Piedmont Realty Trust Inc (PDM) 2010 Q2 法說會逐字稿

Greetings and welcome to the Piedmont Office Realty Trust second-quarter 2010 earnings conference call. At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Bobby Bowers. Thank you, Mr. Bowers, you may begin.

Good morning. This is Bobby Bowers, the CFO for Piedmont Office Realty Trust. Welcome to our second-quarter 2010 conference call.

In addition to our press release distributed last night, we have also filed our June 30, 2010, Form 10-Q and furnished our unaudited quarterly supplemental information to the SEC. This information is also available for your review on our website at www.piedmontreit.com under the investor relations section.

On today's call, the Company's prepared remarks and answers to your questions will contain forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements address matters which are subject to risk and uncertainties that may cause actual results to differ from those discussed today. Examples of forward-looking statements include those related to Piedmont Office Realty Trust's revenues and operating income, financial guidance, as well as leasing and acquisition activity.

In addition, during this call we will refer to non-GAAP financial measures such as funds from operations, core FFO, AFFO, and EBITDA. We encourage all of our listeners to review the more detailed discussion related to risks associated with forward-looking statements contained in the Company's filings with the SEC and the definitions and reconciliations of our non-GAAP measures contained in the supplemental financial information available on the Company's website. You should not place any undue reliance on any of these forward-looking statements, since those statements speak only as of the date they are made.

I will now turn the call over to Don Miller, the Chief Executive Officer of Piedmont Office Realty Trust.

Good morning. I too welcome you to the second-quarter 2010 conference call. We will review our second-quarter results with you and then take questions after our prepared remarks. Bobby Bowers will discuss our financial results in detail. And Bo Reddic, our EVP of Real Estate Operations; Ray Owens, our EVP of Capital Markets; and Laura Moon, our Chief Accounting Officer, are here with us to provide additional perspective during the Q&A portion of our call.

This is our second earnings call as a publicly traded company. To review quickly for those of you who are new to our Company, Piedmont specializes in the acquisition and management of primarily high-quality Class A office buildings located predominantly in the 10 largest US office markets.

Our office portfolio consists of 73 buildings totaling 20.2 million square feet. These properties are located primarily in central business district and urban infill markets in the larger MSAs such as Boston, New York, Washington, DC, Chicago, and Los Angeles, among others.

The properties are predominately multitenant and are leased principally to high credit quality tenants. Over 80% of our tenants have investment-grade ratings or are nationally recognized agencies organizations such as Blue Cross Blue Shield and Harvard University. As of the end of the quarter our average lease size was over 40,000 square feet, and we had an average lease term remaining of 6.0 years.

Another element of our core operating philosophy has been to maintain a low leverage balance sheet. Our debt to gross assets ratio of 26.7% at June 30 is among the lowest in the public office REIT space.

Piedmont is rated as an investment-grade company by Standard & Poor's and Moody's, with Moody's raising our rating in April 2010 to Baa2. We attribute this largely to the quality of our properties, the credit strength of the tenants, the length of the average lease term, and our policy of maintaining low leverage.

Now let's turn to the quarter. For the second-quarter 2010 we slightly exceeded our expectations, with $0.38 per share in core FFO and $0.30 per share in AFFO. As we discussed on our conference call in May, during the second quarter we took a one-time impairment charge of $9.6 million related to the upcoming sale of our 111 Sylvan Avenue property located in Englewood Cliffs, New Jersey. We are very pleased with the timing of this transaction, as the sale will be consummated at a time when the lease for the entire 410,000 square-foot property is expiring and the existing tenant was only interested in a short-term renewal on a portion of the square footage.

The acquirer of the property is a major international firm which plans to build its US headquarters on the site. This sale allows us the opportunity to deploy capital away from an aging, nonstrategic asset into assets which should enhance our portfolio in terms of aging, quality, and add to the long-term earnings potential.

I would like to speak a bit about our leasing and markets before I turn it back over to Bobby for details on the financials. There has appeared to be some momentum in the office leasing market during the past quarter. Clearly we have seen tenant leasing executives and their agents move from the prevalent 2009 mindset of avoiding leasing decisions to a willingness now to enter into long-term negotiations for space and the consideration of expansion.

For the quarter, we executed 870,000 square feet of leasing, 557,000 square feet of which were office space transactions, an increase over 180,000 square feet of office leasing executed during the first quarter of 2010. These leases were primarily located in the Boston, Massachusetts, and Dallas, Texas, markets.

Of our $600 million of annual lease revenues, we now have only 3.6% of our lease revenues related to leases still expiring in 2010. Although the near-term leasing situation remains challenging, we have been able to achieve a 78% retention rate on expiring leases during the first six months of the year.

