Highwoods Properties Inc (HIW) 2006 Q4 法說會逐字稿

Good morning. My name is Kevin, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the Highwoods Properties conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [OPERATOR INSTRUCTIONS] Thank you. I will now turn the conference over to Ms. Tabitha Zane. You may begin your conference.

Thank you, Kevin, and good morning everybody. On the call today are Ed Fritsch, President and Chief Executive Officer; Terry Stevens, Chief Financial Officer; and Mike Harris, Chief Operating Officer.

If anyone has not received a copy of yesterday's press release or the supplemental we distributed, please visit our website at www.highwoods.com, or call 919-431-1529 and we'll e-mail copies to you.

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 and effects of asset dispositions, the cost 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 yesterday's release and those identified in the Company's Annual Report on Form 10-K for the year ended December 31 , 2005 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 non-GAAP financial measures such as FFO. A definition of FFO in management's view of the usefulness and risks of FFO can be found toward the bottom of yesterday's release, and it'salso available investor relations section of the web at highwoods.com. I'll turn now the call over to Ed Fritsch.

Thank you, Tabitha. Good morning, and thank you for joining us today. 2006 was a great year for Highwoods and a great year for our shareholders with a total return of 50.6%. We made meaningful progress on the initiatives of our strategic plan which included ending the year with 90% occupancy, and robust and expanding development pipeline and a significantly improved balance sheet.

I'll begin with a brief review our 2006 financial results. Reported FFO for the 12 months ended December 31, 2006 was $2.37 per diluted share. Reported FFO includes property impairments of $0.04 per share, debt extinguishment charges of $0.02 per share, and preferred stock redemption charge of $0.03 per share. Excluding these items, FFO for the full year of 2006 would have been $2.46 per share exceeding the high end of our original FFO guidance of $2.28 to $2.42 per share.

Operationally, we had a solid fourth quarter and a terrific year with strong [INAUDIBLE] demand and improving rent trends. Specifically, we improved occupancy, improved the quality of our portfolio through new development in strategic in-field locations and the disposition of older non-differentiating properties strengthened our balance sheet and sold non-core, non-revenue generating land.

Since January 2005, occupancy has increased 500 basis points to 90%. As most of you know, one of the goals of the first three-year tranch of our long-term strategic plan was to achieve 88% to 90% occupancy by year end 2007. We reached the high end of this three-year goal in two years, a full year ahead of target, strongly seen as the primary driver of this occupancy increase helped also by dispositions.

Looking ahead, occupancy at the end of this year is projected to be between 91% and 92.5% and over the next two years is expected to reach 93% to 94%, what we consider to be the stabilized occupancy level for our portfolio as a whole. The quality of our portfolio is significantly better today than it was just two years ago due both to new development and non-core dispositions. As I've said many times before, one of the core initiatives of our strategic plan is to continually work towards owning a higher quality portfolio, differentiated assets that will outpace market absorption trends and materially improve the stability of our cash flow.

In 2006, we completed 10 development projects encompassing just over one million square feet and representing a total investment of $110 million. If you include 2005 deliveries, this total grows to $199 million of completed development projects that are 73% leased today. Last year, we also commenced $354 million of new development including three build-to-suits, and our current pipeline encompasses 20 projects across 10 markets.

Implementing our strategic plan at the beginning of 2005 we have started $452 million of development and we now expect development starts to be between $445 million and $640 million from 2005 through 2007, the initial three-year period of our strategic plan. Remember, our original three-year goal was $300 million to $400 million of development starts so we've exceeded the high end of another goal 12 months in advance.

Our disposition program has also been a key initiative of our strategic plan. In 2005 and 2006 combined we disposed of $597 million of non-core differentiating properties. When including the $40 million of dispositions thus far in 07, we've sold a total of $637 million at an average cap rate of 6.7% since the beginning of '05. We now expect our three-year dispositions to reach $700 million to $750 million by the end of '07.

Our original goal was $450 million to $550 million of dispositions, so the high end of our third goal has been exceeded in advance. Again, in accord with our strategic plan a significant portion of these disposition proceeds were used to pay down a high coupon secured debt and redeem preferred stock. Since the beginning of '05 through today, we've reduced our secured debt balances by approximately $150 million. This includes $62 million of 8.2% secured debt that we've paid off this month.

We've also redeemed $180 million of 8% preferred stock. We still have $92.5 million of 8% preferreds that are callable and we will consider redeeming an additional portion of these preferreds this year. Our debt plus preferred stock as a percent of adjusted assets has decreased from 51% at 12/31/04 to 48% at the end of '06.

Between 2005 and 2006, we sold $58 million of non-core land for a net gain of almost $16 million. And this year we've already sold $16.5 million of land for a net gain of another $12.4 million bringing total land sales to $75 million from January '05 through the present day, exceeding our original three-year land sales goal of $60 million to $70 million. We have revised this goal to reach $90 million by the end of '07.

Other significant accomplishments and milestones in '06 include the recasting and expansion of our credit facility to $450 million, getting current with our SEC filings and changing auditors. Also, we announced last November that the SEC wrapped up its investigation with a quote-unquote "no action" conclusion.

Going into 2007, our established concrete goals include delivering $150 million of new development, starting another $100 million to $200 million of additional development, disposing of another $100 million to $150 million of non-differentiating properties, selling between $18 million and $32 million non-core, non-revenue generating land sales for a total gain of $13 million to $16 million, retiring $16 million of high coupon debt, being CAM positive, improving operating margins and exiting Columbia.

Our strategy is a living document that is routinely reviewed and updated by our board and management with ongoing three-year goals. We've also established goals for '08 and '09 and we monitor our execution on a very disciplined basis.

