Eastgroup Properties Inc (EGP) 2005 Q4 法說會逐字稿

Good day. [OPERATOR INSTRUCTIONS] I would now like to turn the program over to Mr. David Hoster, President and CEO. Go ahead, sir.

Good morning and thanks for calling in for our fourth quarter and year end 2005 conference call. We appreciate your interest in EastGroup and apologize for those of you who were affected by our releasing earnings on Valentine's Day. We were not paying attention when we set the date. 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 news 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 predicted. Also, the content of this conference call contains time-sensitive information that's subject to the Safe Harbor Statement included in the news release is accurate only as of the date of this call.

Thank you. In 2005, EastGroup continued its track record of creating value for its shareholders in both the short and long term. This past year, our shareholders experienced a 23% total return. Our average annual total return over the last three years was 28%. For five years, 23%. For 10 years, 21%. And for 15 years, 21%, which is longer than most REIT's have been in existence. Operating results for the fourth quarter and the full year met our guidance. Funds from operations for the fourth quarter were $0.68 per share, compared with $0.64 per share for the same period last year, an increase of 6.3%.

For the year, FFO was $2.64 per share, which was a 6% increase compared to 2004. Fourth quarter results were affected both positively and negatively by both Hurricanes Katrina and Wilma. On the positive side, we had a gain on involuntary conversion of $243,000, which is an accounting way to say that insurance proceeds exceeded the net book value of a roof which was replaced.

To the negative, we had expenses below our insurance deductibles totaling $248,000, which was greater than we had initially estimated since the deductibles were calculated on a per-building basis. 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 fourth quarter operations, we are pleased with the continuing growth in the same property operating results, even with the negative effect of the hurricane-related expenses.

We had an increase in same property operations of 0.9% without the straight-lining of rents. And with straight-lining, same property quarterly results improved by 0.4%. If the hurricane repair expenses are eliminated from the calculations, same property results would have been up 2.1% and 1.6% respectively. This was the 10th consecutive quarter of positive results for both measures. For the year, same property results were up 3.4% before straight-lining of rents and 1.2% after straight-lining.

On a GAAP basis, our best major markets for same property results in the fourth quarter, after the elimination of termination fees; with the San Francisco Bay Area, which was up 13%, Dallas up 6.8%, and South Florida up 5.4%. South Florida would have been up 31% without the hurricane expenses. The trailing same property markets were; El Paso, down 37%, Jacksonville down 10.4%, and Memphis, down 4.6%. The differences are basically all due to changes in property occupancies in the individual markets.

Occupancy at the end of the year was 94.3%, which was our highest quarter end occupancy since the first quarter of '01. As in previous years, occupancy is projected to decline in the first quarter of 2006 and then increase during the three subsequent quarters. We continue to generally experience improvements in fundamentals in all of our markets, increased leasing activity and lower vacancy. The only markets that are not meeting our current expectations are El Paso and Dallas. Occupancy in our four core states of Florida, Texas, California and Arizona was 94.8%, as compared to 90.8% in the non-core markets.

During the fouth quarter, we renewed an unusually low amount of square footage, 38%, but leased an unusually high amount of vacant space, 883,000 square feet. This leasing of a greater proportion of the total being vacant space resulted in higher tenant improvements and commissions and a reversal of our positive trend in rental rates. We don't see these quarterly statistics as being indicative of what we expect in 2006. Our Florida market was our best performer for the fourth quarter and full year. As a whole, it experienced increased same property results and rent growth for both periods and ended the year 97% leased and 96% occupied.

The leasing activity of our development properties is good. And the basic fundamentals in our development markets are continuing to improve. As a result, our development starts in 2005 increased to a projected total investment of over $55 million. And we hope to start at least $70 million of new development in 2006. At December 31, our development program consisted of 15 properties totaling 940,000 square feet, with a total projected investment of $68 million. Six of the properties were in lease-up and nine were under construction. These totals represent more than a doubling of our program compared to the end of 2004, and are the highest ever for EastGroup. Geographically, the developments are diversified in four states and seven different cities, and overall are currently 34% leased.

