Prologis Inc (PLD) 2004 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third quarter Catellus earnings conference call.

My name is Anne-Marie and I will be your coordinator for today.

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

We will ber 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, 0 and a coordinator will be happy to assist you.

I'd now like to turn the presentation over to Miss Margan Mitchell, Vice President, Corporate Communications.

Please proceed.

Thank you, Anne-Marie.

Good morning, everyone.

Thank you for standing by for the Catellus third quarter 2004 earnings conference call.

With us today are Nelson Rising, Chairman and Chief Executive Officer, and Bill Hosler, Senior Vice President and Chief Financial Officer.

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

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 10K for the year ended December 31, 2003 and our form 10Q for the quarter ended June 30, 2004.

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

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

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

Thank you.

And with that said, it gives me great pleasure to turn the call over to Catellus Chairman and CEO, Nelson Rising.

Good day, everyone.

Welcome to our third quarter earnings release conference call.

I plan to make initial comments today regarding our financial results for the third quarter, the status of our rental portfolio, our development activity and the progress with respect to our non-core assets.

Then Bill Hosler will provide further detail on how these subjects after which we both will be available to answer questions.

Our third quarter financial results were in line with expectations.

EPS per fully diluted share was 29 cents compared to 20 cents for the same period in 2003.

EPS per fully diluted share for the 9 months ended September 30, 2004, was 93 cents compared to 63 cents for the same period in 2003.

Core Segment FFO per share, again, on a fully diluted basis for the third quarter of 2004, was 33 cents compared to 32 cents for the same period in 2003.

And then Core Segment FFO per share on a fully diluted basis for the 9 months ended September 30, 2004, was $1.16 compared to $1.08 for the same period in 2003.

These results are consistence with our previous guidance -- are consistent, rather, with our previous guidance for Core Segment FFO per share for 2004 of about $1.50.

At September 30, our rental portfolio totaled 40.7 million square feet.

This is down by 700,000 square feet from the end of the 2000 -- excuse me, from the end of the second quarter, due to the sale of an industrial building in Stockton to our tenant who exercised its purchase option.

The occupancy of our industrial portfolio remains the highest in our sector at 94.7% although this is down from our second quarter occupancy of 96.6% in large part due to the vacancy of a 500,000 square foot industrial building in Stockton and a 423,000 square foot industrial building in Texas.

At September 30, we had Core Segment construction in progress of 3.5 million square feet and of this 3.5 million square feet, 1.4 million square feet will be added to our rental portfolio.

The projected cost of completion of this space is approximately $98.1 million and when fully leased is expected to yield a return on costs of approximately 10.9%.

Of the remaining 2.1 million square feet under construction, 1 million square feet is development per feet, 791,000 square feet is a build-to-suit-for-sale and 338,000 square feet is included in a joint venture.

During the third quarter construction commenced on 1.3 million square feet in 4 projects. 2 of which are build-to-suit-for-sale, a 456,000 square foot building in Minooka, Illinois and a 335,000 square foot building in Kaiser Commerce Center in the Inland Empire.

We started construction on a 428,000 square foot warehouse facility in Atlanta to be held in our portfolio and started without pre-leasing.

And finally, a -- we started construction on a 49,000 square foot build-to-suit in Glenview, Illinois that will be contained in our portfolio.

We have significantly increased our position in Northern New Jersey with the acquisition of 290 acres of land at Exit 12 of the New Jersey Turnpike in Woodbridge, Northern New Jersey.

This site, which is adjacent to our 25 acre site in Carteret, where we're developing a 360,000 square foot warehouse facility, has been approved for up to 3.250 million square feet of industrial space.

By applying the same set of land development skills we've applied successfully at other challenging sites, most recently our Kaiser Commerce Center in Inland Empire of Southern California, we plan to develop this site into the Port Reading Business Park and provide a state-of-the-art big box distribution warehouse facilities in the nation's third largest distribution market.

Development is expected to occur over 5 -- the next 5 to 7 years with a projected total investment at completion of $175 million.

We feel this is a great infield site in a sub market with low vacancy and virtually no new big box distribution facilities, so, needless to say we're very pleased with our progress in -- with our intent to move into this very important market.

We are continuing to work with the City of Austin, Texas on the master development agreement for the redevelopment of Robert Mueller Municipal Airport, that we expect to execute by year-end.

Under the proposed agreement, Catellus would act as a master developer, consistent with our strategy to apply our land development skills, excuse me, to selected development opportunities.

We are extremely excited about our success with respect to our non-core assets.

During the third quarter, we sold land at Mission Bay capable of supporting 508,000 square feet of commercial space to Alexandria Real Estate Equities, Inc. and subsequent to the quarter we sold an additional land to Alexandria capable of supporting an additional 935,000 square feet.

We believe Alexandria is uniquely suited to implement the vision we both share of Mission Bay as a premiere location on the west coast for biotechnology research and development.

Also, subsequent to the end of the quarter, we confirmed a story in the local media that we are in negotiations with the University of California San Francisco to ground lease a 9.65 acre site at Mission Bay capable of supporting 1 million square feet of office and life science space as a location for their replacement hospital.

The proposed 99 year ground lease, which is currently projected to commence on January 1 of 2005, would include a purchase option at year 10 of the lease.

To put these transactions into perspective, Mission Bay is entitled for 5 million square feet of office and life science development and these 3 transactions together with the other transactions previously completed consume 3 million square feet of this 5 million square feet entitlement.

During the third quarter, you recall we announced that we had entered into contracts to sell land at Mission Bay to a multiple -- to multiple residential developers for approximately $200 million.

Last week, Catellus and our partner entered into a contract to sell the leasehold interest in Mission Place at Mission Bay.

You will recall that Mission Place consists of 595 residential units, 83,000 square feet of retail space, 50,000 square feet of office, excuse me, and nearly 1,000 parking spaces.

Under this transaction, we will continue to own our fee interest in the land and collect ground rent.

The buyer will have an option to purchase the land in 2009 for approximately $61.5 million.

