Oct 29, 2012
Executives
Joel Marcus - Chairman, President & Chief Executive Officer Steve Richardson - Chief Operating Officer & Regional Market Director Dean Shigenaga - Chief Financial Officer, Senior Vice President & Treasurer Rhonda Chiger - Investor Relations
Analysts
Philip Martin - Morningstar Michael Carroll - RBC Capital Quentin Velleley - Citi Steve Sakwa - ISI Group Michael Bilerman - Citi
Operator
Welcome to the Alexandria Real Estate Equities Incorporated third quarter earnings conference call. My name is John and I’ll be your operator for today’s call.
And at this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session.
Please note that this conference is being recorded. I will now turn the call over to Ms.
Rhonda Chiger. Ms.
Chiger, you may begin.
Rhonda Chiger
Thank you and good afternoon. This conference call contains forward-looking statements within the meaning of the federal securities laws.
Actual results may differ materially from those projected in the forward-looking statements. Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements is contained in the company’s Form 10-K, Annual Report, and other periodic reports filed with the Securities and Exchange Commission.
Now, I would like to turn the call over to Mr. Joel Marcus.
Please go ahead.
Joel Marcus
Thank you everybody and welcome to the third quarter call and all of us here are obviously praying for the safety of those impacted by hurricane Sandy. I’m going to try to breeze through my comments pretty quickly, turn it over to Steve Richardson and then to Dean Shigenaga and then go to Q&A.
But as I finished my first board meeting last week for the NIH, it reminded me actually of the great work that the life science industry has done in disease management. If you think about what has happened to HIV AIDs, moving that disease from a death sentence to a chronic condition, I think emphasizes the critical nature of this industry and its ability really to manage the economic cost of disease to society.
So I think we remain very positive on the critical nature of this industry’s impact on society. I think the third quarter and certainly year-to-date for the industry and then our tenant base in particular has been a, I think a good year in another wise very tough macro market, and one that seems to be eroding pretty much daily.
The NASDAQ biotech index was up almost 40% year-to-date. We have 13 IPOs in the first nine months and many of them are performing pretty well.
The FDA approvals as I mentioned on past calls are up 27 to-date and 59% are our tenants, which is pretty amazing and then a recent notable clinical success was Lilly’s success with the huge market potential of that drug for CNS, for Alzheimers. So all pretty good news in general.
Moving real quickly to balance sheet leverage, capital allocation and Dean’s going to have a lot to say about this, so we’ll focus his comments pretty detailed. Our target as Dean will get into, our target debt to EBITDA for year end is about 7.2 and that will be almost leveraged neutral from last year’s 12/31/11 at about 7/1 times and again he’ll talk about, we don’t expect to draw down or to use the ATM this quarter.
I think one of the highlights for the balance sheet this quarter has been land sales. We’ve got $46 million completed for this year as you see from the supplement.
We got $34 million pending and another $13 million headed in the sale direction, so that will aggregate a total of almost $93 million, so that’s good news and a strong effort by our teams in many of the regions and we will continue this effort into 2013. Steve’s going to talk about asset recycling, but in general, again, by the supplement we’ve had about $30 million to-date, $84 million pending.
We are looking at potentially others. Again, this suburban to urban theme and Dean will detail the implications on the NOI run rates.
I’ll see you on the take account of that. On construction spend, $167 million for the fourth quarter.
At the mid point, about $630 million some odd for 2013. We’ve got many second submissions in that, as that will be the peak year trailing down into 2014 and we are working hard to manage down those cost project-by-project and we’ve done some good work, given some earnings release.
Dean will walk you through the categories of spending for 2013 and the likely specific sources of capital for each. So the significant land sales, free cash flow and construction financing are needs for equity for the coming year.
Actually, more modest than I think some of the street has anticipated. When we get to internal and external growth for the third quarter, I think one of the highlights continues to be our quality of tenant.
40% of the AVR from investment grade tenants is about equal the last quarter and again, particularly important in a tough macro economy are leasing and Steve will try to give you some granular views. It was pretty solid at 732,000 square feet.
Dean will talk detail about the core. We are pleased with our deliveries this quarter; 131,000 square feet out of development, 100% leased and 226,000 out of redevelopment, 99% leased.
When it comes to the Alexandria Center for Life Science, New York City as we announced on September 20, we’ll begin vertical construction of the 420,000 odd square foot West Tower in the fourth quarter, with delivery approximately fourth quarter of 2013. In our fourth quarter and year-end release in February, we’ll detail the estimated constriction costs and expected initial stabilized yields.
Talking about pre-leasing progress to date, again about a 420,000 square foot building. Roche has signed a lease for two floors as we’ve highlighted in our release and there’s been many articles written.
We are in negotiations with two-biotech companies to move to the Alexandria Center and they would take between a half a floor and one floor each. We are also in discussions with an existing tenant for two floors and others at the showing stage we have one floor to a contract research organization and another floor showing to an institutional shareholder.
So we feel pretty positive about progress to date and our target rental rates we’re comfortable with. Dean is going to get into guidance.
We’ll release 2013’s very detailed guidance in conjunction with our Investor Day in New York City on December 5 and a topside view of 2014 to put a longer-range view into context. And then I guess finally on the dividend, the board will continue to assess an ongoing increase in the dividend as a way to share increasing cash flows with shareholders and you’ll hear more about that.
So, let me turn it over to Steve for a pretty detailed view on the leasing side.
Steve Richardson
Thank you Joel and today my comments will focus on four key areas; asset recycling, life science real estate markets in 2012 leasing, a preview of 2013 roles and prospects and finally the 499 Illinois evolving demand. First on asset recycling, the company’s pursuing asset-recycling program in a very careful and disciplined fashion during the year.
We are seeking to monetize non-essential land assets as Joel referred to and sub-urban assets lacking strategic long-term importance. As we really move the concentration of our facilities to tightly integrated brain trust cluster submarkets in high barrier to entry core urban locations.
A number of these recycled facilities are legacy assets that originally served as viable locations for life science companies 10 to 15 years ago. The industry has grown and matured over time and high quality facilities became available in more desirable urban knowledge locations, adjacent to the major academic institutions and in high quality recruiting locations, the nature of the demand for these locations have evolved and so it makes good sense to recycle this capital.
