SL Green Realty Corp (SLG) 2010 Q2 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the second quarter 2010 SL Green Realty earnings conference call. My name is Noellia, and I'll be your coordinator for today. At this time, all participants are in a listen only mode. We will be conducting a question and answer session at the end of the conference and would like to remind everyone to please limit your questions to two per person. As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today's call, Ms. Heidi Gillette, Director of Investor Relations. Please proceed.

Thank you, everybody, for joining us and welcome to SL Green Realty Corp's second quarter 2010 earnings results conference call. This conference call is being recorded. At this time, the Company would like to remind the listeners that during the call, Management may make forward-looking statements. Actual results may differ from predictions that Management may make today. Additional information regarding the factors that could cause such differences appear in the MD&A section of the company's Form 10-K and other reports filed with the SEC. Also during today's conference call, the Company may discuss non-GAAP financial measures as defined by SEC Regulation G. The GAAP financial measure most directly comparable to each non-GAAP financial measure discussed in the reconciliation of the differences between each non-GAAP financial measure and the comparable GAAP financial measure can be found on the Company's website at www.SLgreen.com by selecting the Press Release regarding the Company's second quarter earnings. Thank you, everyone. Go ahead, Mr. Holliday.

Okay, thank you and good afternoon, everyone. As reported yesterday, the Company's financial performance in the second quarter and year-to-date for the first half met and exceeded our estimates and guidance in almost all categories. Earnings right now are tracking at the high end of our 2010 guidance, notwithstanding the significant and dilutive steps we have taken to further reposition the balance sheet in 2010, which included the sale of one of SL Green's largest single investments, that being our interest in 1221 Avenue of the Americas, and also a sizeable amount of debt reduction and retirement that we began in 2009 and continue to pace in 2010. Portfolio occupancy, same-store NOI, average replacement rents, and operating margins are all very consistent with the specific estimates we rolled out in December and are reflective of a market that bottomed in 2009 and is now improving, which improvement will become more evident in future periods.

After two years of decline, New York City has added about 37,000 private sector jobs in 2010, with roughly 25% of such amount being office using employment. While this growth may seem modest in merit, contrast these amounts with the New York City budget projection over that same period of time for 25,000 job losses, resulting in a swing of about 60,000 jobs positive swing over and above what was budgeted to occur in the first half of this year. These numbers should be increasing more sharply as Financial Services firms who have restrained their hiring for much of the year we believe will become greater drivers of job growth in this market in the second half of the year as the regulatory and tax landscapes become clearer and the firms are able to sort through their hiring needs and business lines for 2011. Wall Street's profits were a sizable $10 billion in the first quarter of the year and look to be tracking at about $16 billion year-to-date. On track to exceed the budget estimates of $20 billion for the entire year and the expectation that these record profits will translate into a meaningful amount of new jobs.

These positive job trends are filtering their way through the commercial leasing market in Manhattan, both in terms of job creation and as a stimulus for tenants to lock in their long term space needs ahead of oncoming rental increases. Notably, overall Manhattan vacancy fell to 10.8% in June from 11.3% in May as a result of over 2.2 million square feet of leasing. Important to note here that vacancy peaked in this cycle far lower than many people were forecasting, so we are entering our recovery with the lowest peak vacancy rate in over 20 years.

As the peaks in the past two downturns were 18.5% in 1992 and 12.5% in 2003, contrast that against this cycle, where we peaked at about 11.6% and have quickly reduced that level to the 10.8% I mentioned earlier on its way toward equilibrium, which is around 9%. In Midtown, the leasing market is improving even more rapidly as vacancy fell to 12.5% in June from 13.2% in May, directly related to 1.5 million square feet of leasing that was completed in June. If you recall in December, we highlighted the significant pick up in monthly leasing which occurred starting at around November and has been proceeding at healthy levels since that time, and we communicated that 1.5 million square feet per month is what's typically necessary to get meaningful absorption in Midtown. And I think we're starting to see those results slowly but steadily and on track with I think how we're viewing this recovery market.

All of these positive and improving trends are apparent in the portfolio appearance performance in SL Green for the first half of the year. SL Green has already leased 1.1 million square feet out of our stated goal of 1.5 million square feet for the entire year, with approximately 500,000 square feet of leases currently under negotiation. This includes this morning's announcement of 172,000 square feet lease with Healthfirst at 100 Church, a huge lease we were able to negotiate and execute within six months of foreclosing the property, notwithstanding that this same space had stood vacant for over five years. For the first time in many years, we have competition for space, competition that is giving us some amount of pricing power to trim in our concessions, which have been sequentially reducing on average over the past four quarters. And this can be seen in our supplemental for both new and renewal leases. These contracting concessions are a first step that we had predicted would occur in 2010 on its way to meaningful increases in effective rents of up to 25% over the next three years. I would now expect that when the dust settles in 2010, the total leasing volume for the Manhattan portfolio may eclipse 2 million square feet, or something very close to that number.

Based on this positive performance, and not to be outdone by its downstate parent, our Reckson subsidiary also just recently announced as early as a couple minutes ago the signing of about another 150,000 square feet of renewal leases, one for Pepsi in Valhalla and one for Citibank at Stamford, two very important leases that the Suburban team has been working on diligently. And in looking at today's signings, Healthfirst and the suburban leases, I think it's clear that there's nothing like a quarter end to encourage our leasing team to get out there and force tenants' hands to at least get things done, and a good job to everyone in this Company who worked on all aspects of those deals. Very important deals for this Company in its attempts to carry out our business plan for the year.

