Highwoods Properties Inc (HIW) 2003 Q3 法說會逐字稿

Good morning. My name is Nicole and I will be your conference facilitator today. At this time I would like to welcome everyone to the Highwoods Properties 2003 third quarter earnings conference call. All lines have been placed on mute to prevent any background noise. [Caller Instructions]. I would now like to turn the call over to your host, Ms. Tabitha Zane, Director of Investor Relations.

Thank, Nicole. Good morning, everyone welcome to High Wood Properties third quarter conference call. On the call today are Ron Gibson, Chief Executive Officer, Ed Fritsch, Chief Operating Officer, and Carman Liuzzo, Chief Financial Officer. If anyone on this call has not received a copy of our 3rd quarter press release or supplemental financial package, please visit our website at www.highwoods.com or call 9199-875-6717 and we'll fax or email a copy to you.

Before we begin I would like to remind you this conference call will include forward-looking statements concerning the company's operations and financial condition, including estimates of asset dispositions and contributions to joint ventures; the reinvestment of disposition and joint venture proceeds; the discussion of share repurchase activity; the cost and timing of development projects, rollover rents, occupancy expense and revenue trends and funds from operations. Such statements are subject to various risks and uncertainties.

Actual results could differ 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 31, 2002, and subsequent reports filed with the SEC. 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 GAAP financial measures such as FFO. A reconciliation of FFO and other nonGAAP financial measures to net income as defined by GAAP is available in the Investor Relations section of our Web site. I will now turn the call over to Ron Gibson.

Thanks, Tabitha. Good morning, everyone and welcome to our last conference call for the year. While we still have too months to go before we put the year behind us and even though this has been a challenging year for reaching our sector, we continue to be encouraged by the sustained leasing activity in just about all of our markets. This tempered somewhat by the fact that our pricing power is minimal and [inaudible] remain high and frankly until we see sustained employment growth burn through much of the excess capacity that's out there our ability to influence rents and concessions will continue to be marginal.

In the third quarter we leased a total of 1.7 million square feet of which 1.1 million, or 62 percent, was office space. This doesn't include first generation space which increases our quarterly leasing activity to approximately 1.8 million square feet. I want to point out this is the fourth quarter in a row that we leased over 1 million square feet of office space. So our leasing teams have been very effective and obviously with our tough markets.

We had a big hurdle to overcome with 19% of our portfolio expiring this year. Through October the 24th, we've leased 5.4 million square feet with 2003 start dates. In Ed's remarks he will give you more color on expected leasing for the rest of the year. What I am going to do is focus on 2004 expirations.

As you can see our, page 20 of the supplemental--once again there's 5.9 million square feet set to expire, or 19% of our portfolio. However I want to point out that there are significant difference in the task at hand between '03 and '04. In '03, 68% of the square footage expiring was office space. In '04, expirations are pretty much evenly divided between office and industrial just under 3 million square feet for each. We've already taken care of a big chunk of both. As of October 24, we signed leases representing 882,000 square feet of industrial space with '04 starts, or about one-third of the industrial square footage set to expire next year. We also signed leases for about 815,000 square feet of office space with '04 start dates.

So before we even start the year we've already reduced our exposure to about 13% of our Portfolio. To give you one more example the differences between '03 and '04, last year this time signed leases with '03 starts were less than 10% of our expirations. Today we have a third of our '04 expirations taken care of. So at this point in the game our confidence level is high that we can sign leases with '04 start dates to match these expirations if not exceed the base level. If anything we believe we will be operating in a much improved environment with the economy on the mend and our customers feeling more confident about their own long-term prospects. As we look at '04 we're optimistic that we will see a small increase in net occupancy.

Let me turn to FFO. This quarter we reported 64 cents per share which was in line with published estimates. Our CAD pay out ratio was 114%. We expect this ratio to exceed 100% next quarter as well. You can see that as we move through the year the level of tenant improvements and leasing commissions committed for the released office space has increase from $1.39 per square foot of year of lease term in the first quarter to $2.09 per square foot per year of lease term in Q3. One of the biggest reasons for this is that more of the leases signed in the first half of the year were renewals which generally require significantly less TI's and lease commissions than leases signed with new tenants. So we expect to see a similar pattern in '04.

We will obviously fund these small CAD shortfalls, and we don't anticipate this situation to continue throughout next year for a couple of reasons. First, as I mentioned earlier half of the expiring spaces is industrial and second generation Capex related to this type of space is significantly less than TI's for office space. A second reason for the optimism is the refinancing of 246 million of public bonds that expire in December. Under the current terms interest payments on these issues total about 18.5 million annually. What we're doing is refinancing 127.5 million of the notes with ten-year secured debt at an effective rate of 5.25%.

We will also take out 100 million two-year unsecured term loan with a floating rate that will initially will be set at 130 over LIBOR and then the remaining 19 million will come out of our current credit facility or be repaid with proceeds from asset sales. So all told we will be saving about 9 million annually in interest payments which will add about 15 cents to FFO next year.

We continued to sell assets this quarter. We disposed of seven properties totaling 968,000 square feet for 87.2 million at an average cap rate of 9.2%. We also sold land, 21.1 acres total proceeds of 6 million.

