Prologis Inc (PLD) 2004 Q2 法說會逐字稿

Good day ladies and gentlemen, and welcome to the second quarter 2004 Catellus Development Corporation earnings conference call.

My name is Ann

, and I'll be your coordinator for today.

At this time, all participants are in listen-only mode.

We will be facilitating a question and answer session towards the end of this conference.

If at any time during the call you require assistance, please press star zero and the coordinator will be happy to assist you.

I would now like to turn the presentation over to Miss.

Minnie Wright.

Please proceed.

Thank you.

Good morning everyone, and thank you again for standing by for our second quarter 2004 earnings conference call.

With us today are Nelson Rising, Chairman & CEO, and Bill Hosler, Senior Vice President and CFO.

Both Nelson and Bill will be making a few comments regarding the highlights of earnings release this mornings.

We will then open the phone lines for questions.

Before we continue, I would like to state that this conference call will contain projections and other forward-looking statements regarding future events and the future financial performance of the Company.

We refer you to the documents the Company files from time-to-time with the SEC, including our Form 10-K for the year ended December 31, 2003 and our Form 10-Q for the quarter ended March 31, 2004.

These documents identify important factors that could cause actual results to differ materially from those contained in the Company's projections are forward-looking statements.

The broadcast of this call is the property of Catellus Development Corporation.

Any redistributions, retransmission or rebroadcast of this call in any form without the expressed written consent of Catellus is strictly prohibited.

Thank you.

And with that, it gives me great pleasure to turn the call over to our Chairman & CEO, Nelson Rising.

Good morning or good afternoon depending on where you are, and welcome to our quarterly conference call.

This morning I'll make a few initial comments regarding our financial results for the second quarter.

I'll talk about the status of our rental portfolio, our development activity, and then the progress we are having on our non-core assets.

After that, Bill Hosler will make his initial comments, and then we'll both be available to answer your questions.

We are very pleased with the financial performance for the second quarter and for the first six months of 2004.

Our EPS per fully diluted share was $0.34, compared to $0.19 for the second quarter of 2003.

For the six months ended June 30, 2004, EPS was $0.65, compared to $0.42 for the same period in 2003.

The increase in net income for the second quarter and for the first six months reflects a significant reduction in tax expense, resulting from our conversion to a

affective January 1, as well as the gain from the sale of desert land.

Core segment FFO for the second quarter of 2004 on a fully diluted basis was $0.39, compared to $0.38 for the same period in 2003.

Core segment FFO for the six-month period on a fully diluted basis was $0.83, compared to $0.76 for the same period in 2003.

Bill will go through these numbers in more detail in a few minutes, but I want to point out that our results are trending ahead of the guidance given both at the beginning of the year and at the last quarters conference call.

Our rental portfolio continues to perform extremely well.

At June 30, the portfolio totaled 41.4m square feet, up in net 1.4m square feet since the end of the first quarter.

This is the result of the addition of three new buildings.

Two of these were at Kaiser Commerce Center in the Inland Empire.

One a 758,000 square foot building, and the other 617,000 square foot building, both of course distribution warehouse buildings.

We also added 117,000 square feet as an expansion of an existing building in Woodridge, Illinois.

We sold 84,000 square feet in Portland, to a tenant who had exercised a purchase option.

So, the 1.5m square feet of new space that was added to our portfolio during the quarter is 100% leased.

It represents a total investment of $52.8m, with a projected return on cost of 10.6%.

At June 30, the occupancy rate of the entire portfolio remained unchanged from the end of the first quarter at 95.7%.

Just over 90% of our rental portfolio consists of industrial properties, and these buildings enjoy the industrial leading occupancy rate of 96.6%.

Because of our high occupancy and low lease explorations over the next few years, we've commenced construction on two buildings without preleasing.

A 348,000 square foot building at Stapleton Business Center in Denver.

This is the last large site in this very successful development and we are very optimistic about our prospects for this building.

We also started a 362,000 square foot building in Carteret, New Jersey near Exit 12.

We are very high on this market with this proximity to New York City, Port and New York Airport and we believe that the state of the art built-to-suit distribution warehouse will be very well received.

In addition to the starts, we've already made -- we plan to start construction during the second half of this year on three additional buildings without substantial preleasing.

A 428,000 square foot building in Atlanta, in the I-20 West sub market in Douglas County on a site adjacent to 1m square foot complex that we completed earlier this year for APL Logistics.

Another building in Southern California, we planned to start a 758,000 square foot building in San Bernadino.

This site located just Northeast of the intersection of the 10 and 215 preways.

