Elme Communities (ELME) 2004 Q2 法說會逐字稿

Welcome to the Washington Real Estate Investment Trust second quarter 2004 earnings conference call. As a reminder, today's call is being recorded. Before turning the call over to the Company's Chairman, CEO and President Ed Cronin; Sara Grootwassink, the Company's CFO, will provide some introductory information. Ms. Grootwassink, please go ahead.

Thank you and good afternoon everyone. After the market closed yesterday, we issued our earnings press release. If there's anyone on the call who would like a copy of the release please, contact me after the call at 301-984-9400 or you may access the document from our web site at www.writ.com. Our second-quarter supplemental financial information is also available on our web site.

Please bear mind that certain statements during this call are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Although such statements and projections are based upon what we believe to be reasonable assumptions, actual results may differ from those projected. Key factors that could cause actual results to differ materially include changes in the economy, the successful and timely completion of acquisitions, changes in industry, leasing activities and other risks associated with the commercial real estate business and as detailed in our filings from time to time with the Securities and Exchange Commission. Now I would like to turn the call over to Ed Cronin.

Good afternoon. With Sarah and me today is Skip McKenzie, Executive Vice President of Real Estate and Laura Franklin, the Senior Vice President of Accounting and Administration and Corporate Secretary. This afternoon after my brief comments, Sara will provide a review of our financial performance for the second quarter of '04, Skip will then discuss our portfolio performance, current development activities and general market conditions affecting our properties, then we sill open the call for questions.

As you will hear from Skip, we're seeing truly positive activity in each of the property sectors. The exception is the office sector, particularly in North Virginia, but the signing of new leases is somewhat lethargic by comparison. There appear to be several reasons. Some (indiscernible) to expand but are still uncomfortable with the pace of the economic recovery, causing them to stay put and double up. Others with whom we have completed space planning and lease negotiations have been advised by various government agencies that their contracts will not be issued or expanded until the beginning of November. Occasionally when contracts are delayed and we know for sure they will be issued within a month or so, we will sign a lease subject to the contract being issued but not start the lease term nor invest in TI's (ph) until the contract is issued. In summary, we feel comfortable the leasing momentum from government contractors and general space users will increase, but will be delayed for a few more months.

Looking back over the last six months and comparing sequential quarter '04 numbers, combined with what we believe to be realistic projections for the next six months, we expect to be at the lower end of our previously issued guidance of 208 to 212 FFO per share of the year 2004. This includes meeting our $100 million acquisition assumption before year end. Based on our current pipeline, I'm confident we will meet that target. Now I will turn the call over to Sara.

Thanks, Ed. As you know, all per-share amounts are (technical difficulty) on a fully diluted basis. Net income for the second quarter totaled $11.1 million, or 26 cents per share compared to $11.3 million, or 29 cents per share in the second quarter of 2003. Funds from operations for the second quarter totaled 21.2 million, or 51 cents per share as compared to FFO for the second quarter last year of 19.5 million, or 50 cents a share, representing a 2 percent increase on a first-year basis. After adjusting for recurring capital expenditures, tenant improvements, leasing commissions and the straight-lining of rents and amortization of lease intangibles, our funds available for distribution include second quarter totaled $16.1 million compared to 16.9 million for the second quarter last year. During the quarter, we announced a dividend increase of 8 cents per share annually, an increase of 5.4 percent. This marks our 34th consecutive year of dividend increases.

For the quarter, we distributed 39-1/4 cents per share, resulting in an FFO payout ratio of 77.5 percent. Our (indiscernible) payout ratio was 102 percent. Looking ahead at the remaining two quarters in 2004, we expect our FFO payout ratio to be in the 73 to 75 percent range and our BAS (ph) ratio to be in the 91 to 93 percent payout range. A reconciliation of net income to both funds for operations and funds available for distribution can be found in our earnings press release and in the second quarter's supplemental financial report, both of which are available on our web site.

In the second quarter, same-store cash NOI for our overall portfolio decreased 1.7 percent compared to cash outlies for the second quarter of 2003. Breaking that down by property types, office same-store cash NOI decreased 6.2 percent, decreased occupancy in Tysons and in Maryland, plus increased operating expenses, primarily utilities and real estate taxes, were partially offset by lower bad debt expense. Same-store apartment cash NOI decreased 0.1 percent as we started to experience very modest rental rate growth with our newer units starting to lease up, although that has been offset by increases in operating expenses across the portfolio. Same-store cash NOI for the retail portfolio increased 5.7 percent, despite a small drop in occupancy due to the renovation of Westminster Shopping Center.

The industrial portfolio sees its second sequential quarter of positive same-store NOI growth with same-store cash NOI increasing 3.5 percent over the second quarter last year. Occupancy increased 530 basis points with only a slight rolldown in rent. Sequentially, we achieved very positive results. Same-store cash NOI for the overall portfolio increased 1.3 percent over the first quarter of 2004. Multifamily increased 4.5 percent, office increased 1.2 percent, retail decreased 0.9 percent and industrial increased 1.4 percent. Overall, same store operating expenses decreased 0.6 percent, primarily due to seasonal lower utility and snow removal costs.

