Earnings Call Transcript - ARE Q3 2014

Operator, Operator

Welcome to the Alexandria Real Estate Equities, Inc. Third Quarter 2014 Earnings Conference Call. My name is Matt and I will be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please note that this conference is being recorded. I would now like to turn the call over to Rhonda Chiger. Ms. Chiger, you may begin.

Rhonda Chiger, Investor Relations

Thank you and good afternoon. This conference call contains forward-looking statements within the meaning of Federal securities laws. Actual results may differ materially from those projections in 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. And now, I would like to turn the call over to Mr. Joel Marcus. Please go ahead.

Joel Marcus, Chairman, CEO and Founder

Thanks, Rhonda, and welcome everybody to the third quarter call. With me today are Dean, Steve, Peter, Tom, and Dan. So we've got a full house here. We are pleased to report the third quarter FFO of $1.21 a share and an increase in our narrowed guidance of $4.79 to $4.81, FFO up over 14% from the third quarter of '13, characterized by strong demand as well as strength in our core operations. And I think the key to the success this year has clearly been our platform, which is our Class A facilities located in our collaborative science and technology campuses and the best urban innovation clusters we've certainly benefited significantly from that. I think if you think about Alexandria at this point in time, maybe ten kind of key strengths come to mind. First of all, very strong core operations across all key metrics as set forth on Page 1 of the press release and accelerating FFO growth into 2015. Second, we've got 2.3 million square feet in current value creation development or redevelopment projects, 85% leased or in negotiations, as outlined on Page 29 of the supplement. I think this is a great testament to the teams in each of our markets, plus an additional approximately 1.8 million square feet in near-term value creation development projects, virtually all of which are under active negotiations, again Page 29 of the supplement. I think what's also important to note is the average initial cash stabilized yield generated from approximately 6.4% to 8.3% in value creation, substantially exceeding our implied cap rate base cost of capital, resulting in strong profit margins over the coming several years. You can take a look at Pages 30 and 34 for those updates. Alexandria clearly owns the best science and tech campuses in our urban innovation clusters of any REIT or private investor today. A very well-run asset base at the asset management level. Five, very few challenged assets. Six, I think a deep long-tenured and highly talented team which are fully integrated members in all of the key innovation clusters. As Dean has pointed out, we have a high level of liquidity, almost $2 billion, a strong balance sheet able to support a strong value creation pipeline for the future. Nine, a low dividend payout ratio and increasing dividends, sharing growth in cash flows with our shareholders. And I think ten, continued sales of non-income producing assets as well as non-core assets while maintaining accelerating growth into 2015. Just a few macro comments. There certainly is a strong trend toward the urbanization of the innovation economy and workforce, and again we have been fortunate to take significant advantage of that. I think also regarding our tenant base we see the strong confluence of structural factors along with positive cyclical factors which don’t necessarily line up in time, but we are seeing that now really in the best of times for our tenant base. On the operations and internal growth side of things, we continue to beat our occupancy and rental rate increased estimates. And leasing in the key regions helped drive internal growth this quarter at about 871,000 square feet, Greater Boston contributed 35% and San Francisco 32%. On external growth, Steve will comment on the acquisition. The Mission Bay parcels in connection with the Uber joint venture result in the development of 422,000 square feet in the heart of Mission Bay. It's a superbly executed transaction to continue to drive our growth in San Francisco. Alexandria's goal is to maintain strategic optionality regarding its growth strategy. This is really kind of our mantra. And as such, due to the extraordinarily strong build-to-suite leasing demand for Binney Street development parcels and a corresponding reduction in the lease-up risk, we've updated our strategy which we announced in the fourth quarter of '13 which was to sell a minority joint venture interest in the Binney land parcels, and we will now seek to keep them on balance sheet assuming their term leasing and all. So again, that’s just an update on the strategic optionality approach. If we aren’t successful in leasing, we wouldn't move forward with the joint venture. Clearly a key to this move on the assumption side of things is our desire to capture the extraordinary economics and the extraordinary demand for these three buildings versus our ability to move out our leveraged target somewhat. But Dean will address how we plan to tackle that through free cash flow, growth in EBITDA, land sales, and some asset recycling, et cetera. And we’re very comfortable I think with our current plan regarding our overall leverage. Dean will talk about the balance sheet, and I would conclude by saying that on December 3rd at Investor Day we’ll lay out the 2015 business plan which will confirm accelerating FFO growth into 2015 as well as what we expect to be a strong increase in our NAV into 2015. So let me turn it over to Peter Moglia for some comments.

