Jul 28, 2011
Executives
Gerard Sweeney – President and CEO George Johnstone – SVP, Operations and Asset Management Howard Sipzner – EVP and CFO
Analysts
Jordan Sadler – KeyBanc Capital Jamie Feldman – Bank of America Brendan Maiorana – Wells Fargo David Rodgers – RBC Capital Markets John Guinee – Stifel Josh Attie – Citi Richard Anderson – BMO Capital Markets John Stewart – Green Street Advisors
Operator
Good morning. My name is Angie and I will be your conference operator today.
At this time, I would like to welcome everyone to the Brandywine Realty Trust’s Second 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) I would now like to turn the conference over to Mr.
Gerry Sweeney, President and CEO of Brandywine Realty Trust. Please go ahead, sir.
Gerard Sweeney
Well, Angie, thank you very much. Good morning, and thank you for participating in our second quarter 2011 earnings call.
On today’s call with me are Gabe Mainardi, our Vice President and Chief Accounting Officer; George Johnstone, Senior Vice President of Operations; Howard Sipzner, our Executive Vice President and Chief Financial Officer and Tom Wirth, our Executive Vice President Portfolio Management and Investments. 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 that 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 releases as well as our most recent annual and quarterly reports filed with the SEC.
Moving in to the presentation, our actual results are progressing well ahead of our 2011 business plan and we are very pleased to report solid progress during the second quarter. Market conditions range from stable to improving and we continue to see strong tenant activity levels.
Certainly the return of strong real estate fundamentals generally is subject to macroeconomics events such as the federal deficit to divide on public policy which appears to be ongoing, steady municipal budgetary constraints and private sector employment growth. Essentially, however, we continue to see a steady recovery.
This recovery top with our tactic of aggressively pursuing occupancy has created a solid platform for Brandywine to exceed our original 2011 business forecast. We will continue this market driving leasing strategy and this approach will vary by submarket.
In some we have been pushing rents and in others we will continue to buy occupancy. In those weaker submarkets we will continue this aggressive approach until those markets returned to start activity levels.
We also continue to see a slight up the quality curve that has greatly benefited our portfolio. Some observations on our second quarter leasing, balance sheet, management and investment efforts tacking leasing first.
On the leasing front we posted another very strong quarter. There is no single bigger contribution to our growth profile than simply leasing up our existing space.
As evidence by our second quarter results we are making strong progress and leasing production remains our primary focus. We had our third consecutive quarter of leasing activity in access of 1 million square feet, additionally our 65% tenant retention rate for the quarter significant had plan and as a result we are projecting a 2011 retention rate of 60% versus 55% in our original plan.
The strength of this leasing production has resulted in the following positive adjustments to our key metrics. We are increasing our projected 2011 core occupancy percentage at year end to be 86.6%, a 90 basis improvement over our projection last quarter, and 100-basis point improvement over our year end 2011 levels.
We have moved our speculative revenue target of 6.2% to $34.4 million and we are 94% executed on that planned component. Our same-store has improved from our original forecast and from last quarter.
We are now projecting a same-store GAAP NOI decline of 3% to 4% versus our originally forecasted 4% to 6%, and a cash-based decline of 4.4% to 5.5% versus 5% to 7% previously forecasted. Capital costs are up quarter-over-quarter, George will outline the detail in a few minutes, but note that we have accelerated leasing activity and while doing so, have increased the average length of our lease by about 20%.
We’re up to 5.4 years on average versus our 2011 business plan. More importantly, we’re up 35% from the 4.0 year average lease term that we experienced in 2010.
For leases commencing in Q2, the average lease term was 6.5 years. Additionally, as George will outline the size of our four leasing commencements as an early paying of commissions on leases that will not commence for a number of quarters.
We continue to make progress on managing rental rate declines, even as we are aggressively pursuing tenants, our GAAP rental rate decline has remained at 1.5% to 3%, which is in line with last quarter, but a significant improvement over earlier projections. On a cash basis we continue to anticipate a range of between 6 to 8% which has tightened a bit from last quarter and the upper limit is down from the 10% we originally forecast.
Increasing market share remains a major objective and on that front the plan also continues to progress well. By way of example, in Southern New Jersey we experienced a 51% increase in activity Q2 over Q1 but more importantly our leasing teams did 36% of all the deals in the market place compared to 19% ownership stake.
In the Pennsylvania suburbs we had similar results where we captured 58% of the market share for leasing activity versus a 14% ownership stake. So the overwriting goal remain to seal deals, be aggressive where we need to be and execute as many transactions as we can.
We are currently 88.7% leased which is significantly ahead of our target. We are maintaining about 200 basis points spread in our leased versus occupied percentage.
Our 2011 business plan anticipates that we will hold this 88 this 89% leasing level through year end. So all in all nicely improving picture on the leasing front and we are seeing solid rental rate growth in several of our markets.
We also made good progress on expense control and improved our operating margins to the best levels in the last six quarters. As a result of our leasing success and expense management programs, we have increased FFO guidance range for the year from to $32 to $36 share.
This is an improvement over our previous range of $27 to $32 per share. Given a high level of plan execution, we believe this range is readily achievable.
Looking at our balance sheet and investment grade rating coupled with continued leverage reduction and maturity management programs remained key objectives. As you know we recently completed $325 million bond transaction.
During the quarter we used those net proceeds primarily to reduce our 331 line of credit balance from $197 million to $42 million and pay up a $115 million in various secured mortgages on several of our properties. These tales were part of our long standing plan to reduce property level debt, to provide us more investment flexibility and to increase the strength and financial metrics of earning number four.
