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Edited Transcript of BDN earnings conference call or presentation 30-Jan-20 2:00pm GMT

Q4 2019 Brandywine Realty Trust Earnings Call

RADNOR Feb 5, 2020 (Thomson StreetEvents) -- Edited Transcript of Brandywine Realty Trust earnings conference call or presentation Thursday, January 30, 2020 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* George D. Johnstone

Brandywine Realty Trust - EVP of Operations

* Gerard H. Sweeney

Brandywine Realty Trust - President, CEO & Trustee

* Thomas E. Wirth

Brandywine Realty Trust - Executive VP & CFO

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Conference Call Participants

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* Craig Allen Mailman

KeyBanc Capital Markets Inc., Research Division - Director and Senior Equity Research Analyst

* Daniel Ismail

Green Street Advisors, LLC, Research Division - Analyst of Office

* Emmanuel Korchman

Citigroup Inc, Research Division - VP and Senior Analyst

* James Colin Feldman

BofA Merrill Lynch, Research Division - Director and Senior US Office and Industrial REIT Analyst

* Jason Daniel Green

Evercore ISI Institutional Equities, Research Division - Analyst

* Omotayo Tejamude Okusanya

Mizuho Securities USA LLC, Research Division - MD & Senior Equity Research Analyst

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by, and welcome to the Brandywine Realty Trust Fourth Quarter 2019 Earnings Call. (Operator Instructions) Please be advised that today's conference is being recorded. (Operator Instructions)

I would now like to hand the conference over to your speaker today, Mr. Jerry Sweeney, President and CEO.

Sir, you may begin.

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Gerard H. Sweeney, Brandywine Realty Trust - President, CEO & Trustee [2]

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Crystal, thank you, and good morning, everyone, and thank you for participating in our fourth quarter 2019 earnings call. On today's call with me, as usual, are George Johnstone, our Executive Vice President of Operations; Dan Palazzo, our Vice President and Chief Accounting Officer; and Tom Wirth, our Executive Vice President and Chief Financial Officer.

Prior to beginning, certain information discussed during our call may constitute forward-looking statements within the meaning of the federal securities law. Although we believe estimates reflected in these statements are based on reasonable assumptions, we cannot give assurances that the anticipated results will be achieved. For further information on factors that could impact our anticipated results, please reference our press release as well as our most recent annual and quarterly reports that we file with the SEC.

So after a very brief review of our '19 results, I'll provide an update on the status report of our 2020 business plan, Tom then will provide an update on our financial results for the year and a look ahead to the balance of '20. And then after that, all 4 of us are certainly available for any questions.

We closed 2019 on a very strong note. We exceeded our business plan metrics on cash and GAAP mark-to-market, tenant retention and achieved many of our other targets, including ending the year at 95.5% leased. We achieved our speculative revenue target, which you may recall, we increased twice during the course of the year. We did come up a bit short on our occupancy target, primarily due to several tenants not having completed their tenant-directed fit-out and a minor bankruptcy. Our fourth quarter and full year FFO was $0.38 and $1.43 per share, respectively, and both were at the upper end of our guidance ranges. Fourth quarter operating performance was strong. It was masked a bit by the termination of KPMG at 1676 International Drive. Absent their vacating, our fourth quarter absorption would have been 112,000 square feet positive, tenant retention would have been 77% and our year-end occupancy would have been 94%. Those statistics, along with the same-store growth of 1.5% on a GAAP basis and 2.7% on a cash basis, with our GAAP rent growth and cash rent growth, we think demonstrate the underlying strength of our portfolio's operating performance.

Also, during the fourth quarter, we sold some remaining joint venture properties in Charlottesville, Virginia. They aggregate about $51 million in sales. We were a minority partner, and we recorded $8 million gain and exited those properties. Also during October, we completed a full building lease for our redevelopment property in Pennsylvania suburbs. This 13-year lease rate was very much in line with our targeted rent levels. The lease, however, was 5 years longer than anticipated, so required more upfront capital. So our going-in initial cash yield was in the 8% range versus our earlier target but we picked up 5 additional years of term. So the overall economic returns were very much in line with our projections. That lease will commence in 2020, and wraps up an extremely successful redevelopment undertaking.

As Tom will touch on, we did end the year at a 6.1 EBITDA target, which really does position us well going into 2020. So turning to 2020, we are off to a very good start. The 2020 business plan is really quite simple. It's, first of all, to take advantage of strong market conditions to meet all of our operating targets and drive net effective rent growth. And then secondarily, to capitalize on all the development planning and approval efforts that we undertook in 2019 by getting some vertical construction underway to drive earnings growth over the next several years. So in pursuit of the operating goals, as you noted in the supp, we're 73% done on our speculative revenue target. Our leasing pipeline remains deep for our existing inventory, including 270,000 square feet in the advanced stages of lease negotiations.

As we outlined on Page 10 and 11 of our supp, we expect both the Greater Philadelphia and Austin markets to remain strong during the year and generating good activity, a building pipeline and good leasing levels.

Now looking at it, Austin continues to ride the growth wave from corporate attraction efforts and end market expansions. The unemployment rate fell to 2.6% towards the end of the year. Asking rents continued to increase year-over-year, with about 2.1 million square feet of absorption during the full year 2019.

Philadelphia also experienced about 500,000 square feet of absorption over the last year. The Trophy Class vacancy rate went down to 5%, among the lowest of the top 5 largest MSAs. Philadelphia has grown jobs over the last year, continuation of its performance in the last several years. And we experienced solid demand in the fourth quarter, with asking rents increasing 4.4% year-over-year. Just one note on a major redevelopment project, 1676 International, that comprehensive 24 million square -- $24 million repositioning is substantially complete, and we're in a full marketing mode. We've already leased 75,000 square feet in the Lower Bank for mid-2020 occupancy. We have about 220,000 square feet remaining and a current pipeline of just shy of 400,000 square feet. In addition, based on the current stacking in the building, we have constructed several spec suites on the lowest available floors to accommodate smaller tenants who are in need of quick occupancy. Rental rate levels in our proposals and the executed lease matched our pro forma rates and represented about a 15% increase over the expiring rent.

