Highwoods Properties Inc (HIW) 2005 Q4 法說會逐字稿

Good afternoon. My name is Paula, and I will be your conference operator. At this time I would like to welcome everyone to the Highwoods Properties conference call. [OPERATOR INSTRUCTIONS] I will now turn the call over to Tabitha Zane. Thank you. MIss Zane, you may begin your conference.

Thanks, Paula. Good morning, everybody. On the call today are Ed Fritsch, President and Chief Executive Officer. Mike Harris, Chief Operating Officer, and Terry Stevens, Chief Financial Officer. If anyone has not received a copy of yesterday's press release or supplemental, please visit our website at www.highwood.com, or call 919-431-1521. This call is being webcast, and for the first time, we are offering the call in the form of a podcast for those of you who may want to download the call onto your MP3 player. Before we begin, I would like to remind you that this call will include forward-looking statements concerning the company's operations and financial condition, including estimates of asset dispositions, the expected timing of the filing of our SEC reports, the expected use of net proceeds from disposition, the effect of tenant bankruptcies, costs and timing of development projects, rollover rents, occupancy, revenue trends, and so forth. Such statements are subject to various risks and uncertainties. Actual results could materially differ from those currently anticipated due to a number of factors, including those identified at the bottom of today's release, and those identified in the company's annual report on form 10-K for the year ended December 31, 2004, 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 also discuss nonGAAP financial measures such as FFO. A definition of FFO and management's view of the usefulness and risks of FFO can be found towards the bottom of today's release and are also available on the Investor Relations section of our website at www.highwood.com. I'll now turn the call over to Ed Fritsch.

Good morning, and thank you for joining us today. We have a lot to cover so I'll begin with a brief review of our financial results for the first nine months of 2005, which Terry will discuss in more detail. As noted in yesterday's release, the financial statements are unaudited and have not yet been reviewed by our new auditors, Deloitte and Touche. However, at this point, the company is comfortable with these numbers and believes no material change will be forthcoming once our financial statements for the full year have been finalized by management and audited by D and T. Reported FFO for the nine months ended September 30, 2005, was $1.68 per share. This includes property impairments of $5.1 million and reflects $4.2 million reduction in FFO recorded in the third quarter related to the redemption of [130 million] of preferred stock on August 22nd. Excluding these property impairments in the preferred stock redemption charge, FFO for the first nine months of 2005 would have been $1.83 per share.

On our last call, we said we expected 2005 FFO to be on the high side of $2.27 to $2.33 per share. Having gotten clearer visibility on the full year's numbers, we now expect 2005 FFO to be $2.39 to $2.42 per share. As outlined in yesterday's release, this increase is primarily driven by higher land sale gains, higher than expected FFO contributions from joint ventures and lower G&A expenses. Based on FFO of $1.83 per share for the first nine months of 2005 we expect fourth quarter FFO to be between $0.56 and $0.59 per share.

Operationally, we had a solid fourth quarter and a great 2005, with strong leasing activity and meaningful progress on our three-year strategic management plan. In the quarter, leasing activity remains strong with 1.7 million square feet of second generation leasing signed, 1.2 million of which was office space. Full-year second generation office leasing was a robust 4.6 million square feet. When we were putting together our strategic management plan toward the end of 2004, our occupancy hovered around 83.5%. Our steady goal under the plan has been to achieve 88% to 90% occupancy by year-end 2007. As we expected and have often publicly stated, growing our occupancy over this three-year period from 83.5 to year end '07 target would be lumpy. But even with the lumpiness, we are clearly moving in the right direction. We have exceeded our occupancy targets for both year end '04 and again for year end '05 and remain confident we'll achieve our SMP occupancy goal by year end '07. In 2005, we placed into service four development projects encompassing 713,000 square feet including two GSA build-to-suits that were delivered late in the fourth quarter.

These four projects represented a total investment of $87 million, are 100% leased, and the average stabilized cash yield is 9.4%. In 2005, we also commenced $69 million of new development, and we have since announced three additional development projects. Metro West, a Class A office building in Orlando, Enterprise II, an industrial project in Greensboro, and the RBC Centura headquarters building in Raleigh, the latter of which doesn't commence in the late this summer. In total, these three projects encompass 784,000 square feet of leasable space, represent a total investment of approximately $88 million, which includes $3.9 million of land already owned by the company, and they are 40% preleased. We're also in the running for additional build-to-suit projects and are quite optimistic about more announcements forthcoming in the next few months.

We are very pleased with the progress made on our disposition program. The target under our strategic management plan was to sell $100 million to $300 million in 2005. The ultimate goal of both our disposition and development programs is to continually work towards a higher quality portfolio of differentiated assets that will outpace market absorption trends and improve the stability of cash flow. As most of you know, we exceeded the high end of our 2005 goal with $356 million of asset dispositions for the year at an average caprate of 7.6%, an average occupancy of 82.5%, and these last two metrics exclude the two vacant buildings we sold to Met Life at [inaudible]. In addition, with the $141 million of dispositions we closed on January 9th, total sales of noncore assets since the beginning of 2005 now stands at $497 million at an average caprate of 7.6%. These dispositions include the exiting of the Charlotte market and the closing of that division office which will net an approximate $500,000 in annual G&A savings. We believe that in 2007 we will sell -- we believe that between now and 2007, we will sell an additional $100 million to $150 million of noncore properties. This would bring our three year disposition program to between $600 million and $650 million.

