Highwoods Properties Inc (HIW) 2014 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Highland's Properties conference call. (Operator Instructions). As a reminder, this conference is being recorded, Wednesday April 30, 2014. I would now like to turn the conference over to Tabitha Zane. Please go ahead.

Thank you, good morning, everybody. This is actually the Highwoods Properties conference call. On the call are Ed Fritsch, President & CEO, Mike Harris, COO, and Terry Stevens, CFO. If anybody has not received a copy of yesterday's press release, or the supplemental, please visit our website at www.highwoods.com, or call 919-431-1529, and we will email copies to you. Please note, in yesterday's press release, we have announced the release of our 2014 conference calls. Also, following the conclusion of today's conference call, we will post senior management's formal remarks on the website under the investor section.

Before we begin, I would like to remind you that this call will include forward-looking statements on the Company's operations and financial condition, including estimates and effects of asset dispositions and acquisitions, the cost and timing of development projects, the terms and times of financings, joint ventures, roll over rents, occupancy, revenue and expense trends, and so forth. Such statements are subject to risk and uncertainties, and actually results could differ materially from those currently anticipated due to a number of factors, including those at the bottom of yesterday's release, and the Company's 2013 annual report on 10K and subsequent SEC reports.

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 managements view of the usefulness and risks of FFO and NOI can be found towards the bottom of yesterday's release, and are also found on the investor section of the web at highwoods.com. I will now turn the call over to Ed Fritsch.

Thank you, Tabitha. Good morning, everyone, and thank you for joining us today. At the beginning of the year, we noted our 2014 expectations, namely, the U.S. economy would continue it's positive trajectory, albeit slower than we would all like, second, measured positive growth would continue, albeit at a choppy pace and without meaningful growth and real wages, and third, interest rates would be a wild card, but our guess was any movement in 2014 would be relatively mild. Now, four months into the year, the upshot is the story hasn't changed, although there are two areas worth commenting on. First, even with this mornings commerce department's extremely frigid first quarter GDP estimate of 0.1%, we believe full year GDP should still clear the 2% Mendoza line.

Second, interest rate movement has been mild, in fact, rates have ticked down slightly, while interest rates remain a wild card threat, they have remained in check thus far in 2014. Given all of this, the economy is performing as expected with the exception of old man winter having an unusually active and grumpy first quarter. Our markets continue to benefit from the improving economy and available class A space is becoming increasingly scarce. Our YTD leasing activity is robust as our team is doing an impressive job of attracting new customers to the Highwoods portfolio, validating our concentration on high quality, VBD located assets. We are therefore pleased to raise the mid point of the 2014 FFO outlook by $0.02 cents. The range is now $2.86 to $2.94 with a mid point of $2.90. Our first quarter FFO results of $0.66 per share were impacted by old man winter waking up on the wrong side of his igloo, as well as significantly higher first quarter G&A expenses related to how GAAP requires the bulk of our customary annual long term equity grants to be booked in the first quarter.

Quarterly lumpiness aside, we're more optimistic about 2014 than we were in February when we provided our initial 2014 outlook. During the quarter, we leased space of 1.4 million square feet of second generation space, of which, 1.2 million was office. A 20% of 2013's quarterly average. This leasing momentum has continued throughout April. In fact, with over 500,000 square feet of new second gen deals in April, we have re-let more office space this month than in any quarter since the first quarter of 2001. We have made substantial progress backfilling the larger vacancies in our same property portfolio. We have re-let 97% of 5405 Winward, 75% of the Life Point space that they vacated in January, and 52% of the Lake Point 1 and 2 space. Leasing activity also remains strong in the 13 office buildings encompassing 3.4 million square feet required last year. These buildings were on average 81.3% occupied at closing. At the end of the first quarter of 2014, occupancy was 86.3%, up 500 basis points. In addition, we expect these properties to be over 90% occupied by the end of this year. As a result of all this leasing activity, we have increased the mid point of our outlook for year end occupancy by 50 basis points to 91.9. On the investment activity front, it has been a quiet quarter.

