Earnings Call Transcript - ARE Q2 2012

Operator, Operator

Good day, ladies and gentlemen, and welcome to the Second Quarter 2012 Alexandria Real Estate Equities, Inc. Earnings Conference Call. My name is Diana, and I will be the coordinator for today. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Ms. Rhonda Chiger. Please go ahead.

Rhonda Chiger, Investor Relations

Thank you and good afternoon. This conference call contains forward-looking statements within the meaning of the federal securities laws. Actual results might differ materially from those projected in the forward-looking statements. Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements is contained in the company’s Form 10-K, annual report, and other periodic reports filed with the Securities and Exchange Commission. Now I would like to turn the call over to Mr. Joel Marcus. Please go ahead.

Joel Marcus, Chairman, President and CEO

Thanks, Rhonda, and welcome, everybody, to the second quarter conference call. With me today are Dean Shigenaga, Steve Richardson, Peter Moglia, and Krupal Raval. I guess I would like to start out with a bit of a macro view for the second quarter, which really epitomizes where we see things today from a strategic advantage point. That is scientific advancement as a team thrived that can be best done in a biotech hub with multiple players; that is what Boston is to us. This was a quote recently in an interview by Elias Zerhouni, he was President of Global Research at Sanofi, and as many of you know, he was the former head of the NIH who really pioneered translational research in areas best positioned to take maximum advantage of this. I'd like to label the macro industry comments today, what I’d call the gathering pipeline momentum. We’re witnessing a perfect explosion of biotech products, earnings, and expansion, what I call the biotech business. Just to name a few companies that are participating, many of which are our clients: Amgen, Celgene, Biogen Idec, Gilead, Alexion, Vertex, and Onyx. If you look at the markets, the Supreme Court’s confirmation of the constitutionality of essentially Obamacare will move the U.S. to full coverage of over 300 million people, which means the market will be increasing, and clearly the emerging markets are where big pharma is heavily focused as well. Last year, the U.S. spent $320 billion on medicine, so there certainly is a robust business. Today’s climate is actually a lot better than you might think; the FDA has been doing a much better job, I think from the industry perspective, in the approval of new medicines. As of today, July 31, 2012, 18 drugs have been approved, and an amazing 50% of which were our client tenants. The PDUFA law that was just enacted included some very important helpful attributes for the biotech and pharma industry, including confirmation of 12-year data exclusivity and fast track approval for new novel drugs which we were involved with. It’s also fair to say that based on what we hear from Washington, it appears that the NIH will be spared cuts if we get an election that makes sense here, so we’re hopeful about that. From the technology standpoint, the lifeblood of biotech and pharma, we’re seeing a variety of emerging new highly disruptive first-in-class drugs, including things like small molecule inhibitors for cancer stem cells, which really have the potential to someday reduce or maybe even eliminate radiation in chemotherapy. So, the outlook is strong; we’re entering a second wave of biotech successes and we’re extremely well positioned as the leader in each of our key adjacency submarkets to take maximum advantage of this second wave expansion. Moving to the balance sheet and capital allocation, it’s clear and Dean will speak to this a bit. Our goal over time, as we’ve said, is to operate in about the 6.5 times debt-to-EBITDA range, achieved through various strategies including onboarding additional NOI, continued use of the ATM, pay down of debt, and continued sales of selected non-income producing land parcels, you'll see some coming up here in the third quarter. We’ll likely see an equity partner for Asia operations to share CapEx for what we consider to be a big opportunity. We see significant near-term opportunities to take advantage of two converging macro forces: pharma penetration of our adjacency clusters as we’ve referred to, and now the emergence of this second wave of biotech expansion, primarily in Greater Boston, San Francisco, and New York City. We’ll selectively continue to allocate capital including recycled from suburban asset sales including some even closed today to our core cluster development sites with quality tenants where yields are significantly better than prevailing cap rates on sales of stabilized assets in such submarkets. So, there is a real good business there. In the second quarter, we did acquire a modest redevelopment site in the AAA location in Torrey Pines for almost $14 million. When we look to the second quarter for internal and external growth, one thing that I think we’re very proud of, and it’s kind of an amazing statistic, is an astounding 48% of our annual base rent comes from investment-grade tenants. Once again, Steve will speak to this. We had a very strong leasing quarter, almost 960,000 square feet with a pretty solid staff; Boston kind of won the prize at 29% of leasing, San Francisco about 22%, and Maryland about 18%. This included landing the new NIH’s mission-critical MCATs requirement, which we’re very proud of. Other than East Jamie and the Gates Seattle Headquarters conversion, and again, Steve will talk a little about this, we had solid returns on development and redevelopment. We’ve seen pretty solid returns on our India projects and with a pretty high level of credit, we’re working on expansion there. South China, which was originally a failed joint venture with a U.S. and European firm, really represented our first test case: could we actually build a building in China ourselves and then ultimately lease it? It’s about a 300,000 square foot, two-building flex manufacturing complex in South China. Hopefully after we fully lease it, we’ll exit that asset, and it’s a non-lab asset. In Northern China, we’re working on technical infrastructure, working hard to lease that development. The challenge in China, as I’ve said a number of times, is the incentive system; when you bring a client to China, there are about 30 offers to go all over the country. I was just last week in Beijing and met with officials to ensure that we have an incentive scheme in place to land some of our important tenants, so stay tuned there. Steve will talk a little bit about 499 Illinois; we do continue to be disappointed with the slowness of leasing up this asset, particularly in light of strong tech demand in the Bay Area. We hope as we enter the third quarter, we’ll see a little bit more robust results, certainly into 2013, in our core internal growth. But we understand we are obviously in a dramatically slower growth macroeconomic environment. So, with that kind of as a setting, I’m going to ask Steve to do a bit of a detailed review of our leasing this quarter.

