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Edited Transcript of PSB earnings conference call or presentation 23-Oct-19 5:00pm GMT

Q3 2019 PS Business Parks Inc Earnings Call

GLENDALE Oct 30, 2019 (Thomson StreetEvents) -- Edited Transcript of PS Business Parks Inc earnings conference call or presentation Wednesday, October 23, 2019 at 5:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Jeffrey D. Hedges

PS Business Parks, Inc. - Executive VP, CFO & Secretary

* John W. Petersen

PS Business Parks, Inc. - Executive VP & COO

* Maria R. Hawthorne

PS Business Parks, Inc. - President, CEO & Director

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Conference Call Participants

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* Anthony Paolone

JP Morgan Chase & Co, Research Division - Senior Analyst

* Blaine Matthew Heck

Wells Fargo Securities, LLC, Research Division - Senior Equity Analyst

* Craig Allen Mailman

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

* Emmanuel Korchman

Citigroup Inc, Research Division - VP and Senior Analyst

* Eric Joel Frankel

Green Street Advisors, LLC, Research Division - Senior Analyst

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Presentation

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Operator [1]

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Good afternoon, and welcome to the PS Business Parks Third Quarter 2019 Earnings Results Conference Call and Webcast. (Operator Instructions) It is now my pleasure to turn the floor over to Jeff Hedges, PSB's Chief Financial Officer. Sir, you may begin.

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Jeffrey D. Hedges, PS Business Parks, Inc. - Executive VP, CFO & Secretary [2]

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Thank you. Good morning, everyone, and thank you for joining us for the third quarter 2019 PS Business Parks' investor conference call. This is Jeff Hedges, Chief Financial Officer. Here with me are Maria Hawthorne, CEO; John Petersen, COO; and Trenton Groves, CAO.

Before we begin, let me remind everyone that all statements, other than statements of historical facts included in this conference call, are forward-looking statements. These forward-looking statements are subject to a number of risks and uncertainties, many of which are beyond PS Business Parks' control, which could cause actual results to differ materially from those set forth in or implied by such forward-looking statements. All forward-looking statements speak only as of the date of this conference call. PS Business Parks undertakes no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

For additional information about risks and uncertainties that could adversely affect PS Business Parks' forward-looking statements, please refer to the reports filed by the company with the Securities and Exchange Commission, including our annual report on Form 10-K and subsequent reports on Form 10-Q and Form 8-K.

We will also provide certain non-GAAP financial measures. Reconciliation of these non-GAAP financial measures to GAAP is included in our press release and earnings supplement, which can be found on our website at psbusinessparks.com.

I would now turn the call over to Maria.

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Maria R. Hawthorne, PS Business Parks, Inc. - President, CEO & Director [3]

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Thanks, Jeff. Good morning, everyone, and thank you for joining us today. We have an outstanding quarter on both investments and the operations. In September, we closed on Hathaway Industrial Park for $104.3 million. Hathaway is a 10-building, 543,000 square foot park located in Santa Fe Springs Los Angeles County, near the intersection of 3 major freeways, the 5, the 105 and the 605. This market is 1.5% vacant, and in-place rents for the park are approximately 20% to 30% below market. There is a single user in the largest building totaling 288,000 square feet who will expire in April 2020. This space represents a near-term opportunity to add value.

On October 8, we closed on the sale of the 1.3 million square foot office flex portfolio in Maryland. The sale totaled $148.8 million and is right in line with our expectations. At this point, there are no other assets for sale in our portfolio for 2019.

We continue to be pleased with NOI growth at Highgate at The Mile, our multifamily asset. Compared to prior year, NOI grew 73%, and weighted average occupancy was 95.6%. Last quarter, I announced that we had received full rezoning of the balance of The Mile and that we are launching our second multifamily development called Brentford, and construction will begin in mid-2020.

Continuing with development updates, we are also going to commence construction of 2 Class A multi-tenant industrial buildings, which are both approximately 80,000 square feet. In both cases, we are taking advantage of excess land located in existing parks. The first to start is located in our Freeport business park in Dallas, which is a mile from DFW Airport. The other building, which will start late next year, is located in our 212 Business Park in Kent Valley, Washington, with close proximity to Sea-Tac Airport and the Seattle and Tacoma ports. We will give you updates on future calls.

Operationally, industrial continues to lead, and customer confidence remains high. Year-to-date total cash NOI is at 5.7%. Cash rental rate change for our commercial property is up 8.5% on 5.3 million square feet of leasing. We feel confident that our positive momentum will carry through the fourth quarter and set us up for an equally successful 2020.