We are currently in negotiations with a financial investor to sell the remaining land and entitlements at Mission Bay, Santa Fe Depot, West Bluffs, that's our 114 unit residential development in Westchester, Playa Del Ray in Southern California, and Bayport, a 485 unit residential development in Alameda, California.

The transaction -- the consideration, rather, for the transaction is expected to consist of cash and a note and we expected to continue to act as the developer for the projects with an incentive fee structure.

We are nearing completion of the 195,000 square foot retail development at our Pac Commons project in Fremont, California with a grand opening scheduled for the end of this month.

By the end of the third quarter, we had executed leases and leases out for signature, together represented over 80% of the -- of this retail center's projected $10.3 million of operating income.

So, as you can tell from my comments, the third quarter and the month that followed have been extremely busy and productive times for Catellus.

With that, I will turn the call over to Bill Hosler.

Thank you, Nelson.

Good morning or afternoon, everyone.

Nelson mentioned we reported Core Segment FFO of 33 cents for the quarter to slightly above last year's third quarter.

Year-to-date we're at $1.16, which is up about 7% over last year.

For the year, we'll still targeting around $1.50 per share in Core Segment FFO, which is about 11% above last year, although we could easily be a penny on either side of that number.

The 33 cents per share in core FFO is about 6 cents below the second quarter of this year.

The decline, as we point out on the call last time is primarily related to NOI, including our joint ventures.

One thing we didn't predict, though, is the third quarter hurricanes which further negatively impacted our New Orleans Hilton Hotel, in addition to the regular seasonal impact we'd expect in the third quarter.

Outside of the JVs, NOI was down a little due to slightly lower revenue with our vacancies and higher expenses, which, again, are mostly seasonal for the third quarter.

As stated in the press release, we closed on a sale of a warehouse in Stockton to the tenant who's Ralph's Grocery.

They exercised a purchase option.

The gain on this $30 million sale was approximately $11.7 million and was excluded from FFO consistent with NAREIT and the white paper in our practice.

Unfortunately for us, the option price was struck years ago and the implied cap rate is right around 8.5 which is significantly above market cap rates today.

As we warned in our last call, our portfolio occupancy declined over the quarter due almost entirely to a 400,000 square foot building in Dallas and a 500,000 square foot building in Stockton.

The Dallas building was an early termination that we spoke about at the first quarter earnings call.

In the first quarter we extended several buildings with one tenant and agreed to an early termination in this building.

We had planned on this building being vacant the last 2 quarters, but actually had it leased on a short term basis to another tenant who has since moved out.

The Stockton building was vacated by Kelloggs who went to a new build-to-suit by a competing private developer.

Both buildings are being actively marketed and although I'd like to say we will see activity soon, they will likely be empty for a few quarters.

Rent expirations near-term are very tame, of the 1.4 million square feet of industrial space expiring in the fourth quarter, over half is committed to renew and a little less than a quarter will likely vacate.

One renewal of about 257,000 square feet is short-term and hopefully that will facilitate a build-to-suit that we will build for that tenant in Southern California.

Half of our industrial renewals in the fourth quarter are in Southern California.

As we pointed out previously, we have very low expirations in industrial over the next several years.

For office, the story is a little bit different, about two thirds of our tenants whose leases expire in the fourth quarter will likely vacate.

In addition, we have a very large planned expiration in Texas that we've been talking about at the end of next year, I think November.

That space will likely remain vacant for some time.

These expirations will result in some negative same-store office performance, probably for quite a while.

Quarterly and year-to-date same-store results were generally in line.

It's hard to predict same-store or find much useful trend data in a given quarter due to the terms of specific leases, timing of expenses and how accounting charges impact a portfolio of our size.

We generally look over longer periods of time for same-store.

Going forward, we currently expect to see same-store over the next year decline about 2% in the industrial portfolio and slightly, well, even more in office, potentially as much as 4% overall next year decline versus -- versus this year.

We're really seeing no evidence of any rental increase in most markets outside of Southern California.

Much of our portfolio is at or above market rents, although we -- although we expect occupancy to hang around 95 plus or minus percent, we expect to see continuing pressure on rents.

Over the last several months, industrial rents that we've been able to renewal or roll over to new tenants have averaged down about 3% on average, more than that on office rents.

And like I said, like everyone else, many of our rents are above the current market rent and outside of Southern California, we're not seeing evidence of rental increases as the drop in the market development yields has significantly reduced rents over the last 18 months.

We closed on a very significant piece of land in New Jersey, where we hope to be able to build over 3 million square feet of high-quality industrial space over the next several years.

The land is a redevelopment, will require infrastructure and environmental remediation work.

The environmental work by itself is only 4 to $5 million and is insured.

When all remediated with infrastructure, we expect to be -- have a cost basis in the land of about $20 a square foot of building square footage.

And ultimately when we build buildings, we should have a cost basis of just under $60 a square foot.

Today we'd estimate market rents in that market anywhere from 5.50 to over $6 a square foot.

We're currently planning a brief investor event in New York in December to provide more information about our New Jersey activities.

Kind a before look, similar to what we did at Kaiser 3 to 4 years ago and hopefully we will be as successful.

In Austin, Nelson mentioned, we're very excited with the prospects in the market generally and specifically at the Robert Mueller Municipal Airport Redevelopment.

As you recall, we were selected to negotiate with the City of Austin over 2 years ago to act as master developer.

The negotiations appear to be nearing conclusion and we hope to present a development agreement to the city this quarter.

As previously discussed, the development encompasses residential, retail, commercial as well as a hospital and we hope to be busy on this project for many years to come.

Upon execution of the agreement we will provide more detail on the specifics of this project.

In terms of other core development, we started 4 buildings in in the third quarter for about 1.3 million square feet. 2 of these buildings are build-to-sell, one in Kaiser in Southern California, one in Manuka in suburban Chicago.

A third building is a non prelease building in our park in West Atlanta and we've talked about this the last couple quarters and we finally got it started, it's in the I-20 Fullerton industrial market in Douglas County.

The building is adjacent to the 3 building APO(ph) campus we recently completed.