Moving onto the life science real estate markets and 2012 leasing, we’ve leased 2.6 million square feet to-date during 2012, including another strong and solid quarter with 732,000 square feet leased. The 7.6% GAAP increase for renewals and release space will provide consistent and term growth going forward and let me also add for a moment the important factor of lease term.
The renewals and releases are over an average term of approximately five years. Again, bearing out that the sector provides significant stability to the company’s leasing profile, as these enterprises are engaged in mission critical activities.
In the new releases for redevelopment and development facilities average approximately nine years and highlight not only the long-term commitment companies are making to these facilities, but often times the significant hard capital investment made directly by the life science tenants. Let me get into the details of some of the regional statistics and trends for the third quarter.
The greater Boston market remains strong with about a 10% vacancy rate for life science space and about 11% for the office tech market. Our facilities in fact exceed this market benchmark as we are 94.3% occupied in our operating properties and have significant releasing or redevelopment projects.
Lease rates for life science space in these Cambridge market are solidly in the 50 to 60 triple net range and higher for build-to-suit projects. The regional team this quarter leased a total of 313,000 square feet with 106,000 square feet on renewals in our Cambridge and adjacent facilities and another 206,000 square feet in our redevelopment pipeline.
This success clearly highlights the company’s ability to conceive design, market and complete strategic redevelopment projects with high quality client tenants at solid yields. The San Diego market has acted as well and is currently at a vacancy rate of approximately 11% across its key sub markets.
Alexandria’s properties again are better than the market level with a 95.2 occupancy rate, as the regional team has very artfully and successfully moved a number of the projects from the redevelopment pipeline and the cash flow in the assets. Lease rates are in the $24 to $36 range, depending upon the product quality and submarket.
The regional team leased 97,000 square feet during the quarter, highlighted by a significant renewal with a strong credit tenant inventory client sub market and a long term lease renewal and expansion stabilizing the key property and its rental leases sub market. Moving onto the San Francisco bay area, that market is highly dependant up on the sub clustering segment, the Stanford and Mission Bay clusters have vacancy in the 10% range, while the South San Francisco market has had another supply increase with sub leases from the land and Amgen, driving the vacancy to approximately 16%.
The company’s operating properties however are very strong at 98% occupancy. Lease rates remain in the low to mid 40’s triple net for Mission Bay; the $30 triple net range for South San Francisco and the mid 30s for the Stanford area, so region leased 88,000 square feet during the past quarter.
Moving over to the east coast, the Maryland market is holding its own in a generally soft market, as we are roughly in line with an occupancy rate of 89.4%, although this is down from 2011. Lease rates range from $14 to $26 depending upon the submarket and the regional team leased another 80,000 square feet, highlighted by a key tenant renewal there.
Seattle in North Carolina remains steady with 96.3% and 95.5% occupancy rates in our operating properties and they leased 17,000 and 12,000 square feet respectively. Moving then to a preview of the 2013 roles and prospects, we have a total of 953,000 square feet slated for roll over during the next year, summarized at a high level in the following fashion.
About a quarter of that or 242,000 square feet are in active negotiations. 6% or 55,000 square feet are specifically targeted for redevelopment and finally 69% or 653,000 square feet are in marketing or early discussions.
Let me get into a little bit more detail on that remaining 653,000 square feet. About 80,000 square feet of that is in the greater Boston market, primarily located in our urban facilities.
Its important to note that half of the square footage is actually rolling during December 2013, so we have plenty of runway and are optimistic we will renew or secure new tenants for a majority of these space, with little or no downtime, given the ongoing strong demand for high quality release stage least space in Cambridge and its immediately adjacent urban clusters. Moving back over to the west coast, we have about 234,000 square feet rolling in 2013 in the bay area.
Approximately 95,000 square feet is concentrated in the very hot Stanford, Palo Alto cluster and good progress is being made with the large 65,000 square foot tenant that is on the verge of commercializing its product, as well as securing a new tenant for a 30,000 square foot space at an attractive lease rate. Another 95,000 square feet is located in attractive smaller suites in the greater South San Frisco market, where we have done very well in spite of the supply overhang in the large blocks of space.
Finally about 44,000 square feet is located in Mission Bay in smaller suites where we’ve had no meaningful vacancy and so we anticipate positive outcomes. We have today about 129,000 in the San Diego market, primarily in the Sorrento Valley and Sorrento Mesa clusters and we are actively marketing these remaining set of suites.
Moving back to the east coast, we have 127,000 square feet in the Maryland market, distributed across its markets. We are now in very early discussions to resolve about a third of these roll overs, another third its too early to tell and we are actively marketing the remaining one-third to new prospects.
53,000 square feet rolling in the North Carolina market. Early discussions with tenants to resolve about half of this roll over and we are actively marketing the remaining 50% to new prospects; and finally no square footage rolling in Seattle during 2013 at all.
And finally let me comment on 499 Illinois. We still firmly believe this is an absolute class-A trophy asset with long-term durable value.
Its provided significant current cash flows in the order of $14 million for the 50% occupied portion and really the game changer for the development portion will be the UCSS medical center. We are willing to be patient to capture the high quality and innovative initiatives that are ongoing between key public and private institutions and at the same time we are also intensifying our focus on the technology sector with a comprehensive out reach effort and re-imagining of the amenity configuration and offering of the facility.
I’ve been in the San Francisco market for 20 years and I’ve seen time and time again the best located properties with dramatic water front views, demanding absolute premium pricing and today’s cap rates for core San Francisco property in the 5% range are certainly a clear evidence of that historical pattern. With that, I’ll hand it off Dean for a further commentary.
Dean Shigenaga
Thanks Steve. Let me start with our core operating metrics, specifically net operating income.
The third quarter NOI was generally in line with our expectations. NOI from continuing operations was reported at $100.8 million and NOI before the reclassification of discontinued operations was about $104.2 million.