Through October 24, we've completed assets sales totalling 128.8 million. We've got 175 million currently under contract or letter of intent. We expect to close approximately half of this by the end of the year. A portion proceeds was to fun the Miller Highlands transaction which closed on July 29. The acquisition of these 15 properties brought an additional 1.3 million square feet into our in service portfolio. To remind you, we paid Miller global 28.000000 in cash which represented their 80% interest. We paid down 41.4 million of the joins debt and we assumed 64.7 million in debt. This increase in our secured be bearable rate debt is reflected on page nine of the supplemental. So as we look out to next year we are certainly more optimistic about the overall environment than we had been a year ago. Mind you we are still bouncing along the bottom but the hole is not getting any deeper and '04, it should be flat if not slightly better than this year. With that I am going to honor it over to Ed for specifics about our markets.

Good morning. We are seeing scattered signs of stability, in some cases indicators of economic improvement. Gain in GDP exceeding forecast improved productivity and sound consumer spending and some of this positive movement is surfacing in our business and in a few of our markets.

Looking at our top five office markets; research triangle Tampa, Atlanta, Nashville and Richmond, combined they reported positive net absorption for the second consecutive quarter. On the leasing front to the end of last week, excluding the 350,000 square feet deal in Atlanta, we have leased nearly 7 million square feet, 1 million square feet more than we leased in all of 2002. Third quarter was another strong quarter of leasing activity having signed 260 leases totalling 1.8 million square feet.

Showings in the volume of RFPs are steady and customers are to be more deliberate in their intent to lease space. However, as we said before until there is sustained measurable job growth we will not see a meaningful improvement in occupancy or reduction in downward pressure on rental rates both of which are critical before we see a rebound in our operating fundamentals. While the economic tide may be shifting, we will continue to bounce along the bottom until a steady flow of expanding and new customers emerge.

The historic high vacancy rates and multitude of space options for customers continue to enable tenants to drive much of the leasing process, as evidenced by the relatively high cost of leasing Capex incurred this year. This quarter total Capex committed for signed office leases was $10.51 per square foot, higher than our rolling five quarter average of $8.19. However we did see an increase in average lease term to 5.5 years well above the first six-month average of sub-4 years. In addition to tenant improvements and leasing commissions and other extremely important metric that we began reporting in the third quarter last year is straight line rent growth.

We believe straight line rent which runs through FFO provides a sound measure of current production while cash rent numbers are impacted by concessions and do not reflect annual escalations as provided for in virtually all of our leases. This quarter office straight line rents held relatively stable and YTD they have increased by 1%. You may recall for the second half of last year office straight line rents increased on average over 2%. This has been a positive trend for Highwoods and an an outstanding achievement for our leasing team in the face of stiff competition.

In our investment portfolio we leased 22 leases, we signed 22 leases totalling just over 638,000 square feet. Total Capex committed related to these leases averaged $1.44 per square foot, lower than our rolling five quarter average of $1.56. We also saw an increase in the average lease term to 4.5 years versus the six-month average before of three years. Same property and net operating income for the quarter declined by 9.8% primarily driven by the. decline in average occupancy from 83.9% from 87.4% a year ago.

Excluding Highwoods preserve from the portfolio same property NOI declined a more modest 5.1% and occupancy declined only 1.1%. Total occupancy declined 100 basis points from last quarter to 82.4% driven by three specifics. Namely, the disposition of 968,000 square feet that on average was 91.6% leased, the purchase of the Atlanta, Raleigh and Tampa based assets in the [inaudible] [inaudible] which were 1.3 million square feet and 78% leased and the expected move out of a single tenants in a 153,000 square feet Tampa Bay based building. As an aside we are optimistic with regard to a lease we have out for signature for 100% of that same building in Tampa to another single tenant for an anticipated lease commencement prior to year end.

Following is an overview of our top five office markets. The research triangle market remains challenging reporting slight negative absorption of 28,000 square feet for the quarter. Over the last five quarters this market has had cumulative negative absorption of just over 400,000 square feet. The good news is that there are some deals being signed in the market that are pure new growth. Unfortunately the contraction of existing market customers has offset the arrival of new customers thus far.

Tampa has also has challenges with over 300,000 square feet of negative absorption for the quarter. Market vacancy is 16.7% with available sublease representing another 2.3% of market. As mentioned our Tampa occupancy was negatively impacted by the loss of 153,000 square feet tenant upon lease expiration but as I mentioned earlier we have a lease out for 100% of that space.

The 824,000 square feet Highwoods preserve campus vacated by WorldCom at the end of last year skews our Tampa occupancy. We are aggressively marketing the preserve on multiple levels and Cushman & Wakefield, our exclusive agent, has deployed a comprehensive marketing plan inclusive of a wide range of sophisticated new marketing materials distributed to targeted prospects and brokers. We've had numerous showings and been invited to respond to a significant number of RFPs perspective clients have toured the space range in size from 60,000 square feet to over 400,000 square feet. They include firms both currently active in the Tampa market as well as those considering the area for a major relocation. Business types are primarily financial services, technology and healthcare.

The feedback we are receiving from brokers and prospects who have toured the facility have been uniformly positive and it is clear they view Highwoods Preserve as a world class facility. However end users simply are not ready to commit at this point in time. In other words the hold on pulling the trigger is a function of economic conditions nationally rather than a real estate issue.

Keep in mind that due to the size of the prospects, most are looking at requirements will that are a minimum of 12 months out. They are large real estate deals typically involving relocations and understandably entail complex decisions and heavy logistics. We are pleased with C. and W.s efforts to date and remain convinced that the quality of the real estate will generate transactions of comparable quality.