Peter Moglia, Chief Investment Officer

Sure. Thanks, Joel. So we had one notable Life Science trade to report in the third quarter which occurred in the Route 128 quarter in the Greater Boston region where GI Partners, a private equity investor based in San Francisco, purchased 850 Winter Street from Marcus Partners for a 6.3% cap rate. The price per square foot for this suburban asset was $404. The other notable trade involving Boston was BXP's sale of a 45% interest in two Boston and one New York City office buildings to Norges for what ISI calculated to be a 3.8% cap rate. This rate was noted by Green Street when they increased their NAV to $91.75 per share on October 1st. The Bay area continued to be extremely hot in the third quarter with 989 Market, 650 California, 50 BL and 60 Spear Street trading separately at a weighted average cap rate of 4.08% and a healthy $621 per square foot. In Seattle, 500 BL Avenue in South Lake Union traded at a 5.71% cap rate. The property is anchored by tech startups space provider WeWork. The buyer was Trinity Capital, led by former executive Richard Leider. A number of Seattle Office assets have hit the market this quarter and pricing guidance has been in the low to mid-5s as owners like Wolk Insurance and Brookfield look to capitalize on a diverse pool of buyers in the market including foreign funds based in Germany and Hong Kong. Domestic funds such as Invesco, private equity investor GI Partners, and several other public and private REITs. Many of these investors were bidders on the life science asset 401 Terry purchased by Kilroy in March, which had a weak tenant credit anchor. The trend of cap rate compression has continued through the third quarter, due in part to low interest rates, a lack of alternative investments, and a deep pool of investors including foreign funds. It appears that the investor market is only getting tighter as an analysis of comps in my core market shows the weighted average cap rate drop from 5.58% in 2013 to 4.8% through the third quarter of 2014, driven largely by a 100 basis point plus tightening in the San Francisco Bay area. As a follow-up to questions we’ve received about who is bidding on life science real estate assets, we can provide some names of those who have been actively bidding on them in the Greater Boston market. They include Related Companies, Deutsche Bank Asset & Wealth Management, which is formerly RREEF, Korean fund Mirae Asset Management, JP Morgan, private investor Rockefeller Group, Swiss fund AFIAA, Clarion Partners, private REIT KBS, Prudential, and Principal. To wrap up my comments, I want to acknowledge that with the end of this year there’s a lot of conversation about if, when, and by how much interest rates will rise, and the effects they will have on cap rates. Analysis of data from the first quarter of 1989 to the first quarter of '13 by Robert Charles Lesser & Company determined that the average spread between cap rates and the 10-year Treasury yield is between 250 and 300 basis points. According to Real Capital Analytics, the current spread for office product is between 400 and 450 basis points. So we believe there is room for cap rates to absorb increases in interest rates and remain at current levels. In addition, rising interest rates should reflect improving economy and real estate fundamentals, which should dampen a rise in cap rates driven by increasing interest rates. With that, I’ll pass it over to Steve.

Steve Richardson, COO and Regional Market Director (San Francisco Bay Area)

