摩根士丹利 (MS) 2003 Q3 法說會逐字稿

Good morning.

I will be your conference facilitator today.

At this time I would like to welcome everyone to the Crescent Real Estate Third Quarter Earnings Conference Call with our host, Ms. Kiera Moody.

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After the speakers' remarks there will be a question-and-answer period.

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I would now like to turn the call over to Ms. Kiera Moody, Vice President of Investor Relations for Crescent Real Estate.

Thank you.

You may begin your conference.

Good morning everyone and thank you for joining us on the call today.

In the room I have our Vice Chairman and Chief Executive Officer John Goff, President and Chief Operating Officer Denny Alberts, Executive Vice President, Capital Markets Jane Mody, and Executive Vice President and Chief Financial Officer, Jerry Crenshaw.

Everyone at this time should have a copy of our earnings release, supplemental report and presentation for the call.

And if not, those can be found at www.crescent.com on the Investor Relations home page.

I also need to remind you that certain statements we will make in today's call are considered forward-looking statements within the meaning of the Federal Securities Laws.

Although we believe that they are based upon reasonable assumptions, our future operations and actual performance may differ materially from those indicated in any forward-looking statements.

You will find additional information that could cause actual results to differ materially from these statements in the press release issued this morning and within our SEC reports.

With that I will turn the call over to John Goff.

Welcome everyone and thank you for joining our call.

As always, we have a slide presentation available on the website, and if you're following that, we're going to begin on Slide 4.

FFO for the third quarter came in at 37 cents, which exceeded our guidance of 30 to 32 cents, principally due to 3 cents per share in lease termination fees above what we had expected.

Along with 2 cents per share gain from a Greenway land sale.

Included in the third quarter guidance also was an 8 cent per share gain from a Houston land sale that we had talked about in the second quarter call.

Strategic highlights for the quarter include we acquired One Briar Lake Plaza, with one of our strategic partners, J.P.

Morgan, Fleming Asset Management, in a joint venture arrangement.

This is a new building located in the West Chase sub-market of Houston near the energy corridor.

It's one of the highest quality buildings we now own in Houston.

It's slightly over 500,000 square feet, about 90% leased.

We acquired it at $150 per square foot against a replacement cost of about $180 per foot.

We will own 30% of the asset with the J.P.

Morgan partner owning 70%.

We will be able to generate management and leasing fees as well as an opportunity for promoted interest down the road.

Our going in unlevered return is over 9.5%.

We also purchased the Colonnade and the Coral Gable sub-market of Miami at the end of August.

We most likely will joint venture this asset at some future date.

This is one of the most prominent corporate addresses in Miami.

It's 216,000 square feet, 92% leased, and our going in unlevered return is roughly 9%.

The cold storage business, turning to that we announced on September 30th that Crescent and Vernado are both considering a financing at this business that would allow us to materially reduce our investment in the Americold assets.

We expect this financing to exceed $200 million which 40% would come to Crescent, or 80 million or more in proceeds.

Timing could be by year end although we have not announced anything more specific.

Proceeds would be used to invest in our core business of office, preferably in a JV structure where we earn mid to high teen returns.

Very acceptable return on equity.

This opportunity is available not because of improvements in the financing markets but more importantly fundamental improvements in the Americold business, which I attribute 100% to Alec Kovington.

He is a terrific manager, he's done a great job of cutting costs, enhancing the management team, focusing on the customer and negotiating long-term contracts with our existing as well as new customer base, as well as growing the more profitable logistic segment of the business, distribution, transportation, and production.

Alec spoke at the Vernado Investor Conference in New York on September 30th and I think did a very good job of summarizing the progress he's made in that business.

If you look at the results of his leadership there, net income before rent has grown over 7% for the last nine months.

And it's up over 15% for Quarter 3.

FFO is up over 12% for the nine months ending September 30th.

Slide 5.

We are reaffirming our 2003 earnings guidance of $1.55 to $1.80 in FFO.

I realize that's a wide range but understand the fourth quarter is typically a very big quarter for this company, primarily due to residential land sales and in this fourth quarter as well as other land sales, and it's the fourth quarter like every fourth quarter in our business, very dependent on our ability to execute these land sales.

So to be more conservative I would tend to focus on the lower end of that range.

Looking forward to 2004 we will provide guidance for '04 in our year-end fourth quarter call, which is what we typically do.

We're currently in the middle of our budgeting process.

Clearly there are many signs of a national economic turnaround, but it is still not translating into meaningful job growth, not only in our markets but even the nation as a whole.

If you look at historical data, economic recoveries typically precede job growth, and job growth is then followed by office occupancy gains which is then followed by recovery in rental rates.