In Atlanta, absorption was basically flat for the quarter. Vacancy remains high, in excess of 18%, with another three plus percent available for sublease. Construction's percent of market is a very low 610ths of a percent. Our occupancy rate remains slightly better than the market and our leasing agents have been seeing solid activity all quarter.

Also encouraging are the latest figures from the economic forecasting center at Georgia State University which predict that Atlanta will end 2003 with a gain of 33,300 new jobs and be followed by an estimated 52,700 new jobs in 2004. Nashville with an overall vacancy of 16% continues to show signs of recovery. Third quarter absorption was a positive 115,000 square feet, and the market has a five quarter total of nearly 400,000 square feet of net positive absorption. National based team has done a tremendous job of keeping and attracting customers and our [inaudible] is now pushing 89%.

Richmond remains one of our strongest markets with overall occupancy rate of 14 percent, overall vacancy rate of 14% and third quarter net absorption of 435,000 square feet. Vacancy rate of 8.5% remains substantially lower than the market. One plus percent occupancy decline in our Richmond portfolio is primarily the result of the disposition of three properties totalling 300,000 square feet that were 100% occupied.

Looking ahead, I'm optimistic we are maintain and possibly increase occupancy slightly by the end of the year excluding the impact of dispositions. As far as 2004, I expect it to be similar in outlook to what we have experienced in 2003. Net effect of market rents are likely to continue to roll down 8 to 10 percent, releasing Capex is expected to remain in the nine to 10-dollar per square foot range with concessions will be in play for a majority of deals. With almost 30% of our 2004 lease expirations put to bid, and continued strong lease activity, I am very comfortable that we will renew or relet all of the space we have expiring next year and we can possibly see an uptick in occupancy as we move through the year.

Thanks. My remarks this morning will include a quick review of the quarter with a focus on the income statement and our expanded FFO disclosure, more color on the refinancing plan that Ron discussed, and then a discussion of the guidance for the fourth quarter and 2004.

First, if you turn to page one of the supplemental, the income statement attached to the press release, the increase in rental income this quarter from 104 million last quarter to almost 107 million for the third quarter was almost entirely related to the acquisition of the Miller Global Assets that took place during the quarter. As also was mentioned we recorded $1.2 million of termination fees. That in our view is a normal level. Our operating expense trend held steady versus last quarter of 34.8%. The increase as a percentage of revenues compared to last year which was just a tick under 32% was related to the decrease in occupancy and the current expenses that we paid at Highwoods preserve where WorldCom vacated that we did not pay last year. They were paid by the customer.

Our G&A is in line with your our prior guidance at 6 .3 million, just slightly above the average of the last four quarters of about 6 million. We also recorded $11.3 million of gains on asset sales. I'd just like to highlight that the transactions that we have under contract, or letter of intent, have an implied gain of approximately $30 million.

Next I'd like to move to the FFO table which is the next page in the supplemental and also follow the income statement in the press release. Pursuant to that are receipts financial reporting bulletin which was issued this past quarter, we are now deducting impairment charges to arrive at FFO. In the past they were added back along with other gains or losses on asset sales. And we have provided additional disclosure at the bottom of the FFO table to reconcile the gains and losses to the income statement and also to quantify the impacts of the impairment charges, which were a nickel last quarter for us related to the write down of the N. G. H. I. W. assets at the partnership level and for last year 2002, all of 2002, it was 23 cents per share. Again all of this information is disclosed in the FFO table.

While we are on that page if you focus on the cash available for distribution section, you will note that we paid our highest level of Capex building improvements and leasing Capex versus the prior four quarters; a total of just a little bit over $15 million-- it's our highest quarter this year and it reflects the seasonality of our business and, as Ron pointed out, we'll have comparable numbers in the fourth quarter of this year and would expect them to decline as we move into '04. Partly to the mix of our leasing which will include more industrial next year versus office because the expirations are about 50/50 in 2004.

On the balance sheet, I am not going to review that because there's very little change there. Much of the balance sheet changes were due to the acquisition of the Miller global assets.

Now just a little color on the refinancing plan that we disclosed and Ron discussed in his remarks. Both of these financing are with existing lenders. The secured financing is with Mass Mutual, an existing lender for us, and a number of locations and the term loan is with four of our current bank group members. The rationale for the financing are the term loan with its terms will be put in place to give us flexibility given the asset sale program that we have underway, and I will give you color on what we expect to dispose of next year in the guidance remarks. The secured debt, we put that in place because of the pricing advantage it provided us versus the pricing that we had available to us at the time we locked that rate in the unsecured market. We expect to close both of these transactions by mid November, therefore, we'll have approximately one month of the interest rate savings in the fourth quarter.

The transactions taken together are positive for our credit statistics. The pro-form impact on our fixed charge, which includes interest in our preferred dividend, increases the fixed charge from 2.24 to almost 2.4 times; our ratio of unencumbered assets to total assets will decline slightly to 66% from 68 percent, and the ratio of unencumbered assets to unsecured debt will improve because of the higher leverage we are putting on those assets from three times to 3.2 times. At the end of the day we'll have $2.5 billion of unencumbered assets after these financings.

