Eastgroup Properties Inc (EGP) 2005 Q2 法說會逐字稿

Good day. All sites are now on line in a listen-only mode. At this time, it's my pleasure to hand off your conference to your moderator, Dave Hostler, President and CEO. Go ahead, please, sir.

Thank you. Good morning and thanks for calling in for our Second Quarter 2005 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 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, and may cause the actual results to differ materially from those projected. Also, the content of this conference call contains time sensitive information that, subject to the Safe Harbor Statement included in the news release, is accurate only as of the date of this call.

Thank you. During the second quarter, we were able to build on the strong activity of the first quarter in development, asset transactions and property operations. Operating results for the second quarter met the upper range of our guidance. Funds from operations were $0.65 per share compared to $0.61 per share for the second quarter of last year, an increase of 6.6%. For the first six months of this year, FFO was $1.29 per share, which was a 7.5% increase over the same period of 2004. Please note that we continue to calculate funds from operations based on NAREIT’s definition of FFO, which excludes gains on depreciable real estate.

In analyzing second quarter operations, we are specifically pleased with the continuing growth of the same property operating results. We achieved an increase in same property operations of 6.8% without the straight-lining of rents and with straight-lining, same property quarterly results improved by 3.7%. This was the eighth consecutive quarter of positive results for both measures. Our investment and operating strategies are working.

On a GAAP basis, our best major markets for the same property results in the second quarter, not including termination fees, were South Florida, which was up 34%; Memphis, up 15.2%; Phoenix, 10%; and the San Francisco Bay area, 8.8%. The trailing same property markets were El Paso, down 10.7%; Jacksonville, down 7.9%; and New Orleans, down 4.8%. The differences are basically all due to changes in property occupancies in the individual markets.

Occupancy at the end of the quarter was 91.8% reflecting a slow but steady 60 basis point improvement over our March 31 level. Occupancy in our four core states of Florida, Texas, California and Arizona was 92.4% as compared to 87.8% in the non-core markets. Although our Florida markets have experienced a slight drop in occupancy, they continue to experience the best overall leasing activity for both second generation and development properties.

Looking at second quarter leasing statistics, we renewed or released 78% of the 862,000 square feet that expired and leased another 267,000 square feet of vacant space. Combining both renewals and new leases, we experienced the following: average lease length was 3.3 years, which reflected recent quarterly results; average lease size was 11,800 square feet, which was in line with past results; the average cost of tenant improvements was $1.44 per square foot for the life of the lease or $0.44 per square foot per year for the lease. This represented an increase from our leasing experience due to a number of larger spaces being subdivided for smaller users, which necessitated new office build-outs. And there was an average decrease in rents of 2.2% on a cash basis consisting of a 2.6% increase on new leases and a 5.9% decrease on renewals. On a GAAP basis, rents increased by 2.5%, which was the fourth consecutive quarter of positive rent growth, which primarily reflects reduced concessions.

The leasing activity of our development properties continues to be good. As we have previously reported, this activity, combined with the overall firming of our development markets, has resulted in our increasing projected development starts for this year to the 53 to $55 million range. This represents 14 projects with approximately 930,000 square feet.

At June 30, our development program consisted of nine properties containing 636,000 square feet with a total projected investment of $41.4 million. The four properties in lease-up are currently 70% leased and the five under construction have no pre-leasing.

In the second quarter, we transferred Palm River South I in Tampa into the portfolio. Completed last December, it contains 79,000 square feet and is 92% leased. At the end of the quarter, we began the development of both World Houston 15 and 21. They will contain a total of 131,000 square feet with a projected investment of $9.6 million. Fifteen will be a two-building service center complex and 21 is our typical rear-load, dock-high business distribution configuration.

In July, we initiated construction of Southridge IV with 70,000 square feet in Orlando and Santan II with 83,000 square feet in Chandler, Arizona, which together have a projected total investment of $9.5 million. In August, we expect to start Arion 14 and Arion 17 in San Antonio. They will have a combined 106,000 square feet with a total investment of $7.25 million.