I briefly want to touch upon a few particular markets and update you on our leasing activity.

First the Boston, Massachusetts, market. At present only 4% of our annualized lease revenues come from this market. We plan, however, to expand this market. As we have announced this quarter, we opened a regional office in Boston and have hired a gentleman named Paul Newman who has over 20 years of property and asset management experience in the market to lead our Boston office.

We made noticeable progress in this quarter -- in the market during this quarter, executing new and renewal leases that totaled 380,000 square feet. We executed a 235,000 square-foot lease extension for 10 years with one of our existing tenants, State Street Bank, at our building located at 1200 Crown Colony Drive in Quincy.

Additionally Advanced Micro Devices, AMD, expanded its space by 22,000 square feet for a five-year term and extended its primary lease of 111,000 square feet for an additional two years at 90 Central in Boxborough, Massachusetts. This brings our 600,000 square-foot Boston portfolio to 96% occupancy.

In Dallas, Texas, currently we have 6% of our portfolio located there and that portfolio is 91% leased. We have seen a downturn in effective rents as a result of both concessions and lower face rates on leases in that market.

Having said that, there has been a good deal of leasing interest in this market, and we've been fortunate enough to sign several lease transactions in Dallas during the second quarter of 2010. First, we signed a lease renewal with Equifax for 13,000 square feet through year 2015 at our Las Colinas Corporate Center buildings. We were also able to complete two new long-term leases with Oracle and National Semiconductor Corporation for a total of 72,000 square feet at our 6031 Connection Drive property.

Washington, DC, is the third market I would like to talk about. It's the second-largest office market that currently represents 20% of our annualized lease revenues. This market is probably our strongest potential leasing opportunity.

We have over 3 million square feet in the Washington, DC, area, with virtually all of our properties located on or inside the Beltway. We have outstanding tenants in this market including Lockheed Martin, IBM, and numerous government agencies such as NASA, FDA, the National Park Service, and the Department of Defense.

Importantly, rental rates are holding up well in this market. Our largest lease renewing in 2010 is in Washington for 323,000 square feet to the Office of Comptroller of the Currency at One Independence Square. We are currently in active discussions for renewal with this banking regulator.

In addition to our renewal leasing activity, our primary growth opportunity is in the DC market at Piedmont Pointe, where we have two recently completed buildings in North Bethesda, Maryland. Although we have not completed any lease transactions at the building, activity has picked up in Maryland and we remain hopeful that leases may be completed in the foreseeable future.

Let me tell everybody again that we provide a leasing update report for leases expiring in 2010 and 2011 in our quarterly supplemental information. This update covers all leases representing 1% or more of our annualized lease revenue.

In summary, we have relatively few lease expirations in 2010, but we do have higher expirations in years 2011 and '12. These higher expirations are mitigated by the fact that the largest expiring leases in both years are located in Washington and represented by US governmental agencies. We're optimistic that we will retain the government tenants in our portfolio, given our high historical government tenant retention rate.

Regarding overall leasing activity, we remain cautious for Piedmont and for the office leasing sector. How quickly the economy recovers will dictate the near and midterm prospects.

The leasing activity pipeline has been strong for the second quarter of 2010, but we have seen some slowdown in the past month or so. Whether this is the typical seasonal summer slowdown or related to broader economic concerns is still too early to tell.

That said, we are very well positioned to capitalize upon the distress of others. While we still see a premium being required to acquire stabilized properties located in our core concentration markets, we believe there will be re-capitalization opportunities for well-capitalized buyers such as Piedmont, whether for one-off transactions or at a portfolio level.

Five years ago we began a process to transition from a cash income driven portfolio into a premiere office property portfolio located primarily in high barrier to entry markets. During that period, we have sold 36 properties and exited 16 non-concentration markets.

Today, 71% of lease revenues are from our properties located in CBD or urban infill areas; and almost 50% of our annual lease revenues are derived from our properties located in our four concentration markets, Boston, New York, Washington, and Los Angeles.

Our goal is to have 60% to 70% of our annualized lease revenues derived from these concentration markets, while continuing to opportunistically capture attractive returns from select non-concentration markets such as Atlanta, Chicago, Dallas, Minneapolis, and Phoenix. This process is expected to continue for the next several years.

We announced this quarter that we have one older nonstrategic building under a binding $55 million sales contract and that we expect to close the sale of that in December.

In conjunction with our filings last night, we announced the acquisition of two buildings totaling 384,000 square feet at Meridian Crossings in Minneapolis for approximately $66 million. This acquisition fits into our investment strategy extremely well.

