Apr 26, 2013
Executives
Pamela M. Garibaldi - Vice President of Investor Relations & Corporate Marketing Michael F.
Foust - Chief Executive Officer and Director Arthur William Stein - Chief Financial Officer, Chief Investment Officer and Secretary John Sarkis - Vice President of Connectivity & Carrier Operations
Analysts
Jonathan Atkin - RBC Capital Markets, LLC, Research Division Jordan Sadler - KeyBanc Capital Markets Inc., Research Division Emmanuel Korchman Vance H. Edelson - Morgan Stanley, Research Division Robert Stevenson - Macquarie Research Matthew Rand - Goldman Sachs Group Inc., Research Division Vincent Chao - Deutsche Bank AG, Research Division Jonathan A.
Schildkraut - Evercore Partners Inc., Research Division George D. Auerbach - ISI Group Inc., Research Division Gabriel Hilmoe - UBS Investment Bank, Research Division John Stewart - Green Street Advisors, Inc., Research Division Michael Bilerman - Citigroup Inc, Research Division Omotayo T.
Okusanya - Jefferies & Company, Inc., Research Division
Operator
Good afternoon, and welcome to the Digital Realty 2013 First Quarter Earnings Call. My name is Mackenzie, and I will be facilitating the audio portion of today's interactive broadcast.
[Operator Instructions] At this time, I would like to turn the call over to Pamela Garibaldi, Vice President of Investor Relations.
Pamela M. Garibaldi
Thank you, Mackenzie. Good morning, and good afternoon, everyone.
By now, you should have received a copy of the Digital Realty earnings press release. If you have not, you can access one in the Investor section of our website at www.digitalrealty.com or you may call (415) 738-6500 to request a copy.
Before we begin, I'd like to remind everyone that the management of Digital Realty may make forward-looking statements on this call. Forward-looking statements are based on current expectations, forecasts and assumptions that involve risks and uncertainties that could cause actual results to differ materially.
You can identify forward-looking statements by the use of forward-looking terminologies, such as believes, expects, may, will, should, pro forma or other similar words or phrases; and by discussions of strategy, plans, intentions, future events or trends or discussions that do not relate solely to historical matters. Such forward-looking statements include statements related to rents to be received in future periods, lease terms, rental rates, leasing and development plans, supply and demand, data center sector growth, acquisitions and investment plans, returns, cap rate, capital markets and finance plans, debt maturities, capacity and covenant compliance, the company's growth, financial resources and success, our connectivity initiatives and deployment plans and the company's financial and other results, including the company's 2013 guidance and underlying assumptions.
For a further discussion of the risks and uncertainties related to our business, see the company's Annual Report on Form 10-K for the year-ended December 31, 2012, and subsequent filings with the SEC, including the company's quarterly reports on Form 10-Q. The company disclaims any intention or obligation to update or revise any forward-looking statements whether as a result of new information, future events or otherwise.
Additionally, this call will contain non-GAAP financial information, including funds from operations or FFO; adjusted FFO or AFFO; core FFO; earnings before interest, taxes, depreciation and amortization or EBITDA; adjusted EBITDA; net operating income or NOI; and cash NOI. Digital Realty is providing this information as a supplement to information prepared in accordance with GAAP.
Explanations of such non-GAAP items and reconciliations to net income are contained in the company's supplemental operating and financial data package for the first quarter of 2013 furnished to the SEC and available on the company's website. Again, that's www.digitalrealty.com.
Now I'd like to introduce Michael Foust, CEO; and Bill Stein, CFO and Chief Investment Officer. Following management's brief remarks, we will open the call to your questions.
[Operator Instructions] I will now turn the call over to Mike.
Michael F. Foust
Great. Thank you, Pamela, and welcome to the call, everyone.
I'll begin today's call with a few comments regarding the important global network connectivity initiatives we announced yesterday, and will follow up with a brief summary of our first quarter operations. After my remarks, Bill will discuss our recent capital markets activity and first quarter financial results.
Following his remarks, we'll open the call to your questions. During the Q&A today, we're pleased to have with us John Sarkis, our Vice President of Network and Carrier Operations, and he's available to answer specific questions related to yesterdays Digital Realty Ecosystem announcement.
As stated in that announcement, the launch of this strategic initiative takes our global portfolio to the next level in terms of providing customers with a carrier-neutral network connectivity offering. From the beginning, our strategy has been to consolidate and grow a global portfolio of enterprise-quality data centers.
This included acquiring key Internet gateway network hubs, data centers that offer our customers network-intensive applications, which are ideal locations to house their mission-critical business systems. At the same time, we've grown our portfolio of corporate data centers, expanding our footprint by assembling a high concentration of properties in key markets globally.
So today by leveraging our global footprint and operating platform, we plan to deploy the Digital Realty Ecosystem across our portfolio, providing a neutral, efficient and connectivity-rich environment for our customers to connect, not only to any carrier of choice, but directly to one another. Beginning with our major campus locations including New York; New Jersey; Boston; Ashburn, Virginia; Chicago; Dallas; Santa Clara; as well as Metro London, we'll be running high count dark fiber between buildings, enabling us to offer customers a "plug and play" GigE product, as well as straight dark fiber cross-connects to customers carriers and service providers campus-wide.
