Earnings Call Transcript - ARE Q3 2011

Rhonda Chiger, IR

Thank you. Good afternoon and welcome. This conference call contains forward-looking statements within the meaning of the federal securities laws. The company’s actual results may differ materially from these 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 annual report on Form 10-K and its other periodic reports filed with the Securities and Exchange Commission. And now, I would like to turn the call over to Joel Marcus. Please go ahead.

Joel Marcus, Chairman, President and CEO

Thanks, Rhonda, and welcome, everybody, to the third quarter earnings call. With me today are Dean Shigenaga, Steve Richardson, who was just elected by the board as the Chief Operating Officer, Krupal Raval and Amanda Cashin. As you know, the current macro environment is highly volatile; it is mixed across the country, and our assumption is that it is not going to get noticeably better in 2012. Let me start with guidance since there’s been a lot of focus on that. Dean will address guidance in detail. He’ll discuss the current range and the detailed assumptions behind that with our stress test analysis. He’ll also focus on the fourth quarter 2011 NOI and FFO run rates and the fourth quarter 2012 NOI and FFO run rates. We’ll update guidance again on Investor Day. In retrospect, I think in the future, we’ll provide a wider initial guidance range for future years and narrow it as we go through the quarters and assess our performance. Our 2012 growth rate could well be in the mid-single digit range. The environment is obviously different, but many of the metrics that are evident today show interesting similarities to the post-Internet crash years of 2002 through 2004. Substantial effort is underway to move legacy suburban assets into key adjacency urban assets, and you’ll see the results of that in the coming quarters. We continue to see solid demand from our ARE’s urban adjacency locations, notwithstanding substantial negative headlines, with San Diego, Cambridge, and New York City as examples. Let me talk about the good, the bad, the ugly, and the misunderstood. On the good side, the achievement this past quarter of our investment-grade rating has substantially de-risked the company’s balance sheet. We transformed from being an unrated niche REIT in 2008 to today being an investment-grade niche REIT with a broad set of capital sources and best-in-class adjacency assets that enable us to attract high-quality tenants, which are transformational and have growth prospects and competitive barriers. We're making very good progress in leasing space, vacant re-lease, redevelopment, and hopefully development as we go forward with reasonable economics, given the current macro environment. We're maintaining solid core operating metrics within a range of reasonableness, again, given the current environment. We’ve seen dramatic positive progress on the lease-up of the assets and the redevelopment pipeline, with two new assets coming into the redeveloped pipeline, including 400 Tech Square. We may be almost fully leased there shortly. Steve will report a little bit about our 1551 Eastlake, the former Gates Foundation headquarters building, making great progress there. That was the good. On the bad side, while we’re generating operating metrics that vary quarter to quarter, we had a very strong leasing volume this quarter: almost a million square feet. Our GAAP NOI was slightly negative for the first time in the company’s history, but luckily, cash NOI has been healthy. GAAP rental rates decreased for the third quarter, primarily due to a step-down on significant renewals signed during negotiations about ten years ago at the top of the Internet bubble, one in San Francisco Bay and one in Cambridge. On the ugly or misunderstood side, the drivers underlying our life science thesis remain intact despite headlines to the contrary. The biopharma industry has undergone a thorough transformational change, and the growing need for quality space in the best adjacency locations has actually increased. Companies need to move more critical functions from isolated campuses to heart of innovation centers. Our business model, our best-in-class assets, and our locations really provide the sweet spot for us in this transformational process. We will continue to concentrate on these key adjacency urban locations. The pharma industry is very profitable, with almost $200 billion in cash on the balance sheet as of the end of the quarter, and total biopharma R&D remains very healthy at well over $60 billion. We believe the business case remains intact: the U.S. is and will remain the heart and center of entrepreneurship and novel discovery in medical and scientific research. Companies will continue to cut costs to improve their top and bottom line results. Pricing and reimbursement are key pressure points. Recently, there’s been a trend to offshore process R&D, particularly clinical trial work, which is broadening into various countries and office efforts. However, innovative discovery and R&D remain headquartered and situated in the U.S. The industry transformation is well underway, and modernization of business models is evident. Innovation is key to continuing success, and both North American and European biopharma companies have the attributes to continue their global leadership with solid growth. The NIH budget has been a hot topic lately, with $30.9 billion allocated for the past year. 2012 remains uncertain, with a bill in the House that could increase it by more than $1 billion and a Senate bill that could decrease it by $190 million. However, that’s not bad considering the current environment, and there’s no real opposition to a strong NIH budget in government—it’s more about getting caught up in bigger defense entitlements and overall spending. For 2013, if lawmakers can’t agree by November 2nd, there could be a 7.9% automatic budget cut to the NIH budget. However, it seems likely that strong recipients will survive. These five-year grants that are in the pipeline won’t be affected, but my opinion and the opinion of many people familiar with the NIH is that lower-tier recipients might be negatively impacted due to fewer new grants available. However, I believe that the top grant recipients will continue to receive their fair share. I think a good sign this year is that the FDA has already approved more drugs in the U.S. as of 9:30 today—26 drugs—compared to 24 in all of 2010. Moving on to operations and leasing, we’re very pleased with the second-highest leasing quarter in the company’s history at almost 1 million square feet. There is very strong momentum in Cambridge, where we have a great position in the market, with 29 leases covering 402,000 square feet being renewed and released, cash down about 3%, but GAAP up 3%. In San Francisco, mass renewals—those 10-year ones just mentioned—were really big contributors. On the development, redevelopment, and vacancy side, we had 27 leases at 583,000 square feet, including a 307,000 square foot build-to-suit for Biogen Idec that just announced their Phase III results for an oral multiple sclerosis drug that could likely generate $2 billion to $4 billion annually, and their stock price has surged this year. The 15-year lease we hope to deliver in the second half of 2013 will feature a joint groundbreaking with the Governor of Massachusetts, the Mayor of Cambridge, Biogen Idec, and the companion building developed by Boston Properties. The remaining 2011 lease rolls involve 572,000 square feet, with 150,000 currently leased or expected to be finalized soon, and about 294,000 in two redevelopments. We’ve talked about 400 Tech Square and 1551 Eastlake, which leaves about 128,000 for the rest of the year—not bad, considering the amount we started with. The amounts are relatively small: about 40,000 in San Diego which should be positive, about 24,000 in Maryland which is likely negative, around 40,000 in (inaudible) which might be neutral, 21,000 in North Carolina which is neutral, and just a small amount in Seattle. In 2012, we foresee approximately 10% of the asset base rolling at a portfolio operating at about 1.3 million square feet. An estimated 25% are expected to be leased, 10% entering redevelopment or change of use, and 65% in marketing. About 240,000 square feet in San Diego is likely to be positive; around 125,000 in San Francisco seems likely to be positive; while 135,000 in Boston could be neutral depending on location in the suburbs. We anticipate the largest roll, at 258,000 square feet in Maryland, is likely to be slightly down, with 64,000 in Seattle expected to be breakeven. Now, let me turn it over to Steve Richardson, who will highlight some of the details on the West Coast, and then we’ll go to Dean.