Steve Richardson, COO and Regional Market Director

Hello, everybody. I’ll talk about the leasing activity on key projects, the 2012 rollover status for the balance of the year, and then a little preview on the 2013 rollovers. Really the emphasis for our fully integrated regional leasing and asset management teams in the second half of this year will be an intense focus on the three critical development and redevelopment projects we have outstanding. The first one is 499 Illinois. We continue to have conversations with tech companies and life science institutions, but no active negotiations are underway, as Joel mentioned, and that is a bit disappointing. However, the Veterans Affairs lease of 51,000 square feet of lab space at 1700 Owens was indicative of Mission Bay’s continued strong appeal and a must-have location for life science companies, and we continue our aggressive pursuit of a quality anchor tenant for Illinois. The UCSF Hospital continues to bring a strong sense of completion to the southern portion of Mission Bay, as the curtain wall is nearly complete and a substantial nature of this facility is becoming very evident. The technology companies continue to gravitate toward growing SOMA and MDMA primarily to be amongst their peers. Given the right opportunity, we believe an anchor tech tenant would change this dynamic for attracting these types of tenants to Mission Bay. The tech sector is clearly focused on SOMA and MDMA, driven really by three factors: first, the immediate adjacency to the BART or Caltrain transportation lines; second, the mature amenity infrastructure; and third, the more edgy urban nature of the setting in the buildings, as they are appealing to a younger demographic there. The second project in Cambridge at 400 Tech Square has us very pleased. We have serious negotiations underway with letters of intent signed with two prospects totaling another 50,000 square feet that would boost occupancy to approximately 80% in this 212,000 square foot facility, and we’re hopeful to have those leases consummated by year-end. A more detailed floor-by-floor review of this facility looks like the following: the lower level in the first quarter was substantially leased to Reagan and Alexandria’s regional offices. The second, third, and half of the fourth floor are anticipated to be leased to the two prospects mentioned above. After the fourth floor, a fifth floor lease is pending, and Reagan has the action on the sixth floor with leases also securing the 7th, 8th, and 9th floor. Lastly, the 10th floor is currently being marketed. Moving back over to the West Coast, at 1551 Eastlake, we do have early discussions underway with an important current tenant of ours for 30,000 to 40,000 square feet on the second and third floors that would bring occupancy up to approximately 90% by year-end in this 117,000 square foot building. Again, a floor-by-floor review shows that we have the lower level and first floor leased to the Puget Sound Blood Center; a portion of the second floor is leased to Adaptive TCR, and the balance of the second floor is in discussions with the tenant that we noted above. The WBBA hub for the life science industry activities is really energizing this building, and this is part of the South Lake Union leases a portion of the third floor, with the balance actively being marketed. Looking over the next two quarters at the 2012 rollover status, we started the year with 694,000 square feet of leases remaining to be resolved, and the regional teams have worked very effectively to reduce that figure to just 178,000 square feet as of June 30, 2012. The majority of the final lease rollovers are concentrated in the following markets: we have 40% in the Greater Boston region, more specifically about 26,000 square feet in Cambridge where demand is very strong and lease rates for these particular spaces are in the mid-$40s; there are 12,000 square feet in Waltham along Route 128, where demand is also healthy and lease rates are close to $30; and then there is another 30,000 square feet in Worcester in the Route 495 Corridor, where demand is weaker and lease rates are in the mid-$20 range. We have another 20% in the San Francisco region, primarily comprised of three leases in Mission Bay, where demand is strong, and it looks like one of the tenants right now would renew, and we’re starting conversations with a tenant for the balance of the space, and lease rates remain steady in the mid-$40s. Another 20% in the Seattle region is substantially located in one facility in the Pill Hill submarket. Lease rates for product in this submarket are in the $20 range but are generally in the mid-$40s for the South Lake Union submarket where most of our asset base is located and where demand is strongest. Finally, the San Diego and Suburban DC markets comprise the balance of our renewal and leasing activity across the country, and San Diego’s demand has in fact slowed from its torrid pace during 2011, but is still steady with lease rates ranging from the mid-20s to mid-30s and Suburban DC’s demand remains weak, although we did have a few highlights for this quarter with lease rates in the $20 range. Just real quickly, a preview for 2013: we have a total of 1.2 million square feet of rollover slated for the year, and we are in active negotiations for more than 300,000 square feet. The remaining 900,000 square feet is too early to forecast in a definitive fashion, but as a framework, those remaining rollovers are concentrated in the following markets: 200,000 square feet in the Greater Boston market with a mix of suburban and urban facilities; 220,000 square feet in the Bay Area market spread evenly throughout the Stanford, South San Francisco, and Mission Bay clusters; about 130,000 square feet in the San Diego market primarily in the Sorrento Valley and Sorrento Mesa market; about 190,000 square feet in the Suburban DC market distributed across its submarkets; another 61,000 square feet in Seattle, again principally in the Pill Hill submarket; and finally, about 50,000 square feet in the North Carolina market. I will provide additional details on the 2013 goals as we approach the end of the year, and with that, I’ll hand it over to Dean now for further commentary.