Income from discontinued operations net was approximately $4 million and consisted of the following: approximately $3.5 million of NOI, about $1 million of depreciation incurred in the third quarter up to the point of classification as held-for-sale and about $1.6 million in gains on sales of real estate. The NOI from continuing operations of $100.8 million for the third quarter includes NOI growth from the completion and delivery of the redevelopment of 10300 Campus Point with 96% occupancy and the development in 4755 Nexus Center Drive with 100% occupancy and both projects are located in the San Diego market.
These projects on average were in service for approximately 18 days in the third quarter and generated approximately $370,000 of incremental NOI. This really represents about $7.5 million of NOI on an annualized basis.
Our forecast for the fourth quarter, NOI is in the range of $110.5 million to $112.5 million, but keep in mind the $3 million of this NOI relates to the increase in assets held for sale for incremental dispositions. Accordingly, our NOI from continuing operations for the fourth quarter, excluding discontinued operations is forecasted to be in the range of $107.5 million to $109.5 million and our projected quarterly NOI for the fourth quarter from continuing operations represents an increase from the third quarter of $6.7 million to $8.7 million.
Page 17 of our supplemental package provided a forecast of 342,000 rentable square feet rolling in the fourth quarter and targeted for redevelopment, mostly late in the fourth quarter, as well as 55,000 square feet rolling in the fourth quarter of ‘13. Of 342,000 square feet rolling in the fourth quarter, 78,500 square feet will be placed in the land held for future development.
The remaining 264,000 square feet is expected to undergo redevelopment. 41,000 square feet is pre-leased at 1616 Eastlake in Seattle and 67,000 square feet at 4757 Nexus Center Drive is expected to be leased to a single tenant user within the next week or so.
The 342,000 square feet rolling in the fourth quarter that’s targeted for redevelopment is expected to generate approximately 800,000 of NOI in the fourth quarter, so for modeling purposes assume this 800,000 of NOI goes away by 12/31/2012. Turning to occupancy, year-to-date, 2012 we really made good progress, increasing our cash flows in occupancy, offset slightly with a step down in cash rents year-to-date related to two leases; one of which was in Research Triangle Park and another one related to an industrial type building in Suburban Washington, D.C.
Overall occupancy, including spaces undergoing redevelopment in Greater Boston has increased nicely to 84.3% as of 9/30, up from 83% as of March 31. Additionally, occupancy is projected to increase meaningfully by year end as we deliver pre-lease spaces from redevelopment at 20 Walkup, which is about 91,000 square feet and 400 Technology Square, we expect to deliver about 70% of the 212,000 square feet under redevelopment, primarily related to Aramco, Epizyme and Ragon.
Overall, occupancy in the San Francisco Bay area, including space undergoing redevelopment has increased to 95.7%, up from 93.9% as of March 31. The increase really reflects lease up of some vacancy and short-term temporary space leased to Onyx, while we complete their build-to-suit development.
Occupancy in San Diego, including space undergoing redevelopment has increased to 93.3%, up very nicely from 81.5% since March 31. About a third of this increase relates to the lease up of vacancy and about two-thirds related to the transfer of 100% leased spaces from our value-added development and redevelopment programs into operations.
Overall occupancy, including spaces undergoing redevelopment of 93.3% as of 9/30 is expected to decline to 88% to 89%, primarily due to the 165,000 square feet of space at Science Park, which was recently acquired specifically for redevelopment and 4757 Nexus Center targeted for redevelopment in the fourth quarter of ‘12. Occupancy in suburban Washington D.C.
reflects the rollover in May of 2012 of approximately 110,000 square feet related to Baxter’s lease of office, warehouse and industrial space in a non-core submarket. Consistent with our prior comments, we expect this space to require some time to release.
Occupancy including spaces undergoing redevelopment at Seattle has been stable through 9/30, but expected to decline from 90% as of 9/30 down to about 80% by year-end, while we complete the redevelopment of space at 1616 Eastlake. In October, Fred Hutchinson Cancer Research Center moved out a portion of their space, aggregating about 80,000 square feet at 1616 Eastlake and South Lake Union.
About 67,000 square feet of this space is office space and as forecasted in October, we began the conversion of this office space into laboratory space through redevelopment. Approximately 41,000 square feet or 61% of this space undergoing redevelopment is pre-leased.
No other significant changes in occupancy is expected next quarter in our other markets. Turning briefly to same property performance, as expected cash same property performance improved in the third quarter to growth of about 4.3%, representing an increase over both quarters for same property performance in the first half of ‘12, and again, we continue to forecast better cash same property NOI performance in the fourth quarter as compared to again in the first half of the year.
Straight-line rents for the same properties declined resulting in higher cash NOI due to the start of about $5.7 million of annual cash rents from one lease in New York City that started back in February of 2012. We also had a couple of other leases with slightly higher rent steps on a cash basis; one in San Francisco at 901 Gateway, and one, in Maryland at 5 Research Place.
Same property operating expenses for the quarter were relatively in line with the same quarter last year. Same property operating expenses for the nine months however were up about 2.4%, primarily related to an increase in recoverable repairs and maintenance expenses by approximately $1.7 million.
Excluding this $1.7 million increase in repairs and maintenance, the increase in same property operating expenses would have been in line at about 1%. Moving importantly on to the leverage, as Joel had mentioned on our Investor Day on December 5, we’ll provide a detailed review of guidance for 2013, including our projection of core operating metrics and other important items, as well as hopefully a high-level viewer thoughts on 2014.
The following recap focuses on the leverage component of our capital strategy for 2012. We started the year with a goal to have slight improvement in leverage to approximately seven times on a debt-to-EBITDA basis.
Projected debt-to-EBITDA as of 12/31 as Joel had mentioned is targeted to be about 7.2 times. Our total spend for 2012 is forecasted just under $600 million consisting of about $429 million for the nine months ended 9/30 and $167 million for the fourth quarter.
Our asset sales for ‘12 are expected to be in the range from $151 million to $156 million, with the fourth quarter sales target being about $76 million to $80 million of that, including about $34 million of land sales. So the total increase of NOI from continuing operations from the fourth quarter of ‘11 to the fourth quarter of ‘12, on a quarterly basis it was projected to be about $9.8 million to $11.8 million, which represents an increase on an annualized basis from $39 million to $47 million and we focused on continued re-investment of cash flows from operations.
