Office Properties Income Trust (OPI) 2010 Q1 法說會逐字稿

Good day, and welcome to the Government Properties Income Trust first quarter 2010 financial results conference call. Today's conference is being recorded. At this time for opening remarks and introductions, I would like to turn the conference over to the Vice President of Investor Relations, Mr. Tim Bonang. Please go ahead, sir.

Thank you and good afternoon. Joining me on today's call are Adam Portnoy, President and Managing Trustee, and David Blackman, Treasurer and Chief Financial Officer. The agenda for today's call includes a presentation by management followed by a question-and-answer session. I would note that the recording and retransmission of today's conference call is strictly prohibited without prior written consent of the Company.

Before I begin today's call, I would like to read our Safe Harbor Statement. Today's conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and Federal Securities Laws. These forward-looking statements are based on Gov's present beliefs and expectations as of today, May 5, 2010. The Company undertakes no obligation to revise or publicly release the results of any revisions to the forward-looking statements made in today's conference call other than through filings with the Securities and Exchange Commission regarding this reporting period.

In addition, this call may contain non-GAAP numbers including funds from operations or FFO. A reconciliation of FFO to net income, as well as components to calculate AFFO, CAD, or FAD are available in our Q1 supplemental operating and financial data package filed in the Investor Relations section of the Company's website at www.govreit.com. Actual results may differ materially from those projected in any forward-looking statements.

Additional information concerning factors that could cause those differences is contained in our Form 10Q, which will be filed with the Securities and Exchange Commission and in our supplemental operating and financial data package found on our website. Investors are cautioned not to place undue reliance upon any forward-looking statements. And now, I would like to turn the call over to Adam Portnoy.

Thank you, Tim, and good afternoon, everyone. We are pleased to announce another active quarter for Government Properties Income Trust. During the first quarter of 2010, we successfully raised $210 million in gross proceeds from a public offering of common shares and acquired two previously announced properties for $72.4 million. After quarter end, we closed on the acquisition of two additional properties and placed a third property under agreement.

Since the completion of our IPO in June 2009, we have acquired eight properties and we have one additional property currently under agreement for an aggregate purchase price of approximately $233 million. These nine properties included approximately 1.3 million square feet and are 100% leased with a weighted average remaining lease term of 7.3 years.

We also continue to remain well positioned for future growth. Our portfolio properties are 100% leased. We have no material lease maturities until the fourth quarter of 2011. We have no debt maturities until April 2012, and our $250 million revolving credit facility is currently undrawn and fully available for us to acquire properties majority leased to government tenants and cap rates materially above historical averages.

For the first quarter of 2010, we are reporting FFO of $0.43 per share based on a weighted share count of $29.1 million shares. We had no outstanding shares during the first quarter of 2009. We closed our IPO on June 8, 2009, so our financial reporting prior to that date was consolidated with our former parent company, HRPT Properties Trust.

At March 31, 2010, our portfolio statistics and balance sheet remained rock solid. Approximately 94% of our rental income was paid by the US government and four state governments. As a result of our recent equity offering, our ratio of total debt-to-gross real estates assets was less than 6% and our interest coverage ratio was almost nine times.

During the first quarter, we had a very modest amount of leasing activity with only 4,000 square feet of leases signed. For the remainder of 2010, approximately 2% of our annualized rental income is expiring. 60% of this 2010 lease rollover is concentrated at one property with the US department -- one property leased to the US Department of Energy in Germantown, Maryland and lease renewal negotiations for this property are close to being finalized. Since January 1, 2010, we have acquired four properties and we have entered into an agreement to purchase one property for an aggregate purchase prices of approximately $144 million.

Our first acquisition was previously announced during our year-end earnings call and is an office property located in Lakewood, Colorado with approximately 167,000 square feet. The property is 100% leased to the US government and it serves as the Intermountain Regional Headquarters for the National Park Service. The purchase price was $28.7 million and included the assumption of a $10.4 million mortgage loan. We acquired this property in January 2010 and the going in cap rate was 10.2%.

Our second acquisition, which was also previously announced during our year-end earnings call, is an office property located in Landover, Maryland with 266,000 square feet. It is 100% leased to the US government and is occupied by the Defense Intelligence Agency. The purchase price was $43.7 million and includes the assumption of a $24.8 million mortgage loan. We acquired this property in February 2010 and the going in cap rate was 9%.

