Aug 1, 2012
Executives
Lisa Palmer – SVP, Capital Markets Martin Stein – Chairman and CEO Bruce Johnson – EVP and CFO Brian Smith – President and COO
Analysts
Paul Morgan – Morgan Stanley Michael Mueller – JP Morgan Quentin Velleley – Citi Tayo Okusanya – Jefferies Jim Sullivan – Cowen & Company Samit Parikh – International Strategy & Investment Group Rich Moore – RBC Capital Markets Cedrik Lachance – Green Street Advisors Vincent Chao – Deutsche Bank Tom Lesnick – Robert W Baird Andrew Rosivach – Goldman Sachs Michael Bilerman – Citi
Operator
Please standby. Ladies and gentlemen, good day.
Welcome to the Regency Centers Corporation Second Quarter 2012 Earnings Conference Call. Please note, today’s conference is being recorded.
At this time, I would like to turn the conference over to your moderator, Senior Vice President, Capital Markets, Lisa Palmer. Please go ahead.
Lisa Palmer
Thank you, Peter. Good afternoon everyone.
Good morning to those of who are on the West Coast. Thank you for joining us.
On the call this afternoon are Hap Stein, Chairman and CEO; Brian Smith, President and COO; Bruce Johnson, CFO; and Chris Leavitt, Senior Vice President and Treasurer. As always before we start, I’d like to address forward-looking statements that may be discussed on the call.
Forward-looking statements involve risks and uncertainties. Actual future performance, outcomes and results may differ materially from those expressed in these forward-looking statements.
Please refer to the documents filed by Regency Centers Corporation with the SEC, specifically the most recent reports on Forms 10-K and 10-Q, which identify important risk factors that could cause actual results to differ from those contained in these forward-looking statements. Hap?
Martin Stein
Thank you Lisa and good afternoon and good morning to those, not on the East Coast. I’m extremely encouraged by the continued and significant progress that is been made towards the key objectives in all aspects of our business.
We realized another quarter of improving operating fundamentals. It is gratifying that these results are meeting Regency’s higher performance standards.
While Brian will spend more time in this area, I want to highlight a few key accomplishments that are evidenced of the quality of the portfolio and the focus of Regency’s management team. Leasing volumes remain robust.
We continue to strengthening of our smaller shop spaces. Percent leased reached 94% for the first time since 2008.
Bad debt expense is still trending towards pre-recession levels. And pricing power well uneven is steadily moving in our favor.
These improved underlined fundamentals translated in the same property NOI growth on a year-to-date basis of 3.8%. In addition to the positive operating results of our portfolio, the $300 million of developments started since the beginning of 2009, continue to register impressive performance.
Currently they are more than 90% leased with projected average returns on the incremental basis of 9.3%. I really like the four developments started this year, which will ultimately represent an investment of close to $150 million and create meaningful value for our shareholders.
These new developments reflect latencies narrowed focus on building and redeveloping dominant in field shopping centers with demonstrated demand from best-in-class retailers. Substantial progress was made on executing our clearly articulated capital recycling strategy; it has also enabled us to further strengthen the balance sheet.
Last week, we closed on the $321 million portfolio sale. Bruce and Brian will describe this in more detail as well as how this and other recent impending recycling transactions are enhancing what was already a higher quality portfolio and its future NOI growth.
Together with acquisitions to date and those in our pipeline, we will have meaningfully increase the allocation of capital to dominant centers with good prospects in core markets while lowering our exposure to nonstrategic assets and markets, and reducing debt. We think caution with the balance sheet to lower leverage makes sense given the uncertainty that we are all experiencing and seeing in today’s world.
Most important of all, despite the dilutive impact from the portfolio sale being a significant net seller and operating at a lower level of leverage we will be even better positioned the compound per share Core FFO including moderate growth in 2013 by sustaining growth 2.5% to 3.5% from our portfolio of dominant centers with annual gross or anchor sales averaging more in $26 million and $500 per square foot and Trade area household incomes of approximately $100,000 in average population densities of 100,000 people and those aren’t future targets that’s the existing portfolio and a key metrics of full network portfolio. Bi-annually developing a $150 million to $200 million of dominant shopping centers at compelling returns on invested capital brings a unique combination of in house capabilities, presence in key markets, anchoring retailer relationships, an impressive track record.
And opportunistically enhancing and already solid balance sheet in excess to capital and lastly by continuing the focus energy from our dedicated and talented team towards achieving these critical goals and objectives. I also want to note that since the portfolio sale was at a minimum NAV neutral in the short term the growth we are generating NOI and the value being created from developments should translate into 5% plus growth in per share NAV this year and into the future.
Bruce.
Bruce Johnson
Thank you Hap good afternoon everyone. From our financial results perspective we had a really good second quarter.
Core FFO per share was $0.69 which was higher than our stated guidance range. Continued improvement in operating fundamentals was a principal driver with same property NOI growing by 3.6% this quarter – 85% of the same property growth came from increased space rent and the remainder was mostly lower bad debt expense.
As we mentioned in last quarter’s call, we changed the fiscal year of our captive insurance company to end in April. As a result, we recognized the revenue in the second quarter of this year rather than in the third quarter as we’ve done in prior years.
This was incorporated in our second quarter guidance and made up the majority of the current quarter increase and other income. Going forward, the revenue will be recognized quarterly in an estimated run rate of between 600 and $1 million and as always will not be included in the same property NOI.
