Oct 28, 2010
Executives
Gerry Sweeney - President & CEO George Johnstone - SVP, Operations & Asset Management Howard Sipzner - EVP & CFO Tom Wirth - EVP, Portfolio Management and Investments
Analysts
Michael Billerman - Citi Jamie Feldman - BofA Merrill Lynch Jordan Sadler - KeyBanc Capital Markets John Guinee - Stifel Rich Anderson - BMO Capital Market Rene Bayarna - Wells Fargo Securities John Stewart - Green Street Advisors Anthony Paolone - JPMorgan Dave Rogers - RBC Capital
Operator
Good morning my name is Latangie and I will your conference operator today. At this time, I would like to welcome everyone to the Brandywine Realty Trust third quarter earnings conference call.
All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session.
(Operator Instructions). Thank you.
I would now like to turn the conference over to Gerry Sweeney, President and CEO of Brandywine Realty Trust. Please go ahead, sir.
Gerry Sweeney
Well Latangie thank you very much. Good morning, everyone, and thank you all for joining us for our third quarter 2010 earnings call.
Participating on today's call with me are Gabe Mainardi, our Vice President and Chief Accounting Office; George Johnstone, our Senior Vice President of Operations; Tom Wirth, our Executive Vice President, Portfolio Management and Investments; and Howard Sipzner, our Executive Vice President and Chief Financial Officer. Prior to beginning, I'd like to remind everyone that certain information discussed during our call may constitute forward-looking statements within the meaning of the Federal Securities Law.
Although we believe the estimates reflected in these statements are based on reasonable assumptions, we cannot give assurance that the anticipated results will be achieved. For further information on factors that could impact our anticipated results, please reference our press release as well as our most recent annual and quarterly reports filed with the SEC.
Before addressing our quarterly performance, just a quick observation on the overall state of the real estate markets and the economy. On the last call we talked about the recovery we are seeing in our primary markets.
We continue to believe that recovery that market has bottomed and that the recovery is still underway. As we have seen with broader economic indicators however this recovery while we anticipated it to be steady will be slow.
From a real estate standpoint even though there are an increasing number of tenants already looking at their 2011 and 2012 space requirements as evidence by some of our traffic and pipeline activity that positive continuous to be offset by tenant downsizing an space give backs. These two factors combine to create a market that while positively biased is one that will have very competitive conditions persisting well under 2011.
In this type of climate given very little new incremental demand we will generate leasing activity primarily by increasing our market share and as such upward pricing pressure will be minimal and will remain selling to our markets return to normal levels of observation and reduce the vacancy rates below their current low to mid-teen averages. So with that overall comment and looking at the third quarter we continue good execution of 2010 business plan including strong leasing performance.
As you look at the quarter and remainder of the year several points to note, our first, the headline news for the quarter for us was 1.4 million square feet of leasing activity during the quarter. A new deal pipeline of 3 million square feet, 414,000 square feet have executed forward new leasing transactions and 518,000 square feet of leases and negotiations, all strong indicators.
Overall velocity was in-line with our expectations, even with this strong leasing metric we continue to face space consolidations by a number of larger tenants that had impacted both our 2010 and will impact our 2011 business plans. From an operating metric standpoint our business plan always anticipated that the third quarter will be challenging so we did see continued pressure on our operating trends during the quarter.
Our mark to market on rents remain negative, same store NOI declined both in line with expectations. Our NOI margins however remain stable and we project we will exceed our 2010 spec revenue target by $3 million or 11%.
Our tenant retention rate for the third quarter was 68.3% excluding early terminations and 63.3% with early terminations. Traffic through the portfolio is up 4% from the second quarter and up 14% year-over-year.
Our strongest performing markets in terms of both activity and rental rates remained Philadelphia CBD, Radnor Plymouth Meeting in Newtown Square submarkets in Suburban Philadelphia, the Toll Road Carter in Metropolitan DC, and our operations in Richmond. As outlined on our last call, our 2010 operating business plan assumptions are they originally contemplated a 46% retention rate.
Based on results thus far we anticipate we'll have an actual retention rate that will approach 60%. Our core portfolio occupancy for the quarter at the end of the quarter was 84.9%.
This occupancy level is down 150 basis points from last quarter's 86.4%, primarily due to 1717 Arch as we now know as Three Logan being 67% leased which has about 90 basis points of vacancy with the balance of the decline due to several large known moves of our tenants back to corporately owned facilities, notably .ARI in Southern New Jersey to move that 158,000 square feet and Verizon and Vanguard to vacate a square feet in our Pennsylvania operations as well as about 33,000 square feet of bankruptcies and lease defaults during the quarter. During the third quarter we did deliver the IRS Philadelphia Campus which is 100% leased to the IRS and the Cira South Garage which is 93.2% leased.
The GSA is now our largest single tenant comprising 6.4% of our annual based rents. During the quarter we acquired the lease hold interest in 1717 Arch, as I mentioned also known as Three Logan, a 1.029 million square foot 53 story trophy class office tower located in the Philadelphia CBD we acquired from Blackstone Group.
The property was acquired for $129 million or $125 per square foot. We funded that through a combination of $51.2 million in cash and 7.1 million operating partnership units.
That partnership is subject to -- that property is subject to a long term ground lease which is prepaid through 2023 that can be extended through 2092 and is subject to a fair market value purchase option. Also during the quarter we announced a $25 million preferred equity investment in the Commerce Square, a Philadelphia CBD Twin-41 story office tower complex owned by the Thomas properties group that aggravates 1.9 million square feet.
Brandywine will be a 25% limited partner in that transaction with a 9.25% cumulative preferred return. That transaction is waiting approval by the property's lenders and is slated to close within the next 60 days.