We currently have three parcels of land for future development under purchase contracts. They include an additional 10.4 acres at our World Houston development, 33 acres in the northwest quadrant of Houston and 30 acres in Fort Myers, Florida. If all three acquisitions are completed, they will add approximately 1.1 million square feet of potential new development to our development pipeline, increasing this pipeline to approximately 3.8 million square feet. Fort Myers is a new market for us and will be our fifth city in Florida.

As we repeatedly state, our development program has been and will continue to be both a creator of value and a major contributor to FFO by adding quality state of the art assets to our portfolio. During the second quarter, we completed one property acquisition and one sell. In June, we purchased the Benan Distribution Center in Northwest Tucson for $2.7 million. This 44,000 square foot business distribution building was constructed in 2001 and is 75% leased to a single customer. Also in June, we sold the 151,000 square foot Lamar Distribution Center II in Memphis for a price of $3.925 million. The sell, which was in lieu of an imminent domain condemnation, generated a gain of $754,000 and the first mortgage of $1.8 million was repaid. Lamar II disposition was our second Memphis building sell this year and we are currently marketing three additional Memphis properties for sell, which we hope to close before the end of the year. We currently do not have any potential acquisitions under contract, but are seeing a pickup in individual property offerings.

Keith will now review a variety of financial topics.

Good morning. FFO per share for the quarter increased 6.6% compared to the same period last year. Bad debt expense was 232,000 for the second quarter of 2005 compared to $17,000 in the same quarter last year. Lease termination fee income was 332,000 for the quarter compared to 17,000 for the same quarter of 2004. FFO per share for the six months increased 7.5% compared to the same period last year. Bad debt expense was $331,000 for the six months of 2005 compared to $70,000 for last year. Lease termination fee income was $499,000 for the six months in 2005 compared to $56,000 in the same period last year.

If you combine bad debt expense and lease termination fee income, the change on period comparisons is less than one cent a share. Debt to total market capitalization was 29.9% at June 30, 2005 compared to 32.9% at March 31, 2005. For the quarter, the interest coverage ratio was 3.6 times, and the fixed charge coverage ratio was 3.2 times, which were both improvements from the previous quarter.

Our floating rate bank debt amounted to 6.4% of total market capitalization at quarter-end. Since the beginning of the year, we have repaid four mortgage notes amounting to $15.7 million for the weighted average interest rate of 8%. There is one remaining note maturity in 2005 of $2.9 million with an interest rate of 8.125%, which is due October 1.

We recently submitted a loan package to a number of lenders requesting a fixed rate ten-year mortgage loan with minimum expected proceeds of $25 million. In June, we paid our 102nd consecutive regular quarterly dividend. This quarterly dividend of $0.485 per share equates to an annualized dividend of $1.94 per share. Our FFO payout ratio was 75% for the quarter. FFO guidance for 2005 was narrowed to a range of $2.60 to $2.68 per share, and earnings per share is estimated to be in the range of $0.95 to $0.99.

Now, Dave will make some final comments.

The second quarter, although not as active as the first, continued to see positive momentum in all three elements of our growth strategy for FFO. Our development program continues to expand in both new properties under development and land in our pipeline. We are acquiring good assets and disposing of non-core properties. Operationally, we have achieved eight consecutive quarters of increases in same property operating results, and we have a strong and flexible balance sheet.

Keith and I will now answer any questions you may have. Thank you.

(OPERATOR INSTRUCTIONS.) Jonathan Litt.

Hey, this is Paul Puryear with John Litt and John Stewart.

In terms of the disposition or the net acquisition guidance that you've given, it's 20 -- 25 to 30 million. And given what you've accomplished so far with the acquisitions of call it 60 million and dispositions of 6 million, the balance, is that entire balance all in Memphis?

Most likely. I wouldn't rule out some other markets where we have some non-core assets that we have a chance of selling, but what's in our guidance assumes three more properties in Memphis being sold.