The leasing in the suburban portfolio is in addition to the 120,000 square feet that was signed within the second quarter. Because of the confidence that we see based on this leasing and also just our continuing belief in the improvement of the market, we utilized the last six months to add a number of investments to the portfolio that we believe will provide future growth opportunities for the firm while also trimming back on some stabilized or non-core product where we have forecasted less growth. Accordingly, we acquired in 2010 600 Lexington, 125 Park, 100 Church Street while also taking debt positions in 510 Madison Avenue, 280 Park Avenue, and several other Manhattan area based collateral. Based on subsequent market activity involving the sale of interest in 340 Madison Avenue and the sale of 685 Third Avenue, we are confident that our early investments were well timed and are all in the money based on today's metrics, and it will now be up to us to convert those new investments into significant gains in the future.

Further demonstration of this value-add approach can be seen in the settlement we achieved on 510 Madison Avenue where, within four months of initiating foreclosure litigation on this asset, we were able to achieve a court ordered settlement with the borrower. For further discussion of the investment market in New York, let me turn it over to Andrew Mathias.

Thank you, Marc. Good afternoon, everybody. Continuing on the theme from our April call, the sales market continues to exhibit pockets of strength and a slow return to normalcy. As before, this is both on the core office deals and transitional properties and structure finance offerings. Interest in Manhattan real estate continues to be very high, with new capital players entering the market and pricing continually being pushed. In May, we announced the third leg of our acquisition trifecta this year, with 125 Park joining 600 Lexington and 100 Church. 125 Park Avenue is a key property in our home turf, the Grand Central submarket. This property has benefited enormously from institutional ownership and a recent $33 million capital program undertaken by prior ownership. With a prominent position on two avenue-width streets, Park Avenue and 42nd Street, the property has great light in there and a flexible floor plate and an underdeveloped retail profile, with the possibility of dramatically expanding the building's retail footprint. The strategy with 125 will be to explore redevelopment opportunities, work within the existing rent rule, and with several large tenant expirations upcoming, take the opportunity to continue to reposition the building and take advantage of more favorable market conditions. As in 600 Lexington, we've underwritten a fair amount of turnover of tenancy. We won't be selling the rental prospects at either of these properties short.

We'll be assuming the properties in place fixed rate financing and our purchase as being structured in a manner that will allow a reverse 1031 exchange into the property. We expect to utilize this reverse exchange with our sale of 19 West 44th Street, which is currently on the market in its second round of bidding. Another notable trade in the market was the recently announced sale of 685 Third Avenue, a building Pfizer is selling subject to a very short-term leaseback, so it will essentially be a fully vacant building on Third Avenue. It saw furious bidding, with capital from all over the world and two full rounds of proposals. At the end of the day, price exceeded the upper end of expected ranges and a national US pension fund wound up the winning bidder with a reported unlevered bid of approximately $300 per square foot. Adding in carry and cost to retenant the building, we expect their basis to be closer to $450 per square foot, a very encouraging comp for the Third Avenue corridor.

We continue to find interesting opportunities in structure finance as well, including $85 million of new investments this quarter, some representing upsizing of existing investments and some de novo investments. On the resolution front, as Marc mentioned we settled our largest structure finance investment in a very satisfactory timeline and manner with a court approved stipulation on 510 Madison that provides us either full power repayment or non-contested conveyance of the property in March of 2011, the final maturity of our mortgage and mezzanine investments.

In the retail program, our primary focus was on leasing this quarter, highlighted by the announcement of the MTV studios lease of 1515 Broadway to complement the Aeropostale deal we previously announced. MTV took the balance of the second floor space and is constructing a new studio to highlight their many special events. With just 2,000 square feet at grade remaining, we're on track to create nearly $9 million of incremental net operating income versus prior rents at the retail of 1515 Broadway. Also in the retail program, we signed a major full building lease with Foot Locker at 11 West 34th street, a property that originated from the structured finance program.

All in all, it was a busy quarter on the investment front. Now here is Greg to take you through the balance sheet.

Great. Thanks, Andrew. During the quarter, we made continued progress in liquifying the balance sheet, reducing our debt, and extending near term debt maturities. As of quarter end, we had approximately $340 million of cash on hand and an additional $157 million of restricted cash, which will principally be used to fund future operating expenses. To date, we have repaid $821 million of near term debt obligations with proceeds from property sales, a prep equity issuance, 10 year unsecured notes, and free cash flow generated from the Company. As of quarter end, the revolving credit facility had been reduced to just $800 million, down from its high of $1.4 billion just a year ago. These efforts have resulted in our debt to EBITDA being reduced to around eight times, which was our targeted goal.

The Company generated $107 million of funds available for distribution during the first half of the year. Future free cash flow will provide the ability to further delever as well as provide additional liquidity to fund future investment opportunities.

As we have stated before, when evaluating balance sheet strength, it is important to remember that we own some of the most liquid real estate assets in the REIT sector. This enables us to safely operate at leverage levels which in certain instances may be higher than some of our peers. The strength of this liquidity was once again on display during the second quarter, most notably with the sale of 1221 Avenue in the Americas, which was purchased with a $500 million equity check from a single investor. Additionally, we have initial indications of interest from 15 bidders on the pending sale of 19 West 44th street and we have received over 10 proposed term sheets for the refinancing of the mortgage we assumed at 600 Lexington, where we expect to upsize that loan while reducing the interest rate some time during the second half of the year.

Other items of note on the balance sheet for the quarter include the following. New accounting pronouncements related to the governance and control of joint venture assets led us to the determination that 141 Fifth and 180 to 182 Broadway should no longer be consolidated, but rather accounted for as a joint venture. This results in the decrease of land and billing improvements seen during the quarter and also contributes to the reduced consolidated mortgage balance.

