Highwoods Properties Inc (HIW) 2008 Q2 法說會逐字稿

Good morning. At this time, I would like to welcome everyone to the Highwoods Properties second quarter conference call. (OPERATOR INSTRUCTIONS). Ms. Zane, you may begin your conference.

Thank you, 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, please visit our website at www.highwoods.com, or call 919-431-1531, and we will email 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 conditions, including estimates and effects of asset dispositions and acquisitions, the cost and timing of development projects, roll over 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, 2007 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 and NOI. Definitions of FFO and NOI and an explanation of management's view of the usefulness and risks of FFO and NOI can be found toward the bottom of yesterday's release, and are also available on the Investor Relations section of the web at highwoods.com. I will now turn the call over to Ed Fritsch.

Good morning. Thank you for joining us today. We have another strong quarter, with high revenue driven by better than anticipated occupancy. Based on our solid performance in the first half of the year and our expectations for the second half, we raised our 2008 FFO guidance from $2.60 to $2.72 per share to $2.70 to $2.78 per share. FFO for the second quarter was $0.69 per share, 19% higher than the second quarter of 2007. We ended the quarter with occupancy at 91.1%, 40 bips higher than at the end of the first quarter and 180 bips higher than June 30, 2007. We leased 1.5 million square feet of first and second generation space, including 1 million square feet of office space. Our development pipeline now stands at $336 million is 66% pre-leased.

Year-to-date, we started $48 million of new development, including Triad Centre III, a $29 million, multi-tenant Class A office building on Poplar Avenue, which is in the most highly desired submarket in Memphis. This is an excellent in-fill location and complements our other 705,000 square feet in this submarket, which are on average 96% occupied. Triad Centre III is scheduled to deliver in the third quarter of 2009. Year-to-date, we have delivered $55 million of development projects, with another $146 million scheduled to deliver by year end, including RBC Plaza and Cool Springs IV. Next year, based on our current pipeline, we expect to deliver $89 million of new development, including two build to suit projects for the federal government. In our revised 2008 FFO guidance, we have modified our estimated development starts for this year to 75 to $100 million, given the continued increase in economic uncertainty and its impact on decision making and absorption. We remain selective in choosing which projects get the green light, balancing a number of factors in this process, including our customers' growth requirements, the current and perspective competitive set and general market conditions, including future demand drivers and the long-term viability of the submarket.

Our revised guidance also includes a reduction in the disposition of non-core properties in 2008 to 50 to $100 million from what was 100 to $250 million. It is obviously been tough sledding for virtually all sellers. However, as a reminder, the purpose of our disposition program is more strategic than financial, allowing us to exercise patience and continuing to get non-core assets out the door. One of the reasons there has been limited trading -- property trading in our markets is the widespread between the bid and the ask. This spread has the potential to narrow as sellers who are quote, unquote financially motivated face increasing pressure to sell, and this could mean buying opportunities for us down the road. For instance, you may have seen the Wall Street Journal article published a few weeks ago that highlighted the problems some ticks are facing with properties that are not generating the group's anticipated returns. Brokers in our markets know that Highwoods has dry powder and can proceed quickly if the right opportunity presents itself, the right opportunity being high quality, differentiated assets that are strategically located and appropriately priced.

On past investor calls, I have stressed that our investment approach is measured and deliberate, whether it be for developments, acquisitions or dispositions, and that we as a management team must always be disciplined, opportunistic stewards of our shareholders' money. Highwoods is significantly stronger today than it was four years ago, and is in a better position to weather a downturn than we were in the last cycle -- the last down cycle. We have a higher product quality portfolio, a well-leased development pipeline, a stronger balance sheet, and an outstanding team of real estate professionals. Now Mike will cover the markets.

Thanks, Ed, and good morning, everyone. Our second quarter was solid, as evidenced by our leasing activity and occupancy increase. Two large future explorations were put to bed: The Price Waterhouse Cooper 312,000 square foot lease expansion in Tampa that we announced on our call in May, and a 128,000 square foot renewal in Tampa with AT&T that was set to expire at the end of this year. Although both renewals reflect the cash rent rolldown, they have nominal TIs and substantial annual rent escalators. Let's start by reviewing the overall trends we're seeing in our portfolio. Leasing activity has slowed slightly, but deals are being signed. To put this quarter in perspective, in the second quarter last year, we signed leases for 1.6 million square feet of space versus 1.5 million this quarter.

The current leasing theme points towards shorter term renewals, with many customers choosing to stay put until economic uncertainty passes. On balance, this maintains occupancy and reduces leasing CapEx. Our preference remains to sign longer term leases. However, we are directing our leasing agent to get deals done, and customers are willing to pay more and accept lower TI allowances for the flexibility of shorter term. Looking at the second quarter over first, within our portfolio we saw no increase in sublease space, no deterioration in accounts receivables, and an improvement in net effective rents. We are seeing higher operating expenses as a result of rising utility and fuel costs and property taxes. We are keenly focused on containing these costs as much as possible, and are constantly looking for ways to more efficiently operate our portfolio to improve our NOI margins. As an example, we recently completed a major lighting retrofit and are in the process of installing variable frequency drives in many of our buildings to help combat utility rate increases.