Next I'd like to move to guidance. For the fourth quarter we provided guidance in the release of 62 to 64 cents per share. The basis of this is flat average occupancy versus the third quarter. Most of the decline that we experienced in the third quarter was at the end of the period. Therefore, we'll have, in the leasing we expect to add will happen at the end of the fourth quarter, so occupancy will be down just slightly over the third quarter.

We also expect modestly higher operating expenses due to seasonality and some dilution from asset sales. We have 175 million under contract. We expect to close about 80 million in the fourth quarter, in the middle of the fourth quarter, rather.

We provided guidance of $2.55 to $2.70. I'd look like to just walk through that with you. First off, just to put it in context, in 2003 we have lease termination fees of about six cents per share and land sale gains of about eight cents per share--in the 2003 YTD numbers. Our occupancy guidance for next year is 82.5 at the low-end to 83.5 at the high-end. It doesn't include any impact from asset repositioning and it doesn't assume any leasing at Highwoods preserve. That's not to say that we won't have any, but as Ed mentioned that will happen at the end of the year and will have a limited impact on the '04 numbers. The asset sales for 2004 are in a range of 100 million to 200 million at an average cap rate of 9.5%. Acquisitions of 20 to 50 million, primarily to satisfy 1031 exchange requirements at an average cap rate again at 9.5%.

Land sale gains, a range of 1.2 million to 3.6 million, again, these are full year numbers, and termination fees, a low of 1.2 million to a high of 3.6 million. Incremental G&A costs full year: 1.2 million to 2.4 million. Much of this is due to the implementation requirements both with internal costs and external costs related to Sarbanes-Oxley. It will include the impact of the debt refinancing benefits for the full year.

Now I will just briefly discuss capital. Building improvements paid a range of $10 to $11 million and then releasing capital in the range of $39 million to $45 million. Those are, in our view, are the principal drivers behind both FFO and will also provide you with the details that you would need to make your own estimate of CAD or AFFO. With that, operator, I would like to open the call to questions.

Questions & Answers

[Caller Instructions]. Our first question from Dan Oppenheim of Banc of America Securities.

Thanks. Quickly I want to do see if you could talk talk about your outlook. You discussed it in 2004 in terms of rents coming down and continued pressure on concessions and T. I.s. As you look out to '05 where you have significant office rollover as well even higher rental rates, how are you looking at that at this point?

Dan, I think it's tough for anybody to see out into '05. Obviously we are optimistic that it will pick up. We hope to see some improvement in the latter half of '04 I think we and everybody else in the industry said the same thing for '02 and '03--'04 is starting to see some signs, but it's still void of new job growth, new customers coming into most of our respective markets. We are hopeful that that will come but I'm not sure and I don't think anybody else is, what's going to happen on the heels of the election in November of '04.

Thanks and Lee Schalop has a question.

Carman, in terms of putting together your guidance would you characterize it as a case where you were very conservative, reasonably conservative; how would you characterize your thought process in putting together these numbers.

Lee, at the low end I would say that would be conservative, because you really don't have much impact if any from your termination fees, land sale gains and also we would have a decline in occupancy over this year, plus it would include dilution from asset sales in the 4 to 5-cent range. I think the probable case is something that is up slightly over this year, and the upper end of the range would be an improvement in occupancy and also a normal level of lease termination fees and land sale gains. So, I guess very conservative at the low end; I would think reasonable in the middle and then some improvement in occupancy and everything hitting on all cylinders, or most cylinders at the upper end.

Thanks.

Your next question comes from Jamie Feldman of Prudential Equity Group.

Hi. Thank you. Do you have a same store NOI estimate for next year?

Jamie, this is Carman. I think we will have cycled through all of the WorldCom and U.S. Air comparisons but I think the same store number for next year would be flat to down depending on your occupancy. It's a plus two to modest 2% for next year.

Do you have any progress update on the Miller Orlando potential acquisition?

Nothing to report there. I mean, we are pursuing options there to either acquire it or to possibly enter into another joint venture with those assets. Next year it would be a March of '04 event.

March of '04. What are you guys assuming for LIBOR for next year year?

Up slightly, not up dramatically, probably 40 to 50 basis points.

Thank you very much.

Your next question comes from Lou Taylor of Deutsche Banc.

Hi, thanks. Carm, can you talk little bit about the Capex and the timing. Are you recognizing the Capex in your SAD calculation when paid or when committed?

Good question, Lou. I mean we recognize it in the CAD table when paid.

When paid. Okay. So some of that advanced '04 leasing that you guys reference, or Ron referenced in the beginning of the call, those payments are going to be Q4 and into next year?

Correct and what I would also like to just mention that most of that or at least half the industrial deals are essentially an as is transaction. So that combined with the mix, more industrial, less office, is behind our assumption for, we believe, lower Capex overall next year.

Can you just expand a little bit on the plan to sell 100 to 200 yet only buy 20 to 50, given the dividend pressure you guys have, why would you be a net seller next year?

Partly, I mean where we may reduce debt, also we are not, part of the asset sales are really cleaning up noncore assets. We would feel like we were able to get fair prices on those, and we haven't seen, at least in this market, assets that we believe to be core and then we also have some development, a couple of build-to-suits out there that we expect to have next year that would also come into that asset repositioning use of proceeds. Certainly we would like to be, have more acquisitions but right now we think it's conservative to make the assumptions that we did in our guidance.

Okay. Thank you.

