Oct 27, 2011
Executives
Gerard Sweeney – President, Chief Executive Officer Howard Sipzner – Executive Vice President, Chief Financial Officer George Johnstone – Senior Vice President of Operations Tom Wirth – Executive Vice President, Portfolio Management
Analysts
Josh Addy – Citigroup Jordan Sadler – KeyBanc Anthony Paolone – JP Morgan Jamie Feldman – Bank of America Brendan Maiorana – Wells Fargo Mitch Germain – JMP Securities Rich Anderson – BMO Capital Markets Dave Rogers – RBC Capital Markets Michael Knott – Green Street Advisors Gabriel Hilmo (phon) - UBS
Operator
Good morning. My name is Latangie and I will be 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. If you would like to ask a question during this time, simply press star then the number one on your telephone keypad.
If you would like to withdraw your question, press the pound key. Thank you.
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
Latangie, thank you. Good morning everyone and thank you for participating in our third quarter 2011 earnings conference 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 of 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 the estimates reflected in these statements are based on reasonable assumptions, we cannot give assurances 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.
The third quarter represented a solid continuation of our 2011 business plan execution. Highlights from the quarter: our business plan continues to run better than earlier projections, leasing activity was strong and we saw a continued improvement in our mark-to-market, our leasing pipeline stands at 3.7 million square feet, generally in line with previous quarters, and even with the change in economic climate since our last call, we continue to see good leasing activity levels and a customer base still motivated to execute transactions.
Occupancy levels also improved and we increased our revenue targets again. We continue to see a flight up the quality curve and towards well capitalized landlords that has clearly benefited our portfolio.
Our market-driven leasing strategy will continue to vary by submarket. In some markets, we have pushing rents and in others we continue to buy occupancy.
We had strong tenant retention during the quarter. We are also increasing our projected 2011 core occupancy percentage to 86.7%, an improvement over last quarter’s projection and 100 basis points over year-end 2010 levels.
Our same store numbers have improved from our original forecast and again from last quarter. We are rebuilding occupancy at a challenging point in the market cycle, so we expect capital costs to be higher.
To compensate, we have continued to increase lease terms from the 5.3 year average in 2010 to the 6.3 years today, a 19% increase, and we’re also incorporating annual rental rate steps in most of our leases. Based on that and as you’ve seen, we’ve had an increase in third quarter capital costs.
While the key metric we monitor, that is leasing costs on a per square foot per lease year basis, actually declined to $2.23 a foot from $2.94 last quarter, the absolute amount of dollars we spent increased due to our accelerated level of current leasing activity and early prepayment of future leasing costs. We are currently 88.5% leased and are maintaining about a 290 basis point spread in our lease versus occupied percentage.
We will hold this 88 to 89% forward leasing level through year-end. As a result of our leasing success and good expense management during the year, we are increasing our 2011 guidance to a range of $1.36 to $1.39 per share FFO versus our previous range of $1.32 to $1.36 in FFO.
A few other comments on our balance sheet and investment program – in looking at our balance sheet, an investment rating upgrade coupled with continued leverage reduction and debt maturity management remain key objectives. During the quarter, we continued to build the strength of our unencumbered pool and paid off our $60 million 1 Logan Square mortgage loan and also prepaid without penalty our $34 million Concord Airport Plaza mortgage.
The total of $94 million was funded off our line of credit. In looking at our line, our $600 million line of credit and our $183 million term loan mature on June 29 of 2012.
In addition, we have $152 million bond maturity expiring on April 1 in 2012. We have commenced the process of re-syndicating the $600 million line of credit.
That process is going very well. We would expect pricing levels and terms consistent with those achieved by other investment-grade REITs.
Additionally, we plan to refinance the $183 million term loan and are evaluating a potential upsizing to our term loan capacity with a laddered maturity schedule. Bank response on this initiative has also been very strong.
We’ll be holding a bank group meeting in the next few weeks, expect to finalize commitments before year-end with a closing in the first quarter of 2012. We anticipate that any increased capacity provided by the expanded bank facility will provide another source to repay our April 2012 bond maturities.
In looking at investments, we had a quiet quarter but continue to have a lot of work in progress. We are in the market undertaking price discovery with a variety of properties.
These assets, as we’ve reported in previous quarters, are non-core either from a locational, future NOI growth or capital consumption standpoint. We have $30 million under contract with closings scheduled in the next 30 days.
These properties are in New Jersey and the Pennsylvania suburbs and will trade for a blended 7.4% cash cap rate. We also have a number of additional properties aggregating at about $160 million in the market with good investor interest.
We made good progress during the quarter on our joint venture efforts on several properties in northern Virginia. We have selected a high-quality institutional partner through the auction process.
We are in advanced document negotiations. Due diligence is being wrapped up and third party mortgage quotes are being actively sought.
If successful, we anticipate this transaction will close by 2011 year-end, very much in line with our original target date. The venture as previously outlined will consist of us contributing several assets, receiving a forward equity commitment from our venture partner that would enable us to form a co-investment vehicle targeting asset acquisitions inside The Beltway.
The total value of the additional contribution approximates $160 million with an expected forward equity commitment of $100 million. We expect to report an attractive cap rate and price per square foot upon transaction closing.
Also during the quarter, we completed the foreclosure on a note we acquired for $18.8 million, and as a result acquired 3020 Market Street, a 56.6% occupied 193,000 square foot office building located a block from our Cira Center building and adjacent to our 30th Street post office IRS campus in University City, Philadelphia. The property is located in the Keystone opportunity tax zone and is undergoing some additional renovations.
We are in active discussions with several prospects to absorb large blocks of its current vacancy. We expect to invest an additional $60 per square foot and obtain a stabilized return of 11%.
In looking at 2012, as we indicate in our press release, we introduce 2012 FFO guidance with a range of $1.35 to $1.41, creating a midpoint of $1.38 which is ahead of consensus estimates of $1.35. That guidance is driven by the following macro assumptions: first, we expect the economic recovery to remain slow.
We also expect tenant demand levels and tenant activity levels to remain static in most of our markets to slightly increasing in several others. Our plan contemplates 2012 total leasing production of 4.1 million square feet, which is about the same level we will achieve in 2011.