With that, I'll turn the call over to JP.

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John W. Petersen, PS Business Parks, Inc. - Executive VP & COO [4]

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Thanks, Maria. Operating fundamentals in our markets were again solid as demonstrated by 2 million square feet of production, Same Park occupancy of 94.7%, up 40 basis points from Q2; retention of almost 74%; and overall cash rent spreads of 6.5%, including 13.6% rent growth on our industrial leases. Results were helped as our customers continue to grow with us in Q3. We signed 53 expansions for a net 82,000 square feet.

Now for a quick Q3 breakdown by market. There is active user demand in Northern Virginia, and we signed 107 leases for 426,000 square feet. Occupancy jumped 100 basis points to 92.8%, well ahead of our peer set, which is currently at 81%. Portion of this occupancy gain was generated by 13 existing customers that expanded in the quarter.

We did have negative rent growth of 8.4% in Northern Virginia, primarily due to 2 office renewals over 20,000 square feet and 1 key office expansion of over 40,000 square feet. All 3 transactions were important wins for us as we grew occupancy and extended lease term with minimal transaction costs. Demand in Northern Virginia is being driven by technology, health care and government contractors.

Northern California was also active in Q3, with our teams signing 490,000 square feet of deals, average deal size of 7,500 square feet, generating cash rent growth of 18%. Occupancy increased 130 basis points from Q2 to 97.1% as the 130,000 square foot vacancy we discussed in Q2 was occupied for all of Q3.

Speaking of largest space in Northern California, I mentioned last call that we had 3 expirations in Q4, each over 150,000 square feet. We successfully renewed 1 and have solid activity with good rent growth potential on the other 2.

Small users drove our leasing production in Southern California. The team in SoCal signed an amazing 149 leases in Q3, totaling 287,000 square feet for an average deal size of 1,900 square feet. This averages about 2 deals per work day and demonstrates our team's ability to drive market demand. Blended rent growth was 6%.

Orange County was up only 1% as we did 1 larger showroom lease with the rent write down.

Los Angeles is a very tight industrial market as you all know, and we increased rents in Los Angeles 10.5%. We did have 1 move out in Los Angeles of 52,000 square feet earlier in the year. We have since repositioned the building. We have a lot of interest in this space and expect solid rent growth upon lease up.

San Diego rents improved 3.7% on the strength of our 1,400 square foot average deal size.

In Texas, solid fundamentals continue to drive business forward, and our team signed over 325,000 square feet and 68 transactions. Combined rent growth in Austin and Dallas was 6.8%. Occupancy in Texas decreased 70 basis points due to 125,000 square foot customer leaving the portfolio. We have since re-leased this space.

Additionally, we signed 30,000 square-foot lease in Las Colinas that occupies in Q1 2020.

Heading to South Florida. We're not seeing any signs of a slowdown due to trade wars or economic uncertainty. Consequently, the Miami team generated good activity in Q3 with 217,000 square feet of leases, producing 13.2% rent growth. Occupancy increased 110 basis points to 95.6%.

Finally, Seattle continue to be a top performer with rent growth of 16%; retention, 91%; and 188,000 square feet of production. The Seattle market is one of the tightest in the country, and we have been able to take advantage of these stellar fundamentals.

Looking into Q4, I have confidence that with 2.2 million square feet expiring, we are poised to produce solid operating metrics, led by strong existing customer demand, low market vacancy and a team that knows how to produce results.

Now I'll turn the call over to Jeff.

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Jeffrey D. Hedges, PS Business Parks, Inc. - Executive VP, CFO & Secretary [5]

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Thank you, JP. As Maria mentioned in her opening remarks, we are very pleased with our third quarter financial results. Net income for the 3 months ended September 30 was $0.96 per diluted common share and $2.95 per diluted common share for the 9 months ended September 30. Year-to-date, funds from operations or FFO was $5.13 per share, an increase of 6.7% from a year ago, while funds available for distribution or FAD increased 9.9% over the same period. The increases in both FFO and FAD were primarily attributable to growth in Same Park NOI, which on a cash basis increased 5.1% over the 9-month period ended September 30 compared to the prior year. We are also very pleased with how our non-Same Park portfolio is performing as all of our recent acquisitions have, to this point, met or exceeded our underwritten assumptions. Additionally, our multifamily property, Highgate at The Mile, continues to perform very well as NOI reached $4.4 million for the 9 months ended September 30, which is in line with our expectations.