Acquisition activity for high quality assets in our market has been slow thus far this year. Deal flow is starting to pick up, but competition is fierce, AKA, very expensive for the highest quality assets. Low cap rates are being supported by this limited supply of institutional product, continued low interest rates, readily available debt, and tremendous sideline cash waiting to be deployed. Given all of this, we continue our pursuit of our wish list and we are in conversations with a number of perspective sellers. We're maintaining our 2014 guidance of $100 million to $300 million for acquisitions. A positive aspect of this current environment is that investors who are flush with cash are increasingly investing in mid tier markets, and we have a well-defined pipeline of non-core assets in the market for sale. At this juncture, it appears likely we'll be at the high end of our $100 million to $175 million disposition range.

Our $227 million development pipeline includes 950,000 square feet that is 86.4% pre-leased. These five projects are on schedule for delivery by mid 2015. We are on pursuit of a range of additional development projects, all of which would be predominantly well pre-leased. Our 2014 development outlook of $75 million to $150 million remains unchanged, includes the $15 million headquarter building for biologics that we announced in January, and we hope to be close to the high end of this guidance range. Overall, the year has gotten off to a good start.

Leasing has been robust, interest in our non-core assets that we put to market has been strong. Our underway development pipeline continues on track. We are pursuing a number of well leased development opportunities. With the re-letting of a good portion of our same-store vacancies in the bag, our shareholders should see meaningful upside in Highwoods as we head into the next couple of years. I'll turn it over to Mike to cover operations.

Thank you, Ed. Good morning. As Ed noted, leasing activity in our markets continues to be strong. In the first quarter we signed 149 leases for 1.4 million square feet of second gen space. 1.2 million square feet was office, with an average term of 5.5 years. Occupancy in our wholly owned portfolio decreased 70 basis points in the 4th quarter, primarily driven by our expansion and relocation of Life Point hospital systems into a build to suit in Nashville. Cash rent growth continues it's positive trajectory. Of the 132 office leases signed this quarter, cash rent growth was -1.9%, compared to -5.6% and -5.4% in the 3rd and fourth quarters of 2013. Gap rent growth on office leases signed this quarter was positive 7.8%. CapEx related to office leasing was $19.70 per square foot in the first quarter.

It was skewed by one large deal, a 210,000 square foot renewal and long-term extension at our remaining Greenville property, which is now in the market for sale. While a meaningful amount of CapEx was invested to secure this renewal, we will more than recoup this investment in the sales proceeds. Excluding this lease, CapEx related to office leasing would have been $16.55 per square foot. Turning now to our markets. Atlanta's office market is strengthening with 1.7 million square feet of net absorption in the first quarter. Atlanta has over absorbed 5 million square feet over the past four quarters, and market vacancy has declined 11 quarters in a row. Our Atlanta team did an outstanding job backfilling 5405 Windward. We got back 223,000 square feet in October, and have already have released 97% of this space.

Activity continues to be strong at 1 Alliance Center, and we have improved occupancy over 1400 basis points in just a little over 9 months since acquisition. Nashville continues to be a strong market and was rated the south's red hot town in the March 7th issue of Time magazine. Unemployment of 5.6% is meaningfully better than the 6.7% national average, and year over job growth was a solid 2.7%, 130 basis points better than the national average. In Nashville, Life Point vacated 145,000 square feet to move into the new 203,000 square foot build to suit we recently delivered. As a result, occupancy in our national portfolio declined 470 basis points to 90.5%. The good news is, we have already back filled 75% of the space, and have strong prospects for most of the remainder. Year-over-year, Raleigh added over 18,000 office jobs, representing a robust 3.8% growth rate, almost 3 times the national average. Unemployment at the end of March was 5.1%, 24% better than the national average. Occupancy in our Raleigh portfolio increased 60 basis points quarter over quarter, and 180 basis points year-over-year.

We have $160 million of development underway in Raleigh, most of which delivers in the first half of 2015. The Tampa economy continues to improve. Unemployment at the end of March was 6.5%, 100 basis points better than March 2013, and year over year job growth was a solid 2.2%. We're pleased to announce that over the past few weeks, we have signed 3 leases with new customers totaling 60,000 square feet at Lake Point 1 and 2. We have now re-let 52% of the 319,000 square feet that was vacated last May, and we have prospects for the majority of the remaining space. Pittsburgh continues to be a solid performer for us.

During the quarter, we signed 118,000 square feet of re-let's, renewals and expansions at PPG Place. Market occupancy was 90.1%, demonstrating the strength of Pittsburgh's diverse economy. Our Pittsburgh portfolio was 93.3% occupied at quarter end. Overall, we were very pleased with the quarter. Our robust year-to-date leasing activity is a testament to the strength of our brand, and our people. Terry?

