NNN REIT Inc (NNN) 2003 Q2 法說會逐字稿

Good morning. Welcome, ladies and gentlemen, to the Commercial Net Lease Realty's second quarter earnings release conference call. At this time, I would like to inform you that this conference is being recorded and all participates are in a listen-only mode. At the request of the company, we will open the conference for questions and answers after the presentation.

I will now turn the conference over to Gary Ralston, President. Please go ahead, sir.

Thank you. I would like to welcome you to the Commercial Net Lease Realty second quarter earnings conference call. Joining me this morning is Kevin Habicht, our Chief Financial Officer.

Before we begin I would like to convey the regrets of Jim Seneff, our Chairman and CEO. Due to the death of a close business friend, Jim is not able to be with us this morning.

We are going to begin with Kevin providing an overview of second quarter financial operations. I will add some comments and color on our portfolio. We will talk a bit about our diversification strategy, and the recently announced acquisition of two Class-A office buildings in Washington D.C.

Kevin, would you like to begin with the financial update?

Sure. Thanks, Gary.

Let me start you off with the usual obligatory remarks. We will make certain statements in this call that may be considered forward-looking statements under federal securities laws. The company's actual future results may differ significantly from the matters discussed in any forward-looking statements, and we may not release revisions of the forward-looking statements to reflect changes after the statements were made. Factors and risks that could cause actual results to differ materially from expectations are disclosed from time to time in greater detail in the company's filings with the SEC and in this morning's press release.

Good morning. As indicated in the press release, FFO was $14,491,000, or 36 per share, for the second quarter of 2003. That compares with 36 cents for the same period last year and compares with 35 cents for the immediately preceding first quarter of 2003. These results were in line with projections and consensus estimates.

Looking at some of the individual income statement line items, total revenues for the second quarter were $24.1 million, which represented a $1.7 million increase from a year ago. Less so if you exclude the impact of the FAS 144 discontinued operations, the increase was about $300,000. The increase is a result of increased occupancy, offset somewhat by some dispositions of properties over the past year, as well as some lease terminations.

At the end of the second quarter 96.9% of the company's properties were leased. That compares with 95.8 at the first quarter and 94.6 at the beginning of '03.

Interest and other income consisted, primarily, of $131,000 of property and asset management fees and $2,054,000 of interest and other income, mostly from our unconsolidated sub. The interest and other income amounts represent $167,000 increase from the second quarter of last year.

G&A expenses $2,641,000. An $87,000 increase from the same quarter last year and $41,000 over the first quarter of '03. Line items largely in line with our projections and not a lot to comment on there.

Interest expense increased slightly from a year ago and prior quarter amounts to $6.8 million. An increase from prior year amounts, largely a result of us terming out $71 million of debt late in the second quarter of '02, and that was somewhat offset by lower interest rates on the bank line. The increase from the prior quarter amounts was due to somewhat modestly higher debt balances in the second quarter versus first.

Turning to the line item for income from our unconsolidated entities, that was $1,191,000 for the second quarter of '03. That compares to $1,137,000 for the same period a year ago. Fairly flat there, but up from $764,000 in the first quarter of 2003.

In our Build to Suit 1031 exchange we sold eight properties during the quarter in our taxable subs. As we mentioned, there will continue to be some choppiness in this number from quarter to quarter but the market remains good for this activity.

Additionally, an item of note here, as we've mentioned before, we do anticipate that we'll begin to consolidate our taxable lease sub commercial net lease services on our financial statements in the third quarter. We do not think this will have any impact on our bottom line or balance sheet, to speak of, except more detail rather than fewer line items consolidated into one.

Lastly, in regard to the income statement, I'll note that we've also again included in our press release a disclosure to allow you to adjust for the various income statement line items so you can see what the P&L would look like if FAS 144 had not been applied. As you know, FAS 144 requires treating a sold property as a discontinued operation.

With regard to guidance for 2003, we're not changing our guidance for the year from the 144-146 range at the moment. Although, based on some potential timing issues with the sales of properties in our unconsolidated sub, coupled with some timing friction, if you will, in connection with last week's equity offering and related acquisition announcement, second half results may be slightly more skewed than we originally thought toward fourth quarter versus third quarter. Previously, we had estimated second half results in the range of 36 to 37 cents per quarter, and now we're estimating a wider range of 35 to 38 cents, depending on the times of selected dispositions and acquisitions. As always, these projections are based on a number of factors and uncertainties as discussed in our public filings.

