Oct 25, 2012
Executives
Gerard Sweeney - President and CEO George Johnstone - SVP, Operations and Asset Management Gabe Mainardi – VP and CAO Howard Sipzner – EVP and CFO Thomas Wirth – EVP, Portfolio Management and Investments
Analysts
John Guinee – Stifel Nicolaus Michael Knott – Green Street Advisors Jordan Sadler - Keybanc Capital Markets Steve Sakwa - ISI Group Brendan Maiorana – Wells Fargo Jamie Feldman – Bank of America Rich Anderson – BMO Capital Markets Josh Attie – Citigroup David Anderson - Green Street Advisors Mitch Germain – JMP Securities
Operator
Good morning. My name is [Latingy] 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. (Operator Instructions) 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
Latingy, thank you very much. Good morning and thank you all for participating in our third-quarter 2012 earnings call.
On today's call with me are George Johnstone, our Senior Vice President of Operations, Gabe Mainardi, our Vice President and Chief Accounting Officer; 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 would like to remind everyone that certain information discussed during our call may constitute forward-looking statements within the meaning of federal securities laws.
Although we believe the estimates reflected in these statements are based on reasonable assumptions we cannot give assurance that the anticipated results will be achieved. For further information on factors that could impact our anticipated results, please reference our press release as well as our most recent annual and quarterly reports filed with the SEC.
That being said, during the third quarter our operations continued to benefit from stable leasing activity, strong market positioning and improving fundamentals. As is our normal practice, I will provide an overview on our three key business plan components - that is operations, balance sheet and investments as well as provide some color on our 2013 guidance.
George and Howard will then discuss the operating and financial results in more detail. The macroeconomic climate remains our biggest concern.
Data points remain mix and in this time of Congressional gridlock, fiscal cliff, global slowdown and a presidential election, our hope is we all get clarity on the trajectory of the economy and political climate within the next 90 days. In the meantime though, uncertainty remains the order of the day and tenants are cautious on near-term economic growth prospects.
Overall though, we continued to benefit from a moderate recovery in our office markets. During the third quarter, we had over 3 million square feet of inspections, which compares favorably to 2.8 million square feet in the third quarter of 2011 but is down from the 3.5 million square feet we experienced in the second quarter of 2012.
Several of our markets have a positive pricing dynamic, and we continue to expect rental rate growth in those operations. This is particularly evident in several of our Pennsylvanian suburban locations, CBD Philadelphia, and Austin, Texas.
In every market we continue to benefit from a flight to quality product that is either pushing rents up or holding rents steady. As we close out 2012, several top-level observations.
We’ve outperformed our original business plan forecast in Philadelphia CBD, the Pennsylvania suburbs, Austin, Texas and our New Jersey operations. Northern Virginia remains extremely competitive and as mentioned on our last call, we will not be achieving the spec revenue or occupancy levels we were originally anticipating nor will our operations in Richmond meet their business objectives for 2012.
George will discuss the impact of this in our [2013] business plan in a few moments. Our retention rate though has improved.
We will have a 62% 2012 retention rate which is up 60% from our last forecast. We've also increased our 2012 same-store guidance on both a cash and GAAP basis and we’ve also further increased our GAAP mark-to-market on new leasing activity.
So overall, a steady improvement in many of our key metrics. Looking at our balance sheet, we remain an extremely strong shape.
We closed the quarter with tremendous liquidity, $242 million of cash and cash equivalents on hand, and we also do not have any balances outstanding on our $600 million unsecured revolving credit facility. From a board liability and debt management standpoint, the company is in an extraordinarily good shape and our next unsecured note is not due until November of 2014.
For the quarter, we improved our net debt to gross assets to 42.4% in pursuit of our long-term goal of 35% and we’re clearly moving in the right direction. This period of economic uncertainty requires that we remain highly liquid and retain ample financial capacity as our portfolio transitions to higher occupancy levels, NOI growth and increasingly strong same-store operating performance.
On the investment front, we’ve already achieved our 2012 sales target. Activity in the recent quarter is outlined in our press release but for the year, we have sold $176 million of properties at an average cash cap rate of 7.3%.
This sales activity is consistent with our strategy of recycling out of non-core assets and redeploying capital through urban and transit hubs, town center markets along with our ongoing deleveraging efforts. Our goal to monetize and deploy up to 35% of our existing land bank over the next several years remains on track and we continue pursuing number of near-term deployments, particularly in the Pennsylvania’s New Jersey suburbs as well as in CBD Philadelphia.
As a result of continued progress on all aspects of our business plan, we've increased the 2012 FFO guidance range from its current $1.32 to $1.36 per share to a new FFO range of $1.33 per share to $1.36 per share. But more importantly, looking ahead to 2013, we also introduced 2013 FFO guidance with a range of $1.38 to $1.46 per share creating a midpoint of $1.42 which is ahead of consensus estimates of $1.40.
Achieving the midpoint of this range versus the midpoint of our 2012 range creates an FFO growth rate of 6%. Our 2013 guidance is obviously influenced by our expectations on the economic recovery, as I mentioned earlier.
That framework remains cloudy and the key constructs underlying our 2013 guidance are as follows. First, we expect the economy to continue its slow rate of recovery.
We do not anticipate any further economic slides. We expect moderate GDP growth, a moderately positive job growth and a slow road to recovery in our more challenged markets.
We do expect tenant activity levels to remain generally consistent with current levels in most of our markets. As a result, our 2013 leasing plan contemplates a speculative revenue target of $43.9 million, which is slightly below our 2012 expectations and the leasing production of 3.6 million square feet versus our 2012 expected performance of 3.8 million square feet.
We do expect our stronger markets to continue to perform well as they did in 2012. In outlining our 2013 guidance, we refer back to our building on momentum presentation from our June 2012 investor day.
