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Edited Transcript of TIER earnings conference call or presentation 8-Aug-17 3:00pm GMT

Q2 2017 TIER REIT Inc Earnings Call

DALLAS Jun 12, 2019 (Thomson StreetEvents) -- Edited Transcript of TIER REIT Inc earnings conference call or presentation Tuesday, August 8, 2017 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Dallas E. Lucas

TIER REIT, Inc. - President & COO

* Scott W. Fordham

TIER REIT, Inc. - CEO & Director

* Telisa Webb Schelin

TIER REIT, Inc. - Chief Legal Officer, Executive VP & Secretary

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Conference Call Participants

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* Anthony Paolone

JP Morgan Chase & Co, Research Division - Senior Analyst

* Mitchell Bradley Germain

JMP Securities LLC, Research Division - MD and Senior Research Analyst

* Piljung Kim

BMO Capital Markets Equity Research - Senior Real Estate Analyst

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Presentation

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Operator [1]

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Greetings, and welcome to the TIER REIT Second Quarter 2017 Earnings Call. (Operator Instructions) And as a reminder, this conference is being recorded. I would now like to turn the conference over to Telisa Schelin. Thank you, please go ahead.

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Telisa Webb Schelin, TIER REIT, Inc. - Chief Legal Officer, Executive VP & Secretary [2]

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Welcome to the TIER REIT second quarter 2017 earnings call. I'm Telisa Schelin, Chief Legal Officer for the company. Before we begin, please note that statements made during this call that are not historical may be deemed forward looking statements that are subject to risks and uncertainties, which are discussed at length in our annual and quarterly SEC filings. Future events and actual results, financial or otherwise, may differ materially from these forward looking statements, which we assume no obligation to update or revise as a result of new information, future events or otherwise. Additionally, we may refer to certain non GAAP financial measures such as FFO and same store NOI. You can find a reconciliation of these non GAAP financial measures to the most directly comparable GAAP numbers in our earnings release or our quarterly supplemental package on the Investor Relations page of our website at tierreit.com.

I will now turn the call over to Scott Fordham, the President and Chief Executive Officer of TIER REIT.

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Scott W. Fordham, TIER REIT, Inc. - CEO & Director [3]

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Thank you, Telisa. I would like to welcome you to our second quarter 2017 earnings conference call. In addition to Telisa, joining me in the room today are Dallas Lucas, our Chief Financial Officer; Bill Reister, our Chief Investment Officer; Jim Sharp, Head of Capital Markets; and other members of our management team. We are pleased to deliver solid second quarter FFO and strong rent increases on commenced leasing during the quarter. And other than Houston, we are energized by the strength and operating fundamentals that we continue to see in our target markets. Dallas will provide detail on our second quarter results, updated guidance and market specifics later in the call.

We have had a productive year with respect to our strategic plan. We have significantly sharpened our geographic focus, having sold almost $400 million of properties year to date and exited 5 nontarget markets including Philadelphia; Burbank; Washington, D.C; Tampa; and Louisville. While our disposition guidance remains $400 million to $500 million for the year, we are seeing increasing investment appetite in the Houston market and as a result, we are exploring opportunities to take advantage of this investment appetite and potentially reduce our presence in the Houston market. With respect to acquisitions, we have strategically redeployed capital in the best in class operating properties totaling $215 million. This redeployment has allowed us to move capital from properties that did not meet either our quality or locational requirements into the highly desirable Tier 1 submarkets of The Domain in Austin and Legacy Town Center in North Dallas. Specifically, our year to date acquisitions included the purchase of our partner's interest in Domain 2 and Domain 7 in January, followed by our acquisition of Legacy District One in June. The acquisition of the remaining interest in Domain 2 and Domain 7, which collectively totaled 337,000 square feet, solidified our relationship with key tenants and increased our concentration and influence within the Domain. Our acquisition of the 319,000 square foot Legacy District One property offers attractive current yields, with in place net rents approximately 16% below market. Equally important, it allowed us to reunite the property with our adjacent land sites and be in the best position to capture efficiencies and maximize value through future development of those sites, which can accommodate approximately 600,000 square feet of future office space in the highly desired and amenity rich Legacy area of North Dallas. As a result of our disposition and strategic acquisition efforts today, our repositioning is now substantially complete, as we operate in only 7 markets with over 90% of our operating NOI contributed by properties located within our target growth markets.