Dean Shigenaga, CFO, SVP and Treasurer

Thanks, Steve. Let me jump right into our core operations. Second quarter 2012 NOI was slightly ahead of our expectations at about $103.8 million. This is before the $5.8 million realized gain in other income, and that NOI is up from the $101.4 million for the first quarter of 2012. The increase in NOI was driven across multiple properties and included value-add project delivery slightly ahead of schedule, the acquisition of the property in San Diego, earlier leases up of a few suites in Boston, and delivery of space in India to the top-tier pharmaceutical company. Our overall occupancy including space undergoing redevelopment in the Greater Boston market was about 85% as of December 31, and about 83% as of March 31. We have leased and delivered space as a result in an increase in overall occupancy including our redevelopment space to approximately 84.1%. We anticipate further improvement in overall occupancy in Greater Boston in the second half of 2012. The occupancy gains were realized through quick re-tenanting at 300 Technology Square and occupancy gains at 790 Memorial Drive and 99 Erie Street, all of which are located in Cambridge. Overall occupancy including space undergoing redevelopment in San Francisco Bay was approximately 96.7% as of December 31 and 93.9% as of March 31. We have an increase in overall occupancy to 94.7% as of June 30, really through short-term tenancy for temporary space for Onyx while we complete the build-to-suit development. Occupancy in the Suburban Washington D.C. market reflects the anticipated rollover of 97,000 square feet related to one tenant that occupied a mix of office, warehouse, and laboratory space in a non-core submarket. As previously highlighted, we expect this space to require several quarters to release. Same-property growth in NOI for the second quarter was down 0.2% on a cash basis and up 1.6% on a GAAP basis. Same-property cash performance would have been stronger this quarter; however, last year, one tenant had a larger contractual payment due under the release of approximately $2.5 million, driving up cash same-property performance in the second half of 2011 to 9.4%. Overall, same-property occupancy was flat to slightly up but does not reflect some vacancy absorbed during the quarter. During the quarter, we absorbed some vacancy temporarily in San Francisco and Boston, and these vacancies resulted in lower expense recoveries and cash same-property performance. Straight-line rents for same-property have also declined, resulting in higher cash NOI due to the start of approximately $5.7 million of annual cash rents from one lease, for which the cash began in February of 2012. We also had a couple of other leases with slightly higher steps in cash rents, one in San Francisco and one in Maryland. Same-property operating expenses increased about 4.5% primarily due to increases in recoverable repairs and maintenance by approximately $900,000. Excluding this increase in repairs and maintenance, same-property operating expenses increased about 1.6%. We’re expecting stronger cash same-property performance in the second half of 2012 primarily due to the recovery of occupancy in the Greater Boston market. In addition, same-property performance for the second half of the year will not be impacted by the larger contractual cash payment received in the first half of 2011. Moving onto our value-added projects, during the second quarter, we completed the redevelopment of 98,000 square feet at Johns Hopkins Court for an affiliate non-profit entity of Novartis and a leading industrial biotechnology company, at yield slightly ahead of our original estimate. Cash yields were 8.9%, up 30 basis points, and GAAP was 9.1%, up 10 basis points. We also completed the development of 26,000 square feet in Canada for GlaxoSmithKline, yielding slightly ahead of our original estimate. Cash yields ended up at 7.7% and GAAP at 8.3%, both up about 10 basis points. We also updated our total cost of completion for our development at 225 Binney Street in Cambridge by $17.7 million as a result of certain design requirements for Biogen. The increase in this cost will generate a return and as a result does not impact our overall estimated yields for cash and GAAP of 7.5% and 8.1% respectively. Lastly, we updated our revenue forecast for our redevelopment project at 1551 Eastlake in Seattle and our estimate of cash and GAAP deals to about 6.7%. Our revenue assumptions updated to reflect about 17,000 square feet of this project, ending up as pure office space at office rents. We expect our lab tenants to expand into this space over time, at which point we’ll generate triple net live rents. As of June 30, we’re 75% leased on 954,000 square feet undergoing development in North America and 76% leased while negotiating on 812,000 square feet undergoing redevelopment in North America. Moving on to our balance sheet as of June 30, we had approximately $1.1 billion of availability under our unsecured line