Armada Hoffler Properties Inc (AHH) 2015 Q3 法說會逐字稿

Welcome to Armada Hoffler's third-quarter 2015 earnings conference call. At this time all participants are in a listen-only mode.

(Operator Instructions)

As a reminder, this conference call is being recorded today, Tuesday, November 3, 2015. I will now turn the call over to Michael O'Hara, Chief Financial Officer at Armada Hoffler. Please go ahead.

Good morning and thank you for joining Armada Hoffler's third-quarter 2015 earnings conference call and webcast. On the call this morning in addition to myself are Lou Haddad, CEO, and Eric Smith, our Chief Investment Officer who will be available for questions.

The press release announcing our third-quarter earnings along with our quarterly supplemental package was distributed this morning. A replay of this call will be available shortly after the conclusion of the call through December 3, 2015. The numbers to access the replay are provided in the earnings press release.

For those who listen to the rebroadcast of this presentation we remind you that the remarks made herein are as of today November 3, 2015 and will not be updated subsequent to this initial earnings call.

During this call we will make forward-looking statements including statements related to the future performance of our portfolio, our development pipeline, impact of acquisitions and dispositions, our construction business, our portfolio performance and financing activities as well as comments on our outlook. Listeners are cautioned that these statements are subject to certain risks and uncertainties many of which are difficult to predict and generally beyond our control.

These risks and uncertainties can cause actual results to differ materially from our current expectations. And we advise listeners to review the risk factors discussed in our press release this morning and in documents we have filed with or furnished to the SEC.

We will also discuss certain non-GAAP financial measures including but not limited to FFO and normalized FFO. Definitions of these non-GAAP measures as well as reconciliations to the most comparable GAAP measures are included in the quarterly supplemental package which is available on our website at www.ArmadaHoffler.com.

I would now like to turn the call over to our Chief Executive Officer, Lou Haddad. Lou?

Thank you Mike. Good morning and thank you for joining us today.

As you can see from this morning's press release we've had another solid quarter that ended with an exciting new announcement about our pipeline. Not only are we seeing continued quarter-over-quarter strength this year in our results and metrics but we also continue to backfill our pipeline with high-quality institutional grade products located in some of the best locations in the Mid-Atlantic.

With sustained profitability in our third-party construction business, stabilization of recently delivered multi-family projects and continued capital recycling we're once again able to raise our guidance for the year.

Regarding this morning's announcement on Point Street Apartments in Baltimore I will spend a few minutes towards the end of my remarks to discuss some details of this new investment. This opportunity once again highlights the benefits of being a vertically integrated full-service real estate Company that not only creates value beyond the traditional buy and hold real estate investment strategy but allows for flexibility and structuring deals that best leverages and combines our various capabilities. We believe that our unique business model continues to deliver superior value to our shareholders.

I will now cover a few highlights from last quarter as well as recent developments and then turn the call over to Mike O'Hara to discuss the quarterly results in detail. We're pleased to report FFO per share of $0.25 and normalized FFO per share of $0.26 which is a reflection of the tremendous quarter we had. In addition we have once again raised both the top and bottom ends of our guidance range, resulting in 2015 full-year normalized FFO of $0.91 to $0.93 per share.

Better than expected third-party construction profit and multi-family occupancy affected our outlook for this quarter's guidance range and contributed to this upward revision. At quarter-end occupancy across the core portfolio was 95.6% which continues to be within our targeting range. As we discussed last quarter, both Encore and Liberty Apartments attained 80% occupancy with continued upward momentum throughout the quarter and thus are both now stabilized and included in our multi-family occupancy figures.

We expect the multi-family occupancy metric in the near future to return to previous levels as lease up at these two properties is finalized in the coming quarters. In fact, as of today Liberty is nearly 100% occupied and Encore is approaching 90%.

As you might expect, we are pleased with the performance and stability of the multi-family sector of our business. Our success in leasing and the strength of our overall portfolio is evidenced by an increase in quarterly GAAP and cash same-store NOI which makes five consecutive quarters of significant same-store NOI growth.