Looking at our operating metrics this quarter, average in--place cash rental rates across our total portfolio rose 2.9% from a year ago, and average in-place cash rental rates across our office portfolio were up 2.8% from the same period a year ago. Cash rent growth for office leases signed this quarter declined 4.5%, but this decline is less than 1% if you exclude the PWC and AT&T deals. GAAP rents for office leases signed this quarter were up 8.2% and up 5.4%, excluding the PWC and AT&T deals. CapEx related to office leasing was $7.54 per square foot in the first quarter versus the -- excuse me, second quarter versus the five-quarter average of $9.49. This is largely a function of the mix between renewals and new deals, as well as shorter term leases. In our top five markets, construction as a percent of total market was just under 3%, a slight decline from the first quarter. Raleigh and Nashville have the highest percentage at just over 5% in each market. However, when you strip out these submarkets where we don't compete, the competitive set drops down to 4% in Raleigh and 3% in Nashville.

Our current development pipeline in Raleigh is 512,000 square feet and is 79% pre-leased. Last week, we announced the signing of a 75,000 square foot lease at RBC Plaza, bringing that project's pre-leasing to 91%. In Nashville, we have one project under way, Cool Springs IV, scheduled to deliver this fall. Our pre-leasing is nominal at this time. The project is in a great submarket and our other office buildings there, encompassing 773,000 square feet, are 98% occupied. Aggregate net absorption in our five top markets was slightly over 100,000 square feet. Raleigh led the group with just under 400,000 square feet of positive net absorption, while Tampa and Atlanta posted combined negative absorption of 300,000 square feet. Tampa's negative absorption this quarter was driven largely by Pinellas County, where where own only 162,000 square feet of office space. Hillsborough County, where 94% of our Tampa assets are located, actually reported positive net absorption of 146,000 square feet.

Notwithstanding the well publicized glut of new office supply in Tampa, total leasing this quarter in the Tampa market was the highest it's been since the third quarter of 2006, and market vacancy was down 10 basis points from the first quarter. Our portfolio in Tampa is doing well, with occupancy at 94.5%, a full 780 basis points better than market. We credit this to a higher quality portfolio achieved through the sale of $204 million of older, non-core assets over the past three and a half years and a top-notch seasoned leasing team. Additionally, we were fortunate to have completed our 461,000 square foot development pipeline in Tampa and leased it to its present 94% level before the market became overbuilt. Let me briefly address our industrial and retail portfolios. As you know, all of our industrial properties are concentrated in Atlanta and Greensboro. Occupancy in our industrial portfolio is 91.4%, up 40 basis points from the prior quarter and up 60 basis points year-over-year. We are currently expanding this portfolio with two industrial projects totaling 618,000 square feet which are 65% pre-leased. We like our position in both of these markets, and we continue to look for opportunities to expand our industrial footprint.

As in our office portfolio, we routinely monitor the financial viability of our industrial customers, and we are paying particular attention to those customers who are directly or indirectly involved in the residential building sector. On the retail side, we've all been reading about the woes of some national retailers. However, most of our Country Club Plaza customers have reported higher year-over-year sales, and our overall retail occupancy continues to be strong -- 93.5%, up 60 basis points from the first quarter. Overall, it was a good quarter for Highwoods. In every one of our markets, our occupancy is higher than the market. This is clearly a function of our higher quality portfolio and our experienced management and leasing teams. Our division heads have an average of 26 years of real estate experience and have been through the ups and downs of the real estate market. They understand that there are opportunities to be realized when others are on the sidelines due to capital market constraints. They're being proactive in identifying and pursuing building acquisitions and in-fill land for future development. All in all, we're well-positioned in each of our markets and have great teams on the ground to execute our plan. Terry?

Thanks, Mike, and good morning, everyone. As Ed noted in his opening remarks, we had a very good second quarter and first half. FFO per share for second quarter was $0.69, which compares to $0.71 in the immediately preceding first quarter and to $0.58 in the second quarter of 2007. FFO from core operations, which we defined to exclude lease term fees, land sale gains and any other similar items, was also $0.69 per share this quarter, up $0.01 from the $0.68 in the preceding first quarter of this year and up $0.13 from the $0.56 of core FFO in the second quarter of 2007. This growth trend in core FFO is resulting primarily from the impact of development projects completed last year and in the first half of this year, from occupancy growth and from lower average interest rates. In addition, $0.02 of the year-over-year increase occurred because this quarter had just under $0.01 of positive cam true up billings while second quarter of 2007 had over $0.01 in negative cam true ups.