During the fourth quarter, we began construction of South Ridge II in Orlando and Oak Creek III in Tampa and acquired Castilian Research Center in Santa Barbara as a redevelopment project. In the first quarter this year, we plan to begin construction of South Ridge VI in Orlando, Oak Creek V in Tampa and three buildings in our Freeport development in northwest Houston. There were no properties transferred out of the development program last quarter, but in January we moved South Ridge V in Orlando into the portfolio and transferred Executive Airport II in Fort Lauderdale at the beginning of February. Both of these properties are 100% leased.

South Ridge I in Orlando and Palm River South II in Tampa will transfer early in the second quarter, and both were also 100% leased. During the quarter, we acquired an additional 32 acres of World Houston land in two separate transactions, which will support approximately 380,000 square feet of new development. At year end, our land inventory contained approximately 270 acres, with another 38 acres under contract to purchase. This total provides us with the opportunity to develop approximately 3.7 million square feet of new industrial space, an increase of 78% since the beginning of 2005.

As we repeatedly state, our development program has been and we believe will continue to be, both a creator of shareholder value and a major contributor to FFO by adding quality state-of-the-art assets to our portfolio. Including our development properties and lease-up and under construction, we have built 24% of EastGroup's current portfolio.

In the fourth quarter, we acquired four properties with a total of 461,000 square feet and a combined investment of 26.5 million. Two were in Houston, which were discussed in our last conference call, one in San Antonio and one in Tampa. Wetmore Business Center in San Antonio contains 198,000 square feet and four buildings and was purchased for $13 million. Built in 1998 and '99, it is located in the north central airport submarket and compliments our acquisition of Arion Business Park earlier last year in the same submarket. Wetmore increases our ownership in San Antonio to almost 1.1 million square feet, including our two properties under development.

In Tampa, we acquired a 112,000 square foot single-tenant building for $7.35 million, which we renamed Oak Creek IV. This purchase also includes land to accommodate a 46,000 square foot potential expansion of the building. The purchase also increases our ownership in the Oak Creek Commerce Park to four buildings with a total of 522,000 square feet. Including Oak Creek III, which is under construction, and another 61 acres of land for future development.

For the full year, EastGroup acquired seven properties with a total of 1.245 million square feet and a combined investment of $81 million. Currently, we do not have any properties under contract to purchase. In 2005, we sold two buildings in Memphis with 253,000 square feet and a 1.9 acre parcel of land in Tampa. These sales had combined prices of 6.4 million and generated total gains of 1.2 million.

In January of this year, we sold a partial of land under our restaurant in Madisonville, Kentucky for $827,000, generating a gain of $773,000. 592,000 will be recognized in the first quarter and the balance of the gain deferred. We are also currently have four properties containing 658,000 square feet in Memphis under contract for sale. If completed, this sale will reduce our ownership in Memphis to less than 370,000 square feet. Keith will now review a variety of financial topics.

Good morning. FFO per share for the quarter increased 6.3% compared to the same quarter last year. Bad debt expense was 315,000 for the fourth quarter of 2005, compared to $20,000 in the same quarter last year. The amount of bad debt expense was higher than we anticipated. Lease termination fee income was 286,000 for the quarter, compared to 82,000 for the fourth quarter of 2004. FFO per share for the year increased 6% compared to last year.

Debt-to-total market capitalization was 31.1% at December 31, 2005. For the quarter, the interest coverage ratio was 3.6 times and the fixed charge coverage ratio was 3.3 times. Our floating rate bank debt amounted to 7.8% of total market capitalization at quarter end. In November, we closed a $39 million mortgage with a fixed interest rate of 4.98%. We have three mortgages that are maturing in 2006. These amount to $36.5 million at 12/31/05 and they have a weighted average interest rate of 6%.

We expect to borrow approximately $100 million in mortgage loans during 2006, and these loans that are maturing, we anticipate borrowing against those also at much higher amounts than the amounts that are maturing. In December we paid 104th consecutive quarterly distribution to common shareholders. This quarterly dividend of $0.485 cents per share equates to an annualized dividend of $1.94 per share. Our FFO payout ratio was 71% for the quarter.

For the year 2005, rental income from properties amounted to 99% of our revenues, so our dividend is covered by property net operating income. We believe this revenue gives stability to the dividend. We are not changing FFO guidance for 2006 and expect a range of $2.77 to $2.87 per share. And earnings per share is estimated to be in the range of $0.96 to $1.06. Now, David will make some final comments.

