Piedmont Realty Trust Inc (PDM) 2011 Q2 法說會逐字稿

Greetings, and welcome to the Piedmont Office Realty Trust's second-quarter 2011 earnings conference call. At this time, all participants are in a listen-only mode. A 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, Chief Financial Officer of Piedmont Office Realty Trust. Thank you. Mr. Bowers, you may begin.

Thank you, Operator. Good morning, everyone, and welcome to Piedmont's second-quarter 2011 conference called. Last night, in addition to posting our earnings release, we also filed our Quarterly Form 10-Q and Form 8-K, including our unaudited quarterly supplemental information. 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, and may cause actual results to differ from those discussed today. Examples of forward-looking statements include those related to Piedmont Office Realty Trust revenues, operating income, financial guidance, as well as leasing and acquisition activity. You should not place any undue reliance on any of these forward-looking statements ,and those statements speak only as of the date they are made.

Now, 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.

I'll review our financial results in detail after Don Miller, our CEO, discusses some of the quarter's activities, including progress towards our strategic operating objectives. In addition, we are joined today by Ray Owens, our EVP of Capital Markets; Laura Moon, our Chief Accounting Officer; Eddie Guilbert, our Vice President of Financial Strategies; and Bo Reddic, our EVP of Real Estate Operations, all of whom will provide additional perspectives during the question-and-answer portion of the call.

I'll now turn the call over to Don Miller.

Good morning. Thanks for joining us, everyone, as we review our second-quarter 2011 results.

We are pleased with the Company's progress this quarter and have several updates for you this morning. We have had a busy quarter as we worked to lease up our vacancies and advance our strategic plan. We've had a strong balance sheet and a portfolio of high-quality, well-located properties, and we continue to execute on our disciplined approach to acquisitions and capital recycling.

Last evening, we reported core funds from operations of $0.38 on a per share basis in line with our previous guidance. Bobby will discuss our financial results in further detail later. However, I'd like to update you on our leasing and capital transaction accomplishments this quarter.

First, in addressing our second-quarter leasing activity, we had a strong quarter, signing almost 1.2 million square feet of office leases, including 439,000 square feet of new leasing and 741,000 square feet of renewals, achieving an 80% retention rate. Year-to-date, we have signed over 2 million square feet of leases, covering almost 10% of our portfolio.

Piedmont's office portfolio was 86.5% leased at June 30, 2011 as compared to 89.2% leased at the beginning of the year. The main driver for this decline in leased percentage is due to our success in acquiring several value-added buildings, including 500 West Monroe in Chicago, which was 67% leased at acquisition with several near-term lease expirations; 1200 Enclave Parkway in Houston, which was 18% leased at the time of acquisition; and the Medici Building in Atlanta, 22% leased at the time of acquisition. If you remove the effect of these acquired properties -- which are detailed on page 31 of our supplemental information -- our stabilized portfolio of office properties was 89% leased at June 30, 2011.

At the end of the second quarter, our weighted average remaining lease term was 6.3 years, up from 5.8 years at the end of 2010. The office markets where we completed the most leasing activity in the quarter were Washington, D.C.; Detroit, Michigan; and the Central Business District of Chicago, although we've seen positive momentum in leasing transactions in a number of markets.

In the Washington, D.C. market, The Office of Comptroller of the Currency renewed 334,000 square feet for two years, with double-digit increases on both a cash and accrual basis with no capital expended to extend the lease. Also, in Bethesda, Maryland, outside of Washington, the regional accounting firm of Watkins Meegan signed a new 12-year lease for 35,000 square feet at our Piedmont Pointe property, bringing that project to over 50% occupancy.

Moving to Detroit, the Chrysler Group signed a new lease for seven years and will be occupying 100% of our 210,000 square foot Auburn Hills, Michigan property at 1075 West Entrance. In the Chicago market, Jones Lang LaSalle extended their current lease on 164,000 square feet at Aon Center until 2017. And after quarter-end, we were pleased to announce that Integrys, a midwest utility company, will be moving its headquarters to Aon Center and leasing approximately 150,000 square feet for 15 years, commencing in 2014.

In some of our other opportunistic markets, we also delivered strong leasing results. In Portland, Oregon, Nike renewed for 105,000 square feet for a little over five years. And in Phoenix, Arizona, we signed a three-year 63,000 square foot extension with AmeriCredit, and a seven-year 46,000 square foot lease expansion with Grand Canyon Education. In Fort Lauderdale, Florida, we successfully re-tenanted our Hiatus Drive Building by renewing Convergys in a 50,000-foot lease for five years, and adding State Farm to 50,000 square feet for five years.