I'd like to now provide a few additional details related to the Maryland sale. First, we want to clarify that the assets that sold are identical to those which were classified as held for sale as of and for the 9 months ended September 30. Of the portfolio which was marketed, we opted to retain one 113,000 square foot office building, which is 100% occupied by a single GSA tenant and the pad site. Both the GSA-tenanted building and pad site had not been previously classified as held for sale and both remain in our Same Park portfolio.

Turning now to the balance sheet. As you may have noticed, we were out on our line $50 million as of September 30. With the receipt of the Maryland sale proceeds, we have paid that down in full.

Finally, I'll wrap up by pointing out that we paid a dividend of $1.05 to common shareholders in the third quarter, and our Board recently declared a dividend of $1.05 to be paid to shareholders in the fourth quarter, payable on December 30 to shareholders of record on December 13.

With that, we'll now open the call for questions. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) And we'll take our first question from Craig Mailman with KeyBanc Capital Markets.

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Craig Allen Mailman, KeyBanc Capital Markets Inc., Research Division - Director and Senior Equity Research Analyst [2]

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Just starting on Hathaway here. And I know you mentioned that almost half the property has an expiration in 2020. Are you guys planning on that tenant moving out and kind of going in with your typical kind of PSB demise program and kind of getting the smaller tenants? Or is that a market where you feel like you want to keep a larger space for bigger tenants? And kind of what's the capital that you think would have to go in if you do decide to kind of do your typical program?

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John W. Petersen, PS Business Parks, Inc. - Executive VP & COO [3]

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Craig, it's JP here. Good question. Right now, we're real confident -- well, first of all, we're negotiating with the customer to renew. We're real confident, if we're unable to come to a renewal, that the market supports a full building user. The rest of the park, as you can imagine, is small multi-tenant industrial. This one big building in LA is very marketable. We expect that there'll be good demand if we're unable to renew the tenant, so. And either way, we're confident because we have really good rent growth there and a small amount of capital to lease the space. So we like our position with that expiration.

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Craig Allen Mailman, KeyBanc Capital Markets Inc., Research Division - Director and Senior Equity Research Analyst [4]

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Okay. And what's the timing to get kind of rest of the leases to kind of capture that 20% to 30% mark-to-market?

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Maria R. Hawthorne, PS Business Parks, Inc. - President, CEO & Director [5]

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Craig, so in the first 2 years, first 24 months of ownership, 76% of the park is turning. As you know, 288,000 of 543,000 is over 50% is this one deal. And then as JP said, the other spaces are pretty small industrially speaking, so we're confident about what's going on there and the rent increases that we'll see throughout the park.

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Craig Allen Mailman, KeyBanc Capital Markets Inc., Research Division - Director and Senior Equity Research Analyst [6]

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And so I know you guys typically don't like to talk about yields, but kind of from you're going into where you think that's stabilized in 2 years, I mean, what do you think the uplift could be on a yield?

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Maria R. Hawthorne, PS Business Parks, Inc. - President, CEO & Director [7]

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Well, Craig, we don't like to give yield information like that. That's spreading the edge of guidance there. But this was definitely a market deal, and it was expensive. But what we loved about it was that it was a 10-building park, various sizes. And we have a great operating team in LA, and we're very confident that we will be very successful moving this asset forward and bringing it to apt market rates. And Craig, with the big acquisition coming -- I mean, with the big expiration coming, you'll see -- I mean, you'll see it happen next year.

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Craig Allen Mailman, KeyBanc Capital Markets Inc., Research Division - Director and Senior Equity Research Analyst [8]

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Right. I'm just trying to get a sense of like the dollar uplift on it. I mean is there any way to say what the in-place rents are on a per month basis or -- kind of just trying to get a sense of how to model the uplift as it seems like there could be a pretty big upper swing, and it doesn't take much to move your FFO a couple pennies.

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Maria R. Hawthorne, PS Business Parks, Inc. - President, CEO & Director [9]

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Yes. Craig, it would be hard to say for 2019 just because with this big customer, if they renew, that will be a big increase immediately. But then, of course, if it goes dark, then it does take 1 or 2 or 3 quarters to lease that size space up. So I wouldn't want to be forecasting FFO for this space, and we will certainly give a better update in February when we talk again.

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Craig Allen Mailman, KeyBanc Capital Markets Inc., Research Division - Director and Senior Equity Research Analyst [10]

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All right. I guess moving on. Outside of this 288,000, what other big expirations do you guys have in '20? Any chunky ones?