In particular, we expect our 2013 year-end occupancy levels to approximate 90% which is a 200 basis point increase over our expected 2012 levels. This 90% occupancy level is down from our investor day expected range primarily driven by the slower pace of recovery that we've seen in metro DC and our Richmond, Virginia operation.
But it’s early in the year and our overriding objective remains leasing space, so we will continually work towards our original targets. We do, however, continue to expect our portfolio leasing to be 92% at year-end 2013, which is consistent with the lower end of our estimate from our investor day.
We are forecasting a 2013 tenant retention rate of 62%, consistent with our 2012 levels, and we also expect a strong mark to market on 2013 leasing activity. Further as indicated in our supplemental package, we also expect a very strong same-store number next year with a GAAP range between 3% and 5% and a cash range between 4% and 6%, very consistent with our investor day presentation.
Capital costs also run at 12% of revenues, well within the range of 10% to 15% target we discussed. Furthermore our business plan does not contemplate any significant capital activity.
Our business plan will continue our path to achieve our interim target of debt to GAV of 40% with an EBITDA multiple of 6.5 times as we work towards our longer-term objective of mid 30% debt to GAV and a below 6 times EBITDA multiple. The equity and debt markets also remain very attractive.
As such even with our strong liquidity position and given the favorable rate climate, we continue to evaluate issuance of long-term debt financing. We’ve not, however, made any decisions and as a consequence, our 2013 plan does not contemplate any debt market activity.
Also, we do not plan to issue any common equity. As has been consistently reiterated, at our current stock pricing levels, our leverage reduction plan will be evolutionary, not revolutionary and will be driven by occupancy gains, rental rate growth and net selling activity.
Not by issuing sub NAV priced common equity. During 2013, including amortization payments we only have $66 million of debt coming due with essentially one secured mortgage on several of our suburban properties.
So from a liquidity standpoint we are in an extraordinary solid shape as we move ahead into 2013. The final component of our 2013 business plan is growth acceleration through an active investment strategy.
Our investment focus remains increasing our urban and town center concentrations and reducing exposure to commodities urban space. That investment predicates combined with continued low rate environment, increased visibility on the economic outlook and relative yields we think will keep major capital sources, increasingly focused on office space as a viable investment alternative.
With this in mind, our 2013 business plan contemplates net sales activity of $100 million. And also while not necessarily affecting guidance, we do remain very focused on our goal of monetizing and deploying up to 35% of our existing $96 million land bank.
The first step of that took place with this quarter’s announcement of the transaction with Toll Brothers, and we do continue to pursue a number of other near-term deployments in CBD Philadelphia as well as Pennsylvania and New Jersey’s suburbs. Our 2013 business plan is imminently achievable.
Another very key point is that for 2013 our lease expirations are only 10% of our portfolio or about 2.6 million square feet. And that is the lowest level we’ve had in the last several years.
These significant improvements were operating platform, our forward leasing momentum along with consistent levels of leasing activity give us tremendous confidence to execute our business plan and achieve all of our stated objectives. At this point, George will provide an overview of our third-quarter operating activity and more detail on our 2013 outlook.
George will then turn it over to Howard for a review of our third quarter financial activity and some additional color on our 2013 financial plan. George?
George Johnstone
Thank you, Gerry. We continue to see good levels of leasing activity during the third quarter.
Our best performing sub-markets continue to be Philadelphia CBD, the Crescent, Pennsylvania submarkets of Radnor, Conshohocken, Plymouth Meeting, and Newtown Square, along with Austin. These core sub-markets, which comprise 48% of the company’s NOI are combined 95% leased.
The tone and pace of leasing activity has continued as expected. Deals executed in the third quarter averaged 98 days from initial inquiry to lease execution as compared to 103 days in the second quarter and 113 days in the first-quarter.
Traffic in markets where we have leasing opportunities improved over the second-quarter, Metro DC up 28%, Richmond up 22% and New Jersey, Delaware up 15%. The leasing pipeline stands at 2.5 million square feet, 1.7 million square feet of new deals and 850,000 square feet of rentals.
552,000 square feet are in active leasing negotiations with the balance all entertaining proposals. This pipeline is down from last quarter’s 3 million square-foot level due to the backfill tenancies in Austin being narrowed down to those that we are in advanced stages with and the execution of several large leases during the quarter.
In terms of the third quarter specifically, lease commencements totaled 1.2 million square feet, our highest total in the past eight quarters. These commencements included 399,000 square feet of new leases, 702,000 square feet of renewal leases and 112,000 square feet of tenant expansion.
During the quarter, we also had 115,000 square feet of early terminations. One in CBD Philadelphia as part of 102,000 square foot relocation and renewal at Three Logan.
We terminated 54,000 square feet at Two Logan. In the Pennsylvania suburbs a 39,000 square-foot tenant exercised an early termination right as a result of downsizing their operations.
This leasing activity resulted in negative absorption of 129,000 square feet and occupancy percentage of 86.3, both in line with quarterly expectations. Leasing spreads for the quarter were positive both on the GAAP and cash basis for new leases, 8% and 1.4% respectively.
Renewal lease spreads were positive 3.6% on a GAAP basis and negative 0.3% on a cash basis. Leasing capital for the quarter was $2.04 per foot per lease year, our best quarter since 2009.
In terms of the business plan for the balance of 2012, we have adjusted our year-end occupancy target to 88%, down 140 basis points or roughly 340,000 square feet from our previous projection. The primary drivers are a 280 basis point decline in metro DC equating to a 120,000 square feet and a decline in Richmond of approximately 150,000 square feet.
Those two operations account for 75% of our occupancy decline. It should be noted that we continue to execute leases in metro DC but an associated 2012 occupancy will not occur.
Occupancy will be 80% at year end for metro DC but we will be 86% leased based on 270 basis points of executed forward leasing and 290 basis points of existing pipeline in advanced lease negotiations. In Richmond, a 40,000 square foot tenant that was expected to stay on a short-term basis beyond year-end will be vacating on their natural fourth quarter expiration.