We also used access liquidity during the quarter to repurchase $21.5 million of our 2012 notes and 1.4 million of our 2015 note via opened market transactions. We continue to monitor the debt markets with an eye towards reassessing them as the need arises, our primary attention however is on investment program which has the potentially generated additional liquidity and reduce our need to reassess the debt market near term.
We are also engaged with the bank market as we assess the process and timing of redoing our line of credit and our $183 million term loan, both of which matured in mid-2012. That market has continued to improve, particularly relatively to spreads, cap rates and related covenants.
Looking at investments, we had a quite quarter, but a lot of work is in process. Our 2011 business plan contemplates $80 million of dispositions, weighted towards the second half of the year.
As such year-to-date, we’ve only sold one property Three Greentree Center; a 13% occupied 70,00 square foot building Malta, New Jersey for growth proceeds of slight less than $6 million and realize the $3.8 million gain on the sale. Looking at a balance of 2011, we would expect the following.
We are in the market with a variety of properties undertaking price discovery to meet and possibly our $80 million disposition target. The properties on the market range from single assets to small portfolios, there are assets that we have deemed to be non-core from either a location future NOI growth or capital consumption standpoint.
We’d expect to provide more visibility on these efforts on our third quarter call. The properties currently being targeted for sale our primarily in New Jersey, Pennsylvania and Virginia.
We have also made good progress in our joint venture effort on several properties in Northern Virginia that offering memorandum was circulated during the second quarter. We want to receive solid indications at interest and are in discussion with several institutional partners.
We expect to advance those discussions over the next 60 days as previously outlined this venture will consist of us contributing several assets receiving a forward equity commitment from our venture partner that will enable us to form at a street co-investment vehicle targeting assets insight the down way. The total (inaudible) the initial property contribution could be between 150 to $175 million with a detention forward equity commitment between 75 million and 100 million.
We expect to report an attractive cap rate in price per square foot and the Brandywine ownership stake between 25 and 50%. Overall we are pleased with the response and look forward to providing more clarity on our next call.
This venture, if it proceeds, we’d expect to close by year end and it is not factored into our 2011 business plan as we anticipate the effect on 2000 earnings to be minimal. As we all well know, the investment market remains bifurcated, we are beginning to see some select opportunities in some markets outside of D.C.
that based on yield, value added characteristics and price per square foot may present interesting opportunities for Brandywine. While we do not have any additional acquisitions built into our 2011 plan, we do continue to seek and underwrite quality value-added additions to our portfolio.
Those investments, if they occur, we’ll be financed primarily through either redeployment of sales proceeds or an equity basis to further improve our balance sheet metrics. At this point, I’ll turn the presentation over to George, who will provide color on our second quarter operational performance.
George will then turn it over to Howard for a financial review of the second quarter. George?
George Johnstone
Thank you, Gerry. Leasing activity for the quarter was strong with positive net absorption of 138,000 square feet and continued progress on the business plan.
During the quarter, we commenced 1.1 million square feet of leases, including 614,000 square feet of new leases and tenant expansions. We had 120,000 square feet of contractions by tenants who did renew a portion of their space, 58,000 square feet of which related to computer associates in our Northern Virginia portfolio as discussed on previous calls.
An additional 230,000 square feet of tenant fee simply vacated at the end of their lease term due to office closures and company downsizings, relocations to other submarkets and a few who purchased their own buildings. In terms of early terminations for the quarter, 80,000 square feet were negotiated to accommodate existing tenant expansion, the remaining 45,000 square feet were the result of bankruptcies and affections.
Traffic for the quarter was up 9.4% over last year with all but Metro D.C. in California posting increased levels of inspections.
Despite inspections being down over last quarter, the pipeline remains strong at 3.7 million square feet, 3.2 million of new deals and 528,000 square feet or renewal deals. We currently have 521,000 square feet of deals in leased negotiations with the balance all entertaining proposals.
In order to achieve the open leasing assumptions and our plan for new leases we need to convert 12% of today’s active pipeline. Our conversion rate during the first half of 2011 was 39%.
So we are very confident of achieving our realized forecast. Several of our core markets continue to perform well and we’re seeing the ability to push rents and leased term.
To illustrate is 100% leased in gap rents on leases commencing in 2011 are up 8.4%. Radnor is now 97% leased with gap rent growth of 6.3%.
Philadelphia CBD is now 94.9% leased with gap rent growth of 4.9%. For the balance of 2011 we expect that Pennsylvania suburbs, Philadelphia CBD, Richmond and Austin will continue to perform well.
We face challenges in both our New Jersey operations and Dallas Toll Road Carter, until the market recovery is complete, but we are pleased with the levels of activity in both of these markets. Our regional teams remain focused on operating expense control, whilst no removal accounts for our majority of the decline in operating expenses from first quarter, our energy procurement and conservation efforts, along with aggressively rebidding service contracts has contributed to improving our operating margin.
Last a comment on capital expenditures. We report capital cost for CAD in the quarter on which they are paid, which is not necessarily the quarter in which the lease commences.
As we continue to achieve higher levels of forward leasing, you can expect this mix matching of capital and lease commencements to continue. This quarter we had $22.5 million of revenue maintaining capital, which was clearly one of our highest to-date.
To illustrate, the $22.5 million we reported this quarter, included $8.6 million of capital on leases that commenced prior to the second quarter, $8.5 million of capital on leases that commenced in the second quarter and 5.4 million of capital associated with leases that will commence in subsequent quarters. This completes the operational overview and I’ll now turn it over to Howard for financial review.