During the quarter, we made three structured finance investments, as Andrew had mentioned, for $84.9 million. We were also able to obtain financing for two structure positions at very efficient levels, which reduced the amount of equity dollars actually funding our structured finance investments. Note that while our structured finance balances are higher than originally projected, our settlement agreement at 510 Madison coupled with the pending refinancing at 66 Fifth could result in reductions of up to $330 million of structured finance balances over the next nine months. Our investments in unconsolidated joint ventures declined as a rut of the sale of 1221, which also provided substantial boost to retained earnings as a result of substantial gain recognized in connection with that sale. We do not expect this gain will generate any additional distribution requirements during 2010, but could accelerate the timeframe for higher distributions in future periods.

Turning to the P&L, it was a solid quarter for the Company, as Marc mentioned. As we discussed in December, new accounting pronouncements require transaction costs to be expensed. Our original guidance did not include estimates for these costs since there is no way to accurately forecast these amounts. Excluding these costs, we generated $1.08 of FFO per share for the quarter, well above the consensus of $1.01. Even after deducting these transaction costs, the FFO per share for the quarter was $1.02. We believe that the expensing of these transaction costs inappropriately penalizes those companies which are active on the investment front and believe these amounts should not be reflected as a reduction of FFO.

The operating statistics for the quarter are largely in line with the guidance that we provided in December. Occupancy remains full at 94.4%, and includes 810 Seventh avenue at 79.9% occupancy and 521 Fifth Avenue at 74.5% occupancy. Expect to see rebounds in these two assets during the third quarter, which should include the releasing of the 45,000 square foot garage space at 810 Seventh as well as 25,000 square feet of retail space at 521 Fifth. The mark-to-market of negative 4.4% is right in line with the plus or minus 5% guidance we had given in December, and the TI and free rent packages are coming down from where we saw them in the first quarter, where they averaged $28 and 5.5 months free to $24 and 2.8 months free this quarter.

As we expected and discussed in December, notwithstanding the modest rolldown in rents we are realizing, the same-store NOI remains positive as a result of the positive lease spreads signed last year as well as several expense control initiatives being generated by the Company. In May of this year, we locked in electric rates on a majority of our properties at their lowest level since 2004. This should help reduce costs and minimize the impact of the hot weather that New York has been experiencing during the last couple of months. We have realized additional expense savings through rebidding the elevator contracts that service the over 500 elevators within the portfolio and have achieved headcount reductions in our engineering payroll without compromising the highest tenant satisfaction ever we achieved during 2009.

Our structured finance income for the quarter was $20.7 million and ahead of our original guidance due in part to several of the new originations coupled with the amortization of the first mortgage discount now being recorded on 510 Madison Avenue. The stipulation that was signed enabled us to amortize the approximate $21 million discount on the first mortgage position, of which $2 million is included during this quarter. During the quarter, we took approximately $5 million of reserves on the structured finance book through three positions, including writing off the remaining balance on [Stuy] Town, a small reserve on a recently restructured position, and a small discounted payoff amount which should be monetized later in the year.

Other income for the quarter was $9.3 million and included $2.4 million of lease cancellation, income, and real estate tax refunds as well as a $2.7 million commission associated with the signing of a retail lease at 1515 Broadway. G&A for the quarter remained consistent with last quarter. We have broken out transaction costs separately and excluded them from G&A. These costs will be separately tracked, as they are difficult to forecast. Transaction costs for the quarter included $2.9 million for transfer tax and professional fees associated with 100 Church, approximately $760,000 of costs associated with Aqueduct, and $1 million related to the recently closed acquisitions.

As Marc mentioned, notwithstanding the dilution associated with property sales, deleveraging, and the terming out of debt maturities, we are reiterating our initial guidance of $3.90 to $4.10. Key variables affecting this guidance for the second half of the year will be redeployment of the sales proceed from 1221, timing of structured finance repayments, interest rates, and transaction costs during the second half of the year.

And with that, I'd like to turn it back over to Marc.

Okay, thank you Greg. Before opening up the call, I'd like to reinforce certain of the key takeaways that I think we've tried to touch upon in the first half hour, and we can take some questions on hereafter. But it's a combination of factors that lead us to believe that our approach to the market will be the right approach over the next few years as things continue to improve.

First and foremost, we're starting from a relatively manageable starting point at around 12.5% vacancy, relative to other market bottoms we've been a part of over the past 20 years. This one feels like it has the ability to very rapidly come back into line, and for the reasons I stated earlier, we are starting to see that. Second, there's no new product of any note scheduled to be delivered in town over the next three to five years. This is critical factor. We're coming out of this recession with very little overhang other than what's in that direct and sublet portfolio. And even there, there are very few large blocks of space available in excess of 300,000 square feet. There's probably under 10, and many of those blocks have deals that are being negotiated now and will drop off hopefully by end of year. So as a percent of this inventory in midtown, which is close to 240 million square feet, new supply is negligible.

This low interest rate environment is driving record Wall Street earnings, which in turn we believe is going to drive sharper private sector job growth. And we're starting to see that slowly in the first half of the year and we think that will pick up momentum over the next couple years if the interest rate environment stays where it is. Tourism, hospitality, and leisure in New York City is back to near peak levels and is very robust, and retailers in our retail program and otherwise have responded by paying essentially 2006 to 2007 rents for prime retail space where they believe they can drive the business in New York given -- in the current climate, not even necessarily the future climate. And as it relates to our own portfolio, we think we've certainly stabilized the occupancy within the portfolio and we'll work on shrinking those concessions. And the structured finance portfolio has also stabilized. We've concentrated it mostly in Manhattan and it's become very profitable again. So all of those things lead us to believe you want to bet with Manhattan, not against it.