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John W. Petersen, PS Business Parks, Inc. - Executive VP & COO [11]

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Yes. We've got -- as I mentioned, we've got a couple in Northern California that are expiring this quarter, again, much like the one in LA at Hathaway. There's a market for big expirations. Our plan is not to slice and dice those, but we could have -- I mean just to be clear, we could have some vacancy in Northern California as we head into '20. We have -- other than that, we don't have any big one in SoCal and nothing that's material really in the rest of the country. It's primarily Northern California, we've got these 2 big ones and we've got another -- a couple others midyear. But again, I like our position there in renewing those and pushing rents as those leases mark-to-market. And we do have -- sorry, Craig, we have one in -- a bigger one in Seattle there, 212 Business Park. So we're pretty sure it's going to come back to market with this midyear next. So that's really it.

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Craig Allen Mailman, KeyBanc Capital Markets Inc., Research Division - Director and Senior Equity Research Analyst [12]

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How big is it?

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Jeffrey D. Hedges, PS Business Parks, Inc. - Executive VP, CFO & Secretary [13]

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It's over 100,000 square feet up in Seattle.

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Craig Allen Mailman, KeyBanc Capital Markets Inc., Research Division - Director and Senior Equity Research Analyst [14]

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Okay. But you guys are still building -- you guys are building another 80,000 square foot facility there, so you, I guess, feel real good about the demand at that park?

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John W. Petersen, PS Business Parks, Inc. - Executive VP & COO [15]

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Yes. We feel great about demand at Kent Valley. We feel great -- that park, our park has been -- when space comes like we really think very quickly. We've operated in the high 90s for the last, I don't know, several years. And we are also -- that's why we're building this new building, as Maria pointed out. And we're building multi-tenant industrial. And that's where the park is and that's what -- even though this is 1 expiration, more than likely, you'll see us slice and dice that, like we always do with our a bigger blocks, or like we mostly do with our bigger blocks. Does that answer your question?

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

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It does. And just on the developments, as you guys are going to spend on aggregate like $10 million to $15 million, do you think of spend that you could fund just through cash flow? Or is it the cost bigger depending on what you're...

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Maria R. Hawthorne, PS Business Parks, Inc. - President, CEO & Director [17]

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No, no. Yes, Craig, even though these are multi-tenant industrial buildings, they're still industrial buildings, so -- and what would make them unique is that they're hyper infill. So Dallas is not a place we would ordinarily develop, but the park that I'm talking about is less -- is about 1 mile from the freight access into DFW. It'll be -- have 28-foot clear height, 10,000-foot units, and that is just something that will be unique, that close to the airport. And it's the same thing with the Kent Valley. That is a completely built-out market in Seattle. And we're putting a 30-foot clear height, which -- and again, we're going small tenant. And we don't have a lot of 10,000, 12,000 square foot spaces at 212 Business Park, and the ones we have usually have a waiting list. So we're very confident that these will be as successful as the development that we did in Miami a few years ago.

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Jeffrey D. Hedges, PS Business Parks, Inc. - Executive VP, CFO & Secretary [18]

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And listen, Craig, we won't have to do anything out of the ordinary to finance these developments. They're -- you're directionally accurate in kind of your thought in terms of the cost of development.

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Craig Allen Mailman, KeyBanc Capital Markets Inc., Research Division - Director and Senior Equity Research Analyst [19]

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Okay. So like $60 a foot ex land basically, roughly?

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Maria R. Hawthorne, PS Business Parks, Inc. - President, CEO & Director [20]

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I think cost have gone up. And it is Seattle, so I would target more $100 to $115.

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Craig Allen Mailman, KeyBanc Capital Markets Inc., Research Division - Director and Senior Equity Research Analyst [21]

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Even ex land? Because you guys already have the land, right? So that's just...

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Maria R. Hawthorne, PS Business Parks, Inc. - President, CEO & Director [22]

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That's right. Yes.

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Craig Allen Mailman, KeyBanc Capital Markets Inc., Research Division - Director and Senior Equity Research Analyst [23]

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Okay. But then just one last one for...

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Maria R. Hawthorne, PS Business Parks, Inc. - President, CEO & Director [24]

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And Craig, we're still getting bids, and so -- but that's -- those are good numbers to model. Seattle, a little more expensive, about 20% more expensive than Dallas.