Our 2020 business plan projects we'll lease an additional 125,000 square feet in the -- during the third and fourth quarter of '20, and our spec revenue target does include, in the aggregate, $3 million of revenue from this project with about $1.7 million yet to do. The numbers support our previously indicated guidance that this project will generate in excess of a 20% return on incremental capital, and we expect it to stabilize around an 11% yield on a fully loaded basis.

The '20 operating plan is also headlined by 2 metrics that we think demonstrate excellent earnings potential. Our cash mark-to-market range is between 8% and 10%, and our GAAP mark-to-market range is between 17% and 19%, our best in recent memory. We do anticipate that for the year, all of our regions will post positive mark-to-market results on both a cash and GAAP basis. Furthermore, our disciplined focus on controlling capital costs, which we expect to stay below 15% for 2020, combined with this mark-to-market does result in us growing net effective rents in our 2000 (sic) [2020] plan by 8%.

Also from an earnings acceleration standpoint, the major 2020 rollovers do create significant upside in '21 and '22. SHI, for example, in Austin, is a 20% cash and a 28% GAAP mark-to-market; Macquarie, in Philadelphia, is an 18% cash and 22% GAAP; and Reliance, again, in Philadelphia, is a 20% cash and a 24% GAAP mark-to-market.

We do expect our GAAP same-store to be in the range of 2% to 4%, primarily driven by Philadelphia, which is about 4.5%, and the Pennsylvania suburbs coming in just shy of 7%. For obvious reasons, Met D.C. and Austin will be negative due to the KPMG and the SHI moveouts.

One point that we think is worth amplifying is our same-store forecast, due to the inclusion of 1676, we don't really think reflects the underlying strength of our portfolio. For example, without the inclusion of this property, our 2020 cash same-store range would be 2.5% to 4.5%. We did illustrate the impact of this in more detail on Page 7 of our supplemental package.

Just a couple of quick words on major vacancies. I've already chatted about 1676. Essentially, there, we have 125,000 square feet of lease-up and need to generate $1.7 million of GAAP revenue in the latter half of the year. SHI, about $2.7 million of GAAP revenue from the 184,000 square foot roll. Cash mark-to-market is over 19%. 80% of that is already booked. So what's left to do is just north of $500,000 of additional spec revenue.

When we take a look at the Macquarie rollover at our Commerce Square Building in Philadelphia, we don't have any leasing or any GAAP revenue really projected as part of our 2020 business plan. It's also important to recognize that the remaining open assumptions in our plan are predominantly smaller spaces. In fact, no single vacancy is larger than 17,000 square feet. And as George can amplify for the interest, now we've already executed 81% of our anticipated renewals for the year and have active negotiations underway with a significant percentage of the remaining balance.

Now for the -- looking forward for capitalizing on all of our development approval work during 2019. During the past year, we achieved all of our goals, on all of our development planning efforts. We completed the full approval, the full design, development and construction pricing on all of our production assets, that being Garza in Four Points in Austin, 650 Park and 155 King of Prussia Road in Pennsylvania. So we are in a full go position on all 4 of those projects.

And as we noted last quarter, these assets can be completed within 4 to 6 quarters. They will cost between $40 million and $70 million. So the aggregate investment in those 4 assets is just north of $200 million. They range in size between 100,000 and 165,000 square feet. The cash yields on each of them are circling 8% and on the -- of these projects, we have combined prospect list of 1.8 million square feet. So they are ready to go, and we do have, as Tom will touch on, 2 development starts built into our 2020 plan.

Quick observation on a couple of our existing developments. 405 Colorado in Downtown Austin is on track for a year-end '20 completion. We are now 52% leased, 97,000 square feet remain, and we have a leasing pipeline of over 200,000 square feet. Project cost remains at $114 million, and we are targeting a yield on cost of 8.5% and expect that to stabilize in mid-'21.

The Bulletin Building here in Philadelphia, that renovation, the exterior work is ongoing and will be completed on budget and on schedule in early Q2 of this year. As you may recall, that entire building is leased to Spark Therapeutics, a life science company owned by Roche Pharmaceuticals, and we still project a 9.3% free and clear return.

In looking at our large master plan mixed-use projects. On Pages 15 and 16 in our supp, we did provide more information. To highlight a few points, the -- our full master plan approvals are now in place. That's 2 years ahead of schedule. So we're able to accomplish all of the zoning overlays in 2019. The design, development and pricing is substantially done on the first 2 buildings. Marketing efforts do continue with about a 1.1 million square foot active pipeline and a significant component of that being life science tenancies. We are in very advanced discussions with joint venture equity financing sources. And as we've indicated before, our current front money investment balance in that -- both of those projects approximating $90 million should be sufficient to meet the equity requirements under our contemplated joint venture structures.

If we are successful in finalizing the current equity and debt financing negotiations, we will be in a position to go on the West Tower in the first half of 2020. The East Tower, which is obviously a larger project with primarily office and a life science component will require an anchor tenant, and we continue that process as well in addition to working on the equity and debt financing arrangements. The Schuylkill Yards master plan can accommodate almost 2 million square feet of life science space. As I mentioned last quarter, we are proceeding with the design development on a 400,000 square foot dedicated life science building. And in addition to that, the new ground-up life science building, we noted on Page 13, that we have started the conversion of 3000 Market Street, an existing 60,000 square foot office building, into a life science facility. Design and pricing is being finalized with selective demo already underway. We do expect to be able to deliver that project in the first quarter of 2021. That decision was really driven by the tremendous near-term demand we're seeing from smaller life science companies with the objective that we can -- if we can get them into 3000 Market, we can capture their future growth at Schuylkill Yards.

