Office Properties Income Trust (OPI) 2011 Q2 法說會逐字稿

Ladies and gentlemen, we'd like to thank you for standing by, and welcome to the Government Properties Income Trust second quarter earnings teleconference call. At this time, all participants are in a listen only mode. Later we will conduct a question and answer session and instructions will be given at that time.

(Operator Instructions)

As a reminder, today's conference call will be recorded. I would now like to turn the conference over to your host and facilitator, as well as Vice President of Investor Relations, Mr. Tim Bonang. Please go ahead, sir.

Thank you, and good afternoon. Joining me on today's call are David Blackman, President and Chief Operating Officer, and Mark Kleifges, 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 we 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 other securities laws. These forward-looking statements are based on GOV's present beliefs and expectations as of today, August 2, 2011. The Company undertakes no obligation to review or publicly release the results of any revision to the forward-looking statements made in today's conference call, other than through filings with the Securities and Exchange Commission, or SEC, regarding this reporting period.

Commencing this quarter, the Company will report normalized funds from operations, or normalized FFO. Normalized FFO represents FFO as defined by NAREIT and is adjusted to include percentage rent and excludes loss on early extinguishment of debt, impairment of assets, and acquisition related costs. In addition to normalized FFO, this call may contain other non-GAAP numbers. A reconciliation of normalized FFO to net income and the components to calculate AFFO, CAD, or FAD can be found in our Q2 supplemental operating and financial data package, available on our 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 2011 Form 10-Q, to be filed with the SEC. Investors are cautioned not to place undue reliance upon any forward-looking statement. And now, I would like to turn the call over to GOV's President and COO, David Blackman.

Thank you, Tim. Government Properties Income Trust is pleased to announce strong performance and continued growth during the second quarter of 2011. Since April 1, we have acquired six buildings for aggregate purchase prices of $185 million and have under agreement to acquire five additional properties for aggregate purchase prices of $142 million.

In July, we sold 6.5 million common shares for net proceeds of approximately $158 million, and we also declared a regular quarterly distribution of $0.42 per share. For the quarter ended June 30, 2011, we are reporting normalized FFO of $21 million, or $0.52 per share, compared to $14.2 million, or $0.45 per share, in 2010. Our increase in normalized FFO is primarily the result of the Company's accretive acquisition activity.

GOV's portfolio statistics and balance sheet remain exceptionally strong. Our properties are 96.5% leased, with a weighted average remaining lease term of four years. Approximately 94% of our rental income was paid by the US Government, six state governments, and the United Nations. We had $384 million of debt outstanding at quarter end, which represented a conservative 34% of our total book capitalization, and EBITDA covered interest expense almost eight times.

During the second quarter, we had minimal leasing activity, entering into only eight leases for 25,000 square feet and committing $356,000 of capital for tenant improvements, which equates to $2.83 per square foot per year. Much of our leasing activity was for non-government tenants. For the 4,000 square feet of leasing activity with government tenants, we experienced an average rollup in rents of almost 8%.

At quarter end, through the remainder of the year, approximately 11.5% of our annualized rents were subject to maturing leases, and we remain comfortable with our progress in renewing a significant percentage of these maturing leases. At quarter end, 74% of our annualized rents were paid by the US Government, approximately 14% were paid by six state governments, and 6% were paid by the United Nations. The Commonwealth of Massachusetts remains our largest state tenant at 5.4% of annualized rents.

Our significant focus remains on acquiring properties leased to the US Government, as evidenced by our year to date acquisition activity. Since April 1, 2011, we have acquired six properties, with 474,000 square feet, for aggregate purchase prices of $184.7 million, excluding acquisition costs. These six properties were acquired at an average cost per square foot of $389, had a weighted average remaining lease term of approximately seven years, are 100% occupied, and had a weighted average cap rate of 7.6%. Excluding our acquisition of the United Nations building in Manhattan, the weighted average cap rate was 8.5%.

In May, we acquired an office building located in Plantation, Florida, with 136,000 square feet. This property is 100% leased to the US Government and is occupied by the Internal Revenue Service. The purchase price was $40.8 million, the going in cap rate was 8.1%, and the remaining lease term was eight years.

Also, in May, we acquired an office property located in New York City, with 187,000 square feet. This property is 100% leased to the United Nations and is occupied by its translation department. The purchase price for this property was $114 million, the going in cap rate was 7.1%, and the remaining lease term was approximately seven years.

In June, we acquired an office property located in Milwaukee, Wisconsin, with 29,000 square feet. This property is 100% leased to the US Government and occupied as a military entrance processing station. The purchase price was $6.8 million, the going in cap rate was 9%, and the remaining lease term was approximately five years.

Also, in June, we acquired a two building office complex in Stafford, Virginia, with 65,000 square feet. The buildings are 100% leased to the US Government and occupied by the Federal Bureau of Investigation. The purchase price was $11.6 million, the going in cap rate was 9.2%, and the remaining lease term was five years.

Finally, in June, we acquired an office building in Montgomery, Alabama, with 58,000 square feet. The property is 100% leased to the US Government and occupied by the US Attorney for the Middle District of Alabama. The purchase price was $11.6 million, and the going in cap rate was 9%, and the remaining lease term was six years.