On the capital market side, we extended our option to draw the remaining balance of the term loans of January 2013. After quarter end we used the proceeds from the portfolio to pay down the $120 million of our revolving credit facility and to pay off the $150 million balance in our term loan, but still retain the right to draw the remaining commitment of $100 million.
The net result is accessing nearly $700 million of available capacity. Our balance sheet is now in even better shape with no significant near-term maturities.
And given today’s uncertain, the uncertainty of today’s world, we intend to preserve a substantial portion of the increased availability in our bank facilities to opportunistic capital market activity. Turning to the portfolio sale, this was an important transaction that will provide us with long-term benefits.
To summarize a few key details of the sale; we sold 15 properties to an affiliate of Blackstone, representing 2.1 million square feet for $321 million. The properties were wholly-owned, unencumbered and 90.5% leased.
And as part of the transaction we’ve retained a $47.5 million preferred equity investment in the portfolio that earns a 10.5% annual return. The investment is callable by Regency after 12 months and by either party after 18 months.
With this sale, we took advantage of an opportunity to efficiently accelerate the disposition of non-strategic assets, and reduce leverage. The dilutive impact of this accelerated capital recycling, and lower leverage is partially offset by improved NOI overgrowth, allowing us to maintain a lower end of the range of core FFO per share guidance.
We also increased guidance for percent leased, which is now 93.5% to 94.5%. While we expect same property NOI growth to moderate in the third and fourth quarters from our year-to-date rate of 3.8%,we have increased our full-year guidance to 2.8% to 3.8%.
Brian?
Brian Smith
Thanks, Chris, and good afternoon. While we are certainly aware of the weakened economy, and are closely monitoring our portfolio, we’ve yet to see any signs of deteriorating tenant health or shrinking retailer demand for space.
The leasing volumes remain very strong including the developments we leased more than 2.1 million square feet of space on a gross basis including almost 1 million square feet of new leases. To put that in context, that’s nearly 60% more than the quarterly average of total new leasing since 2006.
We have substantial net absorption in the operating portfolio picking up a 160,000 square feet of leased space in the quarter and building on the momentum of the previous three quarters. In fact, when compared to the second quarter of last year, same-property percent leased increased to 170 basis points, which represents a half million square feet of net absorption.
What’s even more notable are the gains we’ve made and are continuing to make in small shop leasing. Spaces less than 10,000 square feet gained 280 basis points year-over-year and are now 87% leased.
All signs point to a continuation of this progress. Our pipeline and leasing activity remains robust and as a percentage of vacant space, it is even stronger than it was at this time last year.
Rent growth increased and average base rents for shop space were positive, both for the fifth consecutive quarter. And accounts receivable balances over 90 days continue to fall and are now less than three-tenths of a percent of revenues.
I say this really just to give you a further indication of the health of our tenants. Lisa, Bruce, Hap and I have the good fortune to work with a team of experience and diligent asset managers, who are proactively monitoring our tenant’s health.
So the well publicized Supervalu issues have certainly not caught us by surprise. What we’ve learnt from prior tenant failures is that the underlying real estate can provide insulation to the poor performance or bankruptcy of individual operators.
With respect to the Supervalu exposure in our portfolio, we believe that significant majority of their stores are in high quality properties, where we anticipate readily finding good replacements. And in most cases, we would expect the rent spreads to be positive since our current Supervalu leases are on average more than 20 years old.
Turning to developments, I would like to take a moment to reiterate our development strategy. Development is a core competency and a competitive advantage sets us apart in a way to create value for our shareholders.
Our right-sized and more disciplined strategy is focused on creating dominant shopping centers intended to be held long term and located in target markets with instilled characteristics. The performance is more than $300 billion of development, redevelopment, and expansion starts in the last few years underscores the success of the strategy.
Developments and value add redevelopments started since 2009 are currently over 90% leased and committed and have generated an average return on invested capital of 9.3% and that’s with three quarters of these projects still under construction. As you know these returns from high-quality centers would be impossible to replicate through acquisitions.
Further the properties that were in process at the end of 2011 have gone from 58% to 85% leased in the first two quarters of this year. That’s a lot of leasing in the short period of time, and reflective of the quality of developments.
And looking at this quarter’s two new development starts, the first Erwin Square in Durham, North Carolina is a (inaudible) center. This is an excellent infill opportunity and established business district adjacent to Duke University.
Already nearly 75% of the centers either leased or committed with Harris Peter as the anchor, and many best-in-class retailers taking shop space. The second Grand Ridge Plaza located in one of the most desirable areas of Seattle, Washington is a much anticipated infill town center positioned next door to a planned Microsoft campus, and part of a high-end master plan community.
With average household incomes in excess of $130,000 and extreme development barriers, this is a prime example of the type of community center development that we would undertake. Anchor tenants include Safeway, Regal Cinemas Dick’s Sporting Goods, Alter and Marshall’s Home Goods combination store.
Despite having just broken ground, we have leases in various stages of negotiation for over 90% of the leasable area including executive with top notch local and national operators. Now I’d like to share some color on the portfolio sale, in essence the portfolio was comprised of properties that are not consistent with our current investment strategy and don’t enjoy the long term NOI growth potential of the vast majority of our existing portfolio or of the shopping centers that we are buying and developing.