Our ATM equity proceeds for the year through 9/30 has been about $98 million and as Joel had mentioned, no further proceeds from the program are anticipated in the fourth quarter. So in summary, we expect to end 2012 at roughly a leverage neutral position from the beginning of the year.
We expect to complete about $600 million of construction spending and we successfully minimized common stock equity offering proceeds to approximately $100 million. Very high level of our goal for 2013 is to end leverage the neutral to slightly less leverage from our target debt to EBITDA as of 12/31/2012 of approximately 7.2 times.
Our goal beyond ‘13 is to improve debt to EBITDA closer to 6.5 times in 2014, when we also anticipate construction spending to decline from a high point in ‘13 as we go into 2014. Moving on quickly to our constructions spending, again on our Investor Day, on December 5 we’ll provide significant detail on our 2013 construction spend forecast, but today we’ll provide a few high level thoughts.
Our forecast for 2013, the construction spend is $615 million to $665 million. Our active developments in North America, we are forecasting a spend of about $123 million, focused on a few key projects, the largest of which is about $80 million or so for 225 Binney, which is the build-to-suit for Biogen and again we’ve forecasted an initial cash yield of about 7.5%.
We also have about 16 million forecasted for 259 East Grand for the Onyx Pharmaceutical project, with the initial cash yield of approximately 8%. Most importantly the funding for this project will be provided by the construction financing we have in place.
We also have about 13 million forecasted for 499 Illinois, again, with an overall yield on the 409 and 499 Illinois property within our initial cash yield range of 6.5% to 7%, that was announced upon acquisition. However, we are moving to the lower half of this forecast.
Funding broadly for these projects, the active developments in North America, is expected to come from cash flows from operations and some use of our ATM equity program. Moving to our active redevelopment projects in North America, we are forecasting about $59 million of spending.
The key project in redevelopment spending for 2013 is about $18 million at 400 Technology Square for various tenants with sold initial cash yields at about 8.1%. The remaining $31 million is spread across several other projects and I think as you look at this group of redevelopments that we’ve projected for 2013, we are forecasting an average yield in the low 7% range.
Funding for this group of construction projects will come from proceeds from sales of land parcels and the reinvestment of proceeds from sale of income producing assets. The next category is pre-construction and we are forecasting about $84 million of spending.
The Alexandria Center for Kendall Square, sometimes referred to as our Binney Street development project is the key project consuming capital in pre-construction as you recall, the build-to-suit project for BioGen, which is now under active development, has an initial cash yield of about 7.5%. This provides some insight into potential yields from this development site and we expect initial cash yields to move into the 8% range.
Funding for pre-construction is expected to come from proceeds from our ATM equity program the. The next category is future construction projects, where we are forecasting a range from $250 million to $300 million.
The key projects consists of first of the West Tower in New York City. It’s expected to have about $115 million of spending in ‘13, and as Joel had mentioned, we’ll provide our usual detailed yield information in our fourth quarter earnings release.
The remaining $59 million or the next $59 million is really for future target redevelopment projects, which have been detailed out in our press release, including Hanover Street, Science Park Road, 4757 Nexus Center and 1616 Eastlake, and the yields are expected to range from roughly 7% to the mid 8% range. We also have a spend forecast as we normally do for unidentified future construction projects and a few other projects.
Funding for this category of future construction projects will consist of a significant construction loan, coupled with some proceeds from our ATM equity program. We also have about $30 million of spend forecasted for development and the redevelopment projects in Asia and we are looking to develop a new source of funding for our Asian operations.
Lastly our generic infrastructure and other building improvement projects or forecasted to use about $68 million. $18 million of this represents our share of our JV development in Longwood, and remember, we have a low to mid 8% initial cash yield on this project, and we plan to reinvest almost all of the cash from the sale of 50% of our 55% interest in the joint venture.
The remainder of the projects are spread across really two dozen different projects, including a few in San Diego like the amenity building for alumna in San Diego. This building for example was based on an initial cash yield of 8%.
We expect funding for these projects to be provided by cash flows from operations. Moving on to the balance sheet matters; let me quickly comment briefly on a few areas of the asset sales in our ATM program.
We have four income producing assets classified as held-for-sale as of quarter-end, with an aggregate sale price of approximately $84.5 million. We expect to close on one sale for roughly half this amount by the end of the fourth quarter.
Including this additional sale for 2012, our target sales for the year will be just north of $150 million. In September of 2012, we recognize an aggregate impairment charge of approximately $9.8 million upon classification of the four assets as held for sale.
The sale of these assets are in process, so the information we can provide at the moment is limited. Additionally, we should point out that the sales price of the $84.5 million for the four properties really reflects significant capital.
The buyers are expected to reinvest to renovate the properties. As we complete the sales, we will provide our usual detailed disclosures for each transaction.
We expect to complete a detailed review later this year of potential assets to sell in 2013, with the goal of continuing our asset disposition program. We expect to provide an update of our target disposition amounts at our Investor Day again on December 5.
Year-to-date, we issued $100 million under our ATM program at an average price of about $73.15. This includes approximately $59.5 million issued in the third quarter at an average price of $74.97, leaving us with about $150 million remaining under the program.
Again, at this time, we do not require any further ATM equity proceeds in order to achieve our targeted debt-to-EBITDA metric of approximately 7.2 times by year-end. Lastly on guidance, our guidance for 2012 was adjusted slightly related to our same property performance.
We have been projecting our desire transition of a few tenants that we inherited when we acquired Technology Square and that’s 300 Technology. We plan to re-tenant these spaces with high quality tenants in a similar manger to our success of redeveloping and re-tenanting 200 and now 400 Technology Square.
We have absorbed some downtime between tenancy due to the leasing and minor construction, and remain confident that we will be successful with 300 Technology Square. This transition has impacted same property results this year, slightly more than we expected in the second half of 2012; again, just slightly.