And with that, I'd like to open it up for questions.

(Operator Instructions). Your first question comes from the line of Jamie Feldman with Banc of America, Merrill Lynch.

Thank you and good afternoon. I was hoping you could talk a little bit the lag in terms of -- you're seeing market conditions tighten up a little bit today. When do you think that really translates into return to positive leasing spreads and positive same-store NOI?

Well, I can address the leasing spreads. I think we're forecasting leasing -- nominal in effect of leasing rates going positive 2011, and I think you'll start to see that, if not end of Q4, by Q1. As it relates to concessions, I think you're already starting to see that in our supplemental, where the peak concessions are starting to trim both in terms of free rent and TI, which was relatively low this quarter. You may see a little blip for the Healthfirst lease, which is a 20 year deal. So it was fast, it was done much faster than we had underwritten, but it's a concession package that's reflected over a 20 year deal, not a 10 year deal. I don't think our supplemental makes that distinction.

And the market downtown?

And the market downtown is clearly softer than the market in midtown so that will skew things. But looking at the Midtown only concessions, I think you're seeing that right away, Jamie. As to same-store NOI--

Yes, I think we said same-store NOI would be flat for the year, and so the negative spreads that you've seen in the first and second quarter we think we can offset through expense savings, so that you will not see a rolldown in NOI.

Okay, and then as we think about the structured finance maturity schedule, do you anticipate backfilling and keeping the balance where it is? And if not, how should we think about 2011 earnings?

Well, I think as I mentioned -- [6/6/6], we think probably repay some time later this year in part or in whole and 510 Madison will be out of the mix by probably March of next year. So that's $330 million that will go away. So if you look at it's contributed $20 million in each of the first and second quarter, which is substantially ahead of what we had included in our estimates back in December, so I would expect that it would roll down a little bit from those levels in 2011.

Thank you.

Your next question comes from the line of Steve Sakwa from ISI Group.

Thanks. Two questions. Could you just provide a little more detail on the downtown lease at 100 Church -- just what are face rents and what are expenses there? And if you could disclose the TI package, that would be great.

Well, Steve Durels is here. This is, I don't know, Steve, how much we can or typically could disclose on a lease?

Yes, we typically don't give those details for a lot of reasons, most of which are competitive reasons in the marketplace, but suffice it to say, it was a [4/4] deal, 172,000 square feet. It was a very heavily contested or sought after tenants. We essentially got into a three horse race between 100 Church Street, 77 Water Street, and 125 Broad Street and ultimately, the tenant chose us because of the quality of the floor plate, the location, the amount of transportation that's available on the west side of downtown, and generally bought into our vision as to where we're taking the building on the repositioning effort. But consistent with that part of downtown, the rents average over 20 years into the lower to mid 30s rents, steps up every couple of years, and we gave a market concession package which is north of 12 months of free rent and north of $60 in TI.

That's helpful, thanks. Secondly, I guess we had heard from some broker contacts that Omnicom may be partnering with the pension fund who bought the 685 Third. I was wondering if you knew if that was true, and if so, I know they lease about 0.5 million feet in your portfolio, with some staggered maturity on expirations. If that is true, how do you plan to handle the backfilling of that space?

Well, that's the new rumor, because the initial rumor on which we received at least 10 congratulating phone calls was that we were buying the building and moving Omnicom over there. So it was not true for us, and we don't believe it's true as far as any plans for them to move with the new owner of the building. We've had some very recent conversations with Omnicom representatives who rejected the rumor and we have a very good relationship with them. They are deep in our portfolio. They have a lot of years left on our lease and have no reason to believe that they would be moving out of 220.

Okay, thanks.

Your next question comes from the line of Jay Habermann from Goldman Sachs.

Good afternoon, everyone. I'm here with Sloan as well. Marc, could you comment a bit on just use of capital, where you see your capital going in the near term? And I guess breaking it out between debt paydown as you continue to look at acquisitions, and I guess also looking at the dividend as well? It sounds like you're bumping up against the minimum as you move into next year?

Well, on capital allocation, we used a lot of cash on hand, which we had gotten to be quite sizeable in 2009 primarily for debt reduction, took the line down and actually below our forecasted amount of $1 billion down to $800 million and the possibility that will be reduced further out of cash flow, which right now is cash flowing ahead of our projections. And in terms of the new acquisitions, those are largely being funded out of the sales, which is very consistent with the strategy we've employed for many many years. So selling 1221 and in the process of selling 19 West, and then cycling into the investments I mentioned earlier.

So we think that's relatively balanced looking to take sizeable gains on that which we're selling, which we did on 1221 and we hope to do on 19 West and then trying to reemploy where we think we are going in at relatively low escalated rents, embedded relatively low price per foot, and hoping to make those kind of gains in the next cycle. So I think we look at it generically in that context saying we've got dispositions available for recycling and we had cash on hand for debt reduction, we've got cash flow that can be used for another year or two for debt reduction. But since we have eclipsed the eight times debt to EBITDA, as Greg mentioned earlier, I think we will have some latitude in -- not in 2010 but I think in future years to assess reengaging the dividend back to levels that are more consistent with the amount of cash flow and taxable earnings that we'll be receiving.

Okay, I guess the question asked a little differently -- you're still seeing some downward pressure on rent in the early renewals, and that was I think about 150,000 square feet in the most recent quarter. Does that change at all your appetite for acquisitions today or are you still seeing that positive 25% increase in rents over the next three years?