The fourth building we started this quarter is a small build-to-suit in Glenview, Illinois for Beltone.

Overall in building development we are about 16% pre-leased on properties we plan on adding to our portfolio.

The non pre-leased space is comprised primarily of 3 buildings in Atlanta, Denver and New Jersey.

None of these buildings will be completed until next year and we feel that at market rents, we can achieve returns on cost averaging hopefully over 90% -- or 9%.

By comparison, we're seeing very competitive build-to-suit markets with yields in the mid 7 to low 8% range.

In terms of future activity, we expect to start 1 or 2 new buildings in the Inland Empire in the fourth quarter, where activity is still very strong.

As an aside, we're having a tour of the Inland Empire market as part of the NAREIT Annual Convention on November 16th.

If you'd like to participate, please let us know.

On the land side, we're pursuing additional infield redevelopment sites in New Jersey, which, again, in December we'll talk about a little bit more.

Nelson mentioned the pace of activity in the non-core assets.

We've provided a page in our supplemental, page 32, that provides a listing of major non-core real estate assets, their size and status.

And I just want to run through a few of them briefly.

Alameda people are familiar with, this is the residential portion of Alameda.

It's a development with the City of Alameda and a joint venture with Warmington Homes.

That project has gotten off to a great start.

The partnership with Warmington has closed on 12 homes in the third quarter with 6500 contract out of the total of 485 eventual homes.

Our interest in this transaction could be part of the larger sale that we mentioned in the press release.

The next asset, West Bluffs, we have discussed in the past, currently our entitlements are being challenged and we hope to resolve those issues soon.

That asset could also be part of this larger sale.

We have some land in Oceanside, California and we've seen substantial interest on that land over the last 6 to 12 months.

And although you're not -- we're not yet under contract, we are negotiating for the sale of that land for approximately $14 million, although, again, we're not under contract yet.

We're also negotiating with our partners, Serrano, for the sale of our interest.

And our interest there is probably worth somewhere around $35,000 a lot just to give people a benchmark, but, again, I caution that we're not under contract on that.

Our Parkway Venture will naturally wind up next year as several of the remaining lots are under contract.

Our interest in this venture I would estimate today to be worth about $20,000 a lot.

And again, that's just my estimate.

We've previously discussed Santa Fe Depot in San Diego and how we're under contract for the remaining land parcel down there.

At Mission Bay we've seen tremendous activity.

We sold 2 land parcels to Alexandria, $31 million for the first parcel in the third quarter, $48.5 million, that has subsequently closed in the fourth quarter.

Additionally, we have 10 residential sites under contract, this is all shown on page 32 of the supplemental.

Together, these residential parcels projected to sell over the next few years at about $200 million.

Now, as we discussed in the last call, if we're successful with the non-core sales we're currently working on, we will almost certainly achieve more taxable income from the TRS than we had anticipated at the beginning of the year.

This additional taxable income will likely give rise to a special dividend as our taxable income at the REIT, which includes the taxable distributions from the TRS, exceeds our annualized quarterly dividend.

Our current projections show our taxable income will exceed our annualized quarterly dividend, but is highly dependent on the timing and amount of several of these non-core sales transactions.

Today, our best estimate is that the special distribution will be somewhere in the 15 to 25 cent per share range.

Again, it's highly dependent on what closes this year.

For taxable investors I do want to point out, we're projecting approximately half of our dividend this year will be qualified dividend income from our TRS and is subject to lower federal tax rates.

We've announced in this press release that we're negotiating with a financial buyer to purchase substantially all of our remaining land at Mission Bay, West Bluffs, Alameda and San Diego.

We typically would not discuss potential transactions until they are under contract however these negotiations appear to be nearing a conclusion and given the scope, we decided it was important to let you know what we're working on.

I caution you the transaction is still being negotiated and nothing is, of course, final until it's closed.

However, if it does close it could increase the previous discussed special dividend another 15 to 20 cents per share, bringing the total to around 30 to 45 cents a share.

That's an order of magnitude number.

However, lots of things still have to happen, so I wouldn't spend the money quite yet.

The structure of the potential transaction would involve a purchase for a cash down payment and a note from the Catellus REIT that would amortize as underlying assets are sold.

The initial cash would essentially be used to pay taxes on the gain and help fund the special dividend.

Overall, the structure is similar to what we've done with other sales such as Talega last year.

However, we would continue in this event to act as the development manager for the assets under an incentive fee development contract.

Finally, we've been diligently working on our Sarbanes Oxley 404 compliance.

It's consuming a lot of time and so far we've completed most of our testing and want to let people know we haven't found out anything that would give rise to material weakness at this point, and we're hopefully we won't.

With that I'll open it up for questions.

Thank you.

Ladies and gentlemen, if you wish to ask a question, please press star, 1 on your touchtone phone.

If your question has been answered or you wish to withdraw your question, please press star, 2.

Again, to ask a question, the command is star, 1.

And your first question comes from Ross Nussbaum of Banc of America Securities.

Please proceed.

Hi, it's Christina Galway here with Ross.

You mentioned that the remaining land at Santa Fe Depot is part of the large non-core sale to -- it's to one buyer, right?

The sale we talked about -- ?

Right, the potential sale.

Is all one buyer and includes all 4 of those projects.

That's the 523,000 square feet?

Yeah, the remaining land parcel and it's associated entitlement.

Because you've talked about that land before as potentially closing in the third quarter of '05.

Can we assume that that might be the same buyer?

I think it's in November of '05.

No, the large transaction we're talking about -- we have a lot of land under contract that closes over the next several years.

Uh-huh.

The large financial buyer would essentially step into our shoes and have title to the land subject to that purchase agreement and then would transact with that buyer in the future.

Okay.

The 360,000 square foot project in Carteret, is that designed for a single tenant use?

Yes, it is designed for a single tenant use, but like most of the buildings we build, it could be sub dividable quite easily because of its geometry.

Okay.

We put a bump out at each of the 4 corners of the building typically so we can sub divide every building we build.

Okay, and have you made any progress or had any conversations with potential tenants on that building?