Furthermore, this ecosystem will provide an underlying infrastructure for carriers and service providers to deliver their entire portfolio of products and services to our customers without them incurring the typical capital-intensive deployment cost. We see this strategy as a critical component of our evolution that will further advance our global leadership position as the data center provider of choice for both wholesale and retail colocation customers.
At the same time, it adds significant value to our portfolio, giving us a competitive advantage that is unmatched in the industry. In addition to this exciting initiative, we are very pleased with the pace of leasing activity so far this year.
We achieved our highest level of first quarter lease signings, totaling over $43.7 million of annualized GAAP rental revenue, which was also our third-highest quarter on record. The results this quarter, in particular, reflect the success of our Custom Solutions product strategy, enabling us to capture large requirements from cloud infrastructure providers, as well as cloud-based services.
In North America, the average annual gap rental rate for leases signed in the quarter for our Turn-Key Flex pace was $141 per square foot. This compares to the 2012 average rate of $151 per square foot.
Please keep in mind that the fourth quarter 2012, the average rate for leases signed was $177 square foot, which was higher than our typical average. We believe that the $141 per square foot is more in line with historical averages over the last couple of years.
On a per kW per month basis, the weighted average rental rate was approximately $177 per kW. For our Custom Solutions product, the average gap rental rate was $108 per square foot, and the weighted average rate for per kilowatt per month was $137.
The lease rates for Custom Solutions space reflect the build-to-suit nature of the projects, including the elimination of leasing risk and carry and oftentimes, lower development costs for us based on the customers' engineering requirements and the needs for ancillary space. The stabilized projected ROI for these leases range from 8.3% to 12%.
Markets where we saw the highest global activity in the U.S. included New York, New Jersey, Greater Chicago and Northern Virginia.
Recently, Digital Realty entered into an agreement with the Virginia Economic Development Partnership that will allow the company and our tenants in our data center facilities located in Loudoun County to obtain an exemption from sales and use tax on the purchase of certain data center and computer-related equipment. We believe making this favorable tax treatment available to our customers adds significant value to our digital Ashburn campus.
Excluding leases that commenced in the first quarter, the additional signings bringing our total backlog to $84.2 million of annual gap rental revenue. Another record high, of which, $45.3 million is expected to commence in 2013; $21.5 million in 2014, 2015; and $17.4 million expected to commence thereafter.
Please note that our backlog represents committed lease contracts that have been signed but have not yet commenced. By contrast, excluding the leases we signed during the first quarter, our leasing prospects pipeline for our new facilities ticked up slightly from our last call to about 2 million square feet of prospects.
This figure represents current prospects in our sales funnel to whom we've made proposals and we believe have a 30% or greater likelihood of signing. Notably, these new requirements tend to fall on categories: The first is the large multi-megawatt requirement similar to the Custom Solution leases we signed in the first quarter.
Customers that fall into this category include financial -- global financial institutions, health care, traditional Internet enterprises, social media, cloud providers and large system integrators. By contrast, the second category consists of customers of varying sizes, representing an even broader range of industry verticals.
These customers are often looking to lease data center space in smaller increments, sometimes less than 1 megawatt. These are our more traditional TKF or colocation customers, are looking for move-in ready space with the flexibility to expand then within our portfolio.
Offering customers a full suite of data center solutions is key to our strategy and sets us apart from all of the other data center providers in the market. In addition, our geographic footprint scale, combined with our design and construction expertise and offering platform, enables us to meet a wide range of customer requirements while achieving attractive return for our shareholders.
In fact, the weighted average 1 year -- year 1 stabilized return on investments for Turn-Key leases signed during the quarter was just over 13%. In terms of overall supply and demand, there are a handful of U.S.
markets that have had meaningful shifts. For example, more than 3-megawatts either way up or down, from what we provided in our Analyst Day presentation.
Moving east to west, we are now tracking approximately 36.1 megawatts of potential demand in Northern Virginia, up from 32.2 megawatts. This compares to 24.5 megawatts of supply built or under construction currently.
Chicago saw one of the largest increases with 34.6 megawatts of track demand, up from 18.1 megawatts previously. This compares to an increase in supply of 6.7 megawatts, resulting in a shortfall of supply approximately 18.3.
Demand in Silicon Valley jumped to 25.5 megawatts from 9.4 at the end of January as did supply, resulting in a smaller surplus of supply of 4.7 megawatts. While Dallas still shows a healthy level of demand at 25.7 megawatts, it's the only U.S.
market that decreased. And they decreased from 32.6 megawatts we reported last quarter.
By comparison, supply in Dallas increased only slightly, resulting in a shortfall of supply of about 5.3 megawatts. However, there have been recent announcements of planned new construction for the Dallas metro.
Turning to our lease renewals during the quarter. Including re-leased space, we signed approximately 233,000 square feet of data center space at overall renewal rates that increased 0.8% in a GAAP basis, and decreased 18.2% on a first year cash basis.
This decrease was solely due to 2 leases that we renewed with a particular top 5 customer in a New Jersey property. They were signed at the top of the market in 2008, and the renewals were subject to very aggressive pricing by 2 competitors in the New Jersey market.
It is important to emphasize that these leases represent only 0.6% of our total annual revenue and do not reflect mark-to-market for the balance of our portfolio. From a strategic perspective, by renewing these leases, we were able to expand the customer into additional data center space in the same building, actually resulting in a net increase of $2.7 million of annualized gap rental revenue for the property.