We are acquiring high-quality, Class A assets at a material discount to replacement cost and substantially leased on a long-term basis to an investment-grade company, US Bank, with whom we have a great corporate relationship. After the lease begins, we will be earning an average 8.9% FFO yield and an 8.75% AFFO return over the life of the lease, while growing our desirable Minneapolis platform.

As I have said, the combination of strong yield, low basis, and quality tenants and buildings fit our long-term investment strategy extremely well. However, these characteristics also give us the optionality to consider a shorter-term hold period.

Our industry still has its challenges, but we are enthusiastic about our competitive position, our quality tenants, properties, and the purchasing power we have within this industry. With that, I would like to turn it back over to Bobby to cover in more detail our financial results during the quarter.

Thanks, Don. We reported our second-quarter 2010 earnings last night. Again, our earnings release and our quarterly supplemental information are available on our website for your review.

When doing your per-share analysis and comparisons with previous periods, I want to point out that the results for the quarter and for prior periods reflect the January 2010 stockholder-approved recapitalization of Piedmont's equity into four classes of common stock and an offering in February of 13.8 million additional shares of Class A common stock.

As you can see in our earnings release, in the second quarter of 2010, Piedmont's net income available to common stockholders was $19.6 million or $0.11 per diluted share. FFO totaled $56.6 million or $0.33 per diluted share, including a $0.05 per share impairment charge for the sale of the 111 Sylvan Avenue property. Excluding this charge, our core FFO was in line with expectation at $0.38 per share; and AFFO was $52 million or $0.30 per diluted share.

Revenues for the quarter ended June 30, 2010, totaled $145.2 million compared to $148 million in the previous year. This decline in revenues reflects a 30 basis point decrease in occupancy from 90.1% a year ago to 89.8% at June 30 of this year. The decrease in revenue this quarter also reflects lower reimbursable operating costs, utility charges, and bill backs.

Our cash basis, same-store NOI of $87.6 million is in line with our expectation and reflects a decline of $1.6 million or 1.9% from a year ago due primarily to the partial exit by Kirkland & Ellis of 99,000 square feet in the Aon Center at the beginning of this year, and also free rent abatement associate with the lease renewal for Comcast at Windy Point I in Chicago.

Looking at our leasing activity, we signed 33 leases during the first six months of 2010 representing 1.2 million square feet. Of these signed leases, approximately 570,000 square feet represented office space that had been leased during the previous 12 months.

We use these leases or the subset of leases for our rental rate roll-forward analysis. While these renewals are only a very small percentage of our total square footage, and the rent rollups and rental rolldowns are certainly dependent upon specific leasing markets, it does provide a good indication of our overall leasing environment.

In summary, the economy and competition have driven recent rent renewal rates down. With the exception of one significant 10-year lease renewal for 235,000 square feet in Boston, our average rent rolldowns on a GAAP and cash basis are 6% and 10%, respectively, thus far this year.

Looking at our expenses, our property operating costs year-to-date have come in lower than our expectation. These operating expenses are lower when compared to last year due to various cost control measures, lower utility charges, and lower property taxes.

Despite being in line with last year, I am a bit disappointed however in our G&A expenses because we thought these costs would be lower this quarter due to insurance recoveries for legal expenses. However, our transfer agent expenses have been much higher due to fees for our four classes of common stock and the transfer charges, as our shareholders have converted into Street name accounts. We anticipate this to be a temporary effect, however, as all of our common shares convert to Class A shares by January 2011.

Focusing on our balance sheet, our current $1.4 billion of total debt to gross assets leverage ratio is well under 30%. Not included in this $1.4 billion of debt is a $500 million line of credit that is currently unused and is priced at 47.5 basis points over LIBOR, which is effectively less than a 1% interest rate today. We can extend this credit facility through August 2012.

The $1.4 billion of debt does include a $250 million unsecured term loan. We have exercised our right to a one-year extension through June 2011 on this unsecured term loan. We entered into forward rate swaps with our lenders which effectively lock our interest rate on this one-year extension at 2.36% for the period July 2010 through June 2011.

The balance of our outstanding debt, about $1.2 billion, is secured debt with an average interest rate of 5.2%. There are no significant maturities on this secured debt until 2014.

We easily meet all of our debt coverage requirements, and the Company has a very strong fixed charge coverage and interest coverage ratios compared to our EBITDA, at about 4.5 times coverage.

We have previously discussed potential capital commitments that Piedmont is contractually obligated to provide. These obligations are related to our leasing activities and tenant improvement commitments, which are not reflected on our balance sheet. Tenant needs often dictate the timing of these capital expenditures and whether all the funds are actually spent.

At the end of June 2010, total capital commitments which may be drawn upon by tenants were $112.4 million, down from $118 million at the end of last quarter. Two large lease concession packages in Chicago make up 60% of these commitments.