We also expect there will be marginal increases in net absorption across our core markets and that the majority of our leasing production will come from market share increases. We expect our stronger markets to continue to outperform well, namely Philadelphia CBD, Austin, Texas, Richmond, Virginia, and the crescent suburban markets in Philadelphia.
We do expect better year-over-year activity levels in our more challenged markets of the Toll Road Carter, which is 13.8% of our NOI, and New Jersey, which is 8.7% of our NOI. We do expect year-end 2012 occupancy to be 88.7%, a 200 basis point increase over 2011 year-end levels with the majority of that increase over current levels occurring in the second half of the year.
We are forecasting a tenant retention rate in 2012 of 56%. Our plan results in positive same store growth and continued improvement in our operating metrics, which George will review in more detail in a few moments.
The plan does not incorporate any equity issuances at all. The plan does contemplate $80 million of sales activity with no acquisitions.
As a point of note, if the DC venture closes without any additional acquisitions in that vehicle for 2012, it could be a penny or two dilutive; but if we achieve some of the target investment objectives, we’ll be able to offset that situation. We anticipate that our primary driver of deleveraging will be EBITDA growth.
The 2012 plan is constructed as leverage neutral, but we expect that sales in excess of the $80 million target would be primarily used to reduce debt and/or be actively recycled into higher growth and higher quality acquisitions. The plan reflects the execution of our line of credit and term loan transaction, and no other capital activity is built into the 2012 plan.
At this point, George will now provide color on our 2011 operational performance and more detail on our 2012 outlook. George will then turn it over to Howard for additional color.
George Johnstone
Thank you, Gerry, and good morning. Leasing activity for the quarter was strong with 949,000 square feet of lease commencements and continued progress on the business plan.
Lease renewals commenced totaled 590,000 square feet, leading to a 67.3% retention rate for the quarter. New lease activity and tenant move-outs were as expected, resulting in third quarter occupancy of 85.6%.
Traffic for the quarter was up 1.2% over last quarter and 5% over last year. New Jersey, Delaware and metro DC posted the best levels of increased traffic for the quarter, both up 28%.
The pipeline remains strong and unchanged from last quarter at 3.7 million square feet, 3.2 million of new deals, and 506,000 of renewal deals. 600,000 square feet of deals are in lease negotiations with the balance all entertaining proposals.
Our continued progress on leasing for 2011 has resulted in spec revenue being increased to $34.8 million with all but $268,000 being achieved. Our executed forward leasing and known move-outs in the fourth quarter will result in year-end occupancy of 86.7% and a 62% annual retention rate.
Similar to my comment last quarter on capital expenditures, we report capital costs for CAD in the quarter in 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 mismatching of capital and lease commencements to continue.
To illustrate, this quarter we had $33 million of revenue maintaining capital, which was our highest amount to date: $11 million of capital related to leases that commenced prior to the third quarter, $10 million of capital on leases that commenced in the third quarter, and $12 million of capital associated with leases that will commence in subsequent quarters. Now a few comments relative to our 2012 business plan – we have $43.4 million of revenue budgeted from leases commencing in 2012.
14.8 million or 34% is already executed, leaving $28.6 million of speculative revenue to be achieved. This compares to the $25 million spec revenue target announced on last year’s third quarter earnings call.
Occupancy during the first half of 2012 will be relatively flat with a 200 basis point pickup in the second half of the year. We expect a 56% retention rate based on 600,000 square feet of renewals already executed, current lease negotiations, and known tenant move-outs.
Rental rate trends are also budgeted to improve during 2012. GAAP rent growth will range from negative 1% to positive 2% versus a negative 1.5 to negative 3% in 2011.
On a cash basis, while still negative, the trend line is improving, ranging from negative 4 to negative 7% versus a negative 6 to 8% in 2011. Gerry previously discussed our assumed capital.
We expect the range next year to be $2.25 to $3.25 per square foot per lease year. These leasing assumptions and trends will translate into same store NOI growth of 0.5 to 2.5% on a GAAP basis and flat to 2% on a cash basis, both excluding early termination and other income.
While leasing remains the primary focus of our regional teams, we continue to make good strides in operating expense control. Our energy procurement and conservation efforts along with aggressively rebidding in service contracts and appealing real estate taxes has contributed to lower operating costs.
I’ll now turn it over to Howard for the financial review.
Howard Sipzner
Thank you, George, and thank you Gerry. In the third quarter, FFO available to common shares and units totaled $60.3 million and includes $12 million attributable to our previously disclosed historic tax credit financing.
Without the 12 million, our FFO of 48.3 million compares favorably to 47.5 in the prior quarter and 45.6 million a year ago. The $0.41 per share of FFO exceeded analyst consensus by $0.03 per share and resulted in a payout ratio for the quarter of 36.6% on the $0.15 dividend we paid in July 2011.
Our FFO continues to be very high quality with other income type items such as termination revenue, management fees, interest income and JV income contributing just 5.3 million gross or 3.9 million net of expenses to our FFO figure, each below our 2011 quarterly run rates. A few observations on the components of our Q3 2011 performance – cash rent at 114.8 million was up 3.4 million versus Q3 2010 and up half a million dollars sequentially versus Q2 2011.
Straight-line rent of 5.5 million was up 1.7 million and 0.8 million sequentially versus 4.7 million in Q2 2011. The quarter-over-quarter increases are primarily attributable to full quarters in 2011 for the post office and garage projects and for 3 Logan versus their respective completion and acquisition dates in the third quarter of 2010, as well as the impact of the Overlook transaction, the acquisition in Richmond, Virginia in the first quarter of 2011, and 3020 Market Street being acquired during the current quarter.
Recovery income at 19.8 million and our recovery ratio of just over 35% reflected typical expense recovery conditions and are in line with our expectations. Property operating expenses of 42.4 million were up 1.8 million sequentially due to seasonal factors, including higher electric, while real estate taxes of $13.9 million were down $0.6 million sequentially due to lower assessed values.
Interest expense of 32.3 million decreased $2.4 million sequentially as we benefited from the loan payoffs Gerry identified and a return to typical floating rate balances in the third quarter of 2011. Lastly, G&A at 6.2 million was in line with our expectations.