In closing, we had a great fourth quarter and a solid 2006. I am extremely pleased with the progress we've made on the initiatives of our strategic plan. The quality of our overall portfolio is much better, our development pipeline is robust. our balance sheet is stronger, and we've significantly improved the way we do business. All of us at Highwoods remain focused on our plan, and we're driven to meet the goals we established.

I thank and applaud our my coworkers for their continued dedication, fortitude and hard work. Thanks also to the board for their active involvement and ongoing support of the strategic plan, and, of course, to our shareholders whose belief in our plan and this management team has been extremely gratifying. I'll now turn the call over to Mike.

Thanks, Ed, and good morning, everyone. As Ed said, we had a solid fourth quarter and a very good year overall. Leasing was strong with over 6 million square feet leased during the year. Occupancy at year end was 90% and fundamentals in virtually all of our markets continue to improve. We're seeing modest rent growth in many of our markets, with certain sub-markets, particularly in Tampa, Orlando and Nashville, reporting cash rent growth of 2% to 4%. Construction starts in our top five office markets still remain relatively low at 2.6% of the total market, in line with where it was a year ago.

Net absorption remains positive. For the fourth quarter, our top five office markets combined reported positive net absorption of 1.8 million square feet compared to 1.9 million square feet of positive absorption in the fourth quarter of '05. This quarter we signed 137 second generation office leases for a total of 869,000 square feet, an average lease term of just over five years. For the year we signed a total of 606 second generation office leases for a total of 3.7 million square feet. Office occupancy is up 150 basis points compared to a year ago and up 90 basis points from the third quarter. Office GAAP rents increased 2.9% in the quarter and 2.9% on average for the year.

The decline in office cash rents continues to improve. This quarter cash rents declined 3.3% and for the full year office cash rents declined 4.8%. In 2004, office cash rents declined 10.6%, and in 2005 they declined 7.4%. So you can see the trend is definitely positive. Next year we're forecasting office cash rents to be down 2% to 4%. As a reminder, we measure cash rent growth by comparing the annualized base rent plus CAM for the last month of the previous lease term to the first month of base rent in the new lease on an annualized basis.

CapEx related to office leasing was $13.41 per square foot in the fourth quarter. This is higher than the third quarter and our five-quarter average because of two deals, one in Raleigh and one Atlanta, with both customers signing 10-year leases and taking approximately 100,000 square feet. Excluding these two leases, CapEx related to office leasing would have been $10.92 per square foot lower than our five-quarter average of $11.57. For the full year, CapEx related office leasing was $11.43 per square foot, within the guidance we gave at the beginning of last year.

The impact to Highwoods of rising PI construction costs is negligible as a result of lease negotiations shifting from turnkey deals to fixed allowances.

Turning to our top five office markets and starting with Raleigh, we continue to be very encouraged by the activity in this market and believe it has more upside potential in 2007 than any of our other markets. The market absorbed 1.5 million square feet of office space in 2006, in part benefiting from a large number of high-profile relocations to the area including Fidelity, Credit Suisse, Lenovo, and [Tecalak]. These companies also positively impacted job growth in the triangle where we saw employment growth in 2006 of over 3.5%.

We delivered Glen Lake Four in December and that building is currently 72% leased. It joins Glen Lake 1 which is 100% leased and a few weeks ago we announced we will soon commence construction of Glen Lake 6 which is already 15% preleased. Our Glen Lake Office Park has been a homerun for us. It's in one of the best locations in Raleigh, and we're commanding top of the market rates and attracting high quality customers. Our long-term plans call for a total of seven buildings on this site.

Construction is progressing well at RBC Plaza, our mixed use highrise project in downtown Raleigh. The footings are in the ground, and we're on schedule for a 2008 completion date. The office and retail component is 65% preleased and the 139 condos are well over 200% reserved. You can track our construction project on this and other developments through the webcam on highwoods.com.

Just to give you a sense of how desirable downtown Raleigh is becoming, I will mention DRA's recent sale of Wachovia Capital Center, Raleigh's largest for lease office building. This was a record breaking deal with the buyer paying $153 million for the 29-story 16-year-old building.. On a square foot basis it came out to around $274 per square foot and the cap rate was 6.5%.

Moving to Atlanta, this market is definitely one of our most improved. Our portfolio's occupancy at year end was 94%, up 660 basis points from December 2005 and 160-basis point increase from the third quarter. On a same-store basis, occupancy grew about 290 basis points year-over-year and by 130 basis points from the third quarter. Office absorption in 2006 was 2.6 million square feet and a number of new companies moved or expanded into the area including Arby's, Solo Cup, Rheem and Newell-Rubbermaid.

Rents are starting to increase slightly, about 1% to 2% and free rent, while still there, is no longer the absolute normal in all deals. As Ed mentioned, we sold six 30-year-old classy single-story stick-built office buildings in Century Center last month for gross proceeds of $9.5 million or about $138 per square foot. These buildings were sold to a nationally-recognized developer who is raising these properties and building high-end residential rental units in their place.

Virtually all of our customers in these buildings were relocated to other properties we own in Century Center. Not only did we get a great price for these older, non-core assets, we believe this type and use of in-field development only enhance the long-term value of Century Center as it becomes more and more of a mixed-use park.

Our Florida markets continue to sizzle and show no signs of cooling off. Our Tampa portfolio is 97.7% occupied. Free rent is virtually nonexistent. Cash rents in Class A properties are increasing, up over 5% in just the last six months in the West Shore submarket and average lease terms are getting longer. We expect to deliver our 209,000 square foot base in our one building early in the third quarter and our timing couldn't be better.