Marketwide, tenant concessions have increased for office leases executed during 2010. Further, some tenants are asking for greater flexibility as to the usage of these concessions, such as where these concessions can be used, not just for tenant improvements but also at their discretion for rent abatements.

Having this discretion can impact an office REIT's cash flow forecast and requires us to include the concessions on our balance sheet and in our straight-line rent calculations. The positive corollary is that tenant improvements and leasing commissions have totaled only $3.13 per square foot per year of lease term, which is a little bit lower cost per square foot per year of lease term than we have seen in recent years.

Next I would like to discuss our outlook for the remainder of 2010. We remain comfortable with our previously issued guidance.

Given our low lease turnover this year, a majority of which is rolling not until the fourth quarter of this year, we have a fairly stable same-store NOI forecast in the $355 million to $365 million range. I will remind you that we focus as a management team on annual results and that our individual quarters can fluctuate on both a cash and accrual basis, due to the timing of repairs and maintenance, capital expenditures, and one-time revenue or expense items.

Finally, we have had a few events happen subsequent to the end of the quarter that I would like to briefly review. During the Board meeting held yesterday, the Board declared a $0.315 per share quarterly dividend to stockholders of record on September 15 and payable on September 22, 2010.

On August 9, approximately 39.7 million Class B-1 shares converted into Class A common shares, which are traded on the New York Stock Exchange. That brings the total Class A shares outstanding to approximately 93 million shares today.

Also, related to our mezzanine debt receivable, August 9 was the maturity date for the loan secured by the 500 West Monroe building. As of now, borrowers of those loans have not exercised their extension rights, and Piedmont has therefore exercised its right to extend the mortgage loan and the first priority mezzanine loan. We are now considering our options relative to the collateral.

Finally, as Don mentioned, we have executed this month an agreement to purchase two buildings at Meridian Crossings in Minneapolis. This transaction is not expected to close until the fourth quarter.

That concludes my comments. We can open up the line for questions. I ask that you try to ask only one question so that we can address as many callers as possible.

Operator, will you please explain how our listeners can ask their questions? Thank you

(Operator Instructions) Anthony Paolone, JPMorgan Chase.

Good morning, guys. It's Sarah King here for Tony. Just regarding deal flow and your acquisition pipeline, you touched on this. I think, Don, you touched on this a little bit earlier.

But could you give us some more color there really, what you are seeing and if anything has changed since we talked at NAREIT? I believe you were seeing a lot of bigger portfolio deals or potential REIT IPOs or et cetera that you were considering or at least looking at.

Hey, Sarah. I will start and Ray Owens may want to get something to that. I think deal flows continue to be pretty consistent through the course of the year. I would say it may have slowed a little bit in the summer, but that is very typical. In fact, it may even have slowed a little less than we sometimes see.

We're hearing that the flow is going to stay fairly strong in the third and fourth quarters. I am really talking about brokerage, package kind of deals, one-off kind of transactions.

We are also still seeing and reviewing a fair number of opportunities that are related to larger, more strategic things as we have talked about in the past, whether they be companies thinking about trying to become public themselves, or other public entities that we think could be a strategic fit, or otherwise. So we continue to review those opportunities as well.

Obviously, those are always complicated, take a long time, and have a low probability of success. But we are seeing a lot of that activity still today, yes.

And I think. This is Ray Owens. Hi, Sarah. We also are monitoring very carefully, seeing some things in the press regarding CMBS loans, defaults starting to increase. You're starting to see some stress -- more stress -- in the mezzanine financing area.

So we are starting to believe that down the road, probably starting next year as some of these maturities in the CMBS market start happening, that may push more quality product out into the marketplace. So we're monitoring that very carefully.

Okay. That's helpful. Thank you.

Dave Rodgers, RBC Capital Markets.

Yes, hey. Good morning, guys. Don, as a follow-up to that question, I guess when you look at your acquisitions out there, how comfortable are you? What is your bandwidth for investing in some of the opportunistic versus core markets near-term? Do you have any targets that you would like to stay within as you move to those core markets longer term?

Can you give us some color also on your underwriting criteria today and what you are looking at in terms of maybe cap rate compression in the core versus opportunistic markets that gets you comfortable in deploying capital today?

Okay, hey, Dave. Wow, a lot of questions there. Let me see if I can -- I will start with the first one and see, maybe have you follow up.

We are seeing a fair amount of interesting opportunities in the opportunistic markets as compared to core. Because, as we have been commenting on, I think there is -- if it is not a historically wide spread in yields between core or concentration markets and opportunistic markets, it is certainly one of the wider spreads I have seen in my career. And it's been a bit frustrating for us because, as we have been looking at opportunities on the Coasts, we are really not seeing the kind of yield opportunities that we think makes sense for us from a concentration market standpoint.