Overall, we are still seeing downward pressure on rental rates, including potentially higher concession packages, particularly in the suburban markets. For the quarter, however, the state of contractual run rates on newly-executed leases were up by 5.5% on an accrual basis and 3.0% on a cash basis. Year-to-date, with 1.8 million square feet of executed leases, rents are up 8.6% on a GAAP basis and 5.4% on a cash basis. Many of these leases, however, don't commence until after mid-2012, so we won't see the benefit from their execution immediately. Obviously, we will closely monitor market conditions and adjust our leasing strategy accordingly.

Turning to our transaction activity, we continue to execute on our mission of building value through stewardship by narrowing our footprint, to identify concentration and opportunistic markets, and adding assets to our portfolio that have the opportunity to contribute both value appreciation and FFO growth over time.

Our acquisition growth philosophy is a balanced plan, with tactical value-added transactions where we can leverage our extensive lease-up and operational expertise, and with core strategic transactions, which we believe will result in positive, long-term risk-adjusted returns. We believe there are attractive opportunities for buyers like us with balance sheet capacity and the ability to creatively finance and structure transactions. In doing so, we will maintain our disciplined approach to underwriting, and remain selective with the utilization of our resources.

During the second quarter and subsequently, we have been active in acquisitions and asset recycling. During the quarter, we purchased two buildings in Atlanta, an opportunistic market for us. We purchased the Dupree Building, a Class A, 138,000 square foot building for $20.5 million. This building is 83% leased, and is conveniently located, both in terms of being inside the Atlanta Northside Perimeter Expressway and in relation to executive housing in Atlanta. Additionally, we purchased the Medici Building, a Class A, 152,000 square foot building. It's 22% leased and located in the upscale Buckhead office market. We purchased the building for $13.2 million. Our low-cost basis of these buildings, combined with our knowledge of the market, should allow us to capture superior risk-adjusted returns from these transactions.

As I indicated, we have also been very active in our capital recycling. As part of a longer process of moving out of non-core markets, Piedmont intends to free up capital for assets that are strategic additions to our operating platform. We sold or are under contract to sell three buildings in non-core markets.

These properties include a joint venture at 360 Interlocken Boulevard in suburban Denver, Colorado, which was sold for $9.15 million. And, the day after the end of the quarter, we sold Eastpointe Corporate Center in suburban Seattle, Washington for $32 million, completing our exit from the Seattle market. And, as we previously reported, we are also under contract to sell our interest in 35 West Wacker in Chicago, Illinois at a gross sale price of $401 million.

To summarize, our goals to drive stable returns by combining high-quality, well-located and well-leased buildings in concentration markets with quality value-add properties that will drive both FFO growth and asset appreciation. This strategy means we might be buying vacancy in the near-term, as well as selling FFO as we recycle out of our non-core markets. Looking narrowly, this approach will put short-term pressure on FFO in 2012. However, we are confident that this approach will create enterprise value over time.

As I stated earlier, we'll continue to closely monitor market conditions and adjust this approach, if appropriate. Regardless, throughout this process, we will remain low leveraged and be able to take advantage of opportunities as they arise. We have a strong balance sheet and an experienced management team focused exclusively upon the office sector.

I'm now turn the call over to Bobby, to discuss our financial performance and balance sheet in more detail.

Thank you, Don. Last night, Piedmont reported our second-quarter results, and I encourage you to carefully review the earnings release, the supplemental information, and the financial results filed on Form 10-Q. I'll briefly discuss our financial performance over the quarter and our guidance for the remainder of 2011.

For the second quarter, FFO was $65.1 million or $0.38 per diluted share. Core FFO was also $0.38 per diluted share as compared to $0.38 per share for core FFO for the second quarter of 2010. AFFO for the quarter totaled $47 million or $0.27 per diluted share for the quarter versus $0.32 per diluted share in 2010. This decrease in AFFO was primarily attributed to increased capital expenditures associated with our leasing activities. Total non-incremental capital expenditures were $16.9 million during the second quarter of 2011.

Turning to our income statement for the second quarter, our total operating revenues were up 4.4% to $150.5 million as compared to the same quarter in 2010. This increase was driven by both rental revenue and tenant reimbursements related primarily to our acquisitions. On the expense side, operating expenses were roughly $110 million, which is a 10.5% increase from the prior year, and can be attributed directly to the recent activities -- acquisition activities and related depreciation and amortization expense.

On a same-store basis, quarterly net operating income declined 4% year-over-year, due to modestly lower lease occupancy percentage and rental rate reductions from previously executed lease renewals, which commenced during the last few quarters -- in particular, the State Street Bank lease in Boston and the Nestle lease in Los Angeles, which were both discussed in previous quarters.

Corporate, general and administrative expenses for the quarter were in line with expectations, and included the annual meeting and proxy costs. Interest income and other expense reflects one of the effects of the March 31 acquisition of the 500 West Monroe Building, with the termination of the mezzanine loan receivables and related interest income. This expense category also contains the recognition of $700,000 of acquisition costs, which rather than being capitalized, are now being expensed under new accounting standards.