Turning to Austin, our Broadmoor development -- again, all approvals done. As we've noted in the supp, we can do 2.7 million square feet and 855 apartments with the existing buildings, they're substantially leased to IBM and a couple of other tenants in place. We're into full planning and costing on 3 blocks as detailed in the supp.

Blocks A and F will be in a position to start by midyear 2020. Discussions on the train station, public space sequencing and our retail hospitality initiatives are continuing at an excellent pace. We are also in discussions with private capital sources as we finalize the financial plan for an accelerated build out of this overall redevelopment. We only have one acquisition program for 2020, which is 160,000 square foot building in Radnor that we are purchasing as part of our overall transaction with Penn Medicine. This project is an exciting redevelopment opportunity in one of the region's premier submarkets. Right now, we anticipate closing on that project in the second quarter of '20 and moving it immediately into redevelopment.

On the disposition front, we are marketing several smaller buildings in the Pennsylvania suburbs and continue to have numerous discussions with private equity sources on both the acquisition and disposition fronts.

As you know, our '20 plan has $50 million of incremental spend projected on our 2 development starts. As we'd indicated previously, to finance these opportunities, we will be consistent with what I just mentioned evaluating bolt-on asset sales, looking at some of our existing joint venture structures to harvest profits and to make sure that we generate sufficient liquidity and maintain our balance sheet targets.

So to close, our focus is now on executing our '20 business plan. We are delighted that the bottom line result for 2020 is a strong cash to market -- cash mark-to-market, net effective rent growth, 3% FFO growth rate and a debt-to-EBITDA range between 6.1% and 6.3%.

I'll now turn the presentation over to Tom for an overview of our financial results.

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Thomas E. Wirth, Brandywine Realty Trust - Executive VP & CFO [3]

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Thank you, Jerry. Our fourth quarter net income totaled $16.7 million or $0.09 per diluted share and FFO totaled $67 million or $0.38 per diluted share, which were at the upper end of our guidance estimates.

Some general observations regarding the fourth quarter results. Operating results were generally in line with our third quarter guidance. Some -- one highlight is our operating expenses did benefit from lower tenant reserves, while our G&A was negatively impacted by some onetime transactional and professional costs. And other income was below our forecast also for the fourth quarter due to some timing of anticipated transactions. Our fourth quarter same-store GAAP NOI growth was negatively impacted by some tenants that had some substantial completion delays and tenant leasing slides, all of which will commence in the first quarter of 2020. Our fourth quarter fixed charge and interest rate coverage ratios were 3.7 and 4.1, respectively. Both metrics improved as compared to the fourth quarter of 2018 and were better than our forecasted results.

Our fourth quarter annualized net debt-to-EBITDA decreased to 6.1x and at the lower end of our 6.0 to 6.3x guidance. The ratio benefited from improved operating income and higher-than-expected year-end cash balances. The increase in cash was primarily due to the delay of our acquisition of a land parcel in Radnor, Pennsylvania, which we anticipate will close during this quarter and sales proceeds from the joint venture interest in Charlottesville, Virginia.

Looking forward to the first quarter of 2020, we have the following general assumptions: portfolio operating income will total approximately $84 million and will be sequentially lower by $1 million, primarily due to increased operating expenses; FFO contributions from our unconsolidated joint ventures will total about $2.5 million for the first quarter, which is down about $400 million from the fourth quarter and $200,000 after adjusting for the PJP sale in Charlottesville. For the full year 2020, the FFO contribution is estimated to be about $9.5 million.

G&A, our fourth quarter G&A will increase from

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to $9.5 million. That sequential increase is consistent with prior years and primarily due to the timing of deferred compensation expense recognition. For the full year, G&A expense, we estimate will total about $32 million. Interest expense will be about $20.5 million for the first quarter, with 97.5% of the balance fixed rate on our balance sheet. Capitalized interest will approximate $700,000, and full year interest rate will approximate $82 million.

In looking at that plan, we have several capital items we are talking about. One assumption is the payoff of the Four Tower Bridge mortgage, about $9 million in November 2020. Capitalized interest will be about between $3.2 million, up a little bit from last year. We're going to pay off the Two Logan mortgage, which matures on May 1. This mortgage approximates $80 million at just under a 4% rate. Termination fee and other income, we continue to anticipate termination of their fee income totaling $4 million for the first quarter and $11.5 million for the year.

Net management fees. Quarterly NOI will be $2.5 million and will approximate $8 million for the year. Land sales and tax provision, we expect to net to 0. And we have no anticipated ATM or share buyback activity. On the investments, as Jerry mentioned, guidance assumes no new sales activity. Building acquisition activity is for 250 King of Prussia Road for $20 million and an additional land parcel at Radnor, which did get delayed to the beginning of 2020, and that's another $18 million. Any development starts that we have, which is $50 million in our liquidity, we do not expect them to generate if they do start any earnings in 2020.

Our CAD range is 71% to 78%. The main contributors is going to be some higher straight-line rent this year versus next, just under $10 million. And again, the re-leasing space at 1676 is going to generate revenue, maintain capital of $0.10 due to the tenants that will come in within the first year of the vacancy. Our total uses in capital for the year is $535 million, $150 million of development, $135 million of common dividends, revenue-maintained capital of $64 million, revenue created of $50 million, mortgage amortization of $7 million, $90 million of debt payoffs, which I mentioned earlier for the mortgages, the acquisition of 250 King of Prussia Road for $20 million and the acquisition of the land for $19 million. Primary sources will be cash flow of $220 million, $215 million of line use, using up to $90 million of cash we have on hand and roughly $10 million of land sales that we have programmed.