Your next question comes from Greg Whyte of Morgan Stanley.

Good morning, if--I think you gave a mark to market on the portfolio; can you reminds me what that is.

Sure, Greg. We see it as two to 5% and that's what last year's asking deal signing rate is versus what we see it to be now. Just pure rent roll down, expiring rate versus new rate in the eight to 10% range.

Okay. Then you talked about the percentage of the rolling leases that you've already taken care of which is pretty decent. When you look through the portfolio on a tenant basis are there tenants that you have on watch right now that you are concerned about?

We have a watchlist of about five or 600,000 square feet, primarily driven by the nature of the industry that they are in; whether it be telecom or along those lines. But right now the outstandings on that entire group is less than $100,000 in reserve for it.

Can you just help us in terms of the Banc of America leases, can you give a little color on that, just in terms of what your exposure is and if you've spoken to them that about the merger announcement.

We found on a global basis with this merger and others that have come down the line with First Union, Wachovia , et cetera, it is really early in the process. Those guys are starting to get their arms around it and really haven't drilled down to the leases yet. From a Highwoods perspective we have leases with B. of A. in seven markets, 23 leases, the average lease size is 6400 square feet and the majority of them expire 2005, six and seven. No one lease is greater than 13,000 square feet so we think we are in good shape and they are actually talking to us about some expansions in certain markets right now.

And, Ed, when you look across that is most of it just store front branch type of stuff?

It's more operations than store front. It's having an operations facility, it's Greenville, Memphis, Raleigh, Tampa, Winston Salem, Kansas City, it's across the board.

Some of it is clearly store front, but most of it is just office operations.

Maybe for Ron, just on the dividend front I have to ask, when you look out, given the guidance that you've given today, we would need to see some sort of improvement in the [inaudible] to FFO of GAAP in order for you to cover the dividend. What are you thinking on the dividend these days?

Well, Greg, when we lowered the dividend we recognized the probability that we would be bumping up against the 100% ratio, but we obviously want to maintain an attractive yield for our shareholders, and we believe that the shortfall would be very manageable and it is. We were in a much different situation last April than we are today.

Six months ago we were looking at $30 million shortfall and certainly that would have jeopardized our financial help and it's something we said all along we said we won't do. This quarter we are looking at a modest shortfall. It's about 3 million, probably not much more than that next quarter. As we said earlier when you look at our Capex spent for T. I.s and LCs it's very seasonal, it's generally back end loaded.

So next year if there is a shortfall it should be modest and back end loaded as well, and it could be easily funded. So we are looking at asset sales next year of 75 to 200 million, and that combined with the cushion we are going to get from the debt refinancing I think gives us plenty of room. If there is a shortfall it would be modest and easily covered under our capital structure. We sort of underline that with what we believe is very good leasing activity in markets that are firming, we are comfortable with it.

I will just add to that the low end of the guidance range you are going to be spending lower Capex because you have a lower occupancy assumption as well, so we think as Ron said, the cushion is very manageable.

All right. Thanks a lot, guys.

Your next question comes from Chris Haley of Wachovia Securities.

Hi, good morning, everybody. I have a question on land-- land and sales activity. Carman, you mentioned that you are assuming 1 million to 4 million of land sales for next year for '04. I'm assuming those volumes of land sales are separate and distinct from your asset sale range. Is that correct?

Yes, Chris, the number I gave in the guidance was the gain component which is 1.2 to 3.6 million. The asset sales numbers behind that would be ten to $20 million and would be, is excluded, from the asset sale numbers that we provided of 100 to 200 million.

If I heard you correctly you said that the assets you have scheduled to close in the fourth quarter total 80 million?

Approximately 80 million.

And is that, again, 9.5 cap.

Yes.

Okay. And you said you had a gain of 30 million on unrealized gains?

Chris, let's back up a second. The assets that we have under contract and letter of intent total 175 million at an average cap rate of 9.5. The implied gain on that basket is about 30 million. The cap rate in the fourth quarter is going to be higher due to the nature of the assets at about 10.5% versus the 9.5 on average. And that will be in the fourth quarter. That's partly driving the dilution given the timing that we have modeled in in our guidance for 4Q.

Okay. When I look at your land balance sheet though, your land component has steadily ridge, not much, but it's gone up 20, 25 million in the last year, land held for development. Is that, what is driving that? Is some of the building suits you've announced?

Part of it is we've been putting in improvements on some of the sites, and we have acquired some land due to preexisting arrangements over that period.

Chris, we had a couple of arrangements where we were buying a tract of land over a five year period with equal take downs over the five years and that's what's driven that increase.

Given that land is not income producing right now and given I don't know the right word for this but the need for income right now for you guys, why would you sell assets versus selling land positions taking into account your current market conditions?

It's really just one word for that, Chris, and that's opportunity. The opportunities for repositioning assets is greater as we speak than straight land sales. However, I will tell you that a number of our land positions we are looking at alternative uses for that land as the markets in and around that land have matured, the highest and best use of that property today isn't office or industrial. We will expect to recycle some of that land for other uses.

Carman, question on debt covenants. When you redid your line the middle of this year, what were some of the important coverage covenants that had you changed and where do they stand today?

Chris, what I'd like to do is not get into specifics. I mean, they were disclosed in the last Q. but I will tell you we had more flexibility on the interest coverage. We also on the dividend coverage covenant, that was modified to allow us to consider a component of our asset sales against that. And today that cushion, if you will, is approximately $40 million.

