Eastgroup Properties Inc (EGP) 2004 Q2 法說會逐字稿

Good day. All sites are in the listen only mode. Thank you for joining the EastGroup Properties second quarter 2004 earnings conference call. [Operator Instructions] At this time, I would like to hand the conference over to your host, Mr. David Hoster, President and CEO. Go ahead, please.

Good afternoon and thanks for calling in for our second quarter 2004 conference call. We appreciate your interest in EastGroup. Keith McKey, our CFO, will also be participating in the call. Since we will be making forward-looking statements today, we ask that you please listen to the following disclaimer covering these statements.

The discussion today involves forward-looking statements. Please refer to the Safe Harbor language included in the Company's new release, announcing results for this quarter that describe certain risk factors and uncertainties that may impact the Company's future results that may cause the actual results to differ materially from those projected. Also the content of this conference call contains time-sensitive information that is subject to the Safe Harbor segment included in the news release is accurate only as of the date of this call.

Thank you. Operating results for the second quarter met the midpoint of our guidance with funds from operations of 61 cents per share. This was the same as last year's results which included 1/2 a penny per share in gains on securities.

FFO for the first six months was $1.20 per share as compared to $1.21 per share for the first half of the three which contained 2 cents per share of securities gains.

Please note that we continue to calculate funds from operations based on Nareit's definition of FFO which excludes gains on depreciable real estate.

From my standpoint, the most significant second quarter operating statistic is the continuing trend in positive same property operations. In the second quarter same property results increased by 2.5 percent on a GAAP basis which included straight lining of rents. And without the straight lining, same property quarterly results improved by 1.4 percent.

This was the fourth consecutive quarter of positive results for both GAAP and cash basis statistics. Improving occupancy levels continued to more than offset the decrease in rents experienced with lease rollovers.

On a GAAP basis our best major markets were Houston -- which was up 12.5 percent -- and New Orleans, Orlando, and Phoenix, all 3 of which were up approximately 10 percent. The markets significantly worse were the fact San Francisco Bay Area, down 23 percent. Dallas, down 15 percent. And South Florida down 8 percent. Both the same property increases and decreases are primarily due to swings in occupancy levels between the 2 periods.

Although our June 30 occupancy of 91.4 percent was slightly below our March 31 level, it was above both last year's June total and our projections for the second quarter. The decrease from the first quarter was mainly the result of several large scheduled move-outs in New Orleans and Dallas. And the 58 percent occupancy of development properties added to the portfolio during the quarter. These factors more than offset an otherwise general improvement in occupancy for the balance of the portfolio.

If the development properties had not been added to the portfolio in the second quarter, occupancy would have increased 92.1 percent at June 30.

Our strongest leasing results have been in our Florida markets which, at the end of the quarter, were 96.3 percent leased with Orlando and Jacksonville at 99 percent and Tampa at 96 percent. Occupancy at quarter end in our four core states of Florida, Texas, Arizona and California were 92.7 percent as compared to 84.3 percent in our noncore markets.

Looking at second quarter leasing statistics, we renewed or released 69 percent of the 1.1 million square feet that expired and leased another 353,000 square feet of vacant space. Combining both renewals and new leases, we experienced the following. Average lease length was 3.7 years, average lease size was 12,100 square feet. There was an average decrease in rents on a cash basis of 6.6 percent, consisting of 7.6 percent decrease on new leases and a 5.9 percent decrease on renewals.

And the average costs of tenant improvements was $1.20 per square foot over the life of the lease.

These statistics are fairly similar to those for the first quarter except that the average lease length increased by 6 months and the decrease in rents improved for the second consecutive quarter.

An analysis of the reasons customers do not renew their leases shows that in the second quarter approximately 55 percent of the square feet vacated last year was due to a move from the submarket, 26 percent the result of changing space needs, and 12 percent due to the customer purchasing or building their own facility.

During the second quarter, we transferred 5 properties with 382,000 square feet from development to the portfolio. These included three World Houston buildings 17, 19, and 20; the first phase of Executive Airport Commerce Center in Fort Lauderdale and Expressway Commerce Center in Tampa. The 5 properties represent a current total investment of $19.8 million and are 60 percent leased and 58 percent occupied.