Based on that capital plan, our line of credit balance will be approximately $250 million at year-end. We also project that our net debt to EBITDA will range between 6.1 and 6.3x with the main variable being timing and scope of our development activities. An addition of debt to GAV will be between 42% and 43%. In addition, we anticipate our fixed charge ratio will approximate 3.7, and the interest coverage will approximate 4.1.

I'll now turn the call back over to Jerry.

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Gerard H. Sweeney, Brandywine Realty Trust - President, CEO & Trustee [4]

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Great. Tom, thank you very much. With that, we are delighted to open up the floor for questions. (Operator Instructions). Crystal?

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from James Feldman from Bank of America.

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James Colin Feldman, BofA Merrill Lynch, Research Division - Director and Senior US Office and Industrial REIT Analyst [2]

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Great. I just wanted to start with just kind of the financing side. So 2 questions: one is, can you just talk more about potential JV partners or just kind of what you're lining up in terms of magnitude and size and maybe even your fees for some of these larger developments? And then secondly, I know you didn't include any sales and guidance, but it sounds like you could be doing sales if you start some of these developments. So maybe if you could talk about the earnings impact on that. Or is that not going to be meaningful?

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Gerard H. Sweeney, Brandywine Realty Trust - President, CEO & Trustee [3]

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Yes. Jamie, thanks for the question. On the joint venture side, that we -- the one that we're in very advanced discussion was related to our projects at Schuylkill Yards, and frankly, they're very consistent with what we have indicated before. The objective would be for Brandywine to remain at 35% partner in those transactions, the equity source would wind up providing 65% of the equity. We would line up construction and mini-perm debt financing through our banking syndicate. There would be market-rate development fees and their leasing fees, obviously, property management fees for Brandywine. And we do expect that the structures we're contemplating right now will be reflected in the final documentation. So we feel very good about how those discussions are going.

As we focus on the Broadmoor development, we certainly have a wide range of institutions who we are talking to about a variety of financial structures at Broadmoor, ranging from participating in a couple of the earlier phases to providing infrastructure funding. All of those, we think will progress over the next couple of quarters. And again, if you think about the comments Tom and I made, that we're really gearing up, starting the first vertical construction and site work at Broadmoor very early in the second half of 2020. So our goal would be to finalize those venture structures sometime by mid-second quarter of this year and have a lot more clarity we can share with our investor base. I think we -- as we've been indicating, we do think that one of the sources of capital for the production level assets are going to be some of the smaller asset sales. And we do believe in our plan that the timing of those sales will have negligible impact on 2020 guidance. And that's been kind of the model we set forth in the last several years. We would expect that to continue as well.

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James Colin Feldman, BofA Merrill Lynch, Research Division - Director and Senior US Office and Industrial REIT Analyst [4]

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Great. I guess just a follow-up, so it sounds like Schuylkill Yards is probably one partner, and am I right, Broadmoor maybe multiple partners depending on the building? Is that the right way to think about it?

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Gerard H. Sweeney, Brandywine Realty Trust - President, CEO & Trustee [5]

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Well, I think so. But please give us latitude as some of these discussions involve. I think our focus in at Schuylkill Yards is quite candidly on the first 2 buildings. And I think we're talking to a couple of groups, but really one primary partner on both of those buildings. Where at Broadmoor, I think, Jamie, we're still in the process of vetting through a number of expressions of interest in advanced discussions on how that will ultimately lay out, whether it's above an institutional partner that helps on the residential side or the mixed-use side or some of the retail and infrastructure developments.

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Operator [6]

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Our next question comes from Craig Mailman from KeyBanc Capital Markets.

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Craig Allen Mailman, KeyBanc Capital Markets Inc., Research Division - Director and Senior Equity Research Analyst [7]

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I wanted to circle back on the occupancy piece. Back in October, you guys seemed pretty confident you're going to hit the target for the year? And I know, Jerry, you mentioned kind of construction delays and the bankruptcy. Could you just elaborate a little bit more about kind of -- some specifics about what really -- it seemed like a big miss relative to your confidence back in October.

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Gerard H. Sweeney, Brandywine Realty Trust - President, CEO & Trustee [8]

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Yes, I'm not sure we categorized it as a big miss by any stretch. But, George, let me defer to you and kind of walk through some of the detail there?

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George D. Johnstone, Brandywine Realty Trust - EVP of Operations [9]

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Yes, we had a -- we really kind of had 3 moving pieces, Craig. The smallest of which was a 20,000 square-foot bankruptcy in Austin that kind of came out of nowhere. So we ended up getting that space back in early December. And we feel good about the space that we got back and then have it incorporated into our plan to relet in 2020. The other 2 components really were tenants not substantially completing their tenant fit work. These are conditions where the tenants building out the space and Brandywine is not. And so our policies to-date have been that if that space isn't substantially complete and we're not recognizing income on it, we don't reflect it as occupied, and that was about 50 basis points when it was all said and done. And then the third piece were just some leasing slides themselves that we felt confident back on the October call that we were going to get them papered. They were quick move-ins because the space was, in fact, ready for tenancy and those occupancies slid into January, and they have subsequently to year-end occupied. So those were really the 3 pieces.