Steve Richardson, EVP, Regional Market Director, San Francisco

Hello, this is Steve, and today I’ll review the key trends on the West Coast in the Seattle, San Francisco, and San Diego markets. Starting from the north to the south, in Seattle, the University of Washington continues to expand and has broken ground in South Lake Union on 450,000 square feet of life science space. This follows Amazon’s significant expansion in the same area, resulting in job openings for over 3,000 workers. As seen in our other core cluster markets, life science and technology companies are converging with each other in the best locations to attract the highest quality talent. The South and East Lake Union area—where we’ve historically aggregated our assets—represents a strong, vital, and dynamic cluster compared to other submarkets where lab buildings struggle with vacancies and landlords are forced to pursue desperate measures. The key CBD life science clusters remain solid, with lease rates for new space in the mid-40s on a triple net basis and vacancies of just 1.5% in the Lake Union area, with little vacancy in the First Hill area. Finally, the 1551 East Lake project that Joel referenced is proceeding very well, and we’re pleased to report that it’s now 51% pre-leased. Moving to San Francisco, the technology sector continues to drive top-line growth in absorption into the third quarter, stretching from the Soma area south of market to Silicon Valley. UCSF continues to make significant investments in Mission Bay, with the hospital steel structure clearly defining the magnitude of this multi-billion dollar investment. The Stanford submarket is now quite strong with single-digit vacancy and lease rates in the low 30s to low 40s for second-generation space. Additionally, VMware’s purchase of the Roche site in the Stanford Research Park has removed a total of a million square feet of life science product from inventory and will further tighten metrics. South San Francisco, as reported previously, continues to lag with a 14% vacancy rate, and we remain cautious as lease rates hover in the low to mid-30s. Steady progress is being made at the East Jamie Court project, with approximately 44% leased now and 20% in serious discussions. Specifically with East Jamie Court, we have three separate letters of intent with tenants closely evaluating those. The regional team is in constant contact with decision-makers and brokers involved in the process, and we also have an existing tenant interested in exploring expansion possibilities due to a partnering deal they are close to finalizing. Moving on to Mission Bay, we have 1% direct vacancy excluding a couple of small retail suites, with details including a fully leased 1500 Owens for UCSF expansion for the fourth time in the building. We’re finalizing a 4,000 square foot expansion in the first quarter of 455 Mission Bay Boulevard South, and we’re also completing a 24,000 square foot expansion in that building where the tenant will pay for an option to keep the space off the market until early 2013 as they wait for an important milestone. 499 Illinois is in full marketing campaign mode, with tours and preliminary discussions ongoing. We’ve just had a tour with a very strong technology company and their advisers, who are closely evaluating 499 as an option. We expect fuller tours in the next month or so. We’ve just received an RFP from an emerging stage technology company, which we will be reviewing carefully, along with ongoing preliminary discussions with two institutional-quality life science users. These are serious users with limited options in the market for large blocks of life science space and have recognized the value of 499 Illinois. Finally, moving southward to San Diego, the market is very healthy, particularly in the Torrey Pines cluster, where we can see ourselves trending in the 9% range, with lease rates improved by about 10% to 15% during the past 12 to 18 months, now in the mid to high 30s on a triple net basis. We expect to capture a bit more than our fair share of the demand, tracking approximately 300,000 square feet of requirements in the market. With that, I’ll hand it over to Dean.