So we have flexibility on the coverage which, again, we needed due to a decline in occupancy and we also sought and obtained flexibility on the dividend coverage. Those were the two principal ratios. Again, in our 10(Q) disclosure and MD and A. we provide daily measurement in actual versus the covenant and we do that in all of our quarterly filings.

Great. Thanks a bunch.

Your next question comes from John Lutzuis of Green Street Advisors.

Good morning. Kind of a random selection of questions. Ed I want to make sure I understand the roll down, you mentioned eight to 10% roll down that's cash ending rents with expense overdues to new cash rents.

That's right, it includes the last day's rents basically annualized for the customer that's leaving inclusive of any escalations that occurred over the term to the base rent, any [inaudible] pass through versus the day one rent of the new customer, regardless of the amount of downtime between when the old customer moved out and the new one moved in.

I think you said it was eight to 10% on a mark to market basis for the portfolio. Is that right?

Yes, it may be semantics here but our internal rent roll down for our customer new, eight to ten, but when I said the market, I was more referring to what market deals are being consummated at today versus the same time last year. So it's a year-over-year comparison versus the rent roll down which would be more a three to five year comparison. Follow me?

I'm sorry. I didn't follow that.

The rent roll down goes from, it's the deal that was signed three, five, seven years ago and what it escalated to on its last day versus a new deal signed after downtime, that's the eight to 10 percent, the mark to market that I was referring to is just year-over-year rent expansion or contraction, in this case a negative two to 5%.

So the negative two to 5% is the change in market rent.

Right, year over year.

With respect to '04 versus '03, what's your expectation of what would happen to market rent?

I think that what we've experienced now has been two to 5% and next year will be similar between flat to negative 3%.

So no recovery there on the rents, best guess.

I don't think so, John. Most of our markets there's several years of supply and customers have lots of options. Unless there's a dramatic shift in job growth there's just not going to be, we are just not going to get to the point where where customers have only a few choices for where to lease space. That's what needs to occur in order to drive that back up.

Okay. There's a page with, I guess it's page 11, that has occupancy statistics in it and at the bottom of that page there's a same store occupancy calculation? I'm just looking at the end of the second quarter versus the ends of the third quarter, and it looks like the drop there is about 130 basis points or so? Is that, am I looking at same store sequential, is that what that is?

Yes.

As I understood the comments earlier on the call, the expectation is that it will drop a little bit more in the fourth quarter?

On average, slightly. Again when we talk about getting to 83 percent, and that's at a point into the quarter measure, but on average given the timing of the expiration the large one, the 150,000 square footer that we would expect fourth quarter occupancy to be down slightly versus three Q.

I see your point about the average. What do you think on a point in time at the end of the quarter will it be flat or down or?

I think my hope, as I said in my comments, is that we maintain where we are today and not, if not a slight uptick.

Okay. Carman, in your prepared remarks where you talked about fixed charge coverage ratio--you then went on to talk about a couple of measures of unsecured debt to unencumbered assets. Can you go through what those headings were again? I'm sorry, I didn't.

The measures that I gave, John, I want to discuss fixed charge, which includes interest and deferred dividends... then I discussed the ratio of unencumbered assets to unsecured debt. That's a measure of flexibility and a measure of coverage to the unsecured debt holders. We went from three times to 3.2 times.

Then also I looked at the ratio of unencumbered assets to total assets which looks at how large our unencumbered pool is in relation to our total asset pool, which is, really speaks to flexibility which from time to time we get the question---as you go from secured debt to unsecured debt what do you do to your flexibility? I think at a 56% ratio unencumbered to total; that really says we have flexibility and we have $2.5 billion of unencumbered assets. So we are really we think making the right could corporate finance decision in issuing secured debt today.

Total assets that would be gross undepreciated book?

Yes.

And your credit ratings today are split, right.

That's correct. Triple B minus from S&P and Fitch, and BA one from Moody, which is the one that would be sub investment grade.

Do you have any comment about your expectations for maintaining the investment grade from S&P?

Our expectations are are that we will and all I can tell you is we have good relationships with both Fitch and S&P as well as Moody's and we are executing on the plan that we presented to them. Again, I can't speak to their view but I can tell you that we are in front of them, we have dialogue with them and we are executing on the plan that we reviewed with them several months ago.

Two more questions. One is R.J.R. in Winston Salem, big cut in the work force pending merger. Any comments on the effect of that?

John, there have been unfortunately a number of negative announcements in the entire Triad area. It's had some impact on the marketability of ours and other products there. With see our big challenge with the roll that we have coming in '04 with Sarah Lee, but we are optimistic about that. I think that what we are doing with regard to asset recycling will help insulate us from some of that in '04. We have no exposure with R.J.R.

That's it for me. Thank you.

Your next question comes from Gary Austin of Smith Barney.

Good morning. Carman on the asset sales for next year, any of those going to be complete exits out of markets or are they all kind of one off transactions?

They are not complete exits. I will tell you that they represent somewhat off but also disposing of noncore office parks or assets that we view to have more risk, particularly when the thing begins to move up and not being able to get the upside there or high capital. So that's what's behind it but it's not an exit from any one market.

And you envision these being out right sales not a contribution to a joint venture or something?