Thanks, Mike. Total FFO available for common shareholders this quarter was $61.2 million, up $3.4 million, or 5.8% from first quarter of 2013. This increase primarily reflects $8.0 million in higher NOI from acquisitions in recent developments placed in service, net of NOI from dispositions, including $1.1 million from fourth quarter dispositions, and $2.5 million in lower interest costs from lower average rates and slightly higher capitalized interest, partly offset by higher outstanding debt balances. These positive items were partly offset by $4.2 million in lower GAAP same property NOI, which I'll cover more in a minute, $1.7 million in lower FFO contribution from joint ventures, mostly due to our acquisition of seven assets from two of our joint ventures in third quarter 2013, and $600,000 in higher G&A.

As a reminder, FFO and G&A amounts in my comments exclude property acquisition and debt extinguishment costs which are disclosed in a table in our press release. There were no such costs in first quarter 2014, but $700,000 in first quarter of 2013. On a per share basis, FFO for the quarter was $0.66, $0.02 lower than first quarter 2013, as the increase in FFO dollars was offset by higher shares outstanding. Weighted average shares outstanding this quarter were $93.0 million, up $8.2 million or 9.6% from first quarter 2013, due to equity issuances during 2013. Average leverage, during the first quarter of this year at 41.6% was 2.1% lower than the 43.7% in the first quarter of last year. As noted in our FFO outlook, we expect full year 2014 weighted diluted shares outstanding to be $93.4 million.

First quarter FFO was $0.08 lower than the preceding fourth quarter of 2013. This was due mainly to $0.034 from our share of a JV merchant build in the fourth quarter, $0.012 lower NOI from fourth quarter dispositions, $0.027 cents lower same property GAAP NOI, and $0.017 higher G&A which consists of $0.035 cents attributable to the GAAP accounting for a retirement plan this quarter, offset by $0.018 cents in lower short term incentive comp and other cost savings in the first quarter. These reductions in FFO were partly offset by $0.012 cents in higher NOI from acquired properties and developments, and 6/10 of cent in lower interest. As I mentioned, same property GAAP NOI was $4.2 million lower versus first quarter 2013. $3.5 million of the change was due to the well discuss moved outs we had in May, October and January, including space Life Point vacated this quarter in Nashville when they moved into their new headquarters building we delivered for them. These move-outs reduced average occupancy in the same property pool by 3.0% this quarter, offset by 1.5% occupancy growth in the remainder of the same property pool.

We are pleased to have recently re-let significant portions of those vacated spaces as Ed and Mike have already discussed. These new customers will mostly take occupancy in the second half of 2014, and first quarter of 2015. Compared to first quarter last year, we had a $0.01 per share and higher snow and utility costs, net of recoveries caused by the harsher than normal winter. We also had $700,000 of higher bad debt expense on build and cumulative straight line rent receivables, over half of which is attributable to a single customer. We have a strong prospect for that customer and expect to release the space with little downtime. Excluding properties with the well discussed move outs, and excluding the unexpected winter impact, we had positive cash NOI growth of 3.5% in the rest of the same property pool. Given solid year-to-date leasing, we remain comfortable with the forecast for full year growth and same property cash NOI of .5% to 1.5%.

G&A this quarter was $600,000 higher than first quarter last year. As I mentioned on our February conference call, and as we note in the press release, first quarter G&A is typically impacted disproportionately by the GAAP requirement to expense long term equity incentive grants on the March 1 grant date for employees who have met eligibility requirements under our retirement plan. Full year 2014 long-term equity compensation expense will be approximately $6.7 million, slightly lower than full year 2013. Since $4.3 million of the $6.7 million was expense in the first quarter, the G&A run rate for the next three quarters will be significantly lower.

We remain comfortable with our G&A outlook of $34 million to $35.5 million for 2014. At the outlook mid point, full year G&A should be $600,000 lower year-over-year. Turning to the balance sheet, we expect average occupancy to hover around 42% throughout the year as we continue funding our net growth on a leverage neutral basis. On April 1, , we used our credit facility to pay off a $124 million secured loan. We have only $7 million of secured debt and no unsecured debt maturing in the remainder of 2014, and only $77 million of secured debt in 2015, and $161 million of secured debt maturing in 2016. We are also pleased to have received an upgrade this quarter from Fitch ratings from triple B flat and stable outlook.