In late May, we began construction of World Houston 16. It will contain 94,000 square feet, with the other projected total investment of approximately $5.1 million and will increase our World Houston ownership to over 1.4 million square feet.

In early August, we plan to begin construction of site improvements in the first two buildings at our Southridge development in Orlando. About the same time, we will start construction of our final building at Executive Airport Commerce Center in Fort Lauderdale.

These three properties in total will represent a projected investment of approximately $12.2 million, with 165,000 square feet.

At June 30, our development program consisted of 6 properties. 3 in lease up and 3 under construction. They represent 458,000 square feet with a total projected investment of $25.4 million and are currently 33 percent leased.

Our development program continues to be geographically diversified in 4 different cities and 5 different submarkets. Our average development is 76,000 square feet with an investment of $4.2 million or $55 per square foot. Leasing activity at our development properties has been relatively good in Phoenix and our 3 Florida cities but slower than anticipated in Houston. Houston prospects still seem to be more cost-conscious rather than quality-conscious in this stage of the cycle.

As we repeatedly state, our development program has been and will continue to be a major contributor to FFO. The development starts this year are laying the foundation for FFO growth in 2005 and 2006.

We did not have any acquisitions during the second quarter, but in the first week of July we purchased Interstate Distribution Center IV for $3 million. Located in the Walnut Hill Stemmons Freeway submarket of Dallas, it is a 46,000 square foot business distribution building which was constructed in 2002. It is 100 percent leased to 9/10ths.

Looking at the balance of the third quarter we currently had the Alamo Downs Distribution Center in San Antonio under contract to purchase. This 253,000 square foot two building complex is 59 percent leased and is one of our typical value at investments. San Antonio is a new market for EastGroup and we see the potential for growing our ownership there over time between 1 and 2 million square feet.

We also believe that a portfolio of properties in San Antonio will complement our operations in Houston, Dallas, and El Paso.

In the last week of June we closed on the sale of our 26,000 square foot GetWell Distribution Center in Memphis for a price of $790,000 and recorded a small gain for the second quarter. In the first week of July, Sample 95 Business Part III with 18,000 square feet and Pompano Beach Florida was sold for a price of $2 million.

The transaction generated a gain of approximately $1,280,000 which will be recorded in the third quarter. The GetWell sale reflects our strategy at reducing our ownership in Memphis as market conditions permit. The Sample 95 disposition was an opportunity to recycle capital on an attractive basis into an investment with greater anticipated upside.

We currently have an older warehouse in Dallas under contract to sell with closing anticipated in mid-August and are actively marketing another Memphis property for sale.

I now will turn the call over to Keith to talk about finances.

Good afternoon. There was an error in the first supplemental package we sent out on page 14. Core market operating statistics contained the first-quarter information instead of second-quarter information. This has been corrected and a new supplemental package has been issued and posted on the website. We apologize for any inconvenience.

Debt to total market capitalization was 32.5 percent at June 30, 2004, compared to 36 percent a year ago. For the quarter, the interest coverage ratio was 3.7 times and the fixed charge coverage ratio was 3.3 times. Our floating rate bank debt amounted to 6.9 percent of total market capitalization at quarter end. As noted in our press release on May 17th, 2004, we signed an application for and locked the interest rate on a 30.3 million nonrecourse first mortgage.

The loan -- which is collateralized by 6 properties -- has a 10-year term and a 30-year amortization. The loan is valued at approximately 75 percent. We locked the rate of 5.68 percent which equates to 99 basis points above the rate on a 10-year treasury rate of 4.69 percent as of May 17th, 2004.

As usual, we had the right of property substitution. We also negotiated interest-only payments in the first two years and 120 days from rate lock to closing. And this is usually a period of 90 days. So closing is scheduled to take place on September 15th, 2004. By delaying closing as long as possible we are able to take advantage of our low-interest floating bank line debt and we will save approximately 75,000 per month.

Our three-year bank line expires in January 2005. And we have started the process of renewing this credit facility. We believe that we will be able to lower costs from the present terms. We have one remaining mortgage that matures this year and it can only be repaid at maturity -- which is August 1st -- and amounts to $1,638,000. We were able to pay off a mortgage on July 1st that was actually due on January 1st, 2005. And the loan had a balance of 2,178,000 with an interest rate of 8.75 percent.