Brandywine now owns 4.7 million square feet of office space in the Philadelphia CBD including One and Two Logan Square which are together 97% leased as well as Cira Center, which is 100% leased and the IRS campus which is 97% leased as well as two developments sites in Cira South in University City. Including the Thomas Properties JV, Brandywine now owns about 51% of the Philadelphia trophy CBD market.
Based on this recent activity, our percentage of NOI contribution from Philadelphia CBD rose from 12.9% to 18% and based on this increase we are showing Philadelphia CBD in our supplemental as a standalone reporting segment with the Pennsylvania reporting segment now being comprised entirely of suburban properties. On the investment front, efforts are focused on marketing nine core properties for sale or joint venture over the next several years.
We fully expect that with pricing becoming increasingly dear in New York City and Washington DC, capital will begin to migrate towards high quality office assets in key markets like Philadelphia. As such, as 2011 progresses, we expect to see an increased level investment activity in the Philadelphia metropolitan area as well as in Richmond and Austin.
We closed $18.4 million of sales year-to-date and have another 34.4 million under contract or in contract negotiations at a cap rate of about 70.5%. This is managed with close will bring us to $53 million of sales for the year versus our original forecast of $80 million.
We remain fully committed to moving up the investment grade ratings curve one notch. This is a multiple year plan that we will achieve through a combination of NOI growth, occupancy improvement, disposing of slower growth assets, and funding any future acquisitions on an equity basis.
Through our continuous equity offering program year-to-date we were a $70.8 million of net proceeds by issuing 5.7 million shares and during the third quarter we issued 2 million shares realizing $25 million of net proceeds. As noted in our press release we were at the bottom end of our 2010 guidance upward to a range of $1.32 to $1.34 versus the prior range of $1.30 to $1.34.
Based on the mid-point of our new 2010 FFO guidance, our FFO payout ratio was 45.3%, our CAD payout ratio for the quarter was 68.3% and we continue to expect to generate free cash flow this year between $30 million and $40 million. This is the fourth time this year that we raised the bottom end of our guidance, as with previous quarter this upward revision is primarily driven by better retention rates than we originally expected.
Being ahead of the plan on spec leasing, due to expense control programs that have resulted in stable NOI margins and a low working interest rate environment than we originally forecast back in October in 2009. As we did also indicate in our press release we announced our 2011 guidance with the range of $1.24 to a $1.34 per share creating a mid-point of $1.29 which is the low consensus estimates.
At the mid-point of our guidance we're projecting FFO payout ratio of 46.5%, CAD payout ratio of 75% and again anticipate generating between $30 million to $40 million of free cash flow. This guidance is fairly consistent with our original 2010 guidance of a $1.23 to a $1.34 per share.
As with last year the guidance was conservatively developed and is really driven by the following macro assumptions. As I touched on earlier we do believe the market is bottomed but we do expect the recovery to continue at a steady but a very slow pace.
That assumption is based on prevailing economic data points that we are all familiar with and will also reflect activity that we are seeing in our markets. While we are seeing increasing levels of activity in almost every market velocity still does remain well below historical levels.
Also despite having an excellent 2010 leasing activity level we are still in an environment where net absorption in most of our markets is still below long term averages and large tenants are still rationalizing their space requirements. As such our 2011 business plan projects spec revenue levels that are 18% below what we expect to achieve in 2010.
During the past year another key assumption of our business plan is that we issued the equivalent of 12.8 million shares of stock or 10% of our equity base which while accelerating of our de-leveraging plan has also equated between $0.06 to $012 of delusion depending on assumptions of how we apply those proceeds and the impact of those shares issuances is fully reflected in our 2011 guidance range. By year end -- by 2010 year end our portfolio will have had negative absorption of approximately 854,000 square feet or about a 330 basis point decline of occupancy.
More importantly the majority of that negative absorption is occurring during the second half of 2010 so it has a big carry forward impact into 2011. We also have several known move outs in early 2011, particularly in our metro Dc operation which creates some additional near term occupancy pressure in the early part of next year.
We are projecting flat to 100 basis point improvement in year end 2011 occupancy levels with occupancy dipping in the first half of the year. For 2011 we estimate we will achieve approximately 3 million square feet of leasing activity versus a 3.2 million square feet projected for this year and to provide a frame of reference, our current leasing pipeline stands at 3 million square feet.
So we're confident meeting our targeted leasing objectives that are incorporated into our business plan. We did continue with last year's approaching and compiling our 55% projected tenant retention rate where we basically assume that any tenant that we don't know for sure is staying leaves upon expiration.
On the capital raising front, we've assumed $80 million in sales for 2011 occurring mostly in the second half of the year. We have not assumed any addition acquisition activity or any further equity issuances.
We have provided for a $300 million 10 year unsecured note issuance in the fourth quarter of 2011 and we also plan on keeping our line of credit balance in line with our previous forecast with an average of one third or less funded and a year end 2011 balance well below $100 million. While George and Howard will go into more detail, our objective in presenting guidance this year for 2011 was to continue to recognize the reality in the current markets.
Fundamentals have clearly bottomed. However 2011 will not be a year of quick recovery and as such from our standpoint, both prudence and caution, coupled with the very aggressive leasing strategy is really the order of the day.
This guidance provides a solid platform from which we can; market and distance permitting improve on door in the course of the year, similar to the execution of our 2010 business plan. At this point, I'd like to turn the presentation over to George Johnstone to review the key revenue drivers and operating assumptions behind our guidance.
George will then turn it over to Howard for a financial review of the quarter, the balance of 2010 and 2011 guidance. George?
George Johnstone
Thank you Gerry. From an overall standpoint, given the current state of the real estate markets and the lack of visibility on demand drivers, we took a very cautious view of forward leasing activity.