of credit and about $81 million of cash and cash equivalents. During the quarter, we closed a construction loan for our development project in South San Francisco, with commitments aggregating $55 million. Funding under this loan began in July, and the loan is expected to cover the remaining cost of the project. During the quarter, we issued approximately $40.5 million under our At-the-Market common stock offering program. As of quarter end and as of today, we have approximately $209.5 million available under the program. We expect the remainder of the program to be utilized over a four-quarter period for funding a portion of the equity needs related to our value-added development and redevelopment projects. As disclosed in our first quarter earnings call, in April, we also completed the amendments to the pricing and maturity date of our unsecured line of credit and redeemed our Series C preferred stock. Moving on to the asset sales; again, we remain very focused on our asset sales target of $112 million for 2012. In summary, we completed $33 million as of June 30th located in Boston and Seattle. $22 million as of June 30th was under contract, $8 million of which was sold in July located in the Route 495 Suburbs of Boston. That left us with about $56 million remaining as of June 30th. Today, we completed the sale of two assets located in Pennsylvania for about $20 million. The PNS for this deal was executed, and as a result this transaction did not meet the criteria for held-for-sale as of June 30th. We also have about $15 million related to assets in San Francisco that we expect to close later this year. That leaves us about $21 million unresolved, and we have a number of assets moving along to cover this amount. We are also focused on continuing our asset disposition program into 2013 and we plan to provide an update on our target disposition amount later this year. 2013 asset sales will likely form a range of markets including Seattle, San Francisco, Maryland, Massachusetts, Pennsylvania, and San Diego. Our net debt-to-EBITDA was 7.1 times or 7.6 times excluding the $5.8 million realized gain from an equity investment in the life science entity. We remain committed to lower leverage and will require capital to balance our incremental construction spending over time. Some of this capital will come from land and operating asset sales and some from equity or through our ATM program. Our debt-to-EBITDA will also benefit from the significant amount of NOI and EBITDA contribution through the fourth quarter of 2012 and thereafter from the delivery of our significantly leased redevelopment and development projects. Again, our goal over time is to improve our debt-to-EBITDA to sub 6.5 times. Lastly on guidance, our guidance for 2012, including the fourth quarter of 2012, reflects the significant leasing status of our active development and redevelopment projects. East Jamie Court is now 78% leased, four development projects are 100% leased, and we are working on the lease up of Illinois. Our redevelopment projects are now 76% leased or under negotiation. One lease under negotiation is for 91,000 rentable square feet and is expected to be executed this week. We updated FFO per share guidance for 2012 by $5.8 million or $0.09 per share of additional other income in the second quarter, primarily from an equity investment. We also slightly adjusted the range for interest expense net for the year by about $1 million, in the fourth quarter by about $500,000, and slightly adjusted the range for the fourth quarter NOI by about $0.5 million for the upper and lower end of the range. These slight adjustments reflect the timing of completion of construction and commencement of rent related to spaces aggregating about 75,000 square feet. No other significant changes in our overall guidance assumptions, as highlighted in our press release on pages six through eight, have been made since our guidance from the first quarter earnings. Looking forward, again, NOI is expected to increase from the $103.8 million before the $5.8 million realized gain for the second quarter to a range from $110.5 million to $112.5 million for the fourth quarter of 2012. Roughly 20% to 30% of this NOI growth will occur in the third quarter and 70% to 80% will occur in the fourth quarter of 2012. We also provided a range for FFO per share diluted guidance for the fourth quarter of $1.15 to $1.17. NAREIT FFO per share diluted for 2012 was provided in a range from $4.32 to $4.36, again up $0.09 over our prior range for guidance related to the other income recognized in the second quarter. Our guidance for EPS diluted was $1.36 to $1.46. Now in closing, as a reminder, we have reported NAREIT FFO per share diluted of $0.97 for the first quarter, $1.13 for the second quarter, and we’ve provided a range for the fourth quarter at $1.15 to $1.17. These figures result in a range for our third quarter 2012 FFO per share diluted of about $1.07 to $1.09 per share. With that, I’ll turn it back over to Joel.