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Gerard H. Sweeney, Brandywine Realty Trust - President, CEO & Trustee [10]

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Yes, let me just add on to George's observation on the tenant-directed fit-up. These are leases that have commenced. They're executed. Tenants are there. The tenant is behind schedule on completing their tenant fit-up and based upon the revenue recognition rules because that space is not "ready" for its intended use, we cannot recognize revenue. So we had this a number of -- we have a number of quarters where, from our perspective, the lease is signed, the tenant is either in free rent period or in some cases, actually paying us cash rent, but they have yet to complete their fit-out, and therefore, we can't recognize revenue. So as George touched on that, that's an ongoing struggle we have because to the extent that a tenant wants to do their own fit-out, we certainly are happy to have them do that, subject to trigger dates on a lease commencement so that we know that any of their delay it doesn't affect the commencement date of the lease. The vast majority of times tenants complete their space well ahead of schedule they're in. There's always cases where there is -- where that did not occur.

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Craig Allen Mailman, KeyBanc Capital Markets Inc., Research Division - Director and Senior Equity Research Analyst [11]

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And what industry was the bankrupt tenant in Austin?

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Gerard H. Sweeney, Brandywine Realty Trust - President, CEO & Trustee [12]

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They were a small mortgage lender.

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Craig Allen Mailman, KeyBanc Capital Markets Inc., Research Division - Director and Senior Equity Research Analyst [13]

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And then just on the Macquarie and Reliance spaces, any update there on progress in backfilling?

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George D. Johnstone, Brandywine Realty Trust - EVP of Operations [14]

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Yes, Craig, it's George again. We're seeing most of the activity on the Macquarie spaces, obviously, because they come back to us first, but seeing activity on both. We've got proposals out on about 40% of that space already, and we've got a handful of inquiries and tours, not yet at the proposal stage, but we've got a pipeline that actually exceeds the 150,000 square feet that we're getting back from Macquarie. Reliance, again, those are contiguous floors, and we have seen a couple of inspections by some larger tenants that have either a '21 or maybe even a first quarter '22 occupancy event, and they're just kind of out seeing what the opportunities are. And again, we don't get that space back from Reliance until 12/31 of 2020.

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Gerard H. Sweeney, Brandywine Realty Trust - President, CEO & Trustee [15]

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But in addition to that, Craig, we also -- the team has done a great job in kind of forward planning exactly what selective demo we want to do. We've got programs in place to upgrade some of the common areas. So the expectation would be similar to what we did, frankly, at 1676. As soon as that tenant vacates, we'll be in there. The plan will be to have been locked and loaded. We will have all the permits in place to go and immediately commence work, so we can accelerate delivery of some of that space. And certainly, as you know from previous discussions, the bifurcation of that space between smaller floor plates, upper tower and baseline, really gives us a range of options to present to the tenant market. So even the larger floor plates, we're -- we'll be prebuilding some spaces, including putting some furniture in order to try and accelerate the potential occupancy dates of those floors.

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Craig Allen Mailman, KeyBanc Capital Markets Inc., Research Division - Director and Senior Equity Research Analyst [16]

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Got you. And just one quick follow-up on Jamie's questioning on the financing piece. Sounds like you guys are still trying to figure out the optimal structure, but how much is kind of pricing playing into the discussions at this point? Are you guys close to your partners on expectations? Or is that kind of more of a sticking point on -- than maybe just the correct structure?

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Gerard H. Sweeney, Brandywine Realty Trust - President, CEO & Trustee [17]

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No, no, no. I wouldn't say that pricing is an issue at all.

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Operator [18]

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Our next question comes from Jason Green from Evercore.

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Jason Daniel Green, Evercore ISI Institutional Equities, Research Division - Analyst [19]

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I appreciate the color on the fiscal year '20 move-outs. I guess, if you're able, as we look out over '21 and '22, we know Reliance is leaving space greater than 100,000 square feet. Thought it was in '21, but you guys just mentioned at the end of '20. But I guess, outside of Reliance, are there any other kind of 100,000 to 150,000 or greater square foot tenants that we should be thinking about in modeling in '20, '21 and '22 that are likely to move out?

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Gerard H. Sweeney, Brandywine Realty Trust - President, CEO & Trustee [20]

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Well, at this point, we think we're going to have a major rollout in Northern Virginia with Northrop Grumman. And I think George worked on a couple of other ones. I mean, I know most of them are set. But we do have a few more variables.

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George D. Johnstone, Brandywine Realty Trust - EVP of Operations [21]

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Yes, the large rollover with IBM in Austin that we're confident of a renewal there. In Philadelphia, we've got a large law firm that we're already in active discussions with about renewal. And then Reliance was the other. I mean, those -- that's really the inventory of kind of the 6-figure square footage type tenants.

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Jason Daniel Green, Evercore ISI Institutional Equities, Research Division - Analyst [22]

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Okay. And then just curious, this might be a little bit of overanalyzing on our part, but looking at the Schuylkill Yards page in the supplemental, we noted that it no longer refers to opportunity zones. Is there any reason for that? And then just more broadly with some of the news going on about opportunity zones, if there's kind of any opinion that you guys can share about what's going on?

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Gerard H. Sweeney, Brandywine Realty Trust - President, CEO & Trustee [23]

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It should say opportunity zone.

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George D. Johnstone, Brandywine Realty Trust - EVP of Operations [24]

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Yes, we changed a bullet.

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Gerard H. Sweeney, Brandywine Realty Trust - President, CEO & Trustee [25]

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I know, actually -- hey, Jason, it's the fourth bullet down under Overview.

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Jason Daniel Green, Evercore ISI Institutional Equities, Research Division - Analyst [26]

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Okay.