Total revenues from continuing operations this quarter were up 10.7 million or 10% compared to the same period of 2007. 6.7 million of the revenue increase came from the development properties completed in '07 and in the first half of 2008. 3.2 million of the increase came from our same property portfolio, mostly reflecting higher same property average occupancy and increases in average in-place rent per square foot. Total property cash NOI, which excludes straight line rents and termination fees, and also excluding the cam true ups, was up 2.7% for the quarter compared to second quarter 2007. Due to seasonality, we typically have higher operating expenses in the second half of the year, particularly utility costs; and accordingly, we expect same property NOI growth to be lower in the second half of 2008. For the full year, we now expect same property NOI growth to be toward the higher end of the 1.5 to 2.5% growth assumption provided in our original guidance for the year. G&A for second quarter of 2008 was slightly lower than the same quarter in 2007. Both quarters had over $1 million in expense related to write offs of deferred predevelopment costs, which is the principle reason second quarter G&A was higher than first quarter.

We are still forecasting net G&A to be in the 40 to $42 million range for full year 2008. Net interest expense this quarter was flat with second quarter 2007. Higher average debt balances were offset by lower average interest rates. Capitalized interest was 2.2 million this quarter, down slightly from 2.4 million in second quarter of 2007. The weighted average interest rate for all of our debt was 5.79% at June 30, 2008, down from 6.57% one year ago. We currently have hedged $150 million of our floating rate debt under swap agreements. Preferred dividends were lower by $1 million this quarter compared to last year as a result of last year's retirement of $62 million of preferred stock. On the financing front, we have no debt maturities during the remainder of 2008. In May 2009, our 450 million unsecured credit facility is scheduled to mature, but we have a one-year extension right at our option that we currently plan to exercise. Our other 2009 maturities include a low leverage secured loan, bearing interest at 7.8% and with a principle balance of 103 million at its maturity in November; a floating rate construction loan related to the RBC Plaza condominiums; and a $50 million bond bearing interest at 8.25% that matures at the end of January.

We expect to refinance the secured loan and we plan to pay off the RBC construction loan with proceeds from the projected sales of the condos in fourth quarter this year and in early 2009. We have several options for handling the $50 million of bonds, including using our credit facility in the near term. At June 30, we had $192 million available on our unsecured credit facility and 85 million available on our two secured revolving construction credit facilities. Given this 277 million of funding availability combined with proceeds from additional planned dispositions and other potential capital sources, we're well-positioned to fund the approximately $150 million of development costs that remain to be funded as of June 30, and still have additional dry powder to take advantage of other investment opportunities that may arise. We continue to be CAD positive so far this year, as you can determine from the information we provided on Page 2 of the supplemental, and we expect to remain CAD positive this year. As Ed mentioned, we raised our 2008 FFO guidance to $2.70 to $2.78 per share, increasing the low end of our previous guidance by $0.10 and the high end by $0.06. This increase is primarily attributable to stronger same property NOI, lower than anticipated interest rates, higher dilution from dispositions, and less dilution from dispositions, and our expectation that we will now be closer to the high end of our range for projected condo sale gains. These increases will be partly offset by higher seasonal utility expenses and property taxes in the second half of the year. Operator, we're now ready for questions.

(OPERATOR INSTRUCTIONS). Our first question comes from the line of Lou Taylor with Deutsche Bank.

Thanks. Good morning, guys. Terry, can you just expand a little bit in terms of the components of the higher guidance with regards to less sales dilution in terms of maybe quantifying some of the impact? And on the sales solution, what are your expectations for average cap rates on those sales?

Lou, when the guidance was first developed during the year, we obviously had a much higher range of projected dispositions; and as Ed mentioned, those have been scaled back. I don't have the exact number. But I think we had probably close to $0.04 to $0.05 of dilution in the original guidance going into 2008. That's been dialed back probably by $0.03 or $0.04 at this point.

Okay. And in terms of the condo gains, when are they likely to occur later this year or within the fourth quarter?

They're scheduled to do start closing probably in October, maybe mid-October, and will be closed right through the end of the year into early '09.

Okay. All right. Last question just for Ed or for Mike. In terms of the Piedmont office portfolio, I know occupancy is staying in the low 80s there. Just what's your expectation for some improvement there?

Lou, we hope to have some movement on the leasing, but it is still tough treading there. We've stayed focused on seeing about the opportunities that we could exercise to still get out of that market, so rather than it doing it as a total sale, we're finding that some of the one-offs are easier to complete, and, for example, we expect to complete the sale of an $8 million industrial building today, so we're taking smaller bites and working our way out of it.

And Lou, there's a little bit of tale of two cities. Because remember, Triad -- as we call it, Piedmont Triad -- is Winston, Salem, and Greensboro and Winston market, particularly the office market is definitely softer, and particularly in North Winston, where we had the Madison Park project. So Greensboro is where we more or less staked our future going forward, and we believe that market -- particularly on the industrial side -- is reasonably strong.

Your next question comes from the line of Erwin Kasman with Citigroup.