We have been aggressively very active in the market and aggressively pursuing tenants but at this point we have nothing to announce.

As Bill mentioned in early December, we intend to make a presentation on the Northern New Jersey market and our activities there, when we're in -- in New York.

Okay.

But,Christy, nothing really circled as a tenant on the project.

Do your -- all these transactions at Mission Bay, do these change your plans with regard to the GAAP building?

No.

Not at all?

And on your -- the commercial portion of Alameda, are you still waiting for entitlement on the retail space there?

Yes, we are.

Okay.

And --

The commercial part of Alameda is not included in -- in the transaction to which I just spoke.

Right.

Okay.

And pending the entitlement, what's your anticipated timing on the build-out there?

I mean do you guys have to pay during retail first, then office much further down the road?

Well, assuming the City of Catellus can come to agreement as to the retail portion of the entitlement, given today's market condition it's highly likely that the retail would be much more accepted to the market as opposed to office and I don't see anything in the near future that would change that assessment.

Okay, thanks, guys.

Thank you.

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

Please proceed.

Good afternoon, guys.

I mean I think I understand this, but can you maybe give us your perspective as to why you would proceed with the sale of -- to -- to the financial buyer?

Well, if you recall, going back to early March of 2003, when we made the announcement of our intent to become a REIT primarily focused on industrial ownership and development, we said that it would be our goal to through the development process monetized our non-core assets.

That the residential, the urban and typically the residential and urban assets.

We've already gone through and monetized the desert substantially.

And so this is very consistent with that strategy.

We would remain as the developer if the transaction closes on a incentive fee basis.

This would enable us to have capital to deploy on a more timely basis in our core business.

So, it's very consistent with our overall strategy announced almost 2 years ago and, quite frankly, we're very pleased that we have made as much progress as we had because we thought this was going to be a 3 plus year process when we made the announcement and it looks like we're going to substantially beat that target.

And I guess my only question, Nelson, I mean I see it sort of working within your -- your -- your sort of disclosed plan, but to the extent that you're taking back a note, doesn't that impede the tip of the redeployment of process a little?

As Bill mentioned in his comments, the strategy we pursued when we conclude the sale to Liggett, for example last December, was to take some -- a note as well as some cash because we all know what the reinvestment market is like.

This was a very -- a very difficult market to reinvest at cap rates which allow you to, if you're acquiring properties, allow you to have properties at or below replacement costs.

And so, it was intentionally structured in a way that would give us both the ability to establish pricing now and receive interest on -- on the note and at the same time, give us more time to make an orderly reinvestment of those proceeds.

Anything into the fact that you're selling it now, about what you may think about future pricing or valuation?

Well, we're very optimistic about the valuation on these assets today and in the future.

So, I think that if you look at the supply constraint of markets in which these properties exist, I think that the markets are there, we feel that the way the transaction is structured we would have an upside participation should they continue to improve.

Given the transactions we've concluded or are concluding at Mission Bay, for example, with respect to the life science and biotechnology with the transaction looks very likely -- highly likely with the university's expansion hospital, we feel very good about those assets, but the transaction is structured in such a way that allows us to move on with our stated intention of deploying money and our capital in the industrial side of the business but at same time participate in the development of it as a developer with incentive fees as well as upside potential.

Greg, I'd add, we clearly, you know, we feel the pricing to the extent we conclude these negotiations, I believe we'll feel the pricing as very satisfactory to us so it's less of a statement of what future pricing will be, it's more of a statement of, you know, we've been on a couple year quest here of making the stock and its price very understandable in the market and I think we've been successful and I think this transaction would kind of complete that success.

And we'd have to spend less time and our shareholders spend less time trying to understand the vagaries of valuing land in the City of San Francisco.

Okay, just one final thing.

In terms of the remediation in the -- the New Jersey land acquisition, what's the timing on that?

Or said differently, when might you be in the ground there?

Well, you know, this site is contiguous to a site we bought last year where we've started a building.

That other site actually provides access to this one.

When we combined the 2 into one business park, which we've done, you know, we have started, we are in the ground, but we -- we'll get going on the rest of it fairly quickly.

Although vertical development will clearly depend on the absorption of the first building.

We've been working, as we mentioned in the prior conversations, on this site for quite a while.

And so the plans -- we understand what we want to accomplish, we have the entitlement in place and so we would begin as soon as we can mobilize on the infrastructure remediation portion of it.

I think you guys said what, 4 to $5 million for remediation costs?

Yeah, I think you had sent out an e-mail last night with one of your heads up questions, so, that's about the cost of it.

There's quite a bit of cost that goes into infrastructure, grading, et cetera.

The environmental component is not considered a big number compared to some of the other projects we've been involved in.

Guess what the infrastructure costs may be?

I think grading an infrastructure could easily 15, $16 million.

Okay.

Thanks a lot, guys.

Thank you, Greg.

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

A lot going on.

So, you talked about the sales giving rise to special dividend and you talked about the taxability of the dividend.

I'm curious what the tax implications are at the REIT level and whether the REIT will end up being -- end up paying a material amount of tax related to these sales.

The REIT itself?

Yes.

No, the TRS will pay a very significant amount of tax.

That's what I mean.

Yes, I'm sorry.

I think year-to-date we've already paid, you know, for the -- for the IRS, as well as the state you have to estimate your total taxable income for the year and pay it on a quarterly basis.

So, it's not tied to any actually recognize it, but it's tied to your estimate for the year.

So we've been having fairly large estimates this whole year.

We've probably paid about $40 million in tax so far this year and there's a ways to go.

So, you know, I don't have the exact number, Jim, I can call you back, but, you know, we'll probably pay $60 million in tax this year.

It would be helpful.

Let's have that discussion.

And thinking about the net proceeds, obviously we need to think about it on an after-tax basis so that would be helpful.

In depends if this other transaction closes, that's going to generate some tax, but, you know, I can walk through with you almost asset by asset, what the -- the tax basis is.

Mission Bay, for example, our tax base is -- really isn't substantially different than the book basis.

Santa Fe, as well.

Let's see, L.A.