Absorption levels have slowed and as a result, our revised occupancy target for Richmond is 88.6% with a year end lease percentage of 90% based on existing pipeline. So as Gerry referenced in his remarks, the company will be 80% occupied and 90% leased at year-end 2012.
In terms of other business plan metrics for 2012, our revised spec revenue target of $43.3 million is 97% achieved. The $600,000 reduction is the result of our revised occupancy projection.
Same store NOI will range from 2.5% to 3% on a GAAP basis and 1.5% to 2.5% on a cash basis. Leasing spreads will range from 1% to 2% on a GAAP basis and negative 4% to negative 6% on a cash basis.
Tenant retention will be 62%. Now turning to our 2013 business plan, we had a $43.9 million spec revenue target, $13.3 million or 33% is already executed.
This early achievement percentage is similar to last year's. Leasing spreads will range 3% to 5% on a GAAP basis and negative 1.5 to positive 0.5% on a cash basis.
Leasing capital will range from $2.25 to $2.75 per square foot per lease year. These leasing assumptions and trends will translate into same-store NOI growth of 3% to 5% on a GAAP basis and 4% to 6% on a cash basis, both excluding termination fees and other income.
To conclude, we remain encouraged by the level of activity in our various markets and the quality of our inventory. In New Jersey, for instance, we’ve seen a number of larger prospects particularly in the mortgage title and insurance industries all looking to take advantage of the flight to quality.
In the Toll Road Corridor, we continue to see several technology sector and contract-based companies. In Austin, we've already executed a lease for 55,000 square feet of the Intel given back in January and are in negotiations with several others.
These trends, our inventory, the depths and quality of our regional team and the resulting operating metrics on our business plans have us excited as we close out the year and head into 2013. At this point, I’ll turn it over to Howard for the financial review.
Howard Sipzner
Thank you George and thank you Gerry as well. In the third quarter of 2012, our funds from operations or FFO available to common shares and units totaled $57.7 million.
This equated to $0.39 of FFO per diluted share and met analyst consensus for the third quarter. Our payout ratio in the third quarter is 38.5% on the $0.15 distribution we paid in July 2012.
I’d like to make the following observations regarding our third-quarter results. Our same-store NOI growth rates were positive at 0.2% GAAP and 0.9% cash both excluding termination fees and other income items.
We've now had four consecutive quarters of positive results for these metrics and are on track for our full year 2012 figure. We consider our FFO to be high quality with termination revenue, other income, management fees, interest income, JV activity and the impact on bond buybacks totaling $6.5 million gross or $5.2 million net in line with our targeted 2012 quarterly run rate.
Third-quarter interest expense of $32.6 million ticked down slightly from $33 million in the second quarter and reflects the stability of our liability platform and its limited exposure to floating rates. Our interest income declined to $311,000 as we migrated our cash balances away from securities to bank money market accounts and did not have $1.1 million income item that we recognized in the second-quarter from Trenton note repayment.
In the third quarter, we recognized $11.8 million representing the second of five annual recognitions of 20% each of the net benefit of the previously disclosed rehabilitation tax credit financing on the 30th Street Post Office. We include this income in FFO but exclude it from CAD as it is non-cash.
And lastly, $10.5 million of revenue maintaining or recurring capital expenditures, a moderate level gave us $0.21 of CAD or cash available for distribution per diluted share and an associated 71.4% payout ratio. With respect to balance sheet and financial metrics I would emphasize the following.
Our debt to GAV of 42.4%, our debt to total market cap of 53.7% and our 7.2 times net debt to EBITDA ratio are all at or near their best levels in the last 5 to 7 years. We continue to have virtually no floating-rate debt exposure with our $100 million of floating-rate debt more than offset by $241.6 million of cash and we continue to have no outstanding balance on our $600 million unsecured revolving line of credit.
We are revising our 2012 FFO guidance to $1.33 to $1.36 per diluted share versus the prior range of $1.32 to $1.36 as Gerry noted. A few highlights for the remainder of this year, we continue to expect gross other income unchanged at $20 million to $25 million coming in just above midpoint of our range or $14 million to $19 million net, in that case towards the upper end of the range for a basket of other items such as termination revenues, other income, management revenues less associated management expenses of net, interest income, JV income, including the impact of the preferred return on the Thomas Properties Group commerce square joint-venture and the 3141 Fairview financing obligation costs.
In terms of G&A, we are continuing to be unchanged in our assumptions at $24 million to $25 million. For interest expense, we are now reducing it to a projected range of $132 million to $133 million versus $132 million to $135 million previously.
We have completed all of our 2012 sales activity of $175.8 million and expect no further activity in 2012. We’re anticipating no additional issuance under our continuous equity program and no additional note buyback activity and lastly, we are assuming 146.5 million fully diluted shares for FFO in 2012.
In conjunction with this, we are increasing our cash available for distribution or CAD projection to now be in the $0.70 to $0.75 range, versus the prior $0.60 to $0.70 range per diluted share, reflecting $17 million to $20 million of additional revenue maintaining CapEx in the fourth quarter. As a result, we’re now expecting our CAD payout ratio with the same dividend level and at the midpoint of the CAD range to be at 83% for 2012.
The capital plan for 2012 is essentially done with $242 million of cash substantially meeting our needs. Our usage from October 1 forward totaled $86 million and reflects $3 million for mortgage amortization, $58 million of various capital expenditure and investment activity and $25 million of aggregate dividends on common and preferred, all of which were all already paid in October.
To fund this $86 million we are projecting the following from October 1 forward: $22 million of cash flow before financings, investments and dividends but after what will be $51.5 million of cash interest payments in the fourth quarter due to semiannual payments on unsecured notes. And lastly, we will use about $64 million of our cash balance leaving us with a projected 2012 year end cash balance of about $178 million, up substantially from our prior estimate of $114 million.