Consequently we still don't see occupancy gains until the latter part of '04 in any material way.

With rental rates recovering thereafter.

We are seeing anecdotal signs of the office market bottoming, these signs include leasing velocity, which is still pretty darn healthy when you look at it on an absolute basis.

We have leased through the third quarter of this year roughly 4 million square feet of space which is very significant when you compare that to the fact that we're managing close to 30 million feet.

Many customers are coming to us wanting to renew early and renew for longer durations, so they're seeing that -- I think they're sensing that we're at the bottom.

I'm also comforted by the extremely low levels of new construction going into this recovery period.

Additionally I'm comforted by the past track record of our markets leading the nation in job growth during recovery periods.

If you look out over the last ten years, for example, the nation grew jobs by 16.3%.

That's from 1994 through 2003.

If you look at our four major markets during that same time period, we grew jobs during that same period at 26.6%.

A substantial margin over the national average.

And I don't see any reason why that won't take place over the next ten years.

I think our markets are poised to substantially be better than the nation in terms of job growth, which means higher occupancy gains.

The logical question is, well, are these market going to grow supply greater than the nation?

Again, I would have you look back over the last 10 years, and the data simply doesn't support that.

I think the markets are much more demanding now in terms of return, they're much more capital-constrained, and because of that our markets actually grew in terms of capacity right alongside that of the nation, and it varied market by market, but on average about a 20% increase versus about an 18% increase in the national average over that ten-year period.

Slide 6.

Over the last several quarters and outlined in detail at our annual shareholders meeting for 2002 we set our three key objectives for our business.

One to increase or return on equity, two to grow FFO, and three to strengthen the balance sheet.

When I look at this, it's really a very simple business.

If we only increased our return on equity and did so without the expense of the balance sheet, that would do everything.

Obviously if you increase return on equity you're going to grow FFO.

So the name of the game here in our focus as a management team is to increase return on equity and to do so without sacrificing the balance sheet.

Slide 7.

To accomplish these objectives our strategic plan is focused two key initiatives.

One, to recycle capital through asset sales and joint ventures and to our core office segment.

We've sold slightly over 1.3 billion of assets since 1999 and have joint ventured now close to a billion dollars in asset.

Secondly, the leverage our office platform to become more of an investment management business rather than a straight owner of 100% of assets.

And this is all focused on return on equity in the joint venture format.

Our return on equity is three to five hundred basis points higher and that's before calculating any value a promote to the extent we negotiate a promote.

Going forward you should look for us to strategically exit non-core investments.

The financing of Americold is a good example of that where we're reducing our investment in a non-core asset.

We will continue to joint venture existing office assets, increasing our return on equity and hopefully we'll do that at a more scaled pace.

And third, selectively redeploy capital in our core office business, primarily with joint venture partners.

Additionally, if the balance sheet permits, and our stock is at a material discount to our net asset value we will also look to acquire our own stock.

Denny?

Well, thank you, John.

Good morning everyone.

John asked me to take just a few minutes this morning to update you on our third quarter business operations.

If you will turn to Slide 8, we will begin with the office segment.

As most of you know, our office segment represents approximately 70% of our FFO, and in the third quarter we reported office FFO of 73.9 million, which was slightly ahead of our plan, and as John said it was because of primarily lease termination fees in that particular group.

As of September 30th, our portfolio was 86.2% leased and 84.4% occupied.

This was exactly what we had expected.

It's down somewhat from the second quarter, and the decline was anticipated because of, one, substantial move-out that we experienced in the third quarter, and that was in Dallas.

The Perot Systems for 240,000 feet vacated a building on LBJ.

As I said on our last call we think we ever now bouncing along the bottom in our office occupancy, but also as John said, we expect to stay at these levels for the next several quarters until we see some real job growth.

The strength in our company and in our portfolio is Houston, and our soft spot is clearly Dallas.

Denver, for the third quarter, was actually up 90 basis points, from a leasing standpoint, and Austin was also up 90 -- or 70 basis points in the third quarter.

I'll talk more specifically about these markets in just a moment.

As you can also see on Slide 8, our third quarter same-store NOI growth was down, like most other office REIT's this, was primarily driven by year other year occupancy decline and that resulted in most of that negative number.

Turn to Slide 9.

The third quarter we leased 1.7 million square feet, which I think was pretty good year to date we have leased 4 million square feet.

This compares to 5 million square feet for all of last year, so the activity has been good.

Our challenge is backfilling space as it rolls.