Our third acquisition is an office property with $27,000 square feet located in Burlington, Vermont. This property is a newly constructed build to suit that is 100% leased to the US government and is occupied by the Office of Security and Integrity. The purchase price was $9.7 million. We acquired this property in April 2010 and the going in cap rate was 8.6%.

Our fourth acquisition is an office property located in Detroit, Michigan with 56,000 square feet. This property is also a newly constructed build to suit that is 100% leased to the US government and occupied by the US Citizenship and Immigration Services. The purchase price is $21.3 million. We acquired this property in April 2010 and the going in cap rate was 8.7%.

We have one property currently under agreement that we expect to acquire before the end of the second quarter which is an office property located in Malden, Massachusetts with 117,000 square feet. It is leased to the Commonwealth of Massachusetts and is occupied as the headquarters for the Department of Education. The contracted purchase price is $40.5 million. This acquisition is subject to diligence and customer closing conditions and as a result, there is no assurance that we will acquire this property.

We remain encouraged by the strength of our acquisition pipeline as we are evaluating a number of high quality opportunities for relatively new properties with long remaining lease terms. The opportunities include properties leased to both the US government and state governments and the acquisition cap rates fall within our targeted range of 8% to 10%.

Turning to our capital access, on January 14, 2010, we priced a $9.8 million common share offering at $21.50 per share. The offering closed on January 21 and we raised gross proceeds of over $210 million. The funds were used to repay amounts outstanding on our revolving credit facility and to fund acquisitions.

We believe the results of our first quarter 2010 activity continue to support our business goal providing shareholders a safe dividend, supported by a stable rental revenue coupled with the opportunity to grow the acquisitions and cap rates above, the historical average for government leased properties. I'll now turn the call over to David Blackman, our Treasurer and Chief Financial Officer to provide more detail on our financial results.

Thank you, Adam. First, let's review the results of first quarter operations. Operating income decreased 1.8% as a result of total expenses increasing by 39.8% compared to a 21.3% increase in rental income. We acquired six properties from our initial public offering to March 31, 2010. As a result the primary reason for our year-over-year change in rental income and property operating expenses is our acquisition activity.

Our non-property level operating expenses of acquisition cost, depreciation expense, and general and administrative expense or G&A were the primary drivers in our year-over-year drop in operating income. We recorded $844,000 in acquisition cost during the first quarter of 2010 compared to no acquisition cost in the first quarter of 2009. Depreciation expense increased 37% as a result of acquisitions that also is a result of $2.2 million with capitalized improvement at four of our properties.

Finally, our G&A expense is a comparison of receiving an allocation from HRPT Properties Trust in 2009 and the actual cost associated with operating a separate public company in 2010. A portion of G&A expense is our fixed cost and will decrease as a percentage of revenue in real estate investments as we continue to gain scale.

If you compare to our first quarter of 2010 G&A expense to our G&A expense from the fourth quarter of 2009, the increase is substantially the result of property acquisitions, which helps to exhibit that our G&A expense is beginning to normalize.

Property operating -- property net operating income increased by 21.3% year-over-year and our consolidated net operating income margins were consistent at 66.6% for both the first quarter of 2009 and 2010. EBITDA increased in the first quarter 2010 by 10% compared to last year, primarily as a result of acquisition activity and in spite of our $844,000 of acquisition cost and our increase in G&A expense.

Interest expense was $1.5 million in 2010, an increase by the same amount as we had no outstanding debt in the first quarter of 2009. Included within our interest expense for 2010 is $532,000 in amortization of deferred financing fees associated with entering and amending our $250 million revolving credit facility and the assumption of two mortgage loans for properties acquired in the first quarter of 2010.

Net income for the first quarter of 2010 was $6.9 million compared to $8.5 million for the first quarter of 2009. The decrease reflects the net result of a $1.5 million increase in interest expense, $844,000 in acquisition costs, a $729,000 increase in G&A expense and a $1.4 million net increase in rental income over operating expenses.

FFO was $0.43 per share for the first quarter of 2010 based upon our weighted average share count of 29.1 million shares. We declared our first quarter dividend on April 8th equal to $0.40 per common share. The dividend will be paid on May 24th to common shareholders of record as of the close of trading on April 23rd.