When you say downward pressure, that may be downward pressure off of escalated rents which had escalated to very high levels. If you have a 10 year deal that's rolling in 2010, that very likely was cut in 2000, which was pre dot com bust, those were peak rents that were as high or higher in some cases than there were in 2006 to 2007, and they had grown because they escalated up over 10 years.

So to say that our rents today are only 4% below expiring rents, I think is an enormous accomplishment. I'm not sure many other REITs or companies can have that same kind of result where you're basically flat today coming off a 10 year peak rents in 2000 as escalated. So the market we see and have seen since November is improving, not downward pressure as you're describing it. There may be downward pressure comparing today's rents to historical rents, which were peak rents, but there's certainly much better rents and net effect of rents today than existed in 2008 and 2009 by a wide margin, like not even close, where we have the ability now on blocks of space to decide whether we want to break up those blocks and do smaller deals or hold out for bigger tenants that we're negotiating with and getting a bit of a premium for the block space. That's a new phenomenon that's only three or four months old. So I would say that if we're seeing pressure at the moment, it's an upward trending pressure which is what I tried to articulate in the first part of this call, and I would say that given my view, which I also stated earlier that all the deals we've done over the past six months I think are in the money -- that's another way of saying I'm happy with those deals. So they are all profitable at this point. We'll gauge going forward how to invest -- you might note that we passed on 685, passed on 340 Madison, so our MO is to be early and to hopefully be right and hopefully be very profitable. But I think we have a pretty good track record of picking our spots and I would expect we'll continue to do so.

Well, you mentioned furious bidding obviously for 685. Is your impression would you expect to see more asset sales in the near term? Do you think bidding is starting to get aggressive again?

I think it is aggressive, when you're talking about 30 bids and second rounds of 10 or more bidders, we characterize that as aggressive and I think there will be more asset sales in the future. There's been a steady stream of assets this year thus far and we expect that to continue.

Thanks guys.

(Operator Instructions). Your next question comes from the line of Vincent Chao from Deutsche Bank.

Good afternoon, everybody. Just a question on the OpEx line. It was down fairly substantially quarter on quarter. I know you talked about some expense savings that you had implemented, but just wanted to get some clarity on that decline. Was that just simply because of the elevated Q1 level or was there anything else in Q2 that might not go forward?

No, I think you have some of the expense savings in payroll that I had mentioned and the service contracts on the elevators, and if you also look historically, there's some seasonality there. So first and third quarters are always higher expense for us, and what you're seeing in the second quarter is seasonality, but also some savings on top of that.

Okay, and then just another question on the structured portfolio. I think just at the beginning of the year, the outlook, I don't think you anticipated any additional writedowns in that or reserves, and now we've had two quarters where we're still seeing reserves come through. Just wondering what the biggest difference is now versus your initial outlook in terms of that?

Well, I think on one of the assets I mentioned, we did a negotiated -- what will be a discounted payoff. So in order to get money back early, we took a proactive charge there. We had said I think at year-end that we had a small balance outstanding related to Stuy Town. There was a bankruptcy filing there, so it was a triggering event. And the last one is really just being pro proactive just because there is an asset in a workout that -- we're not controlling what the outcome is going to be there. So I think you may actually see some of those previous reserves reversing themselves in future quarters where we have fully reserved positions where we're actually going to recollect some of our principal, so I would say just being conservative and cautious on the marks there.

Okay, thank you.

Your next question comes from the line of Jordan Sadler from KeyBanc.

Thanks. Could you, Andrew, maybe give us a little bit more color on why 685 wasn't one of your spots? I'm not sure if you were involved in the bidding, but what about it was not as appealing as some of the other investments?

We were involved in the bidding there and I think it's a great located building. It's the prospect of a fully vacant building in six months, because Pfizer was keeping the building for six months. The floor plate is a bit challenging because it is two buildings combined. And at the end of the day, the returns, we felt just -- we had a little bit higher return expectation to take full building lease up risk. Not to say it's going to be a bad deal for the buyer. I think just the return profile with the rents that we thought we could get just didn't meet up with our requirements.

I mean otherwise said, some of the buildings we purchased at 600 and 125, we think we can get as good or better yields with much less execution. And we're always weighing those two things, we'll take less return for less execution risk, or -- we have no problem taking full building vacancy but feel like in this market you still need to get paid for that and that just didn't quite hit our hurdles. But it's not unusual for other institutional foreign investors to have lower investment hurdles or higher rent growth expectations than even we have, in which case one of those two things must have driven that purchase.

Okay, that's fair. And then on the structured finance book, one, were the investments this quarter all in Manhattan? I didn't catch that. And then do you expect the book to get bigger before it gets smaller as we look out over the next 12 months?

The investments were all in Manhattan this quarter and I think we're operating within our self-imposed 10% of total assets. We're really taking opportunities as they come on a risk adjusted basis. We're always evaluating new investments and also resolving old investments. So it's tough to predict exactly where it will shake out, because it really is based on the opportunities that we're able to source.

Thank you. Are there any further questions, Operator?

Your next question comes from the line of Brendan Maiorana from Wells Fargo.

Thanks. Good afternoon. In terms of with buyer activity picking up in New York City, has there been any increased buyer interest in the suburbs and maybe some yield compression there? And how do you think about potentially monetizing some assets in the suburbs and perhaps redeploying capital back into the city?

We haven't really seen the kind of sales velocity in the suburbs that we've seen in Manhattan. Its been much more characterized I would say by foreclosures of overlevered portfolios which still have to get worked through rather than sales of assets that are not overlevered. So there haven't been good data points in the suburbs thus far, and we hope that over the course of time, strength in the city translates to some yield hungry investors looking to the suburbs, which will ultimately lead to yield compression there. But I think it's still too early.