For the remainder of 2003 we have approximately 1.3 million square feet expiring, and of that roll-over, 76% has been addressed, 52% has been signed, 24% is in final negotiations.

And most of the remaining space that make up the difference is month to month leases which we do expect to roll.

So I think as we see the remainder of '03 from a leasing standpoint, it's pretty well taken care of.

Turn to Slide 10.

Take a quick look at lease economics, talk about our lease rate, mark to market for the portfolio.

We have approximately 4.7 million square feet of leases that have been signed that will commence in 2003.

These leases have an average full service rate as you see on this slide of 21 dollars.

For the remainder of the year the 1.3 million square feet that I talked about, the full-service rate for those leases is only $19.58, so you can see that that is a pretty good number and a lower number than what we see in the overall portfolio.

The weighted average of our in-place rents for the whole portfolio is $22.82.

The weighted average is our quoted rates, and we've just reviewed all those quoted rates, is now $21.96.

So our quoted rates are approximately 4% below the in-place rents, and I think this is pretty consistent with most other office REIT's that I've looked at.

Turn to Slide 11.

I wanted to take a minute to comment on tenant improvement and leasing commissions.

They've continued to be at a high level, but if you look at the chart on Slide 11 you will see that over the past four quarters they've been relatively flat, so we are starting to see, I think, concessions stabilize in our overall markets.

Turn to Slide 12.

We continue as a company to focus on customer service and customer retention.

The past two years we've received the Boma-CEL-A.-award rating, ranking us one of the top five office companies in America for customer service.

This year the survey has just been completed and as you can see from the results in the right-hand column, they were better than last year.

We saw significant improvement in a number of the categories, and I am very proud of our people and the hard work that they've done to service our customers.

I'm particularly proud of our customer retention score this year.

The last item on the page, 91% of our customers stated that they plan to renew their lease and obviously customer retention is the focal point in the office industry.

Turn to Slide 13.

Let's look at our primary markets.

Look at Houston.

In Houston our portfolio was 90.5% leased.

Leasing has increased in our Houston portfolio each of the past three-quarters.

We're seeing a lot of velocity now that we didn't see a year ago.

Things have really started picking up, and it clearly is our market leader.

Our roll-over in Houston is in very good shape at 90%, and the level of addressed activity for next year is quite strong also.

At Houston Center we announced this quarter signing approximately 300,000 square feet of new leases which will bring Houston Center up to the mid- '90s from a leasing standpoint.

At Post Oak Plaza we announced the signing of a major lease there which took us up into the low 90's at Post Oak.

At Greenway Plaza we have signed a series of leases in the third quarter that pushed us also into the low 90's with that asset.

So we feel good with what we're seeing in Houston and it is shaping up nicely for us.

Slide 14.

Our soft spot is Dallas.

Dallas continues to be very competitive.

As of September 30th, our portfolio was 81.8% leased.

This is down from 84.8% on June 30th.

The decline, as I said earlier, was anticipated, and it was an early termination by the Perot Systems Group for 240,000 feet.

That caused the bulk of the decline.

Dallas remains capital constrained.

We see very little construction going on in the markets at 233,000 feet but we are going to have to see positive job growth and an improvement in the economy before we think we'll see any significant lift in occupancies in Dallas.

Turn to Slide 15.

We had a good quarter with our business class hotels.

As you can see, our occupancy was a healthy 73%, our ADR was up, our rev par was up, so we were pleased with the business-class hotels.

Look at Slide 16.

Our destination resort business had a very good third quarter also.

Our occupancy was at 76% compared to 74% last year.

Our same-store NOI was up also.

We had a particularly good third quarter at the Hyatt Beaver Creek.

Let's turn to Slide 17.

Our residential business was on plan and exactly where we expect it to be in the third quarter.

Let's look at Harry Frampton's business, Crescent Resort Development.

Harry put 99 lots on the market in the third quarter at Taho.

This is our first experience selling lots there.

We had an average price on these lots of over $300,000.

We sold 89 of the 99 lots in the third quarter, and they are all scheduled to close in the fourth quarter.

So we expect to have a good fourth quarter in Harry's business at Taho.

Also we have a number of condos that we are expecting to close in the fourth quarter in Denver, so I think Harry's business will look pretty good in the fourth quarter.

Turn to Slide 18.

The Woodlands in the third quarter was on plan at 256 lots.

We expected lot sales to come in at that level.

We expect lot sales to come in on plan in the fourth quarter.

We have a number of commercial land sales that are scheduled in the fourth quarter.

It's harder to predict, as John said, the commercial closings.

If they close in the fourth quarter, we end up at a higher level than we do if they close in the first quarter, but overall the Woodlands, in our estimation, is performing well.