During the quarter, we spent $234,000 on tenant improvements and leasing costs and $46,000 for building improvements which included parking lot improvements, the completion of a garage renovation, life safety enhancements and energy upgrades.

Turning to the balance sheet. On March 31st, we held $27.6 million of unrestricted cash and $1.1 million of restricted cash associated with our two assumed mortgage loans. Deferred financing costs of $5.6 million of fees and expenses associated with establishing and amending our $250 million revolving credit facility and the assumption of two mortgage loans during the quarter, all of which amortized on a straight line basis.

Rents receivable includes $2.1 million of accumulated straight line rent as of quarter end. Other assets of $9 million include $3 million held in escrow for our two property acquisitions that closed in April and our $5.1 million investment in affiliate insurance company.

As of today and at quarter end, we had zero outstanding on our revolving credit facility. During the quarter we removed our property in Buffalo, New York at collateral from our credit facility and amended it to remove a provision that established a minimum LIBOR rate of 2% reducing our borrowing costs from 5% to 3.25% based upon current LIBOR rates.

Our credit facility matures in April 2012 and we have a right to extend it for an additional year to April 2013. We believe we are complying with our terms and conditions of our credit facility and are operating well within the established covenants.

During the quarter we assumed two fixed rate mortgage loans for $35.2 million with maturities of 2016 and 2021. Those mortgage loans are non-recourse and structured without financial covenants to the company. But neither mortgage loan has currently opened a prepayment including our assumed mortgage debt, our ratio of debt to gross book value of real estate with 5.6% at quarter end.

Gov remains a well capitalized company without material lease maturities or any debt maturities in 2010. Our properties are 100% leased and approximately 94% of our rental income is paid by the US government and four state governments. As a result, our cash flow is incredibly stable to pay a consistent dividend.

In addition to our stable base we continue to have strong acquisition momentum with both quality acquisition pipeline and significant access to capital as evidenced by our successful equity offering in January and our fully available $250 million revolving credit facility. We are both excited and confident with our ability to have success during the remainder of 2010. That concludes our prepared remarks. Operator, we are now ready to take questions.

Thank you.

(Operator Instructions)

And we will go first to Brendan Maiorana with Wells Fargo.

Sir, good afternoon. This is [Yang Ku] here for Brendan. My first question is in regards to our operating portfolio. It looks like the same-store was actually down 2.5%, the lease rate was essentially 100% fully leased. What was actually driving the rents to go down a little bit?

We had -- really, the primary driver, Yang, was we had increase in snow removal cost for our properties in Washington DC area. That was really the primary driver behind that.

It wasn't a drop in rents as much as was an increase in expenses.

okay. Well, it looks like -- I mean, it's a small amount. It looks like rent dropped about $200,000. But you are saying that the most of the decrease was snow removal cost. Okay. Got you. And can you guys provide a cap rate for the Malden, Mass acquisition?

We haven't and we'd like to hold off on this closing cap rate until we complete the acquisition. But it's within -- it's in line with what we said between 8% and 10%.

okay. That sounds good. And just a question regarding the California portfolio? Not sure, you know, what the bidding process is, whether that's ended or not? I think it did. And it sounds like the pricing is going to be pretty steep with potential for a sub seven cap rate. I was wondering if we can get your thoughts regarding what you guys think about what that type of cap rate means for your portfolio and how, you know, how your portfolio compares to the California.

That's an interesting question. I don't think the process has ended yet. And if something -- it's actually something that we continue to look at. But to talk about the cap rates, I'm not sure where those cap rates are going to end up. There's a lot of broker talk about where they'd like them to end up, but I do agree with you that the cap rates that people are talking about do seem to be fairly aggressive especially given the credit of the California, you know, California as a state. It's the lowest rated state in the country.

I will tell you this, that properties are good assets. They're very nice assets and the lease structure is -- it's a very good lease structure. It's among the best we've actually seen. In some ways, it has all the features. It's as good as any GSA lease structure and in fact it might be a little better because they're willing to have basically step ups in their rent -- annual increases in the rent on top of it.

So, you know, it's a good portfolio, but I think the credit of the tenant is different than the credit of the general US government -- as the US government as a tenant within our portfolio. But I'm not sure that process is winded -- is wind up yet. And it will be very interesting to see who actually buys it and what the cap rate it ends up with.