Union Station, we actually have quite a difference, the tax basis is probably 20 -- $22 million less than the book.

But that's not part of any of the transactions we're talking about.

And on the residential side, as well, we have a little bit of basis less than -- less than book.

I think our total deferred taxes in the non Core Segment, the liability is about 23 or $24 million.

The implies a book tax difference of somewhere around a little over $50 million and again, probably half of that, or just about half of that is LA Union Station.

When we get to -- when -- when we -- when and if we close this deal, we will announce, we'll go through some pretty specific numbers in terms of what we're getting and what the tax impacts are.

But, yeah, it's fair to assume we're paying a lot of tax this year.

Which, of course, would have been the case, that's why we put these in the TRS because the residential end, for example, is taxable.

The only way to do a tax deferred transaction would be -- on these properties would be to build an older building.

Okay.

Mission place, did you say what the contracted price is?

We have not and -- and until we disclose it -- until we close it, we would not disclose that.

Fair enough.

Is your venture structured with a promoted interest there?

Our venture is structured -- no, it -- yes, I guess it is -- it is structured so there is a promote, but I'm not sure we're going to reach the promote on this price, but the -- if you recall that was structured initially as a way to monetize the land in the form of a land lease at the full land value and that -- that will be -- remain part of this because we will continue to get the land rent revenue as well as continue to get our -- at the 9th -- no, in 2009, under the transaction it would be a purchase option at a set price.

Yeah, Jim, I think we have invested in this, our partnership interest, about $25 million.

We actually here in the third quarter took an impairment of about $1 million because of the transaction, so, we still have some fee income to recognize.

There is some timing issues, but we will get right around $25 million out of it we think right now.

The impairment was in the third quarter numbers, you said?

In the third quarter numbers, yeah.

Does the sale affect terms of the ground lease at all?

No, only that there is a right to purchase at a set number, $61.5 million, I believe it is, in 2005.

The existing terms had a ground lease purchase option out in 2014 and we've provided an additional one at essentially that same price 5 years earlier.

Okay.

And then on the industrial building sale, you said it was unfortunate that there was a tenant purchase option set quite some time ago.

How -- how prevalent are these tenant purchase options throughout your portfolio?

And how are they typically structured, fixed price or market value?

That's a very good question.

You know, the recent deals we've done at Mission Bay on the land lease side have purchase options, so, Nelson just spoke of the one at Mission Place.

That purchase option probably implies closer to a -- a 6.5 type cap rate on that.

Or even lower.

The 2 Avalon Bay ground leases were done at an 8.5% return and the purchase price is essentially at that level, so, those are, you know, what you'd say is basically an above market cap rate or below market price for the purchase option.

And I'm just trying to think, in terms of ones that are significantly off, where the price has been agreed to and significantly off market, there aren't -- there aren't many others of those.

But, you know what, for the next call I'll put together a list.

But clearly when you're valuing our whole portfolio at a lower cap rate than this sales transaction happened, you -- you know, some value was lost as a result.

I don't think we have a lot of that other than these couple ground leases and of course you're generally familiar with the terms of the Cisco ground lease at Pac Commons.

Okay.

And then finally, you haven't talked much about industrial market conditions.

There's a lot of other things to talk about, obviously, but can you touch on -- on your current view on some of your key markets?

I think you did talk about the strength of the Southern California market, but can you talk about some of your other important industrial markets, Chicago, the Bay Area, Denver and Dallas?

Yes, Southern California, as both Bill and I mentioned earlier in the conversation, is extremely strong and it's a combination of the demand and -- and growing supply constraint in the more desirable areas.

The -- we feel similarly about the Northern New Jersey market, especially around Exit 12, because it's supply constrained and the huge potential demand for state-of-the-art facilities.

What we're seeing in other markets, whether it's Atlanta, whether it's Dallas, whether it's suburban Chicago, is the extraordinary amount of capital available is encouraging developments that have yields at 8 or lower and yields of 8 or lower have a depressing impact on the rents in the overall marketplace.

So, we see that.

The other point that Bill mention is that many of at least our leases and we think that's the same for most leases done 5 years ago, are over current market today.

So, what we see is leases in Chicago and Denver, Atlanta, to some extent in Denver, rolling into a market condition where they're a little bit lower.

Vacancy, we all can see the numbers, the sub markets and Atlanta.

And the aggregate are about 14%, not -- not quite that high with respect to the -- the marketplace that we are in in Fulton.

And markets in Chicago, they can see, as I think are in a macro sense of 11 or 12, but I think, again, that it varies by sub market to sub market.

Dallas is probably in the same situation approximately as -- as Atlanta.

Denver, the vacancies there are closer to 10 and so Northern California, even through there's a great deal of difficulty with office, the industrial market in the greater Bay Area is -- is not -- is not anywhere near in the condition that the --the office market is.

As -- and one last point, Jim, and then hopefully we can go back and if I didn't answer your question, you can ask other parts of it.

But we are very pleased about our vacancy, or rather our rollover for the next several years and that's not -- that's by design and that we've opted to keep our buildings leased and to not to face rollovers in this particular market.

I'd say, Jim, based on, you know, what we seen and we tend to be more on the cautious side, but, you know, we have been extending leases far into the future if we can, we have very low rent expirations as Nelson mentioned.

But, you know, over the last 18 months as opposed to just in the last, -- you know, I'm not giving you any information you don't already know, you've had rents drop as the people have been willing to accept lower and lower development yields as interest rates have come down.

And at the same time, building costs had increased quite a bit.

A little bit,.

And land prices have now started to increase a lot, as well.

So, it is money coming into develop new industrial buildings.

And then I think the third quarter across the country there was a big increase in -- in development starts on a speculative basis.

So, there is no shortage of space, development yield expectations are very low and that's driving replacement costs rents lower.

So, to the extent that you have buildings that driven on replacement costs, you're going to be in that situation for a while.

If you have a very unique or special building or location, potentially you're not going to see it as much, but, you know, the vast majority of the industrial markets are replacement cost market.

That's very helpful, thank you.

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

Please proceed.

