Douglas Emmett Inc (DEI) 2006 Q3 法說會逐字稿

Good afternoon ladies and gentlemen. Thank you for standing by. Welcome to the third-quarter 2006 earnings conference call for the accounting predecessor of Douglas Emmett Inc. Today's call is being recorded. At this time all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. (OPERATOR INSTRUCTIONS). I would like to remind everyone that this conference call is being recorded.

I would now like to turn the conference over to Ms. Mary Jensen of the financial relations board. Please go ahead.

Thank you. I would like to thank everyone for joining us today. If you do not have a copy of the release, you may access it on the Company's website at www.douglasemmett.com, under the investor section.

During the course of this call management will be making forward-looking statements which are subject to uncertainties and risks associated with the business and industry. For a more detailed description of these risks, please refer to the Company's press release and the current SEC filings. The source of the market data that will be referenced in management's statements is CB Richard Ellis for the office market; MTF Research for the Honolulu multi-family market; and property and portfolio research for Los Angeles multi-family market.

I would now like to introduce the members of management with us today who will be providing remarks, Mr. Jordan Kaplan, President and Chief Executive Officer, and Mr. Bill Kamer, Chief Financial Officer. Also joining us today from management is Mr. Andres Gavinet, Executive Vice President of Finance.

With that I would like now to turn the call over to Jordan for his opening remarks. Please go ahead, sir.

Thanks Mary. Good morning everyone and welcome to our first earnings call following the completion of our IPO on October 30. A little later in the call they will cover some of the highlights from our IPO in more detail. But I want to tell you how pleased I am with the reception that our offering received in the public marketplace. We initially set out to offer 55 million shares at a range of $19 to $21 but ultimately sold 75.9 million shares at the high end of that range for approximately $1.52 billion in net proceeds and were significantly oversubscribed.

Now that our IPO is completed we're half way back to running our business on a full-time basis. The economic climate in Los Angeles and Hawaii remains strong. For the first nine months of 2006, the overall unemployment rate for L.A. County declined 20 basis points to 4.8%. Hawaii's September 30 unemployment rate was 2.6%, one of the lowest in the nation.

The Los Angeles County office markets continued to perform well. At the end of September, office occupancy for Los Angeles County was 90.8%, up from 88.8% of a year ago. The average asking rents for office for Los Angeles County rose to $28.44 per square foot at the end of the third quarter of this year, a 6.3% increase over one year ago.

The occupancy in the ten sub markets in which our office properties are located increased 93.3% by the end of the third quarter of this year from 91.2% at the end of the third quarter of 2005. Our office portfolio lease percentage was 93.7% at quarter end despite the inclusion of our Warner Center and Trillium properties in Woodland Hills and Bishop Place located in Hawaii, which we acquired in recent years with significant vacancy. If we exclude these three office properties, our overall lease percentage for all of our other office properties was approximately 96% at the end of the third quarter, which we think is around stabilization for our portfolio.

Office run rates have also increased in our Los Angeles sub markets in the third quarter with average asking rent in our Los Angeles sub markets climbing 7.1% to $32.30 per square foot since the end of third quarter of 2005. Within our Los Angeles office portfolio, the spread between our average asking rents to our in-place rents has grown since June by about 300 basis points to slightly more than 17.5% at the end of the third quarter of this year.

Overall the fundamentals are as good as we have seen them in most of our Los Angeles sub markets. Most significantly new office supply in our submarkets remains firmly constrained. Assuming that all office projects planned, proposed, or under construction in our submarkets are completed by 2008, we believe that the average increase in competitive inventory will be just above 1% across all of our current submarkets with no new additions to supply in the majority of our submarkets.

The Honolulu Central business district office submarket also continues to perform well. By the end of third quarter occupancy rose to 92.4% and average asking rental rates increased to about $31.56 per square foot, a 10.5% increase over one year ago with no new supply on the horizon.

For our Honolulu office buildings, the spread between our average asking rents to our in-place rents has grown since June by over 150 basis points to almost 4% at the end the third quarter of this year. On the multi-family side both the West Los Angeles and Honolulu submarkets continue to perform well with overall submarket occupancy totaling 97.8% and 94.9% respectively. Our multi-family portfolio occupancy at the end of September was 99.4% in West Los Angeles and 98.4% in Honolulu.