We also plan to build a 544,000 square foot building at Kaiser Commerce Center.

We've talked about this before but the Inland Empires, one of the best markets in the country with a vacancy at 7.2% down from 7.9% on the spring of 2003.

We have a total of 8.8m square feet in this market and it's 100% occupied.

In addition, we have 195,000 square feet of retail space under construction at our Pac Commons development in Fremont.

Bill will go into more detail on the Pac Commons development but at the end of the second quarter, we had leases executed and leases after signature that together represented 80% of the retail center projected $10.3m in annual operating income.

This will provide an important source of FFO growth in 2005.

We currently estimate that our total construction starts on buildings to be added to our portfolio in 2004 will be 2.4m square feet.

This is in addition to 1.5m square feet of development either for pay or build-to-suite for sale or in joint venture.

We've been talking about our plant expansion in Northern New Jersey in previous calls.

We think it's an extremely important distribution center and we pursue with many opportunities.

We are now under contract to purchase a site in the city of Woodbridge from two separate property owners.

The site is immediately adjacent to our land in Carteret.

The city has approved plans for our 3.2m square foot Port Reading business park on these properties.

We hope to close this purchase before year-end.

We continue to pursue other sites in the Exit 10 to Exit 12 Trent Blackwater of Northern New Jersey and as I mentioned briefly, we think this is a very very positive market.

Turning to our progress on the noncore assets, we are very encouraged by the activity we've generated on these assets.

The quality of the assets, the recovering economy and the increased capital flows in the real estate sector combined to create a very positive environment force.

The

residential market remains very strong in California which has been reflected in the high level of activity we are having at Serrano, our project near Sacramento and our Bayport development in Alameda.

To illustrate the latter, to date our development partner Warmington Homes has released 58 homes to the market at Bayport and we have contracts on all 58.

The prices range from $690,000 to $900,000.

There are a total of 488 homes in this development.

The residential market in San Diego is one of the strongest in this state.

And the remaining site we have Santa Fe Depot is under contract and should close in the third quarter of 2005.

We have considerable interest in our site in Oceanside and are in final stages of negotiations on that sale.

We continue to make progress at Mission Bay where we have three residential

under contract for a total of $47m, and have active negotiations on several other sites at Mission Bay with a combined sales price in excess of $250m.

If these sales close and are concluded, the closing will take place over the next few years.

During the quarter, we sold 99,000 acres of California desert land generating approximately $16m of non-core gain.

We are virtually out of the desert land and it's been a flowing process and congratulations to our team, who has made that all possible.

With that, I will turn it over to Bill Hosler.

Thank you Nelson.

Good morning everyone.

We frequently receive questions on our supplemental information package and we try to reflect the answers to many of the more common questions in the next issue of our supplemental.

In this quarter, we have added several new piece of information, I would like to review real quick.

We have added a new page, page 19 which starts with our GAAP NOI for the quarter, as adjusted for property additions and deletions, and provides further data, including the potential impact of development underway, straight-line rents and G&A that's included in our reported NOI, and certain other charges.

I think those provide more information to better help the reader assess the value of the income property and compare our results to others.

We also added a new page 31, which provides more detail on our operating JVs.

On both of these pages, they will provide either quarterly or year-to-date data, I caution you on just simply analyzing the numbers without understanding the effects of seasonality.

Certainly, in the operating JVs and the hotels there is seasonal effects there.

Page 19 also provides a little more detail on our retail development at Pac Commons.

Some of this development is underway and some is not yet encompassed in our

numbers.

So, this page tries to provide more detail leading up to the $10.3m of NOI, I mentioned in the press release that we expect to receive once the development is completed.

I want you to note that approximately $180,000 of quarterly NOI from the Pac Commons retail development is already included in ground rent in our reported NOI in the second quarter.

Overall, on the 730,000 square foot development, we've signed leases or in serious negotiations on all that about 80,000 square feet of it.

Of the total expected NOI, ground leases account for approximately 41% and building rent about 59%.

Building rents range from about

on the larger tenants to as high as $50 in the smaller tenants.

The lease terms are generally ten years, many have terms longer than that.

On page11, we added data in our share count calculation to include all restricted shares, whether or not vested.

This slightly increases the share count over the GAAP definition, but it's a little more accurate.

Last quarter, we added more detail on ground leases and we have further enhanced it in this quarter on page 23 with a footnote on percentage rents encompassed within our ground lease GAAP rent.

These percentage rents can vary substantially quarter-to-quarter and the new footnote provides some historical data.