Yes, good morning, Nelson and Bill.

Sorry to press you a little bit more on the sale to the financial buyer.

If I look on the -- in your disclosures, your non-income producing assets are in the books for just over 300 million.

Would it be fair to assume that we're talking of a transaction where the value is between 250 to 300 million?

I'm not sure what number you're referring to and we're probably not going to comment much on the price here at all, other than, you know, we certainly do expect a book gain as a result from the transaction, the way it's set up at this point.

Okay.

Well, I am looking on page 14 and I'm looking at 3:04 in urban and residential.

Is that my good starting point?

Yeah, you have 304 for urban and then above that, 86 for residential.

Okay.

So, what you're telling is the consideration is likely to be in excess of that number, if I combine the 2?

The 2 combined don't encompass the deal so it's hard for you --

You're going to strip out -- there's a few elements like Union Station, obviously, and a couple of residential plots not included in there?

Correct.

And as the timing -- is that event likely to occur this year?

I think to the extent it occurs, it would occur, yeah, relatively soon, so this year.

Okay, okay.

Could you just talk about build-to-suit margins, most of the companies that we've heard from over the -- actually a number of quarters now, have all been fairly aggressively expanding their build-to-suit activities.

It must be putting some pressure on margins and I'm just wondering what your experience has been?

Yeah, David, you know, comment with Jim Sullivan, that for us, and again, we're cautious and maybe we're spoiled from the past, but all we've seen in the last 2 years is rents go down and land prices go up and building costs go up.

So, cap rates have clearly dropped a lot which is driving it.

But I think we've still seen pretty significant margin compression on top of that.

It really gets down to when you bought your land and, you know, when you locked in your lease rate with a tenant in terms of the -- the build-to-suit market.

We've seen that just be very competitive, you know, for us this year.

We've done a few build-to-suit deals, but we're doing more non prelease deals in hopes that we do get some more recovery volume in -- in the market.

But the built-to-suit deals are extremely competitive now.

Are they -- pick a number, 50% -- 50% lower than they might have been 2 years ago?

Well, yields, you have to tell me where you think cap rates are and where people are ultimately going to transact the sales.

Well, let's pick a 7.7 cap rate.

Right I would say we are, you know, you're not competitive if you're not below an 8 - 8 1/4 on a development right now.

And I'd say for a good credit long-term you better in the low, maybe mid 7s.

Extremely tight.

50 basis points?

But David, the -- the -- the one thing to keep in mind and Bill alluded to this and that is that in the -- at market land, the deals would be at 7.5 for a good credit, perhaps maybe as high as 8.

But the overall yield that we may get may be slightly higher than that because our strategy has been to assemble well located land parcels, as we've discussed many times in the past, and these land parcels, obviously, you buy -- you have to buy market -- buy them at market.

But, if you buy land at market and then you improve it and you entitle it, you end up having the land component of the completed pad for the building at below market.

So it gives us an advantage over the developer who goes out and buys a -- a property at retail as part of just one site.

And so that I think has been able -- helped us maintain higher yield than you see in the marketplace but only because of that cost benefit.

Right.

That's absolutely right.

What you're -- what you are seeing, though, from some more sophisticated users is they hire a broker to go find the piece of land, they completely design the building they want to build and the developer bids purely on a low value-added basis.

Those are very competitive deals for us to get involved in, but, as Nelson said, when it involves a infilled piece of land or something like that we usually are able to create a pretty good advantage.

Okay, and then one final question, when can we expect '05 guidance from you?

In early '05.

Okay, great.

Thank you.

Typically we do that as part of the year-end call.

Yeah, sure.

And your next question comes from Jay Leupp of RBC Capital Markets.

Please proceed.

Thank you, good morning, here with David Copp.

A couple more questions on the portfolio sale.

Looks like with your discussion of the special dividend it would happen this year.

Is there a deposit currently up on the sale and also, could you give us the picture, Bill, of what the left-hand side of the balance sheet could look like after the sale, are you looking for the proceeds to be a majority of note and less cash or a majority of cash and less note?

And also with respect to the structure of the note, do you expect it to be a participating note in future profits or a straight note that just releases that assets as sold?

Man, that's a lot of good question!

I don't remember the first part of it already, but I think we do expect it to -- to -- if it does consume it will consume this year.

In terms of the structure, typically when we sell these, a lot of our non-core assets, we're very familiar with them and in some cases, in this case for example, we'd continue to manage it, it will be substantially a note and a minority amount in cash and the current negotiations are the note, in fact, does participate as does the management agreement in -- in future profits of the buyer on the projects.

Okay.

And then just with respect to New Jersey, how large is it if you can look forward once you get this project developed, these additional acres in New Jersey, how large, potentially, could the stabilized industrial portfolio be in New Jersey with respect to your overall portfolio once you get that new development up and operating.

And also you talked about early December, have you actually nailed down a specific date yet for that investor analyst day?

Yes, we have.

We think it's going to be the morning of the 8 right now.

It's gong to be a breakfast.

And we will put out some information on that soon.

With respect to the number of square feet, if you take the 360 at Carteret and the 3.25 million square feet at Woodbridge, both combined together as a Reading -- Port Reading Business Park, compare that to an overall portfolio of industrial of about 35 million square feet.

So, about 10%.

That -- it is our intention, as Bill alluded to earlier and I've stated in prior conference calls, to expand our activities in the approximate market to where we are, so it is -- it is our goal to increase our -- our foothold in that very important distribution market.

Specifically, Jay, there is another site that we kind of have our eyes on.

It won't close for a while, but it's plus or minus around a million feet of entitlement.

So, all of those together is just about 4.5 million feet.

Okay.

The inland empire we have close to 9 million feet.

Okay.

And one last question, Nelson, given the cycles you've been through in California, can you give us a little bit of historical perspective?

We've got a robust investment sales market, or real estate sales market in California right now.

What period of time is this most like given the last couple of cycles and how long do you think this liquid investment real estate market will continue going forward?

Well, I think that the -- the capital plow we see into the -- into the sector, which is causing all of these gyrations which we've been talking about, is capital markets driven, it's not business cycle driven.