A good portion of the proceeds from these assets was used to pay down high coupon debt. Since the beginning of 2005, we have paid off $176 million of secured debt at a weighted average rate of 6.9%, unencumbering $352 million of assets. We also paid off $20 million of unsecured debt and redeemed $180 million of 8% preferred stock, $50 million of which was redeemed five days ago. As many of you know, strengthening our balance sheet is one of the imperatives of our strategic management plan, and we are making excellent progress. Currently, our total debt plus preferreds as a percent of adjusted assets is approximately 46.9% versus 50.8% a year ago, a 390 basis point improvement. During the year, we also sold $24 million of noncore land, $9 million of which was in the fourth quarter. This exceeded our 2005 stated goal of $15 million to $20 million of noncore land sales. Other significant accomplishments in 2005 include achieving 100% occupancy at the Highwoods Preserve in Tampa. 375,000 square feet was leased to three high quality tenants, namely Met Life, T-Mobile, and [inaudible] Technologies, all New York Stock Exchange-listed companies, and 416,000 square feet was sold to owner/users, Depository Trust, and Met Life.

Another goal we achieved was the increased independence of our board and the reduction in the size of this group with the retirement of three members whose terms expired in 2005. The board now has 10 members, 7 of whom are independent, with 2 of the 7 being CPAs. Additional accomplishments last year include restructuring the compensation plan for our leasing representatives, simplifying and shortening our standard lease agreement, hiring a Vice President of Corporate Leasing, and introducing new brand positioning. I'd also like to briefly turn to our announcement last week concerning the decision of our audit committee to engage D and T for our 2005 audit. As you know, in our December 22nd release, we publicly stated that we expect to file our 2005 10-Qs by the middle of February. However, over the past few weeks it became increasingly likely that this deadline would not be met.

Based on discussions with D and T, we determined that a change in auditors would not end up adding any significant amount of extra time to the process, so at this point in time ,we expect to have all of our '05 filings completed including the 10-K by the end of the second quarter. We will release operating statistics for the first quarter of this year in early May. Most of you may also be aware that last night, Moody's put us under review. They're concerned about the timing of our auditor change that it could limit our ability to access the capital markets on favorable terms if our SEC filings were delayed beyond the end of the second quarter. We did talk with all of our rating agencies before the audit committee made its decision, and understood that a change in auditing firms might trigger a rating review. We discussed this possibility with the audit committee and while we would prefer not to be under review, especially in light of the significant and measurable process on our strategic management plan, it was in the best long-term interest in the company to change auditing firms at this time. There is no new news on the SEC investigation. As I have said in previous public statements, we continue to cooperate fully and remain confident with the information that we have provided.

Some of our established goals for 2006 are the delivering $70 million of new development, starting another $125 million to $175 million of additional new development, disposing of $190 million to $240 million of noncore properties, selling between $15 million and $30 million of noncore land, renewing and expanding our credit facility, refinancing our $100 million term loan, refinancing $110 million of bonds that are due in December, and, of course, hiring a Chief Accounting Officer.

In closing, I'm extremely pleased with our progress in 2005. Already the quality of our overall portfolio is significantly better. Our development pipeline is robust. Our balance sheet is stronger,and our entire management team remains keenly focused on achieving all the goals outlined in our three-year strategic management plan. Now I'd turn it over to Mike.

Thanks, Ed, and good morning. As Ed highlighted in his remarks total occupancy in our in-service portfolio increased 410 basis points from the fourth quarter of 2004, and 330 basis points from the third quarter of 2005. We were delighted to end the year at 89.1% occupancy, well above our targeted goal of 86.8%. Occupancy in our in-service office portfolio, where almost 83% of our revenue is generated, grew by 480 basis points year-over-year and 250 basis points sequentially, ending the year at 87.5%. Same store office occupancy increased 240 basis points from a year ago and 190 basis points sequentially.

Looking forward to our occupancy expectations in '06. As Ed mentioned, we anticipate our occupancy to dip during the year as a result of several large lease expirations, most notably, the January expiration of 168,000 square feet in our 4800 North Park Building in Raleigh. These expirations are scattered among several markets, and we're already making progress on securing commitments for a good portion of this space. Getting space back is rarely a positive thing, but if there is a silver lining to this, we are fortunate the supply of large blocks of space in our markets is scarce, and it appears that there is is demand for much of this. I'd like to point out that this temporary dip in occupancy is not inconsistent with past years particularly, in early '05 when we saw occupancy at the end of '04 decline from 85% to 83.8% in the first quarter, and then steadily climb to a robust 89.1% at year end.