Some will be outright sales and if we contribute them to a joint venture we would retain 20% or so but I will tell you most of what we have on the table right now are out right sales.

Those where we are retaining a piece of the joint venture we are getting no cut, leasing and management contracts. We are even getting that on some of the outright sales.

Okay. Ed, I just sort of broadly, you talked about the markets and activity. I just wanted to see if you are getting any sense of corporate relocation activity into any of your markets given how much rents have fallen and the cost savings that someone might be able to get?

We are seeing some of that which I alluded to in my comments, for example, in research triangle there's been about 400,000 square feet of new customers that have come into the market and taken down or committed to take down space over the last six months and looking out over the next three months.

Certainly in Nashville with Louisiana Pacific coming in taking down space. We've also seen it in Tampa with the prospects and the showings that we've had at the preserve, so that we know, we've got a list of at least a dozen companies that have considered relocation slash expansion into new markets. So it's out there. There's a more deliberate step and a they are more firm in what they are saying.

So we are hopeful that it's not a mirage and that that will start to build but I think that the wildcard for a lot of people is going to be what's going to happen in the election and how much of this is propped up by government spending and others but clearly it's happening. General Dynamics in Charlotte is another example. There are signs of it whereas two years ago it was absolutely dead.

Just last question, pricing on retail assets continues to be a very, very strong. Any thoughts on country club plaza and doing something there?

Gary, this is Ron. There is no doubt that cap rates are very attractive on this type of asset. Like all of our assets we continually evaluate our options. The plaza itself is core to our portfolio, actually for a number of reasons. We've been able to get consistently strong NOI growth there; certainly the diversification has been good for us given the status of the office and the industrial markets; and we still have a number of development opportunities contiguous or nearly contiguous to the plaza. So our view is that that asset continues to be core to our portfolio.

Let me add, we've seen 30% rent growth. Last year we saw 30% rent growth. We are seeing 30% rent growth this year, sales are up 3% YTD on plaza. We are seeing positive growth there and it's a core asset.

Thanks.

Your next question comes from Anatole Pedmeth of Macdonald Investment

This is actually Frank Graywitt. First I was wondering what the occupancy rate was on the assets held for sale?

We are getting it. The assets we are going to sell in the fourth quarter, they are in the mid 90s, and the balance of that pool, we are selling 80 or so in the fourth quarter, the balance is in the low 90s. I think as Ed pointed out when we talked about the occupancy change for this quarter we are selling assets that are typically higher occupied than a portfolio taken as a whole.

You also indicated that a lot of these assets were more noncore and more riskier assets. How can you reconcile that to the higher occupancies?

It could be single tenant couldn't concentrations Frank and that's one measure of risk. I think we certainly understand that given what we've experienced over the last 24 months. So we made a concerted efforts to evaluate assets that may have higher concentration of large future release exposures that may be something that a particular investor wants to own today and part of it is pure portfolio management and those single tenant transactions portfolios future occupancy risk to us and we think we can get paid for it today.

It's really potentially and it's been dislocations historically these properties have been well leased given some of the industry edition locations that we've seen, we are less confident that we can manage that going forward.

A prime example is the reference to the 300,000 square feet that we sold in Richmond. It was all cap one. Cap one is a dominant player throughout the Richmond market but most specifically in the West End and we have a lot of exposure though that one customer so we thought we would capture the value that we created and mitigate that exposure.

In the fourth quarter what is your land sale gain assumption?

It's consistent with this quarter.

Okay.

Over $1 million.

In past supplements, I notice you have a cash expiring and renewal rate on leases signed. I didn't see it in this supplement. Do you happen to have those numbers?

We can get them to you, Frank. Again, one of the reasons behind that is we just feel that the concession numbers skew that and we are providing a lot of numbers around the concession rate that we are paying, we are giving up, and therefore, we've got the actual cash rent change in there but we thought it would be more appropriate to use the GAAP rent in that space. If you would like that we can provide it to you.

That would be helpful. Two more quick ones. It looks like you have two preferred issues that can be redeemed. Any thought of redeeming those or?

We're evaluating the context of our repositioning program. Right now at 8% we certainly would not issue preferred to take it out, it wouldn't make sense but we would consider it a potential use of proceeds.

I will tell you the guidance that we provided did not contemplate that nor did it contemplate the unique charge for the issuance costs that we would have to take if we were to retire one of those issues, but it's something that we would consider. Right now we think it's reasonably attractive price capital, permanent capital, although we can pick up some accretion possibly from take you can it's out for an improvement on the fixed charge we think at a certain level it belong in our capital structure.

Finally on WorldCom, any talks on getting any money from them. You indicated there before there were.

There's a possibility. We are pursuing it but it's not anything that we can bank on so we are aggressively pursuing it. We are certainly not putting anything into our guidance for that.

You said last quarter 47 cents on the dollar, has it changed your estimate.

No, that's the same. That was what they issued as potential.

Thanks.

Your next question comes from Chris Haley of Wachovia Securities.

A question for you and then Carman. What are your retention assumptions on rollover next year?

Historically we've held -- let me regress and just give our definition for it. When we measure it, its economic retention. So if a customer leaves a particular space, now, they could close the shop all together, we could lose them to brand ex across the Street, there could be a bankruptcy, or they could relocate out of the fifth floor of that building or the fourth floor of another building. This is just, another one of our buildings. This is just economic retention where the customer stays in the space. We've run historically and certainly this year around 65%.