The last change that we added more data to our debt summary on page 12, including debt maturities and going forward weighted average interest rates.

And back to the business, we saw our portfolio grow 1.4m square feet from the end of Q1, all from development and all are 100% leased.

I've got specific comments, we currently have two investor buildings for our rental portfolio underdevelopment, both were started recently and without leases, one in Denver and one in New Jersey.

And we are seeing activity on both, the Denver building will probably end up being multi-tenant, the New Jersey building is more likely to be a single-tenant building.

Our year-to-date construction starts are under 1m square feet for our portfolio, but we anticipate starting about 1m square feet per quarter in the next few quarters, but most likely almost all of that would be without pre-leasing or any substantial pre-leasing.

The portfolio of size will actually contract temporarily in the second half as approximately 900,000 square feet of buildings are likely to be sold.

This is primarily due to purchase options, primarily in Northern California, and really it relates to one significant building with Ralph's for 750,000 square feet.

When these buildings are sold, we anticipate reinvesting these proceeds predominately into land and other developments that withstand our portfolio in the future.

Our occupancy has remained very high, although would decline this quarter as the tenants in two larger building totaling over 700,000 square feet vacated in July.

Theses buildings are in Stockton and in Dallas.

And the Dallas building we talked about last quarter it was part of the overall lease extension we did with one of our tenants.

At this point, we are forecasting to release the Dallas space hopefully by year-end and Stockton sometime next.

We collected about $600,000 in rent and reimbursement from these two buildings in the second quarter, just to give you a sense of the magnitude.

As a result of these two vacancies, we expect the occupancy to drop to the low 94% range for the next few quarters, which is really more inline with our historic average.

Our same-store results were very solid in industrial, up 2.6%.

They were flat on the office side and declined on the retail portfolio.

The improvement in industrial is primarily due to higher same-store occupancy, and some rent growth as our renewed leases for the quarter are up about 2%.

Expenses in industrial were also lower, despite the fact that it was still showing unfavorable comparisons from including CFD property tax in property operating cost and some sort of interest expense.

But, this is the last quarter I will have to mention that, that affect will be back to a normalized level next quarter.

We are showing a decline in retail NOI on a same-store basis.

This decline is due primarily to non-cash accounting adjustments, including the write-off of straight-line rents and leasing commission due to the bankruptcy of one tenet that actually left the portfolio last year, a ketch-up on property tax accruals and higher expense due to the inclusion of CFD taxes as previously discussed.

Our retail portfolio is small enough, its small numbers that create fairly large percentage of changes.

So, I wouldn't take this as any particular trend.

As we discussed last time our rollover in the industrial portfolio is low compared to many of peers.

You can view this as either a positive or a negative depending on your view of market rates and where they are going versus in-place rents.

Given in many of our buildings outside of Southern California, have in-place rents that are probably slightly above today's market.

We generally view lower explorations over the next few years as positive, and we rather have our buildings leased and paying rents than wait around for rent growth.

As a result, we do not expect significant same-store growth over the next year or two, and in fact could have some negative comparisons due to expected roll down in office rents and the potential for lower same-store occupancy from today's very high levels.

Overall,

expecting to be relatively flat, but in particular we do have a large office base rolling in Texas at the end of the 2005, which we've mentioned before and this will create some down time at that point in time.

It's now to mention that our year-to-date earnings in terms of Core Segment FFO have increased about $9.5m over last year, or 9.2%.

Approximately half of this growth is due to higher NOI, primarily due to new buildings developed and added to the portfolio.

The other half is due a combination of lower interest expense and higher interest income from the notes receivables.

We should continue to see the effects of lower interest expense but with fewer buildings being added to the portfolio this year, the sale of almost 900,000 square feet of existing buildings discussed above, and some seasonal expense factors, we would expect NOI to be slightly lower in the second half of the year than this quarter.

But, in terms of guidance, we have surpassed both the original and revised expectations for the year.

At the beginning of the year, we forecasted $1.42 per share in Core Segment FFO.

During the last call we said we are likely to beat that by about $0.03, and well, we are likely to beat to that again by another $0.03 to $0.05 bringing us closer to $1.50.

And, that's primarily because of the results we achieved this quarter.

I do want to caution that given the anticipated reduction in the portfolio and the portfolio occupancy of the next two quarters that I talked about, Q3, Q4 results will be below this -- are expected to be below this quarters results.

And, then specifically, as I have analyzed this more, I want to remind everyone that we generally see relatively lower NOI in the third quarter due to seasonality, particularly the hotel JVs, as well as the timing of repairs and maintenance.