And if you get yield compression, which I don't know what the spread may be -- but over time, would you look to monetize some of those assets and recycle into Manhattan? Or is just the potential near term dilutive impact of that a little bit too much to take and you'd rather just keep the exposure in the suburbs?

It really depends on the specific situation. I think selling the suburbs is not a strategic goal of ours. We're not looking to redeploy out of the entire suburban portfolio. So it's just on a case-by-case basis, looking at buyers that may come up for suburban assets and then figuring out where to redeploy those proceeds. Obviously, we're not opposed to the concept of selling in the suburbs and redeploying in the city if we think we can get equivalent returns on our capital, but it's not something we're faced with now given the market.

Thank you.

Your next question comes from the line of Michael Bilerman from Citigroup.

Thanks, it's Josh Attie and Michael. Can you walk through the sale of 1221 and the acquisition of 125 Park, maybe what the valuation was on the sale versus the acquisition, the level of return you're targeting for 125 and maybe some of the underwriting assumptions that you're using to get there?

Well, that we could do that in two minutes or in an hour, but why don't we do this. You want which one, the short or the long?

Let's do the short version now.

Okay, short version. Let's go through 1221 sale. The basic motivating factors.

Generally the sale was a non-managing interest which is never our preference. It was an opportunity to make a very significant gain on our investment and realize essentially an unlevered IRR in excess of 10%, and we sold 1221 at about a little bit north of a 6.5% cap. There was the lease rollover profile in that building. We're not 100% comfortable with it. There's a significant amount of rollover in 2012 and 2013 with very large tenants. The building was going to require an enormous amount of capital to retenant if the Rock Group was unsuccessful in attaining those tenants, so we chose to exit. We found a buyer which, I think we've characterized before, is theres not a lot of buyers for a very very underlevered $500 million cash check. So we chose to exit that investment.

And then 600 Lex we purchased at approximately 6% going in cap rate at around $630 to $640 a foot. That's a 1980s construction building that achieves much higher nominal rents than 1221. There is rollover in that building as well as I indicated in my prepared remarks where we do expect there to be some leasing exposure there, but there are very small floor plates. Steve Durels is able to offer tenants a full floor presence for small tenants, which is a rare commodity in Manhattan's market even today. And we're very optimistic about the prospects and I think we've characterized the Manhattan return parameters at 8% to 10% unlevered IRRs on acquisitions and translating into 12% to 15% levered IRRs for the acquisitions we are targeting. I think that addresses most of your question.

And 125 Park, did it look similar to 600 Lex?

It's a pretty similar profile. It's a lower nominal rent building and we pay a much lower per foot price for the asset. But similar with a lot of capital recently invested into the asset, a similar rollover profile, that building is really a Grand Central story and a potential retail repositioning there where we think there's some significant expansion to the retail footprint that we're investigating.

Just to add to that, though, 125 -- the majority of that role starts in December of 2011 and goes into 2012 and 2013, so it's I think from our perspective is very well suited to catch what we believe is going to be the rising market trend.

Great. Just a clarification on the guidance. I think you talked about amortizing the discount on the loan on 510 Mad, about $21 million, $2 million of which came in the second quarter, which leaves $19 million -- I guess that's straight line through March, which would leave about $12 million in the back half of the year, but about $0.16. I guess a, so that's fully now into guidance and is that reflected in your yield that's in the supplemental? And I guess having that extra call it $0.20 to $0.25 in FFO this year relative to your initial expectations, what's offsetting that sort of gets you still within the range?

Yes, well the upshot is it's not fully reflected in 510 because it's only in there for a piece of the quarter, but that balance will be amortized through the period of March 1 of next year, so you will have a big pick up from that. You remember that you have -- we owned 1221 for half of the second quarter. That income is now gone and those moneys haven't yet been fully redeployed. We have transaction costs that will be coming through in the third and fourth quarters, which were unforecasted, and we've also provided for a potential increase in LIBOR here in the second half of the year and some flexibility that may allow us to do some additional terming out of liabilities which might come at a higher rate if we go from floating to fixed. So I mean as we sit here now, if you look at the run rate for the second quarter, it would appear likely that we'll end up towards the higher end of the guidance. But there are a couple of significant variables out there that we just have to monitor for the second half.

Your next question comes from the line of Mitch Germain from JMP Securities.

Good afternoon, guys. With the 485 lawsuit cleared, would you guys be possibly looking to pursue a sale of that asset as well?

I think for now, we're holding that asset and there's some occupancy leasing that we're working through there and we're content to hold on to that asset for the near term.

And you talked about repositioning 125, Andrew. What sort of assumptions -- I'm reading that Meredith might be departing. What sort of assumptions have you embedded in your underwriting for downtime?

As Steve said, Meredith lease's doesn't expire until the end of 2011, so we should know within the relatively near term if they decide to take space elsewhere or if we're able to make a deal with them. And we'll spend the time that we have, nearly 18 months working hard to try and find a replacement tenant. So I'd like to be able to say hopefully there will be minimal downtime.

With that said, our standard underwriting -- we looked at that deal and we'll look at deals like that with a large tenant staying and going, staying under some renewal terms, and if we have them going in midtown it could be anywhere from eight to 12, nine to 12 months of downtime would be high to low. So it's not material either way, but certainly with 18 months of lead time and then another eight to 10 to 12 months of downtime beyond modeled, that's a property at a prime location right across from Grand Central. We priced it at today's prices and we'll move the space if we don't otherwise retain the tenant. So that's no different than we look at that tenant as we do any of our larger tenants in the 11 million square feet we have in Grand Central.