Population densities and average household incomes for these assets are 55,000 people and $80,000 respectively compared to roughly a 100,000 people in incomes of $100,000 for our portfolio as a whole. Grocery sales for the portfolio assets averaged $21 million compared to $26 million for our total portfolio.
Several of the centers located in non-core markets like California Central Valley and Inland Empire and Akron, Ohio. In some instances we had concerns regarding the amount of shop space, rents in relation to market, the suitability or productivity of the anchor tenant and co-tenancy and kick-out issues.
On the acquisition front, we’re negotiating the purchase of four dominant shopping centers, if we are successful; Regency’s total investment for the centers will be in the $200 million range. Each is an exceptional property with superior growth prospects that together are expected to compound NOI in excess of 3%.
The average household incomes in three mile populations of these centers are well above those of the properties we’ve sold and most importantly, grocery sales for the four centers average $1,000 per square foot. Given these attributes we expect the dominant shopping centers that we’re buying to generate substantially higher NOI growth and those being still being sold.
In time the compounding higher NOI growth rate will overcome the initial earnings dilution and ultimately outperform. In summary, I’m proud of the results that the team has produced so far this year, by continuing to fill our vacancies with proven operators, acquiring and developing dominant shopping centers and disposing non-core centers, I believe the portfolio is in great shape and should be more resilient in the next downturn.
Hap?
Martin Stein
Thank you, Brian, and thank you, Bruce. In closing, while one cannot ignore the uncertainty in the macro-environment, I’m extremely encouraged about the continued and significant progress that is being made to our key objectives of growing NOI, of creating value, and dominant centers to disciplined development, of enhancing the quality of the portfolio and its NOI growth with focused recycling and of strengthening the solid balance sheet with reliable access to capital, which when we combined will translate into growth in per share core funds from operations and NAV.
It is gratifying that these results are meeting Regency’s high performance standards and positioning us well for the future whether it would be prospering in a growing economy even if the growth is sluggish or weathering another recession. We thank you for joining us on the call and now welcome your questions.
Operator
(Operator Instructions) We will take our first caller from Paul Morgan, Morgan Stanley.
Paul Morgan – Morgan Stanley
Hi. Good afternoon.
On the dispositions, I’ve just a couple of questions. First in terms of the Blackstone deal, why did you put the lifestyle centers there in Texas and did that with those at below the cap rate of the average, I mean and if so.
If not is there a pinch of roll down there and maybe the cap rate looks higher than it otherwise would be for certain newly developed centers. And then second why the sale of the San Pedro asset?
Martin Stein
The San Pedro asset, I’ll start with that I mean that was in a partnership and partner center was timed to sell and we had major capital improvements to in effect maintain and continue to the NOI growth rate on that asset. We put together this portfolio and we felt it was – bottom line, we’re pleased with the sale that occurred and not because we feel that we sold Blackstone a bill of goods but because it really – the sale met our objectives.
It was an efficient transaction, with certainty of closed and the assets as Brian mentioned is not – is not up to the standards as far as 100,000 householder income, the supermarket sales in our portfolio and density. And as Brian said that – they don’t have the growth potential.
And there is some risks which obviously Blackstone is very aware of including the anchor co-tenancy in shops placing for example, I’ll talk about the one – one of the Lifestyle centers there the shops that have in village, as you may and may not be aware, Blackstone is added or signed a lease with Whole Foods to go in there and we’re obviously aware Whole Foods interest we communicated their interest to Blackstone. But still given the rents, the risk associated with co-tenancies in (inaudible), although there is not higher probability those risks are going to manifest themselves into occurrence, we just were not comfortable with the amount of management time, or the consequences if something went wrong by – by continuing to hold the assets.
Paul Morgan – Morgan Stanley
Okay. Thanks.
My other question just on core, I mean, you’re seeing kind of great results in terms of occupancy, and same-store NOI, the rent growth on new leases has been kind of stubborn and I’m wondering if you’re seeing any potential for movement there, obviously they seem to be dragged down by some of the older vacancies, but given your leasing velocity in the commentary, do you think that we could see that turning positive over the next several quarters?
Martin Stein
We definitely think that’s possible. As you indicate, we have – we aren’t yet seeing the levels we want to see, but – but we’re really talking about your pricing power and there’s no question that – that power is improving that the trend is in the right direction and we have had five consecutive quarters of positive rent growth, and 80% of the transactions this – this past quarter were positive rent growth.
So, what’s still holding us back a little bit would be as with anybody, some large deals they always – they always move the needle. For example, we had to put in a new we had to renew medical user at Martin Downs 40,000 square feet and in order to get that property sold as we look a hit there and we’ve got – that we’ve got some significant negative spreads on leasing activity in Arizona.
But, rent growth is all about leverage and we are hearing from across the country the return on leverage, multiple tenants competing for spaces. You can see the demand for the shopping centers, more and more, the properties are getting to 95% level where we do have pricing power.
And we’re starting to exercise lot termination rights that’s allowing us put in better tenants, strategic move outs, and that also can give us better options in the future. So, we aren’t there yet, but I do think the trend is heading more (inaudible).
Paul Morgan – Morgan Stanley
Great, thanks.
Martin Stein
Thank you.
Operator
Okay. Now, let’s go to JP Morgan, Michael Mueller.