Primarily, due to this impact we would expect Core Segment FFO to be substantially lower in Q3 than in Q4.

And I will give you the specific numbers, probably closer to $0.30 or $0.31 in Q3, maybe $0.35 or $0.36 in Q4.

Nelson spoke about the activity we are seeing in the non-core assets and the interest is significantly greater than it had been just 12 months ago.

We are in active discussions or under contracts on all of our single-family residential assets, almost all of our urban residential land at Mission Bay, and over half of our remaining commercial land entitlement in Mission Bay.

Now, as said discussions, page 30 of our supplemental provides some details about our current inventory in the non-core land, just to list parcel by parcel.

I remind listeners that we have a practice of not commenting on our discussing details of individual's deals until a transaction is finalized.

But, we want to give people the sense that right now we are having a lot of discussions.

My last comment concerns with dividends.

When we first set our dividend policy last year, we set it based on the projected strength of our operating portfolio and plan developments in our core business over the next coupe of years.

On the core side, we are performing in line to better than what we had forecast.

However, if we are successful with the non-core sales we are currently working on, we could achieve more taxable income from the TRS distributed to the REIT than we had anticipated.

This additional taxable income could give rise to a special dividend if our taxable income at the REIT, which includes this TRS distribution, exceeds our annualized quarterly dividend.

Our current projections show we are very close to hitting that limit, but it's highly dependent on the timing and amount of several potential non-core transactions.

It's worthy to note right now, we are projecting about half of our dividend this year will be qualified dividend income from our TRS and subject to lower Federal taxes.

But stay tuned on the sale activity on the non-core assets and the impact it will have on required distribution.

And with that, I will open it up for questions.

Ladies and gentlemen, if you wish to ask a question, please press star one on your touch-tone phone.

If your question has been answered or you wish to withdraw your question, please press star two.

Again to ask a question, the command is star one and we will pause briefly as questions queue up.

And your first question comes from Greg Whyte of Morgan Stanley.

Please proceed.

Good morning guys.

Bill and Nelson, you put in a fair amount of color on the non-core sales in the release and obviously you have mentioned this a number of times during this call.

Can you just remind me of what else is included in non-core that you would describe as sort of not under negotiation right now?

Not under --?

Yeah, I mean, obviously I mean you've outlined a bunch of things, including the residential lab and stuff like that.

I just want -- are there any other assets that are non-core that you are currently not sort of negotiating or trying to sell?

There is the non-core asset in Alameda, the commercial portion, as opposed to the residential portion, which we've already entered into a joint venture, and that is about a 1.003m square feet of entitlement that initially was designated as

office, and we are in discussion, which we've mentioned before, with the City about the prospect of having some retail added to that parcel.

So, we are under no -- we are not having any discussions with respect to that piece.

We have, as I mentioned earlier, we've sold substantially all of our desert land and while we have active discussions on the West Coast property in Southern California, the status of litigation would delay any closing, I believe, on that parcel.

Greg, Page 30 in the supplemental provides the list of all the properties we have in our non-core segment, starting with residential on the top, and there is really about five residential projects.

Alameda residential, as Nelson mentioned, which is a land development project for us where we take down land, finish the infrastructure, contribute it to a homebuilder.

All right.

If you see there are actually two line items for that.

One is the partnership as a homebuilder; one is just building and take down; the West Coast project, which is pretty sizable value; the ocean side, piece of land is relatively small piece of land and then the two partnerships -- the land of Alameda joint ventures,

.

And then you really have the urban land, all the mission day land, which is detailed really parcel by parcel on page 30, San Diego Depot, which is just one parcel left and under contract and then LA in station where we still have a fair amount of entitlement there.

So, that's kind of the list of what we have in the non-core.

There's one other item that is exactly not a piece of real estate but were due to receive some tax increment and cash flows on our project at Hercules on the books for about $17m or $18m as in other asset categories as opposed to real estate asset.

And the likelihood of the cash flows would be substantially stronger than that over the next, well I think we're entitled to 30-40 years of cash flow there.

I've really listed out that what we have going on or what we have in terms of the non-core and really there is discussions going on in almost every piece except for maybe some of the commercial space at Mission Bay.

And Bill, just how many -- I understand, if you have the sales by end of this year such that it precipitates some sort of special distribution.

I mean obviously a key part that could tell us story here is the withdrawals that are going to derived from the redeployment.

I mean, is there any need to try and time the sales so that more of them fall into next year?

Greg, we answered really as a function of how much sales are happening over the next couple of years versus a longer horizon, and the more they are in general bunched up, the more we're going to trigger some sort of special distribution.