And this, by way of explanation of that, we see cap rates going down and fundamentals not improving.

So, it -- it seems to be clearly capital markets driven.

That, I think, is going to be related to monetary policy and -- as well as the overall capital markets and if rates go up, I think you'll see that slow down considerably.

Or proportionally, rather, not considerably, but proportionally if rates do go up.

Because that's what's driving it, it's a combination of low-cost debt together with -- the -- the enormous amount of capital that's coming to real estate in the U.S. because of capital market conditions in other parts of the world.

Including exchange rates.

But I -- because of that, I don't have a crystal ball.

You hear people projecting last year, this couldn't last and it did and people projecting it this year it couldn't last and it has, so I've decided I can't predict.

Fair enough, thank you.

And your next question comes from Chris Haley of Wachovia Securities.

Please proceed.

Good morning.

Good morning, Chris.

Congratulations on a good performance during the quarter.

Thank you.

The -- the item I wanted to go through particularly was the deals that were added to the development pipeline that you intend on holding versus the build-to-suit-to-sale and the development fee -- or fee development, your yields went down about 100 basis points sequentially, implying that the deals at the margin that were added were pretty tight.

Do you provide maybe some color on what were the yields on the developments that you look --probably that you added in the third quarter?

And is there anything abnormal to those?

I'd say not abnormal, it's clearly, you know, clearly yields are going down per my earlier comments.

The -- you know, the building Atlanta, I think we, you know, depending on how long it's vacant, et cetera, we hoping to get rents somewhere in the 260, 270 range, maybe.

Maybe we go lower if the tenant came in right at building completion.

But, you know, the return on that should be over 9 hopefully.

Again, because of our land costs.

Right.

Were there any modifications to your yield expectations on the pre Q3 development pipeline in terms of what you thought what the development yields would be?

In terms of like over the last 3 to 6 months?

Yeah.

No.

Most of those were leased to the -- at a prior time.

Yeah, I think, you know, where rents are now they've, in our mind, they've been here for a little while now and I commented before, we don't really see signs of it strengthening and we're really cap rate dependent on whether or not they fall further.

But just in mathematically going from a $72 million portfolio at 11.6 yields to a $98 million portfolio at 10.9, why is that the margin that -- ?

You realize a little bit of that is distorted -- well, it's not distorted --

Some buildings move out and some come in.

But retail at Pac Commons is incomplete, it has very high return on cost in the -- you know, up to 11, 12, 13 kind of percent.

You know, it's not very large.

It certainly affects the numbers.

Okay.

On the Mission Bay activity, assuming completion of this sale and the -- the fee that the development manager fee that you will receive, from an income statement perspective or a FFO perspective, will those fees more than cover the overhead costs?

Will this be a profitable structure on an ongoing basis?

Yeah, it's too early to say exactly, Chris, how the fee structure is going to work and how much of it is going to be, you know, more recurring versus incentive based.

Uh-huh.

It's all being taken into account in terms of the overall project, in fact, the accounting requires you to take that into account.

So, for example, it wouldn't be appropriate to book a big gain and then book loss on fees over the following quarters.

Right, right.

In fact, I think it's FAS 66, Chris, that requires you to equalize the margins on your initial sales gain versus your ongoing fees streams.

Ongoing, okay.

So, there will be some, in theory, some profit, but, you know, with overhead, there's also a lot of analysis to be done of how much -- how much of me gets allocated to that for example.

How much of my cost or Nelson's cost.

You know, the -- you have kind of what I would call marginal costs of overhead to generate those fees versus a fully-loaded cost.

Just trying to compare how you're handling capitalization policies pre the sale and how you might handling it post-sale.

I will say that we probably capitalize somewhere close to $3 million of G&A on those projects.

We won't be able to do that anymore.

I don't expect that the non incentive fee stream to be wildly profitable.

I mean the deal's just likely not going to be set up that way.

It will probably be more likely to cover costs, if you will.

Right, right.

Okay.

On the -- on the distribution that you noted, just to make sure I understand this correct, you had indicated that the distribution could be 15 to 25 cents based upon the already announced Mission Bay sales of $31 million, $49 million and the 10 sites under contract, is that correct?

Yes, but the 10 sites under contract, none of those actually close -- are scheduled to close this year.

For some time, right.

So, yeah, the 2 Alexandria sales, we anticipate this -- I mean, currently our forecast is as Oceanside sale closes this year, the timing of Serrano's uncertain, you know, there's a lot of things that are kind of -- could be December, could be first quarter.

Yeah.

But it's based on -- it's based on those.

We do have -- actually one of the residential sales does close this year, actually.

So, Oceanside, Serrano, and the 2 Alexandria sales are the primary drivers for the initial expected 15 cent to 25 cent special dividend.

That is a fair statement.

Okay.

And then the additional 15 to 25 cents, if I'm correct, would relate to solely the financial buyer proceeds at Mission Bay?

Sorry for --

Yes, that's the -- yes, that's the idea.

Okay.

So, when looking at the capital that will come back to you in terms of the gross capital plus any potential gain it's going to be a pretty big number and obviously the gain is then taken into account in terms of taxable earnings.

Relative to special dividend is a function of how much taxable earnings you have under REIT rules, so, it could be -- I guess what I'm getting at -- it could be larger but you're only going to distribute the amount of money that you feel you need to in relation to your core taxable earnings.

Specifically, the TRS generates taxable income it pays tax.

What's leftover is essentially E&P, earnings and profits.

We are -- if it distributes that earnings and profits or makes a dividend essentially to the REIT, which it will do, we will move the money up.

That earnings and profits becomes taxable income to the REIT in addition to our regular NOI less interest expense taxable income from the portfolio.

Right.

That number appears to be large, so large it's probably going to be half or more of the total taxable income at the REIT.

But then leads to -- that's the same distribution requirement for any REIT, only it's just a different type of income.

So we have to make sure we distribute again at least 90%, we'll distribute a 100 or more percent of that.

