Prologis Inc (PLD) 2005 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the first quarter 2005 Catellus Development Corporation earnings conference.

My name is Derrick and I will be your coordinator for today.

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

We will be facilitating a Q&A session towards the end of this conference. (OPERATOR INSTRUCTIONS).

I would now like to turn the call over to your host for today’s presentation, Ms. Minnie Wright, Director of Investor Relations.

Thank you, Derrick.

Good morning, everyone, and thank you for standing by for the Catellus first quarter 2005 earnings conference call.

With us today are Nelson Rising, our Chairman and CEO;

Bill Hosler, SVP and CFO; and Ted Antenucci, President of Catellus Commercial Development, who is calling in from our Denver office.

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

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, 2004.

This document identifies important factors that could cause actual results to differ materially from those contained in the Company’s projections of forward-looking statements.

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

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

Thank you, and with all that said, it gives me great pleasure to turn the call over to our Chairman and CEO Nelson Rising.

Good day, everyone.

Welcome to our call.

I’d like to make initial comments regarding our financial results, the status of our rental portfolio, our development and investment activity, and the progress with respect to our non-core assets.

Then Bill Hosler will provide further detail on these subjects, after which Bill, Ted, and I will be pleased to answer your questions.

The first quarter operating results were consistent with our expectations.

Earnings per fully diluted share were 32 cents compared to 31 cents for the same period in 2004.

Net income for the first quarter of 2005 was $33.3 million as compared to $32.1 million for the same period in 2004.

And core segment FFO per share on a fully diluted basis for the first quarter was 46 cents.

This compares to 44 cents for the same period in 2004.

Based upon the first quarter results and our progress to date in April, we are on track with the guidance we gave earlier this year.

With respect to our rental portfolio, at March 31, our rental portfolio totaled 40.6 million square feet and was 94.7 percent occupied.

The same occupancy rate we had at year-end 2004, and compared to 95.7 percent at March 31, 2004.

Approximately 90 percent of our 40.6 million square feet portfolio is industrial property and this was 95.7 percent occupied at quarter’s end compared to 95.3 percent as year-end 2004.

We feel very good about our occupancy for 2005, with only approximately 10 percent of our portfolio having lease expirations.

We’ve experienced good leasing activity for this space so far this year and once again anticipate that occupancy at year-end will be above 94 percent.

In the first quarter, the University of California signed an option agreement with Catellus to ground lease a 99.65- acre site at Mission Bay that’s entitled for 1 million square feet.

This will be a site for their expansion hospital.

The parcel is located across 16th Street from the University of California San Francisco’s Mission Bay Biotechnology campus.

Upon commencement of the ground lease, the rent on the 99-year ground lease will be included in our rental portfolio.

We are recognizing the option payments, which are equivalent to ground lease payments in our core operations.

We also added 2 retail buildings at Pacific Commons in Fremont, California, totaling 103,000 square feet.

The buildings are 90 percent pre-leased and represent a total investment of $27.9 million, with a projected return on cost of 11.7 percent.

With respect to development and investment activity, at March 31, we had 4.1 million square feet under construction, at which 2.7 million square feet will be added to our rental portfolio upon completion.

The projected cost of this new development is $111.1 million.

The buildings we intend to hold are 33 percent pre-leased, and when fully leased are projected to yield a return on cost of approximately 10.2 percent.

Included in this total, are 2 buildings in the Inland Empire of Southern California, totaling approximately 1.3 million square feet.

The Inland Empire continues to be the strongest distribution warehouse market in the U.S.

As I mentioned in our last conference call, we have approximately 10 million square feet of existing space in the Inland Empire, with no standing vacancy.

We also have a 362,000 square foot building at Fort Reading Business Park in Carteret, New Jersey under construction and we are seeing a great deal of interest in this building, but do not have any leases to announce at this time.

There is an additional building under construction, a 348,000 square foot distribution warehouse that is currently 67 percent pre-leased.

And this is on one of the last sites of our highly successful Stapleton Business Park in Denver.

Also, we have a 428,000 square foot distribution warehouse at our Douglas Hill Business Park in Atlanta.

APL signed a short-term lease for 150,000 square feet in this building.

At Pacific Commons, we plan to start construction of Phase 2, consistent with 240,000 square feet in the third quarter of 2005.

We have signed letters of intent for 65 percent of this space.

When completed, the projected total development cost for Phases 1 and 2 of Pac Commons Retail is $94 million and is projected to have a return on cost of 13.3 percent.

The total annual rental income from Pacific Commons Retail is projected to be $13 million.

You’ll recall that when we announced the re-entitlements of the retail portion of Pacific Commons from office to retail, we projected $9 million in annual rent.

We continue to be very excited about our development opportunities in Northern New Jersey.

We expect to complete construction of the 362,000 square foot building in the Carteret portion of the business park in the next few months.

And site work is well underway on the adjacent portion of the Fort Reading Business Park, located in Woodbridge.

In February, we acquired an entitled site for approximately 1 million square feet in Elizabeth, New Jersey, located 1 mile from the Newark Liberty International Airport and immediately adjacent to the Port of Elizabeth.

We expect to demolish existing structures and begin remediation at the site immediately, and we have a 600,000 square foot distribution warehouse facility projected to be under construction by the second half of 2006.

We have an additional site at a contract that can accommodate approximately 1 million square feet, and we are continuing to pursue other attractive alternatives in this very attractive marketplace.