You know, that process has a lot of contingencies people should be aware. Not only that do they have to pick a winner but then the state legislature has to pass a law, the government has to sign it. Everyone has to remember it's an election year in California this year. So, you know, there is a lot of -- there are unforeseen contingencies. They're contingencies associated with that deal that are not normally associated with the sale that, you know, who knows what happens.

Yes. My guess is the process will run until June because, you know, there is a best and final round and then there will be additional diligence materials provided once they kind of continue to narrow the field down. So it will be into the third quarter, my guess, before we understand who the winner is and what the ultimate price will be for the portfolio.

Okay. Great. Thank you, guys.

Yes.

(Operator Instructions)

And we will go next to Dave Rodgers with RBC Capital Markets.

Hi. Good afternoon, guys. With regard, David, to the debt that you assumed in the quarter or subsequent quarter-end, what was the rate on that debt?

There are two different loans. The loan for the Lakewood property was $10.4 million at an 8.15% interest rate that's the longer duration loan. It goes to 2021 as a fully amortizing loan. So it's expensive debt but a good asset. The other loan was for the Landover, Maryland property, $24.8 million at a 6.15% interest rate. And that matures in 2016. The Lakewood property is subject to yield maintenance provision so it's very expensive to prepay today. The Landover property is closed to prepayment until six months prior maturity in 2016.

okay. Thank you for that color.

You also made comments, I guess, related to G&A and you mentioned, I think, with the more acquisition it's reaching more of a stabilized run rate on the G&A front. Was that just from a transaction fee perspective or the underlying kind of management fee to turn it through the G&A line? What should that number, I guess, look like going forward?

Well, you know, as it relates to G&A, I mean the goal is to make sure that it is relatively consistent and that when it increases, it increases as a result of acquisitions. We pay a business management fee to RMR which is equal to 0.5%. Actually it's 0.7% until we get to $250 million acquisition and then it goes to 0.5% on the cost of those acquisitions. So, you know, when I refer to that in my prepared remarks, basically it meant the increasing G&A was a result of that business management fee we pay RMR.

okay. I want to make sure I understood that right. And then, Adam, you mentioned in your opening comment, I think, $233 million. Was that what you've done year-to-date? You just caught me off guard.

That's right. Since we went public.

okay. Great. I just want to make sure I got that right. And then the final question was, if you look at broader competition for acquisitions, capital markets coming back a bit better, you made some good new property acquisition on the build to suit. You know, what you are seeing in terms of the number of bidders on the properties that you're after? Is that increasing in the competition overall for underwriting, maybe more growth and some of the rollover and how is that, I guess, impacting the cap rates for the yield that you are looking at today?

You know, yes, there are more bidders for properties. The good news is there is still fairly healthy pipeline of opportunities we're looking at. I think that it's safe to say that cap rates are creeping in a little bit. You will notice that the two new acquisitions we made in April, were sort of in mid-to-high eights but I would note that those properties were brand new build to suits with, you know, long-term leases in place.

I still think we have the opportunity to buy properties, you know, new buildings that are build to suits in the eights and I think properties that might be five to ten years old with still five or ten years left on a lease or new lease or renewal lease with the GSA that you can buy those in the nines. I think those opportunities still are out there, but it's safe to say, you know, we are buying properties in the 10th and in 2009 near the end of the year.

And if that's the stuff, I think, it's going to be tougher for us to be able to do. But I still think that we are able to buy things between -- in the eights and in the nines. And we're still looking at lots of opportunities -- single assets opportunities one offs as well as portfolios.

Thank you.

Yes.

We will go next to Jimmy Feldman of Bank of America/Merrill Lynch.

Thank you. As you think about the acquisition pipeline, are there new types of sellers coming into the market that you haven't seen since you've been public?

No. I wouldn't say there's real difference in the type of seller. It's still a lot of developers that -- I mean the part of the -- if you think about the capital markets the part of the capital market is still -- is very tough. It is the local and regional developers giving access to credit. And those guys are typically thinly capitalized.

So they've been the guys that we have typically -- that's been, I'd would say, half the opportunities we look at had been that characterization and that's been like that. Since, we have been public that really hasn't changed.

We still, you know, we see some institutional sellers coming -- maybe that's a little different. We are seeing some institutional sellers thinking about selling properties now because they see this is a -- I think generally people think that there is more bidders in the marketplace so some institutional sellers are now entering the market.