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Craig Allen Mailman, KeyBanc Capital Markets Inc., Research Division - Director and Senior Equity Research Analyst [25]

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Okay. And then just one last one. Anything in the same-store expenses? Cash rents were pretty consistent grower, but expenses were up a bit this quarter.

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Jeffrey D. Hedges, PS Business Parks, Inc. - Executive VP, CFO & Secretary [26]

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Yes. Craig, as we talked about a little bit last quarter, our business is somewhat seasonal and also is impacted by weather patterns or other events that are out of our control. So quarter-to-quarter, there could be little timing differences. We probably benefited a little bit from some timing items in Q2 that came into normalization in Q3. So what I always remind people is while it's important to look at quarterly results for directional indication, it's equally or more important to look at the year-to-date results. And I would say our 9 months ended year-to-date results are a better reflection of how our portfolio is trending from an OpEx perspective.

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Operator [27]

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Our next question will come from Manny Korchman with Citi.

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Emmanuel Korchman, Citigroup Inc, Research Division - VP and Senior Analyst [28]

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Just as we think about the 2 new developments you're starting, are there other places in the portfolio that we should expect announcements of new developments? Or is this kind of it for now?

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Maria R. Hawthorne, PS Business Parks, Inc. - President, CEO & Director [29]

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Manny, that's a good question. And for now, that's it. I mean there is -- there will definitely be opportunities in the future for redevelopment but nothing for 2020.

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Emmanuel Korchman, Citigroup Inc, Research Division - VP and Senior Analyst [30]

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And then JP, on the large leases that you've spoke about in SoCal, are those going to require repositioning assets or a bunch of capital? Or is it just simply trying to match the right tenant with that space there?

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John W. Petersen, PS Business Parks, Inc. - Executive VP & COO [31]

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Well, there's 2. The one at the Hathaway Park spot won't require much capital. That's a 288,000 square foot expiration that's coming up. And the one that we just repositioned, a 52,000 square foot I mentioned, that require more capital. That tenant had been in the building basically for 30 years. And so we had to reposition that building. And now we have it back and we're marketing it, and we're excited about our rent uptick there.

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Emmanuel Korchman, Citigroup Inc, Research Division - VP and Senior Analyst [32]

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So there's no timing delay or capital need from here forward. That's all been done for both those spaces essentially?

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John W. Petersen, PS Business Parks, Inc. - Executive VP & COO [33]

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That's correct.

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Operator [34]

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Our next question will come from Blaine Heck with Wells Fargo.

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Blaine Matthew Heck, Wells Fargo Securities, LLC, Research Division - Senior Equity Analyst [35]

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So just to follow up on the development, how do you guys think about economics? Is there kind of a yield to hurdle that you guys are targeting? Or any other target you use to, I guess, determine whether or not to go ahead with construction?

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Maria R. Hawthorne, PS Business Parks, Inc. - President, CEO & Director [36]

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Yes. Blaine, that's a good question, too. And I can tell you that stabilized returns will probably be at least 200 points higher than what you combine in products these days once it's stabilized.

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Blaine Matthew Heck, Wells Fargo Securities, LLC, Research Division - Senior Equity Analyst [37]

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Okay. That's helpful. And then you guys seem to have several different options for funding between the low cost of debt out there, a potential preferred issuance, your low cost of equity and potential disposition proceeds. So I guess maybe for Jeff, can you just tell us how you're thinking about maybe the relative attractiveness of funding sources for spend on both the development pipeline and potential additional acquisitions out there?

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Jeffrey D. Hedges, PS Business Parks, Inc. - Executive VP, CFO & Secretary [38]

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Yes. Great question. So obviously, we keep a close eye on all the capital markets. And you're right in identifying that all 3, common, preferred and potentially issuing debt are attractive to us right now. So at this point in time, we don't have a funding need that would require us to tap into those markets for new acquisitions or for growth capital. We hope to have something to raise capital around here in the near future. And then at that point in time, we'll assess what the right avenue is for us at that given point in time. What you've heard us say for the last couple of quarters is that even though we historically have not utilized debt, at least not significantly, that is something we will explore potentially. But of course, our cost of common and preferred equity remain attractive to us as well. So we're going to keep a close eye on all of that, and we'll provide guidance on this topic once we have something to actually raise capital around.

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Blaine Matthew Heck, Wells Fargo Securities, LLC, Research Division - Senior Equity Analyst [39]

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Great. That's helpful. And last one maybe for JP, rent spreads have been negative for your office portfolio this year. Do you anticipate those turning positive in the near future? Do you think we'll see negative spreads? And are those negative spreads mostly attributable to the greater DC portfolio? Or are there maybe any other pockets of weakness out there?