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Gerard H. Sweeney, Brandywine Realty Trust - President, CEO & Trustee [27]

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Yes. So it's still there. Yes, we're within a federal opportunity zone. Look, I will tell you, a number of the equity partners that we initially talked to, on Schuylkill Yards, were very interested in the federal opportunity zone. And I think some of those discussions took some time because there was some debate in Washington on what the actual final regulations would be. And I think it was -- there was some points of debate in the tax and investment community of what those requirements would be. I think that dust has settled. And certainly, we continue to have a surprisingly good reaction from investors who are focused on opportunities to invest in very high-quality real estate. And I think one of the things that we have learned through these opportunity zone discussions is that where the federal regulation is directed towards getting money into areas that have been lacking in investment, our location next to the train station and the universities, I think, has given a lot of the investors we have spoken to a lot of comfort that the investment thesis has been proven because of the work we've done at Cira Centre with Spark Therapeutics, the main post office building, FMC Tower, et cetera. So I think we've resonated well for both the federal opportunity zones standpoint. But also and probably more importantly, that the execution level in the real estate has gone very well.

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Operator [28]

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Our next question comes from Manny Korchman from Citi.

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And we're going to take our next question from Omotayo Okusanya from Mizuho.

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Omotayo Tejamude Okusanya, Mizuho Securities USA LLC, Research Division - MD & Senior Equity Research Analyst [29]

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First question, Discovery Labs, the large development that's happening in King of Prussia for life sciences, I mean, do you look at that and think that's going to be competitive against what you're doing in Schuylkill Yards? Or is it kind of because it's so far away or 30 minutes away, you don't really see it as competing product?

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Gerard H. Sweeney, Brandywine Realty Trust - President, CEO & Trustee [30]

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Yes, excellent question. And I guess, and we certainly have tracked that development. And I think 2 reactions: one is, I think it's wonderful because I think what it really speaks to is the real accelerated emergence of a growing life science sector here in Philadelphia, driven a lot by the cell therapy technologies, the tremendous research being done by the Wistar Institute, the pharma companies, organizations like obviously Spark Therapeutics and now Roche, Children's Hospital. So from our perspective, it's been a really strong independent validation that this market really is primed for accelerated life science development. So that's very, very good news for us. Relative to competition, I think we've always operated on the standpoint that we compete against everybody. And we'll be challenged to present Schuylkill Yards as a preferred location and efficiency module compared to any other location within the regional marketplace. But we're -- but fundamentally, even recognizing that competitive threat or potential, I think we're just really excited about the fundamental demand drivers that we're seeing in this market segment. So what -- we talked about the conversion of 3000 Market, that's really been totally focused and driven by the fact that our leasing team is seeing a tremendous number of emerging life science companies with good financial sponsorship and great research capacity who kind of have a short time line to actually start to plant a flag. And we thought that 3000 Market could provide an excellent opportunity to capture some of that near-term demand. And as those companies implement their research capacity and start going through trials and raise more capital that we could capture their growth at Schuylkill Yards. So...

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Omotayo Tejamude Okusanya, Mizuho Securities USA LLC, Research Division - MD & Senior Equity Research Analyst [31]

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And then just another quick one, if you don't mind, the Northrop Grumman lease, when does that expire?

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Gerard H. Sweeney, Brandywine Realty Trust - President, CEO & Trustee [32]

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That expires in January?

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George D. Johnstone, Brandywine Realty Trust - EVP of Operations [33]

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January of '21.

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Gerard H. Sweeney, Brandywine Realty Trust - President, CEO & Trustee [34]

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Yes. And on that building, we have plans underway to do one of 2 things, either significantly renovate it and/or sell our joint ventures. So we're pretty far along in the thought process there.

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Operator [35]

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Our next question comes from Daniel Ismail from Green Street Advisors.

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Daniel Ismail, Green Street Advisors, LLC, Research Division - Analyst of Office [36]

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With respect to the leasing pipeline in Philadelphia, are these mostly tenants in the markets? Or are you noticing any new out of towners taking a look at Philly as a destination?

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Gerard H. Sweeney, Brandywine Realty Trust - President, CEO & Trustee [37]

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Yes. I think when you look at the pipeline, it's probably broken down about 50% outside the city, 50% inside the city. But of what's inside the city, they're all growth. So it's net growth, not just share shuffling. So I think we feel pretty good about the kind of region-wide in Northeast quadrant marketing program. I will tell you a number of the life science companies are really from outside the area. So I think there's a little bit of a skewing there. And the major office or traditional tenants that we're tracking down, I think, are pretty evenly split between kind of in and outside of market companies.

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Daniel Ismail, Green Street Advisors, LLC, Research Division - Analyst of Office [38]

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And staying on Philly, we've seen tenants densify into their space this cycle. Do you think your tenants have mostly gone through that phase? Or is there still more to go?

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Gerard H. Sweeney, Brandywine Realty Trust - President, CEO & Trustee [39]

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I'm sorry, Danny. Your question cut out a little bit on us here.

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Daniel Ismail, Green Street Advisors, LLC, Research Division - Analyst of Office [40]

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Oh, sorry. Yes, I was referring to densification and the trend that we see in the cycle has been that tenants have been -- have densified, call it, 20% or so into the space. Do you think that trend still has some more legs to go? Or do you think we're mostly gone through that trend?