The EBITDA coverage ratios that we experienced in the third quarter are at their highest recent levels of 2.6 times interest, 2.3 times debt service, and 2.2 times fixed charge. Margins are very strong despite being at trough vacancy levels with 60.5% for NOI and 60.6% for EBITDA.
In terms of 2011 guidance, as Gerry mentioned, we’re increasing the prior range by $0.035 to now be at $1.36 to $1.39, and in line with both Gerry’s and George’s comments, reflects substantial and successful completion of virtually all of our 2011 plan. As we look ahead to the balance of the quarter, our capital needs are light, having already funded the acquisition—or the redemption, rather, of our exchangeable notes as well as having paid our October 2011 dividend.
We expect to end the year 2011 with a letter of credit balance of approximately $240 million, reflecting recent activity. In terms of 2012 guidance, we’re providing an initial figure of $1.35 to $1.41 per diluted share; and excluding the $0.08 of historic tax credit revenue we’ll recognize once again in the third quarter of 2012, our quarterly run rate will be in a range of $0.31 to $0.33 per diluted share.
George touched on most of the market metrics that underlie the 2012 business plan, and the remainder can be found in our supplemental package. In terms of other income items, we’re once again projecting a modest figure of 20 to $25 million gross or 13 to $18 million net for a basket of other items such as termination revenues, other income, management revenues less associated expenses if net, interest income, JV income, and any bond repurchase activity, to the extent there is any.
G&A will remain consistent between 6 and 6.25 million per quarter of 24 to 25 million for the full year. We project interest expense, taking into account the refinancing and recast of our credit facility and other maturing debt, to be in the range of 133 to $140 million, above 2011 levels and reflecting the variety of refinancing assumptions.
We are including 80 million of as-yet unidentified sales activity in our 2012 plan, both to raise capital as well as to de-lever and move out of non-core properties. This is weighted about 60% for the year for a gross NOI reduction versus year-end 2011 figures of between 4.5 and $5 million of NOI.
Once again, we’ll recognize in the third quarter of 2012 about $0.08 of historic tax credit income. This is offset by about $0.01 of total annual interest expense which, like in 2011, is recognized ratably over the course of the year in our interest expense line item, and we do back out the $0.08 per share from our CAD calculation as its essentially non-cash.
As Gerry said, no additional equity issuance, and we’re not programming any additional note buyback activity as well, and we’re looking for a roughly stable share count in 2012 at about $147.5 million. We’re expecting this FFO to produce CAD of $0.60 to $0.70, which as a result will yield around $10 million of free cash flow after dividends and recurring CAPEX.
In terms of our 2012 capital plan, we have total capital needs of about $600 million for 2012, consisting of 148 million of aggregate investment activity. In this, we’ve assumed $50 million of revenue maintaining CAPEX, dollars spent on space that had been previously contributing revenue, $80 million for new project lease-up such as acquired vacant space, space in the 3 Logan Square property and 3020 Market Street along with other revenue creating capital expenditures, and about $18 million for funding our capital requirements under the Commerce Square JV.
We have a total debt repayment, excluding the credit facility, of $356 million – 152 million for our 2012 notes, 183 million for our maturing bank term loan, and $20 million for various mortgage amortization and ultimately debt costs in the refinancing. We expect to keep our dividend level consistent subject to Board declaration at an aggregate level of 96 million on our common and preferred.
How are we going to raise this $600 million? We’re programming 175 million of cash flow before financings, investments and dividends, the $80 million of sales we mentioned, and we expect to do 500 million of net new financing most likely in the form of bank term loans, which will be done along with the recast of our $600 million credit facility.
As Gerry said, initial reaction from our banks has been very positive. We expect to complete all the work related to these financings before the end of this year and close and fund them in early 2012.
These sources $755 million, so we’ll use the 155 million of excess funds over our 600 of requirements to reduce our credit facility balance to what’s expected to be an $84 million level at year-end 2012, in line with our program to keep credit facility usage light and maintain maximum flexibility. Account receivables were stable at 9/30/11 with reserves of $15.5 million in total, 3.6 million on 18 and change of operating and other receivables or about 19%, and 11.9 million of reserves on 119.6 million of straight-line rent associated receivables.
At 9.9%, these levels remain consistent with prior quarters. All of our balance sheet and credit metrics continue to be very strong, and probably the most noteworthy item is the degree to which we unencumbered our portfolio in the third quarter, resulting in a very high level of unencumbered assets.
We’re 100% compliant on all of our credit facilities and indentured covenants. With that, I’ll turn it back to Gerry.
Gerard Sweeney
Great. Thank you very much, Howard, and thank you George.
To conclude our prepared remarks, the third quarter was a very good one for us. We exceeded our leasing targets, posted solid leasing activity, and continued a positive trend line on our operating metrics like improvements to mark-to-market and same store performance.
We are in a very good position, as you heard from George and Howard, heading into the year-end 2011 and accomplished all of our key business plan objectives. As we look ahead to 2012, we reiterate our commitment to our primary growth strategy, which is to simply lease up our existing vacancy.
With our 2012 guidance range, our primary attention will be focused on improving occupancy and accelerating leasing activity. As noted, our 2012 plan expects year-end occupancy to be up about 200 basis points, retention rate as George outlined, positive same store growth, and a significant improvement in the mark-to-market from our 2011 forecast.
This guidance also reflects our belief that fundamentals continue to slowly improve, our product quality will continue to provide a competitive advantage, and that other key elements our business plan, namely balance sheet and maturity management and our investment program continue very much on track. With that, we’d be delighted to open up the floor for questions.
We would ask that in the interest of time, you limit yourself to one question and a follow-up. Thank you.
Operator
If you would like to ask an audio question, please press star, one on your telephone keypad. We’ll pause for just a moment to compile the Q&A roster.
Your first question comes from the line of Michael Bilerman with Citi.
Josh Addy – Citigroup
Hi, thank you. It’s Josh Addy with Michael.
Can you talk about what are the drivers of same store cash NOI growth next year of flat to up 2%? It seems like the occupancy gain is very back half-weighted.
Is there anything else that’s driving the same store higher?
George Johnstone
Well, I think it’s a combination of when the leasing occurs but also some of our operating expense measures, primarily in some of our successful appeals on real estate taxes.