During the fourth quarter, we continued our positive momentum and our strategy of taking full advantage of improving fundamentals. Occupancy achieved its highest level in almost five years. Same property operating results experienced their tenth consecutive quarter of increases. Our development program continues to expand in both new properties under development and land in our pipeline, both at their highest levels ever. Our balance sheet remains strong and flexible for future growth. Keith and I will now answer any questions you may have. Thank you.

[OPERATOR INSTRUCTIONS] It looks like we'll take our first question from the site of John Stewart with Citigroup. Please go ahead.

Hi, Jon Stewart here with Jon Litt. David, you mentioned that you expect the occupancy to drop from the end of period number in the first quarter. Can you kind of put some parameters around how much of the leasing in the fourth quarter was seasonal and where you expect occupancy to drop in the first quarter?

We ended up with more seasonal leases than we had anticipated, which is the good news. The bad news is that they're seasonal. So we expect a little over 200,000 square feet to exit, to vacate in the first quarter, most of which has already occurred. Last year, our occupancy dropped by 200 basis points from the end of the year to the end of the first quarter. We don't expect it to be quite as much this year, but we will see our seasonal drop.

So, it sounds like more like 100 basis points in the first quarter this year?

Somewhere between 100 and 200.

Okay. You also indicated that the rent roll down we saw in the fourth quarter is not necessarily what you expect for '06. Can you give us -- I know you're reluctant to put a number out in terms of the market-to-market across the portfolio, but can you give us a sense for where you think rents will roll relative to in-place leases in 2006?

Let me answer that in a couple different ways. In our guidance, we base our numbers on the budgeting that we do for the individual properties. Because we've found we're not very good at determining mark-to-market on rents. When all the office reach talked about embedded rent growth, we didn't think we had any, and rents kept going up. And so instead of trying to determine which individual space should rent for, and each one is a little bit different because of its different office buildouts, we've just worked on leasing the space. In '06, we believe that the rents -- when we look back 12 months from now, the rents will be positive for the year. Maybe not at a big number but at least average a positive figure. And that's our early indication from what we've been doing in renewals and discussions in the first couple of months of the year. Now, last quarter went down for a number of reasons. One was, where some of the roll down occurred. And then secondly, we leased some spaces that have been vacant a long time, a couple that were up to two years or past and so we cut rents just to put tenants in some difficult spaces and that affected the statistics.

Okay. You also mentioned that you have seen some good leasing activity on development. Can you give us a sense just how good it is on the three properties that are in lease-up but don't show any leasing currently?

We didn't do a lot of leasing between the end of the third quarter and the end of the fourth quarter but we've had a great deal of activity. And for example, our South Ridge building that we're just finishing now, we have proposals out to lease it 100%. Whether they're all executed or not, I don't know but -- so that's very encouraging. In Oak Creek and Tampa, the building under construction we preleased 70-some percent of it, and we have activity on the balance of it. So we hope to start a spec building there as soon as we receive the permits. And Houston, we don't have any signed leases but again, just a lot of proposals out. San Antonio, we did preleasing on a building and have activity on the balance of it. So, I think I'm going to be able to brag some more on that when we do our first quarter conference call in about two months.

Okay. And then just lastly, without hanging a cap rate on the Memphis transaction, can you give us a sense for where you expect the reinvestment spread on 2006 acquisition -- or investment activity will come up?

I would assume we'd probably lose 150 to 250 basis points, depending on the cap rates on the purchases. Properties selling in Memphis tend to sell anywhere from 100 to 200 basis points below what the primary markets are from a transactional standpoint. The buyers in Memphis tend to be more yield-oriented, so we're excited about having the properties under contract. We're not excited about the prices we're getting.

Okay, thank you.

We'll take our next question come the site of Ross Nussbaum with Bank of America. Please go ahead.

Thank you, it's John Kim with Ross. Regarding your development pipeline at World Houston from the land you just purchased; at this point, can you provide an approximate breakout between how much of that is warehouse space versus office or showroom space?