While we are fortunate to have the wind at our backs as we settle into our new role as a publicly traded REIT, we know that we have a lot of hard work ahead of us. As we have said in the past, we continue to look for opportunities to acquire attractive office and multi-family assets in our submarkets and comparable submarkets.

With that, I will turn it over to Bill for a view of our third-quarter results and then we will open it up for questions.

Thanks a lot, Jordan. Before I begin I want to thank everyone for joining us today. As you know, yesterday we released our third-quarter operating results for our predecessor and our supplemental disclosure package. Before I comment on that information, let me do a quick recap of our IPO.

As Jordan mentioned, on October 30th we completed our IPO, selling a total of 75.9 million shares including a 20% upsize in the original offering as well as the underwriters 15% over allotment, which was immediately exercised. Upon the completion of our IPO, we raised $1.52 billion in net proceeds from the sale of our common shares. We also upsized our term loan facilities with Barclays and Eurohypo by additional $545 million, bringing the total of these loans up to an even $2.3 billion.

We also consummated our secured line of credit with Banc of America and drew $35 million under that line of credit facility. We redeemed about $1.9 billion of prior investor interest. We repaid approximately $151 million in mortgage debt and we retired approximately $185 million in preferred equity.

On pages 10 and 11 of our supplemental, we lay out our debt structure after the completion of the IPO. As we mentioned in our press release, we entered into $545 million of interest rate swap agreements on October 31 at a strike price of approximately 4.9%, which effectively fixes the interest rate on those additional borrowings at 5.75%. All of our outstanding debt other than our secured line of credit is now swapped to an effective fixed interest rate of 5.09%. Based on our current stock price, our debt to total market capitalization is approximately 39%.

Now moving to our operating results, as most of you anticipated, the reported third-quarter numbers are not very meaningful as a proxy of our future results for a number of reasons. First, we are required to report results from our accounting predecessor, which means that we had to omit the results from some of the entities which we acquired in connection with the IPO. Those omitted entities provided management, leasing, and construction services during the applicable periods and owned four office properties, three multi-family properties, and the fee interest in one parcel of land.

Since we were advised that it is considered inappropriate to provide pro forma financial information for the consolidated enterprise, we are unable to report FFO for the periods prior to the completion of our IPO and we will not report financial results for a full quarter on a consolidated basis until we report the financial results for the first quarter of 2007.

Even for the entities which are included in our third-quarter financials, the results do not reflect a number of significant changes in our future accounting caused by our IPO and the related acquisition. These changes include the purchase accounting adjustments that need to be made as of the date of the IPO, for the FAS 141 rent adjustments, for straight lining of our rents, and for the value of our in-place interest rate swaps. In addition our results may also be affected by potential future property tax reassessments resulting from our IPO transactions. The property tax issue will play out in uncertain ways over a protracted period of time.

Our reported results from 2005 and 2006 were also significantly affected by other items which will not recur in the future. In periods prior to the IPO, we were required to report changes in value for our in-place interest rate swaps. The impact of this was large invariable, resulting for example in a loss of $54 million in our 2006 third quarter compared to a gain of $56.3 million for the third quarter of 2005. Fortunately we entered into offsetting swap agreements at the time of our IPO so that future fluctuations and the value of our interest rate swaps should not impact our financial results.

Our predecessor's third quarter 2006 G&A expense also includes approximately $9 million of the total of approximately $13.5 million in bonuses that was paid to approximately 265 employees around the date of the IPO. This was a onetime event and had these bonuses not been paid to the predecessor's employees, such amounts would have been payable as distributions to our predecessor's principals. Because of these factors, we will not spend the usual time in this call discussing those results. Instead we will focus on some of the third quarter operating statistics that we have provided in the 10-Q and in our supplemental package in order to give you some color on our progress.

On pages 14 and 20 of our supplemental package, you'll note our following leasing statistics for the quarter. We leased a total of just under 500,000 square feet of space signing a total of 130 new and renewal deals. Our overall office portfolio was 93.7% leased as of September 30, 2006, which was an increase of 60 basis points compared to the second quarter. This lease percentage amount includes 260,292 square feet that was leased but were rented not commenced as of September 30.

Our net absorption during Q3 was a positive 78,000 square feet. Our tenant improvements and leasing commissions and other capitalized leasing costs for leased transactions were $17.62 per rentable square foot as compared to $18.06 for the six months ending on June 30, 2006. On an overall basis, our leasing results for the third quarter were very much in line with our expectations.