But, you know, so it has changed a little bit, but again our sweet spots are working with those local and regional players and specifically those developers there then we capitalize. We still have a lot of opportunities with those types of people.

okay. So as you're thinking about cap rates coming in given the conversation and credit market spiking up how are you underwriting? Are you underwriting it as some sort of spread to your cost -- your rate average cost to capital? I guess, how are you guys just thinking about how low you are willing to go on some of these cap rates?

Well, I mean there's several different ways we look at it. We do a discount cash flow analysis, we do an IRR analysis, we do -- and we obviously look at replacement cost probably first and foremost. And then we often look at what are cost to capital is and there's different ways to look at that.

You know, our marginal cost of capital is just a revolver that we never model on acquisition on just buying it on revolver. But, of course, anyone realizes anything we almost buy today would be accretive under the revolver immediately.

But then its higher long-term finance and I think it's safe to say that we want it different ways but we certainly are running it at 94% equity and 6% debt. We're including, you know, more. I think as we talked about when we were doing our equity offering earlier this year, we said that there's a sweet spot where we imagine the company's leverage will probably get to eventually is between 30% and 40% as we grow.

So when we think about our cost to capital, it's safe to say we think about things like we do a pretty simple math and so what's equity between 60%, 70% debt between 30%, 40% and what do we think our equity cost and what do we think our debt costs are.

To get to your question, you know, how much can we keep buying it as cap rates compress, well, I think we can buy safely well -- very safely into the eights and, you know, question is, do we ever get down and buying things into the sevens. You know, it's tough to imagine but we'll be playing in that market where we are playing when cap rates compress that much, but if -- I guess it always depends on the asset and what we are buying.

The other things that we look at, it may be a little bit different from other investors too. You know, we look at the cash rents as well as gap rents. And I think one other thing that is attracting so many bidders to the state of California portfolio is the fact that every five years you have 10% rent bumps in those leases. And so, on a 20 year lease, you've got pretty attractive gap rents. And so that's, you know, something that is relevant to us as we think about acquisitions that may not be relevant to everybody.

Right. But to get to the earlier question, I think we still have the ability -- I think our cost to capital is such that we still have the ability to continue to make acquisitions certainly in this. I think we are still have -- cap rates could compress further still and we still be able to make acquisitions. We are not at the line yet.

So when you think about your cost capital, so you're doing acquisition, let's say eight, what does that give you in terms of the spread?

Well, again if you do it right on the line. Immediately, I mean you could do the math yourself what you think our cost of equity might be and there's different ways to look at that and you say how much you spend on equity and then how much is debt incrementally. You know, if we decide, well, 5%, 6% leverage today, it safe to assume that, I think, leverage will tend to creep up a little bit overtime now.

And as we continue to grow, where we can get debt today, I mean, ballpark, 5%, 6%, 6.5%, somewhere in that range. So, just today, if we bought a building, it would be -- that's funding it with debt and so we have a lot, you know, we have 200 basis points, let say there of spread.

Jimmy, we could get a three to five-year term loan through the commercial bank market at rates comparable to where our credit facility is priced today. So, you know, 3% to 5%. You can get 10-year fixed rate money secure non-recourse in the six, low six.

Low six.

And, you know, we've got capacity for $150 to $225 million of additional debt at the company based upon where our leverage is today. So, I mean, that's where we have an opportunity to create some value and accretion for shareholders as we get to a more normalized leverage.

okay. Thank you. And can you talk a little bit about any uptake to your conservation with the IRS in Fresno? And I know it's further out but your D.C. and Colorado rolls in 2012?

Yes. In Fresno, we have a good meeting in March with both the GSA and IRS to talk about that renewal. It's a good conversation. It's clear that the IRS intend to stay in the property. At this point it's a question of how long they'll stay or how long they renew for, and what the rental rate is.

So we feel very comfortable that we will renew them in 2011. And, you know, my expectation is that we will renew them for no less than five years, potentially longer. But since we're in the middle of negotiating with them, you know, we're going to probably not saying much about where we think rental rates are or where we ultimately think the duration will be until we conclude those negotiations.

On 20 Mass Avenue, you know, that is in the latter part of 2012. We really haven't initiated conversations yet with the GSA or with the primary tenant occupants. My guess is, as we get into kind of July, August, we will really begin those conversations.