In addition to our disposition and acquisition activity and as a result of the exceptional strength of the Austin market, we continue to take advantage of build to core development opportunities. We delivered our 98% preleased Domain 8 development project in the second quarter and commenced construction of 2 additional development projects totaling 670,000 square feet in Austin. The first development project is Third + Shoal, a 345,000 square foot, 29 story office tower located in the center of Austin's New Downtown surrounded by some of downtown Austin's best restaurants, entertainment and residences. We commenced construction on Third + Shoal in March, in a strategic partnership with Invesco. And today, we are well underway, with an anticipated Shoal completion date of fall 2018. Interest in the project has been outstanding, with tenants competing for what is limited space within the Austin CBD. The existing competitive Class A vacancy rate remains extremely low at only 6.1% in the CBD, and no other planned project can be delivered within 9 to 12 months following Third + Shoal. We are currently in lease negotiations with several prospective tenants and expect to be able to provide more specifics with respect to leasing activity in the near term.

The second development project is Domain 11, a 324,000 square foot, 16 story office tower within The Domain in Northwest Austin. We announced in June that HomeAway, the world leader in vacation rentals and a division of Expedia, has preleased all of the office space at Domain 11, which will serve as their new global headquarters upon its completion in late 2018, in addition to continuing to occupy their existing space at Domain 2. This news regarding Domain 11 and HomeAway Expedia comes on the heels of Domain 8, which is primarily leased to Amazon and Facebook. The Domain has fully earned its title as Austin’s second downtown but also as the epicenter for some of the nations fastest growing employers, all desiring The Domain's premier live work play environment. As a reminder, TIER REIT owns 15 acres of entitled land in the heart of the amenities at The Domain, which can accommodate approximately 1.1 million square feet of future office space.

We are seeing escalating demand at the Domain and are in discussions with potential tenants for sizable space requirements. We believe superior market conditions and our prudent cost management can drive outsized returns and create substantial additional value from this pipeline. We encourage you to visit Austin and see all of this for yourself. In that regard, we have sent out a save the date notice for an Austin property tour that we are hosting the Monday before November's NAREIT Conference to be held in Dallas.

So in summary, we will continue our disciplined approach to investing. And while additional near term strategic acquisitions are likely to be limited, we believe TIER REIT has a unique opportunity to create significant value through our key land parcels in both Austin and Dallas. And we expect our current and near term activities to highlight how our development yields, accompanied by our highly selective acquisition activity, are positioning the company for outsized future cash flow growth. That concludes my remarks. I'll now turn the call over to Dallas to cover our results from this past quarter, highlight our operating fundamentals in our key markets and provide updated guidance for 2017. Dallas?

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Dallas E. Lucas, TIER REIT, Inc. - President & COO [4]

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Thanks, Scott. And good morning, everyone. FFO attributable to common stockholders, excluding certain items, for the second quarter was $19.8 million or $0.41 per diluted share as compared to $20.7 million or $0.43 per diluted share for the second quarter of 2016. The results were ahead of expectations on property disposition timing and continued portfolio outperformance as well as a $742,000 or approximately $0.02 per share benefit from onetime items included in interest and other income and income taxes. Second quarter same store cash NOI increased by 5.6% compared to the same period in 2016, in line with expectations and primarily due to lower property operating expenses including fewer repair projects and lower bad debt expense. We have updated full year FFO guidance, with NAREIT defined FFO increasing to a range of $1.58 to $1.62 per diluted share and FFO excluding certain items in a range of $1.46 to $1.50 per diluted share based on weighted average shares outstanding of 47.7 million.

Our guidance outlook included in last night's press release reflects management's view of current and future market conditions and certain assumptions. In addition to our better than expected second quarter results, the key assumptions change leading to our increase guidance at the midpoint is higher estimated same store results due to improving portfolio performance including diminishing near term downsized leasing risk in Houston. Further, we are still on pace for continued improvement in dividend coverage during 2017.

Turning to our operating results. At quarter end, our operating portfolio occupancy was 88.5%, which represents a 170 basis point decrease from March 31, primarily as a result of the known 110,000 square feet vacated by BP Amoco at our Eldridge Place Property in Houston, the impact of which will be fully recognized in our third and fourth quarter operating results. Outside of Houston, leasing fundamentals remain solid in our target markets. Looking ahead, we have 139,000 square feet of space expiring across the portfolio for the remainder of 2017. Of this amount, we anticipate approximately 55% to be renewed or relet, resulting in a slight decline in our operating portfolio occupancy before rebounding in the fourth quarter of 2017 through forecasted leasing activity on currently vacant space.