Good afternoon, everyone. I’d like to take a step back today as we head into the final months of the year and frame the drivers for what has been an exceptional year for ARE's performance and the unique urban and science and technology clusters in which we operate. One, the deep and broad-based demand in the critical science and technology sectors; two, the significant supply constraints in ARE’s highly desirable urban innovation clusters; and three, the rental rate strength and pricing power in those sub-markets. These drivers have contributed to strong core performance again this quarter and year-to-date as we reported cash and GAAP increases of 6.2% and 14.1% year-to-date and 5.6% and 18.6% respectively this past quarter for renewals and releasing of space, as well as historically high occupancy levels of 97.3% for North American operating properties. Very powerful global economic forces are intensifying demand for ARE's Class A product in its urban innovation clusters, as they possess unique and mission-critical attributes that simply cannot be replicated in other locations. Against the significant wave of demand is a set of political and geographic factors that are constraining supply. The ability to aggregate and deliver new product in urban settings is a very complicated and politically charged endeavor, as well as the imperative for high-quality design and technically capable, creative, and collaborative work environments. These two powerful forces, significant demand and constrained supply, have created pricing power in the market. Alexandria's client tenants have therefore been keen to renew early to ensure stability of operations and, more importantly, to seek trusted and long-term partnerships as they seek to establish unique and high-quality urban campuses. A long-term lease and joint venture between ARE and Uber has created a new paradigm and clearly illustrates the desirability of the ARE collaborative urban campus platform for its science and technology partners. Broadly, we've essentially resolved the rollovers for 2014 with less than 0.5% outstanding and just 794,150 square feet remaining to resolve, or just 4.29% of our operating asset base for 2015. Drilling down on ARE's core urban markets, the statistics reveal a very robust set of activity. In Cambridge, Boston, we've seen demand intensify during the past quarter in the Life Science market with 2.5 million square feet of demand and another 2 million square feet of tech demand. Most notable is high-quality demand from seven different potential client tenants seeking large blocks greater than 100,000 square feet. We've refreshed our mark-to-market analysis and across the entire operating ARE asset base we see solid cash increases at 9% and 13.2% on a GAAP basis and pretty amazing metrics for Cambridge, Boston. Growth of 18.2% on a cash basis and 22.4% on a GAAP basis. Occupancy is up by 230 basis points to 98.6% compared to the same timeframe last year, and lease rates are again being pushed to the high 50s to near $60 triple-net for existing product. Prospects seeking new large blocks of space at ACKS are anticipating rents in the low 70s triple-net. Vacancy rates overall continue to tighten and on a regional basis, they’re just 5.7% on a direct basis with 7.8% of total availability. Moving west, the San Francisco to Stanford clusters are also experiencing an intensified demand cycle from science and technology companies. Occupancy is up by 290 basis points from the same period a year ago to 99% in the operating asset base. We're tracking nearly 900,000 square feet of Life Science demand and 9.3 million square feet of tech office demand, with market highlights of several pre-leased large projects with tenants such as Google, EMC, Machine Zone, and, again, most notably, ARE's groundbreaking long-term lease and joint venture for 422,000 square feet with Uber in the heart of Alexandria's center for science and technology at Mission Bay. Lease rates for new products are now in the mid to high 50s triple-net as the Prop M office allocation continues to constrain the supply of new products in San Francisco. The mark-to-market refresh indicates an impressive 8.6% cash and 14.4% GAAP growth trajectory. The market continues to tighten as vacancy rates drop by 100 basis points in the lab sector to 6.2% and a steep drop of 430 basis points to 4.1% in the SoMa tech district. Moving to the south, we see that San Diego's market is again a similarly positive story. Demand in the market is up 300% to 2.4 million square feet compared with last year. Core performance is very solid with an occupancy increase of 340 basis points to 96.1% in the operating and redevelopment asset base, and market vacancy has dropped 140 basis points to 9.6%. The existing tenant base growth trajectory is very strong, and our key large campuses, Campus Pointe and Illumina's headquarters, have over 600,000 square feet under negotiation, a clear testament to ARE's underwriting teams' unique capabilities and expertise, and I'll pass along a shout out for their standout contribution. Finally, the long entitlement and approval process in San Diego continues to constrain supply in Alexandria's core clusters, which in turn will continue to support rental growth that is reaching all-time highs in the mid to upper 40s triple-net. Finally, moving north, Seattle has seen explosive growth in the tech sector during the past quarter with leasing in excess of 1 million square feet. Vacancy rates remain below 5% for lab and tech space with upward pressure on rental rates for new ground-up lab product in the high 40s to low 50s triple-net. With that, I will hand it off to Dean.