Joel Marcus, Chairman, President and CEO

Operator, we’d like to open it up for Q&A if we could, please?

Operator, Operator

(Operator Instructions) Your first question comes from the line of Jamie Feldman, Bank of America.

Jamie Feldman, Analyst, Bank of America

Great. Thank you. Can you guys dig a little deeper on what’s going on in Cambridge? I know when we spent some time out there, it seemed like you had several development irons in the fire, I’m just trying to get the latest thoughts on what’s going on, and is there something that’s changing in terms of sentiment and people’s specificity of signing leases?

Joel Marcus, Chairman, President and CEO

No. I think, I would just say on the build-out side, stay tuned. I don’t want to pre-announce anything, but we’ve talked about significant demand there, and our Alexandria Centre at Kendall Square, one on the Binney Street quarter, I think has been the target of quite a bit of interest from a range of second-generation biotech companies that are experiencing significant commercialization today. So I think that is unchanged, and I think you will see some of that manifest itself and unfold pretty soon. I think when you get back to the Tech Square area and overall just demand, then I think as Steve said, we’re seeing pretty strong demand. My guess is we’ll be out of space at 400 Tech Square by the end of the year. We’re already assuming we sign leases for these two latest LOIs that have been signed; that gets us pretty close to where we want to be. So we’re seeing continuing solid demand in that market. I don’t know if Steve has given other comments or thoughts.

Steve Richardson, COO and Regional Market Director

Yeah, I mean, using 400 Tech Square specifically, we talked about the stacking diagram. I mean once you start factoring the option in that rig and has their – and we’ll just have 10,000 feet or so left on the top floor assuming Ragon did move forward with that. So, it continues to be a very, very healthy market.

Joel Marcus, Chairman, President and CEO

Yeah. And Ragon, just for those who don’t know, it’s a nonprofit institute of Massachusetts General Hospital, and the other two LOIs that we signed; one is a very large credit tenant, and then the other one is an emerging company. But I’d say the demand is coming heavily overall from the big demand heavily from the second generation of companies that are experiencing kind of the commercial stage. So it stays strong. I’m a little less focused on the tech sector there. I don’t know if, Peter or Steve, if you guys have any comments. I think it’s still pretty strong, but I haven’t seen many specific comments that I could elaborate on.

Dean Shigenaga, CFO, SVP and Treasurer

I haven’t seen anything announced recently, but obviously Google and Microsoft have grown. I think Microsoft actually took more space at Cambridge Center that was the last deal that was announced.

Jamie Feldman, Analyst, Bank of America

So can you talk a little bit more about what that means in terms of what you’ll be doing and your time commitments and how we should think about that related to ARE?

Joel Marcus, Chairman, President and CEO

Yeah. I wouldn’t say that it’s a quarterly board meeting in Washington, but I would say I’m kind of a 24/7 guy, so it won’t have any impact whatsoever. Other than it gives me a chance to interface directly with the – and we have at our recent conference with Francis Collins and a number of the people on the Hill requesting NIH funding. So, in a sense, it gives us a direct pipeline to that discussion negotiation between the NIH and the government and Congress as far as continued funding for critical-stage basic research here in the U.S. So, I think it will be a big plus.

Jamie Feldman, Analyst, Bank of America

Okay. All right. Thank you.

Joel Marcus, Chairman, President and CEO

Yup. Thank you.

Operator, Operator

Your next question comes from the line of Steve Sakwa, ISI Group. Please go ahead.

Steve Sakwa, Analyst, ISI Group

Thanks. Good afternoon. Joel, I just want to know if you could talk a little bit about New York. I know there was a story about the New York Genome Center and the fact that they had signed a 170,000 square-foot lease, down more in the – I guess it’s a little further south. I’m just curious if that type of tenant was something you could have looked out to kick-off the West project. Did the timing not fit, or was there just something about your project and that tenant that maybe didn’t allow that deal to happen?

