Welcome to the Washington Real Estate Investment Trust Second Quarter 2018 Earnings Conference call. As a reminder, today's call is being recorded. Before I turn the call over to company's President and Chief Executive Officer, Paul McDermott; Tejal Engman, Vice President of Investor Relations, will provide introductory information. Mr. Engman, please go ahead.

Thank you, and good morning, everyone. Please note that our conference call today will contain financial measures such as FFO, core FFO, NOI, core FAD, and adjusted EBITDA that are non-GAAP measures as defined in Reg G. Please refer to our most recent financial supplements and to our earnings press release, both available on the investor page of our website, and to our periodic reports furnished or filed with the SEC for definitions and further information regarding our use of these non-GAAP financial measures and a reconciliation of them to our GAAP results. Please also note that some statements during the call are forward-looking statements within the Private Securities Litigation Reform Act. Forward-looking statements in the earnings release, along with our remarks, are made as of today, and we undertake no duty to update them as actual events unfold. Such statements involve known and unknown risks, uncertainties and other factors that may cause actual results to differ materially. We refer to certain of these risks in our SEC filings. Please refer to Pages 9 through 25 of our Form 10-K for our complete risk factor disclosure. Participating in today's call with me will be Paul McDermott, President and Chief Executive Officer; Steve Riffee, Executive Vice President and Chief Financial Officer; Tom Bakke, Executive Vice President and Chief Operating Officer; and Drew Hammond, Vice President, Chief Accounting Officer and Treasurer. Now I'd like to turn the call over to Paul.

Thank you, Tejal, and good morning, everyone. Thanks for joining us on our second quarter 2018 earnings conference call. In the interest of using this time as productively as possible, we'd like to change it up a bit today. My opening remarks will focus on key trends within the DC real estate market that are informing our leasing strategy and capital allocation decisions. Steve will then highlight the main elements of our second quarter performance and provide greater color on our updated 2018 guidance assumptions. The key takeaway from this call is that while regional real estate demand is improving and is expected to further accelerate, a landlord's ability to maximize the potential upside will depend on the relevance of its real estate strategy. Today, we'd like to leave you with a solid understanding of ours. Starting with office. The national trend towards flexible space is gaining even greater significance in the DC Metro region, where a large portion of the tenant's base is made up of federal budget dependent government contractors. Some of these contractors have been awarded new contracts or spending increases on existing contracts following the passage of the fiscal year 2018 Omnibus Spending Bill at the end of March. Similarly, the national trend of tenants demanding a wide range of competitive amenities to attract and retain the best talent has greater importance in the DC Metro region where the May unemployment rate of 3.2% was nearly 40 basis points below the national rate. With large increases in federal spending authorized for fiscal years 2018 and 2019, many contractors are gearing up in anticipation of large contract awards, which will continue to fuel the demand for space that is available very quickly with flexible terms and competitive amenities. For example, in conducting our proprietary research, we worked…

Thanks, Paul, and good morning, everyone. Net income attributable to controlling interest was $10.8 million or $0.13 per diluted share, which was higher than the $7.9 million or $0.10 per diluted share reported in the second quarter of 2017, mainly due to the recognition of a gain related to the sale of 2445 M Street. We outperformed our second quarter core FFO expectations by a $0.01 due to better-than-expected same-store multifamily and office revenues and lower-than-expected retail operating expenses. On a year-over-year basis, core FFO per share was flat as same-store NOI growth and the contribution from the acquisitions of Watergate 600 and Arlington Tower offset the sales of Braddock Metro Center, 2445 M Street and Walker House as well as higher year-over-year interest expense. Beginning with key year-over-year variances in the same-store portfolio, office delivered 3.6% GAAP and 4.1% cash year-over-year same-store NOI growth, primarily due to 100 basis points of average occupancy gains driving higher revenues, which offset nearly $330,000 of lower termination fee income compared to the second quarter of 2017. Multifamily delivered 1.8% GAAP and cash year-over-year same-store NOI growth driven by 210 basis points of year-over-year rental growth and 10 basis points of average occupancy gains. And finally, retail same-store NOI was flat on a year-over-year basis as higher revenues, which included approximately $100,000 of termination fee income and the lower provisions for bad debt were offset by an increase in operating expenses which as I mentioned earlier were lower than we originally expected. Moving on to office leasing. With 93.1% of the overall office portfolio occupied at quarter end and only 3% of rentable square feet expiring in the remainder of the year, our focus remains on leasing our 2019 expirations, particularly at Arlington Tower and Watergate 600. We expect leasing volumes to be…

Thank you, Steve. Following the fiscal year 2018 appropriations at the end of March, the region has experienced an uptick in job growth in the second quarter of 2018 when we added 9,800 jobs compared to the 1,200 jobs added in the second quarter of 2017, which is more than an eightfold increase on a seasonally-adjusted basis. Second quarter 2018 professional and business service jobs were also significantly higher than in the second quarter of 2017, primarily driven by professional, scientific and technical services. As federal government contracts continue to be awarded through the end of the government's fiscal year at the end of September 2018, we expect job growth to further accelerate. Our multifamily portfolio is already capitalizing on this growth and has outperformed our expectations on occupancy and rental growth this quarter. With unemployment in the Metro region hovering below 4%, we believe growth at this stage in the cycle will likely result in net in-migration, which should provide continued support for multifamily, retail and office. Washington REIT remains a secular way to play the DC recovery with a platform that's strategically positioned in segments with the strongest supply demand dynamics within DC real estate. Now I would like to open the call to answer your questions. Operator, please go ahead.