Dean Shigenaga, CFO, SVP and Treasurer

Thanks, Steve. Real quickly here on our guidance: we’ve updated for 2011 to FFO per share diluted, $4.38, and EPS diluted of $1.72. Our guidance for 2011 implies a target FFO per share diluted of $1.10 for the fourth quarter of 2011, and this represents a good run rate going forward, equating to about $440 on an annualized basis. Our range of guidance, which Joel touched on earlier for 2012, is between $450 and $454 for FFO per share diluted. It includes, among other assumptions, the following operating and asset-based assumptions. I’m going to pass on commenting on sources and uses since it’s included on page 13 of our supplemental package. Our guidance assumes FFO per share diluted approaching $1.20 per share in the fourth quarter of 2011. I think one of the challenges, given the significant amount of NOI coming online this year, is providing clarity on FFO per share approaching $1.20 in the fourth quarter of 2012. However, with some clarity on NOI growth, I’d like to walk through our reasonable assumptions and highlight some of the upside included in our guidance range. Our press release projected an increase in NOI of approximately $47 million when comparing the annualized NOI of approximately $100.8 million for Q3 2011 to the annualized NOI of about $112.5 million for Q4 2012. The projected growth in NOI is back-weighted due to the timing of deliveries and is related to significant pre-leasing of committed spaces. This results in an approximate 30% contribution of that NOI growth to the bottom line FFO after offsetting the reduction of capitalized interest as we transfer these assets into service. The historical cost basis or GAAP basis of our qualifying basis, which we expect to transfer into service related to this NOI, is in the high $400 million range. Let me walk through each line item that is really contributing to the growth of NOI. For reference, I think you can follow this along on pages 46 or 47 of our supplemental package as I start with development and redevelopment assets. 1119 North Torrey Pines is an 82,000 square foot project under redevelopment. The fourth quarter run-up in NOI of the $47 million equates to about $1.2 million on an annualized basis and is related solely to the 20% that’s leased today. There’s really meaningful upside because we’ve assumed no further occupancy in our guidance assumptions through the fourth quarter of 2012. To frame this redevelopment NOI component, it approximates about $18 million of that over $40 million of NOI growth. John Hopkins Court, the next asset at 90,000 square feet, will contribute about $4 million based on executed leases, so there’s really no risk to that assumption other than a couple of weeks on construction deliveries. Campus Pointe is 204,000 square feet with about $9 million in contribution. 43% is executed, and 47% is under negotiation, so we’re in good shape there. 6075 Nancy Ridge is about 47,000 square feet with an annualized contribution of about $800,000, assuming 63% occupancy by the fourth quarter of 2012, keeping in mind that half of this 63% is already pre-leased. 400 Technology Square, around 210,000 square feet in total, will roll out in October, and the entire building will go under redevelopment. The disclosure only shows 49,000 square feet. The assumption for our model has meaningful upside because we’re reflecting a neutral impact on an annualized basis, and that assumption assumes only 50% of the building is stabilized at that point. We have an anchor tenant under negotiation for that space. 215 First Street will contribute about $1.2 million in NOI, partly through redevelopment and partly through the previously delivered space on that redevelopment project. Quadrangle is a smaller asset at about 30,000 square feet, with about half a million in NOI contributions, of which 61% is pre-leased, and we’re projecting to be 100% by the end of 2012. 1551 East Lake is a future redevelopment project coming online in the fourth quarter that is neutral but represents upside to our NOI assumption and guidance; 51% of this is pre-leased, and we’re only projecting leased-up assumptions to 69% by the fourth quarter of 2012, clearly providing room to exceed that metric. Other projects contributing to about $1.3 million lead us to about $18 million for redevelopment contributions. Turning to the development schedule on page 47, the 4755 Nexus, we’ve taken a conservative approach, assuming we wouldn’t have occupancy by the end of 2012. However, I have a feeling we may beat that schedule, given our progress in San Diego. 5200 Research is a build-to-suit for Illumina, expected to contribute about $4 million of NOI, keeping in mind this is 100% leased with a target delivery in the fourth quarter of 2012. 455 Mission Bay is 40,000 square feet, with 76% of this committed, equating to about $1.6 million of NOI. We may have some contributions from previously delivered space included in that number as well. For 499 Illinois, which is 219,000 square feet, we’re anticipating consistent modeling with our underwriting from acquisition, expecting two-thirds of the project to be leased on average by about 10.1, generating at least $4.8 million of NOI; however, these figures are based on GAAP numbers. East Jamie Court, at 107,000 square feet, is still available, with 16% pre-leased. We’re assuming an additional 25% of that will be leased in the third quarter and another third in the fourth quarter, contributing $3.6 million of NOI by the fourth quarter of 2012. Additional smaller projects, some leased and some candidates for potential developments, will collectively contribute approximately $1.4 million of NOI by the fourth quarter of 2012, totaling about $16 million of development NOI contribution, annualized by Q4 2012. 