Dean Shigenaga, EVP, CFO and Treasurer

Thanks, Steve. Dean Shigenaga here, good afternoon. I have three important topics I want to cover. First, I will provide an update on our capital strategy and our ability to continue delivering strong growth in FFO per share and asset value. Second, I will provide an update on the positive impact of accelerating demand. And third, I will summarize key guidance items for 2014 and provide a few important thoughts for 2015, along with our confidence in our ability to deliver solid growth in cash flows, net asset value, and FFO per share from our Class A buildings and land parcels located in urban innovation clusters. First, on our capital strategy. Our key capital matters for 2014 are substantially complete. In July, we completed our $700 million unsecured bond offering with a weighted average interest rate of 3.5% and a term of 9.6 years. We updated our targeted sales for 2014 to a midpoint of $120 million, down $75 million from our prior guidance. We have about $83 million of dispositions under contract and expect to identify additional sales in 2015. I will come back to this topic in a minute. Moving to leverage. Debt to adjusted EBITDA was 7.2 times as of the third quarter and is forecasted to be 7.1 times by the end of the year based on significant growth in EBITDA and targeted dispositions of $83 million, both of which offset our estimated construction spend for the fourth quarter. Also, significant growth in EBITDA continues into 2015, and we will keep leverage within a reasonable range as we deliver highly leased projects and commence new development projects. Lastly, we expect leverage to improve towards the target range of approximately 6.5 times as pre-leased developments deliver significant growth in revenue, NOI, and EBITDA. Briefly and importantly, on our capital strategy, our capital plan focuses on funding all or almost all of our growth in 2015 and is aligned with our strategy to grow FFO per share and net asset value. Additionally, we are very comfortable with our capital plan and credit metrics going forward, and we will provide an update in detail on our Investor Day on December 3rd. First, we plan to invest cash flow from operating activities after dividends, currently greater than $110 million per year, into high-value development projects. Second, we expect to issue long-term debt to fund Class A highly pre-leased development projects on a leverage-neutral basis through significant growth in EBITDA. Combined with operating cash flows after dividends, these two items in 2015 should allow us to allocate $500 million to $600 million of capital to high-value development projects. Third, we expect to supplement our sources of capital by identifying real estate to dispose of over the next one to five quarters, including operating properties, both non-core and core, as well as land parcels. We are well-positioned to continue to deliver solid growth in FFO per share and net asset value from 2014 to 2015, including the impact of dispositions and the related reinvestment of proceeds. Moving next to the positive impact of accelerating demand on our asset base. As Steve pointed out, tenants are clearly looking to tie down early renewals in anticipation of increasing rental rates in a very supply-constrained environment. Occupancy reached 97.3% as of September 30th and now exceeds our upper end of our guidance. We expect to end the year with very strong occupancy at the top end of our range, from 96.9% to 97.3%. Same-property NOI growth has strengthened throughout the year. Year-to-date same-property NOI growth was solid at 4.5% and 5.2% on a cash basis. Our guidance for same-property NOI growth for the full year ’14 remains strong at a range from 3.5% to 5% and from 4% to 6% on a cash basis. Rental rate growth on lease renewals and releasing the space has also been very strong year-to-date, up 14.1% and 6.2% on a cash basis. Our guidance for rental rate growth for 2014 remains solid at a range from 11% to 14% and from 4% to 6% on a cash basis. While we're on core performance, let me briefly comment on operating expenses. Operating expenses for the third quarter increased approximately $9.7 million, or up 20%, compared to the third quarter of '13. One half of the increase was driven by increases in variable expenses due to the increase in occupancy in our same properties. Occupancy was 96.9% and 93.6% as of September 30th, 2014, and 2013 respectively within the same property pool. The rest of the increase was driven by the completion and delivery of highly pre-leased development and redevelopment projects. Operating margins remain very solid at 69% for the third quarter due to our triple net lease structure with 95% of our leases providing further recovery of operating expenses. Lastly, on guidance. The completion of highly pre-leased development projects will drive a reduction in non-income producing assets to 13% of gross real estate by the end of the first quarter. There are no significant changes in prior ranges of guidance for straight-line rent, G&A expenses, capitalization of interest, and interest expense net. Now that we only have one quarter remaining for 2014, we've provided guidance for these items specifically for the fourth quarter. Capitalization of interest for 2014 is targeted at $46.7 million for the year based upon a midpoint of our guidance. This represents a significant reduction of about one-third from our capitalization of interest for the year of 2014, driven primarily from the completion of high pre-leased development and redevelopment projects over the last couple of years. The decline in capitalization of interest is expected to continue into 2015 again due to the completion of additional highly pre-leased development projects. Really from September 30th through March 31st of 2015. High-quality science and technology entities continue to drive strong demand for our Class A assets and AAA urban innovation clusters and drove improvement in our outlook for 2014. We updated our guidance FFO per share diluted to a range of $4.79 to $4.81 or a midpoint of $4.80. This represents a solid increase over 2013 of 9.1%. Our guidance earnings per share diluted is in a range from $1.65 to $1.67. Briefly let me provide a few key thoughts for 2015. We will not comment further on 2015 beyond these brief comments since we plan to cover 2015 in detail during our Investor Day on December 3rd in New York City. We expect to continue executing on our strategy to deliver solid growth in FFO per share and net asset value, including the impact of reinvesting capital from the sale of operating assets, both non-core and core, as well as certain land parcels. Core performance is accelerating, and we expect cash run growth on renewal and re-leasing space to be significantly stronger than in 2014, and cash same-property NOI growth should be solid and in the general range of growth as 2014. We are occasionally asked about the mark-to-market for rental rates on current in-place leases. We believe the mark to market for cash rental rates for in-place leases is on average north of 10%. More importantly, we are expecting growth in cash rental rates to be very solid in 2015 for lease renewals and releasing space. Construction spending for 2015 is fairly fluid at the moment with various build-to-suit negotiations in process, and we expect to finalize our construction budget for 2015 over the next few weeks. As you know, 2014 is turning out to be a very strong year with FFO per share forecasted to be up 9.1% over 2013, and we anticipate 2015 FFO per share growth over 2014 to be very solid as well. We look forward to providing our detailed outlook for 2015 at our Investor Day on December 3rd in New York City. With that, I will turn it back to Joel.