That said, our portfolio's geographic diversity limits our overall exposure to these markets versus other data center landlords who are concentrated in Northern Virginia, New Jersey and Silicon Valley exclusively. For example, excluding the 2 leases we just noted, rates on renewals were actually up across all product types, including TKF, which was up 18.3% on a cash basis and up 22.7% on a GAAP basis.
Powered Base Building was up 0.2% just slightly in the cash basis and up fully 24.5% on a GAAP basis. Colocation, up 14.5% in a cash basis and 14% in GAAP basis.
And for nontax space, up 2.3% on a cash basis and 5.6% on a GAAP basis. As further evidence of the strength and resiliency of our portfolio, including space that re-leased in the quarter, the combined average retention rate for data center space in the quarter was over 97%.
On a square foot basis, over 93% of Turn-Key Flex space representing 97% of gap rent, renewed in an average term of nearly 107 months. We also renewed, re-leased 100% of expiring PBB space, reflecting 124.5% of gap rent, with an average lease term of over 147 months.
The healthy length of renewals, along with the annual 2.5% to 3% contractual increases, allows us to recapture any decline in cash rents after year 2 or 3 on the new term on average with continuously growing cash flow thereafter. Looking at our projected renewal activity for the balance of 2013 and for the full years 2014, 2015, we project rent spreads for data center space to be relatively flat on a cash basis and up approximately 20% on a GAAP basis.
Occupancy was 94% in the first quarter, down slightly from 94.4% the previous quarter, primarily due to the expiration of non-data center lease, office lease in a tech building in Fremont, California. We're currently marketing space to office users and will consider selling the property once it's been stabilized.
This decrease was partially offset by the commencement of new leases, totaling 27,000 square feet on our existing data center inventory; the commencement of leases from our development program, totaling nearly 94,000 square feet and the acquisition of 4 100% leased buildings. Same-store occupancy also decreased for the fourth quarter slightly, 93.7% to 93.1%, due to the same non-data center office lease expiration.
Turning now to our acquisitions program. We began the year with a healthy level of activity that included 2 properties, totaling 4 buildings that were 100% leased, one of which was the sale-leaseback with a major airline in the Minneapolis metro.
The blended going-in, unlevered cash cap rate for the first quarter stabilized acquisitions was over 11%. In addition, we acquired another development project adjacent to our Chandler, Arizona property for running future inventory in this growing data center market, as well as a development project in suburban Toronto, Canada where we're seeing significant demand from new and existing customers for data center space.
Our current pipeline and prospects for acquisition totals nearly $1 billion including high-quality stabilized property, value-add opportunities, ground up development sites, as well as sale-leaseback transactions. This does exclude larger portfolios that we continue to track.
Finally, I will briefly review our development program. We continue to ramp up construction to add supply in select markets to meet current demand.
Current development activity includes nearly 549,000 square feet of Turn-Key Flex space that is 14.3% pre-leased, over 200 -- over 276,000 square feet of Custom Solutions space that is 100% pre-leased, and approximately 564,000 square feet of Powered Base Buildings for future inventory in key markets. Detailed information in our development activity by market can be found on Page 29 of our first quarter supplemental package.
We are very pleased with the strong start to 2013 and are equally excited about the new initiatives we are working on and we believe will further enhance the value of our global portfolio. These initiatives, combined with our commitment to delivering a wide range of superior data center solutions for our customers, will continue to drive earnings growth.
I'd now like to turn the call over to Bill.
Arthur William Stein
Thanks, Mike. Good morning, and good afternoon, everyone.
I will begin with reviewing our capital markets activity, and then discuss our first quarter 2013 financial performance and guidance. Year-to-date, we have sourced nearly $885 million of new capital, including the GBP 400 million 12-year unsecured note bond offering with 4.25% coupon, which was equivalent to USD 634.9 million based on the exchange rate on the date of issuance, and the 5.875% Series G Cumulative Redeemable Preferred Stock offering in April, which generated gross proceeds of $250 million.
Our funding strategy includes issuing debt in local currencies to provide a natural hedge, mitigating our exposure to foreign currency fluctuations in our growing international operations. Local debt, as a percentage of regional in-country assets, range from 50% to 96% depending upon the country.
In reviewing our balance sheet, total assets grew to $9 billion in the first quarter compared to $8.8 billion last quarter, which is consistent with the continued growth and scale of our business. Deferred rent increased by $19.1 million to $340.8 million this quarter, compared to $321.7 million last quarter due to incremental new leases.
Deferred rent as a percentage of rental revenue at 7.5%, remains consistent with our historical average. Total debt increased to $4.7 billion at the first quarter 2013 compared to $4.3 billion last quarter.
We currently have $1.5 billion of immediate liquidity, including $84.5 million in short-term investments plus funds that can be drawn on our credit facility. If this capacity were fully utilized, we would remain in full compliance with covenants contained in the credit facility, our term loan, our Prudential Shelf Facility and other unsecured debt.
In 2013, we had $219 million of remaining principal amortization and debt maturities with a weighted average cost of 6%, which we plan to retire initially with the revolver and eventually refinance with additional long-term unsecured debt, secured debt or preferred stock. Our net debt to adjusted EBITDA ratio was 5.5x at quarter end, up from 5.2x at the end of the fourth quarter last year.