On Lakewood, Colorado, not a lot at this point that we can say they're either. We do know that the tenant has some expansion needs that we've been in conversation with them about. You know, unfortunately, they're not 100% sure what those real expansion needs are and they're a little bit all over the place right now.

So, I think, as we get into the latter part of this year, we'll have a better idea to what their real space needs are. You know, our advantage is HRPT Properties Trust owns a building to the three buildings we own in this business park. It has capacity to expand these tenants. And it's more than sufficient space to expand this tenant. So we feel pretty good about where we sit competitively.

okay. And then, back to the Fresno lease in terms of PI, do you have any idea where you think those might come out?

No. But, you know, remember the structure of that lease is not absolute net but it is modified net lease so most of the tenant improvement dollars they may need or items that we can amortize into the lease. So, you know, if we spend a dollar and sign a seven year lease we'll get that dollar back over seven years with a return. So that's a pretty good position to be in right now.

Right. But in terms of your actual cash spend next year that will be real cash outlay?

It will be a cash outlay. But, you know, given that that's our only rural material lease, you know, we certainly got capacity to deal with that. And if we can get that money back at a reasonable return its money we're spending.

okay. Thank you.

Thanks, Jimmy.

We will go next to Tayo Okusanya with Jefferies.

Yes. Good afternoon. In regards to the California bidding process, could you give us an information on just how involve you with that at this point? Are you guys, you know, bidding for properties? Are you out of the process and just watching what will ultimately happen? Or what's your level of involvement in that at this point?

I think it's -- I don't want to talk too much about it because it is -- because it's a process that's ongoing, but it's safe to say that we're still involved in evaluating, that evaluating it. That's probably the best answer to give you.

Did anything change with -- I mean, most of the people were saying California is looking for someone to bid on the entire portfolio. Does that actually enhanced or dissuade your position in regards to the ability to come out on top?

Again, the press may not have everything correct b I think it's fair to say that their preference is that they would like to do a portfolio deal. But again we're evaluating it when the mix of -- we are still evaluating it and we'll see what happens.

And then in regards our acquisition outlook, I mean there is also some other news clippings about, you know, the deals that Arizona recently did. Currently, there is also something going on in the West side of Maryland. Are you involved in any of those types of deals or would you like to look at any of those deals too?

I guess I missed the recent press on Arizona. You know, they had put out a portfolio, I guess, in the third quarter of 2009. We took a hard look at it. There were a number of assets in there that were interesting to us, but before we were able to formulate a bid we were told that the state was going to do a municipal bond offering and continue to own the assets. Has there been press that's come out recently that changed it?

It did a deal for $235 million of asset. Most of it went to Fidelity and Vanguard and they're planning to do another small round of real estate sales this coming June.

Well, what they did was they sold those assets into a special-purpose entity. They pledged that this collateral -- probably the Fidelity and Vanguard -- to issue municipal notes. That would be my guess. I maybe wrong, Tayo, but let me look into that because mainly we got bad advice on that.

But what was in that portfolio were an administrative building, the legislature that we have an interest in, there was a VA property that would have been interesting to us. But then there was a bunch of prisons in there and there was a state parking there. And those were things that, you know, oh, and there was also the Convention Center in Phoenix. So majority of that were properties that really didn't work for our vehicle.

What about Connecticut? It sounds like they are conducting some sales up there too?

Well, nothing has -- as far as we understand, it is not just Connecticut, there are several states that we've read about that are thinking about doing this taking a lead from what the press that you saw Arizona months ago as well as California. They are all different stages and it's safe to say when they come -- when they formally come to market we will evaluate it. I think we absolutely will evaluate it. But they haven't come -- they haven't formally to market yet.

Got it. Appreciate it. Thank you.

Welcome.

We will go next to Brendan Maiorana with Wells Fargo.

Hi. Yes. This is Yang again for Brendan. I just have a quick follow-up regarding your acquisitions discussion earlier. Maybe this is just different for government assets, but a number of your competitors have been saying that they are looking at value at opportunities - just leased up opportunities. Do you guys have any of that, some type of multi-tenant assets to different agencies that you guys might be able to acquire?

That's not particularly in our sweet spot. This company is primarily focused on 100% leased assets principally to the GSA. Are there opportunities to buy, let's say, a vacant building and then to go lease it to the GSA, we will look at opportunities like that. Those opportunities like that we could engage in, and that was, I think, you characterized as value add.