[Operator Instructions]. Our first question is from Blaine Heck from Wells Fargo.

Just want to touch on the multifamily side. First, you guys have had relatively healthy year-over-year rent growth around 2% in the last several quarters, just looking at Page 23 in the supplemental. Given the supply-demand picture you're seeing at this point, how should we think about that growth rate trending in the next year or two?

Blaine, this is Steve. I'll start off. Well obviously, we're not giving guidance for 2019 or '20, but we just raised our guidance for '18 for the second time this year. I think some of you have commented, the center of it is now 3 6, which is where we were the year before. We've looked at supply in terms of where it's coming and we think that the market center going to have the heaviest supply waiver not going to directly compete where we have our assets. And we're also very hopeful that this federal stimulus will bring some net job in-migration and population in-migration to the area, which we're hopeful will help with rental rates.

Yes. Blaine, it's Paul. Just to add on that. When we look at where at the supply pipeline right now, what's going to deliver in, let's just say, over the next 12 months, I think the number I'm seeing bantered about is about 13,100 units. 2/3 of those units are going to deliver in the Capitol Hill riverfront southwest market as well as the NoMA H Street market. And I think you are aware that a high percentage of our portfolio is in Northern Virginia. And the other thing I'd say is we continue to see, if I look at this last quarter, we continue to see the B rental growth outpacing the A rental growth. I think it was by about 30 or 40 basis points this quarter. So that's kind of led to what we've reflected in our guidance.

Got it. That's helpful. And Paul, you mentioned you guys are in the market, always looking for value-add multifamily opportunities. I guess are there any properties or projects you'd say you're actively pursuing at this point?

Yes. We are actively looking at two value-add multifamily in there. Clearly, B assets that we think have the -- a type of affordability gaps post renovation that we would like to see. And they also -- both of them have additional FAR potential.

Okay. And Steve, related to that, you guys have done well in keeping leverage down but if there was a significant deal you guys wanted to go after, what's the investment capacity you guys have at this point kind of without becoming uncomfortable with leverage levels? And maybe what would be the preferred source of financing?

Well, we, I think, have stuck to our guns. Timing sometimes happens when buying and selling, but we want to manage our balance sheet leverage between the 6 and the 6.5 debt-to-EBITDA. I think we always say we'll look at all sources of capital. We've got range in our guidance where there could be additional asset sales. For instance, if it were something that we had an immediate opportunity to do.

[Operator Instructions]. Our next question is from John Guinee from Stifel.

Great. Nice quarter. A couple of questions and a few clarifications. First, you didn't access the ATM this quarter. Any particular reason? Seems like a reasonably good stock price.

Well, John, at this point, we started off the quarter a little bit lower and we had a big asset sale to focus on as our primary source of capital which was 2445 M Street. So we didn't think it was the right time to access our equity.

Okay. And then I think I heard you say Blank Rome Space at Watergate 600 for a 2020 availability. Isn't that available right now? Isn't it unoccupied?

All right. John, it's Tom. That's where we had a master lease negotiated with the seller on that for the additional 12 months.

I know. But it's been 12 months, but why doesn't it become available until 2020 if it's vacant now?

It's vacant but it's being leased under the master lease through 2019.

Okay. But if someone want to rent it now, they could, right?

Yes. And we've structured a deal where we would negotiate with the master lessor and a deal to let them off if we were able to find a deal that was mutually beneficial.

Okay. And then on the Space Plus, 96,000 square feet, I think, you mentioned and 32 different spaces. These are basically on average 3,000 square feet, I think, kind of around the corner, not that an elevator bank would be my assumption. Are these just taking some dead space and building them out or is there something more to it? They're tiny little spaces on average, I think.

Yes. I think the traditional specs we've modeled that everyone's been running for many years was exactly that, which is, okay, I got a piece of space in the back, looking at the garage. It's not leasing, so I'm going to build it out and see if the market will take it. And I think that game is pretty much done and if you don't have quality flexible space offerings, you're probably not going to lease some. Especially, John, we know that market's 20% vacant in the suburbs and I'm not too different in parts of the downtown market as well. And that you're going to -- if you got a 3,000 for a piece of space, a tenant rep can show you 50 options. So you better have space that's going to stand out. You better have an offering that allows you to deliver a higher value proposition if you're going to compete. And I think we are now delivering spaces that are high, high quality, great design, shared amenities, good visibility of the elevator bank and the program that we're putting in place at Arlington Tower is probably one of the more innovative concepts that we have come up with to address this flexible space offering.