The only showroom space that we have designed in our World Houston development is our World Houston 15, which is under construction. And it's 63,000 square feet in two buildings. And it was a V-shaped lot and it was the only type property that would fit on that lot. Everything else is dock high in one configuration or another. We have some cross-dock, some of our traditional front park rear-load business distribution buildings and then we've designed a couple of front load facilities. But it's only the one little two building service center complex that's not dock-high.

At this point -- and you generally expect higher yields from warehouse space than showroom space, is that correct?

I don't know of that. We're just more comfortable doing it. We think it has longer-term stability. A lot of the showroom space ends up being a one-story office building. And if you lose a customer in it, then the cost to TI's are much higher. When we look at our TI expense each quarter, the vast majority of the big numbers are all in our service center buildings, not the dock-high buildings. So, it's just not our primary product but we do do it where we think it works from a market standpoint. And like in this case, it's the only thing that would fit on the site.

On the subject of TI's, it went up this quarter and it appears driven by renewal TI's. Is this something that we can extract as a trend going forward or is this a particular lease or two that caused this drive up?

Well, we certainly hope it's somewhat of an aberration. We were $1.45 a square foot for the life of the lease or roughly $0.40 a square foot per year of the lease for the fourth quarter. And we're about 2/3 of that in the third quarter, about that same number in the second quarter. So, it's been jumping around. But we have a number of service center leases where we had some extensive buildout that brought up that number. And we're always going to have some larger spaces. We have one in Los Angeles, our main street development where a tenant had a larger space and we've broken it down to three spaces. And so then the buildout gets expensive when you have to do office space for a new user.

Sure. Keith, I think you mentioned in the prior call that you would potentially pay down the line of credit with either an equity offering or mortgage debt. Is this still the case? And if so, what's the timing of these actions?

Right now we're contemplating just taking on debt in '06. We don't have any equity offerings in place. And of the mortgages that are maturing, I think I've said it was 36.5 million we plan on refinancing those and do a total of 100 million this year.

What is your thought process about potentially tapping the public markets for debt?

We've done a lot of analysis of that and determined that it really doesn't fit our strategy very well. For one thing, the interest rates we're getting on our fixed-rate mortgages are as good or better than what we could do in the public markets. Secondly, in the public markets, they look really hard at your unincumbered assets. And a lot of our good purchases are properties with unattractive mortgages that we assume and then we pay off as the loan amortizes or balloons. And that could restrict our ability to buy that type of asset. We did two of those last year, one in Jacksonville and -- actually, we did three of them, one in Jacksonville, one in San Antonio and one in Tampa.

And then finally, people will say well mortgage loans are too restrictive. Because we do large packages with a variety of properties and diversification, we've been able to have the right of substitution on those packages. We've only done that once, substituting a property. But it gives us the flexibility to with generally a 1% fee, pull a property out of the package, replace it with an equal value and then sell that property without having to worry about being hit on the price for the loan or prepayment penalties. So, we see the way we're doing it works best for us on our operating strategy

Okay. And then a final question, is a follow-up from John Stewart's question regarding rent roll downs. Can we now the expect rent roll downs to diminish in San Francisco now that we're five or six years away from the tech bubble?

We don't have much turning in San Francisco, so I don't think you're going to see much activity there. We could still have a little bit of a turndown. Our property in Milpitas was -- and of course in Silicon Valley, our Hayward properties were less affected by the tech turndown, just more by the recession and the fact that the Hayward rents just went through the roof, and so now they're adjusting. Our San Francisco roll down this fourth quarter was unusually high because we had somewhat of a difficult space and we had a tenant that didn't need all the space, so we cut a good deal, so that they could grow into it. So, I don't see us having that kind of roll down going forward. But like I said, we don't have much in San Francisco anyway.

Okay, thank you.

And we'll move next to the site of Paul Morgan with FBR. Please go ahead.

Hi. Just one question, really. In terms of cap rates in your core markets, can you just comment on the direction? Where they might be right now and the direction that you've seen them go in the past quarter or two quarters? And then related to that is whether at those prices you're in the market for stabilized assets or basically everything in your price range is going to be a redevelopment type play?