All three agency's are at the same ratings level. As Ed mentioned, given our strong year-to-date leasing, we were please to raise the bottom end of our 2014 outlook by $0.04, and we now expect full year FFO of $2.86 to $2.94 per share, which at the mid point is a $0.02 increase from our original guidance. Our full year FFO outlook reflects actual first quarter results including the harsh winter impact, and the GAAP retirement plan effect. As a reminder, while we disclose our expected ranges for acquisitions, dispositions, and new development activity in 2014, we do not include any impact from such investment activity in the FFO outlook until such transactions close. This is consistent with our past practice. Operator, we're now ready for Q&A.

Thank you. (Operator Instructions). Our first question comes from the line of David Rodgers with Robert W. Baird & Company, Inc. Please, go ahead.

Yeah, I wanted to follow up on one of your early questions. The 2% Mendoza line for GDP, is that an indicator that you use internally to think about where business activity might be, and does that give you confidence to build the pipeline, et cetera, or am I reading too much into that?

Yeah, but it's a Mosaic. We also look at how housing is, interest rates, how showings are going, how we're able to negotiate transactions, the absorption, unemployment, and population growth. So it's an important part of the Mosaic, but not a single indicator.

Okay, and then switching maybe to your build to suit activities, it sounds like the development expects to be at the higher range for the year, if I heard that correctly. Talk about the build to suit development starts that you're seeing. Are these projects more like Life Point, where there's an in-market move and an upgrade, maybe like Met Life, where we're seeing more of an net new expansion to the market. And are you seeing more multi-market discussions/negotiations where corporate relocations are becoming a bigger part of those discussions?

I think it's slightly weighted more to consolidation and expansion of existing, with some Met Life type activity but not as much as consolidation and expansion within a market, or to an upgrade of quality of space and location.

Okay. Last question maybe for Mike. Do you want to talk more about Tampa? Sounds like good activity at Lake Point. One, can you give us the sense of the types of tenants taking space there, average size of activity? And then what the read through is for the T-Mobile space that's now vacant. I don't know if that was the Lakeside building, the old T-Mobile space.

Sure, of the activity that we have had, I would say financial services, legal, accounting have been part of the group that have looked at the back build so far, and are continuing. We have a little bit of healthcare as well, because of the proximity of Tampa Bay Park to the hospital, which is a pitching wedge away. So we're getting interest from that sector as well. As to the Lakeside building, as we mentioned on the last call, we're substantially into making improvements to that property. T-Mobile vacated at the end of the year, and we have been working hard to get that project back with some exterior and interior improvements, landscaping et cetera. That's not slowing us down with showing the space, Dan and Laurie are actively on this, and building up a prospect list for it.

All right, great, thank you.

And our next question comes from the line of Brendan Maiorana, with Wells Fargo. Please proceed.

Thanks. Mike, let me just stick with Tampa for a minute. You mentioned you have nice prospects for the balance of the space. Do you think that those are something that is likely to hit in the balance of this year, or is it something where these are deals that maybe take a little bit longer, and you may not get that space put to bed until maybe next year?

Well, Brendan, it seems that every deal takes longer than we would like. The 52% that we've backfilled now has been slower than we would prefer, but it's still the decision making process. These are fairly large. The larger the deal, the longer it's taking for the decisions and they're mostly regional or national. So you get decision that's working not only the local folks that are interested in the space, but there are higher ups in another the market that make the decision. Long story, I do think that we'll be able to hit some licks in the latter part of this year, but I also think that we could expect some of this to bleed over to 2015 to finish that out.

Yes, so if I look at your year end occupancy guidance, there's a spread of about 125 basis points, so it's not that wide. What are some of the things that would push you to the high end of that? Is it backfilling some of the space in Tampa? It seems that you made great progress elsewhere in the portfolio, so there aren't many large holes left to fill.

There is the Tampa space obviously. but we also have the backfill of the space going into Life Point to backfill the buildings that they vacated, as we announced with a customer that's moving out of one space, out of 58,000 square feet into the close to 90,000 feet over there. So, we'll have to backfill that, and given that it's in the Brentwood sub-market, which is very strong, we think there's a good possibility that we could get some traction on that space as well.