Josh Addy – Citigroup
Is there a burn-off of free rent that’s helping that number?
George Johnstone
Yeah. I mean, most of our new leasing that we did in 2011 would not have been producing cash NOI for the full period in ’11, but will be for 2012.
Howard Sipzner
Yeah Josh, it’s Howard. Straight-line rent should trough during the year below its highest levels, but then with a back-end leasing push could once again rise; so there will be some variability in the straight-line rent during 2012.
Josh Addy – Citigroup
Okay. I’m just trying to figure out what the main driver of that cash NOI growth is.
Howard Sipzner
Well as George said, there is occupancy in there and we’re also seeing rents, candidly, bottom in most of our markets and beginning to show some upward bias. You don’t necessarily see that in the mark-to-market because that’s a reflection of whatever prior lease was there, but when looked at on an absolute basis, many markets are rising and none of them are really falling anymore.
Gerard Sweeney
Josh, one other significant contributor next year is the fact that 3 Logan will join the same store portfolio in 2012.
Josh Addy – Citigroup
Okay, thanks. That’s helpful.
If I can just ask one more question – on the asset sales, are you considering any of the CBD Philly assets like Cira Center as a potential source of funds, bringing in a JV partner and looking at that as a way to raise equity?
Gerard Sweeney
Look, certainly a joint venture of some of the CBD Philadelphia assets remains on our radar screen, and we periodically review that and also respond, frankly, to episodic reverse inquiries. So we remain very open to that possibility, particularly as our revenue contribution from CBD Philadelphia continues to increase.
Primary focus, however, on our asset sale program is really identifying those assets, Josh, that are in non-core, non-strategic locations for us that really we believe have very muted growth prospects. That’s what we really have sold for the last two years and would expect that trend line to continue.
But as we look at the entire portfolio, I think we’ve taken a very proactive approach on continuing to assess every single asset and finding out the optimal point of exit, so to speak, and making sure we stay in close touch with the market and monitor where that pricing is versus our exit pricing.
Josh Addy – Citigroup
Okay. Thank you very much.
Operator
Your next question comes from the line of Jordan Sadler with KeyBanc.
Jordan Sadler – KeyBanc
Thanks, good morning. Along those same lines, curious about the size of the portfolio that exists, the non-core portfolio in terms of investment dollars.
How would you characterize that?
Gerard Sweeney
Jordan, I’m not sure I understand the question.
Jordan Sadler – KeyBanc
What’s the size of the non-core portfolio? So if you were to sell it all today, the value of it would be $500 million?
What remains left to be pruned?
Gerard Sweeney
Well, I think in terms of what we’ve put out in the market so far, as I indicated, including what we have under contract and what is kind of in the market today, it’s in that $200 million range. Certainly the level of longer term volume that we would expect to exit is higher than that, and we do in fact look at aggregating assets into portfolios today to try and identify the potential buying population.
Jordan Sadler – KeyBanc
And how much higher – is it a few X or—and are the other assets poised for joint venture? Are those markets that you’ll joint venture, as Josh just suggested and asked, or is it markets you’d look to complete exit?
Gerard Sweeney
Well look, in terms of assets, what we really consider to be non-core, our primary objective there would be to exit. To the extent that there is a blend of core markets but maybe non-core properties in those submarkets, that may become a very viable joint venture opportunity for us, very similar to what we did a few years ago with an institutional investor on some of the submarkets here in the Philadelphia suburbs where we contributed several million square feet into a venture in which we retain a 20% stake.
But typically when we go into the marketplace with the expectation of trading an asset, we always look for a sale first and then take a look at joint venture pricing to see if that’s a better equation for us versus an outright sale.
Howard Sipzner
Jordan, it’s Howard. I would add, Jordan, that in general we don’t have a large block of assets that are targeted for sale.
That’s something very different about us. We’d rather take more of an asset management approach.
We look at anywhere from a bottom 1, 2, 3% of the portfolio via ranking system. We integrate that analysis with our capital plan and we come up with a balance we want to sell.
It was $80 million in 2011. We’ve targeted the same level for 2012, and you’ll typically see us selling a bottom portion of a portfolio as opposed to an absolute portion of the portfolio because we just don’t have that level of assets to dispose of.
Jordan Sadler – KeyBanc
Okay. And just to clarify, the 200 million, the 30 that’s under contract, the 160 that you’ve got good investor interest in, that does not include the JV?
Gerard Sweeney
That does not include the JV, correct.
Jordan Sadler – KeyBanc
That’s also 160, the initial contribution?
Gerard Sweeney
That’s correct, yes.
Jordan Sadler – KeyBanc
Okay. And lastly on that, you said that if you were to go ahead with the JV by year-end, it sounds like you may be successful there, it would be potentially a penny or two dilutive, which I find to be pretty interesting.
Is there debt on those properties and/or what is the expected reinvestment--?
Gerard Sweeney
Yeah, there is no debt on those properties. Maybe Tom, you could walk through the mechanics there.
Tom Wirth
Sure. Jordan, we’re looking at potentially putting financing, relatively conservative 50 to 60% financing.
We’ve been getting relatively good indications of debt quotes below 5%, so if we were to close, we would be simultaneously putting on that level of financing.
Jordan Sadler – KeyBanc
Okay, thank you.
Operator
Your next question comes from the line of Anthony Paolone with JP Morgan.
Anthony Paolone – JP Morgan
Yeah, thanks and good morning. Can you give us an update on leasing at 3 Logan and some of the expirations that are set for next year, how that progress is going?
George Johnstone
Certainly. Look, 3 Logan like the rest of Brandywine, is a lease-up story, and like the rest of the Brandywine story, fortunately the leasing is going well and we’re making good progress.
Right now, we’re about currently 82% preleased. We are in active discussion with many of our renewal tenants.
That process is going very well. Rents and terms of those extensions are very much in line with our expectations, and more importantly on the new leasing front, we are in advanced stages of negotiation with tenants that will create absorption in the building of over 200,000 square feet and we would expect that transactions would migrate to execution certainly by the end of 2011.
The total advance pipeline, Tony, in that building is about 600,000 square feet, so view we’re in very, very good shape. Some of the tenants whose leases expire next year who will occupy space that some of these newer tenants will move into, we will either vacate them so we can build the space out, or depending upon the timing of the newer tenants, we may in fact achieve short-term extensions until we need to take that space back for construction.