Now, I'd like to offer some additional color on the leasing environment within several of our principal markets. Houston's overall Class A vacancy rate increased to 24% at June 30. Sublease inventory continued to decrease during the quarter, although levels remained elevated at approximately 11.1 million square feet. At this point, the new construction pipeline appears to be winding down, with only 2.4 million square feet of active projects that are approximately 45% preleased. We have minimum lease expirations through 2018 and continue to see an uptick in perspective leasing activity in Houston, particularly our Loop Central and BriarLake Plaza properties. While tenant activity is gaining some momentum, the time to complete leases in this market is still protracted, and thus we are not projecting any significant occupancy gains in our Houston portfolio over the next few quarters. However, as Scott mentioned, given the momentum building in the office sales market, together with recent pricing metrics, we are actively exploring opportunities to capitalize on this environment through potential sales of certain of our Houston properties.

Turning north, Dallas' Class A vacancy rate decreased slightly during the quarter to 17.5%, while Class A rental rates have continued to increase, rising 0.6% in the quarter. Construction activity declined in the quarter, with 8.9 million square feet under development of which approximately 69% is preleased. Of note, the $2.1 million square foot Toyota campus in the Legacy area began opening during the quarter and will soon be followed by approximately 2.5 million square feet of additional corporate campuses to be occupied by J.P. Morgan and Liberty Mutual. In all, 14,000 new employees will occupy this corporate office space in the Legacy submarket where our Legacy district properties are located. And in Charlotte, the CBD Class A vacancy rate at the end of the quarter decreased to 8.7%, while Class A rental rates continued to increase, rising 2.7% in the quarter. There is 1.5 million square feet currently under construction in the CBD, of which approximately 61% is preleased. As we previously announced, at our BofA Plaza property we have extended 295,000 square feet of the 379,000 square feet that was set to expire in 2019 for 21 months through the end of 2020 at rates 12% higher than the expiring rate. Further, we will recapture 84,000 square feet of space from the tenant in 2019 with the opportunity to re lease at market rates that are currently 45% higher than the expiring rate. As of June 30, BofA Plaza was approximately 96% leased, with little expiring space until the end of 2020.

Finally, Austin's citywide Class A vacancy rate decreased slightly to 9.7% at June 30, while Class A rental rates remained steady across the market. Office space under development in Austin, including our Domain 11 and Third + Shoal projects, sits at 2.3 million square feet that is currently 38% preleased, while leasing conditions remain robust. As an example, we have 87,000 square feet of combined space expiring at our Domain 3 and Domain 4 properties over the next 6 months, of which 35,000 square feet has been leased and 52,000 square feet is in lease negotiations, all at rates that are approximately 20% higher than the expiring rate. Additionally, the strength of the market is allowing us to push our asking rates throughout our Austin portfolio.

Turning to our balance sheet. During the quarter, we repaid the $80 million loan secured by our Domain 2 and 7 properties and now have no significant debt maturities until the end of 2019. That concludes our prepared remarks. Operator, we will now take questions from our sell side analysts.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of John Kim with BMO.

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Piljung Kim, BMO Capital Markets Equity Research - Senior Real Estate Analyst [2]

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So it sounds like with the Legacy District One acquisition and the development starts that you've announced, that acquisitions are pretty much off the table in the near term. Is that the correct way to read your results?

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Scott W. Fordham, TIER REIT, Inc. - CEO & Director [3]

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John, the guidance that we set out there for acquisitions for 2017 is $215 million, and we've achieved that at this point in time. We're seeing very limited acquisitions that we may think makes sense from a strategic perspective. So I think our real opportunity as we think about going forward is in our development pipeline.

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Piljung Kim, BMO Capital Markets Equity Research - Senior Real Estate Analyst [4]

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Okay. So what about proceeds if and when you do sell either one of your Houston assets or some of your noncore assets? Would that be used to fund the development pipeline? Or would you open the book back up for acquisitions?

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Scott W. Fordham, TIER REIT, Inc. - CEO & Director [5]

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Yes, as we think about it, first of all, we are continuing to work on the balance sheet. So some of the proceeds would go to continued deleveraging. Second of all, the proceeds we do think are best used in the development pipeline at this point in time. To the extent we get out there and we sell more than we anticipate right now because the pricing makes sense, it also could provide us the opportunity to redeploy capital across our target markets and help balance the portfolio and the NOI that comes from each market.