As such, our 2011 business plan is primarily based on conversations with existing tenants and our existing pipeline of activity. Our 2011 guidance contemplates a decline in same store NOI of 5% to 7%.
As mentioned today, on prior calls move outs by six large tenants aggregating 600,000 square feet predominantly in the second half of 2010 and the first quarter of 2011 accounts for 58% of this decline. These moveouts include ARI and virtual health in New Jersey, both 2010 moveouts, Verizon and Vanguard in the Pennsylvania suburbs again 2010 moveouts and computer associates in Verizon and Dallas Corner first quarter of 2011 moveouts.
In addition, $6 million of termination fees in 2010 have been reduced to a $3 million run rate for the 2011 plan which accounts for another 18% of the decline. So, these 6 tenants and reduced termination fees account for 76% of the total same store NOI decline.
In general our leasing plans for 2011 assumes 2.9 million square feet of speculative leasing consisting of 1.8 million square feet of new leases and 1.1 million square feet of rentals. This is about 90% of the 3.2 million square feet we expect to achieve in 2011.
This activity when combined with the forward leasing already executed and anticipated contractions will produce a flat to 100 basis point increase in year-over-year occupancy. Revenue produced from these leasing plans totals $25 million which is approximately 82% of the $30 million of speculative revenue generated in 2010.
Our anticipated mark to market on GAAP rents to a 5% to 7% decline. Occupancy is expected to drop by the second quarter due to large movements in access of speculative new leasing.
Our Northern Virginia portfolio is impacted the most where we expect over 600,000 square feet of tenant contraction during the year. The majority of these contractions are probably in our Toll Road properties.
As we have accessed the speculative revenue plan for 2011 our new leases there is an active pipeline of prospects, 500,000 square feet of leases under negotiation, 206 million square feet of prospects or in a receipt of a proposal and 1.4 million square feet of current space inspections. Relative to renewals, as Gerry mentioned we have assumed tenant that we don't know who are staying will vacate the portfolio upon lease exploration thus leading to our planned 55% retention rate.
In regards to confessions and capital we have assumed based on recent trends that the request for free rental continue to be a preferred concession by our tenants. The 2011 plan assumes 60% of these transactions will have a free rent component.
This is up from 42% in 2010. Tenant improvement cost are estimated which sees historical levels caused by longer lease terms on average and a few ten year deals on our Metro DC region.
I will turn it over to Howard Sipzner for the financial review.
Howard Sipzner
Thanks George and thanks Gerry. In the third quarter, FFO available to common shares and units totaled $45.6 million or $0.32 on a fully diluted basis per share and that net analyst consensus.
It is a high quality FFO figure, in the third quarter termination revenue, other income, management fees, interest income, JV income and debt losses totaled $6.2 million gross or $4.7 million net and are at the lower end of our guidance range for these other revenue components. Our payout ration in the third quarter is 46.9% on the $0.15 dividend paid in July, 2010.
Few observations on the third quarter performance, cash rent of a 112.4 million was up, $2 million sequentially versus Q2 2010 but down 1 million versus Q3, 2009 when that year ago period is adjusted for the FX of deconsolidating 3 JV is effective January 1st, 2010. Straight-line rent of 3.8 million was up 1.1 million versus Q3, 2009 and 1.3 million sequentially versus Q2, 2010 echoing George's comments on increased free rent concessions.
Recovery income of $20.2 million and our recovery ratio of 35.6% reflected typical expense and recovery conditions. Probably operating expenses increased $3.8 million and real estate taxes increased 700,000 sequentially with much of that attributable to new asset that came online in the third quarter.
Interest expense of 34.5 million increased sequentially by $3.3 million and by $3 million year-over-year as we absorb the expense of post office and garage permanent loan. Interest expense in Q3 includes $340,000 of non cash APB 14-1 cost related to our remaining exchangeable notes and also reflects reduced capitalized interest versus the prior quarter.
G&A of $5.75 million was in line with our expectations and deferred financing cost declined to $827,000 reflecting prior period accelerations of deferred amounts as a result of debt repurchase activities, offset by the commencement of amortization on the post office and garage loan costs. So in some Q3, 2010 reflects a partial period of both the post office garage asset as well as for 1717 Arch or Three Loan.
Together they account for $4.6 million of rental revenue, $1.2 million of recoveries, $2.2 million of property expenses, $320,000 of one time transaction expenses in G&A, $2.1 million of interest expense and about $110,000 of deferred financing cost. In the third quarter we had net bad debt expense of $560,000, in line with expectations and reflecting various write offs, recoveries and adjustments to reserves.
The net effect in the third quarter was about a $270,000 increase in our overall reserve balance versus a quarter ago. And lastly we incurred minimal or $64,000 of losses on $1.7 million of debt repurchases.
For the quarter, same store NOI declined 6% on a GAAP basis and 7% on a cash basis, both excluding termination fees and other income items and largely as a result of lower occupancy in the same store portfolio. Our margins were very solid as were our coverage ratios despite our higher vacancy levels and are equal to or above recent levels.
We did tighten the range on 2010 guidance to $1.30 to $1.34 and to echo what Gerry said, seeing many of our assumptions coming in nicely as the year winds down and having very surprises in the overall operating environment. Just to highlight a couple of items, our specialty revenue is up $1.4 million from the July 2010 year and is up almost $3 million from our initial 2010 guidance.
This is a key contributor to our guidance increase. For the year we see between $25 million and $30 million of gross other income items or $20 million to $25 million net and that's in line with prior expectations and we see our G&A coming in consistently for the balance of this year.