Don updated everyone on our success this quarter in leasing. However, I'd like to draw your attention to pages 26 and 27 of our supplemental information, which disclose our capital commitment, and detail the projected capital expenditures and tenant improvements related to leases signed during the quarter.

Total capital commitments that we have as of the end of the quarter are $129 million. But I will note that we expect this total to decrease approximately $40 million later this year with the disposition of 35 West Wacker. Due primarily to the short-term lease extensions by the OTC, without a tenant improvement package, we had a favorable below-average capital requirement for executed leases during the second quarter of $2.87 per square foot per year of lease term. A six-month capital cost of $4.85 per square foot per year of lease term is fairly above average, due primarily to the $40 million of building and tenant improvement package associated with the 600,000 square foot, 15-year renewal by NASA.

Now, looking at our balance sheet, it remains extremely strong and leaves us well-positioned to execute on our acquisition and disposition plans. We currently have more than $200 million of buying capacity with cash and on our line of credit. With regard to our debt, at June 30, we had approximately $300 million drawn on our $500 million unsecured facility. We utilized this line of credit, which is priced at 47.5 basis points over LIBOR, during the quarter to pay off our $250 million unsecured term loan, which matured on June 28.

Depending upon future acquisition opportunities, we anticipate paying down the line of credit with proceeds from the sale of the 35 West Wacker Building, which is scheduled to close later this year. We also have approximately $1.3 billion of secured debt at quarter-end, with a weighted average interest rate of 4.63%.

Regarding near-term maturities, our credit facility and two loans totaling $185 million, which are associated with the 500 West Monroe Building, will mature during the third quarter of 2011. All have one-year extensions -- options, excuse me -- and we are in the process of extending these leases. Pages 17 and 18 of our supplemental information provide more detailed explanation of our debt and associated maturities.

Additionally, our debt coverage ratios remain very stable and well within the debt covenant limits. We ended the quarter with a net debt to core EBITDA ratio of 4.7; our fixed charge coverage ratio is 4.4; and we are very low leveraged with a debt to gross asset ratio of 29.8% at quarter-end. While no new financing is currently required, we have a number of financing options that are available to the Company should various acquisition opportunities materialize. We currently anticipate that any such need would be funded through an unsecured public debt offering.

Finally, we're reiterating the guidance for 2011 that we provided on our last quarter's call, with core FFO in the range of $256 million to $269 million, or $1.48 to $1.56 per diluted share. I want to point out that we may update this guidance in the future due to significant acquisitions or dispositions. We'd also like to remind you that the results may vary quarter to quarter on both a cash basis and an accrual basis, due to the timing of various one-time items.

Now, as Don mentioned, several previously executed leases and lower rental rates, coupled with the prospects of other large leases scheduled to expire over the next two years, the anticipated capital that we believe will be necessary to retain these tenants or re-tenant the spaces, will impact our cash flow going into fiscal 2012.

Although we covered our dividend on an AFFO basis in 2010, and in the first quarter of 2011, we did not cover the dividend on an AFFO basis in the second quarter, and do not anticipate covering our dividend at our current quarterly payout rate for the rest of the year or for the year 2012. Further, while we believe that the acquisitions of select value-add properties and attractive core market assets will create the optimal, long-term risk-adjusted return for shareholders, this investment strategy will also create near-term pressure on cash flow and our current dividend rate.

Our current cash flow generation is being closely monitored, and we anticipate adjusting this dividend closer to industry payout ratios beginning in 2012. Our current taxable income for 2011 without capital gains is estimated to be between $0.80 and $0.90 per share.

All right, this concludes our prepared remarks. I will now ask the Operator to provide our listeners with instructions on how they may ask questions of management. We'll endeavor to answer all of your questions now or make appropriate later public disclosure, if necessary. We do ask that our listeners limit their questions to one follow-on question so that we can address as many of our listeners as possible. Thank you.

(Operator Instructions). Chris Caton, Morgan Stanley.

I was hoping you could spend a little more time talking about the leasing environment in Chicago, with a couple of highlights, maybe. If you could talk about Aon Center and Integrys -- wonder where they're leasing in the buildings, and I believe that'd be a triple-net lease -- how much expenses are you carrying there?

And then over at West Monroe, you changed your language in the quarter in terms of expanding GE. Can you provide a little more color on those negotiations? And if there's a potential for them to move in as Marsh moves out, I believe, at the end of this year.

Okay. Hey, Chris, how you doing? Let's see, start with Chicago. I'll caveat all conversations today -- we didn't do it in our prepared remarks just because I'm not -- everything changes on an hourly basis, it seems like, in this environment. But we'll caveat everything I'm saying -- given the volatility that we've seen in the last few days and then certainly with the downgrade, we are not seeing a lot of impact to the transaction or leasing markets yet. We wouldn't be surprised if there is an impact; but at least at this point, obviously, we have not seen anything. So I'll address comments almost as if these are a week-old, because we don't have any updated information that would suggest things have changed yet.