There's good news with regards to U.S. Air. Based on recent conversations with them, we believe they will remain in all of their space, at least through the end of this year, and this is reflected in our occupancy guidance. Based on our current portfolio size, U.S. Air contributes about 100 basis points in occupancy and approximately $0.06 a share in annual FFO. All this being said we expect occupancy at year end '06 to be between 87.5% and 89.5%, and average occupancy for the year to range between 86% and 87.5%.

As a reminder our published occupancy goal for the year end '07 under our three-year strategic management plan is 88 to 90%. With the lease activity we are currently seeing for our vacant space coupled with the fact that lease expirations in '07 are less than 10% of both total square footage and annualized revenues, we are confident that we will achieve that goal. We're also pleased to report an increase in average remaining lease term for our top 20 customers. At the end of the fourth quarter it was 5.8 years versus 4.5 years at the end of the fourth quarter in '04, a 29% increase. This demonstrates significant progress on a key metric of our strategic management plan.

The strong performance of our portfolio occurred pretty much across the board. In virtually every city, our occupancy improved year over year, and it's better than the market as a whole. We're continuing to see positive economic signs in most of our markets, including solid job growth and small business expansions, and our leasing representatives are encouraged by an increased volume of showings. All of our markets saw positive job growth year over year with the strongest markets being Orlando, Richmond, Raleigh, and Tampa. Overall, our markets averaged 2.2% employment growth versus the national average of 1.5%.

While we're certainly encouraged by the steady improvement in most of our markets rent concessions are still prevalent in a few of our markets. However, these concessions are slowly but surely dissipating, and market rents are beginning to stabilize, and in certain submarkets, we're achieving positive rent growth. We continue to look closely at net absorption in all markets and the trend remains positive. For the fourth quarter, our top five office markets reported positive net absorption and, these markets combined reported positive net absorption of 2.2 million square feet.

As Ed mentioned earlier, our leasing velocity continues to be strong. We signed leases for almost 1.2 million square feet of second-generation office space in the fourth quarter, our 8th consecutive quarter to top 1 million square feet. For the full year, we signed leases for approximately 6.7 million square feet, 4.6 million square feet of which was office space.

Office GAAP rents increased .2% in the fourth quarter, and for the full year, office GAAP rents declined an average of 2%. In the fourth quarter, office cash rents declined 8.1% in line with our guidance of a 5% to 10% decline. For the full year, office cash rent in 2005 declined an average of 7.4%, in line with guidance we provided last January and certainly better than 2004, when office cash rents declined an average of 10.6%. As a reminder, to compute this cash rent comparison, we take the actual base rent plus can pass-throughs for the last year of the previous lease, and compare it to the annualized base rent for the first twelve months of the new lease, after any rent abatement periods have expired, even if the space had been vacant for greater than a year.

Turning to our top five office markets, our Raleigh portfolio showed marked improvement with year-end occupancy of 87.5%, up 370 basis points sequentially. Employment growth in this area is strong, currently 2.6% year-over-year, and the market has had 1.7 million square feet of positive absorption in the last five quarters. Despite this improvement in '05, we expect a temporary dip in occupancy in '06 with almost 700,000 square feet of office space expiring, including the previously mentioned 160,000 square-foot building vacated by IBM.

Nonetheless, we are encouraged by the lease activity we're seeing on this vacancy, and we expect to regain a significant portion of this lost occupancy by year end. Occupancy in our Atlanta portfolio increased year-over-year, growing from 83.7% at the end of '04, to 87.4% at year end 2005. The market reported net absorption of 1.2 million square feet in the fourth quarter, and annual employment growth was 1.9%. Occupancy in our Atlanta portfolio is better than the market as a whole by 210 basis points.

For the second year in a row, Richmond and Nashville remained two of our best performers, ending the year with occupancy at 94.4% and 94%, respectively. Both markets saw solid employment growth year-over-year, and construction in those markets remains relatively low. Last but certainly not least, is the Tampa market, which has clearly been improving all year with positive net absorption with 2.3 million square feet over the last five quarters. The Tampa Bay area saw 2.5% employment growth, year over year, and overall market vacancy was 11.8% at year end, a 330 basis point improvement from a year ago. Our Tampa portfolio saw occupancy climb from 71% at year end 2004 to a solid 87.6% at year end 2005. Highwoods Preserve is now 100% leased or sold to owner/users, and we're confident our portfolio's occupancy will exceed 90% before year end. In closing, let me say that we are very pleased with the hard work with all of our divisions this past year. It continues to be a competitive environment but I think our results prove our team is up to the challenge. Thanks. Terry?

Thank you, Mike. I'd like to spend a few minutes reviewing our nine month results and then discuss our 2006 guidance. As reported, FFO for the first nine months of 2005 was $1.68 per diluted share versus $1.56 for the same period of 2004. For the same nine months, net income allocable to common shareholders per diluted share was $0.52 versus $0.20 for 2004. Both 2004 and 2005 had a number of unusual items that impacted results. And those items are detailed in the table in yesterday's press release.