Our total interest expense for 2010 will be in $131 million to $133 million with next quarter's expense to the current quarter consistent with this quarter's due to the full impact of the post office and garage financing and the elimination of virtually all of our capitalized interest offset by a mortgage pay off on October 1st and the burn off of various underlying LIBOR swaps. We don't anticipate any additional issuance in our numbers for the continuous equity program beyond what' already been done year-to-date.
For the 2010 capital plan, looking at the balance of this year, we'll have total capital leased about $330 million. This will include $40 million of investment activity between finishing up the post office and garage, revenue maintaining CapEx, other capital and the initial funding on the commerce JV.
We will also need $247 million for debt repayments including the 2010 note, a few million dollars of quarter-to-date repurchases and $46 million for the mortgages with the large one already behind us. As noted in the press release, we have also extended our $183 million bank term loan that was due earlier this month and it now runs to June 29, 2011 contemporaneous with our credit facility.
We see $20 million of negative working capital changes primarily due to Q4 interest payments that only needed to be funded cash and $23 million of aggregate dividends again now behind us in the month of October. To raise this 330 million we're projecting a following, we will use the $104 million that w have cash on hand at September 30, $5 million raised during October from the continuous equity program about $15 million of cash flow from operations for the rest of 2010, $34 million of projected remaining sales activity in 2010 brining our total for the year at $52 million and we will borrow a $137 million or so on the credit facility bring us to a year end balance of 159 million ending the year pretty much as planned earlier.
Just to elaborate on a couple of points of 2011 guidance between Gerry and George they went through many of the portfolio metric, I will point out one item and that is on the gross other income items termination fees, other revenues, management revenue etcetera. We are down a little bit on our projections from 2010 seeing those numbers of a growth basis of 20 million to 25 million on a net basis of 15 to 20, that's down anywhere from 5 million to maybe $7 million below our 2010 figure.
G&A should run consistent with 2010 at five and three quarters and 6 million a quarter, interest expense should be consistent with the full year 2010 figure between a 130 and a 133. We do include in earnings and FFO a net historic tax credit financing impact of $0.07 per share.
This will hit the income statement in Q3, 2011 and then we will show as about $0.08 of additional revenue on a newly created line item and we also reflect that extra $0.01 or so of interest expense in that period. This is essentially non-cash and it will be excluded in out CAD calculation.
It reflects 20% of the net proceeds to be realized in connection with the historic tax credit financing that will recognize pro-rata over the next five years beginning in 2011. We do have 80 million of sales activity program for 2011 and up to a 10% cap rate.
It's waited with the middle to back end of the year and we see it having an impact on a growth basis on NOI and FFO of about $3.2 million. We don't have any additional equity issuance programmed into our number for 2011 nor do we anticipate doing any market financing until the end of the year.
So in short we see our plan producing between a $1.24 to a $1.34 of FFO and between $0.75 and $0.85 of CAD as Gerry mentioned producing between $30 million and $40 million of free cash flow. Very quickly on the 2011 capital plan, it's a much lighter year in the aggregate in 2010.
We see about 113 million of aggregate investment activity including any remaining finish up on the post office and garage for final items, $50 million of revenue maintaining CapEx, $40 million for remaining re-development outlays. We recently completed our purchase properties and the middle piece or about $15 million of the commerce JV funding.
We have $240 million of debt repayment programmed for 2011, these include $70 million for the 2011 exchangeable that we believe will be put to us in October, $128 million for mortgages and we have made a conservative assumption that will refinance the last two -- pay back rather $42 million of JV debt. We plan to extend our $183 million bank term loan and the $600 million LOC during the early part of 2011 to a final maturity of June 29th 2012 and lastly maintaining the same current dividend level as a good assumption, we will pay them an aggregate of about $93 million of dividends or in cash.
To raise this $446 million, we're projecting about $170 million of cash flow from operations. We will receive funding of the remaining -- the final HCC installment in early 2011, about $3 million bringing the total gross inflow to about $64 million, the $80 million of sales and a $300 million year end unsecured note issuance resulting in $107 million pay down on our credit facility and a year-end balance of about $52 million.
That wraps up the capital plan. I'll touch very briefly on account receivables.
Total reserves at 9/30/2010 were $15.7 million, $4.4 million on $24.5 million of operating and other receivables were about 18% and $11.3 million on $102.1 million of straight line rent. Receivables are about 11%.
These reserves are line with prior quarters and reflect expected credit activity. And lastly on the balance sheet and credit metrics, we achieved our lowest debt to gross real estate cost of 44.2% in well over 5 years.
We have a very good balance between secured and unsecured debt, maintaining a very high unencumbered pool and we're 100% compliant on all of our credit facility and indenture covenants. And with that I'll turn it back to Gerry.
Gerry Sweeney
Great, thank you Howard. Thank you George.
To wrap up the prepared comments, clearly the market will continue to present operating challenges for the balance in the year and into 2011. We're in good shape as we close the books on 2010 in the next 60 days in terms of accomplishing our key business plan objectives.
Looking at next year, the opportunity implicit in our 2011 guidance is that our best growth strategy is to simply lease up our existing vacancy. We're fully focused on that and believe that our liquidity, inventory quality and strong market position provide a clear competitive advantage for us as evidenced by our year-to-date leasing velocity and strong pipeline.
We plan to continue to executive a very aggressive leasing approach to ensure that we maximize that advantage and achieve our 2010 and forward looking 2011 objectives. With that we'd be delighted to open the floor up for questions; we would ask that in interest of time you limit yourself to one question and a follow-up.
Thank you.
Operator
(Operator Instructions). Your first question comes from the line of Michael Billerman with Citi.
Michael Billerman - Citi
Yeah. Just on guidance, just for 2010 first was, I guess the other income -- all those various line items, it seems that for the fourth quarter you've got $5 million to $10 million baked in there.