FFO per share for the second quarter was the same as last year's results. This thankfully breaks a string of negative FFO growth, dating back to the second quarter of 2002. Bad debt expense and lease termination fee income were minimal this year and last year. Other income decreased due to no security gains this year and 107,000 for the quarter and 389,000 for the six months of last year.

G&A cost have increased due to the reasons mentioned in the first-quarter conference call of compensation expense and outside accounting costs due to compliance with the Sarbanes Oxley requirements.

In June we paid our 98 consecutive regular quarterly dividends. The quarterly dividend of 48 cents per share equates to an annualized dividend of $1.92 per share. Our FFO payout ratio was 79 percent for the quarter.

FFO guidance for 2004 was narrowed to a range of $2.45 to $2.50 per share and earnings per share estimate to be in the range of 93 cents to 97 cents.

Now David will make some final comments.

In summary we continue to be optimistic about future operations. Every one of our markets is experiencing improved leasing interest and activity from real prospects as compared to a year ago.

Same property operating results have been positive for four straight quarters. Our balance sheet is strong and flexible. And our development program is well-positioned to make an increased contribution to FFO growth. Our strategy is simple and it's working. Quality multi tenant buildings cluster around major transportation features and growth markets.

Keith and I -- excuse me -- are now eager to take any questions you might have.

(OPERATOR INSTRUCTIONS) Jonathan Litt from Smith Barney.

John Stuart here with Jon Litt (indiscernible) as well. Keith, on the mortgage -- the $30 million mortgage at 5.68 -- is that in lieu of the what you'd issued guidance for in the first quarter at 25 million at 5.6 percent?

Yes. We originally thought we would raise about 25 million and then the package a little stronger than wait anticipated and raised a little more more money.

So it looks like this issuance will be about obtaining dilutive in terms of slightly higher coupon and the larger size of the issue.

We have already put that in the projections.

Okay, but aside from that the only other change that I see to your guidance is assuming that occupancy would be 100 basis points higher, so I guess I'm a bit confused as to why you would lower the top end of the range?

The top end of the range had some other items that would come in also. For example, more acquisitions, development being a little stronger. We did not list all the assumptions that we had in there for the high end of the range so there were some other things that we thought maybe we could do that we're kind of backing off on now.

The other factor, John, was we had anticipated initially when we put out the guidance that the decrease in rents would have improved a little bit faster than it has. And we started a little deeper in the hole in the first quarter than we anticipated so that is as Keith said drawn in with how we estimated a $10 million purchase of properties by the middle of the year for profit we're going to do better than that in some of those acquisitions like San Antonio is going to have a lower occupancy initially. And we have some sales that we didn't budget in and to be honest with you, we thought we were going to be a little bit luckier in terms of buying some more properties by this time which would've pushed us to the higher end of the range.

David, could you maybe expand a bit on your comment with regards to the sample 95 disposition that you expect to recycle capital and to an investment with greater anticipated upside. What specifically did you have in mind there?

Not to give you more detail than you needed but I guess I always do that. This is an investment single tenant building that tenant had moved out of. It had some older refrigeration in it, user for the building came along. Current tenant rent runs I guess to the end of this year. Based on that rent it was a low 8 cap rate on the sale based on analysis which we assume we were going to have to take the refrigeration equipment out because of its age, rehab the inside of the building and release it. We calculated this was about a 5 cap rate on the sale of this little building.

And every now and then you get a price that's just too attractive not to accept. And so we are investing that money not as an exchange but from a practical standpoint into the property we just bought in Dallas.

You said it was a low 8 percent cap rate on the sample.

On the rent that will be paid through the end of this year. I'm calculating having to rehab the interior of the building and release it, based on being a warehouse rather than a building with refrigeration. Looking at next year's numbers, it would have been about a 5 cap rate.

And lastly, David, if you can kind of reconcile your comment about Houston being more of a price conscious vs. quality conscious market at this point vs. I guess with deciding the go-ahead in breakdown on the World Houston 16.