Moving to the balance sheet, there is very little change from the prior quarter. Total debt outstanding as of June 30 was $448 million, up a little bit from the end of the first quarter. Of this amount, $54 million was mortgage debt, meaning about 11% of our company's total assets are encumbered by mortgages, and 89% unencumbered. Debt to total assets on a gross book basis were 42.8% debt leverage.

On the interest coverage front, interest coverage for the second quarter of '03 was 3.34 times. That compares to 3.40 for the immediately proceeding first quarter, and fixed charge coverage was 2.7 for the second quarter of 2003.

That's all I've got for now on the basic numbers. I'll turn it back over to Gary and we'll circle back in a moment here.

Thank you, Kevin.

Just to update you on our portfolio, we feel obligated to say, periodically, that we are pleased to be one of only 228 public companies that have paid increased dividends to shareholders for 13 consecutive years.

Our investment strategy is designed to create an attractive risk adjusted return for our shareholders. Central to that strategy is our commitment to real estate value. Disciplined diversification geographically, by line of trade, and by individual tenant, enhances the stability of our operating income.

Our portfolio is made up of single tenant properties in good locations that are net leased over a long-term to credit-worthy tenants. We currently own 350 properties located in 39 states, lease to 127 tenants in 45 different industry classifications.

Long-term net leases are a key component to the safety of our dividend, and a common thread to each of our investments. Net Lease structure reduces real estate operating risk because tenants are responsible for paying property taxes, insurance, and operating expenses. Further, we believe that leases in excess of a decade in duration bridge real estate and economic cycles. The weighted average remaining lease term of our portfolio is 12 years.

Our geographic diversification as of June 30 is as follows: In the southeast, 96 properties representing 27% of our annual base rent. In the south, 88 properties representing 20.5%. In the northeast, 47 properties representing 19.5%. In the midwest, 55 properties representing 13.5%. In the west, 36 properties representing 13%. In the Rocky Mountain region, 27 properties representing 6.5%.

We're currently diversified amongst 127 tenants. We have only one tenant representing more than 10% concentration in the portfolio, that's Eckerd Drugstores at approximately 12.7%.

Eckerd Corporation is a subsidiary of J.C. Penney. They are headquartered in Clearwater, Florida and they are one of America's largest retail drug chains with approximately 2700 drugstores in 20 states. Their recently reported first quarter sales were approximately 3.8 billion, and their reported operating profit was $118 million.

We have three tenants with more than a 5% concentration. Best Buy, the nation's leading consumer electronics retailer. For their first quarter, sales from continuing operations rose 2.2% to approximately $4.7 billion. Earnings from continuing operations were $69 million. They stated they expect 2004 revenue growth of 11-13%, and June S&P revised its outlook from negative to stable for the company, recognizing their improved financial standing.

Office Max is a Cleveland-based office products super store selling products to nearly 1,000 super stores, also via direct mail catalog and the internet. It had sales of $4.8 billion in 2002.

Barnes & Noble is the world's largest bookseller. They reported com store sales gain of 10.5% in June. Book stores continue to be the strongest performing sector of their business.

We're diversified across 45 lines of trade or industrial classifications at present. The largest concentration is pharmacies and drugstores representing 13.7%. Super markets and grocery stores represent 9.9%, full service restaurants 9.4%, book stores 9.4%, radio, television, and other consumer electronic stores 9.2%, sporting goods stores 8.9%, office supply and stationary stores 7.4%, limited service restaurants, 6.3%, and furniture stores 5.2%.

We have five lines of trade between 1 and 2%. That's home furnishing stores, jewelry stores, home centers, hobby, toy, and game stores, video tape and disc rental stores, and general merchandise stores. All the other lines of trade categories represent concentrations of less than 1% each.

In the second quarter we sold two properties, both of which were part of our portfolio strengthening strategy. One was a vacant property that was formerly leased to Golden Corral Restaurant and another restaurant currently operating as a Dennys. Both actions were taken to reduce our line of trade tenant concentration.