Michael Mueller – JP Morgan
Hi. First question, it seems like you’re gaining good traction on Gradn Ridge leasing further developments, but when you’re looking at new starts today what are you underwriting for a period to ultimately stabilize the project, and how does that compared to which you’re underwriting for the downturn?
Martin Stein
Again, it depends on the property on the ones where we have 10,000, 14,000 and 15,000 square feet, we’re obviously going to underwrite it a little bit to happen faster than if we have more square footage. But in all cases, we’re looking to put the amount of shop space in there that would allow us to lease that up, and get to 95% within no more than two years from the first anchor opening.
Bruce Johnson
And we’d like to see good visibility, and a good probability of making that within a year.
Martin Stein
Yeah.
Michael Mueller – JP Morgan
Okay, great. And then the second question – oh, sorry go ahead.
Martin Stein
You go ahead.
Michael Mueller – JP Morgan
Yeah, I was going to say in the second question the $200 million in acquisitions that you referenced the four properties, are they individual transactions, or is that a portfolio?
Martin Stein
Those are individual transactions.
Michael Mueller – JP Morgan
Okay, great. Thanks.
Operator
Let’s go to Quentin Velleley with Citi.
Quentin Velleley – Citi
Hi, good afternoon. Just speaking to Blackstone transaction, in terms of the (inaudible) and you sort of commented that they were lower gross assets, could you maybe quantify that a little bit more with a sort of – were you expecting sort of flat NOI or even negative NOI over the next five to seven years versus 2.5% to 3% growth in your portfolio, is that how you are thinking about it?
Martin Stein
I think looking at is flat NOI, may be some upside, but there is also after that – but as also I indicated there is some risk to that and once again Blackstone is a very astute buyer and from their perspective I’m sure they feel like they made a good profit of the transaction, achieved our objectives and from our point of view it was a win-win transaction and, but I think the best way to look at that from our perspective is flat in (inaudible).
Quentin Velleley – Citi
Did you offer Blackstone substantially more assets, or where they easy on the assets that they’ve got?
Martin Stein
This was the portfolio and there were actually thinking.
Quentin Velleley – Citi
Okay and then just lastly on dispositions given the ramp this year, how should we be thinking about 2013 and beyond, you sort of going to get back to a more normalized $100 million or $200 million of dispositions or given where capital markets are at the moment and given where risk is in some of the super market retailers should we expect to see this kind of volume of dispositions next year and beyond?
Martin Stein
I think we feel real good about what we accomplished and that was one of the reasons why we wanted to do an efficient transaction like this and large transaction and I think it’s – in our view as you just said I think we feel comfortable with where we are and that we are going to be able get back to a more normalized rate of dispositions in $150 million to $200 million range.
Quentin Velleley – Citi
That’s it. Thank you.
Operator
Let’s go now to Tayo Okusanya with Jefferies.
Tayo Okusanya – Jefferies
Hi. Yes.
Good afternoon, two quick questions. First of all the $200 million of upcoming acquisitions, could you let us know what cap rate that is, at what cap rates those transactions are being done at?
Martin Stein
Well, they are not finalized yet, but they are – I think you may have seen we slightly reduced our guidance on more acquisitions with these. So you can mention they are lower than what we’ve done so far.
And so let me just dwell in that a moment, the whole reason that we are doing this – the key objective is to maintain sustainable NOI growth of 2.5% to 3.5%, and the capital recycling including the acquisitions there are a key component of that. We want to buy a kind of shopping centers that are highest quality because our experience is they generate the most growth.
So what we’re doing we price those as we look at total return from the asset, so we look at the initial return, plus the average compounded growth rate over the 10-year period. So the only way we can get to those to forward lower cap rate deals would be if these properties are going to generate higher growth rate, so that’s – and the properties that we’re buying just then, and we are not done with them while we do control them all, but we are going through due diligence, you just don’t know what may happen there.
They are all A plus locations, one is the generational kind of product that just does not come on the market, but every 30 years or so, and one has redevelopment component, so those are the kind of ways that were getting to the growth and much of these is either through redevelopment contractual anchors.
Bruce Johnson
And our growth expectation is on the higher end of the 2.5% to 3.5% range sometimes above that especially the one property that has the redevelopment opportunity.
Tayo Okusanya – Jefferies
Got it, that’s helpful. And then on the small shop space like – could you just talk little bit about opportunities, (inaudible) consolidate small shop space for tenants kind of looking for more kind of 15,000 to 20,000 square feet of space whether you’re kind of seeing a lot of that kind of demand.
Martin Stein
We always look for that. We have several examples of that this past quarter.
We have three different centers where we had small shops – three small shops in each case where we consolidate them, some were just tenants that we had given a rent release too, and had termination rights, we triggered them. In three of those situations, we all put in larger pet stores line Petco.
And we had a situation in Maryland where we had three small spaces, and we terminated a couple, relocated one to make room for Michael’s. So, we look for that as often as we can do it, but I think more than just to be clear about that, more often than not, we’re playing offence with that as it relates to merchandising, and as it relates to rent growth, not it relates to because we scared in this space.
Tayo Okusanya – Jefferies
Got it. Okay, thank you very much.
Martin Stein
Thank you.
Operator
Let’s go on to Cowen & Company, Jim Sullivan.
Jim Sullivan – Cowen & Company
Hi. Good morning.