Since April, we have entered into purchase agreements to acquire five properties containing 786,000 square feet, for aggregate purchase prices of $142 million, excluding acquisition costs. These acquisitions remain subject to completion of due diligence and other closing conditions, so we can provide no assurance that we will actually acquire these properties.

In May, we entered into a purchase agreement to acquire three office properties located in Indianapolis, Indiana, containing 434,000 square feet, for an aggregate purchase price of $88 million, including the assumption of $50 million in mortgage debt. These properties are 97% leased to 18 tenants, of which 58% is leased to the US Government and occupied by the US Customs and Border Protection Agency.

In July, we entered into a purchase agreement to acquire a property in Holtsville, New York, with 264,000 square feet, for a purchase price of $40.8 million. The building is 82% occupied, of which 72% is leased to the US Government and occupied by the Internal Revenue Service and the US Citizenship and Immigration Services.

Also, in July, we entered into a purchase agreement to acquire an office property located in Sacramento, California, containing 88,000 square feet, for a purchase price of $13.6 million. This property is 100% leased to the State of California and is the headquarters for the California State Employment Development Department.

We remain upbeat about our opportunity to grow the Company through acquisitions at cap rates within our targeted range of 8% to 10%. We also believe our second quarter results continue to support our thesis of providing a safe dividend to investors, supported by our stable rental revenue. I will now turn the call over to Mark Kleifges, our CFO, to provide more detail on our financial results.

Thanks, David. First, let's review our consolidated property level operating results for the 2011 second quarter. We once again experienced significant quarter over quarter increases in rental income and property net operating income, as a result of our 2010 and 2011 acquisition activity.

At the end of the second quarter, we owned 64 properties, with 7.6 million rentable square feet, compared to 41 properties, with 4.9 million rentable square feet, at the end of the 2010 second quarter. For the 2011 second quarter, rental income increased $16 million, or 62%, to $41.9 million, and property net operating income increased $9.2 million, or 53%, to $26.7 million. Our consolidated net operating income margin was 63.6% in the 2011 second quarter.

Turning to our same store results for the second quarter, for the 35 properties containing 4.4 million rentable square feet that we have owned continuously since April 1, 2010, occupancy declined by 20 basis points from the prior year quarter end to 99.8% at June 30. For the 2011 quarter, rental income decreased by $204,000, or less than 1%, compared to the 2010 second quarter.

Cash base rents increased $227,000, or 1%, versus the prior year quarter, and construction management fee income increased $260,000 versus the prior year quarter, due to tenant improvement projects we are managing on behalf of two federal government agencies. These revenue increases were more than offset, however, by quarter over quarter decreases in escalation income associated with real estate taxes and a decline in other ancillary revenues, primarily, parking income.

Same store operating expenses were essentially flat, quarter over quarter, declining $18,000, with lower real estate tax expense substantially offset by higher maintenance expense and costs associated with the two construction management projects. As a result, same store NOI decreased $186,000, or 1.1%, quarter over quarter, and our NOI margin percentage declined 20 basis points to 66.6%.

Turning to our consolidated results for the quarter, EBITDA in the second quarter of 2011 was $24.2 million, compared to $15.9 million in the 2010 second quarter. Our EBITDA to fixed charges ratio was very strong at 7.9 times for the quarter, and our debt to annualized EBITDA was only four times at quarter end.

For the current quarter, normalized FFO was $21 million, or $0.52 per share, compared to normalized FFO of $14.2 million, or $0.45 per share, for the 2010 second quarter, a 16% increase in normalized FFO per share. During the quarter, we spent $585,000 on tenant improvements and leasing costs and $633,000 for improvements to our properties.

Turning to our balance sheet and liquidity, at quarter end, we had $338 million outstanding on our $500 million unsecured revolving credit facility, and our debt to total book capitalization was 34%. Subsequent to the end of the second quarter, on July 25, we sold 6.5 million common shares at a price of $25.40 per share, raising net proceeds of approximately $158 million, which we used to repay amounts outstanding on our revolving credit facility.

On a pro forma basis for this offering, the adjusted outstanding balance on our revolving credit facility was $180 million, and our adjusted debt to total book capitalization was 20% at June 30. We have also granted the underwriters for this offering a 30 day overallotment option for 975,000 shares that expires later this month.

In closing, GOV remains a conservatively capitalized Company, with great access to capital. Our properties are 96.5% leased, and approximately 94% of our rental income is paid by the US Government, six state governments, and the United Nations. As a result, we have a stable and secure cash flow stream that we expect will allow us to pay a consistent dividend. In addition to our stable base, we continue to have strong acquisition momentum and remain optimistic about the Company's outlook for the remainder of 2011. Operator, that concludes our prepared remarks. We're ready to open it up for questions.

Ladies and gentlemen, we'll now begin the question and answer session of our conference.

(Operator Instructions)

Our first question will come from the line of Mitch Germain of JMP Securities. Please go ahead.

Good afternoon.

Hey, Mitch.

David, curious about Henry M. Jackson Foundation. Have they exited yet, or is that still a pending event for the -- for [2H]?

Yes, their lease matures in December, so they will exit at year end.