The cash balances up at number of our contingent capital expenditures did not occur in 2012 and overall capital expenditure spending remains light. For 2013, as Gerry noted, we are providing initial 2013 guidance of $1.38 to $1.46 per diluted share.
In addition to the revenue and leasing assumptions provided by George and detailed on pages 32 and 34 of the supplemental, please note the following. We’re anticipating that all other income items in our financial statements will remain in a range of $20 million to $25 million, unchanged from 2012 levels and $14 million to $19 million net after expenses for a basket of various other items that I outlined earlier.
G&A for 2013 is assumed to be unchanged at $24 million to $25 million level. We see interest expense in 2013 coming in, in the range of $126 million to $130 million.
Sales activity for the year, as Gerry noted, should represent $100 million net and maybe offset or matched by various investment activity with the expectation that it will be at a $100 million net level. For this sales modeling we’re assuming a somewhat backloaded cycle and have about 25% to 35% of NOI loss using of an 8% cap rate or approximately $2.2 million removed from the model.
We’re also anticipating the third installment of the historic tax credit income in the third quarter of 2013 at approximately $11.8 million in line with the past two years. We again assume no issuance under our continuous equity program and no additional note buyback or capital markets activity and we’re modeling 147 million diluted shares for FFO in 2013.
At the midpoint of our guidance range of $1.38 to $1.46 we will run an FFO payout ratio of 42% at the current annual $0.67 distribution level. In terms of cash available for distribution, we’re expecting it to be in the range of $0.75 to $0.85 per diluted share for 2013, reflecting $60 million to $70 million of revenue maintaining capital expenditures and at the midpoint of that range will result in a 75% CAD payout ratio for 2013.
Lastly, looking at our capital plan for 2013 as Gerry noted again, we’re very clean and very transparent with our projected $178 million of year-end 2012 cash substantially meeting or addressing our needs. Our 2013 uses total production $65 million and they represent $66 million for a combination of mortgage, amortization and a maturing note.
We’re programming about $198 million of total investment activity incorporating $65 million of revenue maintaining capital expenditures, the midpoint of the range I noted earlier, $100 million for all other capital projects such as lease-up of previously vacant space, new projects and another $33 million of contingent projects that we may or may not begin in 2013. So we are fully accounted for on that front.
We’re modeling a $100 million of aggregate dividends consisting of 89 million for our common shares and 11 million for our preferred shares, all at current payout levels. To fund this $365 million we are projecting the following: $184 million of cash flow before financings, investment, dividends and after interest payments; $100 million of net sales proceeds and lastly we anticipate we will use about $81 million of our year-end 2012 cash balance leaving us with a projected 2013 year end cash balance of about $97 million.
Again we do not expect any financings or credit facility usage during 2013 and none been modelled. Lastly, turning to credit matters and accounts receivable, we measured or showed $16 million of total reserves at September 30, 2012 in line with our June 30 balance.
Our reserves consist of $2.8 million on $16.2 million of operating receivables, 17.4% level and $13.2 million on our $130.5 million of straight-line rent receivables or 10.1%. In the third quarter of 2012, we had typical activity with respect to receivables and reserves and no major credit issues.
And with that, I will turn it back to Gerry for some additional comments.
Gerard Sweeney
That’s great, Howard. Thank you very much and George, thank you as well.
Well, to wrap up our prepared remarks, we’re pleased with our third-quarter results. As you all know and certainly we have seen in other sectors reporting earnings, the macro picture remains really a significant impediment to incorporating our optimistic assumption in anybody’s forecast.
Lot of cloud is out there. But 2012 for us will close out being a very successful year.
Most operating metrics have been exceeded and we remain very confident in the forward momentum we've created going into 2013. And in looking at 2013 we remain committed to our primary growth strategy of outperforming our market by leasing office space.
That remains our core. Our operational teams, quality product, extensive relationships continue to provide us with a competitive advantage and we certainly expect that, that advantage will become even more accentuated as fundamentals continue to improve.
With that, we’d be delighted to open up the floor for questions. We ask that in the interest of time you limit yourself to one question and a follow up.
Thank you.
Operator
(Operator Instructions) Your first question comes from the line of John Guinee with Stifel Nicolaus.
John Guinee – Stifel Nicolaus
A great quarter, you guys – and great year, you locked in the balance sheet, re-sized a lot of assets, total leverage clearly worked, in terms of asset total growth et cetera. So a few one question I guess, for Howard, talk about taxable income vis-à-vis your dividend level in 2013.
For Gerry, if you can talk a little bit about the Center City Philadelphia, what's going on with Thomas Properties Group, comp 1 and comp 2, and economics of new development in the Center City Philadelphia. For Gabe, the accounting for your DC JV assets and for George, it looks like the difference between 80% occupancy and 86% leased is about 300,000 square feet of incremental leasing which is very impressive because nobody is leasing any space in DC.
So if you can talk about the economics of those deals in DC.
Howard Sipzner
Okay. So taxable income, John, obviously we track that regularly quarterly, measuring where we stand in terms of the dividend.
2012 will be in good shape. 2013 on a preliminary basis would be in good shape.
As you know one of the things that impacts taxable income in the whole dividend construct would be sales activity. So we monitor that as well and that’s reflected already in our 2012 calculations.
Looking far ahead, it is conceivable that some time end of ’13, early ‘14 we can begin to think constructively about the dividend if the business plan holds. But no change is anticipated between now and that point.
Gerard Sweeney
Great. John, my question – my answer to your question, I think on the economics of development in center city Philadelphia haven’t really changed in the last quarter.
I think to support new ground up development from an office standpoint in the city of Philadelphia will still require triple net range in kind of $35 to $40 range. Current class base rates are still kind of in the low to mid 20s on a triple net basis.
So there still remains a fairly significant economic gap that needs to be closed in order to substantiate the new development. Hence that’s one of the reasons why I think we’re so optimistic on our ability to continue to move rents up in our inventory class in the city as there continues to be a dearth of available space and very high quality office product.