Desert Mountain has struggled the first two quarters, we add pretty good third quarter.

We sold ten lots.

Usually that is our toughest quarter, obviously because of the summer heat.

Last year we sold six lots.

We sold ten in the third quarter.

The fourth quarter we will be opening our sixth and final golf course at Desert Mountain, a beautiful Jack Nicholas course with a small clubhouse and restaurant attached to it this.

This is creating a lot of excitement, some additional traffic, so we'll see how that goes.

It's nice to have that activity in the fourth quarter, but as all of you know, Desert Mountain really is a December business, and a lot of the activity is from Christmastime to the end of the year, so we'll to have wait and see exactly the volume of lots we get closed there in the fourth quarter.

John?

At this point we'll open it up for questions.

Thank you, Mr. Goff.

I would like to remind everyone in order to ask a question please press star, then the number 1 on your telephone keypad at this time.

If your question has already been asked and answered, you may withdraw your question by pressing star then the number 2 on your telephone keypad.

If you are on a speakerphone please pick up your handset before presenting your question.

Please hold for your first question.

Your first question comes from Greg Whyte with Morgan Stanley.

Good morning, guys.

Just a couple of specific questions.

Can you tell us what the outlook is at Sonoma right now and what sort of quarter you had?

Actually, Sonoma had a good quarter, Greg.

The occupancy was at 73% out there, which is up significantly.

And, you know, we had a rough first quarter, a rough second quarter.

I think Fairmont is turning the quarter out there, so we add very good third quarter.

The bookings in the fourth quarter look pretty good, too.

Denny you made some comments on Desert Mountain and the actual lot sales were sort of higher than last year and probably in line with your expectations but the unit price looks as though it's a little lower, and given the fact that you have sort of the better quality lots left, I was surprised that that wasn't a little higher.

Can you comment on that?

It's not discounting, Greg.

It happens to be a couple of older lots that we took back in the trade so it happened to be the mix more than discounting.

We have kept our pricing pretty consistent out there over the last 18 months.

We feel like we've got the best lots left, so we're being a little bit patient here, waiting for the economy to come back.

We think we've got a valuable asset there, and just don't feel comfortable discounting.

So it was really a mix issue.

Okay.

John, you sole some land agreement at the Plaza this last quarter, I was wondering, is there more to sell there, is that something you're going to focus on over the next few quarters?

Yeah, we have a great land inventory, not only in Houston but some of the other markets so we're always looking to dispose of that when it makes sense, and, you know, the timing, I can't speak to right now, but it's something we're constantly looking at, because obviously that's non-income producing asset.

And then G&A was a little higher than I had budgeted for.

Is there something specific in that?

Really, Greg, it's Jerry, it's Sarbach's, it's professional fees on internal and external audit, and some additional staffing, but predominantly professional fees.

We're seeing audit up 25% year-over-year so it's all adding up.

Okay.

That's it for now.

Thanks.

Greg, on the land, we've sold all the land at Greenway Plaza.

To answer one of your questions.

Thanks.

Your next question comes from Gary Boston with Smith Barney.

Good morning.

I'm here with John Lit.

Question on Austin and Denver, Denny.

You sort of highlighted Houston and Dallas and I know you don't have a lot in Austin, but maybe just some stats on what's going on there.

The markets are still real tough there, and, you know, I'm not predicting any kind of turnaround in Austin or Denver, but we have generated a little activity there, Gary, and, you know, as I said, our occupancies -- I mean, our leasing actually went up.

Occupancies are still flat in both of those markets.

Second quarter over third quarter.

But obviously leasing is good, and we expect the occupancy numbers to come up.

Both areas had a good volume of activity.

If you look at, particularly the Denver, just overall class-A market, it actually had a positive an absorption in the third quarter.

The overall market did, which is the first time that's happened in a long time.

If you look at the overall market in Austin, it was relatively flat, relatively flat.

So, you know, not -- the major declines that we've seen in both of those markets appear to have slowed.

And in effect reversed itself in Denver.

Great.

In terms of the assets that you've contributed to the joint venture, the potential to do that for, on the Coral Gables asset, you maybe just talk a little bit about what you're seeing on the acquisitions front in terms of putting those proceeds back out to work also?

Obviously the Americold financing would fund some of that as well.

Well, we're like everybody else.

We've got to be very selective in the acquisition side because it seems like it's probably a better seller's market than it is a buyer's market.

I think everybody knows that.

What we've been able to do is kind of find some nuggets in our individual markets.