Great. And is there any update on potentially back filling?

No, we continue to have conversations with the FDA about taking some or all of that space, but as is typical, the government takes a lot of time in making those decisions and have not committed either way at this point.

And --

We think it's good space. I mean, I think the space that Henry M. Jackson occupies is well fit out. It's got good exterior offices, with quality finishes, so it's an attractive space to the market.

Great. And just in looking at the investment pipeline, I -- are you seeing any change? I know that, as we move along, previously, in the year, it's decreased in size. Is it still remaining pretty robust?

Yes, we continue to have a number of acquisition opportunities that are high quality properties, relatively new, relatively long remaining lease terms. They're attractive, and we're evaluating opportunities every day. We win a few, we lost a few, but there's a good number of opportunities within our targeted cap rate range of 8% to 10%.

Great. And last question. On secured pricing, where are you guys right now for a notes offering?

Yes, we think that we could issue notes today, probably with a credit spread range of 250 to 300 basis points over the ten year, which, today, is around 2.6%. So we'd be issuing somewhere in the low fives.

Excellent. Thank you so much.

Yes.

Our next question will come from the line of Dave Rodgers of RBC Capital Markets. Please go ahead.

Hey, David, good afternoon. Real quick question for you on the government side. Obviously, one of the big concerns, [mainly for] investors, generally, has been the government overhang. Have you continued, or, at least, started to see, maybe, more holdover tenants? Was that evident in the quarter? Have you seen more tenants move into the accounts receivable from a cash pay? And do you, I guess, worry about the next budget resolution getting passed in a timely enough manner that that could begin to affect some of your negotiations here in the near term?

Well, that's a lot of questions, Dave. I don't know that was a quick question either. Well, let me see if I can answer that somewhat in the order that you did. And, I guess, first of all, we haven't seen any change in the payment with our tenants. They continue to pay as normal. Any increase that we've had in our AR has been more a function of just simply our growth than anything else.

We don't really have more tenants in holdover today than we would otherwise. I think, other than maybe some transactions that have been held up in committee in Congress, the contracting officers continue to negotiate deals in good faith. So our conversations with the GSA for lease renewals continue to move along at what we consider a measured pace.

And as I'll give you an example, Fresno is always -- comes up pretty much in every call. We have been approved for Fresno with the Office of Management and Budget. We've been approved by the Senate, and we've been sitting in the House for a couple of months now. The good news is the way the process works with the GSA is you agree on general business terms, a prospectus is written, it goes to the O&B, and then it goes to the -- to Congress committees for approval, and then you begin your lease documentation.

With Fresno, the contracting officers actually suggested that we begin negotiating the lease document, so that once we get approval with the House, we'll have an executed lease, or we'll have a form of lease that's executed so that we can move forward with the transaction. So, I think that's all positive. I think we still feel very good with our conversations for lease renewals right now.

And do you think that, I guess, the overarching concerns that, maybe, investors broadly have with the government, is that making it easier or less competitive on the acquisition side for you guys to be more aggressive out there with capital?

Well, I definitely think that there are two things that have created, maybe, more acquisition opportunities for us this year, one is which, I think there's been a lot of concern in the investment community about where interest rates are going, and a rise in interest rates could have a negative effect on price if you are a seller. And there's adequate liquidity in the market right now, so we've seen a lot of deals, just across all asset classes, come to market this year.

I also think that the negative press that has occurred this year about the deficit and about the debt ceiling, about a reduction in annual budgets has made some owners of buildings that are leased to the government come to market that may not have otherwise come to market. So, that has, I think, been to our benefit.

And we've spent a fair amount of time just trying to get our heads around, really, what is the potential risk to us, with reduced budgets, and there's some interesting statistics out there. Since 1969, the federal budget has grown from $823 billion to $2.9 trillion, which is basically a 250% increase in the annual budget. During that same time period, the number of -- the federal payroll has actually declined by 33%. So, the number of employees that the federal government has has actually shrunk during a time period which the budget has actually increased 250%.

What is going on is that the government has done a great job of outsourcing. Defense spending has grown dramatically. All of that -- or, a substantial amount of that has been through outsourcing to government contractors. And then, the other thing is entitlement programs have grown dramatically. And so, we don't feel like there is tremendous risk to our business that the government will be mass exiting buildings, and we will have difficulty leasing our buildings to the government.

Well, thank you for all that color.

Absolutely.

(Operator Instructions)

Our next question will come from the line of Chris Canton of Morgan Stanley. Please go ahead.

Hey. Good afternoon. Just wanted to follow up on your discussion of your acquisition pipeline on the quarter. With New York, you found a nice asset at a 7% cap rate, which is a little lower than you typically seek. Is that -- are you continuing to evaluate opportunities that might represent kind of good values, but outside your typical range, or was that just a once -- onetime opportunity?

Chris, we don't have anything in the pipeline right now that we're looking at that we believe would justify a bid below an 8% cap rate. Doesn't mean that there won't be some stuff out there that trades below 8%, but nothing we're evaluating that we think is an exceptional asset.