So as we have always said, one of the challenges we are going to have in making our long-term commitments work on the move from opportunistic to concentration markets, moving that percentage up, is obviously there is going to be fits and starts in that process. And we're going to take a step back and then hopefully two steps forward.

So right now the Minneapolis deal is a reflection of the fact that we're seeing very interesting yield at a very good basis in an asset like that. Where we have been chasing things in San Francisco, Washington, New York, and even Boston, we have seen much, much more aggressive yields, to the extent we just can't justify them at our cost of capital.

So I think from a high-level standpoint, the environment right now is a little frustrating from a concentration market standpoint. We are starting to see more and more interesting opportunities in the opportunistic markets, but obviously we don't want to just load up in a direction opposite of what we promised.

Okay, great. Thank you.

Is there any follow-up that would help you on that?

Yes, I guess in terms of the criteria. You talked about your cost of capital and maybe the spreads. I don't know if you can give us a sense of where the spread might be between your cost of capital and what you're looking at on the Coasts, versus what you're seeing in the opportunistic markets that you mentioned.

Yes, I will just give you a real-life example. As we mentioned, our yields out of the Minneapolis project -- after the end of the free rent period burns off -- tend to be upper 8s on the Minneapolis transaction. We are looking at comparable transactions or comparable real estate in the concentration or core markets being at least 200 to 300 basis points less than that and probably in the upper end of that range.

Okay. That helps. Thank you.

John Guinee, Stifel Nicolaus.

Hi, I had another one, but you brought up a very good point. When you went -- if you look at Minneapolis, as you well know, the way the game is often played by owners is they will give a big slug of free rent or give a big TI package in order to get that face rate up, and then convince the buyer that it's really market rate. And then they cap that market, that rent; and the net result is they pay a very, very full price on a per square foot basis.

Can you kind of walk through the deal in Minneapolis in terms of if you straightline or if you adjusted for the free rent to get an effective, and then compare the $1.72 a square foot to replacement cost?

Okay. Let me see if I can try to take your first one. I may not have the exact numbers on your first one, John. But I think if you look at it you say, all right, they start -- the rent starts in the low teens. And with a free rent period it had some very strong steps in rent over a long period of time. So as a result the effective rent is still below what we think is certainly a more stabilized market rent in that market, but even probably below what we would say is a more stabilized market rent in today's environment in Minneapolis.

So we felt like part of the attraction to us on this transaction is -- you're right. Typically for a building that has a lot of credit and term on it you typically have to pay up in terms of your basis. I think we have been consistent in saying that those are not the kind of deals we are going to chase. On the alternative, we are going to chase deals that have been rented more recently at much lower rents, so that when we do capitalize the income stream we are able to get a higher yield on a relatively reasonable basis.

So at $170 a square foot, we think we are orders of magnitude below replacement cost, which is probably at least $2.25 a foot, and you could argue maybe a little higher than that.

How many floors? And is there structured parking or below-grade parking on this asset?

Yes, the buildings are 10-story, Ray?

Eight-story.

Eight-story.

And it does have both structured parking and it has some underground parking in it (inaudible).

And the parking ratio is actually 4.8 per 1,0000. So that certainly would drive up your replacement cost as well.

Great, all right. Thank you very much.

Brendan Maiorana, Wells Fargo.

Yes, good morning. It's here Young Ku here for Brendan. Got a question regarding your OCC lease that is set to mature in 2011.

Could we get some more color on some of the concession packages that you guys might have to give out to renew this lease? And whether there might be any additional extra space around that area, where the tenant might move to. And if you were to renew, whether that rent would roll up or roll down.

Without trying to get into issues of competitive detail on a particular transaction, let me step back from a higher perspective and say the Office of the Comptroller of the Currency as you know has been going through -- like many of the other financial entities out there -- an impact from the regulations that have been recently passed by Congress. As a result there is going to be some changes to their business model over time.

Having said that, I think that they have issues of uncertainty as it relates to their going-forward process, which may actually benefit us in the long run as they try to figure out how much term and where they may want to go. So as a result, we don't have as much certainty as I would like to be able to give you on what they think their longer-term plans are.

But I think at least in the interim we feel very good about a near- to intermediate-term renewal, just -- if for no other reason -- the uncertainty that they have. And typically a near- to intermediate-term renewal would probably have much lower capital costs associated with them.

