Digital Realty Trust, Inc. (DLR) Q1 2008 Earnings Report, Transcript and Summary

Good afternoon ladies and gentlemen and thank you for standing by. Welcome to the Digital Realty Trust's First Quarter 2008 Earnings Conference Call. During today’s presentation all parties will be in a listen-only mode. Following the presentation the conference will be open for questions. (Operator Instructions). This conference call is being recorded today Thursday, May 8, 2008. I would now like to turn the conference over to Pamela Matthews, Director of Investor Relations. Please go ahead ma'am. Pamela Matthews – Director of Investor Relations: Thank you and good morning and afternoon to everyone. By now you should all have received a copy of the Digital Realty Trust earnings press release. If not, you can access one in the investor relations section of Digital's website at www.digitalrealtytrust.com or you may call 415-738-6500 to request a copy. Before we begin I would like to remind everyone that the management of Digital Realty Trust may make forward-looking statements on this call that are based on current expectations, forecasts and assumptions that involve risks and uncertainties that could cause actual outcomes and results to differ materially from expectations. You can identify forward-looking statements by the use of forward-looking terminology such as believes, expects, may, will, should or similar words or phrases. You can also identify forward-looking statements by discussions of future events or trends or discussions that do not relate solely to historical matters, including statements related to the market trends and conditions, pricing trends, the amount and timing of redevelopment space to be delivered, the timing of lease commencements, the future demand for Datacenter space, and drivers of that demand, the ability to raise additional debt and equity capital, the company’s liquidity including future debt availability and capacity, and the company’s future financial results for 2008 including projected FFO per share and unit, the signing and commencement of leases, federal rates, 2008 acquisitions and acquisition cap rates, the acquisition mix between vacant properties and income producing properties, total capital expenditures and general and administrative expenses. For a further discussion of the risks and uncertainties related to our business, see the report and other filings by the company with the United States Securities and Exchange Commission including the company’s annual report on Form 10-K for the year ended December 31, 2007 and subsequent filings with the SEC. The company disclaims any intention or obligation to update or revise any forward-looking statements whether as a result of new information, future events or otherwise. Additionally, this call will contain non-GAAP financial information including Funds From Operations or FFO, Adjusted Funds From Operations or AFFO and Earnings Before Interest Taxes Depreciation and Amortization or EBITDA. Digital Realty Trust is providing this information as a supplement to information prepared in accordance with generally accepted accounting principles. Explanations of such non-GAAP items and reconciliations to net income are contained in the company’s supplemental operating and financial data for the first quarter of 2008 furnished to the Securities and Exchange Commission and this information is available on the company’s website at www.digitalrealytrust.com. Now I’d like to introduce Michael Foust, CEO and Bill Stein, CFO and Chief Investment Officer. Following management’s brief remarks, we will open the call to your questions. To manage the call in a timely manner, questions will be limited to two per caller. If you have additional questions, please feel free to return to the queue. I will now turn the call over to Mike. Mike Foust – Chief Executive Officer: Great, thank you Pamela. Welcome to the call everyone. I’ll begin with a brief overview of Digital Realty Trust, then I will overview our significant first quarter 2008 accomplishments and we'll conclude with a discussion of new research data about a number of emerging Datacenter trends from the survey we recently commissioned. Following my remarks, Bill Stein will address our financial performance and our revised guidance for 2008. First a brief introduction, Digital Realty Trust is the leading owner and manager of technology real estate. Our portfolio currently contains 71 properties containing 12.7 million rentable square feet, excluding one property, the Westin Building in Seattle that’s held as an investment in an unconsolidated joint venture. Our properties are located in 26 metro areas across North America and Europe. The portfolio now includes approximately 1.9 million square feet of space held for redevelopment, a very important source of growth for the company. DLR provides a variety of Datacenter facility solutions including turnkey facilities, Powered Base Building, and Build-to-Suit Datacenters for domestic and international corporate customers. Our properties serve a wide range of industry vertical markets including information technology, internet enterprises, financial services, telecom network providers, energy companies, and other Fortune 1000 firms. Now I will detail highlights from Digital portfolio operations during the quarter. Our team turned in another very successful