For the first nine months of 2005, the two unusual items were impairment charges related to depreciable properties of $5.1 million, or $0.08 per share, and $4.3 million or $0.07 per share related to the previously disclosed writeoff of original issuance costs associated with the $130 million of preferred stock that we redeemed last August. Excluding both of these items,FFO per share for the nine months 2005 would have been $1.83. Nine month results for 2005 also include lease termination fee income of $5.8 million or nearly $0.10 per share, net land sale gains of $2.5 million or $0.04 per share, and $600,000 or about $0.01 per share in severance costs relating to exiting the Charlotte market and closing our division office there.

As Ed noted, our balance sheet continues to improve with the use of proceeds from our property sales to reduce debt and preferred stock, resulting in a 390 basis point reduction in a ratio of debt plus deferred stock to adjusted assets. We continue to have a significant pool of unencumbered real estate assets of nearly $2 billion. As noted in the supplemental, we have three pieces of debt that mature in 2006. Our $250 million revolving credit facility that has $150 million currently outstanding, and our $100 million unsecured bank term loan, both of which mature in mid-July. We also have $110 million of secured -- unsecured bonds that mature on December 1st. We've been working with Bank of America, our lead bank, on plans to modify, expand, and extend the existing credit facility for three more years, and we are pleased with the progress to date. We also expect to extend the bank term loan, which is led by Wells Fargo, and is held by a subset of the banks who participate in our credit facility. Both of these are expected to be completed prior to their maturity date in mid-July.

Our entire bank group has been very supportive of the company, as we've worked through our filing delays last year, and they continue to be supportive in 2006 as we progress toward our goal of getting our 2005 filings out as quickly as possible, and to report and make our filings in a timely basis going forward. We have received waivers extending the financial statement reporting deadlines under our credit facility and bank term loan agreement, and we believe these current deadline extensions give us enough cushion to complete our filings on -- within those deadlines even with the timing effects and the change of auditors. In the second half of 2006, we expect to refinance the $110 million of maturing bonds, plus all or part of the extended term loan with new unsecured debt.

In light of the progress we've made to date on our strategic management plan, once we get up to date on our SEC filings, we believe we'll be able to access the capital markets, including the unsecured debt market, efficiently and at normal market terms. We believe it should allow us to refinance our short term maturities efficiently and capitalize on the growth initiatives in our strategic management plan. We also expect to generate proceeds from additional property sales during the remainder of 2006, as Ed explained. We may use such proceeds to pay down more high coupon debt, additional preferred stock, or the revolving credit facility depending on the amount and timing of such disposition proceeds, and the extent to which such proceeds may be used for new developments. We also have a $50 million separate revolving construction facility, all of which is currently available that can be used to fund new developments. So even with this delay in our 2005 filings, we are currently comfortable with our plans to deal successfully with our 2006 debt maturities and planned capital market activities in the second half of this year.

Turning to 2006 guidance, we've made a number of assumptions to get to our stated range of $2.28 to $2.42 per share. And again, to clarify, this guidance does not include effects of any property impairments or preferred stock redemption charges that may occur in 2006. Starting with some of the differences we see between '05 and '06, we estimate that 2006 lease termination fee income will be $0.06 to $0.08 lower than 2005's higher than average levels. Higher LIBOR rates in 2006 are expected to increase our interest costs by about $0.05 to $0.06 per share, which is net of the benefit we expect from lower margin on the new credit facility that we expect to close in the second quarter.

Same property NOI is expected to be relatively neutral and ranging from slightly down to slightly up. And we are assuming $0.03 to $0.04 in dilute [inaudible] for the full year impact of the 2005 dispositions and from any additional 2006 disposition activity. 2006 FFO will benefit from a full-year contribution from the four fully leased properties that were placed in service in the second half of 2005, plus contribution from two or more developments expected to be completed during the second half of 2006. All of these combined are expected to contribute approximately $0.04 to $0.06 of FFO in 2006.

Also, based on closings to date in 2006, we expect that land sale gains for full year should at least match the $0.07 we expect to report for 2005. There was a chance land sale gains could even be higher as we do have a number of large noncore land sale transactions in process that could close in the second half of 2006. But it's hard to predict at this time how many of them may close, or when they might close, and some could slip into 2007. Finally, we are very pleased to be working with our new auditors, Deloitte and Touche. We will continue to work diligently to complete 2005 closings, and to work with D and T to help them complete their quarterly reviews and year end audit as rapidly as possible. Operator, this completes our prepared remarks, and we're now ready to go to Q and A.

Certainly. [OPERATOR INSTRUCTIONS] And we'll pause for just a moment to compile the Q and A roster. And your first question comes from Chris Haley of Wachovia Securities.

Good morning.

Good morning, Chris.

Congratulations on getting results out.

Thank you.

And also on the '06 guidance. I think it was a little bit sooner than we expected so it's good at least to get your footing back on par. Right?

Right. Thank you.