Joel Marcus, Chairman, CEO and Founder

If we could go to Q&A, operator?

Operator, Operator

Certainly. (Operator Instructions) At this time we will take a question from Emmanuel Korchman with Citi.

Emmanuel Korchman, Analyst at Citigroup Global Markets Inc.

Dean or Joe, does common equity play a part in your capital strategy at all?

Dean Shigenaga, EVP, CFO and Treasurer

Well as we've said earlier, it certainly doesn't for this year. And based on our comments to date, we will certainly give you a full detailed business plan update on December 3rd. Our goal would be to try to eliminate or minimize any common equity for next year based on the factors we talked about. Land sales and recycling of assets together, along with clearly cash flow and growth in EBITDA. So that we hope to kind of do what we did this year if possible.

Emmanuel Korchman, Analyst at Citigroup Global Markets Inc.

You spoke earlier about strategic optionality. You had 50, 60, 100 planned to be in a JV. Now it's wholly owned unless leasing is already expected to be, and then it will be back into the JV. How does a partner think about that given the uncertainty of leasing and what they will be coming into? And also if you do it at 100% now, is there a potential for that to become a JV in the future?

Joel Marcus, Chairman, CEO and Founder

When we announced the intent to go down the JV path last year in the fourth quarter, we had no tenants in hand for 50, 60, or 100. We thought it would be prudent to make a sale of less than a half-interest in that set of parcels. It certainly would help us in a variety of ways and we didn't know how long the leasing would take on that. We did one-on-ones with more than I think 15 high-quality joint venture partners. I don’t think there was a single one of which said we’re not interested. We ended up narrowing that down to a handful and then ultimately one and reached a general term sheet in June. However, during the summer months, when the tsunami of demand reared its head in life science and tech in Cambridge, it was clear to us that if we could take advantage of this very unusual and extraordinary demand in the market versus the desire to joint venture, we would do that. But we clearly want to maintain flexibility. And if the lead joint venture partner were to go back to them many times and decided not to, we know there are numerous high-quality partners who would covet being our partner with this land. This has to be ground-zero land in the best life science market and one of the best sub-markets in the entire country, if not the world, and so we are not too worried about that. So I am sorry if I didn’t address the other parts of that question.

Emmanuel Korchman, Analyst at Citigroup Global Markets Inc.

If it would potentially become a JV in the future, once they...

Joel Marcus, Chairman, CEO and Founder

I think if it turned out that we are not able to sign substantially all of the demand that we are getting at the moment, we certainly would look to go back to a joint venture. And, as I said, I think there are numerous partners that would be willing to go forward with us.

Peter Moglia, Chief Investment Officer

I think that if we weren't successful in leasing these projects at 100%, then a joint venture partner’s hurdle rates would make more sense for the risk profile that we would be bringing back to them. I mean right now, with the type of returns that they are looking for, we are providing very little risk; it's not a big match. So, I think we’d be returning an opportunity that is more suited for a JV.

Operator, Operator

At this time, we will go to Sheila McGrath with Evercore.

Sheila McGrath, Analyst at Evercore

Yes, Joel I wonder if you could talk about how far along in the process these leases are, and are they all life science or tech at 50, 60, and 100 Binney.

Joel Marcus, Chairman, CEO and Founder

Yes. Well since we have Tom here, I will let him comment, but suffice it to say we have a letter of intent that we are working on and coming very close to an agreement on for 50. We are trying to tee up the parameters of the economics on 60, and we are deep into LOI negotiations on 100, but Tom, do you want to characterize it even more globally than that?

Tom Andrews, Analyst

Yes, that's accurate Joe. I think we have some companies; some of the demand is pure growth from existing Cambridge-based tenants, including a couple of life science companies. There is one that is a consolidation of an existing Cambridge tenant that has leases in multiple locations in the city and wants to be under one roof. There is another one that is from an out-of-market life science Company. So we have a number of ongoing discussions and we are quite confident that we will be able to lock down one or more of these probably soon for summer, and perhaps all of the spaces available which totals over 950,000 square feet.