Joel Marcus, Chairman, President and CEO

Yeah. Let me give you maybe a more macro view. I think that we see, as I mentioned, the second wave of biotech commercialization successes coming to New York as well. We also see, maybe even more importantly in New York, as really becoming an important destination for new research or development units of big pharma. The Wall Street Journal documented that last year with Pfizer, we’ve certainly seen it in Lilly and Pfizer. It’s clearly true that there are a number of pharmas looking to place a unit into the New York area. We think that’s one of the most attractive targets that we would look at; obviously, internal demand from our existing clients. The New York Genome Center, I’d say for two reasons, was not of great interest to us, although I think it’s great for New York. Number one, timing was a little too early for us, and secondly, I think our own underwriting of that kind of an entity would basically say that we would be more comfortable seeing them move into a more robust funding environment than they are today. If you compare that to the – they kind of want to be a broad institute. They’re not there yet, but maybe someday they’ll work up to that. They don’t have any anchored donors at the moment; they’ve just gotten donations from a number of the institutions. But you compare it to what Steve mentioned in 400 Tech Square with Ragon. Ragon is a fully funded institute of Massachusetts General Hospital. That’s the kind of tenant we feel pretty comfortable about underwriting. So, for New York, we just weren’t there from both a timing and underwriting perspective.

Steve Sakwa, Analyst, ISI Group

Okay. And then, secondly, on page 33, I want to just thank you for providing a lot more detail on kind of the China and India development projects that you’ve got going, but it obviously kind of begs the question—and you did allude to this—that you’ve got your two projects in China, but not really going forward. I’m curious if you could provide us the information for the operating property. I guess the roughly 300,000 that’s open. Is that cost much different than the $82 million that is expected to be spent on the other 300,000 foot building?

Joel Marcus, Chairman, President and CEO

Yeah. They’re fundamentally—I’ll let Dean comment on the specifics—but they’re fundamentally different projects. As I said, we started South China really with a U.S. company; actually, the requirement came out of the company that we’re close to in the Mission Bay area, teamed with a European company, and we then acquired this site—this land, it’s a 50-year land use in South China kind of near Macau. It’s a region we wouldn’t have normally gone to, but we decided we’d use it as our first ability to have our own team, ‘cause we don’t do joint ventures there to see if we could really build a product. Then once the joint venture fell apart and we kind of faced, we’ve got to finish this development, because in China when you sign a deal, if you’re a foreign company and you just don’t go forward, you’re not likely to do anything else in China. So we wanted to preserve our reputation, and we’re developing it. It’s an area that really is a manufacturing and flex market; it’d be kind of like an industrial area in the U.S. So the costs there are considerably lower than we would expect if we built a lab product, but Dean can give you some highlights.

Dean Shigenaga, CFO, SVP and Treasurer

Yeah, just to give you some rough sense, Steve, I think if you think of what’s in service, you probably have a roughly 50-50 allocation between China and India just on the in-service assets.

Joel Marcus, Chairman, President and CEO

But on that specific asset on cost in Southern China.

Steve Sakwa, Analyst, ISI Group

Yeah, I guess—

Operator, Operator

Your line is open, Steve.

Steve Sakwa, Analyst, ISI Group

Hello, can you hear me?

Joel Marcus, Chairman, President and CEO

Yeah, let us work on that, and we’ll try to give you a little more color on the costs in Southern China, but we would see them to be considerably lower than building a lab building.

Dean Shigenaga, CFO, SVP and Treasurer

Yeah, I agree. We’re probably about $70 a foot there in South China.

Steve Sakwa, Analyst, ISI Group

Okay. And then, Joel, can you just comment—it does look like your leasing activity in India seems to be much stronger. I think your lease—three buildings are 100% leased, one building is about two-thirds leased, but maybe just talk a little bit about the demand drivers you’re seeing in India. It did sound like you’re much more optimistic about that market, and it sounds like you might bring in a joint venture partner to fund that—how far along are you on that?