You done about 15 year-to-date net and you said 20 to 25 for the year. What would take you from -- I guess the $5 million is sort of the normal that you've been earning each quarter.
What sort of takes you up to $10 million?
Howard Sipzner
Yeah, I don't think we'll come in at the high end of that range of that range Michael. It will towards the -- certainly the bottom of that range.
Michael Billerman - Citi
Okay. And then I guess moving forward to 2011 and you gave a lot of details but if I just step back from it and say you're running about $0.32 a quarter.
It's about $1.28 plus the $0.07 non cash from the tax credit does get about $1.35 and your guidance is $1.24 to $1.34. Now I think I heard you guys produce at the occupancy is going to be different in the first quarter I don't how much but 100 basis points is only like a penny a share.
So that can't really drive that much but what's really depressing next year's FFO relative to the pieces. I know that other income you said was going to go down to 15 to 20 but if you are probably going to come in sounds like more like towards 20 – 25 so that's on a big, big driver.
What's really getting this down for next year?
Howard Sipzner
Michael this is Howard, I think there are three factors I think there is a little bit of down draft in terms of the overall operations but the reality is when you combine the same store declines with the new revenue pick ups from the post office. The garage operations as well as three logon, those tend to offset each other.
So we will plus or minus right around neutral in the overall level of NOI. So the factors that are pushing down guidance are really three fold, number one, the full share load of the incremental shares in 2011 versus -2010.
Michael Billerman - Citi
I am already taking that but my starting point is the fourth quarter at $0.32.
Howard Sipzner
Fair enough.
Michael Billerman - Citi
That should be already in there.
Howard Sipzner
So if you look at $0.32 as a run-rate and we ignore the HTC, so we are at a $1.28 to pick up on your comments versus maybe a mid-point on the guidance of a $1.22. I think the two things we can point to are incremental sales activity in both the fourth quarter and 2011 being worth probably on properly weighted basis between 3 million and 4 million net or $0.02 to $0.03 and then I think the other is a much more conservative posture on other income items.
If those come in between $5 million to $10 million that's worth another $0.04 - $0.05 I think between those two components we have pretty solved for the delta in the FFO guidance, what I will point out is in 2010 we took a fair amount of early terminations. You will see that in that in the leasing stats then you will see that in the termination revenue and at this point of the year we are not programming to do anywhere near that level of activity and that plus other factors are leading to a lower other interest item and I think those two do solve the puzzle.
Michael Billerman - Citi
Thank you.
Operator
Your next question comes from the line of Jamie Feldman with BofA Merrill Lynch.
Jamie Feldman - BofA Merrill Lynch
Thank you Gerry, a couple of follow up on your comment where you said you think institutional that will start to move out or will find New York and Washington to expense and move into markets like Philadelphia and Austin. Can you give some indication of what you have seen along those lines so far?
And then also can I help you think about your move, you're adding to your CBD affiliate portfolio and what is that some of your cap rate story or an improving fundamental story?
Gerry Sweeney
I would be happy to and Tom will turn over to you maybe just to give you some observation or seeing an extra market. We started to see even in the last quarter, there is a lot more reverse inquiries relative to properties in the greater Philadelphia area which we were not saying.
Now if you go back to our, initially we thought 2010 would play out is we assume that there will be a higher level of investment velocity in Philadelphia by the end of 2010. I think we are tracking along those lines in spring when the economy started to move side ways I think what we really saw was a real push of money to stay in the gateway markets and essentially bidding up a lot of properties buying growth bonds with the high level security and the liquidity in those two markets -- two markets being New York and Washington.
And I think that put a bit of a damper on what we were hoping to see this year which I mentioned is more of an accelerated investment base and more investment activity in Philadelphia. I think with pricing continuing to get increasingly dear on that and Tom gave you some illustrations, we do think that the folks that are getting priced out of that market will start to turn their attention to some of these very buyable but compared to New York and Washington tier 2 type of markets.
And we think that will come both from domestic institutions as well as foreign capital and we are beginning to outback now. Relative to the view on CBD Philadelphia we think it is a value play as we talked about when the announced the Three Logan transaction.
Our appetite for properties in the CBD Philadelphia is limited to really the trophy class which has been fairly economically resilient from an occupancy standpoint during up and down cycles. We do think that there is some good dynamics taking place long term in Philadelphia will create a good upward movement in rent.
We've been seeing that already in both One and Two Logan with our early renewals on Cira certainly can walk more into more detail on Three Logan later. But Tom, why don't you share some observation what we're seeing on the investment market.
Tom Wirth
Hi, good morning. When you look at the investment market we are still seeing the CBD Washington be very competitive and we're seeing trade still occurring 400 - 600 a foot on some of the properties.
They're core, core plus with the trophy class still going well up above replacement cost. But we are starting to see some activity, some trades that are occurring the beltway and even out into some of the areas around the Toll Road.
So we are seeing some more properties come to market that aren't those core transactions that are commanding the high pricing and we're still seeing some deep pools of investors on those properties. So we expect that as we now start to see some of that pricing improving along the belt way that you'll start to see occurring in some of these markets.
We have not seen a lot of product coming to market but we have had some reverse inquiries about investments in Austin and in Philadelphia. So there is some interest coming that way.
But again not a lot of trade to benchmark with.
Jamie Feldman - BofA Merrill Lynch
So Gerry, I guess going back to CBD Philadelphia, are you actually seeing an increase in the level of interest or you're just getting called? You're think we're closer to being -- A, my question do you think your closer to seeing on local market participants go after buildings there?
Gerry Sweeney
Absolutely. I think we're much closer where we are today versus we were six months ago.
And yeah, I think part of that is being driven by people getting a better flavor for what rental fundamentals will be in the area with the market kind of bottoming even though of course that recovery will be slow but I think it's also being driven the price compression you've seen in those two gateway markets, no question.