7 Triangle was a development project we just delivered in the quarter, contributing incremental NOI between Q3 and Q4 2012. This will come in next quarter or in Q4 as $1.9 million of incremental NOI. Redevelopment and re-leasing the other half of the project at 500 will generate about $2 million of NOI. When I say re-leasing, it’s referring to the re-tenanting of the space as the other half is currently occupied. The fourth quarter acquisitions included in our sources and uses of capital are about $20 million, contributing about $1.1 million of NOI growth. The same-property annualized NOI growth contribution will be approximately $5.9 million on a GAAP basis. Moving next to straight-line rents for 2012, we expect $6 million per quarter, totaling about $24 million for the year, fairly consistent with the total straight-line rents anticipated for 2011. FAS 141 revenue is projected to be about $800,000 per quarter, starting in the fourth quarter of 2011 and continuing through the fourth quarter of 2012. Occupancy is projected to increase slightly, averaging in the 95% range in 2012, with same-property NOI growth expected to be about 3% to 5% on a cash basis and 0% to 2% on a GAAP basis. To highlight where this contribution is coming from: On a GAAP basis, San Francisco will meaningfully contribute due to lease-up plus vacant space. Most is under negotiation or renewals that we expect to move into that space. It’s a little early for exact negotiations. In New York, Seattle, and Canada, we’re getting good contributions from those markets, primarily driven by lease-up of vacancy or lease renewals. The downside in same-store performance appears to be in the Boston market, primarily due to temporary vacancies in Cambridge as we re-tenant some space. Regarding cash same-property performance, there's been a significant spike in cash rents primarily driven by this year's leasing, which had a little bit of free rent involved in transactions. For example, San Francisco will positively contribute along with the suburban DC market as well as New York. The downside in same-store performance appears in the Boston market largely due to this temporary vacancy in Cambridge, as mentioned previously regarding re-tenanting. Moving on to rental rates and expectations for lease renewals, we project 5% growth on a GAAP basis, with cash rates fluctuating slightly negative to slightly positive. Regarding cash statistics, it’s important to note that a few leases in Boston are affecting overall performance given the relocation of tenants to lower-cost spaces. We also have some office space rolling over in Maryland, which remains challenging. However, I can assure you that our leasing performance in San Francisco is positive due to lower expiring rates on leases. As we turn to G&A, it’s projected to increase by about 5% to 8% over 2011, primarily due to the growth in our operations. Capitalized interest is projected to decrease in 2012 compared to 2011, anticipated to be in the $54 million to $60 million range. Now, on to the sources and uses of capital: Due to tumultuous capital markets since receiving our investment-grade rating, we have not had the opportunity to announce our debut bond transaction. However, completing the rating assessment was a significant milestone for transitioning our capital and balance sheet strategy. It’s essential to note that we prepared a broad range of stress test capital sensitivities for 2012 guidance, including some more punitive assumptions. We have no plan to open the bond market for REITs because pricing today for a debut would result in an all-in rate exceeding 6%. We are currently awaiting a more stable environment to issue bonds, as we project ample liquidity and prefer to be patient. Therefore, we have pushed back our bond offering to the latter part of 2012 and increased our all-in rate for the debut bond offering by 75 basis points, now at 5.75%. We remain focused on not expanding our capital needs, with our uses of capital assuming no acquisitions and focusing purely on construction expenses, debt repayments, and dividends. The equity component can only be achieved through net cash flows, capital recycling from asset sales, joint ventures, and common equity. Given the market environment, we will look more aggressively at asset dispositions. However, until we finalize and execute our strategy, we are not ready to include it in guidance beyond the modest $112 million projected for dispositions through Q4 2012. We are committed to not raising equity at the expense of our stock price of late. However, we have assumed $200 million of other capital in our guidance spread across multiple quarters. The key here is this can be viewed as various asset sales, preferred equity, or an ATM program, all with similar impacts on FFO results. Briefly commenting on our credit metrics and refinancing of term loans, we remain committed to maintaining our investment-grade credit metrics, including debt to EBITDA ratios close to six to six-and-a-half times, fixed charge coverage ratios greater than two-and-a-half times, and maintaining adequate liquidity on our balance sheet through significant availability on our line of credit and cash. We anticipate closing a new $500 million unsecured term loan shortly, likely a term of about five years, priced at around 1.5% over one month LIBOR. The proceeds will reduce the outstanding balance on our line of credit, providing significant liquidity as well, ultimately allowing us to retire the $250 million outstanding balance on our 2012 unsecured term loan. With that, I’ll turn it back to Joel.