There have been a couple of deals in DC that we have looked at that we thought were exceptional and could potentially justify something below an 8%, but unfortunately, for us, they were so exceptional that they traded well below where we would have been willing to price, and we just weren't competitive. So, I think your answer -- the answer to your question is no, we -- well, the answer to your question is we would consider an exceptional asset, but we don't see anything out there in the pipeline or on the horizon that would fit that bill.

Yes. And then, follow-up question, I think, for Mark. How are you thinking about capital structure, kind of, through year end? You talked about having pro forma debt on a line $180 million. I think you need about $90 million to fund the pending acquisition. Takes you, what, to $270 million. How much, kind of, floating rate debt are you comfortable with? And then, do you view -- we talked about unsecured bonds pricing low fives. Is that likely to be the next, kind of, source of capital?

Yes, I think you have your numbers right there. We have about $180 million out on the line, on a pro forma basis, for the recent offering, about $92 million in pending acquisitions, which is net of the $50 million of mortgage debt we'll assume on one acquisition, which would bring the line to about $270 million to $273 million, and I think the next capital transaction would be unsecured debt. We'd want a minimum use of proceeds of $250 million for a debt transaction, so I think we will have a use of proceeds. I think the question now is not if we'll do unsecured debt, but when, and we really haven't landed on the when part of that question at this time.

Yes, but in -- right. In fairness, you haven't actually drawn on the $90 million yet to fund these pending acquisitions, so it's --

Right.

July is actually maybe not sized yet for --

Right. We don't have a use of proceeds today, but we do anticipate one in the not too distant future.

That's right. And the good news is we only have one pending acquisition that has debt that needs to be assumed, and that's usually what slows down the closing of an acquisition is waiting for debt assumption. And the one that does have debt to assume, we've been under agreement since May, so we're down the road in that process.

Yes. You talked about it in the past, so do you have visibility that you do think it will go? Have you given us visibility on -- is it third quarter or fourth quarter?

I think today -- what we said today, third quarter, but when you assume -- when you're assuming a mortgage and working with servicers, you can never answer a question like that with certainty.

Yes. In terms of completing that acquisition, yes, we think that definitely has a chance to being a third quarter acquisition.

Yes. And then, just last one, Mark. It sounded like you wouldn't issue a bond before -- ahead of these acquisitions. You'd want to have the line at $250 million or greater, it sounds like.

Yes, that's accurate.

Okay.

And it doesn't make sense for us to sit on cash. Cash is just too dilutive right now.

Thank you very much.

Yes.

Our next question will come from the line of Dan Donlan of Janney Capital Markets. Please go ahead.

Thanks. Good afternoon.

Hey, Dan.

Hey, just quick question on the NOI margins here. Is there any seasonality to those margins? And as we look at this 63.6% margin, where do think that trends through the rest of the year into next year, if possible?

I would say there's no real seasonality in our numbers. What can be somewhat seasonal in our business is our repair and maintenance number, and we do tend to spend more capital, whether it be repair and maintenance or just capital improvements, in the second half of the year.

Okay.

That could potentially have an effect on margins, but there really is no seasonality in our business.

Yes.

Yes. I mean, your utility usage obviously changes.

Yes.

But it doesn't change the NOI margins that significantly.

Okay. And then, could we, potentially, go over the role a little bit in more detail in 2012 and kind of what you're expecting there?

Sure. Our primary role in 2012 is 20 Mass Avenue.

Yes.

I think it represents a little more than 8% of our revenues, call it 340,000 square feet. It's two separate tenants. It's Department of Justice, and it's US Customs and Immigrations Services. Both of those tenants are good quality tenants. They both expressed interest in staying in the building.

We did have a time period under which we weren't 100% certain whether US Customs -- or, US Citizenship would need to be relocate in a Department of Homeland Security campus, but that campus is being eliminated by Congress, so it's not going to get filled. So, we're in pretty good shape with both of those tenants. We think that we've got a good chance of getting two more ten year renewals with them, and we think we probably are positioned to get anywhere from $10 to $14 per square foot rollup in rents. We will have some TI dollars to spend, but I don't believe the TI would be material, particularly in relation to the rollup in rent that we'll get there. Go ahead.

No, I'm sorry if I missed it, but did you talk about Fresno at all?

Yes, we talked a little about Fresno. Fresno is this year, and that's November of this year. We're still stuck in the House in committee. We do expect that we're getting closer to being through the House. One of the things that has made us feel better about that is the contracting officer has actually started drafting a lease for us to begin to review and has actually requested that we work through the lease and that we execute it, so that when approval is received by the House, that we can go ahead and have them countersign it and be done. So, I think we're going in the right direction with Fresno. We're clearly going to have a renewal there, and we're anxious to get through the House.

I guess our next largest maturity in 2012 -- we have three buildings in Lakewood, Colorado, that are leased to the National Business Center, which is part of the Department of the Interior. Represents 2.7% of rents, and we are pretty far down the road with them, working through lease renewal. That is a prospectus that actually has been approved through Congress. Actually, two of the three buildings needed to go through Congress. The third one is a small enough lease that it didn't have to go through, there was an article, maybe, two weeks ago, in the Washington Post that talked about prospectuses being approved, and that was one that got through approval. So that's good news.