So, what's the book value of the stuff that you still have in Memphis?

I'd have to look that up. It's right around 20 million, I think. Just a little bit over 20 million and, Paul, I can give you that exact number later.

Okay. And then also in that same line, what other markets would you say that, you know, the non-core markets would you be interested in disposing of an asset?

Well, at the right prices and the right market conditions, we've said before that we would very much like to exit Oklahoma City and possibly Tulsa. But that's such a good property, we'll probably own that one for a while. And then just in some other markets, there's always an asset or two that at the right price, we'd be willing to sell. But Memphis is our emphasis right now.

Right. And also, just one other question -- as far as your perspective development goes, you know, your pipeline or your perspective pipeline is quite strong at 160 million and at 50 million a year, that's a couple years of development. Would you say that that development pipeline will accelerate in '06 and '07?

It certainly accelerated this year. Based on the fact that a lot of the close in type sub-markets where we like to build are running out of industrial land for new development and so, we've been fortunate to be able to tie up some very good parcels. We are continually looking for new development land in the markets where we're developing and some other markets where we would like to be developing. So, our goal is to continue to have a significant pipeline. As I say, it's -- as you've heard me say before, in a strong market, people would rather sell their land for another use because they can obtain more money for it. So, good industrial land close in is becoming more and more of a premium product.

Right. And then, one final question -- in terms of your current development pipeline, it's at 41 million and then you said that it will get to 53 to 55. There are many size properties going from 9 to 14. You identified Arion in San Antonio that you would have two properties there. Do you have others, the three other properties identified already?

Yes, we do. We have a small piece of land that came with the building purchase in West Palm Beach, Riviera Beach that would be a service center. We are looking at a couple of potential developments in our Oak Creek property where we own two existing buildings and acquired land where we could build 600,000 square feet of new construction. We closed on that earlier this year. And we have two development sites in Phoenix.

Ross Nussbaum.

Good morning. Thank you. Patrick, John and Ken with Ross. Regarding World Houston 15, your development costs there are much higher than World Houston 21 and you discussed this will be a service center complex.

Sure.

Can you provide an update on demand in rents for this type of product versus warehouse at World Houston?

Right now, there are no pure service center buildings in the World Houston complex. We have a skinny V-shaped piece of land where we couldn't put one of our normal or one of our -- we have a variety of designs we use in World Houston, but none of them would fit on that parcel. We've done some market research and think we can build a high quality service center building and have rents at or below what some less quality buildings in that sub-market are currently offering space for. So, it's a new product for World Houston, but we think the demand is there. We're half a block from an Equity Office office building with this site, a Hyatt Regency Hotel and a high-rise Sheraton Hotel. So, it's a fairly upscale corner that we're on. So, we're optimistic about leasing on that.

Dave, are you seeing overall reduction in development cost with sale prices coming down about 30% from its recent high?

Yes. We're seeing some reduction on that, but we're also seeing pressure because petroleum prices, petroleum products go into the roof, asphalt and parking lot. So, yeah, development costs have come down, but not so significantly that we're excited about it. I guess the first step was they stopped going up. And they seemed to spike and stay low for a period and then jump way up and then stay stable for a while. The one interesting thing in Houston on our Techway development is that it's the first time that we've actually experienced any rationing of concrete and that set us back three or four weeks.

So, do you think you're going to have moderating costs for the rest of the year?

I don't know about moderating, just not going up anymore.

Okay, that's positive. Can you discuss the continued rent roll-downs you had in LA this quarter and when do you see this turning around for you guys?

Usually, our rent roll-downs in a strong market, like Los Angeles, are due to fact that approximately 80% of our leases have bumps in them and so that if there has been any kind of slowdown in market rent growth over the life of the lease and the one lease specifically in Carson, I think was, I think it was a ten year lease with lots of bumps so that when it came time to renew the lease, the bumps had gotten slightly ahead of market. And I think that lease was just about a break even on a GAAP basis and a downturn on the other. A second Los Angeles situation was where we had a fairly high office finished and on releasing that, we lost a little bit. But that's, again, we believe that's not a factor of the market. Oh, excuse me -- and then we had another renewal that was a longer-term lease in Fullerton. But it's a fact of having so many good bumps in the lease.