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John W. Petersen, PS Business Parks, Inc. - Executive VP & COO [40]

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Yes, Blaine. This is not new for D.C. office, as you well know. So when we assess doing a lease or renewal, and some of them I talked about in my remarks, it's far better for us to do a renewal, especially ones that I mentioned, one of which was a large expansion. So we're really happy with those renewals even though they came with a rent write down. In terms of looking forward, all of the office rent issues are in D.C., not anywhere else because we don't have much office anywhere else for that matter. But I do think we're seeing more strength in D.C., to be honest. We're seeing more activity from government contractors.

One of the expansions I mentioned was a government contractor is, and they're take -- first, they're taking more space and extending term. That's a good sign that we're seeing. So we do have parks where from time to time we can keep rents flat. It's hard to grow when the market's 20% vacant, through our rents, that is. But I do think our goal is start reducing that office rent decline. It's really tough to do in a market again that's 20% vacant. But from time to time and park to park, we do have opportunities in our office portfolio in D.C. to either hold the line on rents as they expire, or occasionally, believe it or not, we can grow rents in some of our parks there. So -- but it really is isolated in D.C. And again, our view on D.C. is we've had a really good view there production-wise. And we're seeing more activity, frankly, in '19 than we have a long time from the sectors that I mentioned, technology, government contractors. We're not seeing anything directly from the Amazon effect. No direct deals from that or anything, so I don't want you to read into that. But the economy is active, unemployment's 3% in DC. The nationals are in the World Series and things are good there, so.

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Operator [41]

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Our next question will come from Eric Frankel with Green Street Advisors.

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Eric Joel Frankel, Green Street Advisors, LLC, Research Division - Senior Analyst [42]

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Can you remind me on the dispositions, what the occupancy was of the portfolio that's sold? I know there was a tenant move out. I wasn't sure if that occurred late in the quarter or earlier in the quarter, so I just wanted to get better sense of the cap rate and what that entails.

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Maria R. Hawthorne, PS Business Parks, Inc. - President, CEO & Director [43]

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Yes. Eric, the big tenant that moved out was about 160,000 square feet, and that did occur in the first quarter. And we were around 80% occupied upon the sale.

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Eric Joel Frankel, Green Street Advisors, LLC, Research Division - Senior Analyst [44]

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Okay. It seems like a pretty negative read-through for overall property guys for that office flex properties in Maryland and Virginia. Can you comment on whether that valuation that we -- that you experienced, is that appropriate to extend to the rest of your portfolio there? Or is there special circumstances that kind of give this portfolio a bit of a discount?

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Maria R. Hawthorne, PS Business Parks, Inc. - President, CEO & Director [45]

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Okay. Yes. There are special circumstances. So first off, it is -- Maryland and Virginia are 2 different markets. We break it out that way. Virginia is a right to work state. It's very pro business. In fact, Montgomery County did a survey on -- and Montgomery County is where we have these assets, did a survey on why Fairfax County was getting more business than Montgomery. And it came out that the issue is pro business, lower taxes. Maryland is a very high tax state, Virginia's a lower tax state. So don't ascribe the Maryland asset sales to Northern Virginia.

Secondly, the portfolio that we sold, when we say flex, this was a large tenant flex that was really 95% built out as commodity office. So -- and the office portfolio in Maryland was larger tenant office than what we have in Northern Virginia. So those -- with the market as well as the type of product, that was the difference. So if you think about like what we bought in Northern Virginia last year, that 1.1 million square foot acquisition, that was pure play industrial, which is seeing rent growth, seeing occupancy growth, and we're very, very happy. And so -- and that should have industrial cap rates on it. But the suburban Maryland office, quite frankly, right now, just has a black eye.

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Eric Joel Frankel, Green Street Advisors, LLC, Research Division - Senior Analyst [46]

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Right. But would you ascribe that the Suburban Virginia office, I understand the fundamental a little bit better there, they're a little bit better business environment. But the occupancy between your 2 portfolios isn't all that different. And the right spread hasn't been all that meaningfully different over time, too. So I'm just wondering how an investor would view cash flow in Northern Virginia office versus -- or flex versus Maryland. I understand last year's purchase and a little bit of the industrial portfolio, it has a different tenant profile and different economic drivers. But it seems obviously that office is heading in one direction and industrial is heading another direction. So I'm just trying to understand it where we should think about valuation?