Jamie Feldman - BofA Merrill Lynch
Okay, thank you.
Operator
Your next question comes from the line of Jordan Sadler with KeyBanc Capital Markets.
Jordan Sadler - KeyBanc Capital Markets
Thanks. Good morning.
First question, I think maybe George you can provide some additional color surrounding the detail you gave on the leases or spaces under negotiation versus prospects versus I think inspection. Can you make me give us a historical number in terms of percent hit rate related to those three categories?
Gerry Sweeney
Sure I mean I think, I mean our average conversion of deals that we issue proposals on, runs anywhere from kind of the mid to high-20s to the mid high-30s and on inspection it's probably 10 percentage points beyond that. As we have talked on prior calls I mean we kind of track every prospect through the pipeline on kind of a nine stage category and as they move up that pipeline clearly we see a better conversation rate.
Those are very negotiation; its typical north of a 90% conversion, rare is that we get kind of a draft release or actually negotiating a lease with the deal turned sideways on us.
Jordan Sadler - KeyBanc Capital Markets
Prospects it could be 20 or 30, inspections could be 30 to 40, is that what you are saying?
Gerry Sweeney
I think that's kind of the range that we have seen over the last couple of years.
Jordan Sadler - KeyBanc Capital Markets
Okay and then as it relates to 1717 Arch and CBD Philly, Gerry or Tom, if you could walk through sort of how the investment opportunity is shaping up I know it's we are two months into this deal for you guys or so but maybe a month or three year ready but any early reed on sort of activity tenants that are in the market and sort of asking the rates will be helpful.
Gerry Sweeney
I think we continue to be very pleased with the level of activity. We are seeing I think that we got a marketing opportunity we saw on that transaction was that because of the master lease structure was in place on that building for a number of years that was schedule to mature and was about to expire in 2012.
That property had effectively been out of the tenant market for a number of years. Certainly we assume I think that assumptions are bearing some fruit is that once the high quality building like Three Logan also called 1717 Arch came on to the market and had to go to the lease space on market conditions.
We be able to generate a lot of activity and that's exactly what's happening. We have had about 25 inspections thus far with over 1 million square feet of aggregate activity.
We have I think six pretty good proposals outstanding on a vacant space remember that, at the top half of that building is fully leased to sub-tenants on leases that mature in mind-year 2012 that are paying an average rate of about $22 a foot. On the bottom half of the building is where really the vacancy is absent a 125,000 square foot recently we signed with Verizon.
So, activity levels has been very good. There are a number of larger tenants in the market we are working with, they certainly know guarantee that any or all that can get across the finish line but we certainly been very aggressive.
The rental rates that we performed are very much in-line with the proposals and discussions we are having with the tenants and their advisors. On the upper bank of the building, again there is about 55 tenants up there about 550,000 square feet.
We are in discussions with about 30% of that square footage already. On early renewals basically blends and extends, all on economic terms that are at or slightly better than our pro-forma.
We've also been able to realize some nice expense savings. Relative to electricity we saved about $420,000 versus our underwriting janitorial, about $500,000.
We've been able to improve the parking NOI a little bit and I've seen good activity in the vacant space. The focus for 2011 is really to convert some of the activity we get as much as we can through the door due early renewals particularly on the lower bank and the upper bank and lock some of those away and hopefully get one of the large deals across the table for occupancy either later in '11 or more likely early 2012.
So nothing has been done and certainly the market is fraught with uncertainty. I think we are pleased with the activity, the economics being discussed and the reaction of the sub tenant base in terms of their desire to stay in the building.
Jordan Sadler - KeyBanc Capital Markets
And just as a clarification there is a little bit of a delta between what you disclosed I think with 63% occupancy when you announced the deal and then the stuff is 66.5%. Is that a clerical difference of some sort or did you actually do some leasing?
Gerry Sweeney
No. I think that I have to go back and check but the occupancy level hasn't changed in the 90 days we are on the property.
We'll take a look at that for you.
Jordan Sadler - KeyBanc Capital Markets
Okay, thanks.
Operator
Your next question comes from the line of John Guinee with Stifel.
John Guinee - Stifel
Okay, thank you. A bunch of little nits and nats.
First, I might have gotten that wrong Howard but I think you said $93 million worth of dividends in '11 and I think it's the weighted average share count for your guidance is in the mid 140s. A quick math translates to a $0.63 dividend.
Is that correct or incorrect?
Howard Sipzner
That would be incorrect because you are including the units from the Three Logan transaction in full. And those if you recall do not get distribution until the one year anniversary of the transaction.
So we did not assume in those figures or in the projected payout ratio a change in our dividend level.
John Guinee - Stifel
Got you. Okay.
How many square feet of buildings did you demolish recently and did you have to take an impairment charge when you knocked those down?
Howard Sipzner
You guys check in -- no actually we were carrying those to what we thought were essentially land basis.
Gerry Sweeney
Yeah, the square footage, we don't even show the square footage any more. And the aggregate there now about eight acres of land area.
Howard Sipzner
Right. It was approximately 100,000 square feet, each building about ---.
John Guinee - Stifel
Okay. And then how is the accounting going to work for Three Logan 1717?
Do you have about 100% in service for the entire time or you are taking it out of service in 2011 or 2012?
Gerry Sweeney
Yeah, no that will be a core operating property, not a same store property. There will be no capitalized interest on any component of base building as we do larger or any TI jobs consistent with our practice; any open jobs for tenant work will get capitalized interest treatment for the duration of that job, three, six, whatever many months.
John Guinee - Stifel
And then last what's the earliest-- maybe Tom, what's the earliest timing in terms of even your Thomas Properties exercising the buy-sell. On the One and Two Commerce Square.