Joel Marcus, Chairman, President and CEO

If we could move to Q&A, operator, please.

Operator, Operator

Please stand by. (Operator Instructions) And our first question will come from Jonathan Habermann of Goldman Sachs.

Jonatnhan Habermann, Analyst, Goldman Sachs

Hi, good morning, everyone. I have a question here on dispositions. Dean, you mentioned potentially raising above the $112 million in guidance, but can you give us a sense of the magnitude that you’re anticipating beyond that original forecast?

Joel Marcus, Chairman, President and CEO

Hi, Jay, it’s Joel. Let me comment on that. It would be our goal to see that number approach $200 million to $250 million if we’re successful. But clearly, we can’t assume that.

Jonatnhan Habermann, Analyst, Goldman Sachs

Okay. And just switching to 499 Illinois, can you give us some sense of the tenant looking at the space and what their timing would be for actually utilizing that space?

Steve Richardson, EVP, Regional Market Director, San Francisco

Yes, this is Steve. We’re on track. We’re fully engaged in a marketing campaign. As I noted, we’ve had tours, and there’s legitimate activity in the market; we need to complete the warm-up process. I think we’re talking about a mid-2012 occupancy target.

Jonatnhan Habermann, Analyst, Goldman Sachs

Okay. And just one final question: can you provide any updates on New York City in Phase Two?