quarter on all fronts, leasing, operations, acquisitions, and finance. Based on that success, we are raising earnings guidance for the year as Bill will discuss in detail. In addition, market trends and conditions are very favorable for customers demand and Datacenter supply in our major markets. Portfolio occupancy excluding space held for redevelopment held steady at 94.7% at the end of the first quarter, the same as the previous quarter and compared to 94.8% at same period in 2007. Note that total lease space actually increased in the quarter, and newly completed vacant turnkey space were approximately 98,000 feet we’ve added to the portfolio from the redevelopment inventory. During the quarter leases commenced on approximately 334,800 square feet space. This includes 256,200 square feet updated of turnkey datacenter space leasing an average annual GAAP rental rate of $119.25 per square foot, and also includes 46,300 square feet of powered base building space that was leased at an average annual GAAP rental rate of $52.42 per square foot and 32,300 square feet of non technical space leasing an average annual GAAP rental rate of $19.31 per square foot. In addition we signed the leases during the quarter totaling 260,200 square feet of space, consisting about 106,400 square feet of turnkey datacenter space leasing an average annual GAAP rental rate of up $100.05 per square foot. Nearly 120,000 square feet power base building space in average annual GAAP rental rate $67.60 per square foot, and 33,800 square feet of non-technical space that was leased an average annual GAAP rental rate of $25.93 per square foot. We expect lease rate to fluctuate somewhat quarter-by-quarter due to varying rates with different products and different markets. In particular, in the first quarter, a unique and highly accretive transaction in already occupied space were the average lease weight for turnkey space on the previous quarter. Excluding this transaction, the average turnkey rate would be above a $114 per square foot. Overall, we continue to see very attractive pricing product half market by the strong demand for our new turnkey and powered base building products. Turning to our development and redevelopment program, we currently are underway on construction projects and high demand markets in the US and Europe that will add approximately 5 47,000 rentable square feet of additional datacenter to our operating portfolio. We expect the space come online through the first quarter of 2009. Of this space, approximately 330,000 of turnkey data center, and 217,000 square feet of built to suit datacenter facilities. Overall we are pleased that our leasing and product delivery program are on track to contribute for improved 2008 results, as reflected in our increased guidance. Tuning now to our acquisitions program. In February we acquired 365 Randolphville road a 265,000 square feet redevelopment project located in Piscataway, New Jersey, next towards our 3 Corporate Place facility. This new property is capable of supporting the development of up to 150,000 square feet of improved data center space, bringing new [more] product to a market experiencing strong demand. We plan to make base building improvements and upgrades to the power with plans for an initial build out of two turnkey data centers, totaling about 20,000 square feet of raised floor in building. Our key initiative for Digital Realty Trust has been to gather research and the annualized market trends for data center demand and that continues to be significantly underserved by independent research. In response again this year we commissioned our own research data focused on the current demand for data centers in US, including immediate and longer term growth prospects. Consistent with last years study the survey was conducted in March 2008 by compos research and analysis, and examine critical issue such as power cooling, space requirement in the drivers of in facility expansion. The metrics reported in the results are drive from web based service of over 150 IT decision makers in a wide range of large corporations in North America with revenues of at least $1 billion or at least 5000 employees. All survey participants are involved in the process of managing corporate Datacenters, implementing new facilities, or expanding existing Datacenters and our senior level executives including C level management in MIS and finance. The result did not only confirm our understanding of today's market trends but more importantly provides specific data from users on the underlying demand characteristics for Datacenter space. While we plan to release the results of the study in greater detail in a press release later today, I wanted to discuss a few key findings now with you this morning. First 86% of respondents in the 2008 study noted that they will definitely probably expand their number of Datacenters in the next 12 months. This indicates an active phase of Datacenter expansions during the second half of 2008 and first half of 2009. Second, 45% of respondents plan to expand in three or more locations. This is an increase of nearly 20% over the 2007 result indicating that the scope of Datacenter projects has increased along with the number of projects. Third, the planned square footage requirement for an average expansion site went up 50% from 10,000 feet in 2007 to 