Good morning. Ed, I just had a question about the lease roll. In the last several quarters, it looks like it has been flat to slightly down with the exception of the PWC and the AT&T situations that you just talked about. I am wondering as you look out into 2009 or 2010 whether you expect perhaps some of the leases from -- that were signed in the trough period of '03 or '04 to start rolling off and for that trend to reverse?

Are you talking with regard to rent growth, GAAP rent growth, cash rent growth?

Cash rental.

Cash. I would expect that we're dead in the middle of the guidance that we had given, and we achieved the same thing last year. If you look at the trend over a dozen quarters, it is -- if you did a regression analysis, it is clearly been towards the positive because we were negative 10 plus percent in 2004; so now to be close to break even on average for the year as we were at the end of last year and hope to be there again this year. I think looking forward, that we'll probably end up somewhere around the same position that we are for 2008.

Right. I am just thinking -- I am just asking whether going forward you know when sort of the leases that you signed in '03 and '04 started to burn off and whether you see -- whether you expect to see a big uptick in cash rent spreads because of that.

Yes. It is difficult for me to get a sense for what the market would be at the time that they roll in '09 or 2010, but what we do have in every one of our leases is a base year kicker so that every year there is an escalation of somewhere from 2 to 3.5% that kicks in every year, that holds that -- that continues to push that rent up.

Erwin, even in the down times, if you would, we have been very successful getting those annual kickers, which is what maintained the good GAAP rent growth. Hard to say in '09 or '10 where we'll be in the cycle and whether we'll be on the uptick or the trough, and that will have a big impact on the market and what we're able to get in terms of cash rent growth or decline.

And just one other question on occupancies. You're projecting about a 100 to 200 basis points increase in occupancy to get to your guidance towards the year end. I was wondering if there are any particular markets where you expect to see an uptick?

You broke up. Where we expect what?

Where you expect to see sort of an increase in occupancies to get from 91 today to 92 to 93 at the end of the year.

Well, hope to pick up in the lower markets. I think the markets where we're now at 93, 93.5 to 95, it is going to be difficult to push that much higher, so it will come from the markets that have the lower occupancy percent. I think that probably most of it that we would see come would be coming from Atlanta, Greenville, and Orlando.

I was going to say, we'll pick up, we believe, in Memphis toward the latter part of the year as well.

Okay. Thanks for the detail.

You're welcome.

(OPERATOR INSTRUCTIONS). Your next question is from the line of John Guinee with Stifel Nicolaus.

Thank you. You guys really have done just a great job. Do you feel to get to the next level and really get the stock up another 4 or 5 bucks, you have got to generate dependable FFO, dependable FAD, dependable dividend coverage and dividend growth. Do you think the business model and the portfolio and the market conditions are set for you guys to continue to generate a 5, 6, 7% growth across the board?

I think that we've done a lot of things to position ourselves to do that. There are a lot of moving parts, be it from our ability to dispose, our ability to develop; our development today is obviously much more modest than what it was in the way of starts just two years ago, but we didn't want to be in a position where we had tremendous overhang in the market with development that was started late in the cycle and then sits there with a long lease period because there is not the demand for it. It is our job to find the opportunity in each aspect of the cycle, and we're thinking right now that it is at a tipping point -- development right now that's not substantially pre-leased is risky business, so we're being very deliberate about that. But acquisitions, where we're on the sidelines for the last three years, we think that the conditions are turning in our favor on that front -- or at least the potential is there for that. People who bought properties that were aggressively underwritten, and the properties were financed through some debt instrument that couldn't be replaced today, I think that there is good chance that they'll come back on the market.

Now, we haven't seen distress sales, distress pricing of Class A product to date, but we're of the belief that that could come about. So long answer to your short question is we need to find the opportunities in each part of the cycle to bring about that continued reliable FFO growth; and by having a better, more stabilized cash flow -- and we've tried to establish that with better assets, better credit leases, et cetera -- and then having a team that focuses on what's the coming opportunity, whether it be development or acquisitions, to be able to do the due diligence and be prepared to pull that off is essential for us. For example, as I mentioned, development now is not nearly as robust in starts for us as it was two years ago, but there is a lot of work being done on designs, schematics, pricing, marketing of product that could easily come online when the first signs of recovery come about because just like in the last cycle, we want to be out early. We have land that would support a billion dollars' worth of development. We have dry powder in our balance sheet where we can make acquisitions, and we have some other things that we can do. I would hope to believe that this Company is in a position to be able to do what you outlined, and I think that the team has demonstrated it to date. We need to stay focused and not relent going forward.

Just a quick follow. You have a little bit of low hanging fruit remaining on debt maturities. Do you have any low hanging fruit left on occupancy within the core portfolio?

Well, I think that there is clearly -- if I am understanding your question right -- there is clearly opportunity on the remaining lease up -- another 30 percentage points on our development pipeline would be the most attractive in our view. It is brand new product in the best submarkets that we develop in, so to me that would be ideal. And then there are some markets that do trail on an occupancy perspective that we hope to push that occupancy up some; but we'll continue to wrestle with the day-to-day rollovers that we have that you would -- sometimes it's two steps forward, one step back; but to be at the 91.1 is better than what we anticipated at the outset of the year.