Accordingly we narrowed our range of same property performance on a cash basis from a range of 3% to 5% to a range of 3% or 4%, and on a GAAP basis from zero to 2% to slightly negative to slightly positive. I should also point out that our same property performance for the second half of ‘12 is expected to be better than the first half of ‘12.
Guidance for NAREIT FFO per share diluted for 2012 was reconfirmed at a range of $4.32 to $4.36 and our guidance for EPS diluted was reported at $1.16 to $1.26. With that, I’ll turn it over to Joel.
Joel Marcus
So operator, could we go to Q&A please.
Operator
Our first question comes from Philip Martin from Morningstar. Please go ahead.
Philip Martin - Morningstar
Good morning. Good afternoon actually.
Well first of all retention rates. Based on discussions you’re having with tenants, what do you think your retention rate is likely averaging in 2013?
Joel Marcus
In ‘13 or…?
Philip Martin - Morningstar
For 2013 the lease expirations, the discussions you are having around those lease expirations. Retention rates are in the upper 80s, I know this quarter I believe it was 88%, so it’s clearly.
Through the nine months it was 78%. Just trying to get a feel there?
Joel Marcus
I’ll have Steve comment. One item that might take exception to that general rule is 300 Tech Square that Dean alluded to.
That’s a building that we did not fully we did not go and re-habit like we did 200 and 400, because it was in very good shape when we bought it. But we bought it in ‘06 and MIT had recruited a number of companies there that at the time we did not necessarily viewed as long-term tenants.
So we’ve thought as they’ve rolled out other leases not to renew or to seek to retain them and looking to aggressively back fill that space with new tenants. So I think our goal is given our 48% of ABR being investment grade, really where we see opportunities in core, infill locations, where we can replace I would say less creditworthy tenants with more creditworthy tenants, but I’ll leave it to Steve to give you color, generally speaking.
Philip Martin - Morningstar
That was a bit where my question was heading anyway in terms of, if they were a little bit lower, might they be lower because you are seeing demand from a different or a higher quality tenant?
Joel Marcus
Yes, the answer is for sure, and that’s a good question.
Stephen Richardson
Yes, I think when you start looking at the specific markets and where we are going to have product available, Greater Boston is really concentrated in the urban core area. The Bay area market will be in that Stanford, Palo Alto cluster.
I think we are actually okay generally in Maryland. So we are going to be in places where either the retention rate will be consistent with what we’ve experienced in the past or as Joel just alluded to, we may have a chance to backfill with higher quality tenants.
Philip Martin – Morningstar
When you look at the lease term, I know you mentioned that in your opening remarks looking at the TIs and leasing commissions, they are right around 523. Right now pretty consistent I think throughout the year.
But you see that leveling off at this point and do you see that average lease term going north of five. Can you just give us an idea of trends based on discussions?
Dean Shigenaga
Philip, it’s Dean here. I would say that the renewed and released spaces typically average somewhere between five and seven years, historically, if you go back five or seven years.
And so I think that 4.8 year statistic for the three months or 4.6 for the nine months is right down where it’s been historically and the development and redeveloped space traditionally is closer to 10 years. So I think the statistics for a lease term is right in line there as well.
Stephen Richardson
Yes, I think if space has turned, just remember small and medium size spaces, generally released for shorter to medium term where you have larger blocks of space, those tend to renew for longer term. It’s just kind of the way it is and so I think we feel comfortable and as we migrate more space from suburban to urban, that I think can only help us.
Philip Martin - Morningstar
Okay, okay. And my last question, just could you provide a little more detail on Asia.
I know you mentioned potentially looking for new sources of financing there, but can you just give us a better feel for how those developments are coming along in terms of pre-leasing timing, that sort of thing and that’s it?
Joel Marcus
Well, I think in China we have had some success although not at great yields in South China and in North China we are still working hard to complete that project and lease that up. Our goal in China over time will be to obviously look at finding someone who can come in potentially and help us potentially take the burden of those properties from us, so that’s something longer or medium term we’re looking at and I think the India operations, we had good success this quarter, a reasonable success on leasing and as I said previously, we are looking at trying to bring in a third party to help us finance those operations, because I think the real key message and you kind of got it from Dean, Dean took the time to go through a very detailed fashion category-by-category.
We have more opportunities here in the U.S. than we actually have sources of funding for and so even though that has jumped a bit from this year to next year, we’ve got a full platter for investment here in the U.S.
on redevelopment and development. So I think that’s a good sign.
So we are looking to kind of shift some of the burden of overseas investment to third-party and hopefully over the coming months and quarter or two, I’ll have more detailed news on that.
Philip Martin - Morningstar
Okay, that is helpful. Thank you.
Joel Marcus
Yes, thanks Philip
Operator
Our next question comes from Michael Carroll from RBC Capital. Please go ahead.
Michael Carroll - RBC Capital
Yes. Guys, can you give us – I know you alluded to this in your comments, but a little bit more details and what’s going on at 499 Illinois Street.
Which type of tenant is looking for that space? What kind of interest do you have so far and kind of what the outlook for that property is.
Joel Marcus
Sure. We really do have the breadth of interest there.
Technology companies are looking very closely at the cluster there. Very impressed by the facility; the ability to expand as well as the Soma market gets tighter and tighter large blocks of space are becoming a little more precious.
So that certainly a set of discussions we are having with various people on the tech side. Then the life science side as well, early discussions with groups looking to anchor the building and got a couple of very intriguing opportunities that I had mentioned, kind of innovative, public-private types of institutions, working together in collaboration on solving some very big challenges in the life science world.
So we do have what I would characterize as a series of discussions and in some cases warm discussions going on.
Joel Marcus
Yes. So one of the challenges there is because this is a heavily institutional market, by its nature, it moves more slowly than a more dynamic market like a Cambridge or a Palo Alto.
That’s just the nature unfortunately of that submarket, so we just have to be patient. But I think as Steve said, we view the backend to be a good one if we can get a high quality set of tenant, the sort of tenants with solid rental rates I think we’ll have a cap rate there.
If we ever choose to accept that would be phenomenally attractive.
Michael Carroll - RBC Capital
All right thanks. And could you explain why you believe capitalized interest is going to drop?