For all the reasons that I have mentioned, the third-quarter results of our predecessor are not very meaningful as a basis for projecting future results. Therefore we are not in a position to provide guidance at this time. As we move forward we will continue to assess the appropriateness of guidance and will keep you posted.

With that I will now turn the call over to the operator so that we may take your questions.

(OPERATOR INSTRUCTIONS) Michael Bilerman, Citigroup.

I was wondering if you guys can provide an update on the three assets from the repositioning -- where you stand now, what the outlook is, and sort of the timing of getting those up to stabilization?

Well, I think we are making essentially the progress we expected to make. The lease up is going pretty well. Bill, do have the actual stats on what we've moved that -- that group of three buildings?

Yes, well with regard to the Warner Center submarket, you know the overall leased percentage which is referenced on page 14 of the supplemental, increased from 80 to 86.3% from 84.1% at the end of June, so that is both of those two repositioning assets. So we remain confident in our expectations about stabilizing those assets by the end of next year, which has been our goal along.

In Hawaii, our overall assets, the other two assets there rose 40 basis points to 90.6% from 90.2%. So we are confident that we are remaining on track to do the lease up that we've been discussing.

Maybe you can just give us some color on the 500,000 square feet of leasing that you did in the quarter. Just give us a sense of where those lease bumps were relative to the expiring leases both on a renewal basis and on the new leases?

Okay, let's see. On the 500,000 feet I think on a cash basis we moved things up about 2%. In terms of our average unit in place to where we're looking at deals today, that number has moved up quite a bit since let's say our road show, we were in the 14% range and now we're in the 17% range.

How would you compare it being up 2% in the leasing that was done in the third quarter relative to the larger spread we see it today? Was there -- is it a mix issue? Was the leasing done in certain assets?

Actually if you think about the cycle of our market over the last five or six years, the end of 2001 was very strong with the dot-coms, so it was sort of one of the leasing rental rate peaks. So that's tough as it compares to this quarter and rolls off compares at least favorably to the rents that we're getting today. As we move forward in the quarters you'll see that spread widen quite a bit because they will be rolling off leases that were done in weaker markets and rolling onto leases that I assume are going to be negotiated in much stronger markets.

And when you look at the 2% you said that was a cash basis. What would have been the GAAP number including I guess you are now having a little bit of higher bumps in your leases so was your average to average a little been higher than 2%?

You know, we have not gone back to recalculate it on a GAAP per GAAP basis but I think you can safely assume that entrees and raise Anders that you probably would be 10 to 12% higher on a GAAP basis assuming 3% bumps on an annual basis for the leases at 3% to 4% that we're getting now compared to the 3% that we already had on the leases that are expiring.

Great. Thank you very much.

David Harris, Lehman Brothers.

Bill, I think you referenced Prop 13 in your prepared remarks. Do you today have any more clarity on the magnitude of the impact than you did at the time of the road show?

The short answer is no.

Okay. Moving on. If we look at the TI for the quarter, is that a reasonable run rate or is there something aberrational about the third quarter number?

No, you know for the third quarter I think you see on a blended basis that is what we played it out on the supplemental package. We are about $17.62 for the quarter which I think sequentially seems to be kind of in line with our expectations. For the first six months of the year we were just over $18. So I think those are kind of the overall results that we were kind of expecting.

Okay. I've got a bigger picture question. This probably for you Jordan, I think. When we look at the state of the market, obviously it looks as if rents continue to power ahead. How many tenants are you speaking to on renewals or even a prospective basis where you're getting to a point of resistance where rents are going up so aggressively that it is going to be difficult for these people to pay rents? And on a forward basis we can anticipate perhaps higher levels of turnover in your portfolio simply because rents are spiking up so aggressively?

You know, we've talked about this before. I am real comfortable that there is a lot of running room in the rents. If you think about the character of our leases and our tenants, it is a smaller tenant portfolio and rent as a percentage of an expense of running their businesses is tiny. You could double it and you still would not have rent and everything else be more than let's say 10% of their operating costs with personnel being somewhere in the 90s, in low 90s.

So I think there is still a lot of room in the rents and I don't think we have gotten any resistance from anyone. Generally we don't have a type of portfolio tenants that are evaluating let's say West L.A. and comparing it to moving to Phoenix. They are comparing one building to a building that is like a block away and what they care about is that they are not paying more than the guy that is down the hall from them. So I am real comfortable that we have a lot of room and I haven't heard any anecdotal information that we're getting resistance on an absolute level in terms of threats that are going to move out of the market.