But the comment on the special distribution would be on the after-tax gain at most.

Not certainly on the basis of the asset, so in totaling these assets, we have over $400m of bases, when we were talking about it if we made substantial gain on that after we paid tax on that gain, the after-tax gain could give rise to a special distribution.

If you have to --

We are not taking about a mandated distribution of dollars, we're talking more of dimes in quarters.

Okay.

So, it's a relatively small amount and if you have to handicap it happening this year.

What do you think?

I wouldn't handicap it for you soon.

I think the important thing to understand, Greg, is we are in discussions and one of that, as Bill said, virtually all the process submission date.

The timing of those closings are dependant on the number of things that are beyond either the buyer or the sellers' control, giving certain assurances from the city about their design, plans, and various due diligence.

So it would be very difficult for us to --

I mean Greg realistically absorption for about that land has to happen over a few years.

So --

I understand, yes.

Just a matter of what ends up kind of in this year and next year, how much we get bunched up, or is there -- is that if absorption get accelerated somehow?

So it's, I think the point we want to make is that, we're feeling pretty good about the activity, we have been going on there and it's probably in terms of velocity, it's probably appears to be exceeding our expectations, but easy for us to say nothing is really gone in --

Right, nothing has happened for a while.

Right just one last question.

The contract building you've begun without a tenant on assuming that you feel pretty good about that market, and now from your outlines the new set of industrial park adjoining that.

What -- I mean beyond just what we all know about that market.

What is giving you the extra confidence to put more dollars in the ground there?

Well, as I have mentioned briefly in my comments the full terms like quarter, 10 to 12 -- is really a very dynamic market, this is a prime location, an excellent site.

There is not a very large supply of state-of-the-art distribution warehouses, or with the kind of truck codes and the kind of the buildings that we build.

And so it's our view that -- there is no question that there is a tremendous amount of goods flow in and out of the port.

And that our experience in Southern California has been with all the goods flow that comes through the port of Long Beach and Los Angeles as well as the large market, there is tremendous demand for distribution warehouse storage.

And the problem has been assembling sites that would allow us to do what we in

did for example to do it in that robust northern New Jersey market.

So, we feel a very good about the overall demand of the market, we feel great about this location within that market, and we think the site that we have under contract is a terrific site within that market.

Is there, ground field clean up on that new site?

There is some remediation work.

Remediation and development.

Okay, I mean is that part of the reason why you guys may be got it over competitors, more than some of your competitors?

Yes, it was -- I mean the figure of sites we're looking at, which were adjacent to the smaller site we'd already bought.

I think on part of the site there was a chemical plant, I think there was a

pond.

So, the site's been kind of more like a Kaiser type-site, in that extent sitting there for a while under utilized.

But it's something we've been working for probably two years, it's not as though, it's a book mailed out to people and everybody submit the bid on Friday, required some creativity to make it valuable.

And the remediation work has been very, very carefully analyzed before us, our involvement and certainly since our involvements, we're very comfortable with the level of remediation and the resultant of the building of the site.

Thanks a lot guys.

And your next question comes from Ross Smithbaum of Banc of America Securities.

Please proceed.

And it is Christie

here for Ross.

Just a follow-up from an earlier question.

Do you pay through development activity on your actual monetization of the non-core assets?

So basically if you monetize it at a faster than expected pace, will you ramp up your development activity?

I think our development activity is going to be a function of how we perceive the market.

We certainly are having cash generated from the monetization of the non-core assets, will give us the capital to redeploy.

But we are not going to be redeploying it just to be redeploying it.

I think the market is going to be a very important component.

We have selected markets in which we are now developing that we feel justified development.

We are also looking to acquire opportunities like we described in Northern New Jersey for future development.

So, overall I would say we are not -- we don't view ourselves as capital limited in our development decisions, but more marketing opportunity on it.

On the development that you are currently doing, have you had any progress in your pre-leasing of that?

We have in -- on one building in

, where we are in a building we are going to start this next quarter.

We think we'll have a little bit of that pre-leased.

On the two buildings we started, there are lots of discussions going on in the New Jersey building, but it just started in the last 60 days.

And then the Denver building, which started a couple of months before that or a month or so before that, I think we are talking to a couple of different tenants.

I mentioned it's probably going to go to more than just one, that market is a little bit smaller tenant market, and we are in -- just as of this moment in discussions with two tenants for probably about a third of the space or so.

And going back, just remember, when we were in the fourth quarter of last year, we had two buildings near

that we had started, but when we grew ground, they were not pre-leased, and by the time we completed they were leased.