15,000 square feet in 2008, another indication that the scope of Datacenter projects has increased significantly in the past year. The results of this study confirms of our teams are already experiencing in the market that demand Datacenter space is increasing and being driven by the growing IT infrastructure needs of companies across the industry sectors. Despite the challenging economic environment, companies are making significant investments in IT infrastructure reporting the critical needs of these assets for today's corporations. We believe that these important trends coupled with our proven business model and flexible capital structure will continue to drive strong long-term FFO growth for DLR. Now I'd like to turn the call over to our CFO Bill Stein who will discuss our very positive first quarter 2008 financial results and our revised 2008 FFO guidance. Turn over to Bill. Bill Stein – Chief Financial Officer and Chief Investment Officer: Thank you, Mike. Good morning and good afternoon everybody. I’d like to begin with a review of our first quarter 2008 financial results and our revised guidance for 2008. Following my remarks, we will open the call to your questions. FFO on a diluted share on unit basis was $0.58 in the first quarter of 2008, up 16% from $0.50 in the same quarter last year and up 9.4% from $0.53 in the fourth quarter of 2007. The first quarter 2008 one time items accounted for approximately $0.02 per diluted share and unit of additional FFO. These items include additional capitalized interest related to a prior period, fee income from development services, and energy incentive payment from an electric utility, and a reversal of previously recognized bad debt expense. Adjusted funds from operations or AFFO for the first quarter of 2008 was $27.5 million or $0.37 per diluted share and unit. This compares to fourth quarter 2007 AFFO of $27.1 million or $0.37 per diluted share and unit. The AFFO ratio for the first quarter of 2008 was 83.8% which was the same as that of the previous quarter. Reconciliation of FFO to net income, AFFO to FFO, and FFO and EBITDA to net income for these periods is included in our supplemental operating and financial data furnished to the SEC and available on our website. EBITDA was 56.6 million in the first quarter of 2008 compared to 65.7 million for the first quarter of 2007 which included an 18 million gain on the sale of two properties. Excluding the gain on sale, EBITDA for the first quarter of 2007 would have been $50.7 million reflecting an increase in 2008 of 11.6%. The net income for the first quarter was $11.1 million up from 5.6 million in fourth quarter of 2007 and down from 22.1 million for the same period of 2007, which includes the $18 million on the sale to assets. Net income available to common shareholders in the first quarter was $2.9 million or $0.4 per share up from $254,000 or zero per diluted share in the previous quarter. Net income available common shareholders in the same period of 2007 was $18.6 million or $0.32 per diluted share reflecting a non-recurring gain on sales to properties. Excluding the gain, net income available common shareholders would have been approximately $3.6 or $0.6 per diluted share. Gains on assets sales are not included in our FFO. Same store NOI increased 10.8% to $16.7 million in the first quarter of 2008 from $62 million in the fourth quarter of 2007 and increased 17% from $58.7 million in the first quarter 2007. Same store NOI adjusted for straight line and FAS 141 adjustments which we refer to as same store cash NOI increased to $60.4 in the first quarter, up 13.5% from $33.2 million in the fourth quarter of 2007 and up 17.3% from $51.5 million in the first quarter of 2007. These increases were primarily the result of new leasing and our properties commencing during the 12 month period ended March 31, 2008. I will now review specific items in the statement of operations to provide additional detail on the results for the quarter. For the first quarter rental revenues increased to $92.7 million up 8.9% and 85.1 million in the previous quarter. The increase was primarily due to the leases signed in 2007. Likewise tenant reimbursements increased 5.8% to $21.8 million from $20.6 million in the fourth quarter of 2007 due to the new lease announcements. Total operating expenses for the first quarter were $89.3 million, up 5.2% from $84.9 million in the fourth quarter of 2007 primarily due to a one time property tax credit of $3.1 million that we received in the fourth quarter and impart to the new lease commencements. Turning now to our balance sheet, during the first quarter we capitalized23% or $4.1 million of interest related to construction projects, which compares to 21% or $4.2 million in the fourth quarter of 2007. In addition we capitalized approximately 29% or $2.6 million in compensation expenses compared to approximately 25% or $1.9 million in the fourth quarter of 2007. Liquidity continues to be a significant concern for real estate companies are access to capital has become increasingly constrained over the past year. As I have said in previous calls we believe that our track record of accessing well priced debt and equity capital from several different sources, particularly in difficult markets is a powerful competitive advantage. We also believe that we have sufficient capital to fund our