During the second quarter we acquired seven properties. That included a Value City general merchandise store in Missouri, Winn Dixie grocery super market in the Atlanta metro. Two of those. Amoco ground leases located in Miami, A Home Depot ground lease in the Miami market, and a Walgreens ground lease in the Miami market.

Releasing is a critical part of our business. We consistently demonstrated our ability to lease space in the past, and we remain ever vigilant. As Kevin reported, we are pleased that in the second quarter we were able to lease another approximately 80,000 square feet, bringing our total occupancy to 96.9%.

As you'll recall, one of our top priorities from last year was to lease vacant space and return the portfolio to an occupancy level in the range of the mid 90s, 95%, if you will. We believe that maintaining this occupancy level demonstrates the attractiveness of our property locations and the effectiveness of our leasing team.

Kevin, would you like to make a few comments on our unconsolidated affiliates?

As I mentioned earlier, the results for the quarter came in at $1,191,000 in the subsidiary. As you recall, that activity involves our Build to Suit development activity, as well as some of our 1031 exchange acquisition and flip businesses. The profits from that entity are derived from the gain on sales properties.

In the Build to Suit side we completed three projects during the quarter. We started five, leaving two completed at the end of the quarter not sold, one Eckerd, one Macaroni Grill. And we currently have seven projects under construction that are leased to Walgreens, Best Buy, Eckerd, Cash and Carry, and Lazy Boy. So the portfolio, I think, on that end is coming along well, and the market has been very good for dispositions of those properties.

I think we wanted to jump into talking more broadly and strategically about our recent activities in terms of Capital Markets and the PSA office buildings in Pentagon City that we have under contract. And before we get into that, I wanted to say that this is something that's been under consideration for some time internally and we made the decision to move forward in 2003 into broadening out beyond retail in the net lease sector.

Earlier this year we brought our bank group in the rating agencies up to speed and we were in the early stages of beginning to communicate this strategy to the public equity market when the Pentagon City transaction opportunity quickly arose. We acknowledge we are a little behind on our communications plan regarding office to the portfolio so we wanted to take -- we apologize for that, but it's the way the transaction fell and got a little bit ahead of our communication plan, but we wanted to take time now to more fully talk about that.

Gary, why don't you go ahead.

Thank you, Kevin.

We believe that retail properties represent slightly less than 1/3 of the over 2 trillion universe of properties available for single tenant corporate net lease investment. The balance of this investable universe, obviously, is office and industrial properties. A disciplined application of the principles of diversification would hold that our portfolio of single tenant net lease properties should be distributed between these property types.

As part of our long-term business plan we've adopted a corporate strategy of concentric diversification. Diversification into nonretail assets which otherwise shares certain characteristics with our retail properties.

For example, single tenant net lease, common asset capitalization strategies, and acquisition marketing and operating methodologies. In addition, a generally uniform underwriting criteria and methodology can be applied to the evaluation of the market, the property site, the tenant, and the lease, regardless of the property type.

Finally, our diversification across property types provides an enhanced opportunity to achieve our other goals of diversification by individual tenant, line of trade industrial classification, and geographic location.

Further, we feel that the ownership of office and industrial properties provides a hedge against any potential long-term negative retail trends.

Lastly, the addition of office and industrial single tenant net lease properties to our portfolio will provide enhanced property acquisition opportunities. We'll be in a position to pursue a larger pool of potential property acquisitions, including portfolio and consolidation opportunities, and we will be able to avail ourselves of the opportunity to participate in the positive impacts of property sector rotation.

We work to backfill experience and talent to handle and address the office and industrial properties and any unique idiosyncrasies. For example, approximately a year ago we were successful in recruiting a new vice president of property management. A certified property manager with 15 years experience in office and industrial properties that serves to compliment a number of key executives that have participated in a broad spectrum of property types during their career.

Finally, we believe diversification into single tenant net leased to office and industrial properties is the next logical step in our pursuit of a safe and growing dividend.

Let me share with you some of the details of our recent acquisition. As you may have noted from the press release last week, we agreed to purchase two Class-A office buildings, rentable square footage of 540,000, net usable of 491,000 square feet, and a two story garage containing 1,079 parking spaces that is leased to the United States of America. The buildings are located in the Pentagon City submarket of the Washington, D.C. metropolitan area, and serve as the headquarters of the Transportation Security Administration under a lease that expires in 2014.