And clearly, the portfolio we're dealing with today, John, the remaining vacancy, if you would, it is in better buildings as a result of our disposition program over the last few years. So we're not dragging a lot of dogs around with us this time around, so these properties even in down cycle, will be more desirable than their competitive subset of second gen space. First gen, as Ed said, is where you really feel like there is a good pickup there, and that won't really reflect too much in occupancy until those buildings are put in service.

And I think the fact that we're 480 bips better occupied than the average of our top five markets is telling, and I guess the other aspect of this is that we hopefully can fortify it with some build to suit wins, whether it be in the private sector or the GSA.

Thank you.

Thanks, John.

Your next question comes from the line of Cedric Lachance with Green Street.

Pre-leasing you did at RBC, the law firm Williams Mullen, (inaudible) be up for 75,000 square feet is coming from one of your buildings. Can you give us a sense if your plan is to back fill their space?

It's a little bit biased on that space. It's an extremely nice space. It's a law firm that was founded many years ago here in Raleigh that merged with a law firm in Richmond, and they needed to grow by 50%, so they were coming out of the building because we couldn't accommodate them in that building, and we were fortunate that we had just the right amount of space downtown because that takes the office component of RBC to 95%. The space that they're moving out of has a tremendous amount of custom millwork that if we find the right customer they'll be dearly attracted to it because the millwork is so well done and has a custom crafted atwood monumental staircase connecting the two floors. It will show extremely well, so I think we just need to find the right user; but fortunately it is the size 10 shoe, it is not a size 3 EEE.

There has been a lot of mergers and consolidations, and growth in new legal firms, particularly that have come into Raleigh. There is limited space downtown as that market becomes very tight, so as these firms start looking outside, this building is well-positioned to garner one of these firms as I look at it.

Just time will tell on it, Cedric.

Okay. In terms of the rent that they currently pay in their current location versus the rent they will pay at RBC, can you give us a sense of the gap between the two?

Yes. It is significant. I am hesitant to put numbers out because we have a number of customers that we've done deals with in each building, but I can tell you that there is a significant uptick in rent from where they are to where they're going.

And I can also tell you they signed a fifteen year deal. So we have RBC at 20 years, this firm at in 75,000 and 15 years, and the other firm at 10 years, so the average is somewhere north of 15 years.

In regards to dispositions, you've sold a few buildings in Kansas City this year. Is it simply pruning lower quality assets or do you have any plans to curtail even further your presence in Kansas City?

Those buildings were very old buildings. They weren't buildings that contributed to our position or clout on or about the Plaza by any means.

Average size tenants, they were under 100,000 square feet. Lots of very small tenants. They were almost residential construction, so they were definitely ripe for selling.

Okay. You've addressed the short-term leases a little bit earlier. Can you give us a sense of how your tenants are thinking about leasing space right now? Obviously you've had a lot more renewals. Those renewals have been definitely for shorter terms than before. Is it widespread among your tenant that renewal is the key direction, but at the same time the terms will always be low, or is there anything special with the leases this quarter?

I will start mine.

Sure, go ahead. I think, Cedric, it is just -- and I think Mike had in his script the word theme. It just seems to be a repetitive theme that we're encountering when we talk with our customer that is now is not the time to grow or to relocate, that it makes sense to stay where they are. The rates that they're getting are attractive in that they're foregoing any significant TI packages because we don't see the merit in investing significant dollars for an on average three-year lease; so we were basically able to hold the face rate, and then not have to spend much in TI, and obviously the commission is reflective of only a three-year term. I think it is absolutely tied to the uncertainty of present-day economic environment, and that as confidence builds, decision makers will return to making their decisions to grow their business, add space, add personnel.

Okay. You alluded to do a wide bid ask spread in the market right now. Can you give us a sense of how wide that bid ask spread is?

Well, underscored with the point that we still haven't seen a tremendous amount of trading, so the data points are few and far between, I think that all that we've seen from deals that we've looked at all the way to what you and many others have monitored, I guess the GM building in Manhattan is the pinnacle, and that is an amazing number, but we've seen a spread of up to 75 bips on the types of product that we're looking to either buy or sell.

And if we are to compare that versus the cap rates that you used for your NAV back in February, where would those cap rates be on the bid ask continuum right now and are those cap rates still valid today?

We feel they are. We made a commitment to change Page 4 of the supplemental any time that there is a material move that we need to adjust this during a year, otherwise we do it once per year. And we had lengthy discussion about this, and we feel that the range that we give at the top of the page and given that it is by product, that there is enough information there for everybody to draw their own conclusions and that we're still appropriately within a range.

Are those cap rates more reflective of the bid or the ask?

It depends if you're buying or selling.

All right. Thank you.

Okay, thanks, Cedric.

Your next question comes from the line of Wilkes Graham with FBR.