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Piljung Kim, BMO Capital Markets Equity Research - Senior Real Estate Analyst [6]

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I may have missed this, but what is the timing as far as moving forward with developments at Legacy? And also, that 600,000 square feet is that all office? Or is there other potential uses like retail or entertainment?

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Scott W. Fordham, TIER REIT, Inc. - CEO & Director [7]

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Yes, so in terms of Legacy, at this point, we are looking for preleasing opportunities. So that's both in the Domain as well as Legacy. So there's no set timing at this point. We are out there, ready to go. The buildings are designed, and we're marketing the projects. And so at this point in time, we're just looking for the appropriate amount of preleasing.

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Piljung Kim, BMO Capital Markets Equity Research - Senior Real Estate Analyst [8]

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Okay, and then can you also clarify at Legacy District One your rents are, I think you said, 13% or so below market. But can you remind us when the leases expire or how you realize market rents of that asset?

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Scott W. Fordham, TIER REIT, Inc. - CEO & Director [9]

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Yes, so in that particular asset, first and foremost, we looked at that asset as very complementary to our development sites. And we think it helps us optimize the value on those developments. The in place rents today are just under mid 20s on a triple net basis. I think we look at those as being about 16% below market on a triple net basis. So as we think about the projects and developing out, I think we are looking at low 30s at this point in time as we think about building out to 600,000 square feet. And that 600,000 square feet is all office.

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Operator [10]

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Our next question comes from the line of Mitch Germain with JMP.

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Mitchell Bradley Germain, JMP Securities LLC, Research Division - MD and Senior Research Analyst [11]

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I'm just curious the space that you get back from Bank of America where is that located within the buildings stack?

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Dallas E. Lucas, TIER REIT, Inc. - President & COO [12]

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This is Dallas. It's the lower half of the building.

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Mitchell Bradley Germain, JMP Securities LLC, Research Division - MD and Senior Research Analyst [13]

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And so is the mark to market potential on the lower half as significant as you could get on the upper floors? Is that dynamic existing in the go ahead.

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Dallas E. Lucas, TIER REIT, Inc. - President & COO [14]

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Yes, actually to clarify, it's the top 4 floors of their space, which they occupied pretty much the lower half of the building. So maybe you could see a $0.50 to $1 variance to mid upper floors but not substantially.

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Mitchell Bradley Germain, JMP Securities LLC, Research Division - MD and Senior Research Analyst [15]

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And the increase...

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Scott W. Fordham, TIER REIT, Inc. - CEO & Director [16]

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I'm talking recent leases are based on (inaudible).

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Mitchell Bradley Germain, JMP Securities LLC, Research Division - MD and Senior Research Analyst [17]

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Got you. And the increase in the property guidance, I guess, maybe just the cadence of occupancy you indicated a bit lower third quarter, higher in the fourth quarter. I'm curious, is the fourth quarter leases committed? Or is that just based on the conversations that you're having with customers right now?

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Dallas E. Lucas, TIER REIT, Inc. - President & COO [18]

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Some of that will commence later in the third quarter and fourth quarter and some that we're in discussions with.

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Mitchell Bradley Germain, JMP Securities LLC, Research Division - MD and Senior Research Analyst [19]

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And then maybe Dallas, could you just provide some perspective about some of the backfill opportunities that you've got at in Houston?

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Dallas E. Lucas, TIER REIT, Inc. - President & COO [20]

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Well, we've got a fair amount of vacancy at Eldridge now. So we are focused on trying to lease up all across our portfolio. But Loop Central is where we're seeing the vast amount of activity. But we're about mid 80% level leased rate at that project right now but still seeing a fair amount of activity across the board. BriarLake, as we inferred in the transcript, we are seeing a lot of increased activity, tenant perspective tenant activity, in that project. But as I mentioned in the transcript, it's taken a while to get at least over the finish line. So we do feel much more optimistic than we did at the beginning of the year, but it's going to take a little while for full traction to hit the market.

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Mitchell Bradley Germain, JMP Securities LLC, Research Division - MD and Senior Research Analyst [21]

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Got you. And then last one for me. I guess, Scott, you mentioned the potential for further development, obviously, based upon preleasing success. So is there a willingness if you can get a lease structured to start something right away? Or would it really be matched against your ability to sell properties as well?