I want to remind everyone of our plans to have an investor and analyst tour of our Northern New Jersey activities on Tuesday, June 7th, the day before the [May conference] [ph] in New York.

We’ll have a bus leaving midtown Manhattan at approximately 3 PM.

Please contact our Investor Relations department if you are interested in joining us.

Much has happened since our last call when we announced approval of our development agreement by the City of Austin City Council before our role as master developer of the former Mueller Airport.

We are making great progress with the infrastructure and it’s our intention to purchase land from the city and develop and hold approximately 300,000 square feet of retail, similar to Pacific Commons.

We also have significant activity on Residential and the Commercial components of the project.

In April, we entered into 2 build-to-suit transactions, totaling approximately 1.8 million square feet.

Quaker Sales and Distribution, a division of PepsiCo, signed a 10-year lease for a 913,000 square foot warehouse distribution facility in Atlanta at our Douglas Hill Business Center.

We’ve broken ground for this building and completion is projected to occur in the first quarter of 2006.

Douglas Hill Business Park has been a big success for us.

With APL as a tenant and 3 buildings totaling 1 million square feet and a short-term tenant in our 428,000 square foot building, which was started without pre-leasing, and now with the 913,000 square foot building for Quaker Sales and Distribution, we have a very, very vibrant foothold in Atlanta.

The Clorox Sales Company, a division of Clorox Company, signed a 10-year lease for an interim 850,000 square foot build-to-suit distribution warehouse at the Internationale Centre South, in Minooka, Illinois.

Construction is expected to commence immediately, with construction completion projected to occur in the first quarter of 2006.

In March 2003, when we announced our plans to convert Catellus to a refocus on industrial properties, we stated our goal and have significant presence in the 5 major U.S. distribution markets – Southern California, Chicago, Northern New Jersey, Atlanta, and Dallas.

At that time, we were only active in 3 of these markets – Southern California, Chicago, and Dallas.

With our recent success in Northern New Jersey and Atlanta, we are very pleased with our progress toward the achievement of our stated goal.

With respect to our non-core assets, we began 2005 with non-core assets having a net book value of $93.1 million.

So far this year we have sold a portion of the Glassworks building at Mission Bay for $2.9 million, a 47,000 square foot office building at Los Angeles Union Station for $10.5 million, and entered into an option agreement with the University of California for 1 million square feet of entitlement at Mission Bay at a value of approximately $45 million.

We have remaining the following assets with an aggregate book value of $49 million, 36 acres of land at Los Angeles Union Station entitled for $5.2 million square feet of office, a portion of which can be converted to residential or retail, based upon a pre-agreed formula, based upon relative traffic generation.

We have 2 residential developments in suburban Sacramento Parkway and Serrano and the cash flow from tax increment and profit participation at Victoria-by-the-Bay in Hercules, California.

Another reminder, the 2005 Annual Meeting of Stockholders will be held in San Francisco on May 3rd at 9 AM at the Ritz-Carlton hotel.

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

Thank you, Nelson.

Good morning, everyone.

As Nelson mentioned, we reported core segment FFO for the quarter of 46 cents versus 44 cents last year.

This is in line with our earlier forecast and guidance.

I noticed that this is significantly more than many expected.

In looking back at my notes last quarter, I realized I didn’t discuss our plans for a higher first quarter.

Last year, our first quarter was high as well, and like this year, primarily due to lumpy sales activity.

Our third and fourth quarter, on the other hand, tend to be a little low, primarily as a result of higher operating costs and repairs and maintenance.

Last year, we did 44 cents in the first quarter, 39 cents in the second, and then 33 cents in each of the last 2 quarters.

The remaining quarters this year should be right around 39, 40 cents, bringing us in line with our initial guidance of about $1.63 in core FFO for the year, maybe a penny higher.

In comparing our income in Q1 to the first quarter of last year, NOI, which we define as rental revenue less property operating costs and equity and earnings of operating joint ventures, rose about 1.3 percent, or $800,000, to $58.9 million.

Sales gains in earnings and development JVs, net of tax and discontinued operations in the core segment, totaled $6.2 million.

That’s down $200,000 from last year.

But both years had big relative sales gains.

Both fees and interest income were up substantially, both due to the sale of non-core assets at the end of last year, resulting in a larger notes receivable balance and development fees.

Fees were up $2.7 million and interest income up $5.6 million.

Offsetting the higher fees in interest income were higher interest expense of $1.8 million, due primarily to lower capitalized interest and higher SG&A of $3.1 million, due to less capitalized G&A, and G&A moved from the non-core to the core segment.

Our expectations for the rest of the year, NOI will have a run rate slightly lower than Q1, as we always pick up a penny or two in Q1 from the seasonality of the hotels and lower operating expenses.

Development gains, net of tax, will also have a lower run rate of maybe 2 cents a quarter, down from over 6 cents in Q1.

These will stay about the same for this year, but interest income should decline a penny or two as the current notes are paid down or earned as lower rates.

Interest expense and G&A might grow a small amount throughout the year.

For the portfolio, occupancy is in line where we had projected it would be at 94.7 percent.

Industrial portfolio occupancy is at 95.7 percent.

We have about 1.5 million square feet of vacant industrial space.

A million of that is in Northern California, and half of that is in 1 building that we’ve talked about previously in Stockton.