With regard to stabilized assets, we continue to deliver on our promise to actively manage our portfolio while mitigating risk and proactively managing our balance sheet. Building off the previously announced disposition of Whetstone Apartments and the partial use of those sales proceeds to purchase Socastee Commons last quarter we utilized the remainder of the proceeds to close on the acquisition of Providence Plaza for $26.2 million during the third quarter.

To remind everyone, Providence Plaza is a 97% occupied 103,000 square-foot mixed-use complex located in the South Park submarket of Charlotte, North Carolina. This asset was constructed in 2008 and is comprised of 54,000 square feet of office space and 49,000 square feet of retail space across three buildings.

This acquisition allows us to diversify the Charlotte market and in particular the South Park submarket where average household income immediately surrounding this asset exceeds $145,000 per year. This mixed-use asset is a fantastic addition to the Armada Hoffler portfolio.

Additionally, this site includes an undeveloped parcel of land that is owned for multi-family development. We've already begun our efforts to determine how the value of it this additional land can be best monetized for our shareholders and we'll keep you updated on our progress.

The previously announced sale of the Oceaneering building located in Chesapeake Virginia closed at the end of October. And as expected the sale yielded a profit of approximately 20% on cost after only an eight-month holding period. Our intention is to reinvest the proceeds from the sale to create additional value for our shareholders while continuing our focus on asset quality and regional diversification.

In keeping with the theme of portfolio management, we discussed during our last earnings call the acquisition of Columbus Village which took place early during the third quarter of this year. The 65,000 square-foot retail asset adjacent to the town center of Virginia Beach is 100% leased and was purchased with an assumption of debt and the issuance of 1.275 million operating partnership units. This five-acre property is a prime target for redevelopment and ultimate integration into the dynamic town center environment. The strategic nature of this property fits squarely within our investment philosophy and is expected to create significant long-term value for our shareholders.

Lastly, as evidenced by our previous sales of single tenant assets such as the Virginia Natural Gas building, the Sentara office building and most recently the Oceaneering facility we are constantly assessing each individual asset with regard to its current and future value prospects. As many of you know we have been evaluating the risk reward equation of our Richmond Tower office building.

While it is a Class A institutional grade office building within Richmond's central business district with superb location and visibility, the NOI from this asset represents a meaningful percentage of the Company's total NOI from stabilized real estate. This size and the predominantly single tenant nature of the income stream has led us to the conclusion that our Company's better served by the redeployment of the equity in this building into other opportunities.

Thus we have entered into a contract to sell this asset for $78 million which represents a 7.5% cap rate on a pro forma basis. Closing is subject to customary conditions including the seller's benefactory completion of due diligence.

As such we have not yet fully evaluated how best to deploy this capital. However, our primary focal point will continue to be quality real estate, credit quality tenants and geographical diversification. We expect to reach a conclusion in the near future.

Having touched on asset management I now turn to our third-party construction business. We are pleased with the progress of the $170 million Exelon Tower in Baltimore's Harbor Point. The project is well underway and is proceeding as scheduled for the summer of 2016 completion.

Construction profits continue to outpace expectations and should now top $6 million for the full gear. While these stellar 2015 results will be difficult to sustain at this level the outlook for this segment of our business over the next two years is promising and we expect that 2016 will again skew towards the higher end of our historical range.

During our last quarter I provided an update on our approach to maintaining a strong development pipeline. At that time Johns Hopkins Village and Lightfoot Marketplace were the remaining two undelivered projects in our pipeline. Both projects are on schedule for a midyear 2016 delivery.

Notably leasing activity at the Harris Teeter anchored Lightfoot Marketplace has been robust and hence we have decided to initiate Phase 2 of the development which will include an additional 22,000 square feet. Ultimately this best-in-market center will encompass over 130,000 square feet.

You will also notice in our supplemental that we have added a Brooks Crossing project to the development pipeline. Those of you who have followed us for a while will remember Brooks Crossing is a joint venture with the city of Newport News, Virginia to bring an urban mixed-use lowrise development to the inner-city.