And then, I guess our last material maturity in 2012 is with the FDA in Rockville, Maryland. That's the tenant that we're also talking to about possibly expanding into Henry M. Jackson space. So, we are in ongoing dialog with them, but, at this point, we're not far enough along to really know where that's heading.

Okay. Well, then, I guess, going back to prior calls, it sounds like to me that maybe the vacancy -- the biggest vacancy that could occur would be the FBI lease in Phoenix. Just kind of curious there with -- you're talking about how there's been a kind of an unwillingness for tenants to -- or, for the government to build new buildings. Is that starting to look like they could potentially renew there in Arizona? I know they had been talking -- had an RFP out there. Any commentary you could offer there would be helpful.

Yes. No, unfortunately, for us, the concern about the deficit came a little bit too late for the FBI in Phoenix. They started construction of a new building, I think, in June or July of 2010. So, we're going to lose them sometime during 2012. I don't know whether it's going to be the first half of the year or the second half of the year. I'm guessing it's going to be around midyear when we lose them. So, that's something that we have in our budget and we're prepared for.

We're having conversations with potential tenants about either leasing space in that building -- we've also considered selling that building to a potential user. But it is difficult to get too far down the road with a tenant on that building, because, one, we don't know exactly when the FBI is moving out, and, two, it's a difficult building to get in. I mean, you've got to go -- you've got to be fingerprinted, you've got to be screened through the government security clearance in order to get in the building. So we can't take tenants through that -- potential prospects through that building on a daily basis.

But they'll still be paying rent through 2013, though?

No, they have a termination right. I mean, they -- I mean, this is a classic example of why the government will sometimes use termination rights. They knew they were looking for a build to suit opportunity when they renewed their lease in 2008. We entered into a five year lease with a two year -- with an option to terminate in the fourth or fifth year. So, we will expect them to exercise that termination right at some point.

Okay. But, going forward, do you think this is -- the trend is probably if you have -- if somebody is talking about building a new building, chances are they're probably just going to enter a five year extension or something to that effect? You don't see the threat of build to suits in this area -- as much of a threat as maybe it would have been, call it, seven to eight months ago?

Yes, I think that is the case. I mean, in fact, what we have read, and I believe there is legislation that was passed in the last 30 days, that suspended the build to suit program for the GSA. So, I think, until such time as Congress and the President can agree on where we're heading, unless it's an absolute need, there's not going to be money available for build to suit activity.

Okay.

Now, there's stuff in the pipeline that's been approved, and they're going to continue to work through that pipeline, but if there hasn't -- if it hasn't been approved by now, it's likely they're going to be held up.

Okay. Thank you.

You're welcome.

Our next question will come from the line of Brendan Maiorana of Wells Fargo. Please go ahead.

Thanks. Good afternoon. Question -- David, I think you mentioned that your dividend is pretty well covered, but when you think about all the leasing that is going to happen, just, on renewal and then, a little bit of back filling some of the move outs, do you think, as you look out over 2012, that you're still going to cover your dividend from a FAD perspective?

Yes, this is Mark. Yes, I believe that we'll continue to cover the dividend from a FAD basis. I mean, we do have some move outs. We've also, as Dave had mentioned, had some fairly significant rollups, and you combine that with the acquisition pipeline, we feel pretty good about the dividend.

Okay. So -- and, Mark, in terms of TIs and leasing commissions, you guys haven't done a whole lot of leasing, because you haven't had a whole lot of rollover in your portfolio over the past few years, but you are going to get more rollover now. And what do you think we should look for, in terms of a reasonable level of TIs and leasing commissions on a per square foot or per square foot per year basis?

Yes, that's a hard one, because, for example, at 625 Indiana Avenue, those prospectuses were approved a couple weeks ago as well. We're finalizing the leasing documents for those ten year renewals. We will have -- one of the things we're doing over there is the government has a day care in that building, and we're going to spend a little bit of money to help them refit the day care, so that TI dollar is going to be above average. That's probably going to be a $40 TI, because it's not a very big space, and it's some specialized improvements for them.

But normally, we would think that we're going to spend $10 a square foot for paint and carpet when we do a renewal with the government. You're going to spend more than that for a nongovernment tenant. So, on a quarter over quarter basis, it depends on the mix of government versus nongovernment tenants. It's going to depend on renewals versus new leases. And then, because we're small, you get somewhat of an odd renewal, like the GSA day care at 625 Indiana Avenue, and that can skew your numbers a little bit. So, it's really hard for us to give you perfect guidance on that.

Yes, understood. I'm just trying to look for a little bit of color, because relative to kind of the TIs and leasing commission's numbers that you guys have provided, or, the run rate that you've given, which has been very low, has been, call it, $3 million, $4 million, $5 million a year. It's certainly going to move up from there, it would seem, just based on the amount of leasing that you're going to do.

Yes. Yes, I would like to think that we can manage our TI number kind of in that -- somewhere between $1 and $1.50 per square foot per year on a renewal.

Okay. And then, this kind of brings me to my second question. I mean, just thinking about -- or, last question -- just thinking about it overall -- I mean, since you guys have had your IPO, which was back in first part of 2009, or middle of 2009, at the time, you had very little leverage, and you guys have done a good job acquiring assets, in line with, kind of, your stated objectives of cap rates, anyway, of 8% to 10%.