Joel Marcus, Chairman, President and CEO

Yeah. So let me maybe just say one or two other things about China, and then I’ll speak to India. I think when it comes to China, we’ve realized the basic challenge in China is less the demand and more the incentive system, and Steve and I have both spent considerable time in China; I was just there last week. You bring a client over, and literally that client, once they go shopping in China can end up with a dozen, two dozen different offers from any number of economic development zones, cities, provinces, and it creates a challenge of sticking tenants. So our view is, I don’t think we’ll be doing much more in China, but if we were ever to do it, it would have to be done on a pre-lease build-to-suit because otherwise, it’s just a very hard goal. We need to work out of the two projects we’re on. We hope to complete them, and ultimately, we would probably exit those projects. In India, we think because you can actually own land, there is no government interference; there is no real incentives. It is much more of a normal environment, although India still is an emerging world country. There is huge demand from really what we would consider to be life science, kind of health science, industrial uses of laboratories. We think it’s a big opportunity in a number of clusters throughout the country. We like the South, but the North and Northwest are particularly good. Delhi is an interesting location. We’ve tried to establish kind of critical mass. We’ve got our own team on the ground. We’ve put into construction and development a number of projects where we tried to do a little bit like we did pre-crash, where we would try to meet existing demand with a product that we’re constructing. I think going forward, we would really go-forward only with either 100% built-to-suite or a substantial prelease for future developments. But we think the demand is really substantial. It’s a country with over a billion people; healthcare is an important part of what they’re doing. They’re still battling over patent protection, but fundamentally most of the big pharma and a lot of the industrial companies that use laboratories for their R&D aren’t looking at India’s novel discovery platform—they are using it as a base to penetrate that huge market and one where they can do process work. So, it’s a pretty fertile market. It produces, I think, the most engineers of any country on earth. There is an emerging big middle class, the size greater than the U.S. So we think that the demographics and the pieces are in place for good productive work. We think the yields are pretty good and we think the locations when you can cluster in knowledge canter make a lot of sense. But we do think, given where we are in the capital side of things and where the U.S. is macro-wise, it would be to our best interest, much like we did with Longwood, to team up with a financial partner, not—we don’t need an operating partner, but a financial partner that we could split the upside, but also split the capital cost. I think we’re proceeding with that effort, so I’d be happy to answer anything more specific than that.

Steve Sakwa, Analyst, ISI Group

Is that something you think you could get done this year, or is that a 2013 event?

Joel Marcus, Chairman, President and CEO

I think that’s probably first; my experience in India, I don’t know, I’ve been there maybe 40 times, is it kind of depends—for a U.S. firm that operates there, it could go fast; if it’s a firm in Asia, somewhat slower. So I would say six to nine months would be a kind of estimate. It could be that our effort with Clarion and Longwood went pretty fast. But, again, India is different. So I would say probably early part of 2013, the first half.

Steve Sakwa, Analyst, ISI Group

Okay. Thanks.

Joel Marcus, Chairman, President and CEO

Yup. Thanks, Steve.

Operator, Operator

Your next question comes from the line of John Stewart, Green Street Advisors.

John Stewart, Analyst, Green Street Advisors

Thank you. A couple of questions for Steve, actually. Steve, first of all, just curious; what is the Veterans Administration doing with lab space in Mission Bay? And then if you could give us an update on Salesforce. Lastly, you and Joel both sort of alluded to 499 Illinois, and I guess just given the perceived strength of that market, we would have expected to see more leasing there. Could you give us kind of—, I guess for the quarter what do you think has held you back there? Is it that tech users have gone shy on Mission Bay, or do you need to put more capital in the building? What’s going on there?

Steve Richardson, COO and Regional Market Director

I think it was the regional manager's hold this Bay. On the VA, they had an existing research facility. It’s really their leading research facility in the entire country for veterans as they have various maladies. They relocated from a location in the Presidio based in San Francisco that was very antiquated. We’ve been talking with them literally for a number of years. I think we first chatted with them five years ago, just shortly after we purchased the property in Mission Bay. They were very keen to locate kind of a must-have type of location, and we were able to pull together a lease with the government actually in record time. It went very, very quickly, because they really wanted to seize the opportunity there. On the Salesforce land, there is really nothing new to report. They had said that it would be two or three quarters while they were in pause mode looking at their existing headcount needs, trying to find existing facilities to accommodate that before revisiting whether or not they would move forward with actually building out a campus. It’s really not clear at this point. I don’t know that we’re overly optimistic or pessimistic. It’s just under further consideration by their team.

Joel Marcus, Chairman, President and CEO

And then finally with Illinois, it absolutely has been disappointing there. You see somebody like the VA who has to be in Mission Bay and wants to be in Mission Bay, so they moved quickly. We just haven’t seen additional demand in the window of time we’ve had since we acquired the asset from a high-profile, high-credit tenant, and the tech companies really have wanted to stay very, very close to their peers. I think there’s a little bit of frankly a lemming mentality, where they get concerned about recruiting people if we’re next door to Twitter and Zynga and their brethren. They just have more comfort. Mission Bay hasn’t really been identified as a clear tech destination. I think if we were to secure an anchored tenant with a floor or two, I think that would change literally overnight—but we’re just not there yet.

John Stewart, Analyst, Green Street Advisors

You might just talk about when the hospital gets delivered, because that’s clearly a game changer.