First of all, may question for Brian, kind of a follow-up to the comment you just made about the 2.5% to 3.5% same-store NOI growth rate, when we look back at the prior cycle from the – I think 2005 to 2007 or so, the same property NOI growth rate was averaging pretty close to 3.5%, and I know every cycle is different, and it maybe that the uncertainties today are causing the people to be a little more conservative, but given how your occupancy is ramping, and you’ve mentioned that I think in your prepared comments pricing flexibility, are you pretty optimistic that we’re going to have a period here where we should see multiyear same property NOI growth in excess of 3%?
Brian Smith
Yes, yes. We – for the reason we talked about, I mean occupancy can drive right now.
We do have contractual rent steps that have helped us throughout the period, good times and bad. And then we are seeing the pricing power for the rent growth so that plus we’ve significantly upgraded the quality of the portfolio.
We’ll continue to do that. I think we have better retailers.
We’re going to be able to drive sales better. We got more productive grocers so, but I think, yes.
Martin Stein
I think we’ve given a range of 2.5 to 3.5, but I think the expectation of being on the upper hand of that as long as the economy holds together is realistic.
Jim Sullivan – Cowen & Company
Okay. And second question, obviously Supervalu has been in the news recently and there’s always one or other supermarket chain that seems to be losing market share and suffering and – and I’m just curious given what we’ve been through and obviously you guys maintained a very substantial development pipeline for many years when – when the cycle was strong.
I just wonder as you think through formats and as formats change and the industry buffer grocers as well is total center size, what can we expect or should we expect going forward in terms of your appetite for either the larger supermarket formats or the larger format centers altogether? I’m talking about in terms of what do you want to commit to in terms of your development pipeline?
Martin Stein
I think when we started this quarter is indicative of an infill grocery-anchored neighborhood shopping center in Duke – University of Duke Medical Center and a larger format grocery-anchored, multi-anchored center in one of the better areas of Seattle.
Bruce Johnson
Yeah. Jim, we want to make sure that where we can, we want to focus on – on the grocery-anchored shopping centers.
Now it so happens, that would typically be a neighborhood center and we wanted to do in infill locations or those areas with strong infill characteristics. But if you look at this acquirer, the centers in Seattle, that one is a community center, but it does have the leading grocery store up there in Safeway and it is such a high barrier to market, the last shopping center was built in that area was 20 years ago.
It’s a 100% lease now. This will take you years and years, so we’re really comfortable to develop a larger center in that kind of space, but the focus is on grocery anchor centers.
Jim Sullivan – Cowen & Company
And, in general if you’re – if the focus is infill presumably it’s difficult to find these sites, I know you have to work on them for a long time and getting approvals can take a long time, and as you think about what kind of level of development starts you can ramp up to as the market strengthens, I’m assuming you’re still thinking it’s going to be well below what it was in the peak previously?
Bruce Johnson
Yes. Because, we were $500 million a year, we’re staff for that, we were capable of doing that, but you know that’s a very difficult problem or program to manage.
We plan to be $150 million to $200 million a year to the extent we see opportunities greater than that, then we’re just going to start picking, which ones we like the best of those, and we do not plan to grow larger net, but we think, we’re there now, and the outlook for it starts down the road, it’s pretty promising.
Jim Sullivan – Cowen & Company
Okay. Then final question from me also on development, the level of quarterly development cost being capitalized is running about $2.5 million, I’m assuming we should assume that the path to the run rate that you will be at if you may maintain this level of development?
Bruce Johnson
That’s correct.
Jim Sullivan – Cowen & Company
Okay, thanks.
Operator
A question now from Samit Parikh, International Strategy & Investment Group.
Samit Parikh – International Strategy & Investment Group
Hey. Good morning.
Wanted to see personally so if you could help me get to your guidance range with 3Q, I know that the cap to insurance will go down call it $0.04 to $0.05 of FFO sequentially, and then there is the Blackstone sale as well, but you know having difficulty getting from call it 69 core to sort of the mid-to-high point of your 55 to 59 range next quarter.
Martin Stein
I think it probably is related to disposition activity, primarily I think that that always going to be the difference when analysts can’t get to our numbers, our assumptions versus whatever you have been assuming.
Samit Parikh – International Strategy & Investment Group
Okay.
Bruce Johnson
Yeah, just really quickly because it’s have to – it is buried in the other income line. It was a little bit larger this year than it has been in typical years on a combination basis.
It was north of $4 million, when I say combination; I mean what’s coming through equity income, pickup as well as on the consolidated income statement. So, a little bit larger than normal.
Samit Parikh – International Strategy & Investment Group
Okay. That’s helpful.
And then I guess also could you comment maybe on Safeway and their plans on developing their own shopping centers. It seems like clearly they are developing in markets that you compete.
How much of a sort of competitor are they for you guys to sort of gain these sites that going to develop on?
Martin Stein
Well, we know that the Safeway Development Team well. We like them.
We respect them. In fact, a former employee or ours is part of that team.
They are not new to development and we’ve been competing with them for some time probably 10 years ago, we competed with them on our Folsom and Tracy projects and we prevailed on those. They do obviously have a new focus and emphasis on it, but the reality is we don’t run into them very much and I think it’s just because we’re different.
We’re focused on new round of dominant centers, anchored by however is the best grocer in the given market and Safeway focuses on Safeway Stores. So, that means where they have a store presence, they may not be very active.