We have about 50,000 square feet of that 500,000-square foot building leased short-term and have just signed a new lease for 100,000 feet that starts in Q3.

Overall, we expect our occupancy to generally stay in this 94 percent range.

Quarterly same-store results were slightly down at .5 percent overall, and again, a little more in office.

In Q1 ’05 versus Q4 ’04, same-store actually rose slightly at 1.7 percent, but most of that was due to higher re-collectible revenues and lower expenses.

We’ve not yet seen any gain in base rents on a same-store basis.

Industrial was up 2.2 percent quarter-over-quarter and recent new renewal industrial leases have been flat.

Office leases have continued to decline.

It’s hard to predict same-store or find much useful trend data in any given quarter due to the terms of specific leases, timing of expenses, CAM reconciliations, etc. and how they impact a portfolio of our size.

We have added 2 new pages to our supplemental - pages 23 and 24 - that show square foot and monthly base rent lease expiration by state by year just for our industrial portfolio.

If you do what I did, and you ratio these numbers, you can get a sense of the average monthly base rent per square foot expiring.

Once you do this, you can see that our average rent on industrial-based rent expiring over the next 4 years is about 39 or 40 cents a month.

As we’ve said before, in Southern California, rents will likely roll flat to up, but in Northern California, in the middle of the country, the in-place rents expiring over the next 2 to 3 years are generally above today’s market rents by about 10 percent in the rest of the country and maybe still 20 or 30 percent in Northern California, on average.

Demand does seem to be improving, but rent pressures continue to be driven by low development returns.

We didn’t see much change in the portfolio composition with only a couple of retail buildings that Pac Com has added and nothing sold.

I’ve already discussed our objective to try and sell Park Central office building in 2005, which represents our most significant leasing challenge over this year.

We also have started to market our office complex in San Jose, totaling about 427,000 square feet.

At this point, neither asset is under contract.

We spoke last call about our plans to buy the remaining 50 percent interest in the Embassy Suites hotel in San Diego.

This should close in June or July.

Once it does, we’ll consolidate that partnership, which will increase NOI and interest expense but decrease equity and earnings of operating joint ventures.

In terms of core development, we had no starts in Q1, but signed 2 large build-to-suits in Atlanta and Chicago for $1.8 million square feet in April.

For 2005, we’re still estimating development starts at 3 to 4 million square feet.

At this point, we would expect the majority of our starts to be build-to-suit, but that may change if the leasing of our existing construction accelerates.

We are seeing very competitive build-to-suit markets with yields in the low 7 percent to low 8 percent range, as mentioned in the release.

We plan on starting more retail development at Pac Com in Q2 and Q3.

We also plan on starting some retail development in our airport redevelopment in Austin late this year or early 2006.

This quarter saw the first earnings from our partnership to develop the new L.A.

Air Force Base.

We recognize 1.5 million on the percent of completion method on the building we are building for the Air Force.

That’s in the equity and earnings of development joint venture as a line item.

We should recognize about 1.25 million this year until the building is complete, which is projected right at year-end.

Next year, we could make substantially more upon the sale of the remaining surplus land in El Segundo as part of that project.

In terms of non-core, as Nelson mentioned, we have signed an option agreement with U.C. to lease the remaining piece of land we own at Mission Bay.

The option agreement runs month-to-month through this year and pays the same monthly amount as the lease rate is projected to once it starts.

Once in place, rent will be about 3.7 million per year, purchase option in 2014 at $45 per square foot.

With this transaction, we’re down to a few non-core assets with a net book value of $49 million.

And just as an aside, our most recent thinking might be to hold onto Serrano if it looks like a substantial portion of that land may be sold within the next 12 or 18 months, but we haven’t yet decided.

I know in the past we’ve talked about selling that partnership.

Lastly, in keeping with the times, we are planning on having a link on our website to an MP3 version of this call, so those of you on the go can download it to your iPod and listen to it on your way home from work.

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

(OPERATOR INSTRUCTIONS).

David Harris, Lehman Brothers

You guys have been extraordinarily successful at selling non-core assets over the last year or 2. [Have you taken into] [ph] consideration to tapping into the main year to buy investment properties by clearing out some of the assets that you hold outside the target markets that you identified from your core portfolio?

As Bill mentioned, David, we are marketing the Park Central office building and the building in San Jose, as well as we are planning to market the Santa Fe Well Center in Chicago.

These are 3 office buildings and the market is very good for those efforts, I think.

Columbus is very productive.

With respect to the other markets we have, we are very pleased with the properties we have in the markets outside of the core.

And at this point, we don’t have any plans to market those.

The real challenge is that we will be doing exchanges, and the cap rates are so low for industrial that to exchange into other buildings at these cap rates you may very well find yourself above replacement costs.

So that’s our current thinking.

Is there any argument for perhaps seizing the moment and stepping up sales and perhaps giving out a special dividend?

The issue there is, given the fact that we converted to a REIT at the end of ’04, the built-in gain situation in our portfolio would require us to pay tax and then distribute, which is not the case with someone who was a REIT prior to that where they can in fact just sell and distribute.

So that would not make that strategy appropriate.

Yes, David, that’s a big point I’d like to emphasize and make sure everyone understands.

We do have, because we converted to a REIT as opposed to a rollup, we do have a built-in gain and it’s in our financial statement.

You can read about it.