So all in all, going very well. Good levels of activity, rent levels and I mentioned terms, capital investment, et cetera staying very much in line with our pro forma.
Anthony Paolone – JP Morgan
Okay, thanks. And then just another question – you laid out the reasons for the bigger CAPEX in the quarter.
Just wondering if you can give us a sense as to how much has been committed that might be on the sidelines that’s outsized that we could see over the next, say, few quarters.
Gerard Sweeney
George, you have that number?
George Johnstone
Yeah, I think really when you look at our leasing statistics page, for the third quarter we committed $17.22 a square foot, which would translate to about a $16 million CAPEX spend. So the fact that we had $33 million of revenue maintaining capital in the quarter, the majority of that was future quarters related.
I had referenced in my commentary 12 million for subsequent quarters. Ten of that 12 are on leases that will commence in the fourth quarter.
We had the balance of $2 million are on 2012 commencements. So again, I think a better way to kind of look at capital is really through the capital committed on our leasing statistics page in the supplemental.
It’s really the cash payment timing that is skewing the CAD percentage quarter-to-quarter.
Gerard Sweeney
And that’s one of the reasons why we really do focus on that capital cost per lease year. As we’ve discussed and as you know from just monitoring the office market, we’re not going to tell you it’s going to get less expensive to get tenancies in this current climate.
It really isn’t. We do think capital costs will continue to have an upward bias.
We think we have a pretty well diversified portfolio so we’re able to blend lower CAPEX markets with higher CAPEX markets to get a good result. But really, until net new demand increases and vacancies significantly tighten, I think we’re going to be seeing that upward bias.
So our focus, really, is on control over our leasing cost per square foot per lease year. We’ve been, as I mentioned, lengthening lease terms, holding face rates to preserve investment value, which is one of the reasons why the straight-line rents that Howard touched on is going through the phenomenon that it is.
We are getting 2 to 3% annual cash increases in most of our leases, and that’s been a very effective approach. But as I mentioned, we’re aggressively building occupancy off the trough levels and as a result, we’re incurring a higher level of absolute total spend.
But as we economically evaluate it, each of those leases we’re creating will hopefully create some good value so it still winds up being a very good investment for the company, particularly with these longer lease terms and the rent steps. And look – certainly as the market continues to recover, we fully expect that our retention rate will return to pre-2009 levels in the mid-70s and that the investments we’re making today to attract new tenants to our portfolio will provide a very, very good return for this company over the next few years.
Anthony Paolone – JP Morgan
Got it, thanks. Just one quick clarification – on the $33 million type number, are the capital costs associated with things like 3 Logan and Janney Lease, is that going to be in that number?
George Johnstone
No, that would not. The 33 million was on revenue maintaining transactions.
Gerard Sweeney
It’s the capital that we would spend on a 3 Logan on previously unoccupied space or 3020, that’s a revenue creating transaction for us.
Anthony Paolone – JP Morgan
Okay, thank you.
Operator
Your next question comes from the line of Jamie Feldman with Bank of America.
Jamie Feldman – Bank of America
Thank you. Can you guys just talk a little bit more about what you’re seeing on the ground in your markets?
I mean, granted, we’re not seeing a lot of job growth out there but you are seeing decent leasing demand, so can you just kind of frame that? And as you’re heading into 2012, CBD versus suburban, what you think will have more demand and also along those lines, what lease negotiations look like given CAPEX versus free rent versus rent bumps.
Gerard Sweeney
Sure, we’ll tag-team that, Jamie. Look, the economic picture remains clouded, as we all know, and every day there’s different data points that can swing you one way or the other.
Yesterday, the durable goods order came out that was—if you excluded airplane orders, it was a sharp increase in all the other investments. So it would seem that that measure of capital business spending jumped sharply, and it’s hard to believe that businesses would continue to invest heavily if they didn’t see demand that they needed to support those expenditures.
So it’s very much of a reactive market to economic data, and we recognize that, which is why we have varied at all from our program of executing lease transactions as promptly as possible and getting new tenants into our portfolio and being very aggressive in maintaining existing tenants. In general, we are seeing activity levels, as I mentioned, static from where they were last quarter.
We continue to see in some markets good levels of activity with a slight decline in concession packages. But more importantly when we look at 2011 versus 2012 and some of our key markets, we are actually seeing cash mark-to-market projected to move from negative in 2011 to positive in 2012, which is a very, very good sign of some markets recovering.
And that type of trend line we’re seeing evidenced in markets like Radnor, Pennsylvania, Conshohocken, Philadelphia CBD, Austin, Texas. We’re continuing to see still a static mark-to-market that might be negative in the Toll Road Carter, New Jersey, et cetera; but generally activity levels we see even in those challenged markets will remain around the levels we had this year with hopefully a little more throughput.
Have not really seen a change – George, please weigh in – in the level of concession packages required by tenants versus what our plan was. They’re still there and they still are on the table in every transaction, but in terms of what we projected for ’11, what we’re anticipating for ’12, we don’t really see much variability to that on a submarket basis.
George Johnstone
Yeah I think, Jamie, on new transactions we’re still seeing the requests for one month of free rent per lease year, and we obviously weigh that in the total capital stack of the deal with both the TI improvement and the leasing commission.
Jamie Feldman – Bank of America
Okay, thanks. And then can you talk a little bit more about the properties you think will go into the fund and what pricing is?
Gerard Sweeney
Well we haven’t disclosed the pricing. I think at this point we’d prefer to hold off on that until we actually announce the transaction, but I think in order of magnitude we expect they will be northern Virginia, Maryland assets in that $160 million range, and we would certainly disclose that information upon the close of the transaction, Jamie.
Jamie Feldman – Bank of America
Okay, thank you.
Operator
Your next question comes from the line of Brendan Maiorana with Wells Fargo.
Brendan Maiorana – Wells Fargo
Thanks, good morning. Wanted to just ask a little bit about the 2012 guidance and kind of how the outlook compares to the guidance levels that you gave initially for 2011, because if I look at—I think, Gerry, you mentioned that your speculative revenue targets today after what you’ve gotten done thus far is about comparable, maybe a couple million dollars higher than what your initial estimates were for 2011; but then you guys had a very good few months from late October to early February getting a lot of the spec targets done.