And from what we have seen in the market is that most of what they are doing and it just may not be (inaudible) access to whole pipeline, but most of our capital going to redevelopments or single tenant buildings or Safeway store maybe a fuel center, and so we don’t run it might the only two projects that I know of that we have competed with them recently with the Grand Ridge project in Seattle where they are going to be an anchor of it, and then we both went after the project in San Jose, and neither one of us got it. So I don’t think it’s like we just don’t run into them that much we could, and when that happens sellers make their own decisions as to what it is that they are looking for.
I think personal relationships don’t matter solving seller’s problems or matters and then in the case of master planned community like Grand Ridge, I think the seller felt that having multiple relationships with different kinds of retailers was advanced in terms of creating an amenity for that community.
Samit Parikh – International Strategy & Investment Group
Okay. That’s all.
Thank you.
Operator
RBC Capital Markets, Rich Moore please go ahead.
Rich Moore – RBC Capital Markets
Yeah. Hi.
Good afternoon, guys. The two new development projects and once I guess you are looking at going forward.
Are those primarily on land that you are identifying as new parcels of land that you want develop or do you have any legacy land in your portfolio that may also make its way to the development start status?
Bruce Johnson
Well. We certainly have legacy lands that we want to move into development, and I think we have about $60 million worth of that land with cost to date in land like that we plan to develop, but in terms of the ones that, that we are talking about this year or next year the vast majority of those would be new properties, in fact for 2012 they are all, they are all new except for the South Bay Village.
Martin Stein
Last year, we started the project in Petaluma, Southern Sonoma County, which was on land held, and we’re actively working on several other sites.
Rich Moore – RBC Capital Markets
Okay, fine, good. Thank you, guys.
And then on the – on the Blackstone transaction, why the preferred position I mean what’s the rationale behind hanging onto that?
Martin Stein
Well, that was a transaction – that was a structure of the – they’ve all forgotten the – if you may or may not be real estate, using other transactions, where they bought properties and we negotiated that down to a short period of time of 12 to 18 months, and higher returns.
Rich Moore – RBC Capital Markets
Okay, and so they, yeah I was aware of it, I think it happened – and so they, just basically insist on the strategy like that?
Martin Stein
I wouldn’t go there, but that was part of – that was part of their offer.
Rich Moore – RBC Capital Markets
Okay, that’s it. Thank you.
Martin Stein
And that’s it – (inaudible) that’s the question where we ended up.
Rich Moore – RBC Capital Markets
Okay, I got it, thanks very much.
Martin Stein
Thank you.
Operator
Let’s move on to Cedrik Lachance with Green Street Advisors.
Cedrik Lachance – Green Street Advisors
Thanks. You acquired a small CVS property this quarter, I know it’s not a lot of money, but where is the strategy behind it?
Martin Stein
Yes Cedrik that was one that was brought to us by a joint venture partner we’ve done multiple developments with, and it was just – frankly just a no greater opportunity to get development returns with zero risk. I mean, it’s tight this quarter, it’s ground zero, in terms of Washington DC real estate, and that was the situation where the partner identified a building that because of very quick damage had been emptied out, three story office building, and we went ahead and bought that, we had the grocer take the center, I’m sorry, the grocer take the center as is, complete bondable lease, we don’t put nickel into it.
We get a development return, we literally can do anything and we’ve got 9% return project with great credit.
Cedrik Lachance – Green Street Advisors
Okay so there is nothing else what we done there over time it’s a simple long term lease with quality credit tenant.
Martin Stein
Quality credit tenant like I said total bondable lease, we are not responsible for anything. So we have no operating dollars going forth, we have no construction dollars going forth, and really it’s just the – the ancillary benefit to that is you get your name in that market as continuing to be active in development or redevelopment opportunities of that magnitude and nature.
Cedrik Lachance – Green Street Advisors
Okay and then what is the current gap between your lease space and the physically occupied space in your portfolio?
Martin Stein
Oh, 240 basis points, total which is that 230 pre-lease, and 24 slow pay
Cedrik Lachance – Green Street Advisors
Okay
Martin Stein
This isn’t much different than what’s it’s been for a while now
Cedrik Lachance – Green Street Advisors
Okay I mean you’ve been anticipating I guess the shrinking of that GAAP when you think you go back to more normalized 100, 150 basis points?
Martin Stein
Well I think the risk is so high as we continue to keep doing this volume on leasing. I mean this is a huge quarter of new leasing for us.
So that’s what’s keeping that line up there, the pre-leasing line, and that will have to start to fall as we get, as there is less space to lease, if you look at the effective rent paying occupancy, all that preleasing has been translating into rent paying occupancy it’s just continue to do lot of leasing.
Cedrik Lachance – Green Street Advisors
Okay thank you.
Martin Stein
Thank you Cedrik.
Operator
(Operator Instructions))Moving on let’s go to Deutsche Bank, Vincent Chao.
Vincent Chao – Deutsche Bank
Hi, everyone. Just going beyond the Blackstone transaction, just I wonder if you could provide some commentary about the general interest in B Class or secondary market properties today?