Brendan, just a footnote, I think as you look at our guidance, what enabled us to get comfortable in raising the guidance is predicated heavily on what is inked and in the bag. So, the occupancy number year end that you wisely brought up, obviously it's important that we hit that range, and we feel relatively comfortable that we will but it won't have as much meaningful an impact on FFO because it will be late in the season. So, I want to get you comfortable that the amount of spec leasing that we have in order to achieve these numbers is very consistent with our historic run rate.

Yeah, and I guess to follow up on that, or maybe add to that point, I can't remember if it was Ed or Mike that mentioned that a lot of the leasing that you've done is hitting late in the year, and then also in 2015. So, if we think about the guidance for the remainder of this year, just the straight math, it's almost $0.75 a quarter of FFO just average for the remaining three quarters, and I presume that's an upward sloping trajectory. And then if I heard the comments correctly about occupancy, in early 2015 that you've signed but hasn't commenced until early 2015, I gather there's a pretty good slope early in 2015 as well?

That's an accurate gather and I would footnote to that we have the development projects delivering in the first half of 2015 for added FFO.

Sure, great. And then this last question, just a housekeeping question. It looked like the lease term for HCA changed in the supplemental by only a few months, and I wasn't sure if that's something that's a quirk in the supplemental or did they do a short-term extension?

They did a short-term extension, Brendan. In several buildings with us, they announced that they are considering a build to suit alternative in the market. They haven't quite come out and said where it is, and when it is, but they came to us and asked for an extension on there. It was to accommodate this very large and good customer.

Okay, so to give them more time to figure out what they may do with their build to suit.

Yes.

Okay.

(Operator Instructions). Our next question comes from the line of Vance Edelson, with Morgan Stanley. Please go ahead.

Hi, this is actually Jill Slattery on for Vance. Can you comment on your appetite for asset recycling, and do you have any pipeline in terms of potential acquisition targets or existing buildings that you might consider shedding? Thanks.

We give guidance in both of those categories. This is just our methodology, that we tie our guidance to specific street addresses. We don't do it just based on where we feel the current market environment stands, so when we put together our guidance, we base it on specific street addresses, and what we think the pricing would be that we acquire these assets, or the odds of happening, and then from there to put out our guidance. The answer on the acquisitions is, last year, we did $540 million total acquisitions, this year our guidance is $100 million to $300 million. We have specific street addresses. Whether we'll be successful on those or not, time will tell, but it's specific. On the disposition side, our guidance for this year is $100 million to $175 million, and yes, we have specific street addresses for that as well. In fact, a goodly portion of that is in the market at the present time listed with investment brokers, and at different stages in the evaluation and marketing process.

Okay, thanks.

And our next question comes from the line of Michael Knott, with Green Street Advisors.

Jed Reagan here with Michael. You talked about the fierce competition for core assets in your markets, and I'm just wondering if you've seen any noticeable changes in CAP rates or asset values in your markets so far this year?

Hi, Jed. We have seen some movement for the highest quality assets that have come to market. So in short, I would say yes. If I had to scale it, I would say 50 to 75 bps worth.

On a cap basis?

Yes, Sir.

Okay, that's helpful. And then, are you seeing rent growth trends moving up in the markets? Or is the 2% to 5% range, is that still what you're betting on?

Yes, Sir. What we gave you in our last "at a glance" is I think what you're remembering. The 2%-5% year-over-year asking increases is pretty consistent.

And I guess a related question. Where do you think mark-to-market rents in your portfolio stands today?

We do such a miserable job of avoiding that question. We have never gone through our whole portfolio, and I think if we look at what's expiring between now and the end of next year, that we would expect to be flat to slightly up, maybe to slightly down. It just depends on what roles and the timing of re-let's and renewals. but we still have the annual kickers in all of our leases that get us better than 2% annually, and we have an amount of large exposures between now and the end of 2015. In fact, we have two leases just over $1 million in revenues for the remainder of this year, and I think it's two leases next year that are more than $2 million in annual revenues, and both of those have a decent probability of renewal.

Okay, and then just in terms of some of the recent leasing activity, the larger chunks you announced. I'm curious how the economics of those leases came in and your initial expectations that you talked about. For instance, a possible 10%-15% markup for Windward. We are wondering how those ended upcoming in.

On Windward, we came in actually better than 20% better with in place versus what had expired. So, we enjoyed better than 20% rent growth there. At the Life Point backfill that we have done thus far, about 3%-5%, and then on the Lake Point, as we forecast, high teens to low 20s rolled down on that.