Howard Sipzner
George and Gerry, thank you. For the second quarter of 2011, we reported FFO available to common shares and units of $47.5 million, at $0.32 per diluted share we exceeded analyst consensus by $0.01 per share.
It is once again a high quality FFO figure in that second quarter termination revenue, other income; management fees, interest income, and JV income totaled just $6.8 million gross or $5.3 million after management expenses, in line with our 2011 guidance range for these other items. The FFO payout ratio in the second quarter of 2011 came in at 46.9% on the $0.15 dividend we paid in April 2011.
A few other observations on the components of our second quarter performance. Cash rent of $114.3 million was up $5.4 million versus second quarter of 2010.
Straight line rent of 4.7 million was up 2.2 million versus second quarter 2010 and is flat sequentially versus the first quarter of 2011. The quarter-over-quarter increases are primarily attributable to the Post Office and Garage completions and the Three Logan acquisition in the third quarter of 2010 as well as the Overlook acquisition in the first quarter of 2011.
Recovery income of 19 million and our recovery ratio of 34.4% reflected typical expense and expense recovery conditions and are inline our expectations. Property operating expenses were down $5.4 sequentially due to snow cost in Q1 2011 as George mentioned while real estate taxes were flat sequentially.
Interest expense of 34.7 million increased 2.3 million sequentially due to the closing of our $325 million on secured issuance on April 5th and lower floating rate balances in the current quarter, G&A 5.9 million was in line with our expectations for this item. In the second quarter of 2011, we had net bad debt expense of $322,000 in line with expectations and reflecting a combination of right-offs recoveries and adjustments to reserves.
The net effect in the second quarter was $135,000 decrease in our overall reserve balance. For the quarter same-store NOI decline 4.7% on a GAAP basis and 6.9% on a cash basis both excluding termination fees and other income items and in line with expectations.
EBITDA coverage ratios are solid and consistent at 2.4 times interest, 2.2 times debt service and 2.1 times fixed charge coverages. And the emphasis on these is an important part of our ratings upgrade strategy.
Our margins are very strong and are above recent levels despite the vacancy levels at 61.1% for NOI to 34.4% for recoveries and 62% on our EBITDA margin. As a result, and as Gerry outlined, we are increasing our previously issued 2011 guidance of $1.27 to $1.34 per share by $3.05 at the midpoint to now be in a range of $1.32 to $1.36.
With our $0.65 per share six-month result, this translates to a quarterly rate of $0.30 to $0.32 for the balance of the year once you exclude the $0.08 of gross historic tax credit transaction impact we’ll recognized in the third quarter. Portfolio metrics and assumptions as George and Gerry both noted, are equivalent or better than we’ve previously guided to on combination of cash and GAAP rental rents, yearend occupancy, retention and overall leasing.
And these are factor in our guidance upgrade. We are continuing to project 20 million to 25 million of gross other income items, or about $13 million to $18 million net, resulting in again a very high quality FFO for 2011.
These figures at the midpoint are about $0.05 per share or $6.8 million below the figures we reported for these items in 2010. We are continuing to expect G&A at about $6 million per quarter.
Interest expenses for the year should come in between 133 and $136 million down from the prior figure of 136 to 140million, due to accelerate loan repayments during and just after Q2 2011. Please not that we will accelerate an expense about $800,000 of deferred costs in the third quarter due to the One Logan square mortgage loan repayment and this is of course included in our guidance.
We see about 75 million of additional 2011 sales activity at up to a 10% cap rate but it will be weighted heavily towards year end for an expected gross NOI reduction of only about $1.8 million in the balance of this year. As I mentioned earlier the historic tax credit impact should appear to be about $0.08 per share on a gross basis in the third quarter of 2011.
For the full year this is offset by about $0.01 of interest expense that’s been running through our interest expense line item and has been facing entirely for the past six month and will continue to do so. The revenue component is essentially non cash and will be excluded for our head calculation.
It reflects the – for the annual impact of 20% of the proceeds realized in connection with the historic tax credit financing and this will be recognized in the third quarter of each of the next five years, 2011 through 2015. We are not assuming any additional issuance under our continuous equity program and no additional unsecured note buyback activity.
And we are running our modeling at 147 million shares for FFO in 2011 versus 139 million in 2010. The overall impact of higher capital expenditures both on a current and forward basis is reducing our estimate for CAD for diluted share to be between $0.58 and $0.64 for the year, reflecting approximately 20 million of revenue maintaining capital expenditures per quarter for the balance of the year.
Our 2011 capital plan for the balance of the year is actually quite simple and easy to achieve. We have total capital needs of $279 million over the last six months of 2011, including the 60 million we used earlier this month for the Logan Square payoff.
This comprises 71 million of investment activity, about to 44 million of revenue maintaining CapEx, 21 million for other capital expenditures and $6 million of potential investment in our commerce JV. We see 160 million of debt repayments, 60 million we already disbursed for one Logan, 60 million for an expected early redemption of our remaining exchangeable notes and 40 million for assorted mortgage repayments and amortization and we expect to pay at current levels 48 million of aggregate dividends on our common and preferred shares.
To raise this 279 million, we are projecting the following. 85 to 90 million of cash flow before financings and investments, 2 million of remaining HDC proceeds bringing the ultimate funding to $64 million, the 75 million of additional sales and a 113 million of borrowing under our unsecured credit facility, with a projected year-end balance of about $155 million.