Steve Richardson, EVP, Regional Market Director, San Francisco

Yes, we continue to view New York as a strong market. We had a sizable opportunity this week that had strict timing, which we had to let pass, but it’s worth noting. We have two external institutional requirements, as well as one internal for substantial expansion down the line when we initiate the West Tower, which is 400,000 square feet. The determination will really depend on capital to fund it, and we would want to move those opportunities towards signed leases and ensure that we have over 50% occupied. At this current moment, none of this is included in our 2012 plan.

Jonatnhan Habermann, Analyst, Goldman Sachs

Okay. And just to clarify, in the dispositions, what portion of that would be assets versus possibly liquidating from land?

Steve Richardson, EVP, Regional Market Director, San Francisco

The majority of that would be assets.

Jonatnhan Habermann, Analyst, Goldman Sachs

Thank you.

Operator, Operator

And our next question will come from Anthony Paolone with JPMorgan.

Anthony Paolone, Analyst, JPMorgan

Hi, thanks. Good afternoon. First question is on Illumina, who had preannounced and are having a tough time. Just curious if you could provide a sense if there are any impacts on both their main lease and with the building you are constructing for them.

Joel Marcus, Chairman, President and CEO

No. In fact, we’ve had discussions with them as recently as yesterday. Some details we can’t share with you because they aren’t public. They filed an 8-K today regarding a small layoff. We know where that’s coming from, and it’s not affecting their operations that we're involved with. I’ll ask Amanda to elaborate on Illumina, as there seems to be a misunderstanding regarding their situation.

Amanda Cashin, Assistant VP, Life Sciences

Sure. As you mentioned, Illumina did announce their earnings and provided guidance, which mentioned reductions in customer spending. A lot of this is attributed to uncertainties surrounding federal funding from research grants, creating some slowdowns in customer spending. Additionally, the roll-off from stimulus funds peaked in 2010 and is leading to revenue reductions—just a 1% decrease in Q3 2011 from Q3 2010. However, it’s important to note that this is a profitable company with a $3.7 billion market cap that remains committed to growth and innovation in R&D. While their stock price may have dipped, this could be due to market overvaluation driven by high expectations of their performance.

Joel Marcus, Chairman, President and CEO

For the timeline concerning the space that they’re taking, they have reiterated their timeline and space commitments, and we do not foresee any changes in that arrangement.

Anthony Paolone, Analyst, JPMorgan

Okay, and regarding the $3.3 million for the fourth-quarter GAAP NOI on that project, is that the full amount excluding the $4 million that would come in from the additional property you’re building for them?

Joel Marcus, Chairman, President and CEO

Yes, that’s correct.

Anthony Paolone, Analyst, JPMorgan

Okay. I just reviewed that to understand the transition from Biogen to Illumina. You indicated the sequential roll-down of $1.7 million. This suggests Biogen was approximately $5 million per quarter in NOI, around $20 million a year, is that correct on a GAAP basis?

Joel Marcus, Chairman, President and CEO

Yes, from a GAAP perspective, you’re roughly correct. If you add $1.7 million on top, the GAAP rate was about $36 million. Originally, when we purchased the property, it was subject to a 15-month leaseback. Shortly after this, we executed a lease with Illumina for the campus, whom we’d like to accommodate sooner. We negotiated a return of space from Biogen to meet our timeline for Illumina, which was a gradual process, resulting in a re-estimate of the amortization period for the 141 revenue, leading to that increase in GAAP rent income in Q3.

Anthony Paolone, Analyst, JPMorgan

So, in essence, the Biogen yield on a GAAP basis was something like 15%+, and now with Illumina, you’re trying to achieve the 10% yield you've guided historically, is that correct?

Joel Marcus, Chairman, President and CEO

Yes, that's correct.

Anthony Paolone, Analyst, JPMorgan

Additionally, I wanted to inquire about the Illinois Street property; you spoke about two institutional life science tenants. Can you clarify what alternatives they are considering? What is their mindset in this situation?

Joel Marcus, Chairman, President and CEO

Currently, they have limited alternatives. 1700 Owens is nearly fully leased, and 1500 Owens is now fully leased with UCSF expanding for the fourth time. 455 has also reached full leasing or commitments. Thus, high-quality life science spaces are limited, which implies that this is just a matter of time.