Joel Marcus, Chairman, CEO and Founder

Yes, at the moment all of these are life science companies, but there is significant demand from tech and there is one large tech RFP that's out there that we will clearly respond to as well. We are looking at multiple backup offers as well. So it’s not just one shot on goal here, so we feel pretty comfortable about that.

Sheila McGrath, Analyst at Evercore

And if we look at the potential cost, is it accurate to look at the cost per square foot of 75 to 125 Binney to estimate, or is that higher?

Joel Marcus, Chairman, CEO and Founder

So I think we in some cases are looking at tenants who are more office and lab use within some of these buildings. You recall when we did 225 Binney, we had a life sciences tenant that took office use in that building. So be cautious that the lower end total, I would say the range could be up to as much as 75 to 125 Binney; that's kind of a higher cost project in terms of the model lab space in that tenant requirement, and it could range down somewhat from, but it wouldn't be too far off the total that 75 to 125.

Sheila McGrath, Analyst at Evercore

Okay, last question on funding. Joe, you mentioned asset sales. These projects will be coming online till '16 and '17. Are the asset sales going to be mostly concentrated in '15 or stretched over a longer period?

Dean Shigenaga, EVP, CFO and Treasurer

We are working through a number of assets that we will identify here over the coming months. So it's a bit fluid on the dispositions, but our goal for solving our capital needs for '15 will be to execute a number of transactions that fit the capital plan in our business. Really, that will allow us to reinvest the capital into these really high-value development projects. But I would say we would likely continue with this broad strategy, i.e. invest cash flows that we retain from operations, use EBITDA growth to fund debt without impacting leverage, and then continue to identify assets selectively for recycling and reinvestment into the business. Like we mapped out, there’s not a whole lot of land left, but we’ll do some land sales, and we will identify some that are more core-like which should represent some high-value opportunities for monetizing and reinvesting.

Joel Marcus, Chairman, CEO and Founder

I think Sheila, with that though different than what happened in the past; I think you can still expect that we would have an increase in FFO per share during this time period. So that’s something we’re keeping firmly in mind as well.

Operator, Operator

And now we’ll take a question from Jim Sullivan with Cowen and Company.

Jim Sullivan, Analyst at Cowen and Company

My question for you is in terms of just how strong this market is in Cambridge. It does seem to be a level of demand growth which is exceptional, and I think in the prepared comments you talked about low 70s is the rent per foot triple net for high-quality build-to-suit. I wonder if you could just remind us back in the first half of the year, I think we were talking about low 60s to mid-60s, is that right? Is that how much the movement has been?

Tom Andrews, Analyst

The movement is on that order. I would say that we’ve certainly seen in proposals that other landmarks have been sending out to tenants and our own proposals we’ve seen significant movement from earlier in the year on the magnitude of $10 a square foot or more.

Jim Sullivan, Analyst at Cowen and Company

Can you give us a handle on what might have happened on construction costs for the same period?

Dean Shigenaga, EVP, CFO and Treasurer

We project construction cost increases currently in the range of 6% NOI.

Jim Sullivan, Analyst at Cowen and Company

And then finally from me, can you give us an update on what’s happening with the Volpe site? I know this is some time off, but there was this I guess RFI. Maybe I don’t know if there is another date certain for the next step in the process, but if you could just give us an update, if there is another step and number one and number two. What Alexandria's posture is here in terms of partner or not and the scale and the size of that project.

Joel Marcus, Chairman, CEO and Founder

So there was an RFI which was due in early October, and we know there were a significant number of respondents to that RFI. We're told that the federal GSA is working on an RFP. We've had some folks tell us it might be out as early as sometime in Q1 of next year. We would imagine there would be probably a multi-month response timeframe for that. Many development companies and operators would likely pursue that property, which under proposed disowning in Cambridge accommodates if my recollection is correct over 2.5 million square feet of commercial space and over 1.5 million square feet of proposed residential zoning. Alexandria certainly is following this closely; we made a response to the RFI. We expect that once we see the RFP, then we’ll work carefully to evaluate how we ought to pursue what will be a very interesting opportunity.

Jim Sullivan, Analyst at Cowen and Company

And in terms of, you have a partner I believe with this working with you on this?

Joel Marcus, Chairman, CEO and Founder

We have spoken with multiple partners; we have not selected a partner.

Operator, Operator

At this time, we'll move to the next analyst. Please state your name.

Unidentified Analyst, Analyst

Just wondering if you could sort of approximate the returns on joint ventures versus just going the company-owned route? What order or kind of spread are we talking about?