But, at the same time, looking back at what our expectations were for earnings back then, it was somewhere between $1.90 and $2 a share on a very low leveraged number. Now, as we're looking out, post this equity offering, thinking about everything that you've got in the hopper, in terms of new acquisitions that are coming online and where the leverage is going to be, which is still going to be moderate, but around, call it, 25% on a pro forma basis, it would seem like your FFO per share is actually lower, so -- or, at least, in line with kind of where we were expecting a couple of years ago.

I mean, what do you think you need to do to be able to grow earnings, if you are meeting your numbers from a renewal basis, you're meeting your numbers from an acquisition basis? Is there anything else that needs to happen to get FFO per share growth to be positive as you look out in '12 and '13 and beyond?

Well, I know when we went public, we -- I think we were pretty specific that we weren't going to be levered at 15% in perpetuity. That we had a desire to add equity to our Company, because we needed to increase our market cap. We needed to grow to a point where we could be investment grade rated.

And so, I think we've kind of done what we said we were going to do, which was, we were going to take the Company from low leverage to moderate leverage, and I think we're kind of in that moderate leverage range. We're at 20%, pro forma, for the equity offering, which gives us a fair amount of room to run to continue to acquire properties, issue some unsecured notes, add some long-term debt to our capital structure, which we haven't really done yet.

So, I think we continue to operate our business plan as is. We continue to make accretive acquisitions at cap rates in the 8% to 9% range, and we appropriately manage our balance sheet and capital structure. I don't know. Mark, do you have anything else you would add to that?

No, I think that sums it up. Obviously, there is some tradeoff in FFO per share of growth for stability, from a balance sheet perspective, and that's the part we need to focus on managing to make certain that we have the right balance of stability and FFO per share of growth going forward.

No. Understood. Okay. I'm just -- so, as you guys look out, you think that the acquisitions that you do and the -- understanding that you're going to grow the Company further, and you're going to probably manage your balance sheet to have leverage. That's -- say, it's at 25% or 30%, somewhere around there. But you think the acquisitions that you do, on a per share basis, will be additive if you look at FFO and FAD growth over the next couple of years?

I think, on a long-term basis -- I mean, we're not running this Company on a quarterly basis. We're running this to create long-term shareholder equity -- or, value and to provide a safe dividend to our investors. So, yes, I think the answer is we do think it will be -- they will be accretive on a long-term basis.

Okay. Thank you.

Yes.

Our next question will come from the line of Jamie Feldman of Bank of America. Please go ahead.

Thank you. Good afternoon. So, back to the discussion of your 2012 rollover, can you just give us a sense of where you think the rental spreads will be? Like, what's the -- what are your latest thoughts on 20 Massachusetts Avenue, assuming they renew?

Yes, I think what we said was we're expecting somewhere between $10 and $14 a square foot increase at that property.

And what is the current rent?

They're currently paying $36 a square foot.

Okay.

So it goes anywhere from, say, $46 to $50 a square foot.

And then, what do you think your TIs will be?

I would guess our TIs are going to be between $10 and $20 a foot for a ten year renewal.

Meaning it's a ten year?

Yes.

Okay. And then, in terms of Fresno, are you still thinking down slightly?

Yes. (inaudible - multiple speakers) change with Fresno.

With what amount?

With no TI.

Yes. No TI. We'll have a lease commission there, but we won't have any tenant improvement dollars.

So, how -- what do you think the rental spread will be, on a percentage basis?

Well, I think what we've said is we think it's going to roll down, maybe, $0.50 a foot.

Off of what rent?

Off of $16.65.

Okay. So you get down to, like, $16 a foot?

Yes.

And then, what's the process here? So, you said it's approved. It's sitting in the House for several months now. What if it -- what if the lease comes due, and it isn't approved? Do they just keep paying the same rent, or does it go in --?

Right. They pay -- they keep -- they stay in occupancy. They pay the same rent until we get an approval.

And you get the cash rent, or do you get an IRU?

No, they're -- they pay us rent.

Okay.

They pay us -- they have an obligation to continue to pay the same rental rate that they're currently paying until such time that they vacate, or we enter into a new lease.

Okay. And then, Lakewood, Colorado, you said, is the next largest? Assuming they renew, what do you think the spread could be there?

I think that the spread will be up slightly there. That was one where I was concerned we might have a roll down, but I think we may go up slightly, and I couldn't tell you whether that means is it 2%, is it 5%, or is it 10%, but I think it will be up slightly.

Okay. I guess what I'm getting at -- so, your biggest chunk is this 8% of revenue, which is 20 Massachusetts Avenue, but you've got, I think, 27% of your revenue rolling next year. [I mean] -- I guess I'm like, the remaining 19%. What do you think the leasing spread is there?

I think that on -- I think, on average, our rents with government tenants are below market, and we're going to roll up. I think that 2012 should be a very good year for us, because 20 Mass Avenue is, I think, our second largest contributor to rental revenue, and we're going to have a pretty dramatic rollup there. So I expect that we're going to have a pretty good year next year with our rollups.