On accounts receivables, our total reserves at June 30th, 2011 were 15.1 million, 3.5 million on 17.7 million of operating or other receivables or about a 20% coverage ratio and 11.6 million on 114.8 million of straight line rent receivables about a 10% ratio. Neither of these categories experienced any particular change in this quarter.
Our balance sheet in credit metrics remain extremely strong, we have 57.7% debt-to-total market cap and a 44.9% debt to gross real estate cost most importantly the various financings or repayments we undertook in the second and now third quarter continue to improve our balance sheet from an unsecured basis. Our secured debt is only 10.7% of total growth assets and our floating rate debt is just 14.7% of our debt.
Our leverage levels are in line with recent quarters and our mix of secured, unsecured and floating fixed remains, reflects our commitment to overall credit quality in an improve rating. Our $600 million was $42 million drawn on June 30th, 2011, following the July 11th prepayment of the One Logan loan and other storage activity, our credit facility balance outstands at $113 million with closed to $500 million of availability.
We are 100% compliant in all of our credit facilities and in venture covenants and are extremely pleased with the second quarter performance. Now back to Gerry for some additional comments.
Gerard Sweeney
Great. Thank you very much, Howard and thank you George.
The second quarter was a very good one for us. We exceeded our leasing targets posted over 1 million square feet of leasing activity for the third quarter in a row.
Lengthened our lease terms, reduced the negative spreads in our mark-to-market and same-store forecast and produce good expense management. Moving our year-end targeted occupancy level of 90 basis points reflects our high level of production that stat combined with our continued strong pipeline as George outlined, clearly indicates that we are well on the path to continued occupancy improvement.
With that, we’ll open the floor for questions. We would ask that in the interest of time, you limit yourself to one question and a follow-up.
Operator
(Operator Instructions). Your first question comes from the line of Jordan Sadler with KeyBanc Capital.
Jordan Sadler – KeyBanc Capital
Thanks, and good morning. I wanted to get a little bit of clarification on the leasing guidance update.
The incremental $2 million spec revenue, which is up from last quarter’s guidance. That is now 94% complete, so I’m just curious based on sort of your historical hit ratio or close ratio of 39% in the pipeline, which is materially better than you are projecting for the back half, are you still being pretty conservative here on the spec revenue.
And if you were to hit the 39% close ratio on that pipeline that you’ve got in a negotiation, what would the spec revenue number be then?
Gerard Sweeney
George, why don’t you take that?
George Johnstone
Yeah. Sure.
I don’t think that we are conservative at this point. I mean a couple of observations.
One, the window of contribution towards 2011 is closing. So, one, we will have to get that pipeline converted, negotiate the lease, build out the space, so we’re really kind of looking at for the most part our fourth quarter and potentially a late fourth quarter commencement to drive that spec target up even further.
The $2 million that we increased this most recent reforecast most of that revenue will be recognized over the second half of the year.
Jordan Sadler – KeyBanc Capital
Okay. That’s helpful and then just as a follow up, you disclosed 731,000 feet of executed leases that are schedule to commence, could you give us a little bit of color on the timing and maybe the average rent on that pipeline?
George Johnstone
Well I think our most recent press release addressed some of that and that we had 400,000 – I am sorry 97,000 square feet of new deals commencing after 2011, not included in that press release but in our subsequent press release was the 146,000 square feet with Jannie but the lease is in the 731 of forward leasing at the end of this quarter. We’ve got 197,000 square feet commencing in the third quarter, 284,000 square feet of new deals commencing in the fourth quarter.
Jordan Sadler – KeyBanc Capital
(Inaudible).
George Johnstone
Yeah I don’t have the average rental rates but I think as we kind of outline in some of sub markets even with the trends we saw in the second quarter, we are seeing that on our new leases we are starting to a positive mark to market on the gap rent.
Jordan Sadler – KeyBanc Capital
My last one is just on the Jannie deal closing, where are we relative to original underwriting on (inaudible) and maybe can you just talk about the prospects?
George Johnstone
We are in very good share relative to your underwriting, we have right now after the Janney lease execution, roughly 200,000 square feet of current vacancy. We have about 1 billion plus square feet of active prospects for that.
About 800,000 of that million is large use where the balance stands small users in a range in size from five to 25,000 square feet. We still are in very good shape from that standpoint.
We also as you know there is a component of that doing, has leases in that and leases have expire, mid-year 2012 and that’s about another 250,000 square feet or so. So live at leasing pipeline is also directed towards that forward roll.
The leases that we’ve executed and the leases that we are in discussions with all have economics or very much in line with our original pro forma.
Jordan Sadler – KeyBanc Capital
Okay. I’ll hop back in the queue.
Thank you.
Operator
Your next question comes from the line of Jamie Feldman with Bank of America.
Jamie Feldman – Bank of America
Thank you and good morning. I was hoping you can talk off – it sounds like you are pretty comfortable with the way, the back half of 2011 is going to shapeup, can you talk a little bit about your explorations in 2012?
And where you think there is risk and then along those lines, if you could talk about, different regions, kind of what’s the different sentiment given everything we’re seeing on the economic side?
George Johnstone
Sure. We’ve not provided 2012 guidance and we don’t expect to do so till later this year.
We are at the early stages of our 2012 budget and reforecasting process. So we are in the middle of trying to answer Ken, the renewal probabilities of tenants were up for 2012 renewals.
So that process is still underway we can certainly provide better cloud in that in the year. In terms of overall sentiment, I think we are seeing that sentiment reflected in some of the numbers that you would should outlined earlier.
