Brandywine Realty Trust

Ladies and gentlemen, thank you for standing by and welcome to the Brandywine Realty Trust fourth quarter 2019 earnings call. At this time, all participants' lines are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star then one on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star then zero. I would now like to hand the conference over to your speaker today, Mr. Jerry Sweeney, President and CEO. Sir, you may begin.

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 four 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 gap mark-to-market, tenant retention, and achieved many of our other targets, including ending the year at 95.5% least. 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 $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 was 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 rank growth and cash rank 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 aggregated about $51 million in sales. We were a minority partner, and we recorded an $8 million gain in exit at those properties. Also during October, we completed a full building lease for our redevelopment property in the Pennsylvania suburbs. This 13-year lease rate was very much in line with our target at rent levels, The lease, however, was five years longer than anticipated, so it required more upfront capital. So our going in initial cash yield was in the 8% range versus our earlier target, but we picked up five 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. 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 sub, 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 stage of lease negotiations. As we outlined on page 10 and 11 of our SIP, we expect both the greater Philadelphia and Austin markets to remain strong during the year and generating good activity at building pipeline and good leasing levels. Looking at it, Austin continues to ride the growth wave from corporate attraction efforts and in-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 of 2019. Philadelphia also experienced about 500,000 square feet of absorption over the last year. The 12-feet class vacancy rate went down to 5%, among the lowest of the top five largest MSAs. Philadelphia has grown jobs over the last year, a 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 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 a 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 match our pro forma rates. and represented about a 15% increase over the expiring rent. Our 2020 business plan projects will lease an additional 125,000 square feet 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 the fully loaded basis. The 20 operating plan is also headlined by two metrics that we think demonstrate excellent earnings potential. Our cash mark-to-market range is between 8% and 10%, and our gap 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 gap 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 plan by 8%. Also, from an earnings acceleration standpoint, the major 2020 rollovers do create significant upside in 2021 and 2022. SHI, for example, in Austin is a 20% cash and a 28% gap mark to market. Macquarie in Philadelphia is an 18% cash and 22% gap. And Reliance, again, in Philadelphia is a 20% cash and a 24% gap mark to market. We do expect our gap 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 DC and Austin will be negative due to the KPMG and the SHI move-outs. 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 quick words on major vacancies. I've already chatted about 1676. Essentially there we have 125,000 square feet to lease up and need to generate $1.7 million of gap revenue in the latter half of the year. SHI, We have about $2.7 million of gap revenue from the 184,000 square foot roll. Cash mark to market is over 19%. Eighty percent 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 gap 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, if of interest, 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, 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 and Four Points in Austin, 650 Park and 155 King of Pressure Road in Pennsylvania. So we are in a full go position on all four of those projects. And as we noted last quarter, these assets can be completed within four to six quarters. They will cost between $40 and $70 million. So the aggregate investment in those four 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 of these projects, we have a combined prospect list of 1.8 million square feet. So they're ready to go, and we do have, as Tom will touch on, two development starts built into our 2020 plan. A quick observation on a couple of our existing developments. 405 Colorado in downtown Austin is on track for a year-end 20 completion. We're 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 SUP, we did provide more information. To highlight a few points, our full master plan approvals are now in place. That's two 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 two 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 both of those projects of 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 if we can get them into 3,000 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 SUP, we can do 2.7 million square feet and 855 apartments with the existing buildings that are substantially to IBM and a couple other tenants in place. We're into full planning and costing on three blocks as detailed in the SUP. Blocks A and F will be in a position to start by mid-year 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 a 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 in incremental spend projected on our two development starts. As we've indicated previously, to finance these opportunities, we will be consistent with what I just mentioned, evaluating well-timed 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're 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 financial results.

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. One highlight is our operating expenses did benefit from lower tenant reserves, while our G&A was negatively impacted by some one-time 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 gap at OI 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 6.1, and at the lower end of our 6.0 to 6.3 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 the land parcel in Radner, Pennsylvania, which we anticipate will close during this quarter, and sales proceeds from the joint venture interests 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 a million dollars, 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 FFL contribution is estimated to be about $9.5 million. G&A, our fourth quarter G&A, will increase from $6.9 million 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 1st. This mortgage approximates $80 million at just under a 4% rate. Termination fee and other income, we continue to anticipate termination of the 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 we'll approximate $8 million for the year. Land sales and tax provision, we expect to net to zero, 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 Crusher Road for $20 million, and an additional land parcel at Raptor, 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 releasing space at $1676 million. is going to generate revenue-maintained capital of a dime 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, $7 million, $90 million of debt payoffs, which I mentioned earlier, for the mortgages, the acquisition of 250 Kingwood Pressure 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 the $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 IPEDA will range between 6-1 and 6-3, with the main variable being timing and scope of our development activities. In addition, our 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 Jared. Great, Tom.

Thank you very much. With that, we are delighted to open up the floor for questions. As we always do, we ask that in the interest of time, you limit yourself to one question and a follow-up. Crystal?