And we’ll soon be pretty well positioned within that market.
Gabe Mainardi
John, to address to your question on the DC JV, it’s a nonconsolidated venture. Of the three properties that we originally contributed two were deconsolidated.
They are not part of our discontinued operations because of our continuing level of involvement. So on the same-store page those two properties end up in the other columns.
So that’s part of the reason why the prior year other columns looked a little bit different than the current year. For the new assets, they are unconsolidated as well.
We did incur about that $1 million charge this quarter related to the loss on the formation of that venture and that charge related to a contract that we terminated at a discount during this quarter with a broker that had a right to participate in some – or earn some fees on future acquisitions. But again it was in our best interest to terminate that this quarter.
Again it was at a discount, so that’s $1 million charge was for.
George Johnstone
And John, in terms of DC leasing, we continue to be impressed with the activity levels we’re seeing, but more importantly with the ability of our team to convert that activity into executed leases. I think you got flavor for some of that in our third-quarter press release where the Metro DC was the highest volume region for the first time in many quarters.
So of the 600 basis points of pre-releasing that we expected at year-end about, half of that’s already done, and we’ve got good visibility on the pipeline that we are confident that we will convert the remainder. Those deals are running anywhere from 20,000 to 40,000 square feet and have a projected GAAP mark to market that’s positive.
But we still expect a little bit of a roll down on the cash leasing spread.
John Guinee – Stifel Nicolaus
And by the way, just congratulations to Michael Cooper. And thanks.
Operator
Your next question comes from the line of Michael Knott with Green Street Advisors.
Michael Knott – Green Street Advisors
So sorry just because it’s early on the West Coast but little grouchy about 140 basis points. I am just trying to understand how that fell so dramatically and it looks like on page 27 it was sort of widespread across every market for the year in 2012.
I am just trying to understand that and then how also the ‘12 same store guidance came up despite that. And then also the 4% to 6% for 2013 seems pretty good, which is great but just curious how that works in conjunction with occupancy being so far off.
Gerard Sweeney
I think as you kind of look at the math, Michael, and we appreciate you’re really rising on the West Coast. That 75% of our occupancy revision from the 89 towards 88 was really coming out of the Metro DC and Richmond, Virginia operations.
In Metro DC, as George touched on and can certainly amplify some more, a lot of that was due to the leasing activity that we thought would take occupancy in 2012 but actually occupancy days will slide to 2013. In Richmond, major driver there was the loss of that one tenant that we really had every evidence that they were going to stay but they gave us notice they’ve actually been moved out as George touched on, on their natural expiration date.
One of the reasons for the minimal impact on our revenue targets was that we’d assumed that this space was going to be occupied fairly late in the year any way. So it really had very little impact on our revenue overall, particularly when coupled with the fact that our leasing spreads were continuing to improve in a lot of the other operations, which George maybe can add –
George Johnstone
Yeah, and I think Michael, as you noted every region was down a little bit I think with the exception maybe of one. But we had a 50,000 square-foot deal that we thought, back in in July we were still going to get done in the Pennsylvania suburbs, that lease was associated with that tenant, procuring some contracts which they have not procured to this date.
We still feel good that if and when they do procures those contracts that we’ll have an opportunity to still gain that tenancy in ’13. And then we had one deal that we literally had to lease-out for signature on 50,000 square-foot prospect in New Jersey and at the eleven and a half hour they opted to exercise – or basically stay put in the space they were in.
So again, we kind of had outlined previously that we bought DC and Richmond would come up a little bit short. We’ve got some of the other regions, we’d have the ability to kind of make up for that and really kind of this -- the 100,000 square feet of the two deals I just referenced was really part of the cause for that.
I think as we look at next year, some of the growth that we’re projecting, again I think based on our kind of ground up budgeting on a suite by suite basis, we feel confident in that plan. We are seeing on our in-placed leases.
We’re kind of on the downside of the straight line curve. So cash rents are actually exceeding GAAP rents.
So that’s why you are seeing what we think is a very good same-store number on both the GAAP and cash basis for ’13.
Michael Knott – Green Street Advisors
Just trying to I guess synthesize a little more, so the 140 basis point delta for the end of this year, part of that is timing and part of it is unexpected tenant decisions that you didn’t expect. And then as far as the year end 2013, I think that delta was 100 basis points.
Is that right?
Gerard Sweeney
In terms of our projected year end ’13, 90 versus the lower end of our range for investing, 91 that’s correct.
Michael Knott – Green Street Advisors
And that 100 basis points is attributable obviously not to timing, so that’s just – you now have more dour view of your markets for this year than you did in June.
Gerard Sweeney
Well, look, I think it’s a fair way to characterize it, the dour might be too strong of a word. But I think certainly some of the recovery that we were anticipating in the southwest markets of Richmond, Virginia, as well as the additional pickup in the Dulles Toll Road corridor has been slower to materialize.
And we certainly have factored into our thinking the fact that we think we will probably lose one of those pieces from our Maryland portfolio as well in DC.
Howard Sipzner
Michael, it’s Howard. One other thing to think about it is, it is true that we dropped 140 basis points on occupancy.
But we only dropped the back end of 2013 by 100 basis points. So we’re actually seeing very good levels of similar, if not greater, activity in 2013 and when you waive the occupancy over the course the year, it ends up being - we expect a bit more front-loaded and therefore will allow us to maintain the same store guidance.
Operator
Your next question comes from the line of Josh Attie with Citi. Mr.
Attie, your line is open. There is no response from that line.
Your next question comes from the line of Jordan Sadler with Keybanc Capital Markets.
Jordan Sadler - Keybanc Capital Markets
But I am curious also on sort of your comments, Gerry, the open on recent tenant caution. It’s similar to what we've heard from some of your peers in the space.
And I'm just curious given sort of the tenant in that context and sort of the lowered occupancy for year end, what gives you the confidence that we won’t see further slip through ’13?