The one thing I wanted to ask about, particularly from Mike regarding the expirations of some large leases, what was your retention rate in '05 and what would be your retention rate assumption for '06 on the office portfolio?

We were -- well we ended up the year, Chris, at around 76% was our retention rate in -- excuse me. That was our renewal versus new. We were actually around 70% retention rate for the year.

In '05?

In '05. And then in '06. I believe we're actually looking at, because of these large expirations that we've got coming up, it's going to be down from that figure in the year. In terms of the exact calculation, Chris, I couldn't give it to you, but I will get back to you on that.

Okay. Do you think it's going to be -- what was the trough year for you guys regarding retention? I guess it was obviously had to do with Tampa? That was probably hurt the most?

No doubt.

'02, 03?

When both Preserve and U.S. Air hit at the same time that was a trough year but we have traditionally run from the mid-60s to 70.

Okay. Terry, I wanted to go through the balance sheet question, for balance sheet issues. I couldn't remember if it was you or Ed had mentioned that the current balance sheet looked like [inaudible] in terms of debt plus preferred as a percent of capitalization. Could you give us the exact numbers today after the preferred redemption what the balance sheet looks like in terms of wholly owned debt, JV debt and preferred?

I don't have that readily handy, Chris, but the -- if you look at the balance sheet that was in the press release, the biggest things that have happened since the 9-30 balance sheet are the sale that we did in early January for $140 million. We took those proceeds, and we paid off, as Ed mentioned, 50 million of -- of preferred stock in -- in February. We paid down a -- our revolving construction loan facility of about $43 million, and we paid the balance of the proceeds down on the credit facility.

So where is the credit facility today?

We currently have $150 million outstanding on the credit facility today.

Okay. Okay. And then regarding guidance, just to make sure I understood -- if I could just segment this, so you're saying the drags will be lower lease termination fees by $0.06 to $0.08, higher interest rates impacting results by $0.05 to $0.06, that will be -- that $0.05 to $0.06 will be offset by -- partly offset or completely offset by lower margin on your line?

No, the only partially offset, Chris.

Okay. So negative $0.05 to negative $0.06. Same store flattish '05 sales will be a negative $0.03 to $0.04 and then the pluses largely relate to -- I'm sorry. The pluses will be your developments to the second half of '05 [inaudible] plus $0.04 to $0.06?

That's correct.

Okay. The other thing -- just a question -- the land sales, what was the gross amount of land sales in '05, and what is the gross amount of land sales you expect in '06? I'm trying to reconcile the variance or the not variance.

In '05 it was [23.7] in gross proceeds and in '06 we've projected $15 million to $30 million.

Okay. All right. Thank you. I probably missed that.

Thanks, Chris.

Your next question comes from the line of Jamie Feldman of Prudential.

I'm on page 22, what kind of yields do you guys expect on these projects?

Jamie, the cash yields on the development projects are from the low to mid-9s. The three that we announced thus far this year are at [9-4], [9-5]. The ones that we delivered were [9-4]. That's on a cash basis. On a GAAP basis, it's just over [10].

And then how does this compare when you say 6 -- 6 to 12 months ago? What are rising construction costs doing to your development yields?

The -- the cash and GAAP yields have been about the same. As I mentioned, what we delivered was about mid-9s and what we have underway is about mid-9s.

And those projects that have already started have been 100% bought out, so we feel like we're insulated from cost increases there, and those that have been announced, we have -- we're in the bid process as we speak, and we have included a fair amount of contingency in those to insulate ourselves to cost increases relative to those yields.

Okay. And the cap rates that you show in the press release, is that GAAP or cash, the disposition?

Cash.

Cash? Okay. I think you made the comment or in the press release you said that you know, some of the upside to your '05 numbers is from JV income.

Correct.

Is that all operations or is some of that accounting changes?

It's driven by operations. They just perform better and we have the lion's share of that falls in Orlando and the Orlando team has done phenomenally well in taking full advantage of a recovering market.

Okay. And then the same store occupancy gain year over year, if you were to break out kind of the biggest pieces of that, what would they be?

Of what? Of same store sales, Jamie?

No. Same store occupancy was up 240 basis points year over year, so if you were to break that out by market, where were the biggest movers?

I think Tampa clearly was the largest contributor to that, Jamie, when you look at where they came from 71% at the end of '04 up to 87.6%, and the size of that market, they were a big contributor, but really across the board, virtually every market had pretty decent increase. Raleigh actually had strong increase, Atlanta had strong increase, Memphis, it's a smaller market for us but went from 83% to 88.2%, and then our solid performers which are consistent such as Richmond and Nashville maintain that low to mid-90s so it was pretty much across the board. And the only one, Jamie on the opposite end of the spectrum was the properties that we have in South Carolina. Year over year. they didn't fare nearly as well. In fact, recessed from where we were a year ago. We've publicly stated and we're working on getting out of Columbia, as an example.