And we're actively out there already offering the space to prospective replacement tenants while we continue a dialogue with Meredith. As a matter of fact, we've had several requests for proposals that we responded even this far in advance.

Why don't we continue?

Your next question comes from the line of Sri Nagarajan from SCR Capital Markets.

Yes, thanks. With respect to an earlier question, following up on that, Greg, in terms of transaction cost assumptions and debt charges baked into the rest of the year for guidance, could you give some color on that?

The answer is as it relates to transaction costs, I can't -- because as you can imagine, it's virtually impossible to forecast what they are going to be, which is why I made the comment that I think they should be out of FFO. So it will be completely dependent upon what the investment activity looks like, what the size of them are, and how complicated the transactions are. So the bigger more complex transactions will result in obviously higher transaction related costs, which is why we've left the guidance where it is, notwithstanding the run rate that you see in the second quarter.

So the assumption is that basically it's (inaudible) as you obviously encouraged?

Sorry, say that again?

I'm saying your assumptions is pretty minimal or is it a run rate of the third quarter I mean?

I don't think it will be as high as it was in the second quarter. We just don't know. It's whatever -- $0.06 in the second quarter. I would say it's probably not going to be that high in the third quarter, but we're obviously very active in the marketplace, so that can change quickly.

I think, Andrew, you commented on the downtown softness obviously. Outside of the Health First lease, perhaps can you give us -- it appears obviously they are moving out of 25 Broadway. What interest are you seeing from tenants right now, and if so, are they expanding or consolidating in downtown?

I think I'll give -- from my perspective, the interest is strong because we're priced, right which was sort of the concept when we took the building back in January. We got on the phone and said that we will price this space, we'll basically undercut the market where we need to and get the prime tenants. And this is -- Healthfirst is the first leg of that strategy. I think there's a lot of activity downtown. It's mostly musical chairs. I don't think it's a lot of vast expansion, but our concept is we're in the building at the right basis and we're going to be aggressive and make deals and lease up our vacancy.

Just to add to that, we are seeing tenants from Midtown migrate down there. You've seen the Daily News sign a lease for 100,000 square feet at 4 New York Plaza. They have a lease out with another tenant for about 100,000 square feet. They brought 250,000 square feet to market only six or eight months ago, so where it's properly priced, and that is very price competitive space, it is gaining the attention of Midtown tenants. We've seen 77 Water Street do a lot of leasing over the past 18 months, and all of a sudden you've seen our lease at 100 Church. You're also seeing big leases in play at World Financial Center, so despite the doom and gloom for downtown, there is a lot of activity.

All right, great. Thanks.

Your next question comes from the line of Michael Knott from Green Street Advisors.

Hi, Marc. I thought your commentary on the market was very encouraging. I was just wondering if some of the recent negative economic data points from last couple months have been a non-event as far as tenants' decision-making or confidence goes in terms of market health and fundamentals?

Well, if indicated by -- I guess something we can talk about now, right? In addition to the leasing rack they've it we announced this morning, we just got news that there's another 280,000 foot renewal that just signed during the tenor of this call with CBS at 555 West 57th Street. So I think having announced today close to 600,000 square feet, that answers the question, Michael, right there.

These are deals that were hard fought, important big deals that this team has been working on for months and months, and notwithstanding some of the news out there that's certainly added to the malaise, whether it be some of the sovereign debt problems in Europe and the uncertainty over FIN REG, which hopefully will start to dissipate as people get their hands around what that means for their businesses, and I think that could turn into potentially a positive for space use in the city and BP oil spill, it was just lots and lots of news out there.

But the tenants who I think are forward-looking and know an opportunity to lock in their bottom lines went they see it and when they see a market turning and possibly getting away from them they act very decisively. And now we can say that with respect to Healthfirst, PepsiCo, Citi, and now CBS, who's just made what I think will be one of the largest leases in the city this year, signing today with Steve Durels and his team, Ed Piccinich and their team, Neil Kessner, everyone who worked hard on this lease, and it's turned into for us probably the cornerstone day of the year for us. So I would say to you we don't see the pullback.

Excellent. Thank you, and then my last question is, do you guys have any take on the financial reform and kind of the impact it may have over the next few years broadly speaking on the Manhattan leasing market?

I think the feedback from the people we interface with down at the financial institutions is that relative to what it could have been, it was actually a pretty favorable result, so. And I think a lot of them were waiting to see how that was going to fall out before they started adding headcount. And you're absolutely seeing hiring going on in a number of these places, including Morgan Stanley and Goldman Sachs and Citigroup. So I would say that it's far better that it could have ended up being is the general feedback so far.

Okay, thank you.

Your next question comes from the line of Ross Nussbaum from UBS.

Hi, close, Ross Nussbaum here with Rob Salisbury, guys. On the structured finance portfolio, it looks like maybe two of the three new investments you referenced showed up in your top 10 list in the supplemental. One is a $60 million mezzanine and one is like $140 million mortgage mezzanine -- are those on 980 Madison and 530 Fifth? We had seen some press reports on those.

No. I guess Marc had mentioned in his prepared remarks the $60 million investment is on 280 Park and the other is on 530 Fifth Avenue, which is a pre-existing investment.

Did you take an interest in the loan at 980 Madison?

We owned rate bonds in 980 Madison, which is a portion of the mortgage, yes.

And then with respect to the Lipstick building, what's the status of that potential asset stale in your involvement and given your ownership of the land?