This increase is due to additional borrowings to fund the development and acquisitions program. Pro forma for the recently issued preferred equity, net debt to adjusted EBITDA is 5.2x.
Our GAAP fixed charge ratio decreased to 3.5x at the end of the first quarter compared to 3.8 in the previous quarter. Let me now turn to the quarter's financial results.
All per share results are on a diluted share and unit basis. As stated in today's earnings release, first quarter 2013 FFO was $1.16 per share in line with fourth quarter 2000 FFO of $1.16, and up 9.4% from first quarter 2012 FFO of $1.06 per share.
Adjusting for items that do not represent core expenses or revenue streams, first quarter 2013 core FFO was $1.18 per share, $2.9 million higher than reported FFO. These adjustments largely resulted from transaction expenses and fair value adjustments related to the central earnout.
As I noted on our last call, a fair value assessment on the 3-year Sentrum earnout obligation is required in each reporting period and is likely to result in some quarterly earnings fluctuation. Changes in fair value are considered noncore adjustments.
Quarter-over-quarter, core FFO decreased slightly from $1.19 per share in the fourth quarter, primarily due to higher interest expense, as well as G&A and tax expenses, which were offset by higher NOI in the first quarter and was up 11.3% from first quarter 2012 core FFO of $1.06 per share. Adjusted funds from operations or AFFO for the first quarter of 2013 was $123.6 million, up $115.8 million in the previous quarter.
The diluted AFFO payout ratio for the first quarter of 2013 was 84.1%, up from 82.6% in the last quarter. Adjusted EBITDA at quarter end of $212.6 million grew by 4.2% from $204 million last quarter and was up by 23.6% from $172 million in the first quarter of 2012.
Turning now to the income statement. Net operating income increased by $7.7 million or 3.5% to $227.3 million in the first quarter of 2013 and from $219.6 million last quarter.
The increase was due to incremental revenue from new leasing and acquisitions, as well as approximately $900,000 in insurance proceeds related to Hurricane Sandy. These are partially offset by an increase in property taxes and the present value accretion adjustment related to the Sentrum earnout as previously mentioned.
Property, taxes increased by $1.3 million to $21 million in the first quarter 2013 from $19.7 million last quarter due to tax assessments at 2 properties, a portion of which was recoverable from tenants. NOI margins, excluding utility reimbursements, increased by 60 basis points and remained consistent with historical levels.
Likewise, first quarter same-store NOI increased by $9.3 million to $195.4 million, compared to $186.1 million in the previous quarter. Same-store cash NOI, which we define as same-store NOI adjusted for straight-line rents and adjusted for noncash purchase accounting adjustments, was $174.7 million in the first quarter up 5.6% from $165.4 million last quarter.
The increase quarter-over-quarter was largely due to an incremental revenue from new leasing and the insurance proceeds related to Hurricane Sandy previously mentioned. G&A increased to $16 million in the first quarter compared to $13.4 million in the last quarter, primarily due to certain 2012 year-end accrual adjustments amounting to $1.9 million, which reduced G&A in the fourth quarter.
Interest expense increased by $7.7 million to $48.1 million in the quarter from $40.4 million last quarter primarily due to the sterling bond issuance and lower capitalized interest in the quarter. Tax expense increased to $1.2 million in the first quarter of 2013 compared to $10,000 last quarter, primarily due to noncash deferred taxes based on booked-to-tax differences from foreign operations.
While we do not give quarterly guidance, I would like to bring your attention to a few items that we anticipate will impact next quarter's results. First, our Series G Preferred Offering which closed in early April, will result in approximately $3.4 million of incremental preferred stock dividends in the second quarter, which will be partially offset by interest expense savings of $830,000 from repayment of revolver borrowings.
Second, we expect NOI growth to be partially offset by $800,000 each quarter through the rest of the year due to the non-data center lease expiration at the Fremont, California tech office property, which Mike referenced in his remarks. And third, while we are not revising 2013 guidance at this time, we are closely monitoring foreign exchange rates and plan to revisit their impact on our 2013 guidance at the end of next quarter.
Finally, in reviewing consensus estimates, there are a few items that do not appear to be reflected in some of the 2013 models. The first item relates to $3.4 million increase in capitalized interest in the fourth quarter of 2012 from the third quarter that was due to the inclusion of additional qualifying activity.
We expect capitalized interest to normalize at approximately $5 million per quarter. Also as a reminder, we manage to a 5.5x debt to adjusted EBITDA.
As I discussed at our Analyst Day event in January, our 2013 guidance assumptions include $900 million to $1 billion of bond issuance, $300 million to $400 million of preferred or common, as well as a small increase in the balance of the revolver. As I mentioned in my opening remarks today, we've issued $635 million of bonds and $250 million of preferred stock.
We expect to access both the debt and equity markets later this year to raise the balance of capital required to meet our 2013 funding requirements. Subject to market conditions, we may choose to issue additional common or preferred equity or unsecured debt to further enhance our financial flexibility.
These assumptions would exclude additional capital associated with any significant portfolio acquisition, which is not included in our guidance. This includes -- this concludes our formal remarks.
Mike and I would be happy to take your questions. Operator?