I think it was at $16.8 million in the third quarter and I think the guidance in the fourth quarter is between $13.6 million and $14.6 million. Is there a specific large project coming off capitalization that’s dropping those estimates down?
Dean Shigenaga
It’s actually two primary items Mike; partly the delivery of 10300 Campus Pointe and 4755 Nexus, which I described in my commentary. And then as we all know we’ve been preparing for that significant increase in NOI, primarily driven by the delivery of our value-added projects in the fourth quarter.
I think my commentary described the growth in NOI in the fourth quarter. So that NOI is offset by the shutdown of capitalization as we deliver those projects, so it’s really being driven by that, offset slightly by an increase in overall CIP from the spend that will occur in the fourth quarter.
Michael Carroll - RBC Capital
So then the commencement and the value-add portfolio is driving that or is largely driving that increase in NOI from 3Q ‘12 to 4Q ‘12?
Dean Shigenaga
That’s correct.
Michael Carroll - RBC Capital
Okay great. Thanks guys.
Joel Marcus
Thank you.
Operator
Our next question comes from Quentin Velleley from Citi. Please go ahead.
Quentin Velleley - Citi
Hi, how are your doing? Just in terms of the 2013 construction spend, the $615 million to $665 million, Dean I know you went through a lot of detail in terms of where the funding is going to come from.
Can you maybe just summarize the key resources in terms of how much cash you are going to be using from the cash flow from operations like you paid the dividend, how much you are expecting to issue on the ATM, and then how much you are broadly expecting to get from land and asset sales?
Dean Shigenaga
Actually Quentin, that’s a fair question I think as we had discussed in the prepared commentary, our plan is to provide all that granular detail on December 5 at our Investor Day, but hopefully we hope to provide some sense of funding by the major buckets. We are obviously at a cash flow perspective today from operations that allows us to reinvest into our business at about $80 million in 2012, and I would expect that number to increase.
The mix of asset sales, whether its land, operating assets and proceeds from the ATM program will be a little bit different than what it was in 2012, but it’s safe to say that we are going to continue to monetize some land parcels and also monetize some income producing assets.
Joel Marcus
Maybe to give you a better fix on that, I think Dean’s commentary on the free cash flow would be somewhere about $100 million plus. Land sales and recycled assets we’ll have to give you more detail at a granular level on December 5 and I think when it comes to the ATM program, probably if you think in the 250 range, that’s probably where we’d be thinking about for 2013, if that’s helpful.
Quentin Velleley - Citi
Okay. The joint ventures, like a development joint venture or something similar to Longwood, is that something that’s on your agenda?
Joel Marcus
Not necessarily. I think on the big construction project in the Binney Corridor we would be looking at a large construction loan and mini perm takeout at about 100%.
So that will cover a pretty sizeable chunk of that funding requirement. I don’t think we’ll be joint venturing anything, at least domestically in the U.S.
of size in 2013 at the moment.
Quentin Velleley - Citi
Okay. And then just kind of on the West Cal, it seems that the rush pre-commitment is pretty small relative to the size of the project and I know you sort of covered it a little in your prepared remarks.
But can you just sort of pull through what gives you the confidence that you can commence the project when you’ve only got a very small amount of pre-commitment?
Joel Marcus
Well, I think having Roche there and the decision was made, the visit was made and the decision made by the CEO. He actually wanted to know when our next building; beyond that we have an option on the Northern Parcel, when that might be ready.
So, I think that’s initial commitment from their translational clinical group, but it is what it is at the moment. We feel very good that we have two relationships with biotech companies that we believe have a very high probability.
We’re actually in negotiations with each one on additional space, that could be as much as half a floor to floor piece and then we have a current tenant whose business has a milestone in the fourth quarter, and if that’s reached, they’ve requested and we’ve started to work a proposal out between us for two floors, plus we’ve got a very, very strong set of active showings to a range of different parties. So I think we’ll end up probably over the next couple of quarters, I’m pretty confident probably in the 40% range, so that gives us confident.
We own the steel, we own the curtain, while we only have to go vertical and I think that gives us confidence, it made sense to kick off that project. It’s also a time in New York where there is less construction going on.
So the ability to buy out contracts and trades with the trades is somewhat more favorable.
Quentin Velleley - Citi
Okay, thank you.
Joel Marcus
Yes, thank you.
Operator
Our next question comes from Steve Sakwa from ISI Group. Please go ahead.
Steve Sakwa - ISI Group
Thanks. Good afternoon.
I guess the main question I had was the one Quentin asked, so I guess we’ll wait until December to get some more details, but Joel maybe you or Tom could talk a little bit about the demand up in Boston. I just wanted to kind of get your -- a little more granularity on what you guys are seeing in terms of either biotech pharma and possibly tech up in the Binney Street area and then I’ll ask a question about San Francisco?
Joel Marcus
Yes. So I’ll let Steve address that question, but let me make a preliminary remark.
I guess what we’ve seen in Cambridge over the last couple of months is a number of companies and this has happened in the San Francisco Bay Area to some extent as well. We call kind of the second generation of companies that are now commercializing in products, fairly large market caps, relative to the biotech industry as a whole.
They will move to significant cash flowing entities and they need substantial space and that’s really independent of the macroeconomic environment that’s because of product approval. So we’re seeing I think reasonable demand in Cambridge from those groups.
I think when it comes to pharma, we know that Pfizer has made significant inroads in their work. MIT is doing a built-to-suit.
We know they’re looking potentially for more space. It’s rumored that Santa Fe and maybe another one or two are looking at Cambridge for moving some additional research units there, plus there’s a strong continuing evolution of early to mid-stage companies.
That’s the one market we see that in a pretty dramatic fashion. Not so much anywhere else.
The Bay area to some extent, but other markets not so much. So Steve can give you a highlight on Tech and maybe his observations as well.
Stephen Richardson
Yes, just to add to that Steve, I mean I think if you look at 400 Tech Square and the leasing that was done in the last quarter, that’s pretty indicative of looking forward and you had Aramco lease a chunk of space. They absolutely wanted to be in this location, they were supporting MIT’s energy fund initiative, so you’ve got a classic case of a company having to be adjacent to these types of institutions, you couldn’t get a better credit profile than that type of company.