And can you discuss what you believe the mark to market is for the rest of your portfolio for the rest of this year and '06?

Without being too longwinded, we've never taken the time to try to figure that out because it changes so quickly. And we also have found in the late '90s when everybody was talking about, and especially the office companies, about imbedded rent growth that they eventually never saw. And we tried to figure what our imbedded rent growth was and we always said we didn't have any and then we kept having rents go up every quarter. So, we decided to just spend more of our time just leasing the space at what we think are market rates rather than trying to hit a moving target on roll-down or imbedded rent growth.

Tony Howard.

Several questions. Can you spend a little bit more time, Dave, talking about El Paso? I noticed that the occupancy had gone from 90% down to 82 just since the first quarter. You also show that same store NOI actually went up sequentially.

What happened there, Tony, was we have a building that was 62,000 square feet. I think it was 100% leased by a plastic injection molding manufacturer who went out of business, closed his doors going broke. And that happened near the end of the quarter, so we didn't experience that in the rent. Actually, we leased the space during most of the quarter to the company that was auctioning off the equipment on the inside. So, that distorted those numbers a bit.

El Paso is showing increased activity over the last 60 to 90 days. It seemed to be slow coming out of the recession and negatively impacted by a downturn in the maquiladora manufacturing across the border in Mexico. As that's started to pick back up, we're optimistic that activity is going to continue to improve there. But in terms of market activity, El Paso's been lagging our other four core state markets.

Okay, thanks. Second question, a little bit more discussion on tenant improvements--TIs went up sequentially, also. I guess, Keith, what do you expect as a run rate and--?

--Well, let me interject on that, Tony and Keith, and reiterate that we had a number of spaces where we had a larger customer move out and then have gone in and subdivided the spaces. For example, Exchange, you know, Orlando--a long time tenant downsized, moved out and we immediately released the space I guess within 30 days to three different users and since there was only one office build out, we had to go in and upgrade or build initially office space. And so, that runs the TIs up.

Now, in the long run, we see that as an increase of value for the building because future customers are going to be able to use it. But as you subdivide space, you spend a lot of money because of the office and restroom build outs. We had a space in Denver that never had been built out because it was left over from a release - had big numbers there. So, I don't think there was anything unusual that shows any trend. It was more due to some very specific circumstances that we can point to.

And expected run rate is?

Well, Tony, last year we had about 11 million in real estate improvements and, as you know, that depends on the tenants you get into this space and various things like that. But we don't see much difference between last year and this year right now. We think around 11 million still.

Yeah, and on a per square foot basis, Tony, that's probably around between $1.00 and $1.10, I hope.

Okay, good.

Per square foot.

Yeah, final question along the balance sheet issue--I notice notes receivable and unconsolidated investments went down sequentially. Can you kind of inform me what that was for?

That was the note that we had with our 50% co-owner of a Los Angeles property.

Oh, okay.

And we had a mortgage that we closed during the second quarter. And with those proceeds, he paid down one of his notes.

Now, did any of that flow through the income statement?

On the payoff of the notes? No, just the interest income on it.

Just a reminder, ladies and gentlemen--if you do have a question, press star and one. We'll take our next question from the site of Srinkanth Nagarajan. Go ahead, please.

Hi, this is Srinkanth Nagarajan of UBS. Dave, in your prepared remarks, you talk about the strength of the Florida market.

Correct.

I'm wondering whether you've found any difference between the performance in Jacksonville, say, and Orlando and Tampa?