Operator
[Operator Instructions] Your first question comes from the line of Jonathan Atkin with RBC Capital Markets.
Jonathan Atkin - RBC Capital Markets, LLC, Research Division
My question centers around the network connectivity focus here and how that might influence your approach to M&A going forward and whether it -- maybe it changes the likelihood that you will look to purchase a wholesale-oriented asset. As well, I would be interested in seeing if you could ballpark the revenue uplift that you might see longer term just within your existing properties and existing base of tenant leases from customers that used to cross connect with each other and presumably that becomes a revenue event for you?
Michael F. Foust
Sure, yes. We think this is going to be, really, a big benefit to our customers who are either requiring network access, customers who are carriers themselves who are ISPs, customers who are providing peering and cross connecting as we'll be able to pull more customers to them, as well as leasing more in our properties.
In terms of revenue, we think that there's going to be, certainly, a material uplift, especially after we get all the infrastructure in place next year, by the end of this year and will realize in the end of the year in 2014. We haven't fully defined our product set at this point.
A lot of the financial benefit will be from making our buildings much -- even more attractive to a wide range of customers, including cloud providers, infrastructure, ISPs and carriers. So it will help to ramp up our leasing activity.
And we expect to be able to rent more space in our network pops, in our spaces, in our buildings. John Sarkis, I'd like John to comment on kind of the overall program and the benefits.
John Sarkis
Okay. Thank you, Mike.
Yes, I guess in looking at the size of our portfolio, we have very large amount of buildings, and there's attractiveness on the wholesale and the retail side. By putting an ecosystem in place, all our buildings can accommodate both ends of the spectrum for our offering.
So any new buildings that come online will automatically fall right into the ecosystem and operate seamlessly across the entire portfolio.
Jonathan Atkin - RBC Capital Markets, LLC, Research Division
And in terms of CapEx or OpEx implications, just because you talked about connecting building and cities together and so forth, can you maybe discuss that a little bit?
Michael F. Foust
Yes. I mean, the operating expense will be pretty low and on the increment, because it's spread across almost our entire, portfolio.
We'll probably be -- on the capital side, we'll probably be investing somewhere around, oh, probably no more than $25 million over the next 9 months or so. But then that's -- once again, that's spread out over a very large number of buildings.
Operator
Your next question comes from the line of Jordan Sadler with KeyBanc Capital Markets.
Jordan Sadler - KeyBanc Capital Markets Inc., Research Division
I wanted to -- my follow-up there to the connectivity initiative surrounds sort of the competition with some of your existing customers. And to the extent that you're, I guess, engaging their customers and their product offerings to or -- offering similar products to a greater extent.
Is that sort of the nature of the business, this sort of virtual -- vertical integration that you're seeing? And now that you're doing it basically across your sort of core cities, that you just -- the overlap is just to an increasing extent?
Michael F. Foust
Well, it's really for us to be able to put in the infrastructure so our current customers and new customers can more readily offer their services across our portfolio and be able to connect, have the infrastructure and to connect everyone. We're not going into the carrier business at all.
And John, I'll let John comment a little more on that.
John Sarkis
Yes, we are not, and I like to overemphasize the word, not becoming a network provider. What we're doing is we're making it easier for carriers and service providers to deliver their services to our customers across our entire portfolio.
And that is what our customers have been asking and looking for. And our carrier partners, as well as our data center industry partners there are looking for ease to navigate through our entire portfolio.
And this ecosystem will provide them with the seamless cost efficient and secure environment that they look for.
Michael F. Foust
In other words, you can get to from, hopefully, any building in our portfolio to virtually any carrier, any Meet Me Room, any cross-connect peering platforms, any cloud infrastructure provider. And in that way, should be driving more business for everyone who resides or has facilities in a Digital Realty portfolio property.
Operator
Your next question comes from the line of Emmanuel Korchman with Citi.
Emmanuel Korchman
I just had a question on your international portfolio. It looks like in early March, you made an investment in Mexico but I didn't see anything mentioned in the release or in your prepared remarks.
Just wondering what that was and kind of what your plan is for that market?
Michael F. Foust
Sure. We think there's opportunities for us in several locations in Mexico.
The investment that we're making, it haven't fully closed yet, is a very small minority investment, about 8.5%, in one of our customers in Mexico City who's a metro fiber provider. And we've done work for them on data center design and project management.
And what this will let us do, making a small investment, but gives us the ability to have a good lens into the growth and evolution of the Mexico market in Mexico City. Guadalajara, Monterrey, so we can have a good idea, kind of a front-row seat, if you will, on how that market is growing and where demand is for our wholesale products.
So that's kind of the genesis of that initiative.
Operator
Your next question comes from the line of Vance Edelson with Morgan Stanley.
Vance H. Edelson - Morgan Stanley, Research Division
Just going back to the capital side of things. The maintenance or recurring CapEx trended a bit lower.
Could you just walk us through what exactly drove the decline and perhaps what should we should model going forward?
Michael F. Foust
Yes, and that's probably really kind of reflects first quarter seasonality, if you will, on deploying capital. And I think we'll generally be in line with our projections over the course of the year.
Operator
Your next question comes from the line of Rob Stevenson with Macquarie.