But to the extent we sell an asset for tax purposes and generate a gain over and above our basis on the day we converted rather than counting that as capital gains and distributing to our shareholders, we actually have to pay corporate income tax on that until January of 2014.

That issue goes away.

However, we can do exchanges, and if we find ourselves in a situation where cap rates provide an arbitrage there from one product type to the other we’d certainly do that.

Or from one geographic location to another, we would certainly do that.

But our focus right now is on the larger office buildings in Chicago, Dallas, and San Jose, and we hope we’ll be successful this year in trading those.

In order of magnitude, David, those 3 buildings are probably about $140 or $150 million, if we’re successful at selling all of them, which presents on its own a pretty big redeployment challenge.

All right.

Bill, while I’ve got you, thanks for giving some extra clarity on the quarterly run rates.

Maybe it will be 10 cents light of the numbers on a go-forward basis.

Could you just remind me, 163 that you’re guiding to for your core FFO for this year?

That was the initial guidance and I think that’s where we’re planning on being, or maybe a penny higher.

Jim Sullivan, Green Street Advisors

Can you remind me what your role is at the L.A.

Air Force Base redevelopment project, and given the growing rumblings about the potential closure of that Air Force base, what might that mean for your involvement there?

Our role, we have a joint venture with Morgan Stanley and [inaudible] Street and we are the developers of the L.A.

Air Force Base office facilities.

The transaction was structured so that we would be providing them with the completed buildings to replace the antiquated facilities they have there.

And then take an exchange of land, which will be suitable for residential use.

I’d like to have Ted Antenucci expand a little bit further, since he is the driving force behind this project.

Ted.

We certainly were aware of the potential for the base to close when we signed the deal, and the deal is structured in such a way that we are not taking that risk.

What may happen at the end of the day, if the base gets closed, the Air Force would end up with a brand new 5-story office facility that they would then go and do whatever they decided to do with.

They’ll let us do whatever.

But it would not impact our deal structure.

Okay.

And then switching to the industrial portfolio, Bill, you mentioned rollups in Southern California, roll-downs elsewhere.

In aggregate, what’s the mark to market for the portfolio, if I look at ’05 and ’06 rollovers?

I would say in aggregate about half our space that’s rolling is in Southern California.

And I would say that’s flat to maybe up a little bit.

And then you can see there is a little bit -- the other half clearly is outside of Southern California where things would roll down anywhere from 10 to probably on some of the leases in Northern California as much as 30 percent.

So our good news continues to be we don’t have a lot of leases expiring over the next 2 years, but I think we’re still projecting to be flat to negative on lease rates over the next -- well, I mean certainly anything we can see in the very near term.

It just depends on where the market is a year or 2 from now.

Also, one thing we do see, Jim, is that in some of the markets, and actually all of the markets, because of the economy strengthening, we do see more tenant demand.

The problem is that from the standpoint of rollovers is that many of those leases were done at the time when rental rates were higher than they are today.

But it’s not to say a demand issue; it’s simply that the rental rates on those leases, in many cases, were done at a higher point in the market.

The other factor that could enter in here is construction costs, which would seem to continue to have some pressure to them.

And if those go up, rental rates on development will have to go up, which will allow secondary market rental rates to go up as well.

You touched upon the outright sale of assets and cited some of the reasons why that would be hard for you to do.

What about the alternative of doing joint ventures and contributing properties to joint ventures?

It seems like, given the quality of your portfolio, track record as an operator, would be very attractive to institutional capital.

What about the joint venture option?

Some of the tax issues still raise their head.

If we were to contribute assets to a joint venture, in theory, a joint venture partner would then contribute, say, a majority of the equity to that partnership.

That partnership would then be full of cash that we would have to, as a partnership, turn around and deploy.

And so it’s a function of how robust we think investing all that money would be on the partnership’s behalf.

To distribute that money out of the partnership gets quite tricky and starts to look like a sale as opposed to a contribution.

So the bigger your gain in a property, the more likely that they tax when you contribute to a partnership and take out money.

How do your peers, or probably credit peers, make that contribution and not trigger a sales event or have it treated as a sales event?

There is a provision in the tax code that you can do it on newly constructed, I think it’s pre-formation costs of a partnership.

I think, we’re a little outside my expertise here, but I think you can go 24 more months back in terms of the costs you’ve contributed to a project.

When you put it in a partnership, it’s called pre-formation costs, and those get -- you are able to pull those out effectively tax-free.

But I think, and there may be other ways, but I think that’s why you see most people doing it on newer properties.

Again, if you had a situation where you had a lot of debt on the property and you contributed and the other partner paid down the debt that would be another way to do it.

But it’s harder and harder to do with large built-in gains on existing in-place property.

Ross Nussbaum, Banc of America Securities

Hi, it’s Christy McGill right here with Ross.

On Embassy Suites, have you thought further about what you plan to do with that asset?

Either sell it or net lease it down the line?

Our plan is hopefully to exchange into it.

There is a provision in the code that we can exchange into essentially the other half of an asset where we own one-half already.

So, we’re hoping to exchange into it, about a $36 million purchase price.

Hopefully, that will be one of the exchanges, one of the uses of proceeds from an office building sale.

Once we’ve exchanged into it, clearly our plan is to hold it for investment purposes under the tax code.

So, I think our plan is to, one of 2 things, either have Hilton continue to operate it for awhile on our behalf, or potentially seek out a net lease arrangement from another party who would still have to then use Hilton to manage the assets.