World Houston 16 is very similar to our World Houston 13, which is geared to smaller tenants with higher office finish. It has more glass across the front -- storefront glass. A little higher parking ratio. And the way the building steps back, we can lease spaces down to the 5 or 6,000 square foot base for customers. World Houston 20, which we've been very frustrated with, we've got a number of prospects but no real good lease proposals out. It's designed for tenants in really the 20 to 60,000 square foot range and we've not had any real interest at that level.

Our World Houston 19 which is really in between the other two in terms of the type space, we are about 50 percent there and have prospects to improve on that. So we just felt that with the different type space with what we viewed as an improving market over the next six to 12 months, it made sense to kick that building off.

(OPERATOR INSTRUCTIONS) Keith Mills from UBS.

This is actually (indiscernible) with Keith Mills. My question is related to the Dallas Waldon (indiscernible) submarket acquisition. Could you just generally comment on the outlook for this particular submarket given your asset base here?

It's a close in -- what we refer to as an in-field market. There is very little land for new development and most of that is becoming commercial or restaurants. As a result, the occupancy -- excuse me the vacancy level in this submarket historically has run 2, 300 basis points below Dallas's average vacancy for industrial. We've just done very well in this submarket. Some of the property being older because that's the nature of it and we saw this as an interesting opportunity with a newer building and geared to smaller customers than what most of our other buildings in the submarket are. We would love to continue to buy in the submarket because of its strength.

My second question was related to the Tampa market. I noticed that these rental rates for new variable lease was actually positive (ph) while occupancy was dropping. Is this more due to one-off lease or is it to be interpreted as some sign of the strength of the market?

I think our occupancy dropped there for two reasons. One is that our Expressway Commerce Center -- which is about 2/3 leased -- came into the portfolio so that third vacancy there knocked us down a little bit. Also we had an expanding tenant in another one of our Tampa airport properties. We were going to lose them if we didn't move them into Expressway so we did that. And we picked up that vacancy. So that combination, I think, was the main reason that we were knocked down in Tampa. Rather than -- our average tenant size in Tampa I can't give you right this second but it's the smallest in the portfolio. And with the smaller tenants, you have more pricing power. And so as a result, I think that we've done better with rents there than in some of the other markets.

My final question is regards to the small tenant segment. Other than the lack of bankruptcies this quarter are you seeing any particular improvements in leasing or renewal activity?

No,it's -- our numbers would have been up without the development vacancy going into the portfolio. Just overall, even in some areas where our occupancy has not gone up, we've seen increased activity. And the very positive aspect of that is that that activity is from real prospects. These are companies that are out looking to sign new leases, either to move into the market from another area or to expand and meet their new needs in the market already.

So good things are happening in the marketplace. In some markets we've gotten a better share of it than in others. Phoenix is one where there's a lot going on but our occupancy has not improved. But I think that will come with time there.

(OPERATOR INSTRUCTIONS) Tony Howard from Hilliard Lyons.

Couple of questions. In the past conference calls you've always talked about Memphis. Can you give us an update on that. And are you seeing any kind of improvement there?

Actually our occupancy has inched up a bit there. Every time we sell a building it's usually going to be a leased building so it's going to hurt the occupancy a little bit but we have seen increased activity there. It tends to be for shorter term leases but we're not ready to get excited about the market. It sure seems to have bounced off the bottom. That's not changed our thinking about continuing to sell assets there as -- the asset occupancy and market conditions allow us.

You mentioned as far as the San Antonio new market. Are you going to put it in your tables on the core market side and 2, what are some of the dynamics or the reason why you see that as an attractive market?

Sand Antonio will be included as a core market in Texas our fourth market there. We've been looking in San Antonio for actually a long time and came across this current opportunity that I don't think was very well marketed and get us from the standpoint of being able to buy well below replacement costs, do some positive leasing and give an above average yield. San Antonio, geographically, is the eighth largest city in the country. It has benefited, somewhat, from NAFTA trade.

It is just -- I have announced I guess in the last year a new Toyota truck plant that is going to be built there. That should help pick up activity. It's just a very solid city with solid growth. It currently has above-average vacancy rate on overall industrial. But on a Class A basis it's just about 8 percent vacant and we would categorize our 2 building property there is Class A. One of the buildings was built in '86 and the other in 2002.

