest expense true up or interest in other income changes in the quarter?

No, Chris. I mean, the capitalized interest number was comparable to last quarter and the other income line. Again, it's something that it did not really include anything unusual in it.

With regard to your second half of the year expectations on occupancy, physical occupancy and looking at -- or actually economic occupancy. Are you assuming any materially improvement from where we are today?

I'm not, Chris. It's our expectation that we will be able to lease that 1.5 million square feet that would maintain our occupancy in this 83% range net of any impact from dispositions.

And the impact of dispositions will be modestly negative, about 1%. Because, again, we're buying Miller Global at 80 which is great the upside in it we see and we're selling the single tenant assets which much of what we sold are in that range. So those are in the mid to high 90s.

You take all of that together, you know, we'll have some difficult lugs of occupancy from that repositions.

Okay.

But again, you separate that out, you look at how we're making progress in leasing and we're doing quite well there.

Chris Haley I was just trying to put -- besides the leasing, which appears to be now stable, the changes really occurred on the transaction side, so am I correct in assuming kind of prior guidance included in net sale activity of somewhere around 100 and that net sale activity of 100 did not really include any acquisitions. Now we're selling still a net 100 but we've got 200 sold out and 100 coming in?

Chris, I think that's -- other than possible timing impacts --

Right.

-- that's an accurate way to look at it. I mean, it's very close. The numbers have been grossed up but the net effect --

My last question is Ron, when you purchased Miller and you say that these are slightly better assets and there's been a value decline of 10%, let's say, over the time period, and these are better assets, what would you say the value decline is for the not to good assets or in some of your markets?

Does that mean that you're looking at those assets as well?

Well, you know, Chris, it's pretty much an individual situation.

As Carman indicated a indicated a little earlier, these profits were leased at an 80% level. So -- and I really can't tell you based on the sales that we have been able to complete, that there's a material decline.

This transaction is obviously a little less than (inaudible) length . And, quite Frankly, I think outside of this transaction they may have, on a one-off basis, brought a value at or above what we view replacement cost to be.

Okay. Last, I think more recently, the last quarter or quarter prior you said there were limited acquisition opportunities so this one may have some up quickly based upon at least our notes. Are there any other joint ventures that you're looking at or does this represent another opportunity for you looking elsewhere?

No, Chris. This opportunity was not anticipated (inaudible). It popped up on the screen after we last spoke.

Okay. Great. Thanks a lot.

Thank you.

Your next question comes from Scott O’Shea at Deutsche Bank.

Scott O’Shea: A question here at your percentage of your NOI (ph) that is coming from encumbered properties? What's that number currently and how will that change with the Miller portfolio?

Scott, the number currently is roughly 1/3 that's encumbered. And with the Miller transaction, and it will increase slightly, it will be less than 40%. I don't have the precise number in front of me, but it would be below 40%. Probably 36%, 37%.

Scott O’Shea: Okay. As you're looking at, you know, potential refinancing sources for December, where would that number go if you say you went entirely to the mortgage market?

Scott O’Shea: Well, 45? I know we're ahead at this. We're carefully watching the --

Scott O’Shea: The 50%.

-- the 50%. And, you know, it's a we're trying to balance that with the fixed charge and you go to the unsecured market, you know, you end up your fixed charge sum. So we're trying to balance that and we're not ruling out a combination of both. But, we're watching closely and we've had the discussions with the agencies with respect to this financing plan.

Scott O’Shea: Okay. But even if you did the full 246 secured, you've still got a little bit of wiggle room even after that?

Yes.

Scott O’Shea: Okay. That's great. Had a question, too, you quoted some LTVs in secured market, 160 to 200. The spreads for secured financing. Can you give LTVs that goes along with each one of those?

65 to 75.

Scott O’Shea: Okay. That's helpful. Also, do you have a sequential same-store NOI figure for Q1 to Q2 here?

I don't. I mean, we can even cover that off line. I think all of that information, we'll just have to pull together from public data. I can do it for you.

Scott O’Shea: Okay. That's fine.

Scott, I was just going to say the biggest change between the two quarters was the loss of revenue from U.S. Air that we had in the first quarter, it was about 700,000 that we didn't get in the --

Scott O’Shea: In Q2. Great. The last question that I had is, are you seeing any sense of stress in the private market among your competitors, people that may be higher leveraged, main of a little bit mower occupancy than you do?

Any sense that there's some stress out there in terms of just potential, you know, repositions by the mortgage lenders or anything like that? Any sense of what the private market might be looking like?

I wish I could tell you we were observing some of that that would enhance our opportunity to acquire assets in our markets, but we see absolutely no sign of that. I think it's going to take a pretty good jump in interest rates before you see that. In as much as a lot of these buildings are cash flowing at very low occupancy.

Scott O’Shea: Okay. That's helpful. Thank you very much.

You're welcome.

Next question comes from Keith Mills with UBS.

Good morning. A few questions for you. Carman, you referenced with the Miller transaction the development cost was originally around $115 to $116 per square foot.

Yes, that's correct. It was the acquisition price by the venture.

Okay. Which some of these properties we acquired prior to the contributions so it's really not fully developed cost but it's what the joint venture paid. Does that cover only the properties in Atlanta, the Research Triangle and Tampa?

That's correct.

What would you say the value would be for the properties in Orlando?

Give me just a second. Approximately $200 million for the real property. Again, there are other assets at the JV level.

How many properties are there in total in total square footages of those properties?

Five properties, and I think it's about 1.2 million, 1.3 million in those as well. Those are central business district assets of a -- probably if higher -- highest quality in the -- in the portfolio.