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Scott W. Fordham, TIER REIT, Inc. - CEO & Director [22]

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At this point in time, we feel pretty good about the balance sheet and have the capacity certainly to develop out what we've got in the pipeline as well as another development project. But we are in the market with several assets, which we think will yield proceeds. Right now, when we think about the perspective possible tenants, we're seeing a lot of activity not only around the projects that we've got in the works right now with Third + Shoal but also the potential projects certainly in The Domain. I think you've been down there, and you've seen that it's a pretty exciting place at this point in time. And I think the tenants are thinking about the land sites that are remaining and their ability to take advantage of that. And so we'll see. Nothing to report at this point in time. But we're going to continue to move in that direction and make sure we're ready to develop when the time's right.

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Operator [23]

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(Operator Instructions) Our next question comes from the line of Anthony Paolone with JPMorgan.

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Anthony Paolone, JP Morgan Chase & Co, Research Division - Senior Analyst [24]

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First question on Domain 8. With that being pretty well leased, is there a certain point at which that your partner puts that stake up for sale, it becomes similar to Domain 2 and 7? Or what do you think happens there?

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Scott W. Fordham, TIER REIT, Inc. - CEO & Director [25]

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We do think at some point that our partner will want to sell their interest in that project. We obviously see the advantage of being the owner of that project, kind of like Domain 2 and 7 where it really gave us that heightening relationship with the tenants that we're in Domain 2 and 7. So we can certainly see that, but at this point in time, there's no details on that particular deal.

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Anthony Paolone, JP Morgan Chase & Co, Research Division - Senior Analyst [26]

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Okay. And then you also have in Domain the ability to do some multifamily. Any thoughts on whether it makes sense to go down that path sooner or later?

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Scott W. Fordham, TIER REIT, Inc. - CEO & Director [27]

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In terms of the multifamily, I think, first of all, we're not multifamily guys. So if we ever felt like that it was the best use of the property, we would certainly have to team up with somebody that that's their expertise. At this point in time, there's nothing slated for that. The land that we've got right now at this point in time we think the highest and best use is office.

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Dallas E. Lucas, TIER REIT, Inc. - President & COO [28]

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And Tony, as Scott mentioned in his transcript comments, we are seeing a lot of prospective tenant activity in the office side. So right now, that's definitely is the highest and best use.

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Anthony Paolone, JP Morgan Chase & Co, Research Division - Senior Analyst [29]

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Okay. And then in terms of next 12 months expirations in Austin, sorry if I missed that, did you lay out where those are or what the mark to market look like?

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Scott W. Fordham, TIER REIT, Inc. - CEO & Director [30]

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Yes, so I'll comment and then let Dallas add a little bit more detail. But over the next 12 months, we talked a little bit about some of the expirations out in the Domain and how a lot of that is put to bed at this point in time or very close to being put bed. I think we're looking at about 20% mark to market on those particular projects. So that's where most of it comes from. Then we do have a little bit in The Terrace as well.

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Anthony Paolone, JP Morgan Chase & Co, Research Division - Senior Analyst [31]

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Okay. And then just last question. With so much activity in your portfolio geared toward Dallas and Austin, where do you think the overall portfolio split looks? What does that look like? And what does that look like in 2, 3 years time? Because you've got more target markets than just Dallas and Austin and Charlotte, for that matter. But it seems like so much of the activity is skewed to Austin and Dallas. Like where do you think that goes?

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Scott W. Fordham, TIER REIT, Inc. - CEO & Director [32]

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Well, there's certainly the opportunities to grow in both Austin and Dallas. And I think that there's also the opportunity to recycle out of properties where we believe we've reached optimal value or will real reach optimal value over that time period. And so what we would look to do over the next 2 to 3 years is continue to balance the portfolio, with the goal of ultimately being about 20% in each market or not having more than 20% of our NOI come from any one market. So we are certainly thoughtful about that, and obviously if we get out there and we're successful on selling some of Houston, that would bring Houston down.

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Operator [33]

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This concludes our question and answer session. I'd like to turn the floor back to Scott Fordham for closing comments.

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Scott W. Fordham, TIER REIT, Inc. - CEO & Director [34]

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Great. Thank you, again for joining us this morning, and we look forward to getting back on the phone with you soon.

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Operator [35]

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This concludes today's teleconference. You may disconnect your lines at this time. And thank you for your participation.