currently planned acquisition and the redevelopment plan program for the year when combined with our planned activities in the debt markets. In February in underwritten public offering of 13.8 million shares of series D cumulative preferred stock which generated approximately $333.6 million of net proceeds. We utilized the net proceeds to temporarily repay borrowings under our revolving credit facility, to fund acquisitions, development and redevelopment activities and for general corporate purposes. Currently we have $175.2 million outstanding on our credit facility including letters of credit. Based on the covenants and our credit facility we have a total borrowing capacity over $724.8 million consisting of $474.8 million of immediate liquidity under the credit facility and additional secured debt capacity of approximately $250 million. This capacity were fully utilized our pro forma total debt-to-total market value would be approximately -- our total debt at quarter end was $1.2 billion and our ratio of debt to total market value was 26.8%. Our non-GAAP fixed charge coverage ratio was 2.1 times and our non-GAAP debt service coverage was 3.2 times. You should think of those items as more of a cash coverage test. As of March 31, our weighted average cost of debt was 5.5% and the weighted average maturity was 5.7 years including debt extension options. The breakdown of how we calculate these ratios can be found in our supplemental operating and financial data report furnished to the SEC and available on our website. We've exercised the first of our two options to extend the maturity on the 350 E. Cermak mortgage. The maturity date on the mortgage subject to completion of legal documentation is now June 9, 2009. The current amount outstanding on the mortgage is $97.5 million and the interest rate as of March 7, 2008 assuming the extension were effective will be 4.82% a 141 basis point reduction from the current swap rate. We continue to work on a number of financing options in support of our growth and development. In the US we are exploring the opportunity to access the unsecured product placement debt market. This potential financing vehicle would supplement our capital structure with medium to long term unsecured debt while providing further diversification of our capital sources. In addition, we are in various stages of due diligence in documentation on two standalone secured financings of domestic properties that would generate total proceeds of over $120 million with terms ranging from 3 to 5 years and interest rates ranging from 6 to 6.5%. In Europe, we are also in various stages of due diligence and documentation on two standalone secured financings. The first transaction is for a datacenter facility located on London's perimeter. Estimated proceeds range from 50 to £55 million with a five-year term and an interest rate in the range of 6.5 to 6.75%. The second transaction involves two datacenters located in Dublin. Estimated proceeds range from to 50 to €55 million with a five-year term and an interest rate in the range of 6 to 6.25%. All these loans are subject to the approval of the respective banks credit committees and other conditions. I would now like to turn to our revised guidance for 2008. We are increasing FFO guidance by $0.05 on each end to a range of a 235 to 245 per diluted share and unit because of the results of our leasing activity and a reduction in expected G&A expenses. The new guidance is based on the following assumptions: Total acquisitions for the full year in the range of 125 million to a 185 million consisting of 65 million to 75 million of vacant properties for redevelopment and 60 to $110 million of income producing properties at an average cap rate of 8%. The commencement of leases for approximately 190,000 square feet to 990,000 square feet of turnkey Datacenter and Powered Base Building space at an average annualized gross rent of $90 per square foot. The commencement of leases for 100,000 square feet to 125,000 square feet of basic commercial space at an average annualized gross rent of $19 per square foot. Total capital expenditures for our redevelopment program of $550 million and total G&A of $41 million. These new assumptions reflect a shift in the mix of investment capital, increasing capital expenditure for our redevelopment program, and reducing capital allocation for acquisitions, as well as a $3 million reduction in G&A due to the elimination of third party acquisition and disposition related professional fees from FAS 141R G&A line items which will not become effective until next year. We established 235 per diluted share and unit as a low end of our 2008 FFO guidance, primarily due to our foreign currency translation loss. As of May 8 2008, 81.4 million outstanding under our revolving credit facility is denominated in foreign currencies. Where we to repay these borrowings today? Depreciation in the US dollar since we borrow these funds would cause us to recognize its charge to earnings in FFO, using yesterday's exchange rate of approximately $5 million in foreign currency translation losses. We expect to repay some, if not all of these borrowings over the next several months with proceeds from the new secured loans that I mentioned earlier. This concludes our former remarks. We would now be happy to take any questions that you might have. Thank you.