Peter Moglia, Chief Investment Officer

This is Peter. From a yield-on-cost perspective, it won’t dilute what we aim to achieve; however, the total amount of investment will be diluted by the capital we bring in from partners. We may be able to earn a promote, which means we could leverage the partner’s investment to enhance our own return. But this also means we give up potential future upside by accepting that capital.

Unidentified Analyst, Analyst

Are you potentially yielding assets in the future?

Peter Moglia, Chief Investment Officer

I am sorry, you cut out. Could you ask that again?

Unidentified Analyst, Analyst

I mean employing capital could you, being that you can employ that capital at higher rates in the future that you anticipate at higher lease rates of because they are the properties that you see with higher potential returns.

Peter Moglia, Chief Investment Officer

We might utilize other people’s capital as an alternative to raising equity through common stock sales. The opportunity cost for doing so is the potential upside from our own developments.

Unidentified Analyst, Analyst

Have you figured out what the blended cost to capital is for ARE currently versus those alternatives?

Joel Marcus, Chairman, CEO and Founder

We have, but we’re not prepared to share that.

Operator, Operator

I think we need to move on to another questioner. Next question will be from Ross Nussbaum at UBS.

Ross Nussbaum, Analyst at UBS

Couple of questions. Joe, is there anything you can say at this point about the press reports that you're acquiring Memorial Drive in Cambridge?

Joel Marcus, Chairman, CEO and Founder

Yes, I can tell you that similar to the press report that we were joint venturing with somebody for an apartment building in Boulder, Colorado, you can't always believe everything you read. But I think it's fair to say that we don't comment on speculation, and when we're prepared to announce if that happens to be an acquisition or whatever it is, we'll announce it when the time is appropriate, so I’d have nothing more to say.

Ross Nussbaum, Analyst at UBS

Okay, second question is back to Binney Street. How would you characterize your discussions with the tenants you're having today versus where you were three months to six months ago? Because I know when we've spoken and met all year you've been, I'd say, extraordinarily bullish on the leasing prospects there. So are you finally at the point where you're pretty darn confident this is getting over the finish line ASAP?

Joel Marcus, Chairman, CEO and Founder

Yes, let me say this and then I'll ask Tom to come in. When we go back to the fourth quarter of '13 when we announced kind of our strategic optionality strategy, we were assuming we were going to joint venture, and we put into play a pretty intense process to accomplish that. I’d say the level of demand and forward movement of that demand in Cambridge probably didn't come to a head until the summer. That was the real operative time, then I’ll let Tom kind of characterize it.

Tom Andrews, Analyst

Yes, look, I think there are a number of transactions that we would characterize as pipelines, and a handful of them are getting to be very real in terms of the trading of proposals, the frequency of discussions with brokers and with principals, and these feel very much like they’re moving toward completion. Of course, the truth is that they're not complete until they are complete, and we don't have anything signed yet, but we're very positive about negotiations ongoing, and they feel they’re moving quickly.

Joel Marcus, Chairman, CEO and Founder

And I would say that in all three circumstances, the lead party in all three of these cases we’ve had prior relationships with, so these are not parties that we have not had a prior relationship with. In other words, we know each other, so that's also I think a very helpful factor.

Ross Nussbaum, Analyst at UBS

Okay, and then finally for me, I guess I'm wondering a little bit why you'd wait, if you will, for proceeds from potential asset sales to come in ex-quarters or ex-funds down the road rather than just hang up the phone from this earnings call, pull the trigger and issue equity to handle on the stock price given that we're in an uncertain and increasingly volatile world. Why take the risk that you'd be able to transact on asset sales a couple of months from now then just take the equity now and get the balance sheet down toward your goals?

Joel Marcus, Chairman, CEO and Founder

Yes, well that's certainly a relevant question and certainly one part of an argument that one could conceive of. In reality though, Ross, we have enough confidence in the demand going forward here for a while. I think Peter articulated we also feel that we're in a pretty decent environment on the recycling of both land and some assets that I think we can look forward to. I don't know how long that will last, but I feel good about at least as we look at a few quarters. Our leverage, let’s face it, we’re operating in a better leverage level than we ever had before and better than a number of other companies that are really in great shape and have strong stock prices. Besides, we just had meetings with the rating agencies in July. So we feel comfortable with where we've come over the last couple of years, we’ve made dramatic improvements on virtually every single credit metric one could look at. And I think we feel good about where we are. We would like to protect our growth and earnings by minimizing equity issuances and look at those assets that we could sell. So I think that's our current game plan at the moment, but the situation you passed is related is certainly one that reasonable people could look at, but I think we're going to try to repeat what we did this year and in '14 and try to do it in a way that I think makes the most sense all around and minimizes dilution. But again, if there was a big change in the equity markets, then we'll deal with that.