We don't have many multi-tenant buildings. We have one large buildings, Sacramento, that does have some private tenants in it that. But it doesn't have much in the way of any vacancy. As you know, we are 100% leased.

There are opportunities to buy buildings that are majority leased to the government, and then try to lease up the rest, but again, it's probably not something we would be focused on and that gets to the point of the -- government tenants typically like to lease the entire building, principally security reasons. And they like to have the entire building. So if you lease to the GSA, yes, there are opportunities to buy buildings that partially lease to the GSA and they have to be comfortable that they are going to stay there for long time even though they don't lease the whole thing or you get comfortable that you might be able to lease the remainder of the building to them.

But that's not really -- I think it's safe to say that's not where we're focused on trying to add value for the company. I think we are still primarily focused on buying 100% leased buildings, 100% leased buildings to the US government and state governments.

okay. So, I mean you guys are still targeting 8 to 10 type yields. If the cap rates come in a little bit in further, then would you guys just prefer top sit on sidelines then or -- I mean it sounds like you guys still have a couple of deals of the Harper, but I was just wondering what the volume might be going forward towards the end of 2010 and maybe into 2011.

Well, it depends. I mean, your question is speculating on where cap rates might go. I mean, if they compress with tremendous amount, you know, us and a lot of players in the industry will have a difficult time acquiring properties that are attractive. It poses spread investing, but we still got room in our business plan. Cap rates could compress more than they have already, and we still have room to buy and we can still do at a positive spread.

Remember, we have 94% of our capitals equity, only 6% debt. And I think we are going to go lever it up, tomorrow, but we have capacity to add modest amounts of leverage and leverage is cheaper than our equity. So I think we can -- I think we are going to be able to grow for the foreseeable future.

Now, we got this question a lot when we did our IPO and our - when we did our secondary. At some point, if cap rates get back to the way they were in 2007 or 2006 and see the CMBS market comes back to the way it was and banks open up their lending and these types of asset trade at 5% or 6% cap rates where they have historically, even 4% if some trades happen back then, I think you're right, we'll have a difficult time competing but I think we're a long way from being to the point where we wont be able to compete effectively. I think we still have a lot of run way left, either with cap rates compressing.

okay. That's helpful. And do you guys -- would you guys care to put out some type of acquisition, you know, guidance out there for say 2011 or 2012 or is it little too early for that?

We will be acquiring property in 2011 -- 2010, '10 and '12.

Yes. Sorry. We can't -- we just - it's too tough. We don't give any formal guidance and - yes, we are actively buying - it just unfortunately it's tough to giving any sort of guidance on the amount. It's very -- especially on acquisitions it's very difficult because, you know, you can look at $200 million opportunity one day and the following day you can look at $20 million opportunity. And, you know, pricing may be differently and you don't know which ones you are going to win.

Yes, sir. Thank you.

Yes.

We will go next to Tayo Okusanya with Jefferies.

Hi, guys. Just a quick follow-up question. If you do end up in the world where it's either taking longer to make acquisitions or, you know, acquisition volumes are slowing, is there any opportunity on the cost side in your opinion to lower cost. So you still -- generally meaningful FFO growth on a going forward basis?

We run a relatively lean organization. And we are very thoughtful about how we bid out third-party services for cleaning, landscaping and things like that. So unless there its kind of a, you know, an ability generally within the economy to create savings in bidding out for cleaning and landscaping and things like that, I think there is not significant savings opportunities at the property level.

I think we will continue to try to do things as effectively as possible on non-property expenses, but I think what helps us the most is continuing to gain scale. And so that's why we're still very focused on growing the company. It's because we believe that, you know, continuing to gain scale will help us with our cost of capital, will help spread fix overhead over a larger base and all of that will, you know, improve our access to capital long-term.

okay. That's helpful. And could you just remind us again which of the operating expenses you can pass through to the government?

A 100% real estate taxes typically and basically increases in all other operating cost up to rate of inflation for CPI.

Got it. Thank you.

You're welcome.

That does conclude today's question-and-answer session. I would now like to turn the call back to Mr. Adam Portnoy for any additional or closing remarks.

Thank you all for joining us on our first quarter conference call. We will be at NAREIT in June in Chicago and we look forward to see many of you there, speaking with you on our Q2 call in early August. Thank you and good afternoon.

That concludes today's conference. Thank you for your participation.