So, either we’ll keep it on our books 100 percent and take whatever ups and downs are provided or we may seek out to see if we can get someone to net lease it for, say, 10 years.

That would kind of lock in our cash flow and leave them the up or down side of the hotel operations.

Okay.

And then the 1 million square feet that you bought in Elizabeth in the quarter, can you go into more detail in any zoning or remediation that’s needed before you start development?

And on the 600,000-square foot building plan, is that a build-to-suit or a spec project?

Ted, why don’t you handle that?

The 600,000-foot building would be a spec project.

The zoning is in place.

I mean we are entitled to build a little over -- about 1.2 million square feet.

Right now, we are in the process of doing the remediation and our remediation budget is in the range of $5 million.

And that’s commenced.

We are actually out there demo-ing buildings right now.

The building isn’t projected to start, or even be able to start, until sometime in the middle of next year.

I think at this point in time if we had a pad ready we would start a non-leased development project.

But by that time we may not have to start at non-lease.

And also, is one of the most outstanding sites that we have in our portfolio.

It’s nearly adjacent to Port of Elizabeth.

It’s a mile from Newark Liberty International Airport.

It’s really a terrific site.

We’ve had a tremendous amount of activity on it.

The reason we won’t break ground sooner is the site needs to be surcharged for structural purposes.

And so the cleanup doesn’t take that long.

The cleanup will take 90, 120 days, and then we will be surcharging the site, which puts us into next year for a start.

I understand we’ll be seeing that on the tour in June?

Yes.

And then your NOI in Northern California picked up in the quarter, was that a result of the 2 Pac Common buildings coming on line?

And if not, when do you start receiving rental income on those properties?

Probably is.

They came in line in the middle of the quarter.

Are you comparing versus first quarter last year or --

Fourth quarter.

So it would be probably that, as well as whatever completions happen mid-quarter in the fourth quarter where you’re seeing a full quarter impact.

Okay.

And then your projected rental income of $13 million for Phase 1 and 2, can you break it out between Phase 1 and 2?

I want to say it’s about $8 or $9 million in Phase 1 and the balance in Phase 2.

Jay Leupp, RBC Capital Markets

Here with David Copp.

Bill, we’re anxiously awaiting the iPod version of the call.

Nelson, I wanted to ask you about the UCSF transaction, the lease of the last parcel there.

Can you describe a little bit about what they have in store in terms of plans for that 1 million square feet and what the timing of that construction would be and what that could do in terms of adding additional traffic and job generation to the Mission Bay site?

The plan is to do a replacement hospital for the current hospital up at Parnassus Heights.

There is a state law requiring a certain level of seismic conformance that’s triggered in 2012.

So the plan is this will be that replacement hospital.

At that point, they would do seismic upgrades at the current hospital.

The 1 million square feet of entitlement would allow them to perhaps do a 400-bed hospital.

It would be state-of-the-art, as you can imagine, with the UCSF, which is one of the premiere medical schools in the country.

I don’t have a number for you as to the number of jobs and the traffic it would generate, but put it in perspective, the 2.6 million square foot biotech campus is projected to create 9,000 jobs.

I can just say this, it will cause a great deal of interest in the area from the standpoint of medical office and also from the standpoint of the employees demanding residential units.

And then, Bill, could you get -- I’m sorry if I missed them in your opening comments, but could you give us the dollar amounts and the yields on the 2 build-to-suits you announced after the quarter?

I don’t have the specific numbers.

They are going to be around $30, $35 a foot and in the 8 range.

I think one is a little lower and one is a little higher.

Okay.

And then on your last call you mentioned that, given the upwards trend in construction costs, you might consider buying even vacant completed buildings that someone else had built and take them into inventory.

Are you getting any closer to doing something of that nature?

I’ll let Ted answer in a minute, but we haven’t really talked about that for awhile.

I think once, and if, these office buildings get teed up we’ll have to look at what we have in terms of exchanges.

If we have a gap, that may help drive that potential activity.

Ted, do you want to comment on that?

I think that for right now we’re still struggling with some of the price per square foot.

I mean acquisition versus what we’re able to build for.

As yields continue to go down, cap rates, even at low levels, if they’re capped out on the lower rent rate, that gets it more in line with construction costs.

It will never be right in line because people are going to make profit.

And that’s occurring, but I don’t think we’ve found any opportunities that fit that criterion yet, but we think it’s kind of the trend and where it’s going.

I think Bill’s answers are probably the most direct in that when we have some exchange money to place, we’ll definitely be looking harder at that.

And in terms of that exchange money, should we expect that to be strictly going into industrial.

I mean obviously you are looking to get out of some of your office, but would you consider getting into some other office buildings or some other property type if the yields were attractive to you?

We would not be considering getting into office.

I think our focus will try to be exchanging into land and/or industrial.

And, of course, hopefully, the Embassy Suites in San Diego.

Last question, just the Union Station land, the 39.5 acres you have left down there that you call non-strategic or non-core, any interest from the part of a potential acquirer at this point and would you be kind enough to extend what you think would be a possible valuation if you sold that sometime this year?

I don’t think there is a high likelihood of selling Union Station, in bulk, to one buyer.

What I do see is a very robust demand in downtown Los Angeles for residential.

And as I mentioned, both for sale and rental.