In Orlando, where our wholly-owned properties are 100% occupied, professional and financial services firms are expanding, particularly in our CBD portfolio. Cash rents are up 5% year-over-year and are now breaking $30 for some high-end Class A space in downtown Orlando where we own a 40% interest in 1.3 million square feet. Free rent is also pretty much a thing of the past. While not quite as steamy as downtown, lease activity and rent growth in the suburban markets is strong as well.

Moving north to Richmond, our occupancy at year end was 89.8%, a 120-basis-point increase from the third quarter. We delivered Stony Point IV in December and that property is currently 86% leased with a projected stabilization date of fourth quarter 2007. We're not yet seeing cash rent growth in this market, but free rent is becoming less of a concession and average lease terms are getting longer.

Occupancy in our Nashville portfolio dipped slightly to 91.6% primarily as a result of some expected lease expirations, much of which has already been released. The market as a whole remains very strong with 248,000 square feet of office space absorbed in the fourth quarter, and just over one million square feet absorbed in 2006. We're starting to see rent growth and healthcare companies continue to expand in the area. We delivered Cool Springs III in July and that building is now 63% leased with good near-term prospects and a projected stabilization date of fourth quarter of '07.

I want to again emphasize, as I did on our last call, that controlling operating expenses remains a high priority for us. We continue to keep a close eye on utilities, taxes and insurance expenses as there is significant upward pressure on these expenses. We're fortunate to have excellent in-house expertise dedicated solely to focusing on these expenses, and we have implemented specific programs within our system to create cost savings in each of these sectors.

We remain very enthusiastic about the growth prospects for all of our markets but we're not about to rest on our laurels. We're focused on the leases we have expiring in the balance of '07 and into '08, as well as the remaining vacancies in our existing portfolio and the specs base in our new developments. Renewing expiring leases, backfilling vacant spaces and leasing up our new developments is job one for our leasing personnel. Our division heads are leading the way to source new development opportunities, particularly build-to-suit product, and we're encouraged about the growth potential we're seeing in most of our markets. Thank you. Terry?

Thanks, Mike. As Ed and Mike have said, we were very pleased with fourth quarter and full-year 2006 operational and financial results. FFO per share was $0.71for the quarter, and after adjusting to exclude prior quarter impairments on depreciable assets, preferred stock redemption charge, loss on debt extinguishments and other charges FFO was $2.46 for full year 2006. This compares to $0.56 per share and $2.42 per share previously reported for the same periods of 2005 on comparable basis.

Fourth quarter 2006 FFO was positively impacted by $0.11 in land sale gains and by $0.025 from a settlement of a tenant bankruptcy claim. This was a tenant that vacated in late 2003 and in the fourth quarter we received stock in settlement of our claim which we sold for cash.

FFO from core operations, that is after taking out land-sale gains, lease termination fees and the tenant bankruptcy settlement, was $0.56 for the fourth quarter up $0.01 from third quarter and up $0.02 from fourth quarter of 2005. We're pleased with our growing core FFO performance given that this has been occurring during a period of significant property dispositions, rising short-term interest rates and increases in certain operating and G&A expenses.

Total revenues from continuing operations were up 5.2% for full year 2006 versus 2005, and were up 7.7% fourth quarter '06 over fourth quarter '05. This growth in revenues primarily reflects higher occupancy and contributions from new developments placed in service in 2005 and 2006, and also from consolidation in 2006 of a joint venture that was previously accounted for under the equity method. This change to consolidation accounting does not affect our reported FFO contribution from that joint venture.

Lease termination fees are included in total revenues and because lease term fees for '06 are down $3.1 million from 2005, our 2006 full-year revenues from continuing operations, excluding term fees, were actually up 6.1%. For full year 2006, our NOI contribution from continuing operations, revenues less operating expenses, was up $8.7 million over last year. NOI contribution as a percent of total revenues was down slightly from 64.3% last year to 63.3% in '06, however, this trend reversed in the fourth quarter with fourth quarter '06 NOI percentage up slightly from fourth quarter '05.

The full-year decline in the percentage margin was due to significant increases in utilities, property taxes and insurance in 2006 including higher Tennessee state franchise taxes due to a tax law change effective mid-year 2006 which impacts our properties in that state along with other companies with real estate in Tennessee. Franchise taxes typically are not recoverable from tenants. We are expecting our NOI margin percentage to stabilize in 2007 as the rate of growth in utility and other costs should moderate and as our revenue and occupancy growth continues.

As Mike mentioned, we're focusing hard on controlling operating expenses and on negotiating the most favorable lease terms we can to maximize our CAM income. G&A was up during the fourth quarter and for full year 2006 as compared to 2005. In addition to typical annual increases in salaries and other inflationary effects on expenses, we also had higher annual and long-term incentive compensation costs in 2006.

Long-term incentive costs consist of stock option expense, restricted stock expense and certain other forms of deferred compensation that are recognized for accounting purposes based on relative and absolute levels of our total shareholder return. As Ed mentioned, our total shareholder return was 50.6% in 2006 and was also strong relative to peer company total returns.

We also incurred increased expenses in 2006 from new retirement provisions under our long-term incentive plans, from the retirement costs from one of our division officers this year, and from the Company's share of FICA and Medicare taxes on the taxable compensation aspect related to stock-option exercises that occurred in the third and fourth quarters, mostly from former employees.

So based primarily on our actual 2006 performance compared to the criteria in the annual and long-term incentives programs and in the total return-based grants, these various compensation-related expenses combined were higher by $3.6 million or $0.06 per share in '06 compared to 2005, and approximately half of that increase occurred in the fourth quarter.