Rent roll down, rent roll up, without getting too specific, I think typically in Washington, DC, on our government leases we have been doing pretty well relative to our corporate tenants on a rolldown, rollup scenario. So quite often when you see a lot of government leases in our lease profile you will see better numbers on that than you will see on the corporate side.

And in terms of a competing space, are there any big blocks of space that may be able to accommodate them?

Actually there was until just very recently one very large space down the street at a project called Constitution Center. There had been extensive rumors in the market that the Department of Homeland Security might take the entire million square feet in that building.

As it turns out somebody did take nearly the entire square footage in the building, but it turned out it was the SEC, not Department of Homeland Security. And that is by far the biggest block of space available in the Southwest submarket.

The real competition for blocks of space in downtown DC for us right now are a few in the East End, which would be very, very expensive options for the federal government. And then, obviously up on NoMa area there are still some new buildings delivering that would be more competitive with what we would be able to offer.

Great. Thank you.

John Stewart, Green Street Advisors.

Don, I know you touched on Minneapolis in response to a couple questions. But as far as the market strategy goes I wanted to post the flip side of the question and ask -- rather than immediately hitting your concentration markets what, I guess, is preventing you from executing on exiting some of your -- the markets that you don't plan to be in for the long term?

Why is this the best use of capital and acquisition/disposition energy at this point?

Yes, John, I think the simple answer to that is although we are seeing pretty nice movement in pricing in all markets right now -- and we have talked about that before on a bigger picture basis. For example, the Chicago transaction that everybody has been talking about at $500 a square foot.

So there is certainly starting to be some spillover of pricing from the Coasts into our more opportunistic markets. But I am not sure we have seen enough of that and have it gone far enough that it meets the hurdles or the thresholds that we would like to achieve on our exit in some of those assets.

We are actively talking to or pursuing certain of those situations, as we have consistently said. And when we feel like the right deal has come along we are going to jump on it.

We don't feel like market pricing is about to turn around and move back in another direction. If we are wrong obviously we will have potentially missed a little bit of a window here. But I think overall, we are pretty confident that pricing is going to stay or actually improve in some of those opportunistic markets as we see people getting impatient -- as we are -- with the pricing on the Coasts.

Okay. How long is the free rent on the deal? And what sort of bumps are entailed in the lease?

We've got -- I will give you the front-end of that and somebody else here may be able to give me the specifics. But the deal actually starts, commences in February of 2011, and we are not anticipating closing until fourth quarter of this year.

The deal then has 10 months of free rent on it. It starts in the low to mid teens, and steps up strongly for the first few years, and then has more inflationary steps thereafter.

Okay. Then one quick one for Bobby. Bobby, you referenced, I believe, expected insurance recoveries related to some litigation. Can you give us some color on that?

Well, obviously, from an accounting standpoint, we spend and expense our legal cost that we have incurred. You file for recoveries under your various insurance programs and record that once you think the recoveries are likely.

We had a large block that came in, recoveries from legal costs over the past year or so, that we recognized; and I thought we would beat our G&A because of that item. But as I had indicated, our transfer agent costs were higher this quarter and offset that.

Got it. So you did receive the recovery but you had transfer costs that offset that.

That's correct.

Okay, thank you.

Paul Adornato, BMO Capital Markets.

Hi, good morning. I was wondering if you guys could talk a little bit about the national job picture as it relates to your portfolio. Obviously, the consensus is for slow or even stagnant job growth.

I was wondering if you could talk about what tenants are actually looking to expand their space within your portfolio, if any; and regionally, if there are any job growth differences that you are seeing out there.

Interesting question, Paul, because we do get a pretty nice perspective on the broader market, given how many markets we are in. I would like to tell you we have seen some big trends. Certainly '09 the trends were -- health, education, and government were the three main users of space and the only people we were really talking to about new leases at the time.

That has expanded out into seeing more financial services, quite a bit more technology. And in fact if there is one sector that I think we're seeing people take a little more space in here or there or grow their platform a little bit, it is probably on the technology side.

We haven't seen much out of some of the larger financial services entities. Obviously US Bank just did this lease in Minneapolis, but that was really a consolidation of other leases in the Minneapolis market. It might have entailed a little bit of growth, but not a lot. And US Bank is doing as well as just about any bank out there.

So I wouldn't say there is any obvious trends that we are seeing from a tenant leasing standpoint that would give you some comfort or hope or increased expectation for activity in particular markets because it just hasn't been strong enough to see that.

Okay. What about your appetite for having large tenants or small tenants within your portfolio? I think you guys have an average larger tenant size. Would you want to bring that number down a little bit and concentrate more on the smaller tenants that might be more likely to hire?

You know, it's something we think about a lot, Paul, as we are thinking about lease accounting changes and things like that coming up in the next few years. So we're trying to be smart about that and think about what our risks and such are, as we look at our larger average tenant size.