So we think it will be a good, steady industrial market. At the present time, Prologis (ph) tends to dominate the market. They are the biggest institutional holder there but we see opportunities in several submarkets to have our kind of product in our kind of location.

Final question. Given the low cap rate environment and possibility of rates rising, I'm a little surprised that you for the second quarter and also maybe for the first half of this year that you have not had more sale of properties. Can you give a reason why and can you kind of give a reason why? And was it just the difficulty finding the people willing to buy or what?

Really two factors, I'd say, Tony. One is that the markets that we want to sell out of -- Oklahoma, Memphis, selected other properties -- are not the popular institutional markets. So you're not seen experiencing the lower cap rates there. Our property in Dallas that I mentioned we have under contract to sell. It's over 40 years old and it's more of a manufacturing building really than a warehouse.

So those type properties are not in demand institutionally where you read about 7 percent cap rates. Secondly, some of the bigger properties that we would like to sell, possibly, we have not gone ahead to sell them because we haven't had the opportunity to reinvest the proceeds. So what we're trying to do is match up sales with purchases. And in an environment where there are not a lot of quality individual buildings being sold today, that could be difficult to do. So you could just continue to see selected sales from us that fit our strategy of dispositions.

At this time, it looks like we only have one more question. (OPERATOR INSTRUCTIONS). Paul Puryear from Raymond James.

Good job with the name there. I guess following, David, on that last question can I assume that asset pricing hasn't really moved? Can you just address that a little bit?

No. I would say that even the interest rates have moved up a little bit it's probably only affected a syndicator type buyer who is generally not competing for the Class A properties and the primary distribution markets. It appears that the institutional buyers, the pension fund advisors are still geared to the lower cap rates. They have money to put out. They haven't been able to meet their quotas so they are keeping cap rates down and prices up. Also the number of the packages we see seemed to in the last six months have more cats and dogs in them than the higher quality properties.

I think a lot of people are not sellers today, because they say if I sell this good property what am I going to do with the money? And so they might -- they figure they might as well hold on. So we're just not seeing a lot of opportunities to buy.

In addition, we have now another competitor in the marketplace. Dividend Capital out in Denver. They're an aggressive buyer of industrial properties in the Southwest, anyway, so far.

I mean, surely pricing is not getting worse?

Yeah no. I don't think it is but there hasn't been enough transactions that I know the exact cap rates on to give you any kind of valid statistical analysis. It's more just subjective from that feel (ph) talking to people but I guess if there's any surprise in some of the lesser quality properties with some higher risks that are going for low cap rates rather than the cap rates going any lower for the good properties. There's almost a desperation to buy industrial properties out there.

And then 1 more question. I mean shouldn't we be seeing some release relief in the TI costs? When do you think that happens in this cycle?

I would think very soon, I mean, ours have been flat for pretty much the last four quarters, I think it is. So that, I mean we've deemed just over $1.00 for the length of the lease. We don't view this as being onerous. Our bigger some one times our average gets a little bit higher it's due to some service center space or it's to demise bigger spaces for a series of smaller users, so that's -- our pressure is, we see more on rental rates than TIs.

I know there are mix issues but if you went back to the late '90s when occupancy rates were very high, what were those numbers? TIs?

Actually if you go back to '02, we had 3/4 of over $1.50 a square foot. We are down to -- we dipped a couple of quarters but the last four we've been $1.03, $1.10, $1.10 and $1.20. So I think it's pretty safe to say we have been averaging just over $1. You go back to the first quarter of '02, we are down to 63 cents and I think there was one six-month period in there when our TIs averaged 18 cents or something like that. So I don't think we'll see that again for a while. Our bigger worry in industrial is just rental rates and, in some markets, free rent.

Some of these TIs I mean they're getting they're basically a cost against the rent, right?

They are. Yes. And in some cases and I don't have an announces on this, some of it we're getting back in higher rents so it's -- I mean there's a number of different ways to look at it but I think the trend is going to be down from here forward unless it's a unique property.

At this time we have no further questions. I would now like to hand the conference back over to your President and CEO, Mr. David Hoster.

Thank you. We appreciate your ongoing interest in EastGroup and as always please do not hesitate to call Keith or me with any other questions that you have or that might come up as you review any of our information. Thanks and have a good day.

This concludes today's teleconference. You may now disconnect.