As noted in the guidance section of our release, we currently expect G&A for 2007 to be lower compared to fourth quarter and full year 2006. Due to the paydowns on debt and preferreds that we've made from capital recycling in the last two plus years, interest expense net of amounts capitalized and preferred dividends are both lower for the fourth quarter and full year compared to 2005. Specifically, such expenses combined were down $3.6 million or $0.06 per share in the fourth quarter compared to 2005, and were down $15.6 million or $0.25 per share for full year 2006 compared to 2005.

These positive effects were offset by the foregone NOI contributions from our dispositions. However, given how we've been able to use the disposition proceeds to pay down some of our higher rate debt and preferred stock and also for our development projects, and given that our dispositions since 2005 were done at an average 6.8% cap rate, we have had minimal FFO dilution as we've told a significant amount of non-core assets.

On the financing front, in the fourth quarter we paid off $110 million of 7% bonds using our revolving credit facility and in February of 2007, as Ed noted, we paid off $66 million in total of 8.2% secured debt which unencumbered $161 million of assets based on undepreciated book value. Since we embarked on the strategic plan in early 2005, we have unencumbered a significant amount of our assets and, as a result, the portion of our total annualized NOI that is encumbered by secured loans has declined from 49% at the beginning of 2005 to about 41% today.

In late January 2007, we obtained a one-year $150 million, nonrevolving unsecured credit facility. We expect to obtain long-term unsecured and/or secured borrowings in 2007 and repay all outstanding borrowings on this one-year facility. We presently have $216 million of borrowing capacity under our unsecured credit facilities and our secured construction facility combined.

As noted in yesterday's release, we closed on a large land sale in January with gross proceeds of $16.5 million and a net gain of about $0.20 per share. As a result of this sale, we've narrowed the range of our 2007 FFO guidance to $2.53 a share to $2.65 per share, excluding any impairments or other charges consistent with our past guidance. The key assumptions underlying our guidance were included in the release.

We also updated our net asset value analysis in the supplemental. Many of you gave us comments and suggestions regarding our methodology for computing NAV after last quarter and we appreciated your input. So based on that and our own internal considerations, we modified our methodology from how we had traditionally done this and also carefully evaluated current cap rates. We have used our 2007 forecast NOI rather than our prior approach of annualizing historical NOI. Given our significant occupancy increase trends, we believe using projected 2007 NOI is more reflective of current asset values.

We also adjusted our cap rates downward for office and industrial categories by 75 basis points and for retail by 50 basis points. This was done in light of industry increases in valuations and in replacement costs that had been occurring, particularly over the last six months.

Our updated net asset values implied that our in-service office properties have a value of $168 per square foot on average at the midpoint of the range and this amount is very consistent with current values for our class of properties in our markets based on recent transactions and real estate research and brokerage reports.

Again just to clarify, our NAV analysis is intended to provide data that should be useful for investors and others to formulate their own NAV estimates which, as you know, are highly sensitive to cap rates. Because of the new methodology we'll update our NAV estimates quarterly during 2007 only for significant changes to our projected NOI or in market cap rates.

So in summary, 2006 was a solid year and we look forward to an even better year in 2007. Kevin, this concludes our prepared remarks, and we're now ready to take questions.

[OPERATOR INSTRUCTIONS] Your first question comes from the line of Michael Bilerman.

Yes. John Litt's on the phone as well. Mike, you were talking about rents being down 2% to 4% cash. Can you talk about what that would be GAAP and just go through some of your major markets and where you see rent spreads heading into '07?

Sure. In terms of the GAAP rent projections for these markets for the year, it was expected to be up 3% to 5% for the year. And in terms of looking at the major markets, I think we'll continue to see Tampa lead the charge in terms of the cash and GAAP rent increases, predominantly driven by the strength of the West Shore submarket where we've a strong presence.

As you look into Nashville, Cool Springs is a fairly new market so there's not a lot of rollover in that area, but our presence in Brentwood and Maryland Farms and West End, I think we'll also see decent cash rent growth in those particular submarkets.

In Richmond we're predominantly located in Innsbruck in the west end of Richmond, which has been a very stable market for us in some time. I don't think we'll be seeing cash rent growth there at this time, but I think we'll continue to see GAAP rent growth. And finally in Atlanta, I think Atlanta, again just the size of the market, while it's improved I think we'll continue to see cash rents to be down there and improving GAAP rents.

And then thinking about your same-store forecast of 1.5 to 2.5, it looks like average occupancy for the year is upwards of almost 250 bips year-over-year. You have positive GAAP rent growth on rollovers. I guess what's hampering your forecast for same-store NOI?

Well, we do have -- we continue to have some pressure on operating expenses that we're trying to get our margins back in line but with some significant increases, particularly in insurance driven by largely by Florida properties with the windstorm coverage down there up significantly, that's coming really out of the '04 season and it's now starting catch up with us.

We have the franchise taxes in Tennessee which is a new tax. As Terry mentioned, that was a result of the law change there, and that's a non-escalatable operating expense so we can't really pass it through, and we're hopeful that with some activity that the Florida state legislature is addressing with regards to rising insurance and property taxes that that'll help us mitigate that. And then real estate taxes themselves because with the pretty frothy market here, the assessors in these local markets are pretty much taking advantage of these low cap rates, and we're seeing that starting to back up into all of us.

And, of course, we have, as I mentioned, strong programs internally to appeal these and try to hold the line on those. But the cash rent trend is still positive. We still like the fact that as mentioned from '04 all the way to where we are today, it is drastically improving.

And what would your estimate then if you were to break out your same-store NOI between revenues and expense growth, what would those numbers be?

In terms of expense growth, I think we're probably looking at somewhere in the 4% to 8% on average is your operating expense growth. Now, that's just, again, not counting CAM because we do get recovery on some of that. Give me a second, I'll take a look at the revenue growth for you. Talking about for '07, correct?