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Gerard H. Sweeney, Brandywine Realty Trust - President, CEO & Trustee [41]

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Look, I think it's going to be an ongoing trend. And I think that's really where our properties are well positioned versus our competitive set. I mean what we're seeing in -- due to the tight labor market, focus on employee culture, talent attraction, the really well-appointed buildings with a full amenity package like we have tend to rise to the top of the prospect list. So we do think that, that evaluation of efficiency of space design will be -- is a secular trend in our business. We also think, though, maybe to your core question, is that I think the original densification targets that a lot of companies set or have been reevaluated upward where we think -- the initial push was to densify down to 100 to 125 extra square feet per employee. We're not seeing that at all. We're basically seeing kind of almost a reversion to that 150 to 200 square feet per range. Because what we're really seeing is, where there may be a higher percentage of open floor plans or kind of interior core offices, you're seeing wider circulation areas, you're seeing a much more focus on space collaboration within tenant spaces, the creation of more common area gathering points. So when we look at some of the major tenancies that we've done recently and filling even on our development projects, we're seeing a pretty stable outlook on how many square feet per employee tenants will have. In fact, in a number of discussions, we're really driving a little bit away from the rental rate per square foot and beginning to focus very much on the occupancy cost per employee. So it tends to be a much significant positive selling point for us that we're able to present much more efficient floor plates, column-free 10-foot finished ceilings, et cetera, that are delivering a much higher value proposition to our tenant base.

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Operator [42]

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Our next question comes from Manny Korchman from Citi.

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Emmanuel Korchman, Citigroup Inc, Research Division - VP and Senior Analyst [43]

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Just as we think about both Schuylkill and Broadmoor and the large office components you're building there, are you completely dual tracking the process there, talking to tenants, trying to find anchor tenants getting ready to go live with those buildings? Or do you need to find a capital source first to make those projects sort of live?

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Gerard H. Sweeney, Brandywine Realty Trust - President, CEO & Trustee [44]

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Manny, very much a dual tracking. In fact, I mean marketing is usually at the tip of the spear. So we -- that's why we amplified during commentary about -- I mean 2019, for us on the development front, was really getting through all the approvals. I mean there are a lot of them as you all well know, getting completely through the design development process down to see the construction documents for most of the projects, getting final pricing done. Because that really -- particularly at a time of escalating construction costs, you need to kind of know what your platform is and we've got that done. While we're doing that, we're still marketing, but you want to get to the point where you've got quantitative certainty of what you -- what the cost of delivery will be. So whether it was on projects like Garza or Four Points or the suburban properties in Philadelphia or Schuylkill Yards or Broadmoor, mission-critical was getting everything framed out. We've done that, the marketing process on every one of those projects, i.e., the 4 production assets in the Schuylkill Yards and Broadmoor. All those marketing efforts have been launched. We've got big prospects going. Discussions are going on. As I mentioned, we've got a prospect pipeline on the development -- on the production assets of almost 1.8 million square feet. So our prospective quite candidly has been the more we can demonstrate market demand drivers at our targeted rental rate levels, the more constructive those financing discussions are. We'd always rather be in a position where we're -- we've mitigated some of the lease-up risk by the pipeline because that facilitates a much more constructive discussion with the financing sources.

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Emmanuel Korchman, Citigroup Inc, Research Division - VP and Senior Analyst [45]

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If we think about that same sort of concept then, if you get closer, if you land a prelease, are you still on the track to do a JV on the development project? Or would you then consider maybe selling your JV in one of your stabilized assets instead?

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Gerard H. Sweeney, Brandywine Realty Trust - President, CEO & Trustee [46]

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Well, I think the immediate near term as we're looking out over the next several months, I think, given the -- given that dynamic and focusing on Schuylkill Yards, I think the bias would still be to do a joint venture, at least on those first 2 buildings.

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Operator [47]

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And we do have a follow-up question from James Feldman from Bank of America.

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James Colin Feldman, BofA Merrill Lynch, Research Division - Director and Senior US Office and Industrial REIT Analyst [48]

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I just wanted to follow up on your comments on Northrop. So is -- can you just tell about -- like, talk about the building. I think looking at your top tenants list, it's like the #8 tenant. Is that -- are they moving out of that entire space? I just think we want more color on exactly the story there.

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Gerard H. Sweeney, Brandywine Realty Trust - President, CEO & Trustee [49]

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Yes, they do plan on vacating the building, which we think they've been in there about 15 years. It's a great project in our Dulles Corner development, and we fully expect to have a very successful renovation. We're successful still there. So we're going to take one of those 2 paths as we look forward to '21.

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James Colin Feldman, BofA Merrill Lynch, Research Division - Director and Senior US Office and Industrial REIT Analyst [50]

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When do they expire, exactly?

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Gerard H. Sweeney, Brandywine Realty Trust - President, CEO & Trustee [51]

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At the end of the year. Or...

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George D. Johnstone, Brandywine Realty Trust - EVP of Operations [52]

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January of '21.

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Gerard H. Sweeney, Brandywine Realty Trust - President, CEO & Trustee [53]

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Yes, January '21.

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James Colin Feldman, BofA Merrill Lynch, Research Division - Director and Senior US Office and Industrial REIT Analyst [54]

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January of '21. Okay. And it's 250,000 square feet?

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Gerard H. Sweeney, Brandywine Realty Trust - President, CEO & Trustee [55]

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Correct.

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James Colin Feldman, BofA Merrill Lynch, Research Division - Director and Senior US Office and Industrial REIT Analyst [56]

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And do you have -- like, are you in any talks, early talks, with anyone else to backfill it? Or do you think that a sale is more likely? Just how are you guys thinking about it?

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Gerard H. Sweeney, Brandywine Realty Trust - President, CEO & Trustee [57]

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Well, I think there's -- I mean, there's certainly been a tightening of large blocks of space in that market. A team has identified a couple of replacement tenants. We think that there's a very good mark-to-market there. And I think, Jamie, we would be in a position by kind of the next quarter call, to really frame out what the final plan is. We have -- we've had renovation plans pulled together and priced for the building, which are very exciting, but we also want to evaluate what the best financial outcome for Brandywine is as well.

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James Colin Feldman, BofA Merrill Lynch, Research Division - Director and Senior US Office and Industrial REIT Analyst [58]

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Okay. What are they paying in rent? Or, like, where do you think their mark-to-market is?