While somewhat smaller than our typical engagement this project is a showcase for the broad array of abilities present in our Company. With groundbreaking late last year our construction Company is under contract with the municipality to build over $15 million in infrastructure and public facilities.

We are also under contract to develop a $7 million police precinct that will be sold to the city upon completion. And finally we will develop for our own account a 38,000 square-foot mixed-use project that will be anchored by a long-term lease with a credit office tenant. Only a company with our broad based capabilities could take full advantage of these diverse opportunities.

And now to our exciting news of this morning. As I mentioned on our last conference call, we are focusing our development efforts on large Class A assets with a high barrier to entry. With the Baltimore Metropolitan area as well as major markets within the Carolinas being natural geographic points of expansion for our firm, this morning's announcement of our investment in the $93 million Point Street Apartments project allows us to take another significant step toward the next wave of growth for our Company.

Our 20-plus year presence at the Baltimore waterfront has been predominantly comprised of third-party general contracting work valued in excess of $1 billion, most notably the Four Seasons Hotel, the Legg Mason world headquarters and the Waterfront Marriott. These engagements allowed us to develop many long-standing relationships that are now manifesting themselves in investment opportunities beyond the realm of pure construction. These relationships when combined with the multifaceted nature of our Company across both product type and capability provides for some unique opportunities.

Point Street Apartments is an opportunity that arose from a multi-decade association with the principals of Beatty Development Group who control what we and many others consider to be the premier development track in the city and one of the best sites in the Mid-Atlantic.

Similar to the Town Center at Virginia Beach, Harbor Point is a mixed-use multi-asset development. Situated between the trendy historic Fells Point neighborhood and the dynamic Harboe East area offering spectacular unparalleled water views Harbor Point is anchored by the 900,000 square-foot mixed-use Exelon Tower that is currently being developed by Beatty Development Group and built by Armada Hoffler construction Company.

Point Street Apartments is expected to feature 289 units and 18,000 square feet of retail space. We have entered into an agreement with Beatty Development Group to collaborate on the Point Street project. The way we will participate demands some explanation but once again highlights the benefits of our integrated business model by emphasizing our ability to provide a platform for our partners that isn't easily replicated by other firms.

The structure consists of three separate agreements with Beatty Development. We will provide mezzanine financing up to $23 million which when combined with proceeds from a construction loan and the developer's equity will complete Beatty Development's capital stack.

We will have the option to purchase an 88% interest in the project at the developer's cost upon completion of the construction. And we will construct the building as a general contractor with a guaranteed maximum price construction contract.

By proceeding with the venture in this manner we do not stress our balance sheet during development and initial lease-up. We do recognize third-party construction fees and earn interest income on the mezzanine loan. Finally, the at-cost option to buy the 88% interest preserves the traditional development spread which we create on our development projects.

As you might expect this structure and the services we are providing within it appeal to a number of other developers who control desirable sites and need strong partners. This structure is particularly well-suited to multi-family development and we are currently vetting a number of similar opportunities.

Point Street Apartments when combined with our marquee project at Johns Hopkins as well as the 185,000 square feet added to the Company's portfolio from the two Maryland grocery anchored retail acquisitions will constitute a very meaningful presence for Armada Hoffler in Maryland, further diversifying ourselves into the broader Mid-Atlantic market. We believe that Armada Hoffler is the only REIT that provides investors the opportunity to benefit from all three profit centers in real estate.

Number one, the ownership of income property which is where most REITs focus. Secondly, the profitable development of world-class properties at wholesale cost through either portfolio placement or for sale to recycle the capital at a gain. And in-house construction which not only generates substantial profit for third-party business but also controls cost and schedules in our development projects.

We believe that this third factor is unique to Armada Hoffler across the entire REIT universe. We will continue to execute across these profit centers to maximize the investment returns of our shareholders.

And with that I will turn the call over to Mike and then we will take your questions. Mike?

Thanks Lou and good morning. Today I want to cover the highlights of the quarter including thoughts on our balance sheet and I will wrap up with our 2015 guidance.