Well, right now, Orlando is our strongest market. South Florida--we do not include Miami in that, so we're not in Dade County--would be second, Tampa probably third. Jacksonville, there's softness on the west side, which is bigger box space. We lost a customer there, if my memory's correct, about 120,000 square feet and put a 30 or 40,000 square foot replacement in for about a third of the space and still have 80,000 vacant there. And there's a lot of that kind of space out there. So, Jacksonville for the bigger tenants is slower. In South Jacksonville versus the west side where the rest of our properties are, that's very strong. It's a smaller user market and we've done real well there, filled some long-term vacancies. So, we're pleased with that side of town.

My next question is with regards to the Tucson acquisition that you made. What was the, going in, cash yield? And can you also remind as to what do you see in the strength of the market and how confident you are in leasing the other [inaudible]?

Tucson has always been I guess referred to a tertiary market that has a good bit of population growth. And it will become, just because of its growth, I think a secondary market at some point. It's been slower than we anticipated when we first invested there. Our other three assets are larger user buildings on the south side of town near the airport. This building is in the northwest, designed for smaller tenants that are serving just the Tucson market. But on the south side, they handle goods coming out of Mexico primarily.

When fully leased, we'll have about an 8% yield on it, so we're right around a 6% yield going in. We have some activity on the space. The cost of putting a new user in is built into our projections. We would like to have more of the smaller user type facility in Tucson. It doesn't have the strength of Phoenix, but it doesn't have the competition of Phoenix, either.

Move onto the next site, a question from the site of Chris Hailey. Go ahead, please.

So, Tucson is a secondary market.

Well, I call it a tertiary market headed--.

--Tertiary, I'm sorry--.

--Secondary market--.

--Tertiary market, you know, is an 8% rate of return comfortable enough for a tertiary market?

Given what's going on in the marketplace, I would say absolutely. This building was under contract to another buyer who got nervous about the vacancy. And so, we stepped in and took over the contract. Brand new building, high quality, almost exactly built to the specifications that we would have designed for it, so that yield certainly worked.

What are you building in Phoenix close, you know, a couple hour drive away? What are you building for in terms of your Phoenix projects?

Depending on the office finish, I'd have to double check, but I guess we're probably doing about $65 a square foot.

And your rates of return?

One hundred percent occupancy, cash-on-cash would be a high nine to a ten.

Okay.

So, we're looking for both an accretive rate of return to cost to capital and a yield spread for taking lease up risk.

Okay. Was this exchange capital?

No.

No?

No.

Okay. On cap ex, I want to go back to this. I'm looking at the difference between your new and renewal. You mentioned $1.00 and $1.10. Is that--that's just your TI dollars, correct?

That's correct.

Okay. If I look at--and you mentioned that there were several move outs in subdivisions that occurred, which obviously would flow through your new tenant line. Renewal percentages were up this quarter versus last quarter. I don't mean to be too myopic quarter-to-quarter, but the renewal costs look like they're going up, as well. I wanted to kind of get a sense--Keith, you said 11 million for total cap ex. Does that include commissions, TI, building improvements? I just want to kind of get a look at the total freshness cost, if you can call them that.

In terms of TIs, did not include leasing commissions.

Okay. So, what would be your total TI and leasing commission and then building improvement number that we should be looking at for the '05 year?

I'd have to look on my leasing commission--.

--While Keith is looking at that--.

--Yeah--.

--We had several renewals of long-term customers that to get the rate we did and the kind of renewal we wanted from them because nothing had been done to their space for quite a while, we had some above average TIs.

Leasing commissions, we were originally projecting about 4-1/2 million. But again, that same qualifying statement about what we lease, what term and those kind of things, that number could change drastically. It's hard projecting TI cost and leasing cost.

And what was your '04 number, Keith?

Four-two.

Four-two. And what are you guys spending in terms of building, base building improvements?

What do you mean? Do you mean for new construction?

No, no, no. Just maintenance cost.

That would be in the 11 million.

That's in the 11. So, it's TI and base building?

Yes.

Well, which is basically roofs and every now and then parking lots--.

--Parking lots--.

--That you can't pass through.