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George D. Johnstone, Brandywine Realty Trust - EVP of Operations [59]

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Their mark-to-market is north of 20%.

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James Colin Feldman, BofA Merrill Lynch, Research Division - Director and Senior US Office and Industrial REIT Analyst [60]

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Okay. All right. And then it looks like as you look at your kind of speculative development -- or sorry, speculative leasing pipeline, it looks like D.C. is kind of lagging the other markets. Can you just talk about what's in that number? And what you -- is it like a couple of large leases that you need to hit? And maybe that's why -- is it chunkier? Or is D.C. just kind of slower than what you'd -- than some of these other markets? I know it's slow, but slower that you thought.

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George D. Johnstone, Brandywine Realty Trust - EVP of Operations [61]

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No, I think as Jerry outlined, there's still 125,000 square feet at 1676 in that leasing plan left to achieve. And then we've got some additional leasing in our suburban Maryland portfolio and the remaining -- and the other buildings that we have in Tysons at 8260 Greensboro and 8521 Leesburg Pike. So...

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James Colin Feldman, BofA Merrill Lynch, Research Division - Director and Senior US Office and Industrial REIT Analyst [62]

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So I guess, is there anything that's kind of falling out of bed since you made your first outlook? Or everything is kind of going as expected?

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Gerard H. Sweeney, Brandywine Realty Trust - President, CEO & Trustee [63]

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No, I think everything is kind of going as expected because 1676 was programmed for the third and the fourth quarter. The pipeline that we have is still tracking towards the -- that time line. And the other spaces and the other buildings were really kind of 10,000 to 15,000 square foot tenancies that, again, I think, just start to lay in as the year progresses.

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James Colin Feldman, BofA Merrill Lynch, Research Division - Director and Senior US Office and Industrial REIT Analyst [64]

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Okay. And then what are your big picture thoughts on supply in Austin? I know there's a lot of demand, but are you -- are there certain pockets you guys think are starting to get a little risky or maybe (inaudible)?

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Gerard H. Sweeney, Brandywine Realty Trust - President, CEO & Trustee [65]

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Well, we certainly -- we're feeling very -- continue to feel incredibly bullish on the southwest, primarily due to some of the barriers to new construction. So I think we're seeing tremendous pipeline of deals in our Garza development down the southwest. Look, I mean, there's a lot of square footage under construction in Austin. I think the last numbers I saw were they were about 60% pre-leased. The demand drivers still there seemed very good. So our Four Points development kind of up in the northwest, that's the one what we're really tracking in terms of competitive supply, Jamie. But certainly, we feel good about our position with 405 and feel extremely good about what we can convert down at Garza.

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James Colin Feldman, BofA Merrill Lynch, Research Division - Director and Senior US Office and Industrial REIT Analyst [66]

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Okay. And then finally for me, kind of big picture in Northern Virginia, I mean we keep hearing about the impact of the JEDI contract and what that will mean for office demand or maybe there's just optimism it will pick up off this demand. I'm curious what you guys are seeing on the ground? And what -- if you think about the next kind of year or so in that market, do you think you'll see a change in demand or just fundamentals?

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Gerard H. Sweeney, Brandywine Realty Trust - President, CEO & Trustee [67]

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Yes. Look, I think from -- if you take a look at the Northern Virginia, it posted 4 million square feet of absorption. One of the best years they've had since, I think, 2006. With kind of a pretty strong tech and cybersecurity demand, 71% of the job growth in the Met D.C. area kind of floated into Northern Virginia. The -- so we're actually -- we're seeing rents being pushed on the new development projects, which is great. That's one of the things when we take a look at a 2340 where, given that large mark-to-market that George indicated, and really not many large blocks of space available, particularly buildings that have the high level of structured parking that we have at that building. We think that there's a lot of green shoots that will further drive demand. With the JEDI contract, I mean, between Microsoft and Amazon Web Search, they are looking for more space in the market. You've seen a number of other major tenants kind of focus on the Toll Road Corridor. I think, anecdotally, what we're seeing, Jamie, even with the redevelopment of 1676, there's a lot of big requirements. For many, we've got proposals out. The number of proposals we've had are over 100,000 square feet. So I think that marketplace from a demand perspective in terms of velocity of tenants and additional square feet looking for new homes is a much better landscape than it was last year. How that translates into net effective rent growth in the concession package, I think, still remains to be seen. But the little window we have in for -- through 1676 is our pro forma rent targets are being met, we're keeping our capital cost right in line with our projections and we anticipate being able to drive that to, as I mentioned earlier, 9% return on cost.

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James Colin Feldman, BofA Merrill Lynch, Research Division - Director and Senior US Office and Industrial REIT Analyst [68]

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Does this motivate you to get bigger there? I know you just did a big sale there to shrink. But do you feel like market changed when you made that call?

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Gerard H. Sweeney, Brandywine Realty Trust - President, CEO & Trustee [69]

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No, I think we're happy with our platform right down there. Now I think we continue to talk to capital sources and other companies about other things to do in that marketplace. But right now, the major focus in that market for us is to execute the Rockpoint joint venture efficiently and profitably. Solve the 1676 absorption pace for 2020. And really, as we get that done, we'll take a look and see what we plan on doing for future years.

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Operator [70]

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And I am showing no further questions from our phone lines. I'd now like to turn the conference back over to Jerry Sweeney for any closing remarks.

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Gerard H. Sweeney, Brandywine Realty Trust - President, CEO & Trustee [71]

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Great. Well, look, everyone, thank you very much for participating in the call. And we look forward to updating you on our 2020 business plan progression in our April first quarter call. Thank you very much.

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Operator [72]

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Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may all disconnect. Everyone, have a wonderful day.