So how do you kind of feel about the conservatism of your leasing targets for ’12 versus what you guys had in ’11?
Gerard Sweeney
Well as I mentioned, we are—bottom line, total leasing production for 2011 is pretty much what we’re projecting for 2012. Now, the variable in there is that we have had a very good, so far, second half of the year in terms of the depth of the pipeline.
So the pipeline numbers are staying around that 3.7 million square foot number but transactions are continuing to progress pretty nicely through the pipeline. So when we evaluate the 2012 plan, as George touched on, we’re projecting about $3 million more of net speculative revenue that needs to be done.
That felt like a good number for us. Our retention number, again, for 2012 is not too far off our original retention number for 2011 – I think it’s 56 versus 55%.
You know, that’s one of the big variables in the plan. Our leasing agents spend a lot of time with the tenants understanding what their objectives are - we have some schedules in the supplemental package on this – but there is still a fairly wide band of tenants that we’re not sure exactly what their decision will ultimately be.
That tends to be a pretty big driver of the revenue equation, so when we post a retention number like we did this quarter versus our original plan of 55, that’s a very powerful driver of revenue. There’s typically no down time, the capital costs are lower, and we get much more earlier revenue recognition than our plan if we had assumed they would move out.
So as we look at the 2012 plan, I think we’ve maintained the approach of it being conservatively biased. Certainly a lot of work to do, but given the level of traction we’ve seen through our portfolio during 2011, the last four quarters, we certainly feel more confident that there will be a recycling of square footage through the pipeline that should put us in a very good position to achieve these 2012 goals.
Brendan Maiorana – Wells Fargo
Okay, that’s helpful. And then I just wanted to follow up on Tony’s question about the CAPEX.
George, if I heard you correctly, I think you said you were targeting the 225 to 325 per square foot per year. As you think about the leasing strategy for 2012, it sounds like the strategy is gaining market share or stealing market share, which seems like that’s a more expensive leasing proposition.
Do you still think that longer lease terms are appropriate, and does that mean that even though you had some excess CAPEX spend in the quarter relative to the leasing volume that was done, when we think about FAD going out to next year, that we might need to dial back those expectations a little bit because the CAPEX spend is going to be a little bit higher than what we’re typically used to seeing from Brandywine?
Gerard Sweeney
This is Gerry. I’ll just make an observation and certainly George and Howard can weigh in.
Remember, that leasing cost per square foot metric is one element of the equation. In other words, it doesn’t necessarily relate back to the rentals being generated from that space.
So if you take a look at our portfolio, we have a high degree of concentration in northern Virginia, particularly along the Toll Road Carter. That market tends to be one that’s at the higher end of capital cost per square foot per lease year, but it’s also one of the higher rent generating markets in our portfolio, so the capital contribution as a percentage of rents tends to be a very good equation for us.
Your observation on lease terms is a good one, and it’s certainly something that we evaluate on every lease transaction. Certainly even lengthening our leases from five years to a little bit north of six years, it’s still a very manageable length of lease to respond proactively and positively to future market conditions.
But certainly as we assess some of the longer term transactions, be that in the Toll Road or be that in the CBD market in Philadelphia, or even some of our core suburban markets, one of the things we try and do there is through the concession package we present keep our face rates as high as possible, and then from that face rate build an annual increase of 2 to 3%, which tends to be a pretty good economic prescription for us to be able to realize real rent growth as the years progress.
Brendan Maiorana – Wells Fargo
That’s helpful. So I guess the way you guys think about it, the NPV on those leases is better because you’re holding face rates, because I guess initially when I think about it, if you’re doing longer terms, higher call it static CAPEX per square foot for a year but at a trough part of the market, it seems a little bit interesting.
But you’re saying that you feel like you’re getting higher face rates to offset that CAPEX spend?
Gerard Sweeney
Well that’s the objective; and again, certainly as we evaluate and more importantly as tenants and their advisors evaluate the economic equation of doing a lease with us, free rent, face rate, annual rent bumps and upfront capital are key drivers in balancing that economic equation. So certainly the approach we’ve always taken and have been fairly successful, even in our more challenged markets, is to the extent that we need to invest more capital than we would otherwise want to, there has to be an immediate compensation for that in terms of higher face rates.
Brendan Maiorana – Wells Fargo
Sure. Okay, thank you guys.
Operator
Your next question comes from the line of Mitch Germain with JMP Securities.
Mitch Germain – JMP Securities
Good morning everyone. Gerry, Howard, just curious on the progress with the credit rating upgrade.
Gerard Sweeney
Well, as I think we’ve talked about before on the calls, we have a lot of work to do to get the ratings upgrade. Our target is to get our EBITDA to that mid-6 range, continue to reduce our absolute levels of leverage below their current 44% GAV.
So we are working in that direction and that’s a key part of every decision we make relative to sales, financings, et cetera. And certainly we stay in very close touch with the agencies themselves, and what they look for is a stable platform from a fundamental standpoint.
We are hoping that they continue down the path of taking a more constructive view on the U.S. economy and the place of office space in that economy, because as we know a primary driver of meeting that ratings upgrade target is improving our EBITDA.
EBITDA is coming off of rents, so occupancy improvements, stable cash rents with positive movement on the mark-to-market are key drivers in how they’ll be evaluating the company going forward. So certainly our 2012 business plan does not contemplate that upgrade happening.
We work towards that objective with every lease transaction, every asset sale, every financing. But Howard, do you want to weigh in on anything like that?
Howard Sipzner
No, I think that’s a perfect summary. It really is a combination of our activity and macroeconomic activity.
We’ve done nothing, to our knowledge, to upset the ultimate goal; in fact, I think we’ve delivered on just about everything we’ve either laid out to the agencies or the market in general, and we take a lot of pride in that. We’ll continue to lay out a clear plan and hit or exceed those milestones.
Mitch Germain – JMP Securities
Great. And just a little more clarity on the DC market – it seems like about 50%--or your exposure this year is moving out.
Curious – the profile of the tenants that are leaving and the types of discussions that you’re having with tenants in the market today.