And when we entitled the Union Station, we agreed to basically a traffic-driven density, AM and PM peak hour, so that we have a built-in exchange ratio that would say that a certain number of square feet of office would relate to so many square feet of either residential or retail.

I think it’s much more likely to see some activity on the residential side and perhaps a little bit on the retail.

But I don’t think at this point in the cycle in Los Angeles a sale, it’s not projected anyway this year.

I would hesitate to put a price on it.

Greg Whyte, Morgan Stanley

Just a couple of quick follow-ups.

The 2 build-to-suits that you announced to Clorox and Quaker, that’s a first quarter ’06 sort of revenue start, is that correct?

I think somewhere toward the end of first quarter ’06, yes.

So you get a full effect, hopefully, in the second quarter.

Okay.

So three-quarters next year.

And then excuse my ignorance, but can maybe Ted tell us what a surcharging a site means and intends?

Surcharging a site is one way to deal with soil-related issues.

And what you would do in this particular case, we will pile dirt somewhere between 13 and 20 feet high over the building slab.

And we’ll leave it there for -- the engineers determine the time, but it’s typically somewhere between 3 and 9 months.

And that will basically, the weight of that material, will compact the soil underneath the slab and make it structurally stable for us to pour concrete on.

But once that pile of dirt has sat there for 6 months, you will then remove the excess dirt and place it somewhere else.

It’s amazing, because when you do surcharge a site what you’ll find is that over that 6-month period of time it will compress down by anywhere from 6 inches to 2 feet.

It really makes a difference on compacting the soil.

And that’s the reason why you won’t start until mid-’06, is that correct?

Correct.

That impacts us on the other site that we have in New Jersey too.

The soils out there, in general, require something, whether it’s -- and the most cost-effective thing to do is to surcharge.

Rich Anderson, Maxcor Financial

The sales gain of $6.2 million during the first quarter, was that all land sales?

Yes, and just to be specific, when I use that term “sales gains,” I’m looking at, from a GAAP perspective, the sales revenue less the cost of sales.

I’m adding in the equity in development JV line and I’m taking out tax and discontinued operations.

So I’m trying to get a number that directly affects the core FFO.

It’s tough to find on the P&L, that’s for sure.

What’s that?

It’s tough to find $6.2 million on the P&L.

I’d be happy to walk you directly through it.

But I’d say most of that were land sales, some land we sold down in, the last bit of land we had in Rancho Cucamonga, which we had for quite awhile.

It had quite a big margin, probably 70-plus percent profit margin.

We had a little build-to-suit at Kaiser, about 100,000 feet that closed in the first quarter.

Part of that is this percent of completion recognition at the L.A.

Air Force Base on that build-to-suit for the Air Force.

But most of it are those land sales.

The office sales that you have, that you’re marketing, did you give a dollar amount and a timeframe that you were looking at?

No.

I mean we haven’t.

We’re in negotiations on those, pretty hard to give a timeframe.

Did you give a dollar, a potential dollar amount?

No, the 3 buildings together, probably $140 to $150 million.

Park Central, we had written down at year-end, I think, to $35, $35.5 million, something like that.

But it’s too early to give many specifics.

Okay.

At Carteret, you are about to be done with the building.

What’s the leasing progress?

Ted, why don’t you respond to that?

We have, I think at this point, 2 or 3 RFPs out on the space.

One company that seems pretty focused on half the building.

We’ve had reasonably good activity, but we don’t have any leases at this point.

But activity has been good and we are negotiating with 1 tenant and we have other tenants that have some level of interest.

Have you budgeted for some downtime in that asset?

Yes.

In that building we anticipated, and we are typically pretty conservative in our downtime assumptions, we assume that it would be fully vacant for 9 months.

That market doesn’t justify that, but that’s how we underwrite our deals.

And lastly, could you guys just sort of compare or contrast Northern New Jersey with what you’ve been able to do in the Inland Empire?

I know they look differently, but are the opportunities similar in terms of the timeframe to get -- you are going to be at 5, 6 million square feet in Northern New Jersey at some point down the road.

What about returns relative to Inland, do you see it as a similar type of opportunity for the long-term that you’ve gotten out of Inland Empire?

I would say that in some ways I see it as being a little better opportunity.

Our skill set in coming in and buying parcels of land that have issues associated with them, which we are going to go through in probably more detail in the investor tour.

I think really it works well in Northern New Jersey.

I mean there are just a lot of sites out there that have issues and a lot of the sites are owned by large companies that want a comfort level that someone is going to come in and take on the responsibility and work through the responsibility of cleaning up the site.

Could you get to 9 million-plus square feet in Northern New Jersey?

Are there opportunities to get that big?

Absolutely.

I mean in addition to what we already have?

Yes, I mean in total.

Correct, yes, absolutely.

Right now, we’re at -- we’ve closed on 2 sites and those 2 total --technically, they are more than 2 sites because 1 was an assemblage, but those 2 total almost 4.8 million square feet.

Another site we have under contract, that’s another 1.2 million square feet.

So, we’re already -- we can execute on this one deal close to 6 million square feet.

And what are your return expectations on developments in Northern New Jersey?

They are going to be in the -- north of 9 percent at this point.

I mean it’s a little hard to peg the rent in some of these sites.

They are in-fill sites close to the Port and there’s really little to no new product that you can point to to get a feel for what people would pay rental-rate-wise.