For example, particularly in Houston, there's just not a lot of capital chasing product in Houston, and, you know, we believe in Houston long term, and we've had very good experience there, so we've tried to go from a rifle-shot standpoint and pick up some assets in our core markets, and we've done that also in Denver, so that's been our strategy.

We're not go to go up head to head against somebody that's going to pay us fixed cap in Boston.

We're just not going to do that.

I think that's been our strategy and will continue to be our strategy.

We have been looking in southern California.

We think that's a logical extension for us and we've talked about that in the past.

But have not bought anything out there.

But again, it's more of a rifle shot approach.

For those two transactions we have probably passed on a hundred.

I mean, that may be an exaggeration, but I'm looking at Ken, and he's saying 50.

So it's a big number.

Thank you.

Your next question comes from Chris Haley with Wachovia.

Good afternoon or good morning.

I'd like to hear your perspective on if you were to rank your markets, forgetting weighted, just looking at your market, where would you expect to see over the ensuing 12 to 24 months the earliest recovery and latest recovery in the difference between cash available or cash flow from your properties in those markets versus reported FFO?

If I broke down my portfolio by market, which one do I expect to see a tighter spread between cash flow and recognized GAAP FFO?

Well, we're going to answer that question in two ways.

Sure.

The first way to answer it is where do we see the most strength, and if we were to rank strength, I would rank Houston 1, I would rank Denver 2, Austin 3, and Dallas 4.

Just to rank them.

Now, the opportunities in those markets are going to be dependent upon our rolls.

So in other words, you may have recovery in a market, you don't after lot of rolls to take advantage of the recovery, but you also may have rolls in a market that doesn't have a lot of recovery, in which case we're hamstrung.

I'm talking about the big four market, Miami, San Diego, Albuquerque, and Phoenix.

Denny, if you want to cover in terms of rolls, where we think we might see the most up-side.

Well, the --.

In our numbers.

In our numbers?

We think that, on a --.

On a cash flow leasing commission adjusted basis.

Exactly, we think that what we're signing in Houston is obviously much better.

We're making much more economic deals, better economic deals, because the TI and leasing commissions are not as high as some of the other markets, and just the activity that we're seeing there.

So we think that market will lead the way for us, and that's why we've butt a couple of buildings recently down there.

Dallas, we're just not seeing any pricing power right now.

So that's why John ranked that one last.

The TI's have been high here, the rents have been, gosh, really brutal.

But what typically happens here in this market, and, you know, I've lived here 30 years and watched it, when it comes and when it recovers, it really spikes.

Hard to know when that happens, hard to know when that occurs, but given the roll-over that we've had in the portfolio and actually it's coming counsel from where it was in the past.

We used to run 14, 15%.

If you look out into the future in our schedules, it's, you know, 11%, 10%, so it's declining a little bit.

But the spike will come in Dallas, but really don't expect that to occur in '04.

That's got to be later.

It's just later in the cycle.

But we could say, I think, occupancy gains, in terms of sheer cash flow gains, the bulk of that is going to come out of Dallas.

When it turns.

Over the next 12 to 18 months.

Interesting to hear you rank Denver ahead of Austin.

Denver gets cast with a broad-brush, as does every market, and it's important to distinguish the various parts of Denver.

If you think about the Boulder corridor, it's a disaster.

We own nothing in that corridor, never have.

If you look at downtown Denver, it's reasonably healthy, and we're seeing a fair amount of activity.

Business there is pretty vibrant, and I see growth in that market.

We like that market.

We'd love to own more in that market.

I look at the pipeline of transactions our leasing team is working on, and the list is longer, much longer, in Denver than it is in Dallas, and that's why we say that also.

On the Cherry Creek sub-market as well as the Tech Center, both of those markets are respectable, and they're coming back, but again far different than when you look at [Portoweatan] our other broad-brush information, where they conclusions on markets, the red flags, green flags, to me that's all meaningless data.

In Austin what are spot rents gross and net effective, downtown, class-A space that you're seeing today?

Well, they were low 30's gross, and now they're low 20's gross.

Backing out expenses?

$9 expenses.

$9 expense.

And what would be a TI package on an under 5-year-old building?

TI and leasing commissions were under 20, now it's over 20. 25.

For a five-year deal?

Yeah.

Okay.

Lastly, you guys were in attendance, obviously for Vernado's gathering in New York.

You obviously mentioned this in your remarks.

Want to know if you could expand upon the reason for the financing at temperature controled, what this money is going to be used for, why now, just trying to get your perspective there.

Well, we have stated as one of our strategic objectives to reduce our investment in non-core assets.

This falls into the category of non-core.

We want to do that on an intelligent basis.