And then last very quick question. By the way, great answers. Is -- we were talking to a defense contractor in the Baltimore-Washington area the other day, and he told us that roughly 70% of his people are actually housed in DoD space, Department of Defense space and not in their own rented facility. Is that an unusual number? And when the defense contracting business finally grows, do they occupy a third-party space? Or do they occupy the Department of Defense space with their clients?

I'm not sure about the 75% number, but I do think there is plenty of contractors in DoD space. Our research with Congressional Quarterly definitely demonstrated that a lot of the job creation that they are predicting is going to be private sector space. But maybe Steve whose got some experience at a previous life might have some additional color.

Well, just working with -- just to add to that, working with the Congressional Quarterly research team, that may be true. Although, they may be somewhat saturated. But what we're about to see for this research is in and above all the contractors that have been doing work in the budget that's been in place before this new one was passed, we have another $28 billion of spending in '18 and '19 and our research indicates about 45% will be contracted out to third-parties. And they may need to be near some of the DoD key locations, but it's a pretty good indication that they're going to -- there's a bigger space requirement. And I think if I'm -- just to throw it back to you, you've seen activity.

Yes. Well certainly, that's been borne out in the activity we're seeing in Rosslyn and out the Silver Line Corridor.

[Operator Instructions]. Our next question is from Chris Lucas from Capital One Securities.

Just a couple of quick questions for you. Disposition guidance, I guess, is unchanged. I guess I'm just curious as to what would trigger and if the assets that could potentially make it into this year, are they on the market at this point? And if not, what are the triggers that would put them in the market? Is it an acquisition to offset or is it something else that maybe in play there?

There is nothing on the market right now, Chris. Right now -- but what would trigger that would be a potential multifamily value-add acquisition if we were lucky enough to get the award.

And then I guess what's your view on the marketplace. I know when we met just a couple months ago, you were, I guess, frustrated with the pricing and the competitive nature of the acquisition environment. Are you feeling any more confident about your ability given where the stock prices moved to? Or -- what's the dynamic like today?

I think our conversation, reflecting back on it, I think the first thing we were talking about was capital and my observations have not changed at all in terms of the amount of capital that is out there. The only people I've really seen pull back are the Koreans and that is really just because their hedge cost were too high. Definitely, a tremendous amount of foreign capital for the core. I think the domestic capital that we see creases a lot more value-add oriented and particularly, a lot of them chasing the multifamily value-add, the model that we like to employ. I think the biggest culprit that we see is -- are the debt funds that you and I talked about. I mean LIBOR went up 100 basis points and spreads on these debt funds tightened 125. You can easily get 75% to that, 75% loan-to-value deals on the multifamily and the same funds will go to 85%, pricing that additional 10% as preferred. So there's no shortage of capital, I'd say, especially for multifamily. I think a little bit of a pullback, backing off on some of these core plus offers we're seeing downtown. I mean, I was just commenting to the team here. Right now, you're going to have 1111 Pennsylvania, 1001 Pennsylvania, 2099 Pennsylvania, 1399 New York, 1333 New Hampshire and 1130 Connecticut all priced in the next 30 to 45 days. So I think you're really going to have some good data points, but the uber core stuff is really the foreign capital, where we're seeing kind of some whole starting to show is in that core plus office. People are just not getting as aggressive with the underwriting or near-term lease expirations.

Okay, great. Appreciate that color. And then I guess last question for me is just thinking about the Space Plus and just kind of curious as to how we should be thinking about how you'll be reporting on how successful that is and also the capital cost associated with that.

Well, so far the term we've been achieving has been almost in line -- it's four years in change so it's almost in line with the typical suburban deal and the majority of these deals have been out in Virginia. We're starting to add some more in DC. So they sort of the -- the numbers sort of show up like typical leasing numbers. That being said, I think we're formulating how to communicate both the initial investment and rent achievement, along with the sort of retention and additional capital required and the early returns, I think, we touched on in the script are that -- I'll give you an example. At 1600 Wilson, we built out a floor. Each deal was roughly, let's call it, 3,500 square feet, $60 of work and we still are burning off term on all but two of those. And the two that came up for renewal, we ended up re-leasing those with $7 of additional capital and probably only two months downtime.

Okay, great. And then just, Tom, while I got you. Just on the new leasing front, on just -- it's been light for the last couple of quarters. Is it just a function, as Paul described earlier, that tenants are just of that smaller size are just having a hard time committing to a leased space given the time that it takes to get through the permitting process? Or what's really slowed down your new leasing activity?

Well, I hate to say it, but a big chunk of our vacancy, which are some of our best vacancies, guess where? It's in Quantico and that's 100,000 feet and the majority of our vacancy there. And frankly, there's just not lot of deal activity. That being said, we're hoping that there's going to be some contracts awards down there and they're starting to see some activity. So the other aspect of the leasing volume is, it's a lot of infill leasing and we're working on that to get it over the goal line. On the retail side, I think, again it's a little bit of the bigger boxes are just taking time.

And if there are no further questions, I'd like to turn the floor back over to management for any closing comments.

Thank you. Again, I would like to thank everyone for your time today, and we hope that you enjoy the remainder of your summer. We look forward to seeing many of you on our upcoming nondeal roadshows in the very near future. Good afternoon.

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