Generally, the sentiment, the power and that we absent the dialogue on the federal debts of the last couple of weeks has been generally progressing and be more positive. But the pipeline of deals has remained very encouraging I mean we are at 3.7 million square feet.
Our expectations to tenants, the square feet that comprise that pipeline is real. Tenants looking for requirements, not just price checking for stay puts as it was some time ago.
So that both velocity and the intent have allow that tenant activity is by us towards moving up the quality curve and seeking to go longer in terms of the length of leases. So a fairly good prescription we think for the next couple of quarters and leading our upward leasing trajectory and continue to improve our occupancies.
We have a number of tenants who are clearly up in 2012, again the focus right now is to – for us to really answer Ken what their probably of renewal is, some we know we are going to standing, some we know we are going to leave, the vast majority are still in the middle not having provided us with any real clear clarity. And as a consequence really can’t provide a lot of detail on that.
Jamie Feldman – Bank of America
Thanks. I guess if I guess another way, like we think about Northern Virginia versus Philadelphia verses Texas, which you feel like are most concerned about what’s happening in the government, which are more concerned and which have the best job growth prospects?
It sounds like everyone is trading up, but I’m trying to get a sense of which have real kind of long-term demand growth prospects here.
George Johnstone
I think the sentiment that we are seeing does vary by those regions. Look, Philadelphia suburbs, particularly are crash at markets as we call them continue to perform very well.
Sentiment is very positive that’s reflected in the higher levels of absorption as well as the upward pressure on rents. Philadelphia CBD in the trophy class inventory we are in, we believe continues to have a very positive bias.
We’ve been very pleased with the level of activity in generally in the Austin, Texas market and the ability of our team to maintain very high levels of occupancy and upward rental pressure. Richmond has performed well and in line with our plan this year.
Things have slowed there a bit, but we continue to be very much on track for 2011 business plan, circling in on the metro D.C. activity levels are down quarter-over-quarter.
There is clearly a pause in that marketplace by both, federal agencies, but more importantly, private sector employers who rely on the government in terms of coming to large blocks of space, and we would expect that that situation would stay in place until there’s a lot more clarity on the federal spending programs. We were very pleased to announce the other day a major lease that moves on a very seamless base with a vacancy coming up in 2012, so our team continue to do a very good job down there.
The pipeline, well not as robust as maybe some of other markets certainly have some large users in that queue, that are for successful in negotiating transaction with them could change the profile trendy – trajectory of our occupancy ramp up in that market considerably.
Jamie Feldman – Bank of America
Okay and then when you talk to your tenants in D.C. area do you, are they concerned that leases won’t get signed or they are just concerned that it’s going to be on hold for a while, are they, there is a real concern about downsizing actually making the demand go away?
George Johnstone
Look it either depends of what the hell line of the paper is that Dave but I think the reality is there is the primary sentiment we haven’t reported back to us is that it’s on hold. The demand will remain there.
The demand maybe more muted than original expectations based upon how this federal spending program works its way through the system but that is a market that’s historically generated fairly decent job growth in broad base. So long term we believe the prospects that market are solid, but it would be unrealistic for us to be overly aggressive and assuming accelerated absorption there, until there is a lot clearer picture on the federal spending programs.
Jamie Feldman – Bank of America
Okay. Thank you.
Operator
Your next question comes from the line Brendan Maiorana with Wells Fargo.
Brendan Maiorana – Wells Fargo
Thanks. Good morning.
Question on the leasing strategy is the I guess other – kind of buying occupancy what you guys are doing and moving the occupancy up pretty nicely that the CapEx costs are relatively high, is that driven more by your portfolio level occupancy or is that something where if your market start to firm up a little bit, you will back off kind of being aggressive in terms of getting those tenants in and if it is more portfolio driven specific to Brandywine, what kind of level do you think you need to get to you before you maybe a little bit less aggressively on that concession levels?
Gerard Sweeney
Very good question, I think the overall strategy has always been driven by your later point of emphasis which is very much focused on how we are leading the markets. And the best examples we are having on our portfolio is what we’ve seen frankly with our submarket concentrations and New Town Square, Radnor, Contrahawk and (inaudible) to some degree where those markets were 18 months ago kind of were New Jersey and Delaware and a couple of other submarkets are today where we were very aggressive in attracting absorption to the portfolio, paid for, but the market tightened up significantly, so now we are in a position of dramatically exceeding our occupancy centers in those markets.
And New Jersey and Delaware may be slower to recover, but I think as we’ll read in the team lease there the overall objective tactically is to gather significant amount of market share in a market where we own about 20% of the inventory. So the market to our leasing team is to generate tremendous activity both directly and through the brokers community, fully that every prospect, analyze each deals economics both from an absolute and from a relative standpoint and then to the extent we think it’s a fair transaction move forward and absorb that occupancy, cover our some cost, minimize our capital cost to the extent we can lengthen our lease terms and we’re fully confident that in every market we are in that as the suburban market recovers to where it was in numbers of usual we will return to a 70 to 80% average annual retention.
So certain we have a high degree of expectation some of those tenants were bring in to the portfolio today will be able to retain when their leases come up for renewal.
Brendan Maiorana – Wells Fargo
Thank. That’s helpful.
And then just in terms of the next investment activity are the dispositions are is it new investment. If you sell 80 million of non-core assets and then it sounds like proceeds from the JV could be I guess around the 120 million or so and you’re selling 75% of that.
Where do you think you reinvest that at this just day pay down of debt or there are investment opportunities that are available?