Yes, I was trying to piece together the 1.5 to 2.5 between revenue growth and expense growth.

We're looking at right now about 5% in our revenue growth year-over-year, based upon our '07 budget.

And then a higher rate on expenses?

Slightly higher on the operating expenses, that's correct.

And then, Terry, just on the refinancing, what is embedded in guidance for, I guess refinancing that 150 that you took out on that revolver and redeeming any preferred, just so I get a sense of what your baseline is?

In the guidance, we've assumed about $250 million or so of some form of new borrowings, we haven't made a final decision on what that would be, but it probably would happen in the first half of '07. And if we can bring that much in, we'd probably take down maybe another $30 million to $40 million max of additional preferreds this year. As Ed mentioned, we had $92 million of preferreds that we can take in, but we're just watching, there's one ratio that we have in our bonds that we have to -- we can't take all that have right now until we get that ratio a little bit higher.

But we do have about $30 million to $40 million of additional preferred redemptions in our outlook next year.

And we're also closely watching the volume of development starts, what we have in the potential pipeline in addition to what we have underway.

And the 250 would go to repay the 150 that you drew on that --

Well, that facility is not drawn, not wholly drawn at all in this point in time, but we will pay that off in '07 and then the balance would just go down to pay down the revolving facility and then be available to fund future development as required.

And you took out the bonds, the $100 million of bonds that expired in the '06 and the 66 and you rolled that on to the line?

Yes, that's what we -- That's right.

Okay. Thank you so much.

Your next question comes from the line of Cedric [Latay.]

Thank you. I want to talk to you about the cap rate assumptions that you make in the NAV. What do you think are the expected IR's that you have and at the midpoint of that range if you take a 675 office GAAP rate and you look at the way you came up with that cap rates? What would you say the is the IRR there on a nonlevered basis?

On a levered basis, I would say it's approximately 9%.

Unlevered, you'd be in the 6's?

11.

11, okay. What are your expectations for rent growth in your various markets? How do you -- you mentioned that cash rents will probably decline a couple of percent next year. If you're looking out over the next two, three years on average, what would you say are the trends in rent and what do you expect for rent growth?

You know, just mark-to-market, what's -- what we're getting this year versus what we were able to get last year, not asking but mark-to-market, year-over-year is in the 5% range. Mike walked through what we expected with regard to rent growth by market. And then I'd want to go back and emphasize, when we looked at this NAV page as Terry mentioned, we took into serious consideration a lot of the solicited and unsolicited commentary we got on what we put out in the third quarter, and not only numbers but more methodology.

And I just want to emphasize that our method was not IRR driven. It was cap-rate driven and we changed some things from a methodical perspective with regard to -- the core aspects of it is it's a forward-looking as opposed to a historic look at NOI. So I think that when you take into consideration how we look at this, and what we expect with regard to what we're able to get versus this year versus last year, I think it's important.

I appreciate the changes that were made and the way you calculated NOI and it's probably more in line to the way that many of us do it. To go back to the cap rates, so going back to the midpoint, going back to about 675 cap rate, what would you say is the range of cap rates that you've applied there in your markets? Perhaps talking about two, three markets at the low end of that range and two, three markets at the high end of the range?

I would say that the low end was low 6's and, low to mid 6's, and obviously like Mike said, Tampa, Orlando, very strong, so when you look at the assets like what we have in CBD, Orlando, they're Class A and I think that we'd be able to obtain, worst case, a mid-6.

And then the range would go all the way up to, I'd say, mid 7's when you look at some of our tertiary markets like Columbia, Greenville, maybe certain aspects of Winston-Salem.

But again, a reminder that we've seen assets like in Raleigh sell recently at the mid 6's, the one that Mike mentioned, clearly a trophy building as Raleigh goes, downtown Raleigh at 6.5% but there are have been other suburban buildings, one in particular has a fair amount of age on it that sold well below a 7.

Okay. Turning to the retail, what was the main driver of your decline in retail cap rates?

I think, Cedric, that you really need to stand back -- you know, what was the main driver for the addressing this in total? I think some of it was that we were slow to make changes. The market last year, we saw about a hundred bips in decrease and we decreased about 50 bips and then we've seen another decrease in the market, about another 30 bips so I think what we've done is what you said before that we're trying to do a little catchup. We have very concrete results with regard to the office and industrial side.

The retail as little more unique, but based on all the reconnaissance we've been able to do, we thought that we were about 50 bips high on that, and office and industrial we moved down 75 bips each at the midpoint, and on the retail we moved down 50, but there still seems to be phenomenal amount of money out there as underscored by all the deals we've all recently tracked over the last 100 plus days and given the uniqueness of the Plaza and its low beta with regard to what we would consider to be a cap rate range in the market, and its continued ability to garner sales that are now exceeding net of anchors well in excess of $500 a square foot, we think that we're at the right place now for the forward look of '07.

Okay. Turning to your land, your land value, in terms of the core lands, so what you expect not to sell or rather to be building out over time, what is the value you place on that land at this point?

In total, our market value for the 719 acres is right around $170 million.

And so what's the value for just the core land?

The core would be about $90 million.

Okay.

So just I'm going to expand on your question a little bit, if I may. So the 284 of non-core, we think we have another $15 million to $20 million of gain in that.

From, on an FFO basis but all that gain is captured in your market value of the land, correct?

Sure, right. But I would just breaking out the component that we would sell just to give a sense for what we would expect to be the gain in that.

Yes, okay. You acquired an asset in the fourth quarter. You guided for a little bit of acquisition in '07. That's somewhat a departure from what you had been thinking about in the past. And what's your interest in acquiring and why do you think it's time to start acquiring again in your markets?