So with that caveat, Chris, I'll try to address your questions.

Integrys, we signed that lease a week or two ago. They're taking some floors up in the 20s that are floors that ultimately BP will be -- BP/Aon will be giving up at the end of their lease in 2013. And Integrys will be moving in, in middle of 2014. So, very much like the KPMG situation with Kirkland & Ellis, we've been fortunate enough to get well ahead of the curve, and get a lot of that space taken off the market, if you will, by signing a really good credit tenant into a long-term lease in the space. So we're really thrilled about the Integrys situation. It's a wonderful company and we're really thrilled to have them as a tenant.

And then additional activity in Aon Center has been very positive recently. We haven't gotten anything that we've announced, but we're very optimistic on some additional activity in the building that we hope will be concluded in the next couple of quarters. So we feel pretty good about where things are going at Aon Center. So Chicago continues to be, I would say, a bright spot in terms of the activity levels that we've seen downtown. I think we've said many times before, the suburbs are a different kettle of fish altogether, but downtown continues to do pretty well.

On the GE negotiation side, I prefer not to get into that other than to say we did comment that we're hopeful to renew and maybe even expand GE; but obviously, we're in the early stages of a negotiation there, so I wouldn't want to comment any further on that, just so that we don't talk about anything that we shouldn't.

Okay. Thanks, Don. One follow-up question, maybe for Bobby. You talked about looking at the dividend, then you talked about your tax pool and rightsizing it versus industry norm payouts. Are you also going to be looking at AFFO? And what would you view as an industry norm for the payout ratio?

Well, certainly, I think the base mark, Chris, is you start with taxable income. And that's why I put that information out there, because you need to do that much. We do have those spikes in our leasing that have capital requirements, that sometimes from an AFFO standpoint, we may have more TI requirements -- just like we have in 2012, I remember we had a $20 million commitment to expenditure there in the Aon Center as we moved in KPMG. So I'm not going to peg a certain amount towards AFFO, but obviously, on a long-term basis, we want to be covering substantially the AFFO.

And so will you look through to a normalized AFFO run rate after -- say, because of the leases that are starting in mid-'12 or later, will you look into '13 when you think about it -- or '14 and think about it?

Yes, that's exactly right, Chris.

Okay. Thanks, guys.

John Guinee, Stifel Nicolaus.

Bobby, just a great job of telling a wonderful story but not giving the punchline. I guess it's pretty safe to say, though, that 80 to 90 is the range you expect in 2012 for the dividend?

Let me jump in, John. We purposely are not telling you what we think the dividend is going to be yet. So (multiple speakers) --

Oh, really?

That's correct, yes.

Oh, okay. All right. Second, you guys have done a great job of buying vacancy in high-quality buildings. And I'm looking at page 20 -- and then selling a number of assets -- I'm looking at page 25, which is just your 18 different markets you're in excluding Seattle. And then I'm looking at my list of the higher-quality REITs out there. For example, BXT is in four markets; Douglas M is in two markets; SL Green is essentially in two markets. BPO is in 10 markets. [Vornado] is in two office markets. On the suburban side, Highwoods is in 10 different office markets.

In the next three years, do you see an ability to get yourselves down to 18 markets, 15 markets, 10 markets? How concentrated do you want to be over the next -- do you want to get over the next three years?

John, I think we've talked about this a little before, but I'm glad you asked the question, because it's something that we are continuing to try to make sure that everybody hears from us. I think we actually have a list of 22 markets technically today, maybe 21 after signing off Seattle. And we intend to move to no more than 10 to 12 in the next three to four years.

Obviously, market activity and the ability to move product for reasonable prices will have a big influence on that. And after the last week's activities, I don't know if that will impact us or not, but our goal is in a normalized environment to be able to move down to that 10 to 12 market range on the next three to four years.

Great. All right. Thank you very much. Enjoy your August vacation.

All right. Thanks. Hopefully, we'll see you soon.

Anthony Paolone, JPMorgan Chase.

Don, can you talk a little bit about how you guys view Piedmont's cost of capital, your return hurdles, and the types of growth assumptions you've been using in your underwriting? Just trying to understand where the difference have been, given that we just haven't seen a lot of transactions out of you guys in what's been a fairly heated transaction environment over the last, call it, six months.

Okay, let me start with the last part of it first. I mean, I think we've been a pretty consistent acquirer of product here in the last few months now. Not big, splashy, aggressively-priced transactions, but I think we're -- we hope you think that we're doing exactly what we said we were going to do, which is to find value in the markets -- value-added opportunities in those opportunistic markets. And the few things that we've done in our core markets are going to be much more core-oriented. So I think we've actually been a pretty consistent deployer of capital and we hope to continue to be so here in the near-term.