The purchase price for the buildings was $142.8 million. In addition, we've committed to fund $28.9 million for building and tenant improvements. That brings the presumed total investment, if you will, in the building, to approximately $171 million, and we believe upon stabilization, that represents approximately 8%, slightly north of an 8%, capitalization rate.

Kevin, would you like to bring people up to speed on the recent capital events in the company?

In connection with the accusation, we obviously, as you're aware, that an overnight equity offering raising net proceeds of about $96 million, which would, essentially, go toward purchasing of this property. We're working on the debt component related to that. We do, I will point out clearly, that we anticipate this to be a leverage-neutral event, both in terms of debt to asset, as well as coverages.

We close tomorrow morning on the equity side of it, and we're pleased with the demand on that offering. It went well. It appears we are in good shape there. We feel like we have a good handle on the financing of this acquisition.

I might add, since we spoke of diversification and the positive implications, under the presumption of adding the Transportation Security Administration headquarters building to our rent role looking forward, at that point in time, a pro forma percent of current annual base rent means that our largest tenant would be the United States of America, representing 16.8%, and we would have one other tenant north of 10% concentration. That would be Eckerd drugstores at 10.5%, and two tenants that would be north of 5%, Best Buy at 5.4 and Office Max at 5%.

We believe this does demonstrate a continued step in the appropriate direction of diversification to support our safe and growing dividend.

With that ,we'd like to open it up to questions, and we'd be pleased to address those as the operator provides instructions for proceeding.

Thank you. The question and answer session will begin at this time. If you are using a speaker phone, please pick up the handset before pressing any numbers. Should you have a question, please press star 1 on your push button telephone. If you wish to withdraw your question, please press star 2. Your questions will be taken in the order they are received. Please stand by for the first question.

Our first question comes from Eric Rothman from Wachovia Securities. Please state your question.

How large of a portion do you plan to make office and industrial?

Our plans, Eric, have been to work on a three to five-year strategy. We would see a balanced portfolio having 50 to 60% retail, 25 to 40% office, and 10 to 20% industrial. We will address opportunities as they manifest themselves to allow us to reach that level, primarily through acquisition activities.

But you expect that to get there in 3 to 5 years?

That is correct. We expect to be more fully diversified, if you will, over a 3 to 5 year period. That's been our strategic plan.

And what about the targeted asset size? Are they 3 to $5 million buildings, 10 to $20 million buildings?

I'm sorry, Eric. I didn't hear the question.

I apologize. What's the targeted asset size for the office and industrial buildings?

Typically, we would see office and industrial buildings smaller than the subject property. I would add, this particular property represents a couple of unique opportunities. It is two buildings, not one, and it does include 1,079 square foot parking garage. And we take some added comfort in single asset concentration, in that we are totally comfortable with the credit worthiness of the tenant on a firm lease.

It's our feeling that the office assets would typically be in the 50 to 250,000 rentable square foot range, and of course, the price investment would vary based upon certain locational attributes, if you will.

Industrial we see somewhere in the 100 to 400,000 square foot range. Again, the price would range based on certain locational characteristics attributable to the land buys.

And then the rental rates the government is paying?

The government lease provides for approximately $17.2 million in annual rent for the buildings, and $1.2 million in annual rent for the parking structure.

Thank you very much. And then just in terms of financing the property, what are your plans there?

On the debt side we are looking at all things. This, obviously, is very attractive in the mortgage markets, and so we're looking at that to the extent, so we may very well go that direction. To the extent we do, we're also looking at an interest-only secured debt option as it relates to that.

But the rates are very attractive for relatively, you know, moderate amounts of leverage on this quality of property and tenent , so we believe we're not going to have any problems getting attractive financing on this.

How high of a launch value will interest let you go on this?

I don't know how high they'll let us go. How high we are targeting to go is in the 55 to 60% range on this particular asset. However, I do want to underline that to the extent we put additional debt, meaning above average for us, on this particular asset we're not changing the leverage profile of the company as a whole, the portfolio. We very much want to make that clear.

Would you pay down long-term fixed rate that, or would you pay off your line?