Yes. With all due respect, I may tweak your question a little bit. I'm not sure we really stepped out there in a big way. We bought I think a total of $14 million or $15 million since '04. We bought one asset in '06 for just under $11 million, and it was adjacent to existing assets that we own in Innsbruck, so it helped us with things like access and also helped us address some 1031 pressure, so it it wasn't really driven by a change in philosophy here.

To expand that answer. We were actively bidding, the building that Michael referenced downtown, we were active bidders on that, we just didn't win because we couldn't get to the number that the tick buyer got to. We didn't have -- they basically subsidized it with their tax pressure. So we are continuing to evaluate and solicit packages so that we could be in the market. We are partnering with JV money on a selective basis to see what we can chase. It's been a very disciplined approach, but we haven't really changed our philosophy.

We continue to be in the deal flow as we bid on projects that we are convinced fit our strategic plan. I wouldn't take the $10 million building we bought in late '06 as a shift in strategy.

Just the last question, maybe. What kind of development pressure do you see right now in your markets? Do you see more builders giving to market? What are your expectations over '07 and '08, as well?

We really don't see a dramatic change in that. Construction as a percent of market across all our markets is still less than 3% as a percent of total market. We're very comfortable with what we have out there on a speculative basis. We continue to see good opportunities with regard to build-to-suit development particularly in our better markets, and, as Mike said, our division heads are really doing a good job of leading the charge, at pursuing build-to-suit activities with customers that are either migrating into a market or needing to expand within a market and willing to pay up for new product, product that would be in keeping with their personality, or their layout, or their functionality.

The in-field strategy has worked for us. We spent time understanding what the field is doing with regard to prospecting and as a reminder, we had changed our compensation structure so that our leasing agents we feel now, their objectives are more in line with what the Company's trying to achieve, in properly rewarding them and getting the bottom line up for the shareholders.

Okay, thanks very much.

Thank you, Cedric.

Your next question is from John Guinee.

Hi, how are you?

Hi, John, good.

Just a handful of questions. First, on your $300 million to $600 million in development starts, do you anticipate all that coming on existing land or do you anticipate acquiring certain land parcels to execute that strategy?

It's both. But it's more majority on our existing owned land, but there are opportunities that we're pursuing. For example, you're aware of our GSA initiative. We've done a number of buildings for the GSA and in many instances, or the majority of instances, they have defined the land for and included it in their SFO.

So where we have particular opportunities like that, we, obviously, it's land we would buy, whoever the successful bidder is who's awarded the contract would buy, the tract of land that the government's identified. But most of what we would develop would be on Company-owned land.

And John, we're constantly pursuing build-to-suits. Our goal is to be in front of every deal whether it's on our land or not. Clearly, we try to steer the tenants toward our property and do it with REIT-owned land but if not, we're still willing to go out if we have to and acquire the land to make it happen.

And, John, of the 435 acres of core land that we now own, it'll support just shy of 4 million of office and about 1.4 million or so of industrial.

Got it. When you're chasing down build-to-suits on land controlled by a third party you're competing with every other private and public company out there. What do you think the margins are now? How are people underwriting it going in yield versus expected profit margin, typically the merchant builders, Duke, et cetera?

Obviously, a lot of it's driven by the credit of the customer. The quality of the location with regard to in-field versus, you know, something that's not as desirable a market or submarket, the specialty of the building, is it something that's generic where it's easy to release versus does it have a lot of unique aspects to it, lab, et cetera that would be difficult to do. But I would suggest it's in the mid-teens with some as low as 10%.

Above costs.

All right. Kansas City retail, as I recall the tax issues are somewhat mitigated in '08. What's the plan for that? You know, clearly debatable as to whether it's a core or non-core asset?

That's correct. The [sting] tax that we've talked about on many instances expires on the 10th anniversary of ownership which would be July of '08. But there's still a very significant tax issue to wrestle with there to the tune of about $110 or so million that would be there because we, obviously, inherited their basis. We continue to look at all of our assets on a routine basis, what to keep, what to hold.

There is lots of questions that arise when you think about Kansas City. One is that it's been a good diversification for the Company. The long-term leases have already been a strong positive. The leases that we've signed this past quarter have been 15 and 20-year leases. The loan has high prepayment associated with it. And we do continue to identify expansion opportunities. Cordoba, we bought the Saks building, as you may recall, in '05, 100% preleased, the retail component of it.

We've leased a portion of the office that we're delivering now above the retail. So there are aspects that are certainly extremely compelling and positive for a hold on it. And then the big question is, okay, so if you do figure out a way to manage the $100 plus million for the taxes, what do you do with the proceeds, and where do you find an opportunity to reinvest those proceeds in sync with our plan?

Got it. Okay. One little housecleaning issue. Are you capitalizing or expensing your interest carry on your land?

We do not capitalize any interest carry on our land bank, John.

Until you roll it into development?

Until it rolls into an active development, correct.

So what do you think your -- at the end of the day if you sell $50 million worth of land, what does that do to reduce your carry?

If you would just apply that against a credit facility which is a little over 6% so 50 times 6 would be $300 million or so reduction in carry, plus there are taxes and certain other minor expenses associated with the land but they're not generally that significant. But maybe $3.5 million in total.

Okay.

That would be about $0.06 a share.

And last question. When do you increase the dividend?

That's a flattering question. You know, we're focused right now on getting CAD positive. We certainly have difficult deny in our financial model which, you know, we self-servingly say is extremely sophisticated at this point, it's the best model we've ever had thanks to Hugh and Kevin and others here in the shop who spend a significant amount of their time monitoring and improving that model. I think it's too early for Highwoods to be talking about an increase in dividend at this juncture. But thank you for the question.