But getting back to the cost of capital issue, we look at our business model, if you will, as obviously a little lower risk, a little lower -- potentially lower reward, but hopefully, a strong risk-adjusted return at the end of the day. And so if you think about the fact that we look at our cost of debt capital today, although our blended rate is around 4.6%, I think we're probably a low 5% borrower in the public markets, even after this dislocation. If you were to get mortgage debt today, it's probably low 5% mortgage debt at those lower leverage levels that we participate at.

So if you look at blending 35% to 40% of our capital structure at a low 5% with an equity goal, I think, of say, low double digits, say, a 10% equity goal, then I think you'd come up with a blended cost of capital that looks pretty close to 8-ish% I think on a blended basis.

And where do you think some of these larger transactions -- I know you've done some of the value-added stuff and some of the very specific deals in markets you know. But just wondering where you think some of these larger trades have been, where that underwriting has been, and like, how far off you've been on those things.

Yes, on the really large transactions that we've been looking at in some of the core and concentration markets where the yields are dropping down into the 5's, unfortunately, in most of those deals, you're still seeing rents that we, at least, forecast are at or above market. And so it's really hard to foresee without extraordinary growth in the rents in those markets -- and in most places, we're not seeing that -- to still figure out how you're getting an IRR that's dramatically above that over a period time.

And so we're seeing consistently in those core and concentration markets, IRRs that are more in the 6's and 7% range, which obviously, [below] our cost of capital. That doesn't mean we wouldn't do something below our cost of capital in our concentration markets, but we haven't seen anything that we felt like was as good a value proposition as we've seen elsewhere.

Got it. And my follow-up item is just as it relates to 35 West Wacker, it seems like a decent amount of time between now and your end to get it closed. Is there any risk to that? Or is this just the normal length of time that it's going to take to get the thing done?

Yes -- well, it is a complicated transaction from a number of different standpoints, as you know, because we've got a debt assumption on it; we have got a joint venture structure in place; some tax protection issues; and then a management agreement. And so I remember when I actually joined the Company while we were in the process of buying the asset, and it seemed like it took forever to close it when we bought it. I think there is just a -- it's just a lot of processes to go through to get this transaction closed.

I think our best estimate right now is end of the third quarter, early fourth quarter. But obviously, there are things that could come up that could extend it. We don't have any reason to believe it won't move forward at this point, but the world is a funny place.

Okay, thank you for that color.

John Stewart, Green Street Advisors.

Don, just following-up on 35 West Wacker. How much money is hard? And what are -- I know there's $120 million mortgage on that, but what are the expected net proceeds?

John, I probably won't comment on what's hard today. We haven't released any of that information. In terms of net proceeds, I'm looking down the table -- it looks like -- Eddie Guilbert is telling me around $225 million of net proceeds.

Okay. And with respect to the $300 million outstanding on the line at the end of the quarter, would you expect to use 100% of the proceeds to pay that down? And what's the current thinking in terms of a longer-term refinancing?

Yes, I would think if we got the proceeds -- let's say we got the proceeds in, in the next 60 days or so. I would think we would do nothing but just go ahead and pay down the line at this point. There's no reason to hold cash and be dilutive on that basis.

As it relates to the financing, obviously, the last week or so has had a lot of impact on our thought process. We're noodling on a number of different ideas we have here. Probably a little premature to make a comment, because I'm not quite sure we know exactly; but I think the last few days has had some impact on our thinking, and we're going to be working through that. And hopefully, we'll have a little more clarity when things settle down a little bit. But a lot of ideas come out of a very volatile equity market and a very attractive long-term treasury rate.

Right. And then just following-up on a couple of questions that have already been asked -- or at least themes that have been touched on. Don, can you share with us what the current acquisition pipeline looks like? And likewise, I know you addressed your longer-term plans for non-core asset sales, but what can we expect to see in the near-term?

I'm going to give you the same caveat I gave in the leasing front, if you don't mind, which is just obviously that -- everything I comment on at this point is going to presume a relatively stable environment going forward, which probably isn't going to be the case, but we'll deal with it as we can.

We do have a pipeline of a handful of transactions that we're optimistic on going forward; be a mixture of the strategies that we've talked about. We're hopeful that we will get some clarity on those transactions here in the next couple of weeks. But, as a buyer, obviously, we're looking at those deals the same way we are as a seller, which is just to make sure that moving forward is the right thing to do in this environment. And so we're thinking about those things right now, as we speak. But we're not hard on anything, so we're not locked in if we didn't want to move forward.

And then on the disposition pipeline, as we've talked about for some time, the fall hunting season is about to begin, if you will, and we are lining up a handful of transactions that, again, if we think the timing is still right, given the capital markets, that we're going to be bringing to market, that will reflect asset sales that are in our non-strategic markets. And you -- wouldn't be surprising to you that they probably match up with some of our recently completed successful leasing as well.