Having said that, I think by virtue of just sheer time we're going to see some of our single-tenant buildings move to multitenant, and some of our multitenant buildings move to more multitenant. But obviously we don't want to become an executive suite operator. That is not who we are. That is not how our business model set up.

So I think we will always be a larger average tenant size company than most. But I think in the context we are starting to think about the lease accounting issues that are coming up and what kind of impact that may have on us.

Thank you.

(Operator Instructions) Dave Rodgers, RBC Capital Markets.

Hi, this is Mike Carroll here with Dave. Bobby, can you give us any feedback on the share conversions?

When you say feedback on share conversion, how many (multiple speakers)?

Do you know if anybody sold or anything like that?

Well, the only information that we have is of the end of last quarter, which was March 31. And there has not been a lot of conversions from our existing retail shareholder base at that time.

As a result of the public offering, I think we had about 8% of our shareholders held institutionally; and that had moved up to about 10% at March 31. So it will be interesting to see. I think August 15 is when we are going to have that information coming out, and we will be tracking that.

Okay, great. Don, can you give us any color on the termination fee that you received in the quarter?

I am looking around the room. I'm going to have to find out. I don't think we got a lot in the second quarter. I'm sorry?

Yes, I think the only thing that we're seeing in the second quarter from a termination option standpoint would have been -- it's sort of hard to explain. We had a tenant in our industrial buildings in Greenville, South Carolina, that we agreed to a termination arrangement with, so that we could accommodate some new leasing that we did in the building.

As part of that basically, because the tenant was only continuing to pay their rent over on a monthly basis, given that we had an arrangement with them -- that if we were able to lease some of the remainder of the space earlier than the end of their lease term, that that would negate some of their termination option -- we are required to take that termination penalty on a monthly basis over the life of the remainder of the lease.

So the little bit of lease termination income we had in the second quarter was largely as a result of that. Am I missing anything, Bobby?

No, that's it.

So that's it.

Okay. Thank you.

And it was fairly de minimis. What was the number? $479,000 for the quarter.

Great, thank you.

John Guinee, Stifel Nicolaus.

Hi, a quick follow-up. As I recall your buildings in Washington are fairly near the Maritime Plaza transaction or asset that was for sale, which is M Street Southeast, about $120 million. Did you guys look at that? What were your thoughts?

Not this time around. In fact I am not sure I was even aware it was available recently, John. We looked at it a couple times going back a ways.

Remember, Lincoln built the buildings and they were on a ground lease. So although they had some pretty good corporate tenancy we weren't as wild about that location and the fact they are on a ground lease. So we have never gotten terribly aggressive on that particular asset.

Very smart. Thank you.

Thank you.

Anthony Paolone, JPMorgan Chase & Co.

It's Sarah again. Just a quick question. I don't know if I missed this and you touched on this earlier. But regarding CapEx packages in the market now, are you seeing them stabilize or are tenants still demanding more?

Yes, I will start; Bo may jump in, Sarah. We certainly are seeing in many markets tenants now asking for what I think is about the peak of what they could ever ask for in terms of capital improvement packages, just because in some cases they are getting them. So the tenant reps are getting fairly little bold and asking for -- whatever the best deal was out in the market, they are asking for that and more the next time around.

So we're seeing a lot of that. I think what Bobby was trying to point out in our prepared remarks is what is happening quite often is, when we are giving fairly generous TI packages because the term or the credit of the lease justifies the deal, quite often the tenant is asking for some or all of that tenant improvement package to be able to use or be applied towards free rent.

So the point we're getting at is when we are signing some of these bigger, longer term leases, quite often the TIs that would normally be booked into our capital expenditures are being taken out of straightline rent, because the tenant can use the capital for paying down or using it towards free rent in effect.

So as a result what is happening is it is hurting our market rents on a cash and particularly on a GAAP basis; but then it is bringing down our capital expenditures per square foot per year of lease term. So the funny part about what we are trying to communicate here is our CapEx per year of lease term is actually below where it has been, even though tenants are asking for a lot more CapEx; but it's putting pressure on our GAAP mark-to-market rents. Does that make sense?

Yes, that is really helpful. Also on that note -- and this is just a data point; I can follow up after the call if you don't have it -- is regarding the CapEx backlog that you do have currently. I believe you disclosed it in the supplemental.

What relates to actual in-place leases? So versus like I believe you include the KPMG lease in there. I just wanted to know what percentage is related to what is in your portfolio right now.

The vast majority, other than the KPMG lease, would relate to existing leases in place. We would have to go back and do an analysis of what other leases are forward leases. But there aren't a lot of those that would encompass the $112 million. Most of them would be existing in-place leases.