Gerard Sweeney
Jordan, I apologize, the first part of your question got cut off here. So –
Jordan Sadler - Keybanc Capital Markets
No worries. I was just remarking on the tenant caution piece that you sort of alluded to at the beginning of your commentary and how that plays into sort of your expectations for ’13.
Are you feeling -- how confident are you that things won't slip in ‘13 like they slipped in the last 90 days?
Gerard Sweeney
Well, I think it’s a great question. Certainly something we spend a lot of time with our regions reflecting on and kind of debating the best course of action.
We always do conclude that the best course of action is to convert our pipeline as quickly as we can, and I think that's what I guess from systematic standpoint gives us the most confidence that will be able to execute on the goals that we’ve outlined. But in terms of tenant caution, I mean, look, there is no question that with -- these macro forces really do affect companies’ investment strategies.
And I know – on some calls there has been discussions about larger tenants that are being much more decisive, smaller tenants are being less so. We haven't really seen that bifurcation in tenant psychology.
I think it's a matter of degrees but we clearly over the last 30 to 60 days have seen tenants continue to push the deals through their pipeline, and as George mentioned, the compression of deal execution time actually compressed in the third quarter versus the previous quarter. But in conversation and discussion with tenants, I think there is – there remains this sense of let’s wait and see what happens with presidential election, let’s wait and see what happens with the fiscal cliff.
Now those discussions tend to be more accentuated in the Maryland and DC markets, but they clearly pervade I think everyone's thought process. So when we look at it in terms of addressing the core of your question, we’re very confident that this continued pipeline we see, the ever improving number of space inspections we have and our conversion rate puts in a very good position to achieve our ‘13 goals.
One of the important considerations we’re going to take a look at as we’ve all touched on, the absolute level of leasing activity we’re projecting for 13 is actually slightly down from what we achieved in ’12. One of the reasons for that is we’ve been risk assessing what our vacancy is, a lot of our vacancy is in those markets that are more challenged than the Crescent markets or CBD or the Austin, Texas markets.
So I think we’ve really taken a very granular ground-up approach to our leasing process. It’s to really assess what we think is really achievable based upon how we are reading the current figures.
Jordan Sadler - Keybanc Capital Markets
And just sort of the investment activity as a follow-up, what are you seeing in the pipeline? Are there good opportunities out there?
Are they similar to what they've been, how are things changing there?
Gerard Sweeney
I think we’re certainly – we don’t really – if you take a look at our activity year, we’ve only booked out one property in Plymouth Meeting, Pennsylvania that we’re in the process of rehab and that was purely a value add. But we made our investment with Allstate and Station Square properties in Silver Spring.
The pipeline right now is pretty robust. We have nothing under agreement.
We are certainly looking at expanding our footprints in some of our core long term markets but it’s still the core Philadelphia suburbs, Austin. Tom continues to work with our DC team on the Allstate venture and what we are seeing in that market.
We still are very focused on identifying higher quality product, urban or more town center, transits hub is a key issue, diversifying our rent roll and identifying those situations where we can deploy capital into a more value add opportunities we can actually think make a difference in increasing the rates of returns. But Tom, maybe share your thoughts on what you are seeing down the DC of Allstate.
Thomas Wirth
I think on the DC market, the transaction volume have slowed, compared to some of the other markets where it’s been a little more steady or picked up a little. I think DC has slowed quite a bit.
Usually right near the end of the third quarter, lot of transactions appear as people look for 2012 closings by year-end, and that really hasn't occurred down there this year. The difference in pricing expectations between the buyers and sellers continues to be a pretty big divide.
I think that the buyers have taken a more cautious view of the underwriting. I think if you look at projections of rent growth with all the uncertainty around sequestration in budgets that you're seeing a ratchet down on what people think is going to be the rent growth.
So that absolutely translates in the lower pricing. And in most cases the sellers don't have to sell, so you’ve seen some of that just put on pause.
Occasion traced that back to the late summer where we saw five transactions in the CBD, about 1.8 million square feet that were either pulled or didn’t transact. So you start to see that slowdown start to occur and we’ve seen it so far this quarter.
But to that point we’re still looking at transactions. We have been hearing there is some product coming out soon.
Hopefully that logjam changes.
Operator
Your next question comes from the line of Steve Sakwa with ISI Group.
Steve Sakwa - ISI Group
I guess, Gerry as you think about transitioning the portfolio and you talked about kind of the transit hubs and kind of the more urban core, what percentage of your portfolio would you say kind of doesn’t fit that characteristic? And I guess given the fairly favorable debt markets today could we see you accelerate that and could you possibly be a larger net seller next year?
Gerard Sweeney
Look, the debt markets are very favorable. Steve, there is no question.
I think as evidenced by the success we had with the Allstate venture, Silver Spring we did secure the financing at 3.3% and then certainly the work that Howard does on tracking what’s happened in the unsecured market, I mean our secured rates are coming quite nicely. So certainly the ability to look at our debt portfolio is at the top of our list.
In terms of selling assets, clearly the favourable debt markets I think are key catalysts there. When we talk to a lot of institutional investors who are focused on deploying large amounts of capital, the office sector, we shift to a great degrees of proxy for economic growth.
So you really do have people kind of monitoring how they think the economy will perform looking at office because that’s a clear derivative but in addition to that the relative yields on office I think remain a bit high compared to some other real estate sectors. So I think from a relative yield, proxy for economic growth, two key predicates certainly fueling that is very low cost of debt and frankly, the ample availability of secured financing.
So as we do every year at this time, we kind of focus on what we think market number is. We would expect to be in a range of being a net seller next year.
We certainly could see an acceleration of our sales programs, something Tom and his team do on a constant basis is respond to reverse inquiries, talk to money sources, talk to brokerage community. And if that's what we think the appetite might be for some of our non-core properties.