Right. Okay. And then lastly, if I may, I understand that the $4.85 per square foot per year lease term for the year-to-date activity is obviously skewed by the NASA deal, but what's your expectation for this portfolio on a normalized basis? What do you think that number looks like on a normalized level?

John, if you look back at the last four or five years of numbers, I think they pounce around mostly in the 3's -- hold on, give me one second and I'll give you exact numbers here.

No, that's what I've got.

2010 was $3.88; 2009 was $3.41; 2008 was also $3.88. I think we feel like that's a pretty good long-term number. Whether we start -- whether we see a little bit of a blip here in this environment where capital concessions have been up, I can't forecast exactly, but I would say it'll be in the higher end in the short-term. And then I think they'll normalize and maybe even go back to a little bit more normalized basis as the markets start to improve. But I would say low to mid-3's feels like a pretty good number.

And you think that is appropriate in terms of a net effective rent?

I don't know how to deem appropriate; all I can tell you is that we're dealing in the markets, and we're reacting to what we have to do to keep our portfolio well-occupied and keep the kind of credit tenants in our portfolio we'd like.

I mean, obviously, I think a company with a strategy like ours that does mostly larger tenant leases with credit is going to see a larger capital outlay in markets like this. And then we're going to benefit substantially when the markets are stronger, when you have larger leases and a little bit more leverage. And so, we might see a little more volatility in our capital than others because we do mostly larger leases. And right now we're in the bad part of the cycle.

Okay. Thank you.

Paul Adornato, BMO Capital Markets.

On the OCC lease, with the renewal of just two years, was wondering if you could give us a little insight into that. Is that a direct result of what's going on in terms of budget discussion in Washington? Or what's going on in the tenant's mind there?

Yes, Paul, as you may have followed, OCC, if you remember back -- I'm going to guess now, a couple of quarters ago -- was -- right at the end of the year, in fact, OCC made an announcement that they were going to be combining with the office of Thrift Supervision and taking a 600,000 foot lease at Constitution Center down the street from us. OTS was moving over to take some of the SEC space that was over-leased, if you will. There was a large lease that was done. And then SEC got spanked for that, and as a result, needed to lay off some of that to others.

And the combination of office Thrift Supervision and OCC was a good backfill candidate, if you will, for the government space in that project. So OCC at that point in time told us that they would be leaving. We came out and let everybody know that a couple of quarters ago. But they also acknowledged that they needed the space for a couple more years to get ready to move over to the Constitution Center.

So that's when we started moving towards a lease renewal with them of a couple of years. Obviously, only having -- only getting a little bit of short-term renewal with them gave us the ability to demand a little bit higher pricing and no capital expenditure. And so from that standpoint, it's a nice windfall, if you will, at least for the next couple of years. And interestingly, early leasing activity in that space has been fairly strong but it's very preliminary at this point.

Okay. And any insight into what's happening in Washington? Is that stalled government talks, especially for that space?

Yes, I would tell you that, generally, we continue to see a fairly paralytic environment, if you will. It's very slow for people to come out with new requirements. Some of the FFOs that we have, have heard are coming, still haven't come out. For example, our National Park Service -- their RFP, if you will, has not come out to the market. Then that lease expires next year.

So I would think that it would be natural to assume that, at a minimum, they would be hard-pressed to get out of our building next year. So I don't know what that means for our longer-term tenancy there with them, but at a minimum, I would think they're going to have to stay for a period time.

And then just more generally, we're seeing a lot of requirements either canceled or put on hold from the federal government, and similarly, a lot of contractors saying that their contract awards or contract procurement is getting delayed. And as a result, they're delaying their commitments to the space. And so from what we're seeing, at least, it's a pretty soft market in Washington right now in terms of demand. Now, that could start to free up if the federal government starts to get back into the business of making decisions again.

And thanks. And just one more follow-up. As you look to reposition the portfolio and sell assets, and then buy perhaps a little bit more vacancy, on the disposition side, are you looking to reduce exposure to buildings with large tenants? Or at this point, are you agnostic when it comes to tenant size?

No, I would say we're probably fairly agnostic when it comes to tenant size. I think it does -- we are actively trying to sell assets in those non-strategic markets, particularly if they're well-positioned to what we think is maximize the value of the asset at this point in the cycle. But there isn't a goal or a mission to get rid of larger leases or smaller leases, per se.

Okay, thank you.

(Operator Instructions). Dave Rodgers, RBC Capital Markets.

With regard to 35 West Wacker, I think on the previous calls, you really talked about maybe some of the volatility in the dividend -- or the lack of clarity on the dividend, maybe I should say -- stems from the gains related to that asset. Do you think that you would be able to do a 1031, given some clarity on when you're going to sell that asset at this point in time, and give yourself basically a year from now to invest those proceeds? Is that a thought at this point?