Tom Wirth
Well the buy-sell that we have in place for us is in 2016. There is no restriction on them trying to sell property ahead of time before that, but there are just 2016.
John Guinee - Stifel
If we give our right our first refusal or just mark to market if they decided to sell it before them.
Gerry Sweeney
It's a mark to market.
John Guinee - Stifel
All right. Thank you.
Operator
Your next question comes from the line of Rich Anderson with BMO Capital Market.
Rich Anderson - BMO Capital Market
Thanks, the debt offering that you are assuming in 4Q, 2011, does that presume that you get upgraded by then?
Howard Sipzner
We don't believe the upgrade is likely in that timeframe unless there is a dramatic improvement in overall the economy conditions and we have projected that kind of rate currently wider market but it doesn't have any really impact on 2011 numbers one way or the other as we expected to come as the latter part of the quarter.
Rich Anderson - BMO Capital Market
Okay and then a follow up question is on the dividend policy. You being conservative in your outlook for 2011 as you were in 2010 and FFO, can the same be said about dividend growth for 2011?
Gerry Sweeney
The board has the policy of matching taxable income with dividend, certainly we are well covered today and life been intention of generating a level of free cash flow we are as a company. My expectation is that as the door gets more visibility on both the economic climate improving generally, our portfolio performing inline or ahead of expectations with a good positive biased towards the intermediate term.
I will take a look at what the dividend wants to be. Right now we have a dividend that's one of the best in the weak sector, very well covered both from an FFO and a CAD standpoint.
So, certainly the expectation would be that as the portfolio grows off of it's trough low to mid 80s occupancy level. We generate more NOI that will hopefully generate more taxable income and that will create some upward bias on the dividend.
Rich Anderson - BMO Capital Market
Okay and can you just reiterate for me sorry the free cash flow 2010 versus 2011 that you are presuming.
Gerry Sweeney
We are actually presuming about the same levels as year-over-year.
Rich Anderson - BMO Capital Market
So is it $50 million or so?
Gerry Sweeney
It was 30 to 40.
Rich Anderson - BMO Capital Market
30 to 40, okay. Thank you.
Operator
Your next question comes from the line of Rene Bayarna with Wells Fargo Securities.
Rene Bayarna - Wells Fargo Securities
Thanks. Good morning.
So I just wanted a clarification on the occupancy numbers, the last two 100 basis point increase kind of average. Is that a year-over-year expectation or is that from the current level of roughly 85%.
Howard Sipzner
We are expecting the end year by 85% and our expectations will end 2011 there or slightly up with potential dip down or toward 83% in the second quarter.
Rene Bayarna - Wells Fargo Securities
Okay 83% in Q2 and then you go back up and then the retention expectations of 55% you guys have a good feel for the tenants that you have talked to thus far of the 45% and the expectations that are not expected to renew. What's the level of discuss that you have held with those tenants to suggest that you not including them as likely to renew.
Is that something that you are confident in? You have had significant discussions or is that just something you don't have an indication from that?
Gerry Sweeney
Paul we have had discussions with just about every tenant but those that could not give us a good sign in a positive direction, we – not just a conservative approach and rode them out of the plan. I think -- as we look at -- I mean just probably a 10 percentage point upside to the 55% if we can kind of convert everybody in that unknown category but we do have several tenants or more than several that had definitely told us they're moving out and that's the lions share of the 45% not renewing.
Rene Bayarna - Wells Fargo Securities
But the 55%, you are highly confident in it and if things work out well you could possibly move that up too.
Gerry Sweeney
Yes.
Rene Bayarna - Wells Fargo Securities
Okay. And then just lastly sales, I think you have $14 million slated for discontinued auction property but I think Howard if I heard you correctly, the expectations for Q4 are $34 million of dispositions.
What's the additional 20 and how confident are you of getting that done?
Howard Sipzner
We have some other properties in advanced discussions, did not meet the criteria of held for sale and can be conservative. From a revenue perspective we assume those sales would close.
Other than that 20 we don't have any near term sales. So the balance of our sales activity is more mid 2011 to the latter part of the year in terms of timing.
So we'll have to just watch and see if that 20 happens but we have assumed for the time being that will happen.
Rene Bayarna - Wells Fargo Securities
Okay, great, thank you.
Operator
Your next question comes from the line of John Stewart - Green Street Advisors.
John Stewart - Green Street Advisors
Thank you. Howard, just following up on the disposition activity for next year, what is the projected cap rate?
Howard Sipzner
In the modeling we have assumed up to a 10% cap rate. It's kind of got a 40% calendar year waiting on the $80 million.
So that mathematically is about 3.2 million of gross NOI and we just wanted to thank you for getting up early this morning and joining us on the call.
John Stewart - Green Street Advisors
That's right. Thank you.
And how about likewise -- sticking with the guidance, how about same store NOI and the mark-to-market on a cash basis for next year?
Howard Sipzner
Same store NOI, between cash and GAAP they're not going to be terribly different based on forward modeling. So the 5% to 7% range covers them and probably a 5% to 10% range covers GAAP typically being better as well as cash rental rates, unfortunately still down.
John Stewart - Green Street Advisors
Okay. And George, can you give us any color on the known moveouts in DC?
George Johnstone
Yeah. We've got several books.
Two -- they're going to happen in January. One is Computer Associates who currently occupies 230,000 square feet with us.
They are going to renew but only in 67,000 square feet. And in the other one -- the one in January is with Verizon currently in 180,000 square feet and they're going to give us back half of the square footage and extend the other half for 10 years.
So -- some of the other ones that we have are just -- again some more of larger tenants who are moving back to corporate owned facilities or kind of just rightsizing their space based on utilization.