Gerard Sweeney
Yeah, I think that market has slowed down to some degree, I think, with the uncertainty in the government sector and kind of the private sector associated with government spending. We continue to have a lot of traffic through the portfolio.
As I mentioned, inspections were up 28%, but tenants are taking a little bit of a longer time to make a decision and most of the tenants in that market have a more forward occupancy requirement, so they are oftentimes out in the market nine to 18 months in advance of their expected commencement date. Again, I think some of the tenants that we know are not going to renew in the DC portfolio for 2012 are, again, kind of the result of tenants moving back to a corporate-owned facility and just going through downsizing and right-sizing of their own space.
Mitch Germain – JMP Securities
Thanks.
Operator
Your next question comes from the line of Rich Anderson with BMO Capital Markets.
Rich Anderson – BMO Capital Markets
Thanks, good morning. If I could just kind of cut to the chase on CAPEX and with all the mismatch that happens between what you spend and when leases commence, what’s the absolute amount of CAPEX, you know, non-revenue generating CAPEX that you’re expecting in absolute dollars for 2012?
Howard Sipzner
Rich, it’s Howard. As I said, we have 148 million of aggregate investment activity programmed.
We expect 50 million of that to show up as revenue maintaining capital expenditures. We’ll have to fund an additional 80 million for new project lease-up such as 3 Logan and 3020 along with all other revenue creating capital; and then we’re programming about $18 million for Commerce Square JV contributions.
Rich Anderson – BMO Capital Markets
So the non-revenue generating is just 50 million?
Howard Sipzner
The non-revenue generating is 50 million as currently programmed. That’s correct.
Rich Anderson – BMO Capital Markets
How is that possible if non-revenue was 33 million in a single quarter? I’m sorry, if you can reconcile that for me.
Howard Sipzner
It is a space-by-space analysis of what we expect to lease, and where a space did not produce revenue for the prior 12 month period, it does not fall into that revenue maintaining because there’s no revenue to maintain; so it’s space-by-space.
Rich Anderson – BMO Capital Markets
Okay. AFFO—or in your terminology, CAD should not go up next year then.
I mean, I may be master of the obvious, but—
Howard Sipzner
We’re projecting our CAD to be in the $0.60 to $0.70 range per square foot, so some positive cash flow generation out of that.
Rich Anderson – BMO Capital Markets
Okay. And then big picture question maybe for all of you, or Gerry – is the Blackstone transaction with Duke, a billion dollar deal, you know, proposed.
Curious what your thoughts are on that big picture. Do you feel that there’s some appetite coming back to the market for suburban office?
Do you think that was a flash in the pan type of situation? What do you think take from the Blackstone interest in suburban office as a general observation?
Gerard Sweeney
Well, what we take from it is the—I guess, a couple levels. One, it seemed like it was a very good transaction for Duke to accomplish their strategic plan.
We’re not privy to the detailed price in the asset, so only Duke and Blackstone can conclude that it was a good transaction, which it apparently was because they got it done. I think in terms of the broader picture, there is no question that capital looks for dislocated pricing for transition points.
There is generally a perception that pricing for suburban office space is lagging that of CBD office space and maybe other asset classes. There has been a tremendous amount of capital raised by private equity funds.
That private equity is looking for places to go. Juxtapose that with a very fluid, very solid secured debt market that’s providing, as Tom alluded to, we’re seeing debt quotes in the 5% range.
There is clearly an opportunity for large amounts of money to be moving into the suburban office space, buying at a risk-adjusted good rate of return and an all-in pricing level, as you saw with the Duke-Blackstone transaction, below replacement cost, and basically have that trade serve as a proxy for the economic recovery. So from that macro picture, I think what we’re seeing is a lot more interest from a wide range of sources for both small trades and potentially large trades of institutions who are looking to expand their exposure to suburban office space.
And we think as this economic recovery continues, we believe that trend line will continue.
Rich Anderson – BMO Capital Markets
Did they approach you?
Gerard Sweeney
No, we were not part of that transaction.
Rich Anderson – BMO Capital Markets
No, but I mean maybe there was a conversation about your portfolio at some point.
Gerard Sweeney
Oh, we have conversations about a lot of people. It certainly would be imprudent to name any single person or firm, but I think that macro overview of capital looking for economic recovery play fueled by inexpensive and available debt, certainly I would be surprised if sources like you mentioned are not talking to a lot of people.
Rich Anderson – BMO Capital Markets
Okay, great. Thank you very much.
Gerard Sweeney
You’re welcome.
Operator
Your next question comes from the line of Dave Rogers with RBC Capital Markets.
Dave Rogers – RBC Capital Markets
Hey guys. I know it’s been a long call.
Howard, real quick on the debt cost – I know you went through a lot of the financings that you’re working on doing for early next year. I didn’t hear if you gave additional color on or maybe bracketing the types of debt rates or spreads that you’re expecting to see, and maybe why you chose the route of going-or the term loan versus other parts of the market.
Can you give some color on that, please?
Howard Sipzner
Yeah, generally speaking, the types of loans, credit facility and funded debt that we’re talking about are in the 175, 180 to around 200 basis point level. There’s a fairly large body of closed transactions in the REIT space to look at recently, and the reason we went that route is we’re already in that market and we already have about 15 to 20 existing bank relationships.
We’ve had a successful term loan in our capital stack recently. We’ve had them in the past, and that product is very attractive to banks right now who are very flush with deposit money.
We still like the length of the unsecured bond market. We did a successful unsecured bond in March, and that remains a possibility; but for the moment, the more likely path will be the bank market.
Dave Rogers – RBC Capital Markets
Okay. And then George, I don’t know if you had commented earlier, and I guess two ways to ask it – any large 2012 lease expirations in the first half.
I think you’ve been very clear about the occupancy gains in the second half. Do you expect any type of occupancy volatility in the first half of next year?
Another way to ask it – sequential occupancy for 2012?
George Johnstone
Yeah, I think we expect based on the forward leasing we’ve signed and the move-outs that we know are going to happen, we are expecting to lose 40 to 50 basis points of occupancy in the first half of the year, and then rebuild that in the second half of the year.
Dave Rogers – RBC Capital Markets
Is that early in the year—is that first quarter or is that just kind of ratably throughout the first half?