Thank you, sir. (Operator Instructions). And our first question comes from the line of Jordan Sadler with Keybanc Capital Markets. Please go ahead.

Thank you and good morning out there. First question is for Mike regarding, I guess the results of the survey and just your thoughts in general regarding datacenter demand from what you’re seeing. Just maybe you could characterize it in terms of innings, what inning as a ball game do you think we’re in here today?

You know, that's the good question. Certainly demand continues to be strong and by all indications yeah, the datacenter facilities for many corporations really are not discretion, I mean, they required for continued productivity and continued expansion of the businesses, and I think they cut across virtually all vertical markets. I don’t know, I mean, I would think that we’re maybe in the, I am guessing third inning, fourth innings perhaps in the middle of the game, I think we’re going to continue to see leasing our foreseeable future with the next 24 months, 36 months hopefully, we are going to continue to see pretty strong demand.

Okay. And what are you seeing on the supply side?

Supply, doesn’t seem to be picking up to the expense to meet, the forecasted demand that we’re seeing. We are redoing some other analysis in house on the market by market basis, looking at kind of 7 or 8 top markets, and leasing a pretty lease from all our own research, we’re seeing a pretty significant supply demand, shortfall of supply, as much as perhaps on a 50% less supply then for the demand that we’re seeing forecasted over the next 24 months. But that’s kind of our own internal analysis of settle this top markets. So we’re pretty comfortable that it’s a pretty favorable environment for us today.

And then the second question is just on the capital side Bill you outlined the secured financing, but you have done domestically, I suppose those would represent the $250 million as secured debt capacity you mentioned in your opening commentary?

That's right.

Okay. So any other plan?

Hi Jordan, one point Bill. For that $55 million financing on the facility in London, that’s a construction loan. So it won’t go out all at once, it will go out as the facility built. But for most part it should funded this year.

Okay. And so, so on the capital sided things, any other plans either into asset sales or joint, sales on joint venture, in terms of joint venture transactions you could may be update or some?

Nothing really on assets sales plus point. We are looking at several joint venture situations ,one of which would be for European development, and the second would be for stabilized asset sin the portfolio.

Domestically?

Not so gap.

Are those await events sort of not necessarily?

Not necessarily. The development JV might happen this year. I think the stabilize is when you take it little longer. And that’s the – we’re generating build to suit as well throughout development platform and we would see the stabilized as an exit vehicle for delta.

It’s helpful. Thank you.

Thank you. Our next question comes from the line Michael Bilerman with Citi. Please go ahead

Hi this is Micheal Bilerman in this line as well. My first question is about the assets the you have been, especially, the vacant assets that you have been borrowing such as the purpose build datacenter, I am wondering who are the sellers of these completely vacant assets and why the previous owner which used to sell rather than trying to lease the space himself?

Yeah I didn’t give you some insight on there too, lie the last couple of transactions that actually we mentioned today the property scat away that’s adjacent to what free corporate place. That property is a warehouse facility that we will -- that were actually in the process of creating our powered based building and then one or two turnkey partners. So right now the building is warehouse. So its nothing marketed datacenter and engineering work has to be done both on some structural work as well as power and communications fire were being brought into the building. The second one I mentioned Franklin township there will be closing on in the next week or so that building is actually a brand new shell building, that’s being developed for us by a local developer, and so, that’s being build on a shell basis towards specifications on land that the developer own and then with the closing this week we will takeover and then market that building and potentially view some turnkey part later this year depending how the marketing goes on, on the other property.