Well, we've got some outstandings on our line, and obviously, we've got some bonds maturing next year, as well. Initially, it would go to pay down our bank line.

We do believe that this asset provides another spectrum of opportunity for deploying capital to the company in a favorable way.

Great. That's all I've got at the moment.

Thanks, Eric.

Our next question comes from David Fick of Legg Mason. Please state your question.

Good morning. I just want to step back a minute, Gary, to the strategic question and make sure everybody understands. Even though these buildings are single tenant buildings, they are not triple net lease, per se, they are full serve. But they have a lot of triple net characteristics as a result of who the tenant is.

Going forward, you are still a triple net company, you are not buying multi-tenanted office buildings. You will still be looking at very long-term lease terms and very high credit, is that correct?

That is correct, David. There are some idiosyncrasies of operational components to this building. We think of it as providing expensed ops that provide enough protection for us that it is somewhat parallel to a net lease.

But one negotiates at a little bit of a disadvantage with the United States government and their lease form. We feel that whatever additional operational risks related to the real estate we might be assuming here, we are more than compensated for by the elimination of any credit risk associated with the tenant. But we do consider it to be a special circumstance just leasing to the United States of America.

David, to be clear, yeah, we will continue to focus on triple net lease and have no intentions of changing our NNN ticker symbol.

Okay. Thank you, and congratulations.

Thanks, David.

Thank you, sir.

Our next question comes from Hall Jones from KBW Capital Management. Please state your question.

Well, she almost got the company right. It's AEW, but that's fine.

We know, we love you.

I know. I just want to see if I've got this right and then I've got a strategy question of my own. In the D.C. property, is that including your committed funds on build out and TIs, it's a 10.5% cap rate on this property?

No, that is not correct. The cap rate on the property, Hall, would be slightly north of 8%.

Okay. So there are some expenses to go along with the $18.4 million of revenue?

Right. That's NOI versus the investment. There are expense stops.

About 4 million, plus or minus.

That's correct.

Okay. Who were some of the competitors in the bankruptcy court bidding on this asset, either by type of investor, or if you are familiar with who the specifics are?

I mean, what I could add is, that there were three other contenders for the property. There was one other, a foreign investor and a private investor, and that's really all we're at liberty to disclose, because of confidentiality agreements as part of the process.

That's fine. Are there any synergies or is there anything to be gained from the private side of CNL by diversifying into the office and industrial? Because I noticed there's CNL hospitality, there's CNL retirement communities.

CNL hospitality owns some properties in Crystal City. It means that when our property management people go to inspect, presumably, they'll get a more favorable rate for spending the night, or something.

There were no planned synergies. I will share with you that Jim and a number of other people that are in Jim's other companies who are shareholders in Commercial Net Lease Realty, and they look very favorably on our dividend and whatever we do to increase the safety of that dividend.

On the private side, CNL doesn't own any other office properties or anything like that? Other than the headquarters building?

Just the headquarters building. There have been some multi-tenant activities in the past and joint-ventures with other companies that Jim has participated in.

If I can put my cynical hat on here, over the last several years, you guys have tried different strategies, whether it's buying vacancies, developments, and there's been no earnings growth. Kevin, you and I talked about this fairly recently. What can you tell me to give me comfort this isn't going to be sort of the next strategy that doesn't end up going anywhere or being beneficial for shareholders?

Let me add, if I may, Hall, that we think that not all FFO earnings or cash flow is the same. Your point is well taken that over the last several years we have not had significant growth in earnings from our M&A activities or from some of the other initiatives the company has worked on.

If you look closely at our balance sheet, you'll find that we reduced our leverage during that period of time significantly, and we think that improves the quality of our income stream and should be taken into consideration when you look at earnings growth. We think safety is first and growth is second. The market, in many respects has recognized that by awarding us with an FFO multiple, that probably has just been improving.

Kevin, you may want to address that further.

Again, I think the key is just quality of earnings and so we do think less leveraged, we had the advisor, we had to get rolled in, and had some impact. And so we felt like we had a couple kind of head winds.

At the moment we don't see any issues, it's just pure capital raising and acquisition opportunities in front of us. We think will enhance the bottom line results. We hear you. We understand.