And so, we have a pretty good feeling about the markets in which we are developing, and we are trying to gain an advantage on our competitors by having the building through the specified completion date.

Are you starting to be more aggressive on rents in any of your markets?

We've always been -- had the same philosophy on rents which is, we have empty space and the market has a rent, we accept the market rent.

So, I don't know that we ever get any more or less aggressive than that.

You get a little bit of color as to how bad or how good things get in the market, but essentially if there is a tenant looking for space and we have space, we will try very hard to negotiate to deal with tenant at an acceptable rent for both of us.

We are unlikely to let deals go by because of rent, if other people are doing deals at that rent.

Does that make sense?

Sure.

You've said in the past that there is a potential for oversupply in some markets as a result of the proliferation of third party development?

Can you comment on which markets could suffer as a result of that?

Well, I think with what we are seeing, to put that question in the context, what we are seeing is that there is a significant amount of capital entering our sector, and as a result of that and given where the tenure is, in line of that developers are now willing to develop at -- look to returns lower than we find attractive for development, and so there is that competition, and that's not as much oversupply as it is supplied at renewal rates, which could cause pressure,

on us.

As far as specifying specific markets, we are not seeing overbuilding in the traditional sense that the market has been very disciplined generally across the country.

If you look at the overall construction charts for industrial, it's down over the last couple of years, because there was a decrease in demand.

But what we are seeing is that in several markets from Chicago, for example, is a recent case in point, where developers with very aggressive capital are prepared to take returns that are lower than we think are attractive.

Yes.

I'd say that the build-to-suit market is probably less so in the speculative side, as I'm sure there is ample amount of that going on and the build-to-suit market in particular is extremely aggressive of good tenants in the market.

We are seeing yields get down to eight and even sub-eight, which are pretty aggressive for a development deal.

Great.

And one last question, you mentioned that you expect to roll down on expirations, can you quantify that, how your mark to market is on '04 and '05?

Yes, I will give you little color on market by market.

Southern California, good and bad news, our rents in the

probably little below where market rents kind of, are or seem to be going very soon, but we don't have a tremendous amount of roll over there over the next couple of years, I think we have 8.5 to 9m feet, we probably have less than 10% a year rolling in that market.

In Chicago and Dallas, I would say to give an idea rents are probably 10% or 15% below where they were four or five years ago, and that's probably where lot of our portfolio was leased in that time period.

So, in Chicago, if rents were $4 there, $3.50 in Texas, they were $3 and $2,50, $2.70.

So that's the kind of order of magnitude that we see in our whole portfolio, I think we have less than 10% a year of our square footage expiring over the next three years.

Great, thanks guys.

And your next question comes from David Copp of RBC.

Please proceed.

Go ahead David.

Mr. Copp, your line is open for questions.

And your next question comes from David Harris of Lehman Brothers, Please proceed.

Sounds like there is always another David at the other end of the line.

Hi Bill and Nelson.

There has been much talk on the conference call this quarter, and actually there was some talk about this last quarter about rising constructing cost, and the consensus appears that 10% increase in hard cost is pretty much order of the day.

Does that get translated into the thinking that you might have in terms pricing acquisitions of development land?

Well that is a very good question.

First of all we agree with the assessment that there has been an increase in cost, particularly those items that have steel components whether it's rebar or whether it is high beam, and then also lumber and roofing materials, and those cost 10% 15% in some markets.

The pricing of land is unfortunately not terribly rational, we see the fundamentals, for example the last couple of years the fundamentals were not improving and land prices were escalating.

So it's not quite that good of a market, precise of a market where in the short time it will adjust, now over time, I think it will adjust, but it's a live affect there, so I haven't seen anything that would suggest land prices are going down because of increased cost and nothing have offset land prices going up, even though rents were going down.

So, just thinking that through, Nelson, if land prices are staying firm, and rents are not rising and your contractor, your construction costs are 10% higher, it means you as a developer are taking the hit to margin?

Well, if might mean that.

We are certainly margins being -- have in general been squeezed over the last couple of years, but if you remember they expanded a lot as cap rates dropped before rents went down, and then people were chasing rents down, chasing cap rates down with their rents.

Now I think, if anything you are going to see a different effect in rents, you are going to see, if these building cost increases stick, in other words if they are not temporary, building really do cost three or four bucks a foot more to build, every developer is going to have to price that into there, into their rent and their development, and it's ultimately got to flow through to the land.