Robert Stevenson - Macquarie Research
You did another sale-leaseback this quarter. Can you talk about the demand is for these transactions and what your pipeline looks like given the likely changes to lease accounting making these type of deals less advantageous for the lessee?
Michael F. Foust
We've had good activity. We did the Bouygues Telecommunications wireless company in -- outside of Paris and that was in December.
This is the second sale-leaseback that we've done with Delta Air Lines. We're talking with other corporations as well who are interested in freeing up capital from the balance sheet so we're actually -- both in Europe and in the U.S.
So it's hard to predict how many of these sorts of deals we'll be doing this year or next year, but we've certainly seen increased interest from corporate owners. That's for certain.
Arthur William Stein
Rob, it's not accounting driven at this point. It's cost to capital driven.
Lessees just seize an opportunity to either obtain capital less expensively from us than from their banks.
Operator
Your next question comes from the line of Matt Rand with Goldman Sachs.
Matthew Rand - Goldman Sachs Group Inc., Research Division
So I have a couple on lease expirations. So first, just as a quick clarification.
For your Turn-Key and Powered Base building lease expiration schedule, it looks like you added a month-to-month category this quarter, and it looks like some of the leases that went into that bucket were actually previously in the thereafter category as opposed to in 2013. Am I reading that right?
Michael F. Foust
I'm not sure. I don't have the detail.
Arthur William Stein
I don't think so. I think the month-to-month though is really more focused on the colo.
Matthew Rand - Goldman Sachs Group Inc., Research Division
Okay. Well, because it was actually a pretty big step up in Turn-Key and Powered Base.
And if you look at the number of leases in thereafter category, they went down. So I'm just trying to get a feel for if you were consolidating leases or reclassing them or something.
Michael F. Foust
No.
Arthur William Stein
No. We'll get back to you with the details, but that wasn't the case.
Operator
Your next question comes from the line of Vincent Chao with Deutsche Bank.
Vincent Chao - Deutsche Bank AG, Research Division
Just a question on -- going back to volumes, understanding that was a very strong quarter for you guys driven by Custom Solutions. But just wondering what you're seeing on the TKF front.
That seemed like it was, maybe, a little bit lighter than it's been on a historical basis in terms of first quarters. And just maybe some color on why Custom Solutions demand seems to be a little bit stronger right now.
Michael F. Foust
Well, I think we've been seeing, certainly over the last 3 quarters, more interest, I think. As we came out of the recession and demand started to build in the second half of 2012, we're seeing companies looking at some large requirements out there that tend to be more of a build-to-suit nature and more of a custom-design nature.
I think that the relative breakout this quarter between Turn-Key Flex and Custom Solution wasn't unusually large. I mean, we're dealing with a very small data set.
So I think over the course of the year, it's going to even out more, where we'll be leasing more -- relatively more Turn-Key Flex space as we get further into the year. But certainly, the Custom Solutions is -- because we have the ability, the design, the project management, the engineering expertise, really gives us the ability to address a big part in the market that a lot of folks don't have ready access to with whom we compete.
Operator
Your next question comes from the line of Jonathan Schildkraut with Evercore Partners.
Jonathan A. Schildkraut - Evercore Partners Inc., Research Division
It only has 11 parts. No, seriously, I'd like to ask another question in terms of the interconnect product.
For a long time, you guys have run Internet gateways and you've had your colocation products, so you could do some interconnect there. And the ability to tie together your data centers has always been there through the use of the carriers or the fiber backbones that set led into your centers.
What's evolved from a demand perspective today that kind of brings a call to action for this? Is it the need to move workloads in and out of, say cloud environments?
or is it the desire to extend the Internet gateways to the other data centers. I'm just trying to understand why now is the right time for the investment?
Michael F. Foust
Sure. And I'll let John jump in on this.
In terms of timing, we probably should've done it 2 years ago in anticipation of this growth -- great growth in cloud. And -- but we think that we have an opportunity now.
We're not late, but -- and as we're seeing more and more with new data centers coming online, our customers want the ability to have a ready solution from a range of carriers and ISPs and cloud infrastructure providers. And we want to be able to present that to customers, either existing customers as well as new customers coming into new buildings.
And we want have that package of services in a very organized, well-defined manner. And I'll let John embellish on those odds.
John Sarkis
And that was a very good question. As you can see the evolution of the business and the market, bandwidth has created a dependency on the data center provider.
It's become a much more critical component than just space and power. By providing our customers the ability to access their networks and the size of the bandwidth that they require is what the driving component here to get this rolled out as quickly as possible, though we've seen a lot of questions come in about very large bandwidth demands and structured deployment in a customized solution across our data center portfolio where we have one location would act as more as a production environment, whereas some of our other locations would act as a disaster recovery component or less critical equipment.
But the two need to be tied together. So by providing this ecosystem, we will now be able to do that for our customers in a one-stop-shop format.
Operator
Your next question comes from the line of George Auerbach with the ISI Group.
George D. Auerbach - ISI Group Inc., Research Division
Bill, just a question on the balance sheet. You mentioned that the leverage is creeping up and, I guess, will creep up a bit more through the year, and you are putting more debt on the line of credit than you have in the past.
I guess, why the change in the balance sheet strategy over the last 6 or 9 months? And I guess what level from a net debt to EBITDA or fixed charge coverage and also floating rate debt exposure are you comfortable with?