As we look at the vacancy rate of all those markets across the country, Richmond and Nashville continue to kind of pop up as single vacancy rates, and there is only a handful of markets left that are still in the single-digit rates; and you may have talked about a little bit of this before, but we jumped on late because of another call, so I apologize. But can you just talk about how you view Richmond and Nashville, again in the context of -- well, first of all what the demand drivers are that are keeping vacancy down and just in the context of Cool Springs and North Shore commons?

Sure. I will take a first stab. I think first of all it is some of our youngest assets, and I think that it is also evidenced by, if you look at all the sales that we've done, Wilkes, over the last three and a half years, the least number of sales have come out of these two markets Company-wide, so we've done somewhere shy of $800 million and very little dispositions out of Richmond and Nashville, which reading between the lines says that that must have been very high quality for the get go, so given they're some of our youngest assets and driven mostly by a lot of what we've developed, I think that underscores a little bit of differentiation between them and assets we've had in Raleigh, Atlanta, Tampa, for example, we've had a lot of disposition activity. The underlying metrics that drive it, certainly in Nashville, the healthcare industry has been a strong growth mechanism in the market and they continue to grow and consume space. The markets that we're in there, being the West End and then down in Brentwood, Cool Springs, they're superb submarkets just like what we have in Richmond, where we're basically concentrated in West End and Innsbrook. So we're in the -- not only the best submarket, but the best pod within the best submarket. So I think it is our concentrations and positions, and I would be remiss to say if we don't have very high confidence in the people who run both of those markets and the leasing people there, but I think with North Shore commons -- and we've struggled with that.

We've said that from the outset if there was one building, one new development project that I need to do take an ambient on it, it would be that one. But we've seen decent activity on that. At 3Q '07, we were at 9%, and now we're 66% pre-leased; so the activity has been slow, but we're still not stagnant at the 9% that we were just three or so quarters ago. And then Cool Springs IV, we have about 800,000 square feet -- close to 800,000 square feet in that submarket and we're 90 -- 98% leased, so Brian and his team are basically out of product there, and the other products have done phenomenally well, and the submarket as a whole continues to grow in drawing businesses, retail, residential apartments, and I think it is a good place for us to be, and right now that's our last track of land in Cool Springs.

Okay. That's great. I appreciate that. I know you mentioned previously that at this point in the cycle it is certainly more difficult to kind of plan on a material amount of future starts, you know, when you kind of feel comfortable with what you have under construction now. But if you look at the development market, do Nashville and Richmond still -- are they still near the top of the list as far as where future starts would come from? I know you don't have as much land in those markets, but just from a demand standpoint.

I would say yes; but I wouldn't rule out any of the other of our seven division heads from creating an opportunity akin to what was created with RBC downtown here or akin to what's been created with the federal government with the build to suits that we've done recently in Atlanta. So I think that some of it is going to be driven by the customer that we're able to attract to come to our space, our product; so I wouldn't space it solely on what the current vacancy is or what the vacancy trend has been. If we can find a credit user that we can provide a build to suit or substantially well pre-leased building for, that would certainly tilt it towards a different market.

I think as Ed point out in his script, Wilkes, we're being very deliberate, particularly with respect to spec development, which we were comfortable with two or three years ago, now we take a hard look at it. The Triad Centre building in Memphis which we nominal pre-leasings -- 17%. It just happened to be an extremely tight submarket where our own portfolio was 96% leased and we had growing customers that we had to accommodate or we would lose them. So that would be a driver as we looked at our portfolio; because again, our mainstay of this Company is the ability to grow with our customers.

And Wilkes, I go back to something that we said about three years ago -- three and a half years ago. We said it was real important for us to be the first building out and be ready with that second building, be deliberate with the third and not build the fourth, because we were afraid the fourth we would be delivering it at the worst of times which would be about now, and we evidenced that discipline with how we conducted ourselves in Tampa, where we built Bay Center, our largest single investment in a pure spec building in the Company's 30-year history, at $43 million or 86, 87% leased at this point in time. We're pad ready for Phase II, but there is a lot of space being built on a speculative basis in that submarket right now, and we're on hold. I think that some of the best decisions right now are to not start a development; but that doesn't mean that we shouldn't be keeping a very careful watch of when we should pull the trigger for the next uptick.

Okay. I appreciate those comments, and just want to applaud you guys on turning around your dividend coverage in the past few quarters. That has been impressive.

Thanks, Wilkes, very much.

(OPERATOR INSTRUCTIONS). Your next question comes from the line of Jamie Feldman with UBS.

Thank you. I was just hoping you could clarify your comments on the acquisition opportunities, just how much in terms of volume you guys would be willing to do and then maybe how you would finance it? Is this something you would be interested in doing JVs or on balance sheet?