Okay. And then finally, you know, given the employment growth numbers that you quoted, and some of the occupancy gains that you guys quoted by market, if you were to just characterize the sentiment in your largest market in terms of is occupancy -- or is job growth coming from -- is job growth, has it been kind of pent up and it's finally moving because it's moving and people are confident in their businesses, or has it been continuous growth, and people are just starting to sign leases? Kind of where do you think we are in that spectrum and then, should we expect it to continue at the same rate, or do you think that was kind of the big pop in the largest market?

Jamie, this is Ed. I don't think it was an anomaly, and I think the way that we've characterized this over the past year would be fair to continue to say that things are continuing to sputter in the right direction. There has been lumpiness quarter to quarter, but if you look at the trends, whether it be early moveouts where a couple years ago we were averaging 93,000 square feet a month, and this past year it was closer to 40,000 square feet a month, sublease space where it's contracted down to less than 2% of the market, construction has stayed in abeyance. Absorption has been positive in all those markets quarter over quarter, I think that -- that it's not an anomaly, and we'll continue to see it but we'll continue to see it in lumpiness. Of our near 2,000 office leases the average customer side is about 9500 square feet, and small companies are continuing to express growth so it's not necessarily from the large companies that are coming in, but the small- to mid-size companies are continuing to -- to have growth needs. I guess the only sector beyond that that's worth naming is financial services and health care have been robust consumers of space in our markets.

Okay. But in terms of the business decision makers, I mean, would you say that they have signed -- have started to sign space recently and were hesitant to do it for a while or they were all along confident and remain confident in the amount of space they'll need?

So I wouldn't say that there's a measurable difference today versus a year ago in that level of confidence results in negotiations, and from the time we meet a prospect to the date of execution continues to be a lengthy and protracted process in -- in a number of our markets, particularly markets like Raleigh and Atlanta, but it seems to be going better in -- in markets like Nashville, Richmond, Tampa has come on phenomenally strong, and certainly Orlando has been a leader in that.

Those smaller companies that we deal with, they are not the ones that maintain a significant inventory of shadow space, so when they need to expand they have to literally expand in new space not just within space they've been inventorying.

Okay. Thank you very much.

Thanks, Jamie.

Your next question comes from the line of John Stewart of Citigroup.

I'm here with John Litt. Ed, you mentioned in your comments that the change in auditors was in the best interest of the company. Can you give us some insight into the decision making process and why exactly that is?

Sure. As we mentioned, this was an audit committee decision. I want to underscore that and they did have the support of -- of management and -- and the residual of the board. I think with all that we've been through, and our ability to bring on a firm that would be fresh and new to our team, and given that we anticipated that we were going to be missing the -- the mid-February deadline that we had said that we would attempt to accomplish with our '05 Qs, that it was the right thing to do, and I think a fresh start with D and T is good for everybody involved on a go-forward basis, and I don't think there's ever a good time, John, to change auditors. Pick the time, it's never convenient, and I think doing it now and with D and T already on site, and where we're going to be with both of our Ks this year, I think it's a good thing for -- for the company.

Okay. I believe you mentioned that you plan to report operational results for the first quarter in May. When do you expect to return to a normal reporting schedule when you'll be able to file financials in conjunction with operational results?

John, this is Terry. I think that we should be able to do that by the second quarter.

So by the end of July?

Yes. In the July or early August time frame.

Okay. Another clarification on the land sales gains. I think you kind of danced around this and given several numbers, but can you tell us specifically what the gain will be in the fourth quarter?

It'll be about $1 million.

Okay. Can you help us understand why you have a range for the fourth quarter given that, you know, I mean, we're already in March. How come you still have a $0.03 variance with the land sale gain already booked?

John, this is Terry again. I just think that,we wanted to put out numbers in this -- for this press release that we were comfortable with. We still obviously are just beginning to work with Deloitte, and given our late start and we haven't closed the books yet in tally for the full year, and so we wanted to give you as much as we could at the time, but there's still, some -- some degree of uncertainty for the full year which is why we still have that range.

Okay. Then if you provided same store NOI growth for the first nine months I missed that. Do you have that handy?

Talking about for '05?

Yep.

Same store NOI for '05 I think was up around 3%.

Cash or GAAP?

That -- that would be cash.

Okay. And what is your -- I know you gave the occupancy and same store NOI forecast for '06 but what's the mark to market on rents that you're expecting in '06?

In cash rents, we're looking at negative 8 to 3%. A fall of -- of [3 to 8] and on GAAP, we expect it to be [negative 2] to flat.

Okay. And then my last question is, you referenced the IBM moveout in Raleigh, but that looks like it would just be about a 50-basis-point hit to occupancy. How much do you expect to drop in the first quarter, and how do you get, the 160 basis points down from 89.1 to 87.5 at the low end of your range? Are there any other large moveouts out there that we should be aware of?

Most of the early moveouts happen in the first half of the year and aside from IBM Raleigh, there was a large vacancy that occurred January 31 in Nashville, and I'm pleased to see that a good bit of that space has already been -- is under negotiations for reletting. There was a -- or will be an early moveout in Atlanta in one of our projects down there.

And let's be sure we're clear on early moveout.