Just to expand you on that point, you guys go back with plenty of experience and the suffering going through downturns in this market -- if we go back to the early '90s. Where the tenants that were price sensitive then or is it really -- or are you going to tell me that there's really no price sensitivity among -- (multiple speakers) property tax (multiple speakers).

What we saw was a move up. They were price sensitive from the perspective that a lot of guys that had historically been in Class B spaced moved into the Class the space in our markets. So we were able to keep -- the Class A billings really never hit dramatically low occupancy levels the way the whole market did, but you had a big sort of move in -- a shift, and then when things strengthened, they shifted back to the B level properties. So that was more the price sensitivity move that we saw.

Someone was running an operation like I remember an insurance company moved into the -- I don't know what is now called the Yahoo Center and it was MGM or whatever -- they moved into a couple hundred thousand feet. We were laughing. Back office space in that project which in the past had been thought to be a very expensive project to be an. Well, as soon as rents strengthened they moved back out again.

Okay, thanks. Still enjoy being a public company?

For the moment. We have not had a lot of time to get a good feel of it yet, but we are working on it.

All right. Thank you.

Steve Sakwa, Merrill Lynch.

Just one quick question. In looking at the information on your apartment portfolio on page 15, the monthly rent per leased unit is $1707 and as I look back to some of the information that was I guess in the prospectus, that number was 1725. I believe that was as of 6-30. It looks like there is a big drop-off in the Honolulu number and I'm just wondering if you can maybe explain that or tell us what happened there?

I'm hoping Andres can.

Not really. Steve, Honolulu, we have a slight dip this quarter on an overall basis I think we still are kind of flat from the second quarter to the third quarter. But the numbers that we have going into this quarter, I mean they are what they are. There's a couple of [liens] on a couple of units there but nothing significant that I would call attention to.

I have not been getting bad news out of there. There is --

We have heard about -- there were definitely there were the troop redeployment seems to have impacted the market slightly during the third quarter and that is where you saw the overall market -- the occupancy decline just slightly from the June 30 level.

Is it possible that they are paying sort of not a subsidized rent and so the reason that those units that came off line, which I think was maybe 17 units in total occupancy, could they have been sort of higher rented units?

I don't think that's what's going on. I think that you just have some fluctuations there that are minor and I would just call them noise more than identifying a trend.

Okay. Jordan, just the investment landscape. Cap rates, product, how you feel about it today, any differently than you did 60, 90 days ago?

Well, I don't feel dramatically differently about it. I mean cap rates are low but justifiably so. We just went through some of the comparative movement in our portfolio and what's going on with rents and as I have said in the past, when we were buying deals in the '90s, we had to predict the bottom, when we're going to hit the bottom and then when we were going to head back up and then how fast we were going to head back up. It seems a lot easier to do today just because we are already headed up and I don't see any new construction on the horizon, so I don't think things are dramatically bubble valued right now the way I have been reading in a couple different pieces, at least not in the markets we are in.

Okay. Then just to maybe circle back on David's question about Prop 13, can you just remind us the process that you guys go through, how this unfolds over the next three, six, nine, 12 months?

Yes, basically it's a big portfolio. We have to get through a couple of levels of discussion. The first level of discussion is should we be reassessed which it is likely that we will be reassessed. But we have some very strong arguments for why we shouldn't be. And then once that happens we have to go through because in a typical deal where there's a sale of a building, the presumption is that the sale price is what you use for that building. That did not happen here. So actual values have to be determined for each of the buildings.

That is a very long process with the assessor who we have a good relationship with but they are tough and they work hard to generate revenues for the county and the state. So we will go through that process and it takes -- I would be surprised if it is done in a year.

So there's likely to be no sort of the impact for 12 months and then we would likely see something more likely in 2008? Or do you begin to accrue for what think may happen?

Yes, we are accruing for an estimate now so that we don't get surprised or shocked and we are hopeful that the estimate that we've made that we are accruing for is on the high side so that what we have is good news going forward. So we are actually accruing an increase in our property tax expense combined with the offset that is passed through to the tenants right now.

Okay, thanks very much.

At this time I will turn it back over to Mr. Kaplan. Please go ahead.

Okay. It looks like we didn't have a lot of questions which I am happy for. Thanks a lot, everybody. It was a pleasure speaking with you and I look forward to this call next quarter.

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