Operator, Operator

(Operator Instructions) At this time we will take a question from Jamie Feldman with Bank of America Merrill Lynch.

Jamie Feldman, Analyst at Bank of America Merrill Lynch

Can you talk about what was the other income in the quarter? It looks like you are a little bit higher than usual?

Dean Shigenaga, EVP, CFO and Treasurer

Jamie, Dean Shigenaga here. Other income was $2.3 million. Actually I’d call it a little tad light from our run rate rather than higher, since it was just higher from the second quarter. The second quarter was down less than $500,000. So I would suggest for planning purposes that you should expect about a $3 million run rate for the quarter.

Joel Marcus, Chairman, CEO and Founder

Which has been historically pretty much consistent.

Jamie Feldman, Analyst at Bank of America Merrill Lynch

Okay, and then can you talk about any of the largest 2015 expirations? Are there any that may not be covered or you think might be moving out of this point?

Joel Marcus, Chairman, CEO and Founder

Yeah the two big ones that strike me, I will let Steve deal with that, but the two that stand out for me are we have one full building user in a suburb in Route 128 that is moving out, and that’s a building that we're looking to release or potentially market. And then another one that rolls is a full building user, government user in North Carolina, and we have already got good re-leasing prospects on that. Those are the two standout full building users, but as Steve said, we've got unresolved paired down to three quarters of a million feet in ’15, which we think is really at this point in time, a pretty great position.

Steve Richardson, COO and Regional Market Director (San Francisco Bay Area)

You know that’s right, Jamie. To add to that, that’s just about 4% of the asset base, and when you take out those two pieces, that takes out about another third, got a block of space in tech square, so we think that will be an opportunity rather than a concern that's in the 60,000 square foot range, and then potentially in the ETC market in San Diego as well. So, no other real large blocks other than the two that Joel cited, and it’s spread out pretty uniformly with smaller pieces.

Jamie Feldman, Analyst at Bank of America Merrill Lynch

Okay, and then I guess for the 2015 expiration schedule, give the sense of where you think those rents are versus market?

Dean Shigenaga, EVP, CFO and Treasurer

Well that’s kind of a mix, but if you want to go back, Jaime, it’s Dean here again. If you want to go back to my prepared comments, I didn’t give specific guidance for ’15, but I did comment that cash rents on lease renewals and releasing space should be meaningfully stronger than our performance in '14, and we will lay out the plan on Investor Day for you in more detail.

Jamie Feldman, Analyst at Bank of America Merrill Lynch

Okay, so just higher at this point. And then I guess just finally on San Diego, we have seen market conditions are getting stronger there generally across many sectors. What are you guys seeing in terms of your portfolio and maybe opportunities to do more non-life science leasing? Just how should we think about your business plan there going forward given the conditions seem to be exciting?

Dan Ryan, Analyst

Yeah, hi Jamie, this is Dan Ryan. So, word on usual situation at San Diego, we are basically out of inventory like most of the other regions, and we are now actively employing what land bank we have. As Steve mentioned earlier, we are in discussions of an excess of 600,000 square feet of new build in our region. So it’s a rigorous mark right now; a lot of what is responding to is internal portfolio growth. The question about whether we are crossing over into seeing some tech demand, we do have a couple of things. We did a Barnes Canyon project which we leased to a tech user; they have come back after having moved in for three weeks and asked if they can lease the next building over which is about 45,000 square feet, so we are working through that. So we are seeing probably not as vigorous as Steve’s market, but probably 80-20-ish kind of life science and tech demand.

Jamie Feldman, Analyst at Bank of America Merrill Lynch

And do you have a preference one versus the other in terms of your return?

Dan Ryan, Analyst

I think we are generally agnostic about it. I think it’s a matter of where you are in the risk level with life science tenant fee versus the tech tenant fee. And we are generally agnostic about it, just really trying to target the best return in the overall risk-adjusted capital investment.

Operator, Operator

That does conclude the question-and-answer session. I will turn things back over to Joe Marcus for closing remarks.

Joel Marcus, Chairman, CEO and Founder

Thank you everybody. We did well under an hour, and that is great. So we will see many of you at Marriott and look forward to Investor Day or year-end call. Thank you again.

Operator, Operator

Again that does conclude today’s conference call. Thank you for your participation.