Anthony Paolone, Analyst, JPMorgan

But would these tenants consider moving to other markets, or are they feeling pressured to remain within their current territories?

Joel Marcus, Chairman, President and CEO

These particular users don’t have viable options available elsewhere. It’s not particularly sensible to relocate to South San Francisco, for example. So I believe it is just a matter of time for them to settle.

Anthony Paolone, Analyst, JPMorgan

I have a couple of questions regarding the development side. Between now and the end of next year, around $83 million of funds will be allocated to China and India. Can you clarify how many projects that encompasses?

Dean Shigenaga, CFO, SVP and Treasurer

Just to clarify, the total of $83 million spans five quarters, comprising $20 million in Q4 and $62 million projected for next year. We anticipate delivery of some spaces soon, so we expect a rate that might be higher than average for 2011, so you should expect to see that performance reflected in announcements.

Anthony Paolone, Analyst, JPMorgan

And regarding the U.S. versus these international projects, where do you anticipate the yields being more favorable, would you say?

Joel Marcus, Chairman, President and CEO

I would say our benchmark post-tax should be about 500 basis points above what we expect here in the U.S., so depending on the projects it remains a point of focus.

Anthony Paolone, Analyst, JPMorgan

And regarding Toronto, what can you share about the economics there and the overall basis for revenue recognition moving forward?

Joel Marcus, Chairman, President and CEO

The information on the MaRS agreement has been filed and is available. We executed a ground lease within an affiliate to allow them to move forward, and they’ve announced two institutional anchor tenants along with attractive financing from infrastructure in Ontario. From Alexandria’s perspective, we have no fiscal obligations associated with construction or financing for this project, and we expect ground rents to commence upon completion of the construction.

Anthony Paolone, Analyst, JPMorgan

What are your total costs for that land and its associated economics?

Joel Marcus, Chairman, President and CEO

We’ve invested around $80 million in total into the project. We have a 99-year lease with the possibility of recapturing it in roughly 49 years. The commencement of ground rents will start with completion and will step over time. Our return will be relatively modest for this ground lease structure, yielding a single-digit return.

Operator, Operator

And our next question will come from Michael Bilerman of Citi.

Michael Jason Bilerman, Analyst, Citi

Thank you. Dean, thanks for going through the redevelopment and development NOI details. Can you elaborate further on the in-and-outs of this process and how they compare from Q4 2011 to Q4 2012?

Dean Shigenaga, CFO, SVP and Treasurer

Michael, I don’t have that precise schedule with me, but I recommend looking at pages 46 and 47 of our supplemental documentation to get more insight on this. John Hopkins is completely leased with a projected delivery date in Q2 2012. Campus Point is split between the first and second quarters. Nancy Ridge should come in either Q1 or Q2 of 2012. 400 Technology Square is set for late in 2012, with 215 being another small property being delivered shortly.

Michael Jason Bilerman, Analyst, Citi

What is the anticipated yield for these projects? You expressed that the overall amount invested would equate to a yield in the high $400 million range, which corresponds to an 8% yield based on $38 million of NOI. Is that accurate?

Dean Shigenaga, CFO, SVP and Treasurer

That’s in the ballpark, right around the 8% range, with approximately 20% yet to come in, potentially a larger figure. We could make further estimates on these assumptions mid-quarter based on the information I provided. I simply don’t have that exact breakdown at hand.

Michael Jason Bilerman, Analyst, Citi

The $604 million total for development and redevelopment includes that historical high $400 million. Is that all captured in the $600 million, or has some already been transferred to operation? Moreover, is there an anticipated spending plan over the next year that would connect to NOI in the upcoming year?

Dean Shigenaga, CFO, SVP and Treasurer

Yes, you’ve framed it well. The $300 million active redevelopment basis—development basis of $190 million; the basis I’m discussing sits within there and includes spending to complete.

Michael Jason Bilerman, Analyst, Citi

What spending is still required for generating that $38 million NOI? Is it reflected within the capital budget seen on page 45?

Dean Shigenaga, CFO, SVP and Treasurer

That is indeed correct.

Michael Jason Bilerman, Analyst, Citi

Is there a dilution factor for any timing discrepancies on deliveries versus NOI recognition that might affect your numbers next year?