And just to clarify you said that you might setup the development joint venture something in the next 18 months?

That’s right European assets.

I am wondering why what sort of driver decisions that develop within a joint ventures as oppose to developing on balance sheet given sort of the yields that you’re getting on that?

Its really a function of balance sheet capacity versus the opportunities that we see out there, as well as the amount of risk that we think its appropriate to have and development assets so within the portfolio at any one time.

And sort of in keeping with that you mentioned the $800 million of debt capacity that you have to fund developments for this year, but at the same time you mentioned the fixed charges are turning it around two times. I am wondering if you’re considering doing anything to sort of shore up the equity side of the balance sheet to fund developments potentially in '09 to keep that charge off?

Well, I mean the interest rates, when we lease these assets with un-levered in the low-to-mid high teens even with a interest rate of 6 to 6.5%, its not going to be dilutive to the fixed charge coverage ratio basically in two times. But having said that, if you look at our needs, we could make it, I suspect to the first quarter of next year, but I think that would be pushing it, I think that be more likely that we brace equity before the end of the year, this year, and once we do something on the private sign with our joint venture, but we are price sensitive basically and so we are in no rush to raise equity.

Fair enough, thank you.

And your next question comes form the line of Will Mark with JMP Securities. Please go ahead.

Hello Mike, hello Bill. Couple of questions that I guess, to start with, can you give us a little more detail on how you are able to bring down G&A, you gave some comment I think your prepared remarks?

Sure. Well there was a proposed FAS B that would have required all real estate companies to expense third party acquisition cost and disposition cost. So you know, that basically any consultants or anything like that are involved in the acquisition process that -- were those fees have been historically capitalized, it was proposed that those would be expense. We put that in our G&A assumptions for this year feeling that FASB would be effective, and its not going to be effective this year, its going to be effective next year. So that’s a significant component of the G&A reduction, and then other pieces of just growing to continuing to try to manage our business more effectively and efficiently.

Great, okay. Couple other things, one is, I believe when you referred your survey, I said one of the questions related to, I think you said definitely, probably, two thirds will be expanding their data centers, did I hear that correctly?

Actually what that will is that 86% of respondents in the definitely and probably category said they will expand in the next 12 months.

Okay. So it’s a combination of those definitely and probably?

Yeah.

Okay. Sorry. I was just little confused by that, thank you. And one other question, I don’t think Savvis isn’t brought up yet. Can you just give us an update on their business, how it relates to you if there is potential upside or downside?

Sure, obviously there were very important customer wars and we have good insight into their activities in our buildings obviously, and they are selling up on a space with at a pretty good pace. You know its kind of interesting if you look at kind of their filings, and conference calls it had, their data center based business has freeze very nicely and very similar to how other companies like Equinex, rack space and switching data continue to do. So there are data center based business that goes on our building has done very well and I think there has been some drag on growth for them its been on their network side, because they have a pretty extensive private network business. The larger center is underway that the data center that goes on in our building. So we are seeing them actually do quite well in the business well that operates in our facilities.

Okay. So, in terms of more exposure, is that now completely out of the question or could you possibly lease more space to them?

No, I mean there is not anything, any discussions going on now in that way. But I could see we will look at it on by circumstance basis depending on the market and who the customer base is.

More importantly you are not worried about collecting (Inaudible).

Not at all. If you look at there cash flow and balance sheet you know, they’re pretty healthy company.

Great. That’s all from me thanks.

Thank you. Your next questions comes form the line of George (Arabaugh) with Merrill Lynch. Please go ahead.

Hi good afternoon guys. We gotten the increase in redevelopment CapEx, is this purely an increase in the amount of square footage you plan to develop or are you spending more per foot into turnkey space?

It is more square footage that we will continue to build out, both on the turnkey as well as in the powered based building, but our construction budgets are coming in within our parameters and our guys and girls are getting more cost effective all the time in this construction project.