This morning we reported FFO of $0.25 per share and normalized FFO of $0.26 per share which is better than our expectation. This was due to the increased profit in third-party construction business, continued strong multi-family leasing and lower property expense. Please see page 10 of the supplemental for the normalized FFO copulation calculation which this quarter includes debt extinguishment losses, property acquisition cost, development and other pursuant cost and mark-to-market adjustments for interest rate derivatives.

We had another strong quarter of same-store NOI growth. Same-store NOI was positive 2.9% on a GAAP basis and positive 5.7% on a cash basis compared to third quarter of 2014. We added two development projects to our core operating portfolio.

These properties are now stabilized and have been removed from the development pipeline. They are Encore Apartments and Liberty Apartments.

At the end of the quarter our core operating portfolio occupancy was 95.6%. Profit came in at 95.5%, retail at 96.2% and multi-family at 94.9%. Multi-family occupancy numbers declined this quarter due to the addition of Encore to the core operating portfolio.

From a construction front we reported a segment gross profit in the third quarter of $2.1 million on revenue of $54 million. Construction Company had another excellent quarter, one of the reasons the quarter was better than expected.

As we announced earlier our construction company signed a $94 million contract to build two Virginia Beach oceanfront hotels as well as retail and a garage. The owner of this project since decided to build the project in phases and delay the construction of one of the hotels. The contract was amended and reduced by $55 million to reflect this change.

The first phase of the project is under construction. Completion is expected in the spring of 2017.

At the end of the third quarter the Company had a third-party construction backlog of $118 million which includes the reduced contract I discussed.

Now turning to our balance sheet. In the third quarter we continue to take action to enhance flexibility and strengthen our balance sheet. We continued to use the ATM program last quarter as expected, raising $4.1 million of gross proceeds at an average price of $10.11 per share. We expect the ATM program to continue to be used as one of the multiple options at our disposal to raise capital to fund our development activity.

As you can see from our outstanding debt summary on page 11 of our supplemental at quarter-end we had total outstanding debt of $420 million including $106 million outstanding under the $150 million revolving credit facility. Our debt initiatives continue to be in line with our corporate goals.

As of September 30 our fixed-rate debt including swap locks was 52% of our total debt and including interest-bearing caps 77% of our debt was fixed or hedged. After quarter-end we purchased a $75 million LIBOR interest rate cap at 1.25%. Including this new cap 95% of our debt was fixed or hedged. We believe that using interest rate caps limits our exposure to rising rates while giving us flexibility at a reasonable cost.

As Lou discussed earlier on the call, the Point Street Apartments is not consolidated and therefore does not stress our balance sheet during construction lease-up. A project of this size and duration requires debt and equity for over two years with no return on that capital. With this project we have paid a return on our equity and earned a construction fee and during the development have an option to purchase a controlling interest in that property upon completion. Our investment is in the form of a $23 million mezzanine loan which bears interest at 8%.

As with any development project, it will take time for the project to ramp up. And we're not expecting much of an impact from this during the fourth quarter.

From a timing standpoint we do not expect the $23 million loan to be fully funded until sometime in the first quarter of 2016. The construction contract will be approximately $57 million with a fee of 3%.

The other new development project that Lou discussed is Brooks Crossing. We expect to fund this project with a credit facility due to its modest size.

I want to spend a couple of minutes reiterating the details of the Columbus Village acquisition. This acquisition was funded by the assumption of $8.8 million of debt and the issuance of 1.275 million operating partnership units. 1 million of these units do not earn or accrue dividends until July 2017 and 275,000 units will not be issued until January 2017 and do not earn or accrue dividends until January, 2018.

The interim dividend that would have been paid at the current dividend rate equates to $1.8 million. We view this as a reduction in purchase price of the center. It can also be viewed as a higher valuation of the OP units.

The 24- to 30-month period from closing that dividends will not be paid also coincides with the potential NOI growth at the center. Even though dividends are not being paid on these units the total 1.275 million units are included in our diluted share count for FFO per share calculations.