Thank you. Ladies and gentlemen, if you have a question at this time, please press the star followed by the number one key on your touchtone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. Once again, to ask a question, please press star and then one now. And our first question comes from James Feldman from Bank of America. Your line is open.

Great. Thank you and good morning. I just wanted to start with just kind of the financing side. So Two 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 in 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?

Jamie, thanks for the question. On the joint venture side, 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 a 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 in there, 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 quarters. And again, if you think about the comments Tom and I made, you know, 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 have finalized 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've been indicating we do think that one of the sources of capital for these production-level assets are going to be some of the smaller asset sales, and we do believe in our plan that 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, and we expect that to continue as well.

Great. Thank you. I guess just to follow up, so it sounds like Sucliard 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?

Well, I think so, but please give us latitude as some of these discussions involve. I think our focus at Schuylkill Yards is quite candidly on the first two buildings, and I think we're talking to a couple 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 – of expressions of interest and advanced discussions on how that will ultimately lay out, whether it's an institutional partner that helps us on the residential side or the mixed use side or some of the retail and infrastructure developments.

Okay. All right. Thank you.

You're welcome.

Thank you. Our next question comes from Craig Mailman from KeyBank Capital Market. Your line is open.

Hey, guys. I'm going to circle back on the occupancy piece. Back in October, you guys seemed pretty confident you were going to hit the target for the year. And I know, Jerry, you mentioned kind of construction delays and a 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. Sure.

Yeah, I'm not sure I would categorize a big miss by any stretch, but George, let me defer to you and kind of walk through some of the detail there.

Yeah, we really kind of had three 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, you know, the space that we got back and, you know, have incorporated into our plan to re-let in 2020. The other two components really were tenants not substantially completing their tenant fit work. These are conditions where the tenant's 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 three pieces. Yeah, I mean, just to add on to George's observation on the tenant-directed fit-out, 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, quote-unquote, ready for its intended use, we cannot recognize revenue. So, you know, we've had this a number of quarters, where from our perspective, the lease is signed, the tenant is either in a 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. 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 the lease commencement so that we know that any of their delay 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 that does not occur.

And what industry was the bankrupt tenant in Austin in?

They were a small mortgage company. mortgage lender.

And then just on the Macquarie and Reliance space, is there any update there on progress and backfilling?

Yeah, Greg, it's George again. You know, 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 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, you know, what the opportunities are. And, again, we don't get that space back from Reliance until 12-31 of 2020.

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 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... 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 on the larger floor plates, we'll be pre-building some spaces, including putting some furniture in there to try and accelerate the potential occupancy dates of those floors.

Gotcha. 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?

No, no, no. I wouldn't say that pricing is an issue at all. Thank you. You're welcome.

Thank you. Our next question comes from Jason Green from Evercore. Your line is open.

Good morning. 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. I 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 to 150,000 or greater square foot tenants that we should be thinking about and modeling in 2021 and 2022 that are likely to move out?

Well, at this point, we think we're going to have a major rollout down in northern Virginia with Northrop Grumman. And I think, George, we're up on a couple of other ones. Most of them are all set, but we do have a few more variables.

Yeah, a 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 Raynol, and then Reliance was the other. I mean, that's really the inventory of kind of the, you know, six-figure square footage type tenants.

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.

It should say Opportunity Zones. Yeah, if we change the bullet. No, actually, Jason, it's the fourth bullet down under Overview. Okay. Yeah, so it's still there. Yeah, it's still a federal opportunity zone. Look, I will tell you, a number of the equity partners that we initially talked to on scuba yards were very interested in the federal opportunity zone. 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 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 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 university is 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 Sierra Center with Spark Therapeutics, the main post office building, FMC Tower, et cetera. So I think we've resonated well from both the Federal Opportunity Zone standpoint, but also and probably more importantly that the execution level in the real estate has gone very well.

Got it. Thank you very much.

You're welcome.

Thank you. Our next question comes from Manny Corkman from Citi. Your line is open. And we're going to take our next question from Amateo Apisano from Mizuho. Your line is open.

Yes, good morning, everyone. Good morning. Good morning, Derek. 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 say 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 a competing product?

Yeah, excellent question. And we certainly attract that development. And I think two 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 these 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, 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, you know, we compete against everybody. And we'll be challenged to present, you know, Schuylkill Yards as a preferred location for and efficiency module compared to any other location within the regional marketplace. 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. We talked about the conversion of 3,000 markets. That's really been totally focused and driven by the fact that our leasing team is seeing a tremendous number of emerging light science companies with good financial sponsorship and great research capacity who kind of have a short timeline to actually start to plant a flag. And we thought that the 3,000 market could provide an excellent opportunity to capture some of that near-term demand and 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.

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

That expires January. January of 21. And on that building, we have plans underway to – do one of two things, either significantly renovate it or sell or join Ventra. So we're pretty far along in the thought process there. Okay.

Thank you. Our next question comes from Daniel Ismail from Green Street Advisors. Your line is open.

Great. Good morning. 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?