In the major hot coastal markets, which includes most of Florida, cap rates are either at best staying stable or at worst going lower, from an acquisition standpoint. There's just a tremendous amount of capital still flowing into real estate, particularly from the pension funds. I'm sure you've read some of that. But real estate on a risk-adjusted basis is still extremely attractive to the pension fund investor. So, in listening to some of them talk about their plans for the year, my guess is they're buying about three times what they're selling. And I think that's going to keep the rates down or push them even lower.

We're not doing anything in California because the cap rates run on a good property 5, on a bad property 6, and we just can't compete or want to compete with that. We're starting to see some of those really low cap rates in the low to mid-6 range in South Florida. There was an article in the "Wall Street Journal" this morning about the Palm Beach market. We just bid on some warehouses down there with what we thought was a low cap rate and didn't make the second round. So, I think that's going to be a difficult spot to buy.

The purchases that have worked for us where we've gotten the high 7 or low 8 is as I mentioned before, where there's a first mortgage that can't be prepaid without a high penalty, so that affects the price. Or there's extreme turnover in the property, like our Wetmore property in San Antonio that wasn't well marketed either. Or properties that it's hard to find nowadays, but where they're not actually offered for sale and we can contact the owner and do a transaction. So, purchases in '06 are going to be difficult and that's something we worry a lot about in putting out some additional money. But at the same time, it just makes our development program all the more important.

You don't get the same immediate gratification that you do generally on a purchase but over the long haul, that's how we're investing most of our dollars.

What about some of the, you know, the markets that have been softer over the past couple of years, like Dallas or places like that?

That doesn't seem to affect buyers.

Okay.

They've got money to put out, and they're -- in particular the pension fund advisors identify markets that are key industrial markets. And they're going to buy there whether they're soft today or not because they're looking over a longer term hold. The only consolation in listening to some of the pension fund people is they, at least from what I've heard, they see office as a bigger opportunity than industrial. So I hope more of their dollars go in that direction.

Okay, thank you.

We'll move next to the site of Paul Adornato with Harris Nesbitt. Please go ahead.

Thanks, good morning. Just to follow up on that last point. Maybe you could talk a little bit about Dallas and El Paso, the markets that you identified as being the weakest right now. Is it just kind of a near term leasing issue or is it something that might be more endemic to the market?

Attack Dallas first. I think that is more just a soft spot that's going to improve, particularly in our close-in submarket. Dallas is one of those cities, though, where developers on almost whatever property type it is, as soon as they get the slightest scent of an increase in demand, they start building again. So, I don't think the occupancy is going to go way up there. But we historically have outperformed the market in our Stemmons corridor properties. So, I think we're just going to see just general improvement there.

El Paso, we're affected two ways there. One, the market has been soft, and a lot of that has been related to the loss of Mexican manufacturing to Asia. Now, in all the statistics we hear, some of that's coming back and there's new manufacturing going into Mexico. So the -- I think the tide has turned there and we expect to see improvement. We historically have been above 90% in El Paso but last year we lost a 160,000 square-foot tenant, our biggest user there. We have released about 1/3 of the space but they don't move in until this month. So that really hurt our numbers. And then secondly, we had a single tenant building user that went out of business and filed bankruptcy last summer, 62,000 square feet. And we have not been able to re-lease that space.

So, that's really affected us in a down market but we're optimistic that, probably not in the short-term, but over the long-term we'll get back up over 90% with the improved operations from manufacturing on both sides of the border.

Okay. And do you anticipate any new markets in 2006? Are you actively evaluating new markets?

We're looking pretty close at two markets and I hope that we will be able to go into one before the end of the year. San Antonio has been a successful entry for us with now over 1 million square feet in about 18 months. When you're doing that on a property-by-property basis, that's a lot of progress, so I would hope we'd be in one more of our type markets where we can make a difference.

Okay. Thank you.

Wait, I should add, you heard us talk about it before but we do have land that we own in Fort Myers, Florida and plan to have our first two buildings under construction by May or June. We're just waiting on the permitting. And then we have some additional land under contract that will allow us to build probably three more buildings there. So, we're excited about that market, just we're not going to have any income out of it for a year or so.

Okay. Great. Thanks.

We'll move next to the site of Bill Crow with Raymond James. Please go ahead.