Right. So, if you back out 20 Massachusetts Avenue, think about the remaining 20% expiring next year, would you say those are up -- that those are flat, those are up 5%, those are up 10%?

I think they're up, Jamie. I don't know that I can necessarily definitively say if it's 5% or 10%, but I think it's up.

Okay. And then, how should we think about the -- either the remaining '11, or even, the '12 roll? What percentage of those are year to year?

We have one tenant in our portfolio that is on a month to month lease. That's the VA in Boston, which, I think, represents less than 1%.

About 85 basis points.

Yes. So it's less than 1% of [all of our] rents.

And then, everything else is multiyear?

That's correct.

Okay. And then, of the remaining 20%, we went through -- you went through Mass Ave, you went through Lakewood, you went through the [FDA] -- FBI, and then, FDA and FBI. What's the remaining -- I mean, it still looks like you've got, maybe, 15% of your NOI coming due next year. Those are all just kind of relatively small leases?

Yes, we have 14% of our revenue, I think, rolls in 2012. We have what -- I think we have three -- I think we have four tenants that represent 1% or more of our revenue, and then, it's all relatively small.

Okay. And then, if you go to page 23 of the supplemental, and you look at all the different organizations or agencies --?

Yes.

As you guys have been listening to everything going on in Washington, which of those will, like, raise the most concern to you, based on the conversations we're all watching here?

Yes, I don't -- honestly, none of these really give me tremendous amount of concern from a budget perspective. I think if I was a defense contractor, or I leased to a lot of defense contractors, I would be concerned, because, as I said earlier on the call, when I talked about the percentage of growth in the budget relative to the decline in federal employment, the growth in our budget has been entitlements, and it has been defense spending, and that defense spending has mostly been outsourced to the defense contractors. It's not growing by hiring more people and building more tanks and things like that.

So, I don't think that, as an example, Social Security Administration is going to see a dramatic decline in employment. The Internal Revenue Service is not going to see a dramatic decline in employment. Department of Justice is not going to probably see a decline in employment. So I feel very good about our list of agencies that we currently have relationships with.

Which makes sense, but then, I guess, if you think about this list, which ones are most ripe for a BRAC realignment or -- I mean, it's one thing to not lose jobs. It's another thing to change where you're located if the government decides to rationalize real estate.

True. And we have one tenant in our portfolio that has been subject to the BRAC realignment. Defense Information Services, which is leased through 2014 -- they're in our building in Falls Church, Virginia. They have moved out, and they continue to pay us rent. And we've talked about that on numerous occasions, both in meetings with analysts, as well as on earnings calls. So, no real change there.

Okay. And then, what about the -- on the state side? As it starts to push down to the states?

States -- as I said previously, I continue to be concerned about South Carolina. South Carolina has publicly said that, to the best of their ability, they would like to move agencies out of lease space into owned space. I believe that we will have some potential loss of tenants as a result of that, but I think our exposure to the state of South Carolina is less than 1% of our rental income. But that's the state that gives me the most pause.

I mean, as I look at California, we've got essential agencies and headquarter buildings for those agencies that occupy space. Massachusetts, same kind of thing. We've got headquarters and essential agencies. Minnesota -- we've got the Lottery Control Board. Maryland -- we just executed a five year renewal with the state of Maryland two years before the lease matured. So we've got seven years remaining on that lease. So I think we're in pretty good shape with our state tenants.

Okay. And then, how many of the state tenants have the right to break leases if they shut down the group?

Massachusetts has appropriations clauses, so if they decide to shut down the Department of Education, they could terminate a lease. Minnesota has appropriations risk, so if they decide to close the lottery, they could move. I think -- Maryland?

Maryland may. Jersey has to --

New Jersey. New Jersey has appropriations, but they have to basically decide they're not going to appropriate any lease that they have across the state. So, California does not have any appropriations language in our leases. So I think we're okay.

Okay. And then, there's none on the federal side, right?

Yes, we don't have any appropriations language in our federal leases.

Okay. All right. Thank you.

You're welcome.

Our next question will come from the line of Jon Petersen of Jefferies. Please go ahead.

Oh, thank you. Actually, most of my questions have been answered. Actually, I just wanted to get just an extra thought. You talked about the cuts in government spending, I guess, to a certain extent, scaring some landlords and putting their buildings on the markets. Does that mean you're seeing an increase in cap rate?

No, I don't necessarily say we've seen an increase in cap rates from that. There continues to be healthy competition out there to buy buildings. So, no, I think cap rates -- we've actually seen, probably, a slight compression in cap rates from 2000 -- from late 2009 to where we are today, but it's been modest.

And then, I just wanted to ask one question on operating margins. If I look back at the last couple years, 2009, 2010, you were in the 65 percentish range, and in the first couple quarters of this year, you've been around 62%, 63%. I was kind of wanting to get some color from you guys on what's driving down the operating margins and whether you expect them to rebound in the second half of the year.

I think the margins were driven down, really, on some of the acquisition activity in the third and fourth quarter of last year, where we acquired buildings that had about 240,000 square feet of vacancy. So, as we lease that vacant space, we would hope to see the margins come back some.