Two years ago, 18 months ago, even a year ago, many analysts and other doubters of that business were simply saying, why don't you just sell it, get what you can, and move on.

And I made a prediction, kind of went out on a limb, and I said, I suspect we're going to see more growth in the cash flows of that business than anything else we own over the next 12 months, and lo and behold that's been the case, and that has nothing to do with me being a smart prognosticator, it has everything to do with Alec Kovington busting his ass and turning that business around.

Because it has been turned around we have opportunities available to us to do things that we didn't have before, and this financing is a very good case.

It's a way of taking capital out of the business, it's validating the value of what we owned, and we can redeploy that capital at higher returns elsewhere.

Is this all new debt or refi?

New debt.

New debt.

And --.

And, by the way, I will point out we have had several option to pick from.

Not like we had one institution come to us and say here's one thing we can do.

It's a high-wire act.

It's not that at all.

It's actually very traditional financing that can come in several different forms.

And these lenders are financing the business at what kind of loan to value and coverage issues?

Chris this, is Jerry.

I think we can speak to the loan to value.

It's 65%.

Of coverage is normal coverage on secured debt.

Okay.

Thank you very much.

That's it for now.

You bet.

Your next question comes from John Stewart with Merrill Lynch.

Good morning.

Quick question on the early termination from Perot Systems.

Did you guys collect a lease termination fee?

We did collect a lease termination fee but it was in the fourth quarter of last year.

So that was not part of the unexpected 3 cents in this quarter?

No.

Denny, you had mentioned that the percent of the 2004 roll-over in Houston was quite strong.

Could you quantify that for us?

I think about 45%, so I'll leave it at that.

We've got a couple other very significantly -- or very important leases that are big that are in final stages, and, you know, that will push that number way up, but actually signed in Houston for next year is 45%.

Okay.

And then finally if you could give us a bit of detail on the impairment charge and the rational for excluding that from the reported FFO, especially in a quarter when you had a couple of one-time items going the other way.

John, this is Jerry.

Right now we're seeing inconsistency from NA-REIT on how impairments versus gains or losses are reported or tracked.

We've actually shown in our supplemental both ways, before and after, impairment charges, you know, we had gains that, I think on 2003 year to date we have impairments of approximately $20 million, we've had gains of approximately $5.5 million, last year we had gains of approximately $25 million, and impairments of approximately $2 million.

So from our standpoint, there's inconsistency from NA-REIT, and we need further clarification, because it's somewhat ludicrous to add back gains or losses and deduct impairments.

What specifically was the impairment in the third quarter related to?

We have four charter facilities that remain, the impairment related to two of them, approximately $2 million.

Thanks a lot.

Out of -- be out of all of those here shortly

Your next question comes from Dan Oppenheim with Banc of America Securities.

Thanks.

Was wondering if you can just talk about what you're doing in the office side.

You reinvest capital there into the joint ventures, how you'll be structuring that, how much of the current portfolio you think you could joint venture over time and will all the future acquisitions be joint venture.

This is John.

We have said that the -- let me back up for a second.

The reason for the joint venturing is because the office investment business has changed dramatically as a result of the recapitalization of the entire industry.

The opportunities to buy assets at 40, 50, 60 cents on the dollar that we built this company on back in the '90s is essential gone.

That's not to say you don't find anomalies out there but for the most part that opportunity is gone.

So now it's a business -- where you have to be smarter on the acquisition side, and you have to find, in our opinion, to be competitive you have to find a cheap source of capital, cheaper source of capital than what we have.

And what enables us to get back to those same economics that we achieved in the '90s is to match our capital, say 20 to 40% with that of either a pension fund or foreign investor, someone with a cheaper source of capital who's looking for steady cash flow and a quality management team to look after the asset, who's vested in that asset alongside of them, and that is a great business.

What it does is it kicks our return on equity because of the fee stream, it kicks our return on equity up anywhere between three and five hundred basis points depending on the asset and way we negotiate the fees.

And on top of that we typically can get some form of promoted interest above a hurdle, an internal rate of return hurdle.

So to answer your question, would we joint venture -- how much of our balance sheet would we joint venture, theoretically we could joint venture everything.

What you will find us needing to do is to continue to free up assets out of the current financing structure to enable to us do that.

That's one reason we've kind of had a lull in the joint venture activity here recently, and, you know, I think going forward you will see us really focusing more and more on joint venturing what we already own.

Then the question is, that frees up capital, what do you do with that capital?

And what we would look to do is acquire additional assets on a joint venture basis.

We're not finding any trouble identifying joint venture partners.