These are expirations so -- these are early expirations.

Early in the year expirations. Not leaving before their term. Their terms just happen to expire early in the year.

And how big is the Atlanta moveout?

That was approximately 100,000 square feet.

Okay.

And then it was about 85,000 square feet on the Nashville tenant.

Okay. That's helpful. Thank you.

Sure.

Your next question comes from the line of Greg Whyte of Morgan Stanley.

Hey, this is David Cohen for Greg. Most of my questions have been answered, but just a couple quick ones. Regarding Deloitte and Touche, do they have to review any of the recently restated results?

Hi, this is Terry. No, they -- they will -- this is customary when an auditor change occurs. They will not reaudit the prior year results. They may review the former auditor's work papers, but they do not reaudit prior year numbers.

Okay. Is that causing any of the delay in the -- in the timing of the -- of when those Qs and Ks will be released?

Not particularly. It's just -- the -- the additional delay is just really for the time it takes Deloitte and Touche to get up to speed and understanding our controls and how -- and how we do things here. And they are already on-site and beginning to work on that.

Okay. So they're currently working with you guys already?

That's correct.

Okay. Just in terms of the margins, the expenses as percentage of rental revenues were better than I would have expected given some of the other office rates that are reporting higher energy utility costs. Can you just comment on what you're seeing there and what you expect in 2006?

This is Terry again. The -- there's two things really that are impacting the operating expense margin that you see in '05. One, we had a fairly high amount of termination fee income which we commented on in '05, and that is reflected in the revenue line and there's really no associated OpEx with that, so if you would back out the term fee income and then calculate your ratios, you would see much more in line with '04. Still slightly better but not as better as the raw numbers would appear. And the second thing is that we had growing occupancy in 2005 and with a large portion of our expenses are fixed, the high occupancy rate results in a lower ratio of OpEx to revenues. We do expect this ratio to go up somewhat in '06 given higher utility costs and real estate taxes.

We're seeing double digit utility increases announced for the year. We hope to try to mitigate that as best we can, through an aggressive lighting retrofit program which we think has a very significant payback. It will at least mitigate it. It will not reverse it, but that's pretty much across the board in all divisions.

Okay. But if you have some dip in occupancy, you'll probably recover less from tenants. Correct?

I think that's fair.

Just the last question. You mentioned the mark to market on 2006. What is it for the entire portfolio? If you were to guess?

In terms of just --

Just the mark to market on the entire -- on your entire portfolio right now.

In addition to [inaudible] including retail and industrial -- I don't know. David, We'll have to get back to you on that. We primarily focus on office since that's where 83% of our revenues go, so we'll get back to you on that to calculate industrial. I would think, though, in general on the retail portfolio, we're seeing that as probably flat to possibly even positive, and then on industrial, I would expect it will be not too dissimilar from what we're seeing on office, but we'll get back to you with an exact number on that.

Historically though, leading up to this point, David, industrial hasn't been as severe as the office and retail has been positive.

Okay. I guess what I was asking you not just for 2006 but just where your average rents are now for your entire portfolio versus market rents.

Yeah, I --

You'll get back to me?

Yeah, because it's such a -- it's such a collection of -- there are -- most of the leases that we sign that were in the absolute peak of times are rolling off or have rolled off, and we expect to work through all that by sometime in '07. And the rent growth ought to be substantial as we head out of -- out of the first half of '07 and certainly into '08.

And remind you again that there are certain submarkets in virtually every market we're in where that stabilization is pretty much already there, and we're actually seeing a few instances of positive rent growth, both cash and GAAP in isolated instances, and I think we hope to see that start spreading as those remaining submarkets tighten up.

One final question. On the TIs, what would you expect on a per square foot and per square foot per year of lease basis in 2006?

Well, the way we typically report that, David, is we've said that CapEx on a TI and lease commissions is a range of $10 to $12 per square foot, and if you look kind of over the last three years, we've been, you know, well within that range. We've had a quarter or two where it's been -- been below in the $8 to $9 range, and we've had one quarter where it's been above, but on average, we've stayed in that $10 to $12 range, very consistently over the last three years.

Okay. Thanks a lot.

You're welcome.

And your next question comes from the line of Jim Sullivan of Green Street Advisors.

Thanks. Ed, you mentioned that one of the '05 objectives that you completed was changing the leasing compensation for people internally.

Yes, sir.

Given the amount of leasing that you did, I assume that means you paid people more. What did you do specifically in terms of comp for those people, and from an accounting standpoint is that running through G&A, or is that being capitalized?

The way we've modified that was we reduced base pays to a more modest base pay amount, and then we enabled the leasing agents to earn a fee based on net effective rents of what they leased throughout the year, and eliminated a bonus predicated upon how the division and how the company did. So they did earn more in '05 than in previous years, and there were some who earned less, which we had anticipated, and we do capitalize that expense.

Jim, we -- this is Terry. We capitalize based upon a successful efforts modelling that we do. We do time records, and we sample that periodically throughout the year, and capitalize our internal leasing costs to the extent that they are involved in successful lease deals.