And then the implication of that, the positive for taxable investors, is that all that income is essentially C Core qualifying dividend that gets passed through.

So, roughly half of our dividend will be taxable REIT dividend like every other REIT.

The other half will be dividend like every other C Corporation.

Okay.

And so -- I'm sorry, go ahead.

I mean, if you're trying to back into what's the implied gain on the --

No, no, actually I'm just wondering what the size of the gain, first it's a taxation up from the TR -- the taxation at TRS, then up to the REIT, then distributed, just wondering, I would have guessed in terms of the potential magnitude that the special dividend could have been larger or are you saying that the --

I'll give you an example, if I have a dollar of gain in the TRS, the government takes 40 cents off the top.

Yep.

Yep.

60 cents then turns out to be distributed up to the REIT as REIT taxable income.

So --

Yeah.

Yeah.

So, you could imply, hey, if I have 20 cents of additional REIT taxable income, that's probably is somewhere around, you know, 36 cents --

Pre, yeah, pre.

Of pretax gains, but it's, you know, it's never going to be quite that straight forward, either.

But that's essentially how it works.

Okay.

Great, thank you.

Thanks, Chris.

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

Please proceed.

Hi, good morning.

In your opening comments you quickly mentioned that your entitlements, I believe, at West Bluffs was being contested.

Could you give us an idea of what's happening there and how quickly you believe that will be resolved?

As we've talked before about West Bluffs, there were 3, now there's 2 challenges.

One is there was an adverse possession of challenge, which we've won summary judgment on and the plaintiffs have decided not to appeal that.

Another is a -- a challenge at the supreme court under the California environmental quality act and that challenge, basically, says that we should be governed by the Coastal Commission of Affordable Housing requirements rather than the City of Los Angeles Coastal Commission Affordable Housing requirements.

That has been briefed, argued before the supreme court and we're waiting for a hearing.

And the other challenge is a challenge -- an appeal of the unanimous court of appeals decision supporting our position in the approval by the Coastal Commission of the transaction.

That has been briefed, has not been -- have -- has not been argued yet.

So, I can't give a time reference on it, but all the litigation along the way has been favorable and we do -- there was no stay issued by the supreme court and as a result we've completed -- first we completed the infrastructure on the site.

Okay.

I had a question, I can certainly appreciate that you've had your plate full with disposing of some of these non-core assets.

And I think, Bill, you and I have talked in the past about, you know, kind of the challenges of the law of larger numbers, for lack of a better explanation, you know, in how do you keep the amount of development you're able to do on a year-over-year basis, you know, meaningful to earnings as your portfolio grows.

I mean, how much time if any is being spent these days in, you know, exploring potential sales of your core assets?

You mean potential sales of the core assets?

Well, even something fairly large scale in, you know, in the context of -- of a capitalization of or even a recapitalization of the Company?

Not a lot right now.

You know, i.e., a billion-dollar JV sale.

Not a lot right now.

Clearly in the past we've looked at it a lot.

The issue, which comes up every time, is taxes.

We have a fairly low tax basis.

It would require a -- a fairly complicated tax structure and it's not clear that you can do it without paying taxes.

Taxes would be a -- would be a bad thing to pay on our portfolio.

So, the straight sale of assets we would pay a lot of built-in gains tax.

And remember, it's different for us, perhaps than other REITs in that we have built-in gain because we converted to a REIT as opposed to rolled up to a REIT.

And that built-in gain we have to pay for another 9 years, 7 weeks, et cetera.

Right.

So, taxes are -- are a hindrance so that leads to a fairly structured transaction and again, the tax code is pretty -- pretty efficient at not allowing you to pull out cash in some sort of structured transaction that's free and clear.

We can clearly look into things like mixing bowls and certainly 1031 exchange but that requires you to go invest it in something of like nature, which --

Defeats the purpose.

Yeah.

All righty, fair enough.

Thanks, guys.

Thank you.

And your next question comes from Rich Anderson of Maxcor Financial.

Please proceed.

Question here.

The $20 per square foot, building square foot in Northern New Jersey that you cited, how much lower, if at all, is that to market?

You know, I don't -- I have a tough time answering that questioning because I don't -- you can't bind a ready to build site in that market.

So, you have to look at a residual land value from building rents.

So, if you think you can get rents, I think I said 550 to maybe over $6, and although 6 is at the high end of the range we'd expect, I'm going to use that because the math is easy.

And if you believe, you know, the old world of a 10% cap rate that would imply you want to be in a building at $60, we should be in just a little bit under $60.

If you imply a much lower cap rate, which the market probably does today, you can afford to be in the building at a much higher rate.

So, at $20 land, $40 building, those are very rough numbers, we'll be in the building at about $60.

Hopefully we'll make near -- hopefully we'll make 9% plus returns.

What would you say developers are making in Northern New Jersey?

Relative to your 9%.

There isn't a lot being developed in this market so it's hard to --

Most of the development that's taking place is down at 7 A, 8 A. There is not a lot going on in the way of new development at 12.

Any idea what they're developing for at 7 A or 8 A?

I don't have that at my fingertips, but again, they're both Northern New Jersey, but they're very different markets.

I know them well.

Okay, thank you.

You do!

And your next question comes from Chris Haley of Wachovia Securities.

Please proceed.

I'm sorry, what's the -- what is -- is the financial buyer a financial buyer with real estate expertise or just a financial buyer with money?

Could be either, in theory, right?

We have to consult Websters on that one for you, Chris.

Chris, we would prefer not to go any further with describing the transaction until it fact it closes, at which time we will be very pleased to --

But the reason we use the term financial buyer is to separate that out from developer, per se.

Because our world is going to remain as the developer.

As you know, there were some rumors prior in the market here in San Francisco.

Okay.

Thank you.

Uh-huh.

Thanks, Chris.

You have no further questions.

I'd like to turn the call back to Mr. Nelson Rising, Chairman and CEO, for closing remarks.

Thank you all for participating in the call and for your questions.

We look forward to communicating with you as to the end of the year, as -- as transactions move along.

Thanks again, everybody have a wonderful weekend.

Thank you.

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