Yeah, I think when we 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 chair shuffling. So I think we feel pretty good about the kind of region-wide and northeast corridor 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.

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

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

Oh, sorry. Yeah, I was referring to densification, and the trend that we've seen this cycle has been that tenants have densified, call it 20% or so, into their space. Do you think that trend still has some more legs to go, or do you think we're mostly going through that trend?

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 due to the tight labor market, focus on employee culture and talent attraction. The really well-appointed buildings with the full amenity packages like we have tend to ride to the top of the prospect list. So we do think that, you know, that evaluation of efficiency of space design 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 have been reevaluated upward. The initial push was to densify down to 100 to 125, et cetera, 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 you'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 even on our development projects, you know, we're seeing a pretty stable outlook on how many square feet per employee tenants will have. In fact, in a number of discussions, you know, we're really driving a little bit away from, you know, 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.

That's helpful. Thanks.

Thank you. Our next question comes from Manny Corkman from Citi. Your line is open.

I think that's better. Sorry about that. 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 the capital source first to make those projects sort of live?

Okay, Manny, very much a dual tracking. In fact, I mean, you know, marketing is usually the tip of the spear. So we, you know, that's why we amplified during the commentary. I mean, you know, 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 deep 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 the cost of delivery will be. So whether it was on projects like GARS or Four Points or the suburban properties in Philadelphia or Schuylkill Yards or Broadmoor, You know, mission critical was getting everything framed out. We've done that. The marketing process on every one of those projects, i.e., the four production assets and the Schuylkill Yards and Broadmoor, all those marketing efforts have been launched. We've got big prospects going, discussions going on, as I mentioned, a prospect pipeline of development on the production assets of almost 1.8 million square feet. So... Our perspective, 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've mitigated some of the lease-up risk by the pipeline because that facilitates a much more constructive discussion with the financing sources.

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

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

Thanks, guys. Thank you.

Thank you. And we do have a follow-up question from James Feldman from Bank of America. Your line is open.

Great. Thank you. I just wanted to follow up on your comments on Northrop. So can you just talk about the building? I think looking at your top tenants list, it's like a number eight tenant. Are they moving out of that entire space? I just think we want more color on exactly the story there.

Yeah, they do plan on vacating the building, which we think they've been there about 15 years. It's a great project in our Dulles Corner development, and we fully expect to have a very successful renovation or a successful sale there. So we're going to take one of those two paths as we look forward to 21. When do they expire exactly? The end of the year. January of 21. Yeah, January of 21.

January of 21. Okay. And it's 250,000 square feet? Right. Correct. And do you have, like, are you in any talks, early talks with anyone else to backfill it? Or do you think a sale is more likely? How are you guys thinking about it?

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've had renovation plans pulled together in price for the building, which are very exciting. But we also want to evaluate what the best financial outcome for Brandywine is as well.

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

They're marked in markets north of 20%. Okay.

All right. And then it looks like as you look at your kind of speculative development or speculative leasing pipeline, it looks like DC is kind of lagging the other markets. Can you just talk about what's in that number? Is it like a couple large leases that you needed? Maybe that's why. Is it chunkier or is DC just kind of slower than some of these other markets? I know it's slower, but slower than you thought.

No, I think as Jerry outlined, you know, 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 in the other buildings that we have in Tyson's at 8260 Greensboro and 8521 Leesburg Pike. So...

So is there anything that's kind of fallen out of bed since you made your first outlook, or everything is kind of going as expected?

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

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

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 – We're seeing tremendous pipeline of deals in our Garza development down in 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 seem very good. So, you know, our four points development kind of up in the northwest, that's the one 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.

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

Yeah, look, I think from, you know, if you take a look at the, you know, Northern Virginia market, you know, posted 4 million square feet of absorption. You know, one of the best years they've had since, I think, 2006, with, you know, kind of a pretty strong tech and cybersecurity demand. Seventy-one percent of the job growth in the Met DC area kind of floated into northern Virginia. So we're actually, we're seeing rents being pushed on the new development projects, which is great. You know, that's one of the things when we take a look at it 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. You know, with the JEDI contract, I mean, between Microsoft and Amazon Web Search, we're looking for more space in the market. You've seen a number of other major tenants kind of focus on the toll road quarter. I think anecdotally, you know, what we're seeing, Jamie, even with the redevelopment of 1676, is a lot of big requirements. I mean, I think we've got proposals out. The number of proposals we have out 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 and the concession packs I think still remains to be seen. But the little window we have in through 1676 is, Our pro forma rent targets are being met. We're keeping our capital costs right in line with our projections, and we anticipate being able to drive that to, as I mentioned earlier, a 9% return on cost.

Does this motivate you to get bigger there? I know you just did a big fail there to shrink, but do you feel like the market changed if you've made that call?

No, I think we're happy with our platform right down there now. I think we continue to talk to... you know, 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 Rock Point joint venture efficiently and profitably, solve the 1676 absorption pace for 2020, and really, you know, as we get that done, take a look and see what we plan on doing for future years.

Okay. All right. Thank you.

Thank you.

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

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.

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.