Martin Stein
Sure. I think what’s happened probably this quarter versus last quarter or the quarter before is with all the uncertainty out there what’s happening at the end of the year that buyers are less, I mean are more averse and they are not going to go out on the – their risk spectrum without getting compensated with yield, but I think what you are seeing is that buyers will pay up for high quality properties that have strong grocers that are generating strong sales, but you start to lose any of those things, then the pricing falls out pretty fast.
Bruce Johnson
And leverage can also be an impediment to price.
Vincent Chao – Deutsche Bank
Okay. This – but you are not seeing any sort of improvement in the secondary markets, which is something we heard on some other calls.
Bruce Johnson
Well, there is improvement in leasing markets, but in terms of specific to dispositions and acquisitions of the properties or in second tier markets, I think if anything has softened...
Martin Stein
There is a modest because of the huge amount of demand for core institutional quality real estate, there is a modest expansion of the definition of core, but beyond that it’s people are interested in, there is a lot of buyers for core and Brian indicated a lot of buyers for value-add, but the commodity secondary to tertiary markets, it’s a – it’s not a (inaudible).
Vincent Chao – Deutsche Bank
Okay. And just going back to the acquisitions quickly, on the cap rates, they’ve been coming – in terms of your guidance, they have been coming down over the last couple of quarters and I think – I think you’ve commented earlier that to pay that huge mix season of additional growth in those properties and I’m just wondering you know at this point is – you’re changing growth assumptions, is that coming more from your expectations of market rent or are you looking more and more at sort of very under market leases, properties and or lease up type of properties?
Martin Stein
It’s not just was just structure of each individual asset that as I mentioned one of the properties we’re looking at has redevelopment component, we would be adding some GLA, and other properties you have significant contractual rent steps, very little of it, we focus on (inaudible) what is contractual and what is speculative, and the vast majority would be contractual, and you know there is a another A quality property that’s out there, it is an A plus trophy, everybody wants it, but it did not have this kind of growth profile that we’re looking for so, in that case we walk away. So, we’re not changing our underwriting assumptions at all.
Vincent Chao – Deutsche Bank
Okay. And, I mean is that pooled in, I mean I’m assuming that’s a shrinking pool, so at some point I mean do you stop the acquiring?
Martin Stein
If we can’t meet our total return hurdles and especially as I think as Brian indicated, number one focus is, if we can get, we’ve said a range of 2.5% to 3.5%, but if we can take with the incremental help, the meaningful margin of what we’re buying and what we’re recycling out of, that we can get that sustainable NOI growth rate to 2.5% to 3.5% range, that’s our primary area – primary focus there, so if we can’t find it, we won’t.
Lisa Palmer
And, I will just add as Brian mentioned earlier, capital recycling is really a key part of our strategy, an important part to be sure that we can sustain that 2.5% to 3.5% same property NOI growth, but we monitor very closely our ability to invest those proceeds and we tried to be certain that our dispositions don’t get way ahead of our acquisitions. This year is unique, but it’s clearly we are contemplating this portfolio sale if we go back to the guidance that we provided back in December, and so we are well aware that’s how we did the term loan, so we had the flexibility to have debt to repay and we had to use for the proceeds.
So it’s something that we watch very closely.
Martin Stein
One of the assets we are looking at is a fantastic center, grocery center as it is, but there is some small space kind of a mini mall area, and we would look to convert that into an anchor, which would be accretive, and then just some adjacent land right next to it, so there’s many ways to get to that growth profile.
Vincent Chao – Deutsche Bank
Okay thank you.
Martin Stein
Thank you.
Operator
Next question from Tom Lesnick with Robert W Baird.
Tom Lesnick – Robert W Baird
Good afternoon. I am standing in for Paula Poskon.
What line items in operating expenses drove such a huge sequential improvement in the operating margin, are those true savings, or just timing related that might reverse in the second half.
Martin Stein
I would say to you from a trend standpoint, we typically see a reduction expenses in our second quarter just to give last year, you saw from the first quarter primarily in our operating expenses, cost related to winter’s decline, we start paying and turn up to our true real estate taxes that we’re paying and so those for the most part drive those increments in the second quarter..
Bruce Johnson
And occupancy – the increased occupancy clearly helps that as well......
Tom Lesnick – Robert W Baird
Okay, and then relatively what trends are you seeing in real estate property taxes, are you seeing this coming down?
Bruce Johnson
It’s continued to come down, I’d say at this point, we would expect to see that to moderate, I don’t think you continue to see the – the declines that we saw through last year and what we’ve seen since the first quarter, so I think that the second quarter would be relatively typical what we see in the future with exception of if we start to significantly ramping up acquisitions, we’ve get those adjustments for values. But I don’t think you’re going to see significant declines from here at all now.
Tom Lesnick – Robert W Baird
All right and then likewise what drove the G&A savings, this quarter?
Bruce Johnson
When you say G&A savings this quarter versus the prior year or?
Tom Lesnick – Robert W Baird
Sequentially.
Bruce Johnson
Our net G&A for the quarter, there was reported 14.4, its down from 14.6, I would tell you that in general...
Martin Stein
Yeah and that was pretty flat quarter over quarter.
Bruce Johnson
Yeah.
Martin Stein
Some slightly higher capitalization as we increased our development activity, but – but not what I call significant maybe, it’s a 200,000 order impact quarter-over-quarter.
Tom Lesnick – Robert W Baird
Okay. And then separately, how much do you think land prices and construction costs will rise and say in the next couple of years?