Gerard Sweeney
They will be a combination of both Brandon I mean and it’s going to be determined based upon the velocity of those dollars we get in the door. As Tom can touch on we continue to look in a variety of good quality acquisitions.
And we certainly want to continue that effort but we also very much have the priority focus on continue to improve the balance sheet as well. So I think the – with those possible uses of proceeds will make game time decision based upon the timing and the size of the proceeds we actually realize.
One of the interested things of that our investment efforts as we touched on, we are very much doing a lot of price discovery across the board to try and find what we adopt to the investment market is right now in some of our submarkets.
Brendan Maiorana – Wells Fargo
And just a follow-up quickly. Is – has there been any movement on the land parcel that you guys have 20th in market downtown, because you did mention that you are seeing pretty good activity in the CBD market in Philly and any potential that you guys could do something there?
Gerard Sweeney
Certainly, a lot of potential on what we can do there. We are undergoing right now the planning process for mixed use development, talking to a variety of other development companies and financing sources to pull together and overall development program that we would anticipate starting the formal approval process on that site sometime in early 2012.
Brendan Maiorana – Wells Fargo
Okay. Great.
Thank you.
Operator
Your next question comes from the line of David Rodgers with RBC Capital Markets.
David Rodgers – RBC Capital Markets
Good morning, Gerry, Howard. A question on your decision to raise the guidance perhaps relative to taking down leverage a little bit more during the second half of the year.
Can you just give us some thoughts around maybe I guess the hint points to your decision making around that and I guess if timing is the big answer for the second half of this year, maybe what we can think about is key points for moving into next year from a deleveraging versus earnings performance perspective?
Howard Sipzner
Well, Dave, good morning. It’s Howard.
The guidance increase really flows almost directly from a combination of our performance on the plan, some slightly higher retention, a little bit more lease activity coupled with the net result of all the balance sheet transaction and aggressively paying down debt where we could. But having said that, I will point out that that pay-down of debt is not a leverage reduction, so it’s just a substitution of one type of debt for another.
So, what we found out as we were able to put the $325 million that we raised early to work ultimately in a better way then we might have initially expected. We paid off a number of mortgages brought down some forward maturities and in general just put the balance sheet in better shape.
On a go forward basis to the extent some of the disposition activity and the JV activity that Tom is involved in produces called a surplus of proceeds to address the earlier question, we would then have the opportunity to look at those dollars and say do we use the proceeds to bring down overall leverage levels that’s the best use to capital or do we have investment opportunities that would ineffective more accretive than eliminating that debt. No way to know that at this point.
But that would be the decision process we go through.
George Johnstone
Yeah its part of a nature if you look at in terms of key driver in our overall leverage firm is absolutely showing more EBITDA and that’s the most powerful driver in terms of improving all of our financial metrics. We overlay that strategy with the point Howard touched on which is really a point in time the valuation of the best use of proceeds.
The overall objective of this company as we talked about is to put ourselves in a position for that investment ratings upgrade. So we understand that’s part that’s going to involve operating performance improvements, effective capital deployment and recycling as well as overall leverage reduction.
David Rodgers – RBC Capital Markets
Thank you.
Operator
Your next question comes from the line of John Guinee from Stifel.
John Guinee – Stifel
Hi guys nice quarter, congratulations. Drill down a little bit Jerry or George, basically you got a 25 million square foot portfolio, you have 3 million square feet that comes with lease expiry every year, at the 60% tenant retention, we get 1.8 million, you can renew, which means you lease about 1.2 million square feet every year knew to breakeven on occupancy and then you take it one step further each occupancy point is about 250,000 square feet for you guys.
So to get from say 86% to 92% occupancy is a gain of about 1.5 million square feet, above the annual 1.2 million square feet of new leasing, is this a one year process or a three year process or a five year process to get up to stabilization?
George Johnstone
John, it’s a great question. We are focused on making that timeframe is compressed as possible.
The (inaudible) portfolio always ran in that 92% to 94%. Clearly it’s been subject to last few years to a much higher level of tenant vacations and downsizings.
As we’ve talked on previous calls, we think the vast bulk of that is behind us. Our pipeline is returning to historically high level for the activity, both from – primarily for new leasing activity.
And that our convergence rate on that pipeline hasn’t proved historically has been as George touched on just shy 40%. It’s a very hard question to answer, I’ll say through the year and our, we are determining not to make a five years.
So given the three options, we got the absence of making a formal forecast, it’s hard to be three years, but the reality is that we are exercising every effort we can in the company to both absorb space and tell that leasing campaign with our investment program to move from the portfolio assets that we believe we’ll not be effective rent contributors from either NOI or capital consumption standpoint.
Howard Sipzner
Hey John, its Howard, I just want to have one point on that. If you look at page 29, of our supplemental package you’ll see that you may have over stated the 3 million square feet per year.
First of all it tends to be lower in some years and may be more importantly we have done a lot of blending and extending the past of years to take down those forward maturities and put away longer term occupancy. So when you go through the math, I’m sure you’ll do, you’ll see we don’t need quite that million to stay even and it will be less number one and number two with an expected higher retention rate it will be that much less even more.
So the number they are going to start working more in our favor just on an overall basis as we move forward.
George Johnstone
And we also handicapped kind of where we have that vacancy. So if you take a look in a big blocks of vacancy in our company now, Three Logan remain a nice piece of upside for us as we execute some of these additional leases.
We have been occupancy impacted in D.C. but as you well know there is some marketplace it has the ability to absorb a larger space and a fairly sure period of time I think we have good inventory to present in the marketplace.