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Maria R. Hawthorne, PS Business Parks, Inc. - President, CEO & Director [47]

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Yes. Okay. So Eric, a lot of the Virginia office, a lot of it's at The Mile. And we're going to eventually redevelop that entire 45 acres. So we've only redeveloped 5 of it. We're -- and then on the slate, we'll have 2 more phases coming, which will be about another 10, 12 acres. But if you think about that, that will be a redevelopment opportunity. Our other office in -- bigger piece of office in Northern Virginia is Herndon, and that was one of our original park, it has one of our lowest bases. And the Metro literally is being built and is being opened next year across the street. So we feel really good, and that will also be a future redevelopment opportunity. Then we have a big flex office park at Merrifield. And again, down the street, 8th of 1 mile away from the Metro. So our Virginia office portfolio is very well located for future development, has higher occupancy than Maryland, and that's because the demographics and the economic dynamics in Northern Virginia are stronger than suburban Maryland.

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Eric Joel Frankel, Green Street Advisors, LLC, Research Division - Senior Analyst [48]

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Okay. Sounds like Maryland needs to be trailed on, too. My other -- I have a couple other questions, if you don't mind. Just on the development, certainly it makes sense for you to get started on building on some excess land in the market. But why haven't you developed those assets a little bit sooner? Those markets have been in great shape for a few years now.

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Maria R. Hawthorne, PS Business Parks, Inc. - President, CEO & Director [49]

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They have. The -- first off, the space that we're going to be able to build the Seattle office -- or I'm sorry, not office, industrial building, that is currently yard space for the big tenant expiration that JP referenced in an earlier question. So we don't have access to it until that tenant moves out next year. And then quite frankly, the Freeport, our park there is more of a flex park, though not a high finish flex park. And it really hit us. And as we were thinking about it starting last year, we explored the idea of could we build the industrial building? And we can. So we've been working on that, but we didn't want to announce anything until we knew we could build it.

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Eric Joel Frankel, Green Street Advisors, LLC, Research Division - Senior Analyst [50]

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Okay. That's helpful. Final question is related to the acquisition. It seems, obviously, you did -- you haven't disclosed the yield, but certainly, it seems like it has good fundamentals and that market has been in great shape. And I know you're also recycling some proceeds from the Maryland office flex sale. But why not significantly increase your appetite for those types of transactions? It seems like they're out there. I understand that they're not easy to find and it's super competitive, but you guys certainly have a pretty durable competitive advantage in operating small tenant assets. And some of it is in the markets that you traffic in, there's still a fair amount of assets now that are trading. Any -- do you have any appetite for being a little bit more aggressive going forward?

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Maria R. Hawthorne, PS Business Parks, Inc. - President, CEO & Director [51]

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Eric, I would love to come back in February and announce 10 more Hathaways. There would be nothing that would please me more. The problem is, is that while there's been a lot of industrial that's come on the market and some parks, they're in Illinois, Farmland Pennsylvania, lots of stuff for sale in Las Vegas, Reno. And what I would consider secondary market and -- but at cap rates that are now, because of cap rate compression, approaching primary market rates. So those -- that is we're going to pay full retail, it will be in our core market. And quite frankly, it's hard to find these very attractive business parks in our core infill market. And -- but when we see them, as we did with Hathaway, we got very aggressive.

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Operator [52]

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(Operator Instructions) We'll take our next question from Tony Paolone with JPMorgan.

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Anthony Paolone, JP Morgan Chase & Co, Research Division - Senior Analyst [53]

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I guess first question on the development. I think the last development you did was residential and you had a partner. Do you guys have the team and staff to do this? Or do you need to make changes there?

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Maria R. Hawthorne, PS Business Parks, Inc. - President, CEO & Director [54]

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We do, but this -- the thought that we're going to be thinking about redevelopment, not just at The Mile but other locations in the future, we are going to be adding an executive of development to make sure that we have appropriate oversight. We are very happy with our joint venture partner. And the next development, we're going to be working with them again. We're very happy with them, but we realize as we'll continue in the future, we do also need that in-house expertise. Just as a reminder, too, we did also add to our Board a multifamily development expert. So we have that expertise on the Board and, of course, the industrial development we have in-house. I mean that's JP's background, and he's developed millions of square feet of industrial. So we're good there.

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Anthony Paolone, JP Morgan Chase & Co, Research Division - Senior Analyst [55]

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Okay. And then how do we think about then more specifically with G&A, particularly in the quarter, which was a bit higher. How should we kind of roll that as we think ahead?