Arthur William Stein
Hey, George, I don't know that there's been a change per se other than we went to the rating agencies in the fall, and we talked to them about running the company at 5.5x versus 5x, and they were comfortable with that. And we think given the scale of the company's operations and the diversification across various verticals and tenants around the world that, that was totally appropriate.
Frankly, if you look at -- where most REITs, BBB-rated REITs, run their leverage they, I think, 6 is probably more typical than 5.5. So 5.5 is still on the conservative side.
We ended up at end of the quarter 5.5 but, as I said in my remarks, we very consciously did a preferred, we weren't sure whether we're going to do it at the end of the quarter or at the beginning of the second quarter, and that took the leverage back to where it was at the end of the year which was 5.2x. And because we are managed to 5.5, that doesn't mean that we won't go over occasionally.
But we're targeting a 5.5x debt to EBITDA, and we think -- oh, and your question 2 is, I guess, fixed charge coverage. And our target there is to stay in the high 2s or above.
And so the fixed charge did go down in the first quarter and that was primarily due to the sterling bond offering that was done in January, which had a 4 1/4% coupon.
Operator
Your next question comes from the line of Gabriel Hilmoe with UBS.
Gabriel Hilmoe - UBS Investment Bank, Research Division
Can you talk a little bit about the occupancy drop, that 1 11 8. And Mike, you may have mentioned this in your remarks and I missed it.
But what do you think the mark to market is on rents for the portfolio today?
Michael F. Foust
1 11 8, we really didn't have much of a drop. We had one customer who moved into one of our other buildings.
And then we're re-leasing that. I think we've already re-leased that space.
So...
Arthur William Stein
It will commence second quarter.
Michael F. Foust
Commencing second quarter, this quarter. So yes, you just caught that building kind of in between re-leasing.
So that space at 1 11 8, it's actually 100% occupied now. And in terms of mark to market, we talked about how we're seeing renewals over the next couple of years being flat on a cash basis, a very high rate.
So historically high rates based on the cash uplift that we've been enjoying in the leases on average. So we think that mark to market on a GAAP basis is probably -- and this is really just a projection on my part, you're talking 5% to 10% probably, or maybe at least I would think in that case, on a GAAP basis, maybe even slightly more.
Arthur William Stein
Depends on the product class, too. PBB will have a much higher uplift than Turn-Key.
Michael F. Foust
Right.
Operator
Your next question comes from the line of John Stewart with Green Street Advisers.
John Stewart - Green Street Advisors, Inc., Research Division
Bill, could you please shed a little bit of light on the Sentrum earn-out, maybe specifically how it's performing relative to pro forma and kind of help us tie that back to the earnings noise? And then, Mike, came across a story recently indicating that you guys were prepared to make your initial foray into mainland China next year, I guess, with sites selected in Shanghai and Beijing.
Can you kind of talk about, first of all, how accurate that might be, and the underwriting process, and then the type of returns that you would target in mainland China?
Arthur William Stein
So Mike, relative to the earnout. The earnout is a function of both the rents achieved, the absolute rent level runs, the timing for those rents and the capital deployed to achieve those rents.
So that's what goes into the formula to determine the -- whether or not it's a plus or minus. Last quarter, it was a plus.
In this quarter, it's a minus. But most of the changes here are going to be accretive.
But we don't consider that core. I mean, it's just -- again, it's noise and we have another 2 years and a quarter left of that.
And the amount of the adjustment will -- because it's a present value calculation, the amount of the adjustment declines with the passage of time as well. So there will be less as we get closer to the end of the earnout period.
Michael F. Foust
And in terms of our China initiative, we are speaking with -- as we have been over the last couple of years, and meeting with different service providers, both managed services, network providers, cloud providers with whom we might be able to strike up a partnership. So at this point, we're still on an early, relatively early stages of the discussion, but we have targeted a couple of prospects, potentially would be good partners with us in a JV.
We feel very strongly in China that to be successful, we want to be partnered with folks that are providing data center services in the marketplace and have the proper licenses for power and fiber, which is so important. So it's still relatively early days but we're definitely interested in that market.
I mean, it's many markets obviously in China and probably the 3 most likely forays would be Shanghai, Beijing and Shenzhen. But we're not at a point where we have site selection or agreements drafted or anything like that.
Operator
Your next question comes from the line of Tayo Okusanya with Jefferies.
Michael F. Foust
We lose connection.
Operator
Your next question comes from the line of Emmanuel Korchman with Citi.
Michael Bilerman - Citigroup Inc, Research Division
Yes, Michael Bilerman speaking. Mike, just as you think about this interconnectivity that you're building out, just given the fact that data center rents and Powered Base building rents are different across the U.S.
and internationally, I guess do you anticipate a potential shift of tenants that want access to digital and the benefits that you'll have from the interconnect shifting to lower cost locations? And how you think that sort of evolved, understanding that there is a benefit to going into it, but do you think that there may be a shift in demand going to lower cost locations.
That's number one. Number two, just for Bill, as you talked about how doing local denominated debt in different geographies sort of reduces your FX exposure.
And I'm just curious as you think longer term, you look at your sort of largest global REIT peer, Prologis, they want to be 80% to 100% U.S. exposed but have a 60% global x U.S.
portfolio. So I'm just curious how -- do you eventually want to move to that as well as, being 100% U.S.
exposed with a large global exposure?