Dean Shigenaga, CFO, SVP and Treasurer

Yes, that holds true for several assets. However, more relevant is our capacity for capitalization on various projects now entering the operational realm, which shift more overhead costs onto the P&L. We talked a bit about our China projects, which should reach capitalization shortly, affecting FFO through the transition.

Michael Jason Bilerman, Analyst, Citi

Moving to the balance sheet, I think you mentioned stress testing the model with conservative financing assumptions in your guidance. Is the $200 million of preferred sales reflected in the plan?

Dean Shigenaga, CFO, SVP and Treasurer

That is indeed accurate.

Michael Jason Bilerman, Analyst, Citi

You mentioned the unsecured debt issuance is pushed to the end of next year?

Dean Shigenaga, CFO, SVP and Treasurer

Yes, we have postponed our debut bond offering to the latter half of 2012.

Michael Jason Bilerman, Analyst, Citi

If you push back the bond, wouldn’t that be accretive versus the previous estimates due to lower estimates?

Dean Shigenaga, CFO, SVP and Treasurer

Correct, but I suggest further adjustments as needed, as it may not precisely align with our underlying demands. The overall impact of our bond assumptions parallels their organizational alignment with our internal expectations.

Michael Jason Bilerman, Analyst, Citi

I wanted to clarify the $120 you mentioned for the fourth quarter of next year—would that hold now that there's an assumption for bond issuance coinciding with that?

Dean Shigenaga, CFO, SVP and Treasurer

Yes, the guidance includes that bond offering assumption.

Michael Jason Bilerman, Analyst, Citi

So the lower guidance for the fourth quarter is due to development and redevelopment not contributing until later in the year, while the run rate for 2013 should remain steady in alignment with the Street. Would you agree?

Dean Shigenaga, CFO, SVP and Treasurer

Broadly, yes. The various mix of capital might alter as we approach the fourth quarter.

Michael Jason Bilerman, Analyst, Citi

I’d suggest within the supplemental that moving forward, including figures on invested today and gross potential yields, as well as timing for project completion, might help bridge gaps between your sentiments and those of the Street.

Dean Shigenaga, CFO, SVP and Treasurer

I completely agree; that would indeed be beneficial.

Philip Martin, Analyst, Morningstar

Good afternoon. Dean, I appreciate the insights on the model and all the detailed information you presented during your opening remarks. Joel, could you compare your larger high-quality tenant base to the less established tenants and how committed they are to potential NIH budget cuts? Moreover, do you see these potential cutbacks causing increased M&A activity or will venture capital sufficiently fill the gaps?

Joel Marcus, Chairman, President and CEO

That’s a good question, and I’ll run through the highlights. We have minimal real exposure in a significant manner. Top tenants include Novartis, Lilly, Roche, and others that are well-financed. Alnylam is public with promising prospects, as is Gilead. Most of the leading users are not so dependent on NIH funding. The only notable potential exposure would be from Scripps, which garners substantial NIH budgets, but my view is the grant recipients will remain largely unaffected.

Philip Martin, Analyst, Morningstar

Do you believe that these budget concerns are impacting lease decisions for your current tenants or potential new occupants?

Joel Marcus, Chairman, President and CEO

Within our markets, we haven’t encountered significant effects on these decisions. However, the major hospitals in the Cambridge area linked to NIH funding could be an exception.

Philip Martin, Analyst, Morningstar

I feel that the fundamentals tell a better story than what’s being perceived right now. On leasing trends, does having a portfolio with larger and high-quality tenants limit your rental growth over the next 12 to 24 months compared to having smaller tenants?

Joel Marcus, Chairman, President and CEO

Actually, the opposite may be true—larger tenants with pricing power could lead to stricter negotiations on potential rental increases. For major tenants, we’ve seen both sides jockeying for good pricing amidst competitive environments; thus, tighter competition could mean better opportunities for rental growth.

Steve Richardson, EVP, Regional Market Director, San Francisco

I agree; tenants prioritize location to secure the best outcomes, thus enabling a positive balance for upward rent adjustments.

Joel Marcus, Chairman, President and CEO

I appreciate all your questions, and I believe we have answered everything. Thank you for your participation today.

Operator, Operator

This concludes today’s teleconference. Thank you for all your participation.