And in New Jersey we are going to rely on the higher end quality of our portfolio versus a competitive set to get that portfolio back towards historic 93 to 95% leasing levels.
John Guinee – Stifel
Perfect. Thank you.
Operator
Your next question comes from the line of Michael Bilerman with Citi.
Josh Attie – Citi
Hi, thanks. It’s Josh Attie with Michael.
In any of your markets, are you seeing positive absorption on a market-wide basis? And can you talk about how rent economics on a market-wide basis were trending?
Howard Sipzner
Yeah. I mean, we’re certainly seeing decent levels of activity.
On an absorption basis, we’re seeing positive absorption that we’ve seen in the CBD Philadelphia and Richmond, in the PA suburbs, in Austin, where we’ve also seen some positive absorption. Now, all those absorption numbers though, Josh, are well below the 10-year historical average.
I mean, Richmond, Q2 there was about 40,000 square feet of absorption versus historic 10-year average about 167,000 square feet. So, the absorption numbers are kind of working their way back, and that’s certainly a real benchmark that we look at in terms of our ability to move rents.
In terms of our ability to absorb space, we are very keen on the activity levels that we see in the various markets and those numbers continue to be fairly good with very few exceptions. Certainly the activity levels in the metro D.C.
market in the second quarter were down, but we also saw nice numbers of activity in the PA suburbs, CBD Philadelphia, Richmond and frankly in several of New Jersey markets as well.
Josh Attie – Citi
And are rent economics starting to improve in those markets that are seeing positive absorption?
Gerard Sweeney
I don’t think there is any question. As George touched on and maybe, George, you can amplify.
We are seeing good rental rate increases on a gap basis and in some cases on a cash basis in some of those key sub markets. I think George outlined several of them but we probably have 10 or 15 other sub marks we were getting positive gap rents.
Now – probably 15 we’re getting positive gap rents. But that’s certainly something that we’re seeing that list of positive gap rent sub markets grow quarter over quarter which is a good sign.
George Johnstone
Right I mean just for the second quarter we saw gap rent growth on new deals in our Pennsylvania suburbs of 7.5% in Metro D.C. 11.8% and on the deals that new deals that we commenced in New Jersey Delaware for the quarter we saw rent growth of 2.4%.
Josh Attie – Citi
Thanks. And just one more question, on external growth can you just talk about what you are seeing in terms of acquisition and development opportunities, so that as some of this cash comes back to you throughout that sales and the D.C.
joint venture we can think about the prospects are for putting that capital to work through investment as oppose to just debt we pay down?
George Johnstone
Sure Tom.
Gerard Sweeney
Talking about the investment activity we have seeing increases in some of our markets Austin, Washington and Philadelphia, and in terms of what we are looking at I mean the pricing in D.C. continues to be tight, so deep full of investors looking at assets inside the Broadway the district and even outside the Broadway in some occasions, and we still see pricing been tight.
We although seeing maybe because of the GSA maybe taking let’s face from the government point of view you may see slower projects on rent growth when people are taking a look at investments in those markets but other than slower rent projection growth, whether some people that we’re projecting spikes that may be tempered a bit and I think the mortgage market relative to some of those investments us about the same as it’s been very strong. When it comes to looking at Austin for example, we think that that market is showing some tick up.
There is been a few transactions occurring in the southwest and then in the northwest, some well-located assets. And we think there is a few more portfolios coming out on the market there.
In terms of we’re looking at we have about 4 million square feet in our pipeline that we’re looking at. About half of it is of market transactions and then as it relates to the joint venture to the extent we have that done and we have a forward equity commitment, will try to deploy that money in our targeted markets primarily inside the both way for Washington.
Josh Attie – Citi
Thank you.
Operator
Your next question comes from the line of Richard Anderson with BMO Capital Markets.
Richard Anderson – BMO Capital Markets
Thanks. Good morning everyone.
Question is on the guidance of FFO going up a bit, but what does that say about if you were to issue guidance on AFFO basis, would that have been flat or down considering the use of CapEx to kind of buy occupancy?
Howard Sipzner
Well Richard. It’s Howard.
I mean unfortunately we did bring that down a little bit because the capital spend is higher now. As George eluded some of that is forward based.
We’re at one of the highest forward leasing spreads we’ve been in the long time, close to 300 basis points, the brokerage commissions and some of the early spend of those, end up showing up in our financial reporting before the actual leases commence. So I think you can expect to see over the next couple of quarters as we continue aggressively lease is a little bit of an allocation in the capital we spend.
But the expectation is certainly with longer leases that we are going to level that off and bring it back down that coupled with higher overall retention which will be a natural by-product of a stronger market should create a lot of acceleration in our category FFO in 6, 12, 18 months. But little bit far out to really know for sure but that’s the longer term expectation how to play out.
Richard Anderson – BMO Capital Markets
Fair enough. And then just the follow-up question is on dispositions, I guess that kind of two fold question on that.
And first of all the 80 million – as this time you are able to do more than 80 million, do you anticipate that will have any impact on your guidance or do you think it will be kind of late in the year. So no real impact?
And the second is, the target for sale in New Jersey, PA and Virginia, when I think of you guys – my – what I am kind of waiting for is for you to get back to sweets sport and what you are really good at and that’s admitted land I can really focusing on that and I’m curious is to why you don’t have California and Austin included in that list of targeted markets for sale?
Howard Sipzner
Let me take each question in order. Certainly, to the extent that we would have a disposition execution level that was greater than the 80 million we do believe that timing of that would be so late near the impact on 2011 numbers would be minimal.