Arthur William Stein
Well, I'm not exactly sure what your question there is, Michael. I will tell you that our philosophy is to, to the extent we can, we'll put more debt against the foreign assets to provide maximum natural hedge.
So -- and right now our largest market exposure is the U.K.. We're a little over 50% there.
Most of the Asian countries are in the 90s right now in terms of debt as a -- local debt as a percentage of the net asset in that region. So it sounds like we might have a different philosophy than Prologis, if I understand your question correctly.
Michael F. Foust
And let me go ahead and answer Michael's part of first question regarding kind of locational decisions. I don't think we're going to see a significant shift, and I'll let John jump in on this, but we're seeing across our major markets, folks who need to be in London and New Jersey and Virginia still want to be there.
And there's folks who want to be in central time zone or in lower cost environments and are looking at Dallas and Austin and Houston. And there's folks who need to be in Silicon Valley.
So I don't think we're going to see a shift away from a particular market. I think we're going to see more opportunities for our portfolio broadly.
John, what do you see there?
John Sarkis
Yes, I just like to add one thing to those comments. In when looking at a market, you have a different buildings that are gateway buildings and non-gateway buildings.
We will be re-leasing the ecosystem to level the value of our portfolio buildings across the entire platform, making some of our properties much more valuable than they are outside the ecosystem. So if you're looking at a market where there are the 3 major gateway buildings and then we have a number of other buildings outside the gateway, those buildings become that much more desirable and offer the, what I mentioned earlier, the customized solution of splitting a footprint across the region and our building.
I hope that answers the question.
Michael F. Foust
So a lot of it is diversification within a region or across major markets, but not necessarily going to tertiary areas, or at least based on the customer base that we're seeing growing quickly for us.
Operator
Your next question comes from the line of Matt Rand with Goldman Sachs.
Matthew Rand - Goldman Sachs Group Inc., Research Division
I appreciate the color in your prepared remarks on the cash spreads on the leases signed during the quarter, but I'll confess when I saw the supplement this morning, I was a little surprised to see that -- the big negative number on Turn-Key. What it seems like, from your remarks and from everything we're hearing in the market is that, there is increasing divergence between different markets between different density levels between all sorts of things.
And there's kind of 2 key pieces of information that we don't know about your portfolio. One is kind of where the expirations are over the next couple of years.
And the other is what the kilowatts or kilowatt levels are across the portfolio as opposed to square footage, which really actually drives your leasing. Can you provide some color for all of us on the call so that we sort of have a little better sense of how the next couple of years might unfold in terms of lease roll?
Michael F. Foust
Well, I mean we've got a lot of information in supplementals about the rolls. I mean, it's spread out across a lot of different markets.
So it's hard to make a broad characterization other than, on average, we think we're in a good position broadly on the renewals and folks want and need to stay in our buildings. So it's difficult in this call to draw broad conclusions because we are in so many different markets, and as you know, we have different product types.
Bill, I...
Arthur William Stein
Yes, I mean, I think in terms of broad brush, it's safe to assume that the Powered Base, as I said earlier, is going to have a pretty substantial uplift as they renew. And there's several factors that are driving that.
It's not just where the rents were struck and the timing for the initial rents, but typically that was 10 -- those are 10- to 15-year initial deals, so they were some time ago. It's also because the tenants have invested significant capital in that space and have a -- and they tend to be quite sticky as a result of that.
The Turn-Key rents started out at a much higher level. If it once again -- I mean, the tenants although they didn't invest in the data center infrastructure the way the Powered Base customers do, they still have significant investment in their space.
And we covered this on our analyst day, relocation costs are significant even for our Turn-Key customer. And for that reason, we think it's with certain exceptions.
We had one of those exceptions this quarter for a major customer that was under attack in a market where there's been some weakness. On a percentage basis, it was small overall.
But with certain exceptions, we would expect that the cash rents on Turn-Key would be roughly flat on a mark-to-market basis across the portfolio regardless of region.
Operator
Your next question comes from the line of Tayo Okusanya with Jefferies.
Omotayo T. Okusanya - Jefferies & Company, Inc., Research Division
I guess that explanation from Matt was helpful. Just a couple of things, though.
Just in regards to the renewals in the New Jersey market and the much lower rent that those were signed for to keep those tenants. Can you just talk a little bit about overall competition in Jersey and what you're seeing?
Michael F. Foust
Yes. New Jersey, it's definitely good market because you've got the financial services and many large corporations in the region.
The challenge is there's a couple or 3 competitors who are very aggressive on pricing and have had challenges getting traction with their developments and thus are being aggressive in that market. So I think that's probably the market where we're seeing a little more downward push on rents, but I don't think rents are going down further.
I think they stabilized probably last quarter. But there is, in that particular market, probably a couple of folks who are trying to grab market share and trying to get absorption, and they've had some challenges.
Operator
And there are no further questions at this time.
Michael F. Foust
Great. Well, thank you very much, and then thanks, everyone, for your time and good comments and questions today.
And thank you to the Digital team. It's another quarter well done, and we're really excited about our Digital Realty Ecosystem.
I think it's going to make -- bring a lot of value for our customers and for new customers. Thanks very much.
Operator
This concludes today's interactive broadcast. You may now disconnect.