Great. Thank you very much.

(Operator Instructions) John Stewart, Green Street Advisors.

Thank you. Don, I just wanted to ask a follow-up on Minneapolis. You referenced that this asset has elements of a long-term hold in I guess a long-term lease with a credit tenant and discount to replacement cost. But you also alluded to a consideration of a shorter holding period that would be more consistent with an opportunistic market strategy.

I guess I just wanted to find out how you thought about your IRRs under the different scenarios that you are contemplating.

Good pickup, John. What we're trying to say is, hey, this is a quality of asset, quality of tenant, quality of market play that we would consider holding on a long-term basis. Having said that, this also has the qualities, given the step-ups in the rent that you asked about earlier, that we could easily see three, four, five years down the road still be plenty of lease term on those leases, a price per square foot that is still well within replacement cost bounds or less, generating the kind of IRR that we would be very comfortable with on a shorter hold basis that would look more opportunistic. Yet we didn't take that kind of risk to get it.

So without trying to say this is a short-term hold, which we don't typically buy on that basis, but we like -- we love to have optionality in the lease term structure to be able to allow us to do that. So our IRR would be obviously higher on a three- to five-year hold than it would be on a longer-term hold by maybe 100, 150 basis points as I recall from our underwriting.

Right, but I guess -- so what sort of IRR would you be comfortable with?

Well, I think the IRR on a shorter term hold would have been just in the double digits. A longer-term IRR would have been upper single digits.

Got it. Okay, thank you.

Mark Lutenski, BMO Capital Markets.

Hi, how much of your portfolio is subleased at this point? Have you seen any difference in how that has trended versus how it has been historically?

Mark, we have some people pulling that information as you asked the question. I am going to have -- well, I can answer the second part first.

The second part is, we're definitely seeing less sublease activity than we have seen going back a year or two. I would say overall the percentage of our portfolio that is subleased is probably consistent with where it has been, or maybe shortening up just a little bit. But new sublease requirements have been fewer and farther between by a long shot since middle of last year or so.

Our overall percentage of space subleased -- and don't forget this is largely affected by our BP Amoco situation -- is about 11% of the portfolio. And a good 5% and that is BP Amoco, so it would be about 6% if you didn't count the BP Amoco sublease to Aon.

Okay, thank you.

Brendan Maiorana, Wells Fargo.

Yes, it's Young again. Just a quick question on guidance, Bobby. If we take a look at what you guys have done so far, it's $0.80 in the first half. And if we take somewhat of a clean run rate from Q2, it is $0.76 in the second half plus $0.04 of lease termination fees, and maybe a couple cent pickup from interest expense savings.

What can you do -- you guys have to do, or what has to happen for you guys to get to the low end of the range, which is $1.56?

Right now we're running -- and talking about it from a core FFO standpoint -- year-to-date we are about 67, 60 -- add these together, what is that? 80? (multiple speakers)

So the low end of the range, we're looking at probably still target midpoint of that range with lease renewals, rent abatements expiring, still running in the neighborhood of average $0.40 a quarter.

Young, are you asking what would have to happen for us to get down to the $1.56?

Right. Because you guys had raised guidance, but the guidance range itself looks somewhat conservative given what you guys did in Q2, especially since you guys are expecting about $0.04 of lease term fees in the second half.

Just wondering, A, why you guys didn't raise the guidance range? And then secondly, what has to happen for you guys to get to the low end?

I think something unexpected would have to happen for us to get to the low end, we hope. I mean that is obviously -- that is why you put out a range, it is -- things happen. But I think we would have to see something along the lines of some unexpected negative action going on in the portfolio.

We still have some uncertainties in the portfolio. Obviously, we mentioned the borrower on 500 West Monroe stopped paying interest. That will potentially have some impact on us; we don't know yet. Too early to tell what is going to happen with that particular situation. But that could have some impact on us, obviously.

If we were to have some real success buying properties late in the year, but they didn't contribute to income in the year, but we had some acquisition expenses associated with them -- particularly if they were transfer tax related expenses, which could be very expensive -- that could nip us at the end of the year. But I think those are the primary reasons.

And one other thing, too, Young, and if I miscommunicated in our conference call last quarter, I apologize. But the number that is out there for termination fee income is actually -- that is the annual number, not the second-half number.

Got you. Okay. That's helpful. Thank you.

There are no further questions at this time. I would like to turn the floor back over to Mr. Miller for any closing remarks.

Well, we want to thank everyone for attending the call. We hope that we are being communicative and open with our responses. And we look forward to continuing to work with the investment community and our shareholders to create value for you. So thank you so much for your support.

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.