Good morning, guys. Most of my questions have been answered. I do have a question about construction costs. Are you seeing any change, any stabilization in the rate of increase on construction costs?

We're seeing a stabilization over the last 60 to 90 days. The only thing I'm told that continues to move up a bit are PVC pipe but it's hard to put an exact number on it, but if you look back to roughly 2, 2.5 years, we're up 20% to 25% in construction costs. There was a jump in concrete after the first of the year. But overall, there seems to be a stabilization. And I'm told in Florida that there's still tremendous demand for subcontractors but that's slowed down a bit. So we're having an easier time getting subs and they're being a little more competitive in their bidding. So I think the construction boom, not that it's gone down but at least it's stabilized for a while.

One detail item. When you talk about cap rates, are you quoting cap rates after TI and leasing commission is set aside or is that --?

Well, the way -- I think everybody does it a little differently. But when we talk about a cap rate on a purchase, we look at our all in cost as the denominator, all the expenses of closing, any capital fix-up that we're going to do to the property, and any TI's and commissions related to the -- to getting the first year's operation and getting to a stabilized occupancy.

Great.

Generally 95%. On our developments, it's all in cost, land, carry, development fees, as the denominator. And both of those are calculated on a cash-on-cash basis, although in our supplemental data, we show the yields on a GAAP basis.

Right, right. On the acquisitions you did in 2005, you have an average cap rate?

On a stabilized basis, it's a low 8.

Okay.

And we've gotten that number because, as I was saying, on a couple of these deals they either weren't on the market or we assumed mortgages that chased away the institutional-type buyers.

I'm guess taking we were to throw a cap rate on your portfolio, as a whole, it would be much lower than that?

I would certainly think so.

Okay. Terrific, thanks.

[OPERATOR INSTRUCTIONS] We'll move next to Chris Haley with Wachovia Securities. Please go ahead.

Hi, guys, it's Gregg Korondi. Quick question turning back to the World Houston Center. You guys are in there at $9.50 a foot for the land. How do you see the cost side building out? And then what are your return expectations there? Are they still 10% at that cost basis?

No, our cost basis in the land is probably a little bit below $3 a foot.

Looking at the land was [3.6] million square feet, 380,000 square foot buildable. Am I grabbing the right numbers here?

No, I don't think you are.

He's talking about per building foot.

Oh, per building foot. Yes, per building foot, it's probably $9 a square foot, per FAR foot.

And then can you walk us through the buildout from there, construction costs hard and soft and then what your yield expectation is?

I'll get backwards on it because I know from memory, the yield expectation is mid-to-high 9 at 100% occupancy. And I say that's a fully loaded number. Our shell construction is about $26.50 a square foot. And that's lower than Florida because concrete's significantly cheaper in Texas than it is -- at least in Houston, than it is in the Florida cities.

So is that a good assumption for the development you guys will be starting in Houston for the low 9%?

Yes, in our whole development program on a cash-on-cash basis, it's a mid-to-high 9 at 100% occupancy. So, if you back out a little over 5% to look at it at 95, it's a very high 8 to a mid-9. And that has come down about 40 to 50 basis points over the last year. When you look at the increased construction costs, we have absorbed those two ways. One is we're getting higher rents and the markets allowed for that. And the other is we're accepting a somewhat lower yield. And we think the lower yield is justified given the lower cap rates. We like to have at least 150 to 200 basis point spread from what we could sell the finished product for to what we're building it at in calculating the numbers. I think that's more than enough spread to justify the risk of building on a spec basis. Now, if we're doing a build-to-suit or a pre-lease building, the yield's going to be a little less because the risk is less.

Okay. Now just quickly, the fourth quarter there was a pretty nice ramp-up in the CapEx. Is that all hurricane-related or was there something else going on? The maintenance CapEx numbers?

Talking about the new tenant, probably is we leased a lot of vacant space, so we had some tenant increases in that, and with leasing commissions for that. But other than that, there's no -- there's nothing unusual.

Thanks.

And it appears that we have no further questions at this time.

Again, thank you very much for your continuing interest in EastGroup. And as always, if any other questions come up, please don't hesitate to call Keith or me later today or later in the week. Thank you.

This concludes today's teleconference. You may now disconnect your lines and have a great day.