I wouldn't be doing my job if I didn't add on from time to time. Does this also speak to where you think pricing is in retail right now? Is that part of the reason, also reason to diversify [INAUDIBLE] opportunities in acquiring, retail just isn't there, either because of the backup in interest rates or because of competition from 1031 exchange and other people?

No, Hall. Our decision to do this has been something that the board and the management team has really been working on for several years. It is our belief that the safest, and therefore the lowest, cost of capital for an enterprise such as ours comes from taking full advantage of the opportunities of diversification.

So we do believe that over time a better diversified single tenant net lease operator, that would include the basic core property types of retail, office, and industrial, would enjoy a lower capital cost than perhaps a mono line.

Okay. That's all my questions. Thanks.

We do have a follow-up coming from Eric Rothman. Please state your question.

Are you fully staffed up to pursue this new strategy or are you going to have to add to head count?

We believe that we're comfortable addressing the situation, Eric. We have a lot more depth than maybe people would appreciate without visiting us in the office industrial space and sector. We have a number of people that have built and developed large office buildings prior to joining the company, and people who have done substantial office leasing in their life before joining Commercial Net Lease Realty.

In all modesty, dealing with government leases is a bit of a special item. We intend to work very closely with the largest team of experts in the Washington, D.C. area in ensuring that we operate this asset very efficiently.

We have in our budget, the allocation, in the property operating budget we have the allocation to ensure we've got adequate expertise in the form of outside experts to help guide us with the property.

Great.

I might add, the team that we're working with has done over 1500 government transactions comprising almost 30 million square feet. So we feel very comfortable. They helped us with the due diligence analysis of the building and understanding of what we can do for refinements of the current arrangement and to maximize our returns, so we expect to learn more here.

You said you've been looking at this strategy for a while. How many other office or industrial properties did you look at that you passed on, or was this the first you were able to --?

We have underwritten and been unsuccessful, either due to acquisition price or failing to meet certain due diligence tests for the company. Probably 20 office industrial assets so far. And those are things that the company seriously pursued, the acquisition team has probably looked at 150 assets.

I guess, just last question here, you clearly don't expect any accretion from the deal this year, given your guidance. Any thoughts for next year, is this going to be accretive to '04?

We're looking at this asset being able to contribute 1 to 2 pennies of accretion. Frankly, Eric, we did this to improve the safety of the dividend and to provide us additional financial flexibility. We think that's where it begins.

I know people are focused on growth, so are we. But safety is our number one watch word, and we felt this is an asset that has unique locational characteristics. One we are proud to own. We think we'll have long-term value to our shareholders, and one that just provides virtually no credit downsize risk associated with it.

We are comfortable with it being just very slightly accretive and yet increasing the quality of the income the company generates to fund our dividends.

Great. Thank you, guys.

Our next question comes from Ross Nussbaum from Smith Barney. Please state your question.

Hey guys, good morning.

Good morning, Ross.

A couple questions. First, the cap rate that you cited just above 8%, was that cash or GAAP?

That's cash. It's based on NOI.

And what are the rent bumps that are built into the lease?

The base lease from the government is flat for ten years, as it presently stands. There are CPI increases in the component of rent attributable to the parking garage, which is $1,230,000 a year bumped by CPI.

Appreciate that we are working on some enhancements, we think, of this revenue stream. Any time you have the United States government negotiating with a company that is in bankruptcy, and we're acquiring this out of a bankruptcy operation, there are typically some opportunities to do some fine-tuning or adjustments. Effectively, it will have very nominal rental growth over the next ten years.

Okay. Second question is regarding the decision to go ahead and do the equity offering last week. Given where cap rates are on your retail assets, was there any thought given to selling some of those assets to fund this acquisition? It's in my mind it would have been a more accretive transaction.

I hear you. I guess, we do sell properties from time to time, obviously in the normal course of our business, particularly as it relates to the sub, as well as to some degree, in the core portfolio.

Our goal, really, wasn't to only sell properties to make this acquisition. We felt like the costs of capital at the moment were reasonable to go out and obtain new capital wealth, maintaining our retail portfolio that we have. As Gary mentioned, our goal is really, we don't view this as getting out of the retail business, by any means. We view this as an add-on diversification rather than replacing anything.