The leasehold mortgagee has been marketing their position and I haven't heard that they've sold it to anybody yet. We're not really involved in that process.

So you have no interest of owning the bricks above the dirt?

I think at a price we would. It's not a price the lease hold mortgagee was prepared to entertain.

And then lastly, on 19 West 44th, I would assume given your comments that this is an asset you intend to sell above the purchase price back in 2004. Is that a fair comment, particularly given -- ?

Yes, that's why we said we're going to use 125 Park as a reverse 1031.

There's no gain. You don't need 1031 receivers.

Correct, so why that building in particular? I know it's one of the smaller buildings you've bought in the last 10 years. Why did that one stand out?

Stabilized mid block building with not a lot of upside for whatever we would have to do for other properties that we had before us that we can capitalize on. If you look at the rolldown in rents that we've seen in the first and second quarter, some of those have incurred over there.

Your next question comes from the line of Jim Sullivan from Cowen and Company.

Hi. I just have a couple of follow-up questions on the 100 Church transaction. First of all, can you specify when the Healthfirst lease actually commences?

It commences as soon as we deliver the space with a little bit of base building work that has to be finished.

And what kind of timeframe?

It should be in the next month or two.

Okay, and follow-up question, in the first quarter conference call, I think it was Greg indicated that on 100 Church, your underwriting assumed NOI of $20 million to $22 million. I think that's right. And I'm just curious whether this lease term is kind of consistent with that expectation.

It's consistent with that underwriting, yes.

And what would the timing be when you, I know this is a difficult one -- but based on the progress you've made so far and your reading of the market, when do you think you guys will be there on that building?

Well we had modeled within 2.5 years, so I don't think -- we're not changing our forecast. So I would say within 2.5 years of the day we took possession.

Okay and then final question for me, Marc, you talked about your interpretation of the pace of recovery in Midtown and maybe how that contrasts somewhat with downtown. Just curious what your view is on the pace of recovery in the suburban markets.

Well, there was a question earlier about the sales market, we didn't hit on leasing maybe per se. But I would say it's a different market. It's slower. It has lower peaks and I think it's going to have less extreme valleys. But I think our strategy there is just to keep that product as well leased as possible, retain tenants like Citi and Pepsi, and track new tenants in like ConEdison Solution and others that we have done, and in a better market we'll execute the kind of recycling that we do here in Manhattan, we think we can do successfully in the suburbs. But I don't think investors see that as a near term enough event where it's not attracting a lot of equity hours right now. So the first markets to come back are going to be gateway cities like New York, and that's proven to be the case, and I think you'll see it filter to other locations like Sanford, Westchester, where we think the market will come back. We're committed to working through this period of time and hopefully getting gains in the future, so its been just slower than what we've experienced in Manhattan.

Okay, good. Thank you.

Thanks.

Your next question comes from the line of Suzanne Kim from Credit Suisse.

Good afternoon. A quick question regarding your G&A. Regarding the acquisitions expense, how much of that was actually third party brokerage fees and how much of that was in house costs?

It was -- zero of it was brokerage fees. It was transfer tax and professional fees.

And I think you addressed this before. Of the $21 million in investment income, how much of that has been accrued and how much do you expect versus cash in the door at this time? I got $2 million, is that correct?

$2 million was associated with 510 Madison.

Okay, great. Thank you.

Sure.

And your last question comes from the line of John Guinee from Stifel Nicolaus.

Thanks, guys. Your NAV numbers are rock solid. Everyone is concerned about the cash flow. Can you walk through your accounting policies for second generation TIs and second generation leasing commissions? It looks like you aren't -- you're booking around $24 to $28 a square foot for tenant improvements for year-to-date, but it doesn't seem to show up that way on your [add] numbers. And then leasing commissions I'm assuming run about 6% of the gross [rent] and I just can't seem to follow that through on to the page 17.

We're going to get real granular here, which is good. Second type OTIs and leasing commissions as we've talked about before -- when we do an acquisition, we identify vacant space that's to be leased up and that's excluded and comes in over the course of the first -- within the first four years of acquisition. It's excluded and thereafter is included in second cycle.

I mean for example, I'm looking at first half of the year, second cycle TIs and leasing commissions total about $13.3 million. And my guess is roughly you had maybe 700,000 square feet of second cycle leases signed in the first half of the year and it just doesn't seem to the math doesn't seem to work. It seems to come out to less than $20 a square foot.

Well, some of the leasing commissions get paid in subsequent periods.

You aren't paying upfront the entire 6% of gross rents?

No.

First of all, it's not 6%, John. The leasing commissions have a schedule that's dependent upon the length of the lease where it's a rate schedule that starts at 5% for the first year's rent and goes all the way down to 2.5% at a certain point in time, so -- and we don't pay even full commissions on renewal deals, so depending on the length of the lease, it will depend as to what the total commission is. And in general, that commission is paid out sometimes frequently over a period of time split half between signing, half between rent commencement, and then for larger deals even over a longer period of time, so it's hard to generalize on commissions.

Great. Thanks a lot.

John, if you look at those second cycles for the first six months of last year and the first six months of this year, based upon the leasing activity and based upon the fact that there's been higher costs, I think that the actual number coming through the computation is pretty consistent.

Okay, thanks a lot.

Okay.

Ladies and gentlemen, this concludes our question and answer session for today's conference. I'd like to hand the call over to Mr. Marc Holliday for closing remarks.

I think we've gone through an extensive review today of the quarter. We appreciate the questions and we look forward to speaking with you next quarter. Thank you.

Thank you for your participation in today's conference. This concludes your presentation and you may now disconnect. Have a great day.