We have some very good partners who are already dealing with, they would like to do more with us, so we're constantly looking at asset alongside of them, doing due diligence together on things, trying to find additional things to buy.

So it's a key part of the strategy going forward, and if you go back to the annual meeting, we talked about the investment management business in a way I would say this is sort of the investment management business in real estate.

The other interesting thing is, that strategy requires no additional capital on our part.

In other words, we have plenty of equity.

If anything, we may have too much equity, you know, because it doesn't take that much to deploy in that strategy, so, you know, over time it would be nice to be able to shrink the capital base of the company as well.

Whether we'll have that opportunity, don't know.

But that's something we would look to do.

Okay.

Thanks.

One -- wanted to ask also about acquisitions.

You had said in answering this question you talked about how the price anomalies are gone.

Are you seeing any big difference in the market for the fully leased properties versus somewhere there's much more risk, and given your cautious comment about recovering conditions until late '04 does that mean we shouldn't expect to you take up any risk with leased properties?

No, we are willing to take leasing risk depending on the market and depending on our knowledge of the asset, particularly if it's one of our home courts, you know, we actually like to find assets that have leasing risk where we feel very confident that we can fill the building.

So we're not scared of that, not bashful about taking that on.

You know, I think the -- in terms of going forward, we are also looking at new markets, and I would say with new markets we're going to try to find a larger platform, and we're probably going to be less willing to take a lot of leasing risk as we build that platform.

And when we're looking at, you know, taking on the leasing risk we're obviously underwriting it conservatively and it's a function of the price of the asset that we can get, so if we're going to take on leasing risk we're going to get a good price.

I will also -- the question brings up another issue that we wrestle with here as a management team, and that is where you have existing assets on our books that have leasing risks going forward or not that occupied right now, we look at what could we sell that asset in the marketplace today, how would someone else price that risk, and what we're finding in certain cases is other owners may price that risk at a discount to what we would, and consequently, it causes us to think about selling that asset as opposed to leasing it ourselves.

So it's an interesting market that we're in, and it offers several alternatives with assets that are under-performing.

Okay.

Thanks.

And I'll turn it over to Lee Schalop now.

Thanks.

Two questions.

John, in the past you've talked about focusing on a narrower group of businesses when the time was right.

I was just curious if you see the time becoming right for a more narrow focus going forward.

Absolutely.

I think everything we've been saying is we're narrowing the focus.

You haven't seen us buy anything but office assets, and we've only been divesting -- we've been divesting across the board, we haven't been bashful about selling office assets where we see the value topping out but for the most part we've been sellers of non-core assets.

Are there any business lines that --

I would encourage you to go back to the annual shareholders meeting -- is that still available on the website?

Yes.

I think it goes through a lot of detail on that strategy and that's something we've been pounding the table on now for two years, and I don't think anything we've done has been inconsistent with that.

Any businesses that you're currently invested in that you could foresee divesting of completely, let's say in the next 12 months?

I would divest of any non-core business at the appropriate valuation over the next 12 months.

The question is whether that opportunity presents itself.

As we have seen in the cold storage there were people telling us we ought to take $100 million for our position and be done with it.

That was not the smart thing to do.

We're going to own still 100% of what we owned before and take close to 100 million out in a financing 12 months after we got all this wonderful advice.

So we are going to be smart about disposing of assets, we're not -- this is our money at risk, right alongside the rest of the shareholders, so we're going to be intelligent.

I'm not about the predict whether you'll see any sale in the next 12 months.

It's something we look at constantly.

Could you also share your thoughts on the dividend today given where the FFO is and then the AFFO logically below that being less than the current dividend?

What's your thought about its sustainability?

Let me go through the specifics.

If you go back to our last call, we had revised guidance at $1.55 to $1.80.

Let's take the low end to be ultra conservative here.

That $1.55 per share equates to 181 million in FFO.

We stated at that level we have recurring Capex of 75 million, so that leaves 106 million.

We have consistently talked about the residential cash flow that's in excess of FFO.

This is return of capital coming out of that business, which has been substantial, will continue to be substantial.

It's three, four, five hundred million dollars over the next five years.

It's $75 million roughly this year.

So you add that 75 on to the 106, you'd at 181 million against a dividend of 175.

We feel comfortable with the dividend.

Okay, thanks.

Thank you.

Your next question comes from Fred Taylor with Fleet Securities.

All my questions have been answered.

Thank you.

Your next question comes from Todd Voigt with Cliffwood Partners.

Good morning or good afternoon.

Question for you on your land sales business, residential development business.

Looks like margins fell this quarter, and I was just wondering what that can be attributed to.

Todd this, is Jerry.

Really it's a factor of activity.