We closed on the Providence Plaza acquisition on September 1 for $26.2 million, representing a going-in cap rate of 7.25%. This was acquired by using $14 million in 1031 proceeds from the Whetstone sale and the remainder was funded through the credit facility. This property is unencumbered and will be added to the borrowing base of the credit facility along with two other properties to increase the capacity by $25 million. These changes to the borrowing base are expected to close during the fourth quarter.

On the asset sales front we closed on the sale of the Oceaneering building last week. The building sold for $30 million which represents a 6.6% cap rate. This is our fourth disposition in the past 12 months of an asset in a cap range of between 5.75% and 6.6%.

This sale is another example of the value and cap rates of our properties. The 20% profit on the sale is similar to the profit from the Whetstone sale is another example of the equity delivered from our development process. We intend to use the proceeds from the sale in a 1031 exchange.

Now let me walk you through our full-year 2015 guidance. This morning we raised 2015 full-year normalized FFO guidance now $0.91 to $0.93 per share from our previous guidance of $0.88 to $0.91 per share. We are increasing guidance due to the performance of third-party construction business and multi-family leasing.

Our 2015 estimates are predicated on the following assumptions: GAAP NOI in the $53.7 million to $53.9 million range, third-party construction Company gross profit in the $5.8 million to $6.1 million range, general and administrative expenses in the $8.3 million to $8.5 million range, interest expense in the $13.3 million to $13.5 million range, and 41.1 million weighted average shares and OP units outstanding which includes the units associated with the acquisition of Columbus Village. This guidance excludes the impact from future acquisitions, asset sales with the exception of Oceaneering or other capital markets activity with the exception of continuing the ATM program.

Before we turn to Q&A I would like to make a comment about 2016. As Lou discussed we signed an agreement to sell the Richmond Tower subject to the usual due diligence and closing requirements. Due to this uncertainty, the size of the sale and that we are still formulating our plan on how to best reinvest the proceeds it's too early to give any insight into 2016. We will give an update once we close on the transaction and have finalized our reinvestment plan.

I'll now turn the call back to look.

Thank you, Mike. And thank you for your time this morning and your interest in Armada Hoffler. Operator, we would like to begin the question-and-answer session.

(Operator Instructions) Rob Stevenson, Janney Montgomery Scott.

Good morning, guys. Can you talk a little bit about the Richmond office market and where other sort other competing assets have traded recently?

And then also with respect to that market you exit that on the office side with the sale of Richmond Tower. Is this a market that you'd want to be back in longer term or should we read into it that Richmond is part of this transaction that Richmond office is not in the long-term cards for the Company?

Thanks, Rob. I think it's the latter. We're obviously very happy with the assets.

It served us well. It's a marquee asset in that city. There is a competing product going up across the street from the project that's going to be similar in size and scope as ours.

That will represent the only two new office towers in the Richmond market. Actually when we build ours we were the first one in over 20 years to go into the downtown market.

So we're looking at it as more and more of an outlier with not a lot of upward pressure. And as I said earlier in reviewing it we as a rule over our 30-some-years history don't like to hold single tenant assets which this predominantly is for the long haul. And so that's what was behind the decision to divest.

Now we'll see, that's not a hard contract at this point but hopefully it will go along to closing. But I don't see us in the downtown market in any meaningful way in the future.

Okay. And best guess at this point is that like a second-quarter if everything goes well sale?

No, it will be before the end of the year.

Okay. Then and I don't know whether I missed it or whatever but did you, have you guys decided on a plan yet for Columbus Village?

We're evaluating several right now. As you know we're in partnership with the city and both of us are interested in expanding Town Center.

We're not certain just how vertical it's going to go or whether we'll re-tenant it and expand it horizontally. So we're going to bide our time there and let a few more cards be played.

Okay. And what are the leases sort of run on that, what's the earliest you could do anything on that site?

We just extended the Barnes & Noble lease for a period of two years. And so that's about when although we have the ability to relocate them as a part of the expansion. So I could see, I don't see much happening in 2016 but possibly towards the end having a plan finalized.