So I think for modeling purposes right now as Howard outlined we played in $100 million of net sales activity, little more back ended. Certainly based upon the pipeline and our activity levels, that could change.
But in an any event I think the core predicators on which to provide in the company is being a net seller over the next couple of years is a key component of our deleveraging plan as well. So we sold more, we would look to probably be optimistic and deploy a little bit more capital always remaining a net seller.
Operator
Your next question comes from the line of Brendan Maiorana with Wells Fargo.
Brendan Maiorana – Wells Fargo
With for George – George, if I look at the numbers for next year, it looks like you guys need to do about 1.3 million square feet of new and expansion leasing if you're doing 62% retention. Is that the right number and how much of that do you have embedded in terms of commencements that are going to start next year for new and expansion leases relative to the 1.3 that you need to get done?
George Johnstone
Brendan, yeah, we’ve got actually -- our plan calls for about 2 million square feet of new and about 1.6 million square feet of renewals. And we've got I guess about 20% of that combined square footage done at this point.
Brendan Maiorana – Wells Fargo
Is that -- just going back to historical numbers, it looks like that’s a high bar relative to what you guys had done in the past and you’re expressing some cautioning here. So is there something that’s driving that level of improvement?
George Johnstone
Well, our 2012 plan we had 3.8 million square feet and about that same $2 million target amount of new deals. So kind of the same number in terms of new and because of the lower rollover in ‘13 the gross amount of renewals are down year over year.
Brendan Maiorana – Wells Fargo
Maybe I will have to follow up offline because I think I was looking at numbers little bit differently. And then just a follow up question for Howard.
Howard, how much of – it looks like your straight-line of rent is a high portion of revenue today relative to where it’s been historically. How much of the improvement in same store NOI is going to be driven by that straight-line rent number moving down throughout ’13?
Howard Sipzner
Well, it will move down quite significantly. Kind of look at what the quarterly run rate has been, in the past couple of quarters, we ran pretty high in 2012 but we were already off our peak, if you kind of followed the quarters through we were at about $7 million in the first quarter, $6 million in the second and $5 million in the latest.
So it's coming down already. To some degree it will be re-raised so to speak by incremental leasing that takes place over the balance of this year into next year.
But somewhere on a steady state basis, once the leasing settles in, it should be in the $4 million per quarter area. And the ultimate reduction from where it's been historically in 2012 is what will lead to the higher cash same-store NOI performance.
Operator
Your next question comes from the line of Jamie Feldman with Bank of America.
Jamie Feldman – Bank of America
First, I just want to clarify in terms of commencements that are already in the bag for next year, what was the number you gave?
Howard Sipzner
We said 21% of the 3.6 million square feet.
Jamie Feldman – Bank of America
For 2013?
Howard Sipzner
Yes.
Jamie Feldman – Bank of America
And then just -- I mean there is a lot of concern out there about meeting of leasing targets. Can you just give us a sense of kind of what you are working on?
What are the chunkiest leases that can really take down these numbers pretty dramatically? I know you’ve got Pepper Hamilton and Drinker Biddle and the works in Phily.
But both in terms of potential renewals and even new leases you are working on. What are some of the magnitudes where people were talking about of your largest ones?
George Johnstone
Sure, well I mean in terms of ‘13 and as we’ve talked previously we’re going to be getting back roughly 117,000 square feet from Intel down in Austin. We've signed 55,000 square feet to backfill that and we’ve got a number of prospects.
Also down in Austin, we’re getting 72,000 square feet back from Freescale in August and many of the same prospects are looking at both of those building apartments skyway. We've got obviously some -- we've got about six full floors of vacancy at One and Two Logan and Philadelphia CBD.
So you’re looking at 20,000 plus square foot floor place that you get the single floor, multiple floor users to take down that space. We still have 90,000 square feet in a single building over in Mount Laurel, New Jersey.
And we’ve seen some larger sized prospects looking at that. So those are kind of the bigger pieces of our vacancy composition.
Jamie Feldman – Bank of America
Yeah I guess what I am asking is more of the leases you’re contemplating to get to your number. If you’d just started the largest and kind of give the top tenant, and so how big are they that can really move the needle with a couple tenant lease signing yourself?
George Johnstone
Yeah, we’ve got leases ranging from 50,000 square feet plus down to 3000 and 4000 square foot range, it really kind of runs the gamut based on the various sub-markets.
Gerard Sweeney
And Jamie, I mean relative to two law firms you mentioned, they are really 2014 plus events. So they’re not really factored into our 2013 numbers at this point.
Jamie Feldman – Bank of America
And just a follow-up on leasing in general and especially as you grow in the CBD, a lot of talk on certainly in your calls there’s been a more efficient floor place, more employees per square foot, have you seen that hit still yet, do you think it will? And kind of where are in that process in terms of just – and instead using less space per employee?
Gerard Sweeney
It’s a broad-based phenomenon in the office sector where tenants are very much focused on increasing the degree of density of employees, the moving almost from a rental rate construct to average cost of occupancy per employee. So I think as we look at our inventory stock we’re very focused on what are the things that make our space marketable and have competitive advantage even if given with that phenomenon occurring.
So it really comes down to window line column spacing and ceiling heights, HVAC delivery systems. But look, I think that's technology and cost considerations that clearly impact that I think the amount of space per employee that a lot of tenants look for.
We've actually benefited from that by having tenants consolidate out of lower quality product into our product. So our footprints are more efficient, lower loss factors, a much higher levels of sustainability energy management systems.
So that's one of the reasons why we are very focused on the higher end quality stock throughout our portfolio. That will position us to both the receiver for companies consolidating out of lower quality space and position us well for expansions of our existing tenants who are very much focused on those efficiency considerations.
Operator
Your next question comes from the line of Rich Anderson with BMO Capital Markets.
Rich Anderson – BMO Capital Markets
So why is FFO growing by 6% next year and CAD by 10% given all of the uncertainty? I guess I would have thought that the opportunity to grow would be put up.