So 65% this year, and if you just kept a tenant in the portfolio it might go to three quarters?

I'm not sure I would be that aggressive on it.

Okay.

Thank you, though, for compliment.

The most recent quarter, I am trying to find the statistics in your supplemental. It seems you have lower retention. I think it was comprised of more new deals that was driving cap he can?

Chris, let me explain that. On the leasing statistics page, we present deals that are signed. We've added a stack there that breaks out what percentage of those deals are represented by renewals what are represented by new deals.

That's not necessarily a match up with the expiration because we could have signed something this quarter that really doesn't expire until next quarter. So this isn't the renewal percentage. This is the ratio of the deals signed to renewals or new deals. The retention ratio, as Ed mentioned, has been in the mid 60s. The assumption next year is somewhat somewhere between 60 and 65%.

And, Ed, the agent surveys you might be doing for some of your customers what would you say YTD the reasons maybe three or four different buckets of why customers leave your space, leave your portfolio?

Contraction, closing the office, financial issues, finding a deal in the market that is better than what we would do, and that may not mean simply rental rate but it may be a credit issue where we insist upon credit and there are competitors who say, hey, we'll do the deal and we will take the risk without credit. We take a stand on that and let it go.

Where the credit is not in sync with the required Capex and a fifth bucket is where there is some crazy deals out there on available sublease space. But that last bucket is really waning. We see most of the sublease space that remains in the market today either where the primary tenant isn't flexible enough to belly up to the Capex or the spaces, it has some type of functional obsolescence component to it.

The first two, contracture and closing offices would include bankruptcies?

Yes sir.

How has that been trending for your markets?

It's certainly down. I think that in our portfolio, anyway, I don't want to speak to the market as a whole but in our portfolio, anyway, we've had less of that over the last couple of quarters than we certainly had before. That's taking out the WorldCom blip.

Carman, I am going to try some real quick math here. I'm at 63 cents for the fourth quarter, right in the middle of your range. That assumes a little bit of benefit of the refinancing of your debt in the fourth quarter. I'm assuming it also takes into account the impact of your asset sales.

The fourth quarter number?

Yeah.

It does.

Okay. So I run that forward and I've got another $100 million of asset sales that are going to be used for what, to pay down debt, sit on sit on cash.

Next year?

Yes.

It's going to be used to do several things. Some pay down debt. We also made an acquisition assumption and we are going to be funding development. We announced the [inaudible] build to suit. We also may have where we estimated in our modeling another one or two similar side deals on the build to suit front. The use of proceeds there would be partly to pay down debt, partly to fund the development costs and then to fund acquisitions and I think we targeted at 20 to $50 million.

So if I conservatively assume that there is some additional sales that will be diluted to pay down debt and I am looking at a 63-cent run rate, the refinancing offsetting a little bit of dilution multiplied by four I'm at $2.52, assuming no growth in the portfolio. How do I get, how do I get to the $2.55, is that just? How do I get picks do you have.

Do you have, in the middle of your range do you have anything in there for normal termination fees and lands sale gains?

No, I am kind of using what you are indicating for the fourth quarter.

On the debt financing side do you put in the full.

I have to put a full quarter in for that.

Or you are going to get a partial quarter. So you are going to have a penny in the fourth quarter and so really what you are going to have is three...

On an operational basis without the refinancing it looks like you guys would be in a $2.40 to $2.55 range. Is that Is that correct?

Yes.

Just real simple math. Okay. It was either the last call or the call before when you announced a dividend cut which was a tough thing to do, we had estimated and I think you felt at the time that there was probably a couple million dollars of leeway that you still felt you were covering it or it was close enough. I look at these numbers this quarter and maybe in terms of the next several quarters, it looks like the pay out ratio has slipped a little bit further.

Is that an indication in your mind that your markets slipped a little bit or that you maybe underestimated the clearing costs in the market to get this space leased. How would you characterize that in your performance for this quarter in the short term versus where you were when you first cut the dividends.

Let me take this, the Capex this quarter is about $15.6 million, that's 38% of what we funded YTD. We know there's some season that you seasonality and we certainly didn't look it a quarter at a time, we looked at it over a twelve-month period. These costs if you look at a full year number are a little bit higher we spent more on the building improvement side than we initially thought for good reasons for leasing. We had some slightly higher T. I. primarily due to longer term leases with credit tenants, the government for one and we think that's a good thing.

So, yeah, we may have been a little low but also if you look out next year with the mix of office and industrial that we have and the guidance that I provided was a low of 39 million a high of 45; to get to 45 million of leasing Capex we have to do leasing that's going to take us up maybe as much as 1% of occupancy. So we think, sure, we'd like to have a will little more cousin but we are not at all concerned about where we stand right now and the way we pay Capex is lumpy as you all know and I think all that taken together, we are comfortable with where we are.

Okay. Great. Thanks a bunch. Sorry to hold you so long.

No, that's no problem.

Next question comes with John Lutzuis of Green Street Advisors.

What's your sales per square foot at country cub?

About $450 a square foot, net of anchors.

Net of anchors. Was that last year or is that this year estimated?

That's this year, $468 per square foot this year.

And 450 last year?

That's right.

Okay.

Plus or minus, that's right. The growth is three percent.

Okay. Thank you.

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

No, operator. Thank you all for joining us on the call.

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