So...
Richard Anderson – BMO Capital Markets
Okay.
Howard Sipzner
I think that’s, that’s pretty clear from just a timing stand point.
Richard Anderson – BMO Capital Markets
Okay.
Howard Sipzner
On the broader question you touched on I think would have being overly specific, we are undertaking and we use a term price discovery twice now. We are undertaking price discovery on a whole variety of assets through the portfolio.
And our expectations in the next 30, 60 days we’ll be getting some feedback on a variety of single assets and small portfolios, we’ll be able to make a determination on the optimal time to sell. And certainly, the California market as you touched on are not due to the long-term for us.
We’ve talked about that on previous calls, so we continue to very actively monitor that marketplace from an investment standpoint to identify the right time for us to implement our program.
Richard Anderson – BMO Capital Markets
Okay. Thank you very much.
Operator
Your next question comes from the line of John Stewart with Green Street Advisors.
John Stewart – Green Street Advisors
Thank you. Gerry, I wonder if you can address, particularly given the slower rent projects that a mention investors are underwriting in D.C.
I know that you’ve said that you expect pricing to be tight and attractive, but are you seeing – has it been impacted by the pause that you’ve described in D.C. in terms of what you expect to realize on JV?
Gerard Sweeney
Hi, John. No, I think that the pricing that we were expecting are circling is where we expected to be.
I was basically just referring to I think that as we talk to brokers and we see investments, I think the people may start to take a – I think there were some – if you look at a lot of the reports and where we thought underwriting was relative to some pricing, you heard a lot of talk about rent growth of 6%, 7%, 8% over the next several years, and a lot of that being generate by demand both on the private and government side and what we are hearing a little bit more besides not just this week but in the past month has been with the idea the government maybe not taking as much space, not shrinking but taking less and therefore those growth rates that people are using to value some of the assets and get to the returns they are expecting maybe muted, but still growing.
John Stewart – Green Street Advisors
Can you kind of put some brackets around what pricing you think you might achieve?
Gerard Sweeney
Actually at this point we’re going to just give you dollar range and hopefully be in a position to talk about particular cap rates and prices per square foot on the next call.
John Stewart – Green Street Advisors
Okay. Jerry, wondered if your - I guess take first of all in terms of whether there is a market for vacancy I presume that kind of buying occupancy you are really referencing some of the weaker markets where presumably you have non-core assets held for sale and I wonder whether you are better off just taking the pain today and selling vacancy rather than trying to put in the capital and sell leased up asset?
Gerard Sweeney
Look John I think the sales transaction I referenced earlier in the call is perfect reflection of how we view it. That was an asset in Southern New Jersey about 70,000 square feet were 14% leased.
We did our sitting around round table talking about the real the absorption pace, the effective realize, the capital costs, we made a determination that was better for us to see that property in its vacant condition, because the net present value of that sale from our standpoint, we’re in a number of different financial scenarios was better the lease up in whole strategy. So that is a – that’s an approach we are taking on every single asset we review as part of our portfolio management program.
Last year we did sell a number of significant inter lease properties. Frankly for prices per square foot were optimal, but they represent the best financial decision for the company, so I would certainly expect with this wave of assets that we’re currently testing the market on as well as any subsequent ways we continue to follow that same discipline.
John Stewart – Green Street Advisors
What was the total dollar volume be everything that you are kind of testing the market on?
Gerard Sweeney
We haven’t disclosed that.
John Stewart – Green Street Advisors
I mean I realize that it’s not all likely to hit, but in broad brush terms?
Gerard Sweeney
Yeah, broad brush terms are broad brush – really well. It’s greater than the $80 million target we have on our plan.
John Stewart – Green Street Advisors
Okay. Lastly for Howard, Howard you’d reference the rating agency upgrade strategy and I wondered if you could share with us what specifically the agency set communicated there, looking forward from you and when you expect to get there?
Gerard Sweeney
Well I think number one, they never specifically communicate what the goal is, so it remains a bit elusive, but from conversations we continue to have and more importantly monitoring the peer group, what we think we’ll do it for us is mostly on the debt to EBITDA side. And that gets improved primarily by lease up, improving EBITDA, but also at the margin if there is some excess sales activity it could ship in to the debt side of it.
So that becomes really a natural evolution of executing the business plan. In addition, I think it follows and suite from that would be somewhat better but not a great deal, better coverage ratios than we have.
I think our coverage ratios, right now are probably between bottom investment grade BBBs and mid BBBs or BAA3 and BAA2. So I think as we do that leased up that’s going to improve well through where we need to be.
And that assumes that rate stay plus or minus a 100 basis points around where they are. We have been pleasingly surprised that where we have been able to execute fixed rate financings as far.
John Stewart – Green Street Advisors
And you timeframe for (inaudible) when you get there?
Gerard Sweeney
You know it becomes really an answer when we think we are going to hit those higher occupancy levels. I think we are encouraged by the turn in this current quarter.
We still see some ups and downs over the next couple of quarters. But the strength to look forward plan and the strength of the regional teams suggest that we could have some pretty good results going in to 2012.
And then began to accelerate those conversations toward the end of next year.
John Stewart – Green Street Advisors
Okay. Thank you.
Operator
At this time there are no further questions. Do you have closing remarks?
Gerard Sweeney
Just to thank everyone for their participation and we look forward to updating you on our next quarterly call. Thank you very much.
Operator
Thank you. This concludes today’s conference call.
You may now disconnect.