And so you have had a lot of changes in development the last couple of years with cap rates dropping dramatically and new money coming into development because it looks so attractive, now with cost going up, you should see some rent pressure upward because the competition from development is on rents is going to slack a little bit because it's just more expensive to build.

It's been development that has been driving down these big-box rents over there last three years, so development gets more expensive.

It's got to have some upward influence on rent.

With the -- another question on the development theme, with the pressure on local authorities financials, are you finding there is any Brown field site, is there a greater pressure not to give various tax breaks and inducements and instruments like TIF.

Is there any dynamic occurring in that area?

We certainly haven't seen that, in most areas where it is possible.

There is a very strong belief that that's going to be good overall to stimulate the tax increment and so that -- we have not seen that.

It's a case-by-case David.

I don't think that you can generalize one way or the other.

Okay.

And then one final question from me.

What's the staff/management arrangements that you got in place in Jersey, are you still doing this from the fall?

We are at this point still doing from the fall.

We're going to have to make some decisions on that pretty soon, once we start investing a lot of hard knowledge.

And how far is fall?

Well, we are hoping to close on this first site over the next, that Nelson mentioned, over the next couple of months.

It is unusual for us to talk about the site before we close.

I think we felt that we have been talking about New Jersey for a while, so we -- and it has been in some of the local press.

So, we are not really --.

But the answer is that right now we are -- we obviously have people on the ground there.

We -- the person who is the -- senior person is based in our Chicago office.

Okay, that is Chicago.

All right.

Thank you guys.

Thank you.

And your next question comes from David Copp of RBC Capital, please proceed.

Hi thanks.

It looks like most of the sales activity or

portion of it anyway of the sales activity in your industrial portfolio lately and in the next couple of quarters are going to be triggered by purchase options.

Could you talk a bit about how many active purchase options you've got still hanging around out there across the portfolio?

Yes, I don't have a list right in front of me David, but we do have a fairly big one, about $30m bucks in this building with rails, the tenant has purchase option, and that is we're highly confident, he is going to exercise that, and that is going to be in the next two to three months.

There is a little building, actually a pair of buildings, these are the buildings we built originally for level three, three or four years ago.

We've leased them to a company called

.

Sinex has purchase options and we think they are likely to exercise it.

Those are the two really I was taking about in my comments.

Longer term, the bulk of the purchase options tend to be in the land lease, more in the land lease there.

There's probably a handful of buildings here and there, but the land leases, we have two with Avalon Bay, they both have purchase options.

We have one on this mission place, big apartment development for dealing with AW as purchase option in that.

There is probably -- and then of course Cisco purchased option, which is really only to be viewed as net positive.

But just the other land purchase options will probably cost $200m, just those three I mentioned.

Okay, but in terms of NOI producing industrial kind of core type of assets, you've got you know what relatively fewer ones --?

Yes, I don't know the number, I can call you back later with a specific list, but it is not something we sit and generally stew over.

We have never picked a big one this year.

Got you.

Okay and then can you just talk a little bit kind of conceptually about your view of the use of debt at this point, kind of where you see your leverage going in the next couple of years, you know, these are the -- you've obviously got a period of, you know, pick your time frame, three to five years here, we're going to have more capital coming in and are going to not know what to do with, with relatively few options in terms of redeploying that capital.

What is your view on using debt year versus just putting kind of as much capital to work as you can at this point and levering up later?

Yes, I would say in the immediate term, we don't have plans for a lot of debt, but I think we are trying to watch and estimate.

So, I mean your question really requires a whole bunch of data that we don't have and that the fall answer over the next couple of quarters as of this moment seems to be we are not going to generally bring on a lot of debt.

It is going to depend on a billion factors and we are going to make the decisions kind of as we need to, but fundamentally if we are successful on the non-core assets then we have substantial inflow over the next couple of years, unless the development activity picks up from where it is, which it likely will at some point in time, that will absorb a fair amount of that, but I think it is reasonable to expect over the next few quarters our debt is going to stay flat to down little bit.

Okay and then in terms of the land transactions, you got your mission bay in the half run, residential site, do you anticipate earning any, being a JV partner, having any residual interest in those?

We've had -- we are having conversions with a variety of potential buyers and a range of transactions go across the board and what we are trying to do now is just sit through that and come up with a combination of potential transactions that make the best sense.

And pursue them.

So, the answer is it wouldn't be off the table.

We would certainly look at outright sales as well as taking back some sort of participating interest whether it's just straight debt like we did with couple of our sales last year or something more tied to the success of the development.

It's unlikely we would inject a whole lot of additional capital in the vertical development, but pretty much anything else is possible.

Great, thank you.