Okay, that's helpful. And the last one, if I may. It looked like Country Club Plaza lost a bit of occupancy last quarter and I wonder if you could comment quickly on that change, and any softening at that asset, and if there are any metrics today.

Mike will give specifics, but globally we don't see a specific softening. Weather hit Retail, and Country Club Plaza while it's mixed use and office retail, obviously it had some impact on the retail side. But the three specific deals that most caused the roll down in occupancy, Mike you want to fill in here?

There were three transactions. One was move out of Pottery Barn, out of 10,000 square feet there, and thanks to the good folks of Kansas City, we were able to back fill that with another Williams and Sonoma concept. We'll have four and a half months of downtime on that. That's a quick backfill and a good save by the team out there. The other was Brooks Brothers, which opened a store in south Johnson County and we have good prospects for that. It was not a huge number. The biggest being Pottery Barn, so we're still bullish on the activity out there. We feel like we'll get the backfills soon.

As you know, we talked about the Hollister department store coming out. We're deep into the redesign of that building, and how we're going to re-tenant it. We think we'll have some really positive news on how that will go once we're able to reveal our plans, and how our prospecting is going, but we're expecting some significant rent growth in what we'll invest in the repositioning of the Hollister building, that we'll now call 211 Nichols.

Just so you know, that will happen in August. That's when they will basically come out and will start the development process, and the lease will start sooner, but it will likely be the second quarter of 2015 when we bring it back into service, hopefully with some really good customers in that project.

Thanks for the color, guys. Appreciate it.

And our next question comes from the line of Jamie Feldman, with BofA Merrill Lynch. Please go ahead.

Thank you, and good morning. I was hoping that you guys could talk about what the corporate relocation pipeline looks like right now, whether things have picked up or fallen off a little bit this quarter? And then, in terms of which markets and how that lines up with your land bank and maybe build to suit potential?

Sure, Jamie, I think its hard to measure that quarter by quarter. It doesn't move fast enough. From the time that a corporation starts to come up with the concept that their going to evaluate relocating, usually it starts out with multi-states and even more cities and even more developers, and lots of conversation with behind the scenes with economic development departments that are municipal employees, conversations with governors, et cetera, trying to get their arms around what incentives, in any, would be valuable for them if they're able to relocate. And at the same time, they typically deploy another team that goes in and understands the demographics of the market with regard to population growth.

How well educated is the employment base, and what are their areas of expertise, et cetera, and then they start to get a sense of what opportunities are available from developers. It's really not a process that I think anybody can say it really changed this quarter over last quarter, because it's such a protracted process that these entities go through. Given all of that, I can say the activity and the number of conversations remains encouraging. A conversation doesn't mean that a deal is going to be had. We have seen in the past where entities have undertaken very onerous exercises, going back to the governors that up the ante for their own governor to keep them in state. We would say that there are a number of these conversations ongoing, in a number of the markets that we're in, and it's encouraging that development has now become one of the things that is prominent in the reconsideration with corporate relocations as opposed to going into class A space that was not yet leased from having been delivered late in the cycle.

I think that we have an attractive pool of land that would support over $1 billion of new development. It's all entitled infrastructures in place. We have concept drawings for the major parcels of land that we have, so that our division heads and leasing personnel are well armed with what they can show in concepts of what we can do as we enter into conversations, whether it be through the municipality or the tenant-rent broker, who is representing the user. So, I would say all in all, the activity is good, but I would be cautious about trying to measure it quarter over quarter.

I would say, Jamie, the transactions that we're pursuing at this time, our existing land positions are in the mix with all of these, which is good, so our land inventory there is serving us well.

Okay, very helpful. And then can you talk a little bit about supply and where you think you might see supply pick up? I know we have been hearing more and more from brokers, and I think you talked about Buckhead getting started at alliance. What do you think across the markets and specifically Atlanta as the risk?

Well, we're obviously hearing those types of conversations. I think the most significant is in Cool Springs, where Franklin Park is underway, with about a 225,000 square foot building that we understand to be prominently speck. Then, if we move to Raleigh, there's a building downtown that is started this past month that with, what is it, Mike 200?

Franklin park is 250, and Charter Square is 225.