Have a good winter, thanks.

Thanks, John.

Thanks.

Your next question comes from the line of Chris Haley.

Good morning. It's Brendan Maiorana with Chris. Your spread between your development yields and your portfolio, at least in terms of the cap rate that you're putting forth in your NOI is now about 275 basis points at the midpoint. Where do you think that spread has been historically?

Maybe 150 to 200. There are a number of things that are happening in the market, Brian. Obviously, construction costs are continuing to rise, but those who are willing to pay up for new product, it's -- I think it's becoming an accepted practice for those who are interested in moving into Class A brand new space. I think you have to take into consideration what's happening with construction costs which are working against to some degree the drop in cap rates.

Right.

Of course, in our portfolio, we have a mix of build-to-suits versus multi-tenant for lease space and a mix of credit, government credit versus a lesser credit.

Right, I guess just following up on John Guinee's line of questioning. I'm just trying to understand your -- it seems like you're getting a benefit from your legacy land positions in your development yields which are holding steady at 9% to 10%. You mentioned that replacement costs are up, and it sounds like rents are improving somewhat but probably not enough to offset the increases in replacement costs. So can you quantify what benefit or how much you think your legacy land costs are below market?

I would say that they're 15%, maybe 20% below market. It just, you know, varies site by site, obviously, but on the whole I'd say it's in the 20% range.

Okay. All right, great. That's all I have.

Thank you.

Your next question is from the line of John Stewart.

Hi. Thank you. Terry, I presume you don't have any redemption charges in your guidance, but can you give us a sense for whether you do expect any topic D42 charges on the $30 million to $40 million of preferred, and if so, when would you take those?

Yes, we would, John. Just for the others on the call, what you're referring to are the previously incurred issuance costs for the preferred. When you redeem them those have to be written off as a charge against income for common shareholders. And it's a little over 3% of the outstanding value of the preferred. So if we were to redeem $40 million, we'd take about $1.2 million in additional write-off and that would happen in the period that we actually redeem the shares.

And when do you expect that to be?

We just said likely in the first half. Whenever we get the additional long-term borrowings that we talked about. At that point in time we would announce a redemption and there's a 30-day notice period for any redemption of preferred that we would do, so it would be a little bit of time after, after that.

Got it, thanks. And then, Ed, I think you referred for 93% to 94% of stabilized occupancy for your portfolio. You're hoping to end the year 92.5% at the high end. Is it reasonable to think that you get to stabilization in 2008?

Our forecast is that we would -- that we would be -- when we put out our next tranche of three-year goals we said for '08 we would be 92% to 93% and for '09 we'd be 93% to 94%.

Okay. I know you've got a little bit of asset sales in the guidance. What are your thoughts about getting out of some of the tertiary markets at this point?

We're still working our way out of Columbia, but Brian Reames and others have done a good job there of helping with our occupancy. I think we reported mid-40s occupancy in the supplemental, and we hope that by the end of first quarter going into second quarter that we'd be pushing 80% which would make it a much more attractive sale for us.

And as we said before, publicly we're watching Greenville closely. We're now undertaking the marketing of a few buildings in that market and then we'll continue to monitor the others. Greenville has rebounded nicely and that'll give us more flexibility in the future as we go forward, as well. The one that we've talked about the longest, obviously, is Columbia, and we're down to I think 252,000 square feet there. And with the increase in occupancy, I would hope that we would meet our goal being out of that before year end.

Okay. Thank you. And then lastly, Terry, can you give us a sense, or do you have any sense whether you'll get a clean bill of health in terms of Sarbanes-Oxley 404 material weaknesses?

We're just in the process this week actually of rolling up all of our tests and completing our internal evaluations, so I'm hesitant to give a prediction. But I can say that we have made tremendous progress this year in remediating the weaknesses that we reported last year. You know, the team and the accounting department has just worked so hard during the entire year, and we have been focused on this. So we have made tremendous progress across that entire front. And we're right now just finishing up our evaluations. So it's just a little bit too early to tell. We will be getting our 10-K out about March 1 and we will, obviously, have to report all that have in Item 9a in 10-K at that time.

Hey, John. To underscore here, Terry won't say it, obviously. I want to give great credit to him and the folks that work with him. They've made dramatic improvements in process, et cetera, so I, like he, don't know where we're going to be at the year-end, but the actual in-the-field situation today, the universe is much narrower than where it was and the work that they've done in the 15 filings that we did last year, plus the improvements with regard to SOX, they and the audit committee and our new auditors have all collectively done a better job, and we're much better off than we were in prior years.

I think the market would agree with you. Thanks a lot.

Thank you.

Your next question is from Kristin Brown.

Good morning, guys. I just wanted to ask about industrial rents during the quarter, they were down a little bit and what your outlook for industrial rents is for '07 on a GAAP basis?

Kristen, we haven't broken out what we think --

So the 3% to 5% is on the overall portfolio?

That's exactly right, that's exactly right.

Okay. You were going to say?

I was just going to say, on industrial, on our industrial is a little bit different. It's more shallow bay than big box. So we have limited big box and some shallow bay, but it's really varies from space to space.

We also include some FLEX in there as well so it gets a little bit of a hybrid and it's really hard to try to distinguish just how much one of those FLEX buildings might have office. So it's tougher to deal with that because the mix.

Okay. Thank you.

Thanks, Kristin.

Thanks, Kristen.

Your next question is from Michael Bilerman.

Just a follow-up on the G&A. Terry, you said the G&A forecast will be lower next year because you're taking out the LTIP and stock-based comp that was earned --?

That's the primary reason, Michael. Unless we get another 50.6% total return in '07, we wouldn't expect all of those compensation programs would be at the same level based upon next year's, level, or performance.