Martin Stein
Construction pricing has been fairly flat.) We’re just looking at a week or so ago and probably over the last three years we’ve seen a total increase of maybe 10% to 15%.
It’s not in labor. It’s all depends on which commodity prices, a few years back it was oil, it was cement and now it’s metals, so I don’t see anything right now that’s going to drive certainly the labor component of it, land prices in total development program across the country.
For other people it starts dramatically ramping up I don’t think you’re going to see it there. Prices are high for, have held steady well located infill properties, but if it’s anything other than that, frankly we are not interested in.
Tom Lesnick – Robert W Baird
All right. Great Tom.
Thank you.
Operator
Moving onto Andrew Rosivach with Goldman Sachs.
Andrew Rosivach – Goldman Sachs
Hey, team. Really fast one I pulled out the, the same store NOI groups and for the first and second quarter is in the pool dropped about 8 million.
Is that because Blackstone was in the same store poll and now it’s not?
Martin Stein
That’s correct.
Bruce Johnson
Correct.
Andrew Rosivach – Goldman Sachs
And how much just the change of mix contributed to the increase in your same-store guidance. I just kind of took a, an envelope.
Sorry?
Martin Stein
Absolutely none.
Bruce Johnson
Down in the first six months that our expectation is we are more comfortable and probably have some modest positive impact on a go forward basis.
Martin Stein
Year-to-date it was literally it was neutral, and that said from a guidance perspective that that portfolio sale gave us more comfort of increasing lower end of our guidance by more than increase our upper-end. There is just a little bit wider range of outcomes from the portfolio sale, from the properties that were in the portfolio.
Andrew Rosivach – Goldman Sachs
So what you sold to Blackstone on a year-to-date basis have been running at about 3.5% NOI growth rate?
Martin Stein
That’s correct. We increased occupancy.
Bruce Johnson
87% to 90% within the last 18 months.
Martin Stein
Right.
Bruce Johnson
And some of that has occurred recently, so a lot of that is baked into the numbers.
Andrew Rosivach – Goldman Sachs
Terrific. Thanks a lot.
Martin Stein
Thank you Andrew.
Operator
And a question next Citi, from Quentin Velleley. Please go ahead again.
Michael Bilerman – Citi
Yes. Michael Bilerman speaking.
You think back to over the years you’ve always been a pretty active capital recycler and have been pretty disciplined at calling out the bottom tier of the portfolio and to try to keep on enhancing the rest. And I’m curious with the amount that you sold this year if you take your, let’s call $4.7 billion of wholly-owned assets, how much more it sort of fits into this eight cap rate range, in terms of quality, in terms of something that you want to get rid off?
Martin Stein
I don’t want to get specific in that regard, but what I will say is as a result of the sales that have occurred this year and that are pending, we intend to move back to the – what I call moderate levels of annual recycling of $150 million to $200 million a year. Another way of looking at that is that over 95% of our properties and now located in core markets.
So, I think we’ve made significant progress, but we’re going to continue to be a capital recycler, Brian talked about the issues related to Supervalu and there was going to be another Supervalu down the road and for the most part, we want to own good real estate, we are seeing some bad news as good news, but I think that – I think the best way to put that within context is you can expect and we’re expecting return not to say that we might not be opportunistic but $150 million to $200 million of annual recycling a year.
Michael Bilerman – Citi
Well, I guess how would you satisfy the portfolio if you are buying core assets today in the low fives and you’re selling these weaker assets in the eights? You’re talking 250 basis points to 300 basis points spread in value, which is pretty substantial, so if you were to take your portfolio, where would you buck it in terms of value today and how much is in that five category, how much is squarely middle of the fairway, 61/2%, 7% and how what percentages is sort of in that A?
Bruce Johnson
That’s really, you’re basically asking us to tell what we believe we believe our cap rate to be, I mean, I’ll defer to Brian for in terms of the percentages that we believe are As but I think as a whole you would say that our A properties would be in the 5.5% to 6% cap rate range, our B properties would be more in this cost 6.5% to 7.5% and then – that seems to be 7.5% plus. And for a percentage stand point.
Martin Stein
I mean to 60 to two third percent – two-thirds in the AA plus category and the vast majority of the balance are going to be in solid B category.
Michael Bilerman – Citi
And then just last question, comes from the portfolios you sold to Blackstone when you go back to the historical cost of those assets – those assets were developed for about $413 million and obviously a big chunk of the cost is in the lifestyle centers in Dallas between shops higher end at 100 and custom target 60. So, from $413 a current yield about the stock or cost of it six and a quarter for the entire portfolio that you sold.
And Hap I think in the press release you talked about a $20 million net impairment and how should we think about sort of this gross, where there’s a $90 million drop from what you’ve built or pop these assets for to what selling them for today?
Martin Stein
You said it. I mean we think in – the current values are what current values are – and we will make decisions where do we go from here and where we go from here is maximizing our growth and our operating income.
Michael Bilerman – Citi
Okay. Thank you.
Operator
With no further questions at this time, I would like to turn the presentation back over to Hap Stein for any additional or closing remarks.
Martin Stein
We appreciate your time, and we wish – we hope you have a great rest of the week, and great rest of the summer. Have a great day.
Operator
Ladies and gentleman, once again we’ll conclude our presentation for today. Thank you so much for joining us.
You may now disconnect.