Okay. And I guess, maybe, if you could just piggyback on that, if you guys could give a little color on how the showing is going in that vacant space and kind of what you expect, in terms of leasing it up and where the demand is coming from.

Yes, we're actually getting pretty decent visibility with some of the vacancy. We're -- we have a number of showings. We've actually leased some space in Minneapolis. We've leased some space in Memphis, so we're making some progress, albeit slow, but we are making some progress.

Okay. Thank you.

Remember, too, we didn't underwrite -- we didn't ascribe value to that vacant space when we bought those buildings.

Right.

We only ascribe value to the occupied space, so it's all upside to us.

Right. Okay. Thank you. Appreciate it.

Yes.

Our next question will come from the line of Patrick Brennan of RBO Asset Management. Please go ahead.

Hello.

Hey, Patrick.

I just wanted to follow up on an earlier question, where we were talking about, sort of, funds available for distribution on a per share basis, and you kind of make the point that as you -- you think about that number, and you built it up on a safe basis on the balance sheet, and so that required issuing equity, which has been the reason that the metrics been -- have been pressured a bit. So, I guess my question is as you go forward, and as -- it sounds like you're pretty confident about your portfolio, but maybe, as investors' perceptions about risks that may or may not be relevant in your business persist, how do you think about the portfolio -- growing the portfolio when you potentially have to issue equity at the -- not the most opportune time?

I mean, do you think, over the next couple years, if you see a little pressure in your stock, you can slow it down, you're -- do you just sort of say the opportunity you have at these yields is such that we're going to press forward, even if that means issuing equity at prices that we're not crazy about? How do you balance that, because I assume that part of the equation, where you actually would have to price these future offerings, is really going to be quite relevant as to whether you can get the accretion on a per share basis? Thanks.

Yes. No, I agree. You're right. Where we issue equity has a lot to do with the level of accretion on our acquisitions. We've been careful to make sure, as we've issued equity, we've issued at higher prices than where we've issued before. So -- and I think that will continue to be a focus for our Company.

We made the decision to issue equity in July instead of going to the bond market, mostly because we had been telling the market that our intent is to run the Company with leverage in the -- kind of, the 30% to 40% range. And we had found ourselves at a period, when we looked at all of the acquisition opportunities that we had, we were going to be above our targeted range, and we didn't think it was prudent for our management of the Company and for our shareholders to basically go above our targeted range by issuing debt and have the world know that we had to raise equity, because that's never a position that you want to find yourself in, whereas, you have to raise equity in order to execute your business plan. So we spent a lot of time looking at the market, trying to make sure that we thought we could issue at a price that would be acceptable on a long-term basis.

But I think you're right, Patrick, that we always have to make that assessment that are we issuing equity on a long-term accretive basis, or does it make sense not to make that next acquisition? But we felt, based upon what we had in the pipeline and the pricing of those acquisitions in the pipeline, relative to where we thought we could raise equity, that it made sense in kind of a match funding scenario on a long-term basis, and we'll have to make that assessment every time we consider whether it makes sense to go back to the equity markets or potentially slow down acquisitions.

Great. Thanks.

Yes.

And our last question in queue comes from the line of Dan Donlan of Janney Capital Markets. Please go ahead.

Thanks. Just real quick here on the Henry M. Jackson and the FBI space. How much square footage are -- is both of those spaces?

Let's see. FBI is --

99,000 square feet?

97,000 square feet. Henry M. Jackson is 69,000.

And what is the cost of carry, you think, of both those buildings, if -- when and if they go vacant?

Yes. FBI is a -- it's a single tenant building, so our cost of carry is going to be real estate taxes, utilities, to kind of keep the lights on. We're going to have, obviously, a little bit of landscaping, although it's CBD property, so it's not a lot of landscaping. I would guess our operating expenses would go down somewhere between a half and two-thirds for that -- well, probably more like a half, because property taxes will be significant.

And then, on Henry M. Jackson, that's -- they're a -- they're probably what -- 20% of the building, so we'd still have property taxes shared amongst a larger group of tenants. So, the carry there is not going to be nearly as significant as it will be at FBI.

So, can we quantify the FBI then? I mean, are we talking, like, $8.00, $9.00 a square foot?

I would say -- and this is a guess, Dan.

Yes.

This is my best guess. Your cost to carry for the FBI is going to probably be more like $4 to $5 a foot.

Okay.

And I would say, on Henry M. Jackson, it's probably more like $2 to $3.

Okay. Your best guess is going to be better than mine, so --

Well, it's a little bit of a wag.

Thanks.

I would now like to turn the conference back over to Mr. David Blackman for any closing remarks.

Thank you all for joining us on our second quarter conference call. We plan to attend the Bank of America Merrill Lynch Global Real Estate Conference in New York in September and hope to see some of you while we are there. Thank you.

Ladies and gentlemen, that does conclude our conference call for today. Today's conference will be available for replay from August 2 at 3.00 p.m. Eastern Time until August 9, midnight of that day. You may access that conference by dialing 1-800-475-6701 and entering the access code 179321. Once again, that dial in number is 1-800-475-6701, and the access code is 179321. On behalf of today's host and family, I'd like to thank you for your participation in today's conference call, and thank you for using AT&T. Have a wonderful day. You may now disconnect.