George, it basically reflects the fact that we’re north – somebody had to schedule on our leasing plan, and so, we are going forward into 2008 some of 2009 plans.

Okay. And for the past two quarters your redevelopment schedule has not shown that you had a shale product in the construct pipeline , are you just seeing less demand for that product type? Are you focusing your efforts on the higher yields in the turnkey products?

Well. I mean, it really does continue be both products that we’re leasing to customers. So in the same building you will have suites that we’re building out as turnkey as well as space that we’re leasing in multi tenant facilities on a powered based building situation, so its really both. Our products are being absorbed. You know I think we are – leases commenced in the quarter it was much more heavily weighted toward the turnkey facilities, I am assuming in terms of total dollars being expended. If it's going to be the dollars expended in the cap are going to be much more weighted toward the turnkey, it’s just because of nature of that product.

Thank you.

Thanks our next question comes from Omotayo Okusanya with UBS. Please go ahead.

Yes, good morning thanks for taking my question. Great quarter. Looking at the guidance I just had one question in regards to the cap rate assumption is 8%, it seems a little high to me. I am just wondering what you guys are seeing in the acquisition market at this point?

Right now the projects that we've looked at and that we've been closing on we're in excess of 8.5, so between 8 and 8.5 on the income producing properties. So we think 8 will be pretty consistent for us and maybe a bit conservative.

That’s interesting thank you. And who (Inaudible) cap rates on this product were a little bit higher like in the mid seven. So, I mean, I know you guys do a lot of off market transactions at the 8.5 cap rate transactions or off market transactions that you continue to find out there?

Yeah. I mean, firstly everything we are doing is been off market. And a lot of these properties they may have an income producing component and a non-income producing component for redevelopment as well. If you look -- so not all the properties where we’re buying anymore are property that strictly fully leased income producing. Some might represent portions of buildings that were splitting out. With that said, we have seen over the past year a number of sales occurring well down into the sevens. But those just aren't opportunities that are very interesting for us because we can get in more better returns I would say of our development and redevelopment programs.

Got it.

And we've been quite selective in the acquisitions area. So when we look at capital allocation if we have the opportunity to have high teens levered, mid teens levered, the development versus a seven or so on acquisition clearly we’re going to lean towards the higher yielding opportunity, particularly in a capital constraint environment such as this. And that’s really we think what our investors are looking for us to accomplish.

Great thank you.

Thank you. Your question is a follow up from the line Jordan Sadler with Keybanc Capital Markets. Please go ahead.

Thanks guys. I just want to like clarify the mix. Based on the affirmed leasing guidance the 890 to 990 on the datacenter space turnkey and shell staying at $90 bucks, I assume is the spending rate on those commencements expected to stay the same and is the mix expected to stay the same?

No. 50/50 turnkey shell.

Yeah that’s what we are continuing to project right now. Kind of the best of our forecasting. I mean, what's happening also is that we’re leasing and thus commencements are occurring a little more quickly than we forecasted. So the same amount we are forecasting on a square footage but we’re little ahead of schedule.

Right. In terms of booking revenue for the full year…

Exactly.

But your spending on that same square footage went just to go back to an earlier question. And so, but you’re saying the cost you are actually being contained. So it's implicit and that is that you’re going to be pre-funding I guess as Bill alluded to next year commencement?

That’s right.

It’s a function of this years leasing activity accelerating?

Right. We basically need to fund inventory this year for next year's growth.

Can you -- what is the expected spend on HSBC in that guidance in the 550?

Well I assume that’s already have been spent. So, but the loan is ₤55 million.

What's baked into the 550, which will be in – it attributable to that property?

Probably about, I want to say around in ₤55 million, ₤57 million.

I will call it a $110 million.

Okay. That’s helpful. And then there is a larger size portfolio out there for sale that we have talked about previously, any expectations on pricing that you guys might have or whether or not you are still looking at it?

It appears that from what we are hearing in the market place, is that the pricing is getting very aggressive on that portfolio, which I think at the end they will probably be a very favorable comp for us, if it proceeds as we are hearing.