Dave, you may remember, we said, when Don was talking earlier, that that's a joint venture and we're only selling out our portion of that joint venture interest, that's about 96.5%. And therefore, it's not going to qualify for 1031. And certainly, that's one of the drivers that's requiring us to keep our dividend where it is.

Okay. Great. Thank you for that color. I forgot that.

And then, I guess, Don, maybe a broader question. Getting into the core markets, obviously, it's probably getting more and more challenging making those bids. When do you view the exit of non-core assets and the reinvestment of those proceeds -- i.e., new acquisitions that mutually exclusive -- do they have to go together? I.e., do you mind deleveraging further?

And how do you get into those core markets going forward, as I think vacancy opportunities are probably fleeting at this point in time, and more and more bidders seem to be pursuing those same markets. So do you have continued confidence that you can still allocate money to those markets? Or should we have maybe a longer-term view that opportunistic is the growth bubble of the company for now?

Yes -- no, Dave, I think that's sort of the consistent challenge that we all have. If you look at what's going on, the handful of assets that are coming out in those core markets that almost everybody wants to buy are still extremely sought after. And so it's been a -- it's a tough environment to take those down, particularly if you're looking for what we would say is good value.

Having said that, we're finding at the margins a deal here or a deal there that fit our profile. And with our asset sales going on, I think we are -- I think we're going to be successful in getting to that 60% to 70% core concentration market exposure within the timeframes we've talked about before. It's never going to be easy, but we do think we can do that. And so, I think we're still pretty confident that that challenge is going to be met.

And Dave, this is Ray. How are you doing? I think some of the things that we have looked at before in the concentration markets have been a combination of pure core plays, but then some that have some value-added components to it. And we're really curious and interested in following what's going to happen, given the dislocation in the market that's going on now, whether that will move some of the sellers to actually transact -- especially on things that have more value-added characteristics to them in the concentration market.

Those deals are few and far between. We have seen a number of them; have taken a run at them. And for reasons that the sellers have on their own, they've decided they didn't want to transact at that point in time.

Some of the things that are going on in the current market right now and the economic climate without jobs opening as robust as people might have thought it would be -- maybe that will free some things up and make sellers change their mind. But we certainly are going to continue to look at both core type of deals in those markets and then things that have the opportunistic characteristics to them, because we can take on some of that vacancy.

Yes, Dave, I don't want to be a presumptuous in terms of what's going to happen in the markets, but I will tell you, with Washington softening, that we've talked about a lot, and New York potentially heading in the same direction with some of the financial market issues going on, I think it's sort of fascinating -- A, it validates that what we've been trying to do in terms of maintaining our discipline, we feel that much better about, A.

B, we're not concentrated in any of those markets, so any one market starting to turn down doesn't affect us in the same way, so we feel really good about that. And C, if there are better opportunities that come out of this cycle because of this renewed downturn, all the better from a standpoint of someone who's lower leveraged and has the opportunity to take advantage of these situations. So we -- last thing we wanted to see was what happened last week, but on a relative basis, it should be pretty good for us.

Great. Thank you.

Young Ku, Wells Fargo.

My first question, maybe this is for Bobby, in regard to your CapEx commitments. You have about $130 million. $40 million of that should go away with the 35 West Wacker sale, but you do have a lot of pending vacancies out there which require a lot of CapEx. My question is in terms of normalized CapEx level, that $130 million, what do you think would be a better ongoing run rate on a normalized basis? And when can we expect you guys to get there?

Yes, you're talking about a pretty hard number to peg with a normalized number right now. Let me tell you, that $128 million does have a couple of large items in it, though. There's the NASA lease that's got $40 million; and then there's $40 million that's associated with 500 West Monroe. So those [two one] items I think that gives you sort of an idea of what generally is out there. But you've got large leases that come up and it's going to spike up and down.

Okay. That's fair. And somewhat related, I guess, you guys are looking to dispose some of your non-core assets. And what are your thoughts on selling some of the large pending move-outs? For example, the Zurex space and the Sanofi space. Are those on the chopping block as well?

Young, could you restate that? Because you came in and out when you were saying that question, I'm sorry.

Yes, for example, the Zurex space and the Sanofi space, would that be -- would you guys consider selling those as well, since you might be having some large vacancies there?

No, Young, I don't think so. Unless we lost confidence in the ability of that building to compete in the marketplace, I don't think we would be a seller. You never say never, because you may have the tenant that comes along that really wants the space and is willing to pay a user pricing for it or something like that. And there are the occasional small buildings that we have looked at selling off to users in our portfolio, where they have lower occupancy than average.