Okay. Thanks, guys.

Dave Rodgers, Robert W. Baird.

Mike, Lou, good morning. A couple of maybe yielded numbers question just to start off.

On the Richmond Tower is that I think a 7.5% cap rate. I'm assuming based on the length of the lease there that that's a GAAP number. Can you tell me if it is GAAP or cash and what they cash number would be on that?

Sure, Dave, good morning, this is Eric Smith. That is based on a pro forma cash number.

So that's the cash. What would the GAAP be on that?

It's between the 7.5 and 8 cap rate range on a GAAP basis, Dave.

Okay, that's helpful. Thank you.

The investment in Baltimore I think you went through a good amount of detail in terms of the mezzanine loan and financing. I did not hear if you quoted a yield of what you expect your stabilized investment to be. If you bought the majority share in the asset at this point you have a view on what that would be?

Sure, Dave, as we represented this is going to hit our traditional spread. We'd probably shoot for a 125 to 200 basis point spread. Obviously if you move down the cap rate curve that gets a little narrower but we're looking at 100 basis points plus.

I'm being conservative with that statement. A nearby apartment property just sold for what would end up being a 4.5 cap. We're not using that as a comp but I can tell you this is a better product than that.

But I think it's very reasonable that that waterfront real estate where rents are rapidly approaching $4 will trade in the 5.5 cap range. And of course our spread is going to maintain close to 7.

Okay, perfect. Thanks.

Last one on the numbers, the Liberty and Encore stabilized in the quarter. How did those come in relative to pro forma? And can you give us any types of sense of yield there as well on a stabilized basis now?

Yes, I think well Encore is still stabilizing. It's just hitting 90% or so now. It's a little bit above pro forma, a little bit better them what we thought and we'll see how that goes once it gets all the way home.

On Liberty to be honest with you we're not satisfied with the yields there. It's below pro forma. I mean it's great that it this thing's like 99% occupied, but we're not happy with the expenses the way they are coming in.

So we're going to take a hard look at that and see if we can't goose that a bit. But to be honest with you right now we're pleased with the occupancy but not pleased with the yields.

Okay, thanks. That's helpful to know.

With regard to your comment, I think you said there's more projects in the works maybe similar to the Baltimore project you just talked about today, the Harbor Point project. Would those also be in Baltimore? Are you looking more broadly, should we be thinking maybe down the coast toward Charlotte, Raleigh or were you talking specifically in the Baltimore region?

Both, Dave. The Baltimore Metropolitan area is a focus for us. We'll look at other opportunities there and as you know we're looking at opportunities throughout the Carolinas.

So we're excited about that program. Having a well-heeled 30-some-year-old construction Company gives us the ability to control costs through a different mechanism that isn't available to others and makes us very comfortable in making these kinds of investments. As we said it keeps it off of our balance sheet, keeps fees and income coming and maintains our spread. So I think as I alluded to as you can imagine there's a lot of developers out there that need strong partners, so we're vetting a number of opportunities at this point.

Last one for me, sorry, is Mike with the sale of the Richmond office tower slated to come in by year-end, what would you look at your total availability or total capacity kind of going into next year as?

Good morning, Dave. Capacity wise we look good. I think as we mentioned on the call we're going to increase the capacity under our credit facility by $25 million.

The way we're doing Harbor Point it's not going to stress the balance sheet. And actually we're going to create EBITDA through the mezz interest as well as the construction fees, so that one's taken care of from that standpoint.

So from that standpoint balance sheet all looks good. We're going to end up with a lot of cash between the sale of Oceaneering and the sale of (inaudible) and now we're in a great position of looking at how we want to reinvest that money.

Okay great. Thanks, guys.

We have reached the end of our question-and-answer session. I'd like to turn the floor back over to management for any further or closing comments.

Thank you for your time this morning. And thanks for your interest in our Company. And we look forward to updating you again soon.

Thank you. That does conclude today's teleconference.

You may disconnect your lines at this time and have wonderful day. We thank you for your participation today.