We do believe, Ross, this is part of a strategy to grow the company. We think a larger, more diversified portfolio is more beneficial to the shareholders, and will result in lower debt cost over time which creates its own component of accretion.

Thank you.

Our next question comes from Stephanie Krewson from BB&T Capital Markets. Please state you question.

Hey guys. Good afternoon.

Hey, Stephanie.

I guess technically it's still morning, long day.

I have a couple of questions, and I really applaud your efforts to diversify. I think that's great and I'm a big supporter of your overall strategy and your existing assets. That being said, I'd like to drill down a little more on these asset buildings, on these office buildings. Because at $317.50 a square foot, they look a little pricey. Help me get more comfort with what you payed for them.

Can you tell us how much of the purchase price should be allocated to the parking structure, for example?

We look at something in the vicinity of $15 million allocated to the parking facility as a replacement component.

Frankly, if you look at this location, Stephanie, and comparables, which we did for our analytics, we found a range of prices per square foot for such buildings, you know, Class-A buildings in the D.C. market that were at the the 50 yard line, which these are, ranging from north of $250 a square foot to $350 a square foot. We look at appraised value as being an indication of maybe third party confirmation of where we are.

I will say this, that the third party lenders type appraisal on the building places a value that is north of our total investment in the building. And appreciate that spending $30 million to make this, essentially, a like-new building where we are replacing mechanical components and there's some unusual pieces related to that, we think also means we're going to have some reduced costs and increased value to the building. The dollars we're spending are value added.

You answered my follow-up question, which was what sort of building and tenant improvements were you putting in it, and it sounds like it's all going into the actual building and not the parking structure.

To that end, the previous, or maybe I should say the previous tenant of the building, had spent substantial dollars in the '96- '97 period, bringing all but about seven floors of the building up to really Class-A status. So a component of the expenditure we are doing is to take those seven floors to that same state, which, as I said, to us makes it for all practical purposes the equivalent of a like-new building.

Does the building have any special features that make it an irreplaceable asset for the government such as any sort of linkages to any major government agencies, cable-wise, or any sort of special security measures that make this irreplaceable for them? Where I'm going with this, what happens at the end of ten years?

I'll give you two things. Part of the government -- part of the build out is to convert one floor of the building to a high security clearance item and I won't specify which one, it's called a SCIF, super secure area for high level security clearance access. And it means that the walls, ceilings, windows, and floors have special treatment so that no sound comes in or out, and during the TI process, it is actually swept by one of the agencies that has a degree of specialization in electronic eavesdropping.

Having said that, which is just interesting color for the building, based on some research we've done in the marketplace, I mentioned the federal services leasing team of the Spalding and Fly (ph) group who has, over the last decade done 1500 government leases. They represented the federal government as a tenant rep on a number of things, as well as owners, 30 million square feet. Based on their database, lease blocks of space in access of 100,000 to 150,000 square feet, the government renewals are typically in the low to mid-80s just for that contiguous block of space.

It was difficult to find a situation where one could attach renewal rates to a single tenant headquarters stand-alone building. The feeling is that one could expect a renewal rate in the low to mid-90s for such a structure. We feel comfortable that as long as we do a good job as a land servant that it's highly likely we would expect the existing tenant to remain long-term in the future.

Having said that, this is a highly desirable office location. It has visibility of the Pentagon, it's contiguous to a regional mall, and high end residential. It is slightly more centrally located for access than the Crystal City market which has performed extremely well across a range of mixed uses.

We feel comfortable that a great location will prevail, even if we're unsuccessful in retaining the Transportation Security Authority eleven years from now.

Excellent. Thanks a lot, gentleman.

Ladies and gentlemen, as a reminder, should you have a question please press star 1 at this time. Once again, ladies and gentlemen, as a final reminder, should you have a question please press star 1 at this time.

If there are no further questions, I will now turn the conference back to Mr. Ralston.

I would like to thank each and every one of you for taking the time to get more acquainted with the company. Kevin and I appreciate very much your continued interest and support, and we hope you have a great day.

Ladies and gentlemen, if you wish to access the replay for this call, you may do so by dialing 1-800-428-6051, or 973-709-2089, with an I.D. number of 300652.

This concludes our conference for today. Thank you all for participating and have a nice day. All parties may now disconnect.