Meaning '07?

Meaning '07, correct.

What stock price or what total return was underwritten in the G&A for the full year?

It's based on -- the plans that we have are based on actual total returns. So, as Ed mentioned, we had 50.6% and that triggered some of those grants that we had in prior years really paying off. And we had to recognize for accounting purposes that expense this year in '06.

If this year's up -- I mean, I'm just trying to figure out at what point would additional long-term and other benefits be triggered that would be in addition to whatever G&A forecast you have? I mean what's the hurdle rate?

Part of what we have, Michael is we have restricted stock -- I mean, sorry, phantom stock in deferred compensation, which is basically mark-to-market. As our stock price goes up, we're up 10%, 11% this year total return so far, we have to mark that phantom stock up by 10% so that does go up or down.

And that piece is nominal, we have very few officers who are in that and we've discontinued the program on a going forward basis.

And as the year unfolds, if our projections on that change, either up or down, we'd factor that into our guidance updates that we do prospectively in '07.

If the total return stays where it is right now, would you be above or below your G&A forecast?

I think we'd be pretty much right on where we forecast, where we are today, based upon where we are today.

In terms of the interest and other income, that had risen considerably in the fourth quarter about $2.7 million, it had been averaging $1 million to $2 million the past couple of quarters. Was there anything in particular in the fourth quarter?

I guess I'd say for the year it was pretty much, almost exactly the same full year '06 versus full year '05, so it kind of balanced out. We did have in the fourth quarter recognition of some deferred rights that we had been receiving cash to hold off some developments on an old lease, and the obligation that we had to not develop this adjacent property expired at the end of '06.

And so the moneys that we had received and deferred in the past were able to be recognized for accounting purposes. And that was a little over $0.01 per share in the fourth quarter and it ran through that particular line item, interest and other income. That was the primary reason for the change.

And so effectively you expect this to run more in the $1 million to $1.5 million?

Yes, I think it'll be somewhere in the run rate that it had last year and the year before. It should be, you know, $7 million, maybe a little bit lower next year, but not dramatically.

Okay. The $100 million to $150 million of dispositions, what's your timing and your yield expectations on that?

In the first half of '07, Michael, first of all, overall, we've taken a mid-year convention but we've closed as we mentioned on about $40 million thus far. Then what we have in the queue for the next two quarters gets us pretty close to the high end of our range for the year. The average cap rate on these is in the low 6. And that's in part a function of the occupancy, the occupancy on these is lower now. You know, that may change. If Fontaine in Columbia and some of these others pick up on occupancy, obviously it would have an impact on this.

And 6 is a current, including transaction cost? Current NOI?

Correct, that's what's in place. As I mentioned before, Columbia is in the mid-40s. If we're able to push that up to the 80 plus percent range, obviously that would have an impact on that.

You're not forecasting a rise in occupancy in your guidance on that asset? On those assets?

No. Remember, it's only 250,000 square feet in the entire portfolio.

Right. Can you just go over -- last question is on the RBC Plaza, the condos, you talked about in the supplement, the 139 condos and having 309 reservations, talk a little bit about the timing and the pricing and what the expectation is?

Sure. This is Mike. We're expecting, as we pointed out, right now we have the 309 reservations. Those reservations will start going to contract later this spring after we file the declaration for the condominiums which is required in North Carolina. So we would hope to get those converted to contracts, I would say, probably in the time frame of June to July is when we're really expecting to do that.

Pricing is actually held up very nicely per the reservation agreements. We actually have the right to increase the prices plus or minus 5%. We're going plus given the level of demand for these. So once we complete this project, call it in the fall of '08, we'll start immediately on the closings and it's just a matter of closing as many as we can and then trying to move the residential owners in around our office tenants, because just the capacity on the service elevators to do so.

So we would hope that if we can have good conversion from reservations to contracts and then get them closed that by, I think we expected in the second -- excuse me, second quarter of '09 was our date for that to be completed.

Mike. Just to footnote just a couple things. One, based on what we've learned from the folks who are at Dominion who is doing the residential part with us, we understand that the historic fallout level given we're at 309 reservations, you know, we're in very good shape at 222%, that even if we had a higher-than-industry number of drops outs, we would still be in very good position. And then with regard to your question on pricing, the average unit price is $393,000 or $331 per square foot.

And then one other important aspect that we've tracked and we've asked the realtor to track this. When you make a reservation, you have to declare and then attach to whether it's for your residence or secondary residence or if you are an investor, strictly buying for investment purposes. And we're right around a quarter of them are for investors so we were going to raise a flag when it got to 35% or so. And being at 26%, another aspect of this that we feel extremely comfortable with.

And having all but 12 units having not just one but several back up reservations is comforting to the extent that there's fallout, there's still good demand already scotched right behind it.

And what's the split between first and second residents?

I don't have that. We don't have that.

But I can tell you it's heavily weighted toward primary residents.

And your expectation is to reduce your basis in the office component or take the spread as gain into FFO on the units?

Door number two.

Take it as gain?

Yes.

Yes.

And that would flow into '08 and '09?

Yes.

Yes.

And the total level of what your expectation is today for those sort of gains?

$6 million to $7 million.

And that's your share, right?

Correct.

That's correct.

Okay, thank you.

That includes the unit that Tabitha is going to buy for the next analyst. [LAUGHTER]

Thank you so much.

Thanks, Mike.

Thanks.

[OPERATOR INSTRUCTIONS] At this time there are no further questions.

Okay, I again just it wasn't thank everybody for their time on the call this morning, and if you have any questions, as always, please don't hesitate to pick up the phone and give us a call. Thank you.

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