And so it's not that every building we sell will be 100% leased. I think Eastpointe Corporate Center in Seattle was a great example of that. It was a partial user sale for someone who was willing to pay what we thought was a very fair price, because they wanted to at least partially move into it. So, there will be situations where we will do that. I don't think Sanofi or the Zurex Buildings would be buildings that we would sell off in their current condition -- again, unless a user came along with a very aggressive price to try to take down the space.

This is Ray Owens again. Once again, I think, given the benefit of having these strong balance sheets like we do have, and not having a lot of debt, we don't have a gun to our heads to have to force us to do something into the market like that. So we'll continue to be disciplined. Especially on those deals that we believe are good quality buildings, we'll be able to fight through the downturn and fight the leasing game and be able to recover tenancy. Then if it fits our strategic objectives to move them out, we'll consider selling to them, just because it has vacancy in this current environment, we don't have a gun to our head to have to move those kind of deals out.

Great. That's helpful. Just one quick follow-up, if I may. What kind of demand are you guys seeing in some of the non-core assets or markets that you guys are looking to sell out of? For example, in Detroit and Cleveland, are you seeing any actual demand there?

You know, Young, it's kind of funny. We've said this, I think, on a couple of other calls before -- but Detroit has been one of our most active markets this year. Now I think that was one of those markets we were very fortunate in. We had some pretty good occupancy in that market through '09 and '10 and '11 even. And then we had some vacancies starting to come up or some leases starting to roll last year and this year. And we were fortunate enough in the timing of those leases starting to come up, that those tenants were now ready to renew and/or we've seen a lot of other new activity.

So Detroit has actually somewhat surprisingly been a very positive market for us over the last 12 months. We've leased up, as we announced this quarter, the Chrysler Building. And then a building just down the street from it, we've renewed two tenants and done a lease with another new tenant that's basically filled that building up on a longer-term basis as well. So those will be the kinds of assets we'll think about selling as we move forward here.

Cleveland, we actually have only one little small project there that will be on the selling block at some point, if we can re-stabilize the asset. But more recently, we've actually seen a good level of activity on that project as well. And so it's odd -- it's almost market-by-market and project-by-project. But we've actually seen some pretty good activity in places like that -- not at great rents, of course, but at least at good activity levels.

Actually -- I was actually asking in regards to potential buyers for the asset, not (multiple speakers) --.

Oh, I'm sorry. I apologize. We -- obviously, we would not typically solicit buyers until we were ready to bring an asset to market and fully and broadly broker it. And so we wouldn't know the answer to that question until we hired a broker and took it to the marketplace.

(multiple speakers) Okay. Got it. Thank you.

(multiple speakers) Young, I think just an adjunct to that, it also is fairly market-specific. In the better secondary cities that don't fit our strategic objective, you will probably have a wider buyer pool that may include some institutions. Some of the other lesser-viewed secondary markets, you probably have regional and local players. But once again, as Don said, we will go through the full marketing process and then we'll evaluate the best buyer for those particular assets.

Got it. That's helpful. Thank you.

(Operator Instructions). Chris Caton, Morgan Stanley.

Just a follow-up with the discussion of acquisitions, dispositions. Bobby, what assumptions, if any, have you layered into guidance in terms of transaction activity?

Well, certainly, I've looked at the 35 West Wacker Building. That's in there. And that's the significant one that contributes a lot to the FFO. But other than that, the major ones -- I'll come out with some sort of announcement if something comes out and triggers something outside of our range.

But, yes, I think there's a modest, modest amount of smaller activity in the numbers today, Chris, as we forecast our guidance for the remainder of the year. The big one -- but Bobby's point is the big one is 35 West Wacker -- that's in guidance. Obviously, if 35 West Wacker didn't go forward, our guidance would be higher.

And Bobby, what date have you put in for the 35 West Wacker?

I don't have a -- well, not knowing -- but it's late in the year, so it's late third quarter, early fourth quarter.

Got it. And then just in terms of the dilution, if we look in the supp -- there's actually not a page number on this page -- 20 -- you've got Leo Burnett and Winston & Strawn on there. Is that -- if you grossed that, those rents up, it looks like it's $46 million -- I'm doing this in my head, maybe it's a little less, $44 million -- that's a gross, right?

Yes, that's a (multiple speakers) --

About [$45.7 million], it looks like, Chris.

And that's a gross number?

That is a gross number.

That's correct, yes.

Okay, thanks, guys.

Gentlemen, there are no further questions at this time. I'll now turn the floor over to Donald Miller for closing comments.

Well, as always, we really appreciate your support and interest in calling in today. And obviously, if you have any questions to follow-up on, we'd be glad to do so within the bounds of what we can talk about. So we look forward to seeing you all between quarters and look forward to the next call as well. Thank you for attending today.

This does conclude today's teleconference. A replay of this call will be available later today and will remain available until August 24, 2011. You may access this replay by dialing 877-870-5176 and entering the pass code of 375750.

Ladies and gentlemen, you may disconnect your lines at this time, and we thank you for your participation.