Yes, let me just kind of start through. Terry will give you the numbers, Jamie, but just in essence, what we're doing is we've made sure that all the brokers that have made significant money off of us through dispositions over the last three years understand that we now have this dry powder and they shouldn't just think of us as sellers, that we want to be active buyers and we want them to help us identify opportunities. If they're one off, it would be great, but it is not likely in this environment that they'll be one off; but if we can get an early introduction to an asset or a group of assets that we can pursue, that's what we want. And we've been able to evidence, as an example, with the Prudential acquisition, the forum, and we evidenced that we can move quickly, and we evidenced that we had the dollars and the due diligence team and we closed in less than 60 days from the time we signed an LOI to the time we were at the closing table. What we want to be able to do is be sure that we don't go out and buy assets akin to those which we just sold.

They have got to be assets that continue to lift the overall quality of the portfolio so we can do exactly what John Guinee asked about where we expect to be in the next two to three to five years down the road. We have to have a check valve behind us so that we don't go backwards with regard to quality. Terry and Hugh and others have built a balance sheet that puts us in a position where we're not having to sell core assets today in order to feed debt maturities that are staring us in the face; and as you said, we have no maturities left in '08 and maturities that are coming in '09 are certainly manageable and price where we should be able to reposition ourselves to have even better pricing. Terry, the dollars?

As Ed said, we have significant capacity on the balance sheet and the ability to increase our debt probably close to $300 million, plus any additional disposition proceeds before we start to bump up against any covenant restrictions, which gives us a fairly good amount of dry powder. In addition, as we did with the forum, if we could do acquisitions with joint ventures, that would further stretch our own capital to allow us to acquire additional assets, and with the joint ventures where we manage and lease those fees, also help boost our returns vis-a-vis the joint venture returns. We do have good relationships with a number of joint venture partners, primarily some German money that is sourced to us through European investors, and we had a good long-term relation with them and have continued to put money out with that group, most recently the forum deal here in Raleigh.

Okay, but it would still be core even if you did it through a JV?

It would still be what, Jamie?

Yes.

Yes.

So the core quality assets --

Absolutely. Yes, sir.

Okay. And then my second question, can you just comment a little bit more on the mood of tenants? I mean, i think in the past you guys have commented that the downturn seemed to be more of a Northeast focused downturn. Obviously, it is not the case as much any more, but would you say your tenants on average are thinking this is the worst and they need to slug it out for awhile, do they think it's getting worse from here, or things are actually improving?

I think that we all read every day, whether it is online or in the paper, is uncertainty; and everybody is kind of hesitant to stick a dart on the wall or in the calendar and say this is the bottom and things are going to get better. The monitor that we hear is that people are just being cautious -- there is no need or incentive for a lot of people to stick their heads out. We haven't seen the markets shut down like they did in 2001, but we're not as busy as we were in 2006; so our leasing people, I think, have done a superb job of staying close to our customers and enabling them to keep the space that they want, and hopefully when the things turn and the decision makers decide that now is the time to grow, that they'll remember how they were treated by Highwoods during this time of uncertainty.

And, Jamie, remember our average customer is pretty small -- under 9,000 square feet -- and our leasing folks and our property managers that speak to them, there is an overriding theme that basically their business model -- our customer's business model -- seems to be looking pretty good, but they're just kind of concerned to see what's around the corner, and as a result of that they just stayed put for now.

Okay. And then, Terry, I may have missed it. Did you mention if you changed the tenant watch list at all this quarter?

It hasn't changed significantly. We do watch a number of tenants, and there is always some that move on, some that move off, but it hasn't changed materially our accounts receivable. The past due receivables have not changed significantly over the last year or two, so we're not seeing any distress in the receivables and our watch list is not significantly different than what it had been before.

I think we continue to look at companies in the mortgage-related and the residential building sector -- whether it is office or industrial -- in general, just given the woes that are out there in that industry.

All right. Thank you very much.

Thanks, Jamie.

Thanks, Jamie.

Our next question comes from the line of Chris Haley with Wachovia.

Congratulations on a very good results.

Thanks, Chris.

I do apologize. I think we had an incorrect calculation related to our cash flow or CAD related to differentiation between first and generation space, so I also need to congratulate you on getting dividend coverage back up. Wanted to ask a point of clarification regarding your differentiation between first and second generation expenditures. If a space that you've owned for years goes vacant, and stays vacant for more than a period of nine, twelve months, and then you retenant that space and you spend money on it, how is that expenditure treated from your disclosure perspective?

That would be -- we would treat that as a second gen CapEx. First gen for us is space that has never had an occupant in it. So it doesn't matter how long it has been vacant.

So if we delivered a brand new building in 1995 and there was a suite that was never built out -- no finishes, no ceiling put in -- and we leased it this quarter, it would be first gen space. But any space that's ever been built out and previously occupied, whether it is renewal or relet is considered second gen.

And the time period it doesn't matter -- if it's one year, two year, three year. We don't differentiate that.