Activity is down in the third quarter, so margins are pretty much tracking back against it.

Desert Mountain with the price points of approximately $400,000, your margins are lower at that point.

It's a factor of covering your overhead.

Okay.

Now, if we just strip that overhead and just looked at kind of profit on land, your cost of goods for the land and the price you sold it at, what do those margins look like compared to last year?

Margins are actually tracking against last year, the last several years.

The margins in Harry Frampton's business is in the 12 to 14% range, margins at Desert Mountain are in the 40 to 45% range, and margins at the Woodlands are in the 50 to 55% range.

And that compares to last year?

Yes.

And obviously higher?

If you look at it over the last two or three years, on average it's tracking.

Okay.

And then with activity being slower this quarter, I was wondering why capitalized interest rose at a fast pace for that business.

Well, it's clearly a -- on tracking capitalized interest, according to GAAP you start capitalizing really effectively when the project has commenced, so it's just a factor of number of projects that are underway.

Okay.

Makes sense.

Last question was just really on your joint venture and really in the office portion of that, the 40.5 million revenue, I was wondering if you could break out any -- just break out that number between actual rent and any other type of numbers that might be in there.

Right now I don't have that information.

If you want to call us back we could walk you through that.

Okay.

Are there any lease term fees in there, anything like that?

No.

Great.

Thank you.

Your next question comes from Mike Marron with Bear Stearns.

Good afternoon.

Could you repeat the components of the $106 million number that you mentioned previously?

Yeah, Mike.

If you start with guidance at $1.55 per share that's $181 million of FFO.

Okay.

Then I took out of that $75 million as an estimate of recurring Capex to get to 106.

Finally, do you know what, for your '03 dividend, what component would be ordinary income and what would be capital gain?

Yeah, Mike, this is Jerry.

We don't have that allocation right now.

It really will be a factor of the activity in the fourth quarter.

Do you remember what '02 was, Jerry?

'02, 75% return on capital.

Thank you.

Your next question comes from David Loeb with Friedman, Billings.

Hi, John.

Follow up on the question about the dividend.

I saw the $75 million from the residential cash flow above FFO in the slides.

Given that there's a range around the guidance, does that 75 million -- will you be able to achieve that 75 million even at the low end of guidance?

In other words, if the residential land sales are a little softer or more of the commercial lots go into first quarter would that 75 be less than 75?

75 is the low end of what we'll think we'll get out.

It actually could go to 100.

What do you think that number will be next year?

It will go up significantly from the 75.

Over the next three years we think it's in excess of $400 million.

Great.

Thanks.

Your next question comes from Jay Habermann with CSFB.

Just a question on your expectation for distressed selling, given that fundamentals could likely remain flat next year and could you see a sharp rise in rates.

You're talking about on our part?

No, just in the market, looking for distressed sellers, investment opportunities.

I don't see that dramatic rise in rates.

I guess in a way I kind of hope that there is, because that means the economy is really booming, and occupancy is up.

All the fundamentals are going to be better.

But I don't see that happening.

If it does, I think there could be pockets of opportunity.

There are markets, not so much the markets that we operate in, but other markets where in this last cycle you had buyers put traditional financing in place, and then on top of that doing, you know, [mez] financing, so they did somewhat of a high-wire act.

There's not a lot of that but there's an element of that, and it's out there, and could it produce opportunity, but I wouldn't want to overstate that opportunity, either.

You expect it to be modest?

Yeah.

Thank you.

Your final question comes from Anthony Herofina with [Muzenitn] and Company.

Wondering if you could talk a little about your liquidity picture.

I notice that you had quite a lot more outstanding on your credit facility and whether that's going to be going higher or lower and just what -- how you will be addressing your liquidity needs and the expiration of that facility.

Yeah.

This is Jane Mody.

Just briefly, obviously, there remains capacity under the existing credit facility that you're referring to.

Part of what you see, what you saw occur in the third quarter was we took on the additional debt associated with the acquisition of the Colonnade, as well as the $60 million increase in borrowings under our line.

We do have an expectation of additional cash coming in the fourth quarter, obviously from these residential sales.

As well as a number of other strategic initiatives that generate liquidity.

And as far as the credit facility, I know there's a one-year extension, is that right?

Right.

When is the expiration?

May of '04 and it does carry with it a one-year extension option.

Thanks.

At this time there are no further questions.

Mr. Goff, are there any closing remarks?

Well, thank you everyone for joining the call.

We appreciate you listening in, and as always we're available to answer any questions that you may have afterwards.

Please call us direct.

Thank you.

Thank you for participating in today's teleconference.

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