So that change would have had a positive impact on G&A even though the aggregate cash --

I don't think the change had that big of an impact on net G&A.

On page 80 of your supplemental, you do such a great job of presenting releasing costs and net effective rent. Why not include those capitalized costs in this schedule?

It's something we can do. I guess, historically we've never shown that, and it's -- in comparison to the outside leasing commissions, it's a lot less significant. But it's something I guess, historically, Jim, that's not been included here.

Okay. And then switching to occupancy, if I heard correctly, the -- the year-end '07 target is still something below 90% given that you finished '05 at 89%, a little bit above.

Put a range of 87.5% to 89% --

Year end '07 you said --

Yeah, that remains 88% to 90% has been our stated three-year goal.

Given the recovery that you're talking about in a lot of your bigger markets, why wouldn't you get more occupancy growth and related to that, what is the stabilized occupancy for your portfolio? Is 90% as good as it gets, or can you do better, and you just need more time?

Well, the -- again, we set the 88% to 90% when we were putting the plan together in late '04, and we were hovering then about 83.5%, and we knew that it was going to be lumpy but it was going to trend positive over the three-year window. So I think sticking with the 88% to 90% is fair given the known roles given that we have in '06. Now I think we'll get, obviously, better clarity on that as we get through '06, and start to look at '07, and I think it's important to point out as Mike mentioned in his script that the percent of revenues that we have rolling in '07 is substantially less than what we've experienced the last couple of years, so if that holds like it should, and if our development deliveries perform as we expect them to, we may experience better, but it's all going to depend a lot on how we do with these '06 rolls, and it's just too early to speak to that. We have to get more clarity on thats as we go through the year.

Okay. And then finally, when you quote development yields are you including your land at cost or at market?

We include the land at cost and it's -- and it's usually not all that different from the market -- market value of the land, but we do put it in at our cost basis, Jim.

Is that a fair comment with respect to the balance of your land portfolio, that book is fairly representative of market?

I would say on average there still will be additional gains to be recognized going forward as we work our way out of our noncore land inventory.

So gains on what you're selling, but if you looked at the portfolio overall is there much of a difference between book and market?

I'm not saying -- I'm saying maybe 10% to 15% difference between cost and -- it's not a huge differential that would materially impact the overall yield on a development project. I mean, given that the land is only about 10% of the total cost to begin with.

Thank you very much.

Sure. Thank you, Jim.

And your next question comes from the line of Susan Berliner of Bear Stearns.

Good morning. I apologize if these questions have been asked. I got on the call a little bit late, but I guess in regards to the delayed audit and -- and Deloitte specifically, can you give us any idea on what kind of progress they made, or what kind of meetings you have with them to see the progress they're making?

Sue, this is Terry. Given that the release about the change just went out last week and Deloitte was just officially appointed on the 23rd, they have just begun their work. There are people here in our office as we speak, and more are coming during this week. They are only working on the '05 audit. There was a question earlier in the call about will they have to reaudit the prior year '04 numbers. They will not. And they are getting up to speed on our systems and internal controls and are fully dedicated to helping us get our filings out as rapidly as possible.

Now, can the banks line extend the bank line on the term loan before they have audited financials? Will they do that?

I don't know that they would officially extend for three years without the audited financials. I would think that they would want to have those for '05.

Okay. And then in -- I'm sorry, Terry.

That's all. Thanks.

And I guess just two more questions. In terms of refinancings for the year as it stands right now, can you go over your sources and uses? I know you have the bond maturity in December.

The -- in my prepared comments, Sue, we mentioned that we continue to have additional asset sale proceeds this year. The -- which will provide additional funding and perhaps excess funds to allow us to continue to pay down some of our existing debt and/or preferreds. We have -- we do plan to get new, unsecured borrowings in the second half of 2006 in order to refinance the $110 million of bonds that mature on December 1st.

Okay. Great. Thanks very much.

Thank you.

Sue, Ed. One additional comment to that. We are continuing to target the payoff of a secured loan in February of '07, that's about $63-plus million and at 8.2%. It is a goal of ours to put that behind us.

That's great. Thanks very much.

Yes, ma'am.

And your next question comes from the line of Chris Haley of Wachovia Securities.

Sorry. Just a followup on the refinancing that you have outside of the line. You have some debt rolling. I think some unsecured bonds rolling at the end of this year? Is there any material plus or minus to expect related to your cash flow or earnings as you refinance that piece of debt? If you were given a debt downgrade potential?

Chris, this is Terry. Those bonds that mature on December 1st have a stated current rate of 7.0%. Given where we hope to be able to execute a refinancing, we don't see a significant change in our interest carry cost when those bonds are refinanced.

Okay. All right. Thanks.

[OPERATOR INSTRUCTIONS] Gentlemen, there are no further questions in queue at this time. Are there any closing remarks?

Paula, I just want to thank everybody for being on the call today, for their continued interest in our company, and again, applaud all of our employees for their tremendous effort in 2005. Thank you.

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