Good. I'm glad to hear that. Related to leasing statistics, you also had a very high renewal rate largely due to customers that you mentioned in your prepared remarks in Tampa and Atlanta; yet the concessions as they combine tenant improvement and leasing conditions as a percent of the base initial rent were higher than where they were in the first quarter. They still are below where they were in past two years, but they were pretty high in relation to what we would think would be a lower level given the high percentage of renewal activity. Could you comment?

I think that's -- one, I would say it is a little bit lumpy; and looking at your table, for example, Memphis was a market that had a little bit of a spike this quarter. That's only 22,000 square feet of lease activity. And if you look within the transactions there, you have one transaction. It was a renewal, but it had a longer stem to it, and it was a law firm, so it had fairly high TI. Conversely, we had an equal size tenant that just did a twelve-month renewal pretty much as is. So it's hard to -- and I understand your calculation -- but it is hard to look at that and see that that is a trend to us, because it really is lumpy from quarter to quarter. I think there was a slight increase in Richmond -- very similar situation -- but if you look at market to market, really didn't have a significant spike other than those few markets.

Overall averages take into account the differences between a market that has a small amount of leasing versus a large amount of leasing, and it also adjusts for the lease terms signed; so those concession ratios are really meant on a capital dollar per square foot per lease year, so is that a reflection of where the market is -- even on renewal deals, the expenses, the inducements are not as low as one would think just due to the competitive landscape?

I don't think so, Chris. I think it is broader than that. It's the quality of the space that they're in, it's how long have they been in the space, and what TI would be required to make it up, what's the quality of the credit of the customer that's in there, what's our plan with the building, are we planning on -- like when we did the lease in the Nortel building, the intent there was to get it relet and sell the building. So I think that can covers everything from the credit of the customer to what our long-term plan is in the space to the fact that given that we're now at 91% occupancy, what remains can sometimes be the tougher space to lease.

Thank you for that.

Sure.

So when you guys -- the way you disclose your expenditures on your CAD reconciliation are dollars actually spent in the quarter versus your leasing tables, which are those expenses that are committed to be spent, how should we think about the tenant improvement leasing commission costs going into the third and fourth quarter? Not committed, but actually what relationship between CAD and FFO look like in the second half of the year based upon the velocity of leasing that occurred in the second quarter? Obviously there is a lag, so I just am interested.

Well, Chris, it is hard to give an exact relationship because a lease that's signed this quarter, the TIs might not start for a couple of quarters out, and the leasing commissions can be partly now, partly when the lease commences, or paid over time, so there is no exact relationship. I would say that the CAD ratio that we calculate from Page 2 of the supplemental was about 85% for the first six months of the year. I would expect that to deteriorate a little bit -- still be positive by year end, but one of the things that will happen, not so much in leasing, but we tend to have higher building improvement costs in the second half of the year relative to the first half. It is just because some of that is seasonal in the sense that you can get more of that work done in the summer months or early fall, and so we do expect to see BI up higher in the second half, leasing costs may be up marginally in the second half, but -- or may even stay really the same. I think on balance, the CAD ratio should probably maybe end the year closer to 90, 92% which is worse than the 85% it was through six months.

And we are still seeing some marginal increase in TI costs and some construction costs, as we're seeing -- expecting to see drywall costs go up here as National (inaudible) and some of the major suppliers start cutting back production and raising prices -- steel prices for tracks and our stud walls are going up. So that has an impact as well on our TI costs.

Mike, which markets are you less willing -- less able, I should say -- less able to pass through or amortize those higher costs, given the rent structure?

I don't think there is any one market that jumps out as being problematic in that regard. I think that we are seeing, Chris, a little more demand from tenants for turnkey versus allowances, primarily as tenants and customers just won't want to use their balance sheet or come out of their pocket for that, but they also seem to be willing to pay for it. We may not get the highest amortization rate in it, but we are getting paid some for it, and it doesn't seem to be any one market that jumps out to me as being problematic in getting that.

Thank you. Last question. Specifically on markets, if I look at the amount of leasing that done in Tampa and Atlanta, and then the impact that the leasing had to your expiration schedules -- for example Atlanta, looked like you pulled leases from '09 expiration, and in Tampa expirations from '09 and 2010. When I look at the terms for which you signed those leases, they were Atlanta, two years and Tampa, three and a half, four years; so it would appear the tenant has only extended their lease by a year, at most two years, versus their original expiration?

You're exactly right. It is very intuitive, Chris. It is driven by the government deals in Atlanta, and when they have the automatic annual renewals.

Okay.

116,000 square feet just this quarter -- and these are things like Georgia Department of Revenue, Veteran's Affairs has one. So there are at least, I guess, half a dozen of these state leases that come up every year; and by law in Georgia, they can't commit to doing anything but annual renewal, so every year about this time we see those pop up and that lowers the average maturity as well. There is typically no TI, or very little TI, associated with those transactions.

Right. Thank you.

You're welcome.

And at this time, there are no further questions.

Okay, I would like to thank everybody for joining the call. As always, if you have any questions, please don't hesitate to call us, and we'll be glad to answer any questions that we can. Thank you very much.

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