We think the site that we purchased from Continental has some pretty significant upside.

We underwrote the rent in the mid-$7 range and that site could end up being $8.50, $9 rents and that would get our returns significantly over 10 percent.

But I think, comfortably, right now, based on what we have out there, we’re feeling confident that we’ll be in the 9 percent range.

It might be 9.5, it might be 8.75, but somewhere in that range, which is higher than what we would get if we were to buy land in Southern California right now.

And the main reason why is we’re taking risks on the environmental cleanup and the entitlement process.

Greg Korondi, Wachovia Securities

It’s Chris Chandley.

I’m sitting in for Greg.

I guess first and foremost, how are you going to handle all of this national portfolio from a staff perspective over the next, let’s just call it 3 years, at the senior officer level and at the regional level?

I’ll let Ted expand on this, but we have an outstanding SVP who ran our Chicago office who moved to Northern New Jersey and is running the operation there.

And we’ve hired a SVP to replace him in Chicago.

Ted, why don’t you take it from there?

Nelson really answered the question.

We envision having a senior person in each of the major markets.

And so having the person from Chicago move to Northern New Jersey filled a slot in Northern New Jersey.

He has, interestingly enough, 2 people that worked in our offices in Chicago, who, at different points in time happen to be moved to the New York area and so we hired them to work with us.

So we’ve got 3 people that have worked for Catellus in the past in our New Jersey office right now.

In addition to that, we have 2 other people.

So we have a team of 5 people in New Jersey right now.

We have backfilled the position in Chicago with a great person who is just digging in right now and taking over the things in Chicago that we have going on and looking to expand our operation in Chicago.

And I could see us having a senior person in Atlanta at some point in time.

Right now, the person that runs our Dallas office has been handling Atlanta.

But we have enough going on out there that probably justifies getting a senior person in Atlanta.

We’re evaluating that right now.

Continuing on the bigger picture, I remember last 1 or 2 calls it may have been mentioned that the margins, profit margins, on new development deals, particularly for large build-to-suit projects were getting very skinny.

I’m interested in looking at these 2 deals that you just announced and what makes these deals less skinny than others?

Ted, do you want to --

Sure.

I think they’re skinny.

I mean typically -- and I don’t keep track of every single announcement we make, but I think we’re all comfortable and familiar with 10-plus percent returns from Catellus.

And these 2 deals, Bill kind of alluded to it, are in the 8 percent range.

For us, that’s significantly down from what we have done in the past.

I think that is attributable to 2 things.

In Atlanta, we bought a large piece of property and got pretty good returns on the buildings that we built out there.

And this deal that we just did incorporated some of our land, but we also bought land next door to create an assemblage to allow for 930,000 square feet.

We didn’t have enough land to accommodate the requirement.

And we’re paying market value on that land.

There is not a value-add opportunity there.

Because of that, it’s pushed our yields down.

The same thing in our Chicago project.

You know Minooka is a site that has a lot of competition.

There is a lot of land out there.

There is nothing unique about it per se, compared to the land down the street.

In those environments, the yields get pushed down pretty low.

That’s why, in comparison to what we’re doing in Northern New Jersey where we have unique sites that we feel really good about our land bases in, which would be similar to what we did in Southern California with the Kaiser property, we expect higher yields in those types of opportunities.

That’s what we try to focus our time on.

These 2 deals happen to be parcels where there was a lot of competition and we were into our land at more of a market number.

So the value-added component with these 2 deals, large deals, nonetheless, is you think that the end value is better than what your competitors thought it was going to be?

Or do you have the ability to finance these better?

What would you say it is?

I think all of our competitors would be ecstatic with 8 percent returns, deals on 10-year leases with these types of customers.

I mean I don’t think -- we’re certainly not embarrassed about the yield and I think you could turn around and sell these buildings for 7 cap rate and certainly make a lot of money, or a reasonable amount of money I should say, but it’s nothing to be embarrassed about.

I think it’s indicative of the market and I think it’s a good return.

We’re happy with it.

But it’s not –- if I told you those returns were 10 percent that would really turn some heads.

We’re not able in a highly competitive market where we don’t have -- haven’t taken a big risk on the land to be able to generate those types of higher returns.

But we certainly do that a lot.

I mean we did a spec, building under construction at our Kaiser site and we’re negotiating with a tenant now and I think you’ll see those returns much more in line with what we’ve historically accomplished.

Bill, your number you provided or the assets that you are looking at selling in Chicago and San Jose, that 140, 150, that’s your new basis after the write-down?

Yes.

I mean the write-down on the 1 building in Texas was $1 million or so.

So that 140, 150 is your current --

Those aren’t basis.

That’s what we think the aggregate sales --

The value.

Okay.

Right.

It’s buildings we think are roughly worth and together.

What are you carrying them on your books for roughly?

I don’t know, Chris.

I can get back to you.

Clearly, the one in Texas, we’ll probably be lucky to clear book value on that.

And Candley [ph] probably won’t be that lucky.

But the other 2, the 1 in Chicago, the company and its predecessors have owned since 1903.

The one in San Jose we built in ’86.

So I can get you numbers, both before and after depreciation, but they have substantial gains and substantial tax gains.

Look for that gain on that 1903 building.

I’m sure there has been some money going into that one over time.

On the land lease to the University of California, my recollection was there was a purchase option discussed previously.

I may have missed that in your prepared remarks.