John Stewart - Green Street Advisors
Okay, thank you.
Operator
The next question comes from the line of Anthony Paolone with JPMorgan.
Anthony Paolone - JPMorgan
All right. Thanks.
Gerry you mentioned at occupancies at these levels -- there is not a lot of pricing power and you still have rent roll downs in the portfolios. I'm just wondering can you give us a sense as to what the recovery in your markets need to look like so that if we roll forward a couple of years we're still not looking at same store comps being negative?
Gerry Sweeney
A great question Tony, I think it's hard for us to really project with certainty what we see happening over the next of years in terms of total velocity. We have done that, if you take a look at all of our core markets.
Interesting thing it really is a bifurcation of market. So for example we refer to the crescent marks and still not be suburbs or Radnor Plymouth Meeting [contrahawk] and those sub-markets for the class to inventory is rates are well below 10%, we are seeing very good activity and the ability to frankly move up.
Our problems in CBD has filled up in the same category and there is few other spot markets around the company where we are actually having some fairly good leasing velocity generally in the sub-markets along with some positive absorption all be at levels well below long term averages. Other markets particularly as we look at our portfolio, Southern and Central New Jersey and Willington, so I guess about 13 or 14% on rents.
The day you can see the rates there are at a such a level they are in the 16 to 19% range that's up about 3 to 400% basis points from where they were year end 2007 and those markets for the most part are still having negative observation 2010 where they have historically been positive. So, I think those markets will be slower to recover, I think the channels we have in our portfolio is really to identify those areas where we can execute leasing activity on an accelerated basis and then be as aggressive as we need to be at some of those markets.
We think it's going to be a slower slide but certainly I think we are encouraged with what we are seeing in some of our core markets. Very mindful of how slow we will be and the recovery and in Southern New Jersey or Central Jersey or Sub-urban Willington, Southern 202 but also when we take a look at a our 2011 vacancy profile while it's a big disappointing to have the level of contractions that we are going to see in our Metro DC the Toll Road Carter, that is also a market where we are getting back very good space.
Either it would be a good Toll Road Signage or extra-ordinarily good physical plant and quality. With a good leasing team in place and that is a market that can absorb space fairly quickly.
In fact that market will lined up having positive absorption this year, at least year-to-date is positive but that level will be down well off of the 3.2 million square feet of absorption of that market that's all in 2007. So, I think we feel very good about both a mark-to-market uptick and a recovery at a faster pace in our Northern Virginia portfolio.
I think we will continue to see good traction through our crescent marks in the Pennsylvania suburbs and Philadelphia CBD. And I think we're prepared for and have reflected in our business plan a slower recovery in the other sub-(inaudible) property.
Anthony Paolone - JPMorgan
Okay. Thank you.
Operator
(Operator Instructions). Your next question comes from the line of Dave Rogers with RBC Capital.
Dave Rogers - RBC Capital
Hey morning, with respect to the tenants looking for space in the Philadelphia CBD, a number you might be looking bill the suites or have the option to have a building build for them so you can talk about replacement cost in that market relative to your acquisition and if you did that earlier I apologize there is some audio difficulties. And then on the flipside, if you look at metro DC where obviously the capital flows have been strong.
Assets are for sale maybe above historical replacement cost. Does anything in that metro DC market on the flipside to Philadelphia suggest that maybe you should be a seller today if that's what they're trading maybe above where they should be.
Any color would be appreciated, thanks.
Howard Sipzner
Correct. Very good questions.
On the first part, as we talked about -- we announced the Three Logan transaction certainly reinforced by our working in this market on different build-to-suit proposals. We anticipate that replacement cost for a high quality building in Philadelphia is about $400 a square foot.
Our purchase price here on Three Logan was $125 a square foot. We anticipate it will be around in or fully around $170 a foot for land.
So when we talk about a fully loaded land value, we're probably in about 50% or slightly below from a replacement cost standpoint. And frankly while a number of tenants look at build-to-suits in this market, we frankly think the gap up in rents required today is probably in the final analysis a prohibitive jump for a number of companies looking at that.
So while they may want emotionally to be in a brand new building that's built for them I think pragmatically when they assess their various options they migrate back towards the existing stock. The second question relative to metro DC, it's certainly a topic that we have a given a lot of thought too and have had a number of discussions on.
Clearly if we are being priced out of that market from a buying standpoint and certainly an ageing recovery of values in those markets, it certainly is something that -- selling some of our products, certainly some of it we're evaluating and I think our preferred method to do that would be to form a joint venture with some of these institutions who are looking for a very solid operator and those institutions may in fact have the ability to co-invest with on future acquisition activity. But that is certainly that's on Tom and his team's agenda they're spending time working through.
Dave Rogers - RBC Capital
In those discussions, either Tom or Gerry, how far along are you at this point? Is that contemplated in your '11 guidance or could that be added to it in terms of asset sales?
Gerry Sweeney
We've got various stages of discussions taking place and they accelerate, they decelerate on one day and on hold the next day but to go to the core of your question on 2011 guidance, we've not reflected in our 2011 guidance anything relative to new acquisition activity, the formation of joint ventures on existing portfolio, proprieties, related equity issuances there too. It's a very benign investment program that we build into our 2011 forecast.
The only thing we really have built into our forecast for '11, as Howard and Tom had touched on the -- some sales in the $80 million range and kind of stays in the later part of the year.
Dave Rogers - RBC Capital
Okay, thank you.
Operator
At this time, there are no further questions. Gentlemen, do you have any closing remarks?
Gerry Sweeney
Only closing remark is thank you all very much for your participation in the call today and we look forward to updating you on our forthcoming activities on our next call in the first quarter. Thank you very much.
Operator
Thank you. This concludes today's conference call.
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