And then you have Warp Drive, early stage company, very exciting technology, great venture backers and again, wanting and needing to be in this type of location and we do actually have discussions and tours with a couple of technology companies as well. So similar to San Francisco, we do see that Cambridge has the mix of both tech and life sciences and we are experiencing that interest first hand.
Joel Marcus
Yes, I think in the work drive situation, there also is a Big Pharma that’s I think both an investor and a strategic partner in that company, so you might think wow, a startup sounds kind of modest, but it’s a pretty big startup and it has from day one not only substantial funding, but it has a partner and an investor from big pharma, which is actually likely the commercialization path. So we feel pretty good about that market.
Do you want to take a crack at San Francisco, maybe the second generation?
Stephen Richardson
Yes. Similarly in South San Francisco with the Onyx build-to-suit that will be nearing completion I think in Q1 next year, a couple of companies that are doing very well.
The anchor tenant in the 409 Illinois building, FibroGen is advancing their science as well. They just had an orphan drug approval.
So we are just very, very encouraged by that.
Steve Sakwa - ISI Group
Okay, and I guess this – I don’t know if this relates to some of the comments you made earlier, but obviously companies like Boston Properties and Kilroy are getting some of these new development sites by Transbay and I realized there is some overlap in terms of the tenants that you might be talking to. But how are you guys looking at sort of the new development that might be taking place down in the SOMA area in and you do feel like there’s any crossover tenants that kind of maybe looking at both areas?
Stephen Richardson
Not in the near term Steve. Those are probably a good 30 months away in general and then Transbay is at least three to five years before that’s going to ultimately be delivered and occupied.
I don’t necessarily see traditional tech companies considering more of a conservative traditional 60, 70 story tower type of facility. So at first Transbay, I don’t see that being competition.
I think it’s just different location, different product type.
Steve Sakwa - ISI Group
Okay, thanks guys.
Joel Marcus
Thanks Steve.
Operator
(Operator Instructions). Our next question comes from Dave Rodgers from Robert W.
Baird. Please go ahead.
Dave Rodgers - Robert W. Baird
Hey Joel, maybe you could just give us a little bit more color on the disposition market. Obviously you guys have had success this year marketing the properties and the land and getting it out the door.
Talking about any changes in the asset type that you’ve seen or any slowdown in the process if any. Then I guess maybe a broader comment going in to the December meeting.
Give us your thoughts about the overall economic landscape with respect to being the time for you to start really accelerating dispositions? Should we expect to see a fairly sizable number relative to this year just given that you’ve stabilized NOI, the redevelopments have stabilized, you’ve got the leverage down and it seems like now is the time to do that, but that’s my take, but I’d love to hear yours.
Joel Marcus
Yes, well I think we’ll probably be able to give you a chapter and verse come December 5, but maybe broadly on the disposition market and I’ll ask Steve to comment, because he’s pretty deeply involved in that. But I think when it comes to one set of dispositions, they really were generated in a suburban location by a user that really approached us saying, now is a great time.
We had targeted this for disposition. We can’t really say much about the details yet, because it’s still in contract process, but that’s a good example where our desire and their immediate need kind of collided in a positive fashion.
In another situation, we see that there is a need to really move the product into a broader product type in another location and there we thought not really are our cup of tea, so we looked for a buyer who had both the skill expertise and the ability to put in additional capital and look at that really interesting different product types, so that kind of met time and circumstance, which was very beneficial I think. When Dean gave guidance last year at Investor Day for $112 million of asset sales this year, I think we’ll clearly see that number very comfortably.
But I think we were taking our time, because this is a product type that is not necessarily common to lots of buyers out there as far as basic knowledge, but I think we’ve seen a good reception, and I think we’ve got some good targets for the coming year, but Steve you can give your commentary.
Stephen Richardson
Yes. So there’s probably two buckets to think about in terms of dispositions.
The first would be the land, and as we looked at the land sales, those were in high quality locations and really a reuse of the property in terms of zoning was able to be effectuated. So you had property that we had looked to be lab product over time, ultimately be viable for residential.
In another case, I didn’t require a land use change, but the technology sector was stronger in that area, so that viability enabled us to move forward in the land side. On the existing assets, I think it’s important to note, and Joel mentioned it, again these assets are legacy assets, 10 or 15 years ago.
That’s where the industry was located in some cases and as they’ve migrated away, we have a choice to make. Do we invest additional capital, does the product type maybe get a little bit afar from our core competencies and is it really a long-term strategic asset, and at that decision-making point, the ability to raise capital and deploy it to our urban locations rather than the former scenario was again one we just thought made good sense.
Dave Rodgers - Robert W. Baird
Okay, thanks.
Joel Marcus
Thank you.
Operator
Our next question comes from Michael Bilerman from Citi. Please go ahead.
Michael Bilerman - Citi
Yes, I just wanted to come back to sort of the capital and leverage for a moment. Joel you talked about leverage being 7.2 times and wanting to have gotten to a 7 by the end of the year.
Clearly the agencies have you where they want, probably in the mid-6 and I guess you sort of married that up with what a significant spend into next year. Why not be more aggressive at getting that leverage down now, to not have an overhang in the future as you embark on $650 million of spend next year?
Joel Marcus
Well, that’s always a question of the hour, but I think that certainly based on what we have talked about from the last Investor Day and I think you certainly have represented one of the views there that has been important in our thinking. As we wanted to develop a run rate visibility, a earnings guidance visibility and I think a mode of operating that is not so much in and out all the time that there is a consistency and a predictability to it; so that’s one of the reasons we’ve thought to try to be pretty careful and pretty methodical and pretty logical about what we’ve done this year and in the next year.
I think you’ll see construction spend will start to tail off significantly in 2014. I think the agencies are pretty flexible frankly, as long as we are moving in the direction.
I think we’ll be held in good stead. I think Dean and I recently looked at leverage numbers of a lot of the REITs and it was actually surprising to me that a lot of them are actually operating at pretty good – when I say good, higher leverage levels than I would have actually even guessed.