Yes, there is one.

About $45 a foot, plus or minus, $45 million, 2014.

Is that the reason for the accounting treatment or the reporting treatment for you guys?

I’m just trying to understand why you’re accounting for this.

There is on the option side and then you had the lease income.

Yes, so technically right now, we have an option with them where they’re paying us essentially a monthly option payment.

The monthly option payment happens to equal the eventual lease payment, assuming they exercise the option.

We all feel very confident that they’re working through what they need to with the city and that they’ll exercise that option.

The lease is all fully negotiated and ready to go.

So our expectation is the amount of income we’re booking right now is equivalent to what the lease income will be.

We didn’t structure this way for any accounting purpose, Chris.

It was because the city and the university needed to work out some issues that they have between them.

We told the university we were no longer willing to hold the land off the market, that we had monetized the balance of our land out there, and that either we needed to have a deal that we were collecting rent on this year or we were going to do something else with the land.

So where we met in between was gave the UC some time to work with the city to resolve their issues, but during at which point we were collecting rent, which justified us not marketing the site.

Thank you, Ted. $45 a foot, that’s your purchase option in the 10th year.

That’s on a dirt foot?

That’s on a building.

The 1 million square feet of [incodiment] [ph].

So $45 million purchase price.

Land yields today are low, mid-single digits.

Land yields, what do you mean?

The structuring of a land lease like this, or a ground lease?

If there was no option, it would be 5 percent, but there is an option to purchase, which really kind of caps that --

Caps the value.

Jim Sullivan, Green Street Advisors

A question for Ted.

Ted, you talked about acquiring a New Jersey land that has issues.

Can you help me understand from a yield context what sort of yield premium you need for working through these various issues?

On our land development deals, Jim, we shoot for a 20 IOR on the land and then we plug the land into a building pro forma that we hope to achieve a market return on.

And the deals that we currently purchased we’ve been working on for 3 years.

And so those deals were underwritten.

And we liked the sites a lot.

So, 20 is probably a little bit high on those sites.

We’re probably in the mid-teens type return on the land.

And then we plug it into our building pro formas.

We’d like to think we’re going to be certainly north of a 9 on all those deals.

The land, we feel, justifies a return of plus or minus 15 to 20 percent.

And then whatever we believe is market on the return of the building, we kind of take it from there.

In this particular instance, you could either look at it and say -- because today, I think a lot of people would build very happily at an 8 percent return in the Northern New Jersey market.

If they are in-fill locations, I think the buildings cap out, again, sub-7, 6.5, 6.75.

I think you would see our competition building 8 percent return, 7.5, 7.75.

I mean I think the market has gotten that aggressive.

And so on these particular deals, because we acquired them awhile ago, there is some upside beyond that.

But, typically, if we’re taking risks, we’re going to be looking for somewhere between a 15 and a 20 percent IOR on land un-leveraged.

Okay.

And on the projects that you’re involved with now, what are your all-in land costs, if you look at it on a FAR per square foot, or for FAR foot?

You’re talking about New Jersey?

Yes, New Jersey, on the New Jersey projects.

Just trying to get a sense, after you do all the cleanup work and the various surcharges --

Ted, I think the overall --

$20 to $30, depending on the site.

Yes, $20 to $30, depending on the site.

For FAR.

Greg Korondi, Wachovia Securities

Sorry, I’m still filling in for Greg.

Could you remind me, Bill, you mentioned in your call that the FOSL debt balance will come down as a function of the way to deal with structure.

Is that principal balance, how does that impact the balance sheet?

Is it just converted to cash?

What happens?

Just trying to look at what the balance sheet might look like at year-end.

First, you can use your real name.

We won’t discriminate against that.

So I wanted to make sure you understand that.

Second, the way the loan is structured is kind of like a liquidating asset loan.

As properties are sold, the proceeds of the sale have to pay a release price to the lender, which is us.

So that pays down the loan.

We have a page in our supplemental where we show what we think the balance of those loans will be at the end of the year.

So, in theory, when the loan gets paid down, notes receivable goes down and cash goes up.

But I want to caution you a little bit.

On some of these Mission Bay land sites, we have an obligation to the ultimate buyer, a lot of these sites are under contract, to provide them financing for a year.

So, essentially what would happen, picture a piece of land for $25 million being sold for $25 million, maybe we had $18 million lent against that to the FOSL transaction.

That $18 million comes out of escrow.

We turn right around and lend roughly a similar amount, perhaps, sometimes a little more, sometimes less, to the buyer of that land for another year.

So the issue is right now we’re earning I think a 12-percent coupon this year on the FOSL note, but most of these, what I call refinances to the ultimate owner for finished sites, are probably in the 6 to 8 percent interest range for another year on top of that.

Is there a liability then transferred on the right-hand side of the balance sheet when these are paid down and you have your make-whole obligation?

Well, essentially what happens is notes receivable goes down, cash goes up.

And then right away, cash goes down and notes receivable goes back up to the new buyer.

Page 10 in the supplemental talks --

I’m looking at it right now.

Okay.

And you see that little footnote there where we’re required to finance up to another $123 million.

But all those proceeds come from the pay-down of the loan.

There are no further questions at this time.

Thank you all for participating in the call, and for those of you who will be in New York on the 7th of June, we certainly look forward to taking you on our tour of Catellus in Northern New Jersey.

Thank you all.

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Good day.