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Jeffrey D. Hedges, PS Business Parks, Inc. - Executive VP, CFO & Secretary [56]

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So there's nothing to announce. So you shouldn't expect anything with regard to the to-be-named new hire that Maria referenced a minute ago for 2019. We're hoping to have somebody join our team in that role in early to mid-2020, and you could expect a kind of mid-level salary attributable to that person. And you're right in assuming that, that would run through -- that would be a G&A position. Tony, we'll provide -- as that search progresses and we have something to announce, of course, we will make that announcement.

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Anthony Paolone, JP Morgan Chase & Co, Research Division - Senior Analyst [57]

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Okay. And what about just the third quarter you just reported in terms of that number being a bit higher, does that come back down or near term or?

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Jeffrey D. Hedges, PS Business Parks, Inc. - Executive VP, CFO & Secretary [58]

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Yes. So as we try to highlight in the press release, there was what we're trying kind of referring to as a onetime event related to the change in the director retirement share policy. And so for accounting purposes, the stock-based comp expense related to that change was about $1.1 million. And that's a onetime effect. The run rate stock-based comp will be marginally higher attributable for that change, but very de minimis in terms of the run rate effect of that. And that $1.1 million charge is truly a onetime event related to the change. So we expect Q4 to come back in line with what we experienced in the first 6 months of the year.

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Anthony Paolone, JP Morgan Chase & Co, Research Division - Senior Analyst [59]

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Okay. And then for JP, just -- you kind of touched on this number a different way, but I just want to make sure I understand. So the 3 larger expirations in 4Q, one's renewed, but in terms of the other 2, should we anticipate some level of downtime or gaps such that occupancy maybe dips down in 4Q before turning back up? Or how should we think about that just near term?

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John W. Petersen, PS Business Parks, Inc. - Executive VP & COO [60]

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Yes, Tony. So look, what we're trying to do here is secure really good credit for really long terms at really high rents. So we want it all. So yes, there is a chance that there will be some downtime because I think we're at a point in time now in that particular market in Northern California where we can try, and we've been successful, in getting good credit and high rents for long-term leases. So that's what we're trying to do here. As a result, we may not be able to make the deals that we're interested in, so there could be some downtime. My goal is to keep those spaces full. But if we're unable to come to an agreement quickly, yes, we're fine with going forward on the market fundamentals there, and the demand for those tight spaces is very strong. So we could realize some downtime, yes. I hope we don't, but we could, and I'm fine with it if we do. Does that make sense?

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Anthony Paolone, JP Morgan Chase & Co, Research Division - Senior Analyst [61]

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Yes. No, just trying to understand near term since you've had very good occupancy trends, like if we do see that come step back before continuing on. Okay. We'll work that out.

Last question, I guess. And I know Craig, I think, probably tried to ask this 5 ways on the modeling side with Hathaway. But just order of magnitude in terms of thinking about how you're thinking about returns, like if you're going in, in a market return that's probably got a 4 handle on it, like in 3 to 5 years out, for it to be interesting to you, does that need to go to 5? Does it need to go to 8? Like what is an interesting return for you all these days for a core type property in your portfolio?

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Maria R. Hawthorne, PS Business Parks, Inc. - President, CEO & Director [62]

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Well, we always like to get high returns, and we are accustomed to that. But one of the things that happened that I think referenced -- Jeff referenced this in an earlier remark is that interest rates have never been more attractive. They've been attractive for a long time, and we are open to tapping into that. So that allows us to keep historic spreads for our return. But they will be materially lower than what we required in the past, which was in the 7% to 8% range. And for industrial right now in these core markets, we're happy to get a 5.5% to a 6%.

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Anthony Paolone, JP Morgan Chase & Co, Research Division - Senior Analyst [63]

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That's 5.5% to 6% being something a few years out after you kind of stabilized and moved the rents up and that sort of thing?

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Maria R. Hawthorne, PS Business Parks, Inc. - President, CEO & Director [64]

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Exactly.

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Operator [65]

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And there appear to be no further questions at this time, so I turn it back to Jeff for closing remarks.

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Jeffrey D. Hedges, PS Business Parks, Inc. - Executive VP, CFO & Secretary [66]

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All right. Thank you, everyone, and we look forward to seeing many of you at NAREIT in a few weeks. Have a good afternoon.

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Operator [67]

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This does conclude today's program. Thank you for your participation. You may now disconnect.