Charter Square is 225, that's Prudential's money, and they started last month. They're 40% pre-leased in the downtown market. And then in Buckhead, we have heard rumblings about 3 Alliance. What we have seen thus far in the Buckhead market has been more conversation, broker talk than any actual shovels in the ground. Pittsburgh is holding tight, Tampa's holding tight, Richmond's holding tight.

I think as you would expect, the three strong markets that we have talked about. Atlanta and Nashville and Raleigh, is where you see the activity. There's a building with some speck vacancy going in, called the Gulch Area in downtown Nashville, which is underway. It's to be expected in Raleigh, five that has speck component to it, and we just talked about Atlanta. Those are the only markets where you see any meaningful activity going on.

I would say that there's obviously more activity now than a year ago, but it's still very guarded. And the cost of construction, regardless of the volume activity, is still very expensive. So anybody who is going to go into first gen new space to be developed, needs to buckle up for a rate increase. It needs to be part of their business objective that they're willing to pay a higher level. That's, in part, what drives a lot of the new development to be pre-leased.

We have been saying for four quarters now, the disparity between the second gen that's offered out there versus the build to suit is wide. It's narrowing a little bit as we see market rents start to grow, but it's going to take the build to suit folks that come in that are primarily looking at either relocation or they're consolidating and shrinking their space needs to justify going into higher rate space, but that's what's really driving it right now.

The projects that you mentioned, do you think that those have any impact on market recovery at this point in terms of slowing rent growth or challenge against your existing portfolio, or we're not quite there yet?

I would say in general, no. There's not enough of it. And where it's happening, our markets or sub markets that are quite well healed.

Right, so the positive is if they're asking higher rents, that means your existing portfolio rents could be rising.

Should raise the tide, correct.

All right, thank you.

And our next question comes from the line of Michael Salinski, with the RBC Capital Markets. Please, go ahead.

Good afternoon, guys. Just the first question relates to funding. As we think about build to suit, is the plan to fund most of that with dispositions at this point or how should we think about financing that at this point?

We expect to be toward the high end of the disposition range, so that will be recycled back in to use for the development funding. We have increase shares outstanding in the guidance, 93.4 million that I mentioned in my call comments include shares issued during the year from the ATM, as well to keep our leverage neutral as we grow the Company. So, it's a mix of recycled capital, a little bit of ATM, and if necessary a little bit of other debt, just to keep things in balance.

In terms of timing on the dispositions, should we expect anything to close in the second quarter, or is most of that back half weighted?

I think there could be a couple in the second quarter, and the balance would come in the third and fourth.

Okay. You talked a little bit about supply in a couple of the markets, and also about build to suit and tenant demand. Can you talk about just the competition you're seeing from other developers looking to get into the market? Have you seen any compression, in build to suit required yields or new speck construction?

Well, as we just outlined with Jamie, we're seeing some in scattered places but we haven't seen an onslaught of new speck development. It continues to be very expensive to do. It's a risky business in today's environment, given the cost of it, and that job growth is still not unabated from what it typically would be in normal economic times. I also think that for new developers to come into the market, it's a bit difficult to compete against landlords that have brand recognition, a well-located land bank that's well entitled, and a balance sheet that can basically come to the table without having to bring a third party in the way of a banker.

Mike, I think time after time as we pursue these and compete for these, as Ed mentioned, our balance sheet is a strong selling point, as we basically pitch, this is a two party transaction between Highwoods and the customer without a lender in the middle of this. That resonates very well with those folks. So that has been good. In terms of compression, it depends on the credit of every deal. When you look at fortune 50 companies, clearly they're trying to bargain for the best deal they can using their credit to get the best deals they can. We prefer to do an open book transaction whenever possible, yield, and more times than not, we're negotiating yield more than anything else.

Just my final question. I realize that it's a small market in Orlando, but can you talk about what you're seeing in that market, with the leasing prospects in the back half of the year?

As you may know, in July, I believe it was, that we bought out our partnership's interest in five CBD buildings in Orlando. It was approximately 1.3 million square feet. When we bought them, they were 82% occupied. We have seen some good movement on the leasing. We think Orlando has been a market that has been a little bit slow in coming back and comparison to other markets in our overall footprint, but statistically, it's clear that downtown activity is picking up a bit. While Orlando has been a little bit late to the party, we have certainly seen demographics that are suggesting that the timing of our buyout of this 1.3 square feet should prove to be quite profitable.