Howard Sipzner
Well, we go through Rich, it’s Howard, and we model on a lease by lease basis, what we think the capital spend will be. And when we layer that into the FFO modeling we’re pretty comfortable with that new range.
Rich Anderson – BMO Capital Markets
Are you saying then that the need to spend money is coming down even though the environment continues to be uncertain?
Howard Sipzner
I think it’s two factors. I think number one, we have done a good job at the leasing level and controlling CapEx.
And the other factor is the retention that we do and the degree which that contributes to a lower overall capital expenditure. On some of these renewals you're still spending some dollars, on others you’re spending very little.
And then certainly the new leasing can be all over the map, but when we add it all up we look at the most likely outcome for the business plan. We're expecting manageable capital next year which will result in a pretty strong CAD number.
Rich Anderson – BMO Capital Markets
And a follow-up somewhat unrelated question, the Toll Brothers joint-venture getting into residential housing, realize it’s kind of smaller relative to the overall size of the company but somewhat symbolic in the sense that you're going down a different path. Can you talk to us about what are the – why you’re doing that, why you’re getting in the residential housing and for what extent, would this be the model to monetize your land bank on a go forward basis?
Gerard Sweeney
Rich, good question. If you step back for a second, I mean take one of the intangible assets companies like ours, really is our very strong and an extension of local relationships.
And that does create a real franchise that’s giving us the ability to navigate the approval, the regulatory, the political, the labor constructs is only redone. I think as we outlined a number of months ago in terms of our land program, our decided approach is to take some of our land that’s currently zoned for office and test market that or sell to people for other uses.
And we’ve done that, we will continue to do that but in some cases, as in the case of Plymouth Meeting it was a much more viable program for us to commence that rezoning approval process ourselves, try and create value through that approval process using our local contacts. And as we went through that, certainly handled reverse inquiries and the overtures from residential companies on buying the land.
Now in the case of Plymouth Meeting, we thought there was significant development that we created for our company. So in that case we opted for a fair market value land contribution, aligning ourselves with a very seasoned, very well qualified and financially deep residential company.
We were very confident of the location and the product success. And frankly our land contribution and all working capital requirements, and we would create a significant profit opportunity of the company.
So in those cases, the joint-venture seems to be a more attractive route from a profit generation standpoint. From our standpoint, we’re not really entering the residential business.
We’re simply contributing land that we went through the approval process on to create a profit opportunity for the company and hiring a residential company on a venture-basis but they are contributing significant capital as well to make that project a success.
Operator
Your next question comes from the line of Michael Knott with Green Street Advisors.
David Anderson - Green Street Advisors
Good morning guys. It’s David Anderson.
Just a couple quick questions. Do you guys have any a embedded in the ’13 numbers on Lockheed?
I know that 200,000 square feet, any sense of how that is going to play out?
George Johnstone
Yeah, as we had expected and contemplated, we have done a short term renewal on the larger of the two Lockheed spaces down in Maryland. So the larger one was 137,000 square feet, that has extended.
The other one, we’re still discussing with them but the numbers for ‘13 assumed that they move out on their expiration date of May 31. And the balance of the leases we have with Lockheed through Pennsylvania and New Jersey are still contemplated too in the south.
David Anderson - Green Street Advisors
Just also for the acquisition guidance, that’s the $75 million that is inclusive of your pro-rata portion of the JV or – is the JV acquisition not included in that number?
Gerard Sweeney
No, we haven’t identified any acquisition but we contemplated that number would incorporate our pro-rata share with the JV, correct.
David Anderson - Green Street Advisors
Just one other quick question, just looking over the last quarter supplemental and this quarter, the percent of leasing still seemed to tick down a little bit, is only CBD specifically? Was there any specific drivers there, or is that just more and just more clarity on stuff that you thought would happen but actually tenant already thought as the year went along?
George Johnstone
Sure. All the large leads that we had actually commences during the quarter.
So it’s just from pre-lease and occupied and we obviously did not have any comparable amount of forward (inaudible) to kind of offset that.
Operator
Your next question comes from the line of Mitch Germain from JMP Securities.
Mitch Germain – JMP Securities
Gerry, what’s – or maybe George, what’s the success rate of your all the pipeline? I think you previously mentioned about 40-ish percent?
Gerard Sweeney
Yeah, our run rate has gotten in that low to mid 40s. We actually had about 44% for Q3 but really kind of for the last call it 18 months, we've been kind of running in that 40% to 45% range.
Operator
Our final question comes from the line of Josh Attie with Citi.
Josh Attie – Citigroup
For 2013 it looks like about a third of your speculative revenue target is coming from DC and Richmond and more than half of that has not been locked in yet. Can you talk a little bit about that portion of the guidance, how much visibility do you have on it?
Gerard Sweeney
Well, for DC, about half of it has been locked in. So and obviously we've got what we think is a relatively healthy pipeline, and obviously the half that’s not locked in has more of a second half of ‘13 occupancy event tied to it.
Richmond, if we've only got 14% of the spec revenue locked in at this point. But again I think what we continue to see in Richmond is that deals seem to come to the market and get executed a little bit quicker.
I think if you went back and kind of look at the quarterly charts, Richmond probably is closer to the bottom of the stack in terms of pre-leasing as compared to some of our other regions where the some tenants are just out in the market that much more in advance. But certainly some work to do in both of those regions.
Josh Attie – Citigroup
And when you talk about the second half of 2013 commencements for DC, I mean those leases could obviously be signed before then?
Gerard Sweeney
Sure. Yeah, I mean I think as we have said, we expect to have that portfolio 86% pre-leased by the end of 2012.
Operator
At this time, there are no further questions. Gentlemen, any closing remarks?
Gerard Sweeney
Okay. Great.
Thanks everyone for participating the call. And we look forward to keeping you updated on our next call after the end of the year.
Thank you.
Operator
Thank you. This concludes today’s conference call.
You may now disconnect.