But I think we are pretty comfortable where we are. I think we might decide at some point, if something came out of the woodwork that we could accretively match that isn’t part of our program today, I think we would do that.
But I think we are comfortable. We are almost down to seven.
I think we’ll be right at seven or so next year, very close and I think as we see getting into 2014, we can easily gravitate I think into the 6.5, with the huge major on boarding of projects. I don’t know that we need to go out and create a radically dilutive, $0.25 dilutive event, when we think from the sources we’ve described and we can get there in a logical way.
That’s kind of how our thinking is, but others may have different views.
Michael Bilerman - Citi
Well, I’m just curious, because you mentioned 2014 of construction spending coming down, but then when you start to layer in, the Binney Street project and the eventuality of the North Tower, if the West Tower is indeed successful and being…
Joel Marcus
That by the way is downstream.
Michael Bilerman - Citi
No, but it would seem as though there is enough in the hopper to have another $600 million of spend. You talked a lot on this call about redevelopments going into land inventory.
So it doesn’t seem like that figure is going, $600 million, each of the last two years is going down significantly. It seems that that’s going to be a consistent pace in terms of…
Joel Marcus
Yes, I don’t think so. I think again and remember too that we got kind of a cushion as Dean described it; future development projects in one or more of the buckets, so we tried to be conservative with some cushion in the 2013 numbers and I think 2014, I think really looking forward, the only really big project we would have would be Binney.
I don’t see us doing anymore large scale projects in the very near future. I think we see there’s some interesting opportunities potentially for selective redevelopments, buying, locations maybe with them, stabilized income we could convert as opposed to large scale development, so I think we see that as probably more the business model matrix for 2014.
So I think we’re pretty comfortable on this glide path where we think it’s working pretty well. We had a lot of feedback from Investor Day last year and certainly over the past couple of years and so we thought to try to again minimize that equity dilution.
I think Dean and his team have done a fabulous job this year of managing it and I think he’s given you and will give you great granular detail on December 5, but if you look at what we’ve got next year, we think it’s a manageable number. And obviously if we can get our NOI run rate up and our earnings projections going into ‘14 to look at nice reasonable growth in a no-growth environment, we feel pretty comfortable with that.
Michael Bilerman - Citi
That’s very helpful. Joel, you talked a little bit about the dividend in your opening commentary, about seeing what would be a solid increase.
I guess how should we think about that level and then also, how would it impact free cash flow? I think Dean had talked about $100 million of free cash flow as a source of equity for deleveraging into fund, the development since next year.
Dean Shigenaga
Yes. Well, I think the key is to share.
The increase in cash flow is not just suddenly move it obviously all to a dividend category, because clearly it’s the cheapest form of capital that we have. But I think if you look at this past year or so, what we’ve tried to do at the board level is kind of restore a predictable stepwise increase in the dividend.
Again ensuring future cash or ensuring on-boarding of cash flows and I think that’s probably a similar run rate you’ll see, and that still leaves us with at least about $100 million free cash flows for the coming year. Beyond that in 2014, don’t know, but I think that the board’s discussion for 2013.
Michael Bilerman - Citi
Sort of, if this year is a 10% increase, that’s what we should be thinking about for ‘13 at this point?
Dean Shigenaga
Probably somewhere in – I don’t know that I’ve looked at it instantly, but I would say somewhere in the 5% to 10% range.
Michael Bilerman - Citi
Okay. And then just this last question, just in terms of understanding the comparing contrasting 409, 499 and your confidence level when you bought that asset vacant or half the asset vacant and the confidence level here in New York about going vertical on the second Tower and you talked a little bit about this previously.
But how should we just sort of think about those two situations, because when you bought 499, 409 you were really confident about leasing that up pretty quickly. I guess how should we view the ability in New York about going vertical?
Joel Marcus
Yes, well I think on 499, I think our view is actually -- we try to provide and we are still as Dean mentioned, we are still sticking with our yield projection, but at the lower end, so I think what that shows is we still feel like we put adequate cushion into that lease up. We never thought it would be simple day one, but we thought that with the hospital’s momentum it would go faster than it actually has, it kind of sucks that it didn’t.
But I don’t think we’ve changed our view that as Steve said its high quality and that will be successful. The street will judge us by not what we say, but obviously by what happens, but I feel pretty good about New York.
I think Roche has been a big plus. We’ve got some pretty great current tenant interest.
One tenant is step forward. We know that there is one or two others that are in discussions internally about expansion space that could even be as many as three current tenants, which would be pretty amazing, but we’ve got two biotech companies that have high probabilities.
We are in negotiation, specific dollars and provision negotiation, and then we’ve got pretty active showings with a whole range of… I did a trip last week to the headquarters of one major company. They are very interested.
Don’t know where they’ll end up, but my personal view is they’ll come to New York. So we see a lot of activity, but again, we only want to be judged by how we succeed, not what we say, but we feel comfortable pulling the trigger on that incremental spend, because we own, as I say we own this deal, the curtail wall.
We just go vertical and we think it’s a good time in New York to do that and that’s been another reason we felt pretty comfortable with that. So I guess my level of confidence is pretty solid.
Time will tell I mean if we did build the East Tower through the Lehman fiasco and the cliff of almost disaster before TARP kind of came on and so forth. So we managed to get through that and had a firm delivery date to full lease up.
It took a year, which was faster, two years faster than we had gathered. So, I don’t know it’s a hunch, it’s an instinct, it’s a heal based on all the people we are talking to and I hope we are right and if we are wrong, then we’ll get on the Street, we’ll make that judgment, but we feel pretty good about it.
I think having Roche as the anchor has been a huge plus from the quality and the efforts they are going to put forth in New York. So I think if we had no anchor, we never would have pulled this off.
Michael Bilerman - Citi
Great. Thank you so much.
Joel Marcus
Yes, thank you.
Operator
We have no further questions at this time. Mr.
Marcus do you have any closing remarks?
Joel Marcus
Just to say thank you. We’ll talk in February, and again, stay safe over the next day or two.
Thanks everybody.
Operator
Thank you ladies and gentlemen. This concludes today’s conference.
Thank you for participating. You many now disconnect.