We don't have many large box spaces there, so we're basically doing a little bit of backfilling with Cinderella slipper -sized spaces to go in there. Activity is definitely up, our landmark project as Ed mentioned, we're seeing pretty good deals over there. With the Cap Plaza 2 building, we have a little space to lease there, but activity there as well.

And our next question comes from the line of Emanuel Porchman with Citigroup. Please, go ahead.

Good morning, guys. Could you remind us if we look at your development pipeline, stuff that's not currently in progress, how much of that is going to be built to suit versus more speck?

We said in the comments, it would be predominantly pre-leased.

Looking at National, for a second. If we look at the current tenant that expanded and went into the former Life Point space, do you have any backfill prospects for their current or former space, however you want to look at that?

We have suspects/prospects, but we don't have any strong prospects at this point in time.

And they won't be vacating to come over until September. We're just getting into the marketing of this, but our leasing team down there is working pretty hard at it. We expect again, given where it is, strong sub market Brentwood and Maryland farms, we'll see good prospects soon.

Life Point was in two different location with us. So we have signed right out about 110,000 square feet of the 145. We do have strong prospects for another 28,000 square feet of that space, so just to expand on your question that we have got 28,000 square foot prospect for some of the additional space that they came out of in another building to total the 145.

Perfect. Thank you.

And we have a followup question from the line of Michael Knott, with Green Street Advisors. Please, go ahead.

Hey, guys, Jed Reagan here again. You talked about the 50-70 bps of cap rate compression year-to-date. It sounds like that would be for the best assets in the market. I wonder if you can bracket the CAP rate changes that maybe you're seeing for we'll call it the average asset in the marketplace, or your portfolio, or even a below-average type of asset, if you've seen any movement on those type of buildings?

Well, the below is just getting the benefit of there being so much cash, so maybe the overall quality of the deal is a little bit better. I would say it would be difficult to measure a movement in the CAP rate. I think there's a direct correlation between the quality of the asset and how the prices have moved. So basically you've nailed it with what you said. The class AA, the term that some people use, that's enjoyed the most move and on the lower, the non-cord and the non-different asset, it hasn't enjoyed any movement at all, other than the deal terms as a whole with regard to due diligence period, earnest money, quality of buyer, capital stack is somewhat improved given the volume of activity. It would be interesting to see if some of these class AA assets actually trade above or well above replacement costs.

Yeah, it will be interesting to see that as well. Thank you so much.

And we have a question from the line of John Guinee, with Stifel Nicolaus. Please go ahead.

You guys are doing great on the top line. FFO is looking stellar, congratulations, but the Achilles heel on the whole office world is CapEX. So painful questions. First, I was looking at the retail statistics, and over the last five quarters, tenant improvement dollars are $40 a square, and what exactly are you providing for $40 a square foot to the tenants in Kansas City. And the second question, the base building, your non-incremental revenue generating CapEX et cetera, is $21 million a quarter run rate, but that excludes properties under redevelopment and a few other things. What's that $21 million number if you include properties under redevelopment and capital spent prior to 12 months from the date of sale, et cetera?

I'll handle the Kansas City retail question, John. Our retail is principally at 20 Country Club Plaza, which is 90 plus years old, you have a number of these tenant rollovers, and you have antiquated systems, electrical, et cetera. What we call TI for these, or oftentimes white box costs that are bringing it up to a level where the customer can then come in and spend their money. So there's some of that, white box on the TI, as a reminder, these customers are putting substantial dollars of their own on this on top of ours. And we're getting long-term leases, triple net leases with great cam recovery, and they're all very well justified.

I'm going to page two on the $21 million run rate on base building, second generation TIs, et cetera. If you included everything that you exclude in footnote 3, what kind of number is that $21 million?

I don't have that off the top of my head, John, but it's probably another at least $10 million or so, just given the first gens spending, and the white box, the redevelopment projects like we did at Lake Point on an annual basis, so it's higher than 22 obviously, I don't have that handy. I can get it for you and maybe give you a call offline.

Perfect. Thank you very much.

Sure.

Mr. Fritsch, I'm showing no further questions. I'll turn the call back to you.

Okay, thank you, ma'am. As always, we appreciate everybody's time and interest on the call and please don't hesitate to call us with any additional inquiries. Thank you so much.

Ladies and gentlemen, that concludes the conference call for today. We thank you for your participation, and ask that you please disconnect your line. Have a great day.