And your next question comes from James Sullivan of Green Street Advisors.

Please proceed.

Thanks, thank you for the additional disclosure, we find it to be very helpful.

Good.

Question on Mission Bay.

Nelson, you said you are in discussions -- the part of it that I find most intriguing in thinking about what sort of the sales proceeds you might enjoy, when you sell Mission Bay, relates to the office component, given the state of the San Francisco office market, I would think that those discussions are not very interesting, if you are talking about rent for the purpose of your office development.

What are the prospects to rezone some of that office entitlement in the way that you show the office parcels on page 30 the supplemental you indicate Life Science used for all of what is now inside a process, how does the office piece play out?

Well, the entitlement when the development agreement was agreed to the city, had that portion of land that was commercial entitled for either office or Life Science.

The subtle differences would be that portion that was office, needed to qualify to drop in, and that biotechnology Life Science because of more labs space, less office, I had a different standard.

But land that is designated is commercial, can be either office or biotechnology, and we were able to recently receive an increase in the parking ratio for buildings that were Life Science.

And in the post office, the many reasons that was acceptable to the city, one we gave up parking that we did not use in the core parking numbers

, but secondly the biotechnology experience, Life Science experience, as they different peak hour demands than office.

But so, I think that we look at the commercial and conversations we are having now are predominantly with biotechnology users on land that is commercial.

Is there a prospect similar to what you achieved, specific comments of re-entitling or rezoning office lands to another use?

Other than that of Life Science?

Yes.

There is a prospect at this point, it is something that I think would be a bit more complicated in the sense that it may require some environmental restudy about the city.

Right now we are encouraged by the activity level we are having with the Life Science.

The campus is just coming along at an extraordinary pace, and now that the campus is functioning in the new buildings coming on line, we have had a course volume increase in Life Science interest.

There has been a lot of interest to risk getting specific, it said numbers that are reasonable in line with what we thought we should expect.

So, it's different -- a little bit different then it was 12 or 18 months ago.

Okay and then sticking with Mission Bay, buyers tripping over themselves to buy office buildings with long-term leases, is there any prospect that you will sell that building?

We've had some internal discussions and chat a little bit with a couple of people; there is a kind of a minor complication and a more significant one.

The minor one is clear,

not in the building, and we have to finish the TI at some points.

So whatever price they are quoting has to be adjusted for, I think we have about $10m of work to ultimately do on the building, that's not that particularly difficult a complication.

The tax bases we have in the outset, because there is such an enormous development gain, would prohibit us from selling it outright, would make it less attractive to sell it outright.

So, we would have to exchange at levels for that particular building that would be a lot of -- there will be more buildings and we have ever bought in one transaction.

So, that's where we're trying to get our arms around what the -- what we can effectively tax effectively do with the fund.

But, I would evidently agree that the pricing of that is pleasing.

Yes. there is no question -- Jim you are right.

But, there are buyers in the market place and it's also would be a reasonable assumption to think that they have not missed us.

How many years left on the lease.

13 years and 4 months.

And the net revenue is approximately what?

We are just getting a little more benefit today because it's not an occupancy, it's a gross lease.

So, there aren't many operating expenses.

So, we probably net collecting over $1m a month.

It will drop a little bit, if someone -- when if someone occupies.

Okay, Then, finally, the office building that you bought a while back in Dallas, you purchased was JC Penny in occupancy.

It was, I was your expectations of Penny's would move out their lease.

Their lease expires next year-end of 05.

And I think the strategy at the time or part of the strategy was while we got Penny's paying the rent for couple of years during that time we will be able to find the replacement tenant.

Now, that lease maturity is on the fairly near term horizon--

Is it fully exception as to as -- you are going to fill that space, between now and the expectation?

Yes I would say the expectation was never that we would fill it between now and the expiration, so you, -- if we missed spoke I apologize.

The original underwriting assume the building would be empty for a couple of years, the premises on the building as we paid $55 a foot for a 25 story office building with replacement cost was clearly north of that has structured parking etc.

The growing in cash yield was, I think between 11% and 12% on the asset.

We levered the

out of it to us the term with floating rate debt so our return on equity has been on a cash basis 40 plus percent.

So, the original play was to have -- was assume the building would be empty for a couple of years.

I think we thought maybe there is some upside if we can get some floors back from Penny's and get them leased earlier, but the full expectation is that the space will be empty for a while as we retended it and that's all in the economics.

But, it is fair to say that we're earning more today than we pull in the future.

The overall economic reveal these were earned by next November, will earned a lot of it.

Okay thanks.

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