George Johnstone
It’s pretty much ratably through the first half.
Dave Rogers – RBC Capital Markets
Okay, great. Thank you.
Operator
Your next question comes from the line of Michael Knott with Green Street Advisors.
Michael Knott – Green Street Advisors
Hey guys. Just curious to get a little more color behind your thinking in terms of the occupancy next year in terms of flat in the first half and then plus 200 basis points in the second half.
Gerard Sweeney
Yeah Mike, I think as George just touched on, we are looking at a number of known move-outs early in the year that will offset some of our projected new leasing activity, and in the latter part of the year we would expect that the amount of projected new leasing activity would far outweigh what we would expect to lose.
Michael Knott – Green Street Advisors
And then I think, Gerry, you may have touched on it in your opening comments, but what’s the mindset of tenants today and how they’re thinking about their business and space needs?
Gerard Sweeney
Well, I think what we have seen, and it’s certainly benefited us as well as, I’m sure, some other public companies, there really is a strong bias of tenants to move up the quality curve. I mean, tenants are looking at today that they’re able to buy much higher quality product at pricing that they haven’t seen since the mid-2005, 2006 range.
So a lot of the tenants that we’re attracting to our portfolio are moving out of lower quality buildings, and when I say that, they may be older, they may have lower ceiling heights, not great parking ratios, not be in a great submarket, and they are seeing an opportunity to move up the quality curve and that tends to benefit very much landlords like us that have good quality product and good submarket positions. There is also—we’ve spent a lot of time on this call talking about capital.
Capital is a fundamental reality in leasing office space today. Well capitalized landlords that have the ability to have a very accelerated decision-making process on attracting a new tenant has really created a tremendous wind at our backs where our executive team is able to make decisions on a real-time basis in dealing with tenants about whatever they need to do to move into our space versus going back through a secured lending or a financially distressed partnership protocol.
So with that as a backdrop, we are continuing to see tenants who are in a decision-making mode. Doesn’t mean that this economic overtone and malaise continues that it won’t have an impact, which is why, as I touched on, we’re very aggressive in trying to get—if we have a transaction in our pipeline today, the numbers work, we can get that tenancy achieved, we’re in a go mode as opposed to trying to play chess with every single tenant that comes through our pipeline.
Michael Knott – Green Street Advisors
And then you’ve been recording rent roll-downs on a cash basis. I think you expect that to go positive next year.
What’s your overall portfolio OI mark-to-market today, do you think?
Gerard Sweeney
Well, next year we still expect cash to be negative but an improving negative, I guess. As we go through our quarterly review of every asset and compare rents in place versus our master leasing assumptions—look, in some markets we view as though we have a positive mark-to-market; others, we still think that it’s fairly flat or a downward bias, given where existing rents are.
But the key issue for us in this kind of climate, we’re not really looking at our mark-to-market because we can’t convert it today. So the real issue is what’s the current market rate versus the space that’s up for negotiation and the tenant whose lease is expiring and what we need to do on that point.
And from that standpoint, the numbers have not supported a real positive mark-to-market on a portfolio-wide basis.
Howard Sipzner
Dave, it’s Howard. I’ll just jump in with one more thought.
On Page 29 of our supplement, you’ll scan down that third column from the right, and we’ve got an average in-place rent of $23.20. Two things jump out from that page – one, we’ve got a lot of built-in rent because you can see where the end points are for each of those years; and secondly as you compare that aggregate figure of in-place rents, both next year and the year after and whatever, they’re generally in line or below where we’re executing leases.
So back to some earlier comments that were made – on an absolute level, rents have really stopped declining and are starting to show upwards trends. To Gerry’s point, when you compare it to an older five or seven or ten-year lease with whatever was done at that time, you just never know how that mark to former lease is going to work from a calculation standpoint.
Gerard Sweeney
Was that helpful, Michael?
Michael Knott – Green Street Advisors
Yeah, thanks. And then last question for me is I think the 160 you quoted on the JV is an aggregate asset value.
Did you guys mention whether you were going to be closer to 25 or 50% stake, and then also kind of how you thought about which end you wanted to be on?
Gerard Sweeney
The 160 is the aggregate asset value, and we’ll probably be closer to 50% range.
Michael Knott – Green Street Advisors
Okay, thanks.
Operator
Your next question comes from the line of Ross Nussbaum with UBS.
Gabriel Hilmo – UBS
Hi guys. It’s Gabe Hilmo here with Ross.
Not to belabor the point on the CAPEX, but in looking at the CAD guidance for ’12, dividend coverage is obviously pretty tight and doesn’t leave a ton of wiggle room. Can you just talk about how you’re thinking about the coverage and payout going forward into ’12, and maybe even ’13?
Gerard Sweeney
Well I think real simply, we now we’re in a process of rebuilding occupancy, so we are in investment mode. Every lease we do will generate revenue, so we feel as though even if there is a frictional tightness of the CAD payout ratio in 2012, we certainly think we’re creating a lot of value for five and eight quarters out.
Gabriel Hilmo – UBS
Thank you.
Operator
Your final question comes from the line of Brenda Maiorana with Wells Fargo.
Brendan Maiorana – Wells Fargo
Thanks. Just had a quick follow-up.
In Philadelphia CBD, you guys re-classed, it looked like, around 550,000 square feet from industrial mixed use into office. Can you just give us a little bit of color on the nature of those assets and why it was re-classed?
Howard Sipzner
Yeah, that asset is the garage portion of the post office project, and it should not have been classed as anything but office because it’s income is a portion of the underlying GSA lease. It’s probably the best office space we actually have!
Gerard Sweeney
Fully leased with low capital – there you go!
Brendan Maiorana – Wells Fargo
And how much income does the garage roughly generate? Just kind of by goalpost would be helpful.
Howard Sipzner
I don’t have in front of me the exact allocation, but we can get that to you.
Brendan Maiorana – Wells Fargo
Okay, great. Thank you.
Operator
At this time there are no further questions. Do you have any closing remarks?
Gerard Sweeney
Only to thank everyone for their participation in the call this quarter, and we look forward to providing you with a final close-out on our 2011 business plan update on 2012 in our first quarter call. Thank you very much.
Operator
Thank you. This concludes today’s conference call.
You may now disconnect.