Joel Marcus, Chairman, President and CEO

Yeah, that couldn’t be a bigger part of Mission Bay, with a couple billion dollars of investment going on right now, and we do see the full substance impact of a 1.1 million square foot facility there. Just like we saw when a number of the research buildings were being built out, that drove a lot of the clinical demand that has now resulted in 100,000 square feet of leasing by UCSF at 1500 Owens. We do expect additional demand, and it doesn’t necessarily have to be UCSF at all, but other entities will make it imperative for them to be near if not adjacent to the hospital to look at 499 as a very logical location. That still is a ways off from ultimately being operational, but I think the fact that the curtain wall has completed and it looks much more like a finished product will have a meaningful impact on how people perceive this area over the next couple of quarters.

John Stewart, Analyst, Green Street Advisors

Have you had any contact with Salesforce, or have they just gone silent?

Joel Marcus, Chairman, President and CEO

No, we’re in very close contact with them, consistent contact. We’re obviously neighbors, and they just haven’t changed their view on their plans for the future.

John Stewart, Analyst, Green Street Advisors

Okay. And then, Joel, just on the asset sales; a couple questions: one; what is the mix for the $57 million that’s targeted to hit the full-year guidance? What’s the mix, the breakout between income-producing and land sales?

Dean Shigenaga, CFO, SVP and Treasurer

I’m looking at that right now. So, we just closed of the $56 million remaining. We closed $20 million today to Pennsylvania. Since they’re operating, maybe $15 million or so would be land. The last $21 million is still to be determined. I don’t think there is any significant land in there, so I’d say it’s more operating in that bucket.

John Stewart, Analyst, Green Street Advisors

Okay.

Dean Shigenaga, CFO, SVP and Treasurer

I think that’s correct.

John Stewart, Analyst, Green Street Advisors

Okay. And then, it may not be entirely fair to draw inferences from the discontinued operations on page 18, but if you do look at you had the one income producing asset and just if you did take the disclosure, it looks like you’re talking about a double-digit cap rate on the Route 495 asset; is that kind of what we’re looking at for a suburban lab non-cluster asset?

Joel Marcus, Chairman, President and CEO

Yeah. I think you’re taking the implied information from the P&L and balance sheet disclosures on page 18 of the supplemental. And I think what you have to keep in mind is the 196,000 square feet is more of a land type...

John Stewart, Analyst, Green Street Advisors

Right. So we would have expected the NOI will be entirely attributable to the income-producing asset.

Dean Shigenaga, CFO, SVP and Treasurer

On $8 million, I don’t recall the cap rate. There is income related to the land parcels; they are operating but just not at office or lab rents. There is income being generated; I don’t have the breakdown. John, I can give you some better color offline.

Joel Marcus, Chairman, President and CEO

They are happy to follow up offline. One last...

Dean Shigenaga, CFO, SVP and Treasurer

I won’t read too much into the $8 million sale as a benchmark for yields on dispositions or even cost per square foot.

Joel Marcus, Chairman, President and CEO

Yeah, because it’s kind of one-off assets; it’s not even clustered. It’s not part of the Worcester asset group.

John Stewart, Analyst, Green Street Advisors

Sure, and it’s obviously a small deal, but we just don’t see a lot of comps, so that’s why I’m interested. And lastly for you, Dean, if I may—and I apologize if I missed this; your disclosure obviously continues to improve, and thank you for that. But do you break out anywhere the NOI that runs through the P&L from properties that are still in the development pipeline?

Dean Shigenaga, CFO, SVP and Treasurer

We do. It’s on page—it’s in the AFFO reconciliation, which shows up on page 12, and it’s actually burning down fairly significantly. Most of the revenue—always find at your—it was $478 million in Q1, $72 million in Q2, so it’s really burnt down. We used to be running; if you go back to June of the second quarter of 2011, we were about $1 million a quarter. What’s happened is most of that income was being generated out of the Cambridge and Binney Street development site, and as we move closer to vertical construction, we slowly vacated the tenancy in the buildings and since then have taken down most of the buildings out there. If you’ve been out to Cambridge lately, you’d see most of the sites leveled now.

John Stewart, Analyst, Green Street Advisors

Okay. Thank you.

Joel Marcus, Chairman, President and CEO

Thanks, John.

Operator, Operator

Thank you. This concludes the question-and-answer portion for today. I would now like to turn the call back to Mr. Joel Marcus for closing remarks.

Joel Marcus, Chairman, President and CEO

Yeah. Thank you, everybody. Sorry we ran a little bit over here, and we’ll look forward to talking to you on the third quarter call. Thanks again.

Operator, Operator

Thank you once again. Ladies and gentlemen, this concludes today’s conference. You may now disconnect and have a great day.