In the second quarter we had a big parking lot expense.

Okay. Dave, the renewal lease term was only about 2-1/2 years though in the quarter, so there were--I mean, I guess that's a weighted average number, but you were saying--.

--That is not a weighted average number, which--.

--It's a simple average?

It's a simple average.

All right.

And we've had that discussion and we're going to provide both numbers in the future.

Just, I guess more importantly, looking at the direction of these costs, is it a function--we're hearing at least the industrial markets are improving relatively quickly, at least so far in the first half of this year, particularly in the Sunbelt. And the concession numbers I would have thought would be coming down rather than going up. So, one might think that maybe it's the product that you're in whether you have a higher office build out [unintelligible] in a stickiness to your cap ex cost.

I would think--well, I would say for sure we will have a higher cap ex cost and industrial owner and big box business, just by definition. I think in the second quarter, as I said, we had a number of leases we can point to that where we subdivided the space where there's lasting value for the investment, where we got longer renewals or where nothing had gone into the space for a long period of time, that I don't think or I don't believe that our numbers for tenant improvements represent any kind of trend for the second quarter.

Okay. Where did you--I may have missed this. Your occupied percentage for the total portfolio was 91.8, leased was 93.2. Where do you think year-end '05 occupancy or lease percentage would be?

A little bit higher.

A little higher, okay.

Just a reminder, ladies and gentlemen, star and one if you have a question. We'll take our next question from the site of Paul Morgan. Go ahead, please.

Dave, you mentioned the land values and what that's implying for, you know, the scarcity of industrial development. Are you tempted with any of your land parcels to kind of harvest those outside and sell it for alternative uses?

We talked about that, actually ran some numbers on a couple of them and we think that in the long run, we're better off with these good locations building our product and creating an asset with an investment that's many times what the land cost is for long-term growth, that that's much better for the company than some short-term land profits. I mean, if we had unlimited opportunities to reinvest that money, that's something that you'd look at a whole lot more closely. As to some quick profits to help one or two quarters FFO and be able to brag about it, we don't think that's in our best term longer interest.

So, you don't assume any of that taking place, then?

No.

No, okay.

One of the things we had--we are looking at, Paul, is we have in that land inventory some sites that only work for smaller buildings. And so, we've spent a lot of time and analysis looking at the potential sale, construction and sales of smaller buildings to users since that's such a strong market. So, I wouldn't be surprised if we, over the next 24 months, have at least a small amount of that.

Okay. There's a few markets, LA, El Paso and Phoenix, that have pretty sizeable expirations in the second half. Can you provide any color about, you know, how that's looking for releasing that space or renewing?

We're comfortable in Los Angeles. El Paso, we had two larger tenants, larger than what we're used to. The one that's slightly larger is going to move out and we've got a lot of activity on the space. The other one has renewed.

And Phoenix?

Phoenix--Phoenix has been frustrating from the standpoint that over the last couple of years we've just had a lot of shorter-term renewals. We haven't been able to get any length of lease and we're working to improve that now. So, we don't see any big downside in Phoenix.

Okay. And then finally, in San Antonio, it looks like you leased out some of the site there. How did the yields on those leases as you look at the stabilized return from the acquisition that you made kind of match up against your pro forma?

Well, the property we bought last August, Alamo Downs, I think it was about 44%, maybe 45% leased when we bought it. We're now roughly 85%. We projected we would be over 80% by the end of this year, so we're ahead of pro forma. So, we're very pleased with how that's worked out.

What's the yield on that then at this point?

If you look at today going forward for 12 months, we'd probably be at a 9% yield.

Okay. All right, thanks.

It's going to be a high ten when we've got up to 95% occupancy.

And I'm showing no further questions at this time.

Again, thanks to everyone for their interest in EastGroup. Keith and I are available for any additional follow up questions you might have. We'll be here the rest of the day, so please give us a call if there's anything that you think we need to clarify. Thank you.

This does conclude today's teleconference. You may disconnect at this time.