It should be helpful for NAV focused owners of DLR.

But that means you are -- is going to get very expensive, but probably goes away from Digital, it’s down with the digital?

I would say that likely.

Okay, that’s helpful. Lastly, Bill, overall expenses sequentially and is total real estate operating expenses ex real estate taxes, sequentially they went from 33 million last quarter to 31.5 million this quarter. What was that decrease attributable to and what's a good run rate?

I think I mentioned in the last call, where we hired a new contractor to do maintenance across our portfolio and there is significant amount of deferred maintenance last quarter and so, this quarter you are seeing I think more normalized rate.

Yeah there was ramp up with the portfolio wide contract and as well we are able to tighten the speck once we got them up and running. I mean also then there is some cases where we were able to tighten the scope of the contract and reduce ongoing cost there as well. So it shouldn’t be really cost effective and there is a couple of other broad vendor contracts like that that we have been able to fine tune and reduce ongoing costs.

Were any of those one time you discussed that were in the numbers in the operating expense line, meaning like either energy item or the reversal of bad debt?

No. You will find those in revenue and you need to find it in the capitalization issues would be in the interest expense.

So the reversal of bad debt and revenue and the energy is both in revenue?

Right.

Okay. Thank you.

Towards the fee.

Towards the fee. Okay. Thank you.

Thank you. (Operator Instructions). And our next question comes from the line of Dave Rodgers with RBC Capital Markets. Please go ahead.

Hey, Bill question for you. In relation to the acquisition guidance being lower is that a function more of acquisition pricing which you have mentioned it can be aggressive or more a function of capital? And then the second part of that is at what point do slower acquisitions begin to potentially flow the funding or the opportunity for the future growth through redevelopment et cetera?

I think it’s a function of relative yield opportunities between the two buckets of capital. And we are at the point now where we are commencing leases every quarter. So you know, if you are starting a development program afresh you might have to wait a few quarters before you recognize revenue, but we are commencing revenues every quarter. So we don’t have a -- we are not hurting in that respect in terms of the delays you otherwise might see with the de novo development project. And then when you compare with the accretion factors of an 8% cap investment versus lets call it 15% yielding development project that is clearly no comparison.

I would agree with that I think the -- that same dynamic been through you know, say last quarter, I guess when you gave the guidance originally, and just I guess function of the leasing demand and your ability to capture that today through the redevelopment faster, is that all?

I think that’s right.

And what you are also seeing is kind of a continuous process where we are developing step out of the -- that resides in the redevelopment inventory, developing and putting it into the operating portfolio and then in selected markets where we’re refreshing space through acquiring sites and/or existing buildings that we can redevelop, like we just discussed about in Northern New Jersey. So, we’re adding in on an incremental basis to maintain our inventory in those markets where we see a lot of demand. So it doesn’t work for us to add so much more square footage as perhaps we have added in past years.

In some of these assets that have yield when we acquired them they have internal growth opportunities, really are we buying totally full assets.

We were still taking advantage of a lot of growth out, for example 350 Cermak in Chicago or 600 West 7th in LA which we've held for few years now and continuing to build out and then getting good same store growth out of those assets.

And really get to a follow-up to that with relation to your comments on Northern New Jersey, give us just a brief thought on the different strategies between those assets and maybe waiting to go the route of the turnkey space on the asset you are likely to close on here in the next week?

We are likely for the time being finalize or finish reselling improvements in terms of power and fiber that will completed the building and we will hold for you know, likely for larger power based building or kind of custom build situation for users who maybe want larger footprint or standalone facility. And we can utilize the Piscataway asset we just bought next two or three quarters place and utilize that as more of a multi tenant opportunity and will build out a couple turn key pods in that building at Piscataway and have the inventory and Franklin for individual users perhaps or a couple of larger users.

Okay. Thank you.

Thank you. And there are no further questions. At this time, I will turn the conference back to Mr. Foust for concluding comments. Please go ahead sir.

Very good. Well I appreciate everyone's focus and taking the time to come on the call. And we look forward to following up with you in the future. Thank you very much.

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