Okay. Thank you. Ron, you had indicated in your prepared remarks Ron, you had indicated in your prepared remarks about shadow space. Do you have some sense in terms of the space that your tenants are currently leasing, what percentage of that space they're currently use something in other words, how much shadow space is there in your portfolio?

You know, we view that statistic as probably being more limit Ned our portfolio than most in much of the average-size tenant that we lease to is about 8,000 square feet. So we think that number is fairly limited. The comment that I was quoting was from a national source and I'm not sure it's applicable to our portfolio.

But I think we would be pretty naive to suggest that there wasn't any shadow space but we would view it more limited in our portfolio than most.

You know that because it's something you survey on a regular basis or is that more kind of anecdotal?

Anecdotal. If you stop and think about it, if you're 8,000 square feet and you wanted to reduce by a 10%, you're only talking 800 feet to a factor of ten on that, 80, 88, 80,000 feet, you want to reduce by 10,000 feet or the shadow space is 10,000 feet.

Okay. The asset sales in July, which were those specifically and what cap rate did you achieve on those?

The assets sold in July were 3 Capital One buildings in Richmond. and a single tenant asset. And then, also, we closed a building in August, which actually, the buildings in July were Capital One. And then it's a small industrial building to go along with those, but the largest share of those were Capital One buildings.

The total square footage there? buildings?

712,694.

Okay. And the cap rate?

They were a 9.2%.

Okay. You had indicated,, in your remarks that in your -- I guess response to a question that you were able to get rent kickers in your current leases.

Can you share with us those how those typically are and what you were able to achieve historically?

Historically we were on full service office leases, 3% of gross, and now we're typically between 2% and 3% of gross.

Okay. And then you had indicated that also buy Cushman and Wakefield to help you out with the Highwoods Preserve property. Was that planned in advance or is that something-- I know when we sell our property back, I guess it was in March, it didn't sound like you were going to go that route.

Is that something that maybe you looked at as you were having more difficulty than you anticipated in leasing the property?

No, that wasn't the case. At that point in time we were actually soliciting. We had an RFP out to a number of major brokerage firms. We were bringing the information in to understand what the costs associated with that would be and what they would be able to bring to the table. We interviewed a number of the firms and selected CW.

Okay. Thank you. Just one final question. Do you have some sense of your tenants what percentage of your tenants overall are what I guess I would call small employers, small firms as opposed to large?

I know in your supplemental you give a breakdown of your tenants, that accounts for about 20% of your rental incomes.

But for the remaining 80%, do you think it's more smaller companies or large companies like those represented in the top list there?

Given the make up of our markets, we're mostly mid-tier markets. Given the make up of our average lease being between the 7,000 and 8,000 square feet range, and being that we are suburban and not (inaudible), I would say the majority of that tenant base, customer base is smaller regional companies.

Okay. Thank you. Appreciate it. Take care.

Your next question comes from Frank Graywood with McDonald Investment.

Frank Graywood Good morning. I was wondering if you would give us an update with the activity at the Highwoods Preserve?

Sure, Frank. As I mentioned, we have it listed with C.W. They have started their marketing process and building some of the marketing tools that they want with regard to both Internet marketing material, collateral material that the printed and distributed communications throughout the network.

We received the monthly activity report this past week, and we have a relatively healthy list of 100,000 to 200,000 square foot suspects, but we have no strong prospects at the present.

Okay. Are you still pursuing any settlement from WorldCom?

Frank, this is Carman. We are. We have a claim that is in excess of $20 million. And, again, with all of this recent news, I mean, they have -- the reorganization plan applies a 47 cents on a dollar settlement.

And again, it's broken down between Intermedia communications and WorldCom, but again, until that's finalized and they come out of bankruptcy, we don't know. So we're not counting on it nor have we included it in any of our guidance.

Okay. And in your guidance, what percentage of that or how many -- what are your land sale assumptions?

For the balance of the year, I mean, it's minimal. I mean , we probably have a penny of a share or so, a penny to a penny and a half between now and between the third and the fourth quarters-- mostly in the fourth quarter.

Okay. Thank you.

Your next question comes from Chris Haley with Wachovia Securities.

Sorry. There was a follow-up. So if I look at the sales that have occurred, Carman, so far in the quarter? the cap one deals, they're single tenant deals, 92 caps, that's what, about $77 million?

Yes.

Okay. That's the bulk of it. Is there any update on the industrial portfolio? Any possibility of you revisiting the sale there?

We're very active with that portfolio as we speak, Chris.

Okay. Is there any -- Ron, not trying to give away the house, but what kind of range is being, or might we attribute to, the sale there?

Well, it's -- it's a relatively small portion of our industrial portfolio.

Oh, okay. So it's just a piece? And where would these assets be?

In the Carolinas.

Okay. Ed, going back to your earlier comments about Atlanta, Raleigh, and Tampa being the weaker markets. Did you say that those were your weaker markets or were they the weaker markets in general?

No, speaking overall from a market perspective.

Okay. And last quarter I think those top five markets had over 1 million square feet of negative absorption as well. Maybe this quarter, the negative absorption is less.

And I guess given some thoughts about the seller in the south eastern markets being cycle markets, what are the signals that you are looking at internally or the market observers, what are they looking at, to assist in the reversal of negative net absorption?

Just to clarify, the top five markets for this quarter were positive absorption, pushing a million square feet.

I'm sorry, positive absorption. Okay. Sorry. Okay.

Positive absorption. What I had mentioned earlier is that Atlanta, Raleigh, and Tampa had combined for over a million square feet of positive absorption.

That answers question. Okay.

You're welcome.

At this time, there are no further questions. Are there any closing remarks?

Operator, thank you for your help. And as usual, we're available for questions if we didn't accomplish your purposes on the call. Thanks for attending.

This concludes today's conference. You may now disconnect.