The Company continues to take a very conservative approach to reserving for doubtful accounts. At June 30th, our allowance for doubtful accounts stood at 11.9 percent of cash basis receivables and 11.5 percent is straight line receivables. Our actual bad debt expense for the quarter totaled 0.5 percent of revenues on a cash basis, or 0.8 percent of revenues on a GAAP basis. At quarter end, we had 530 million in total debt outstanding with 141 million of secured fixed rate debt, 375 million of unsecured fixed rate notes and 13 million outstanding on our lines of credit. In total, our debt carried the weighted average interest rate of 6.4 percent and a weighted average maturity of 7.4 years. At June 30th, our total market capitalization was 1.8 billion, resulting in a debt to total market capitalization ratio of 30 percent. The Company's debt service coverage ratio remains at a strong 3.3 to 1 for the second quarter. Subsequent to quarter end, we renewed and extended our line of credit with Banc One with Wells Fargo as the purchase (indiscernible). The line was increased from 25 million to $50 million.

Lastly, as Ed mentioned, we're comfortable with our previously issued guidance, although we expect to come in near the lower end of the range. Now I will turn the call over to Skip.

As of June 30th, our portfolio totaled 67 properties, consisting of 11 retail centers, 29 office buildings and 18 industrial properties and 9 multifamily properties. The leasing activity in the office sector increased significantly in the second quarter, particularly northern Virginia, as impact from job growth in the federal government and homeland security contractors gains momentum. Although overall activity is up, certain submarkets continue to have significant quantities of vacant space, thus flat rental rate growth. Additionally, there is significant variance and leasing velocity across submarkets. The WRIT office portfolio was 88.9 percent occupied in the second quarter. During the second quarter, vacancy, including sublet space in the northern Virginia office market improved, decreasing from 14.8 percent vacant last quarter to 14.4 percent at June 30th with a positive absorption of 770,000 square feet, following 2 million square feet of absorption first quarter of '04. Despite the two sequential quarters of significant positive absorption, the large amount of available space kept rental rates generally flat. Leasing momentum continued during the second order with activity dominated by large blocks of space, primarily in the Reston Herndon markets, but also in the Roslyn (ph) Boston (ph) corridor. For example, the GSA in Crystal City leased 278,000 square feet, (indiscernible) Alan Hamilton leased 243,000 square feet in Herndon and Friedman Billings Ramsey leased 111 square feet in Roslyn.

At quarter end, the vacancies within northern Virginia submarkets ranged from a low of 8.6 percent in Arlington and 12.3 in Alexandria to 17.6 percent in Tysons Corner and 24.5 percent in Herndon. Although interest has increased from both large and small users, activity moves sporadically at times and some submarkets are significantly better than others. Given the tremendous amount of still vacant space, for example, Tysons alone has 4.4 million square feet available by itself. Rental rates will continue to be flat except in extraordinary cases. WRIT's northern Virginia office portfolio consists of 1.8 million square feet and with 87.3 percent leased at quarter end.

The downtown Washington D.C. market continues to be the strongest in our region and increased absorption primarily by the federal government and large law firms have offset substantial increases to supply. In fact, large blocks of space have become increasingly scarce and large users need to plan accordingly. Thankfully, only one 350,000 square foot new project delivered this quarter and one 500,000 square foot project broke ground. Vacancy in the two largest D.C. submarkets are 7.4 percent in CBD and 9.0 percent in the East End. In the second quarter, 830,000 square feet was absorbed in the district and 6.4 million square feet was under construction. The WRIT D.C. office portfolio consists of 459,000 of square feet and was 96.4 percent leased at quarter end.

In suburban Maryland, overall leasing activity has improved but still can be described in general as lackluster. As mentioned earlier, suburban Maryland is part of our region which reflects significant variations by submarket. For example, this quarter, Bethesda Chevy Chase absorbed 230,000 square feet but absorption in northern Rockville was a negative 129,000 square feet. The office vacancy rate in Maryland was 11.6 percent overall at the end of the second quarter, down from 12.2 at the end of the first quarter. Absorption was a positive 317,000 square feet, mostly in relet and sublet space. We are still not seeing significant demand from NIH and its subcontractors. Rental rates are flat to down and leasing activity is highly dependent on the submarket. Although absorption was moderate in the second quarter, we're seeing a marked improvement in leasing tours. Thus, we anticipate improvement and absorption in the third quarter.

Individual vacancies range from 8.6 percent in Silver Spring to 15.3 percent in north Rockville, whereas the Maryland office portfolio consists of 1.6 million square feet and was 84.5 percent leased at quarter end. Omitting Maryland Trade Center I and II, the leased rate in the WRIT Maryland portfolio increases to 90 percent. During the second quarter, we leased 152,000 square feet of office space with a 6 percent rolldown in rents on a cash basis and a 1 percent increase on a GAAP basis. Tenant improvement and leasing costs averaged $9.94. Our office retention rate for the quarter was 59.5 percent based on square footage. Our greatest re-leasing challenge going forward continues to be at Maryland Trade Center I and II wherein we now have a total of 123,000 square feet vacant, plus an additional 79,000 square feet rolling over the remainder of 2004. The good news is Lockheed will lease 45,000 square feet of the rolling space and overall interest in this space is up.

The retail market is in excellent shape in the DC region. Retail sales continue to be strong and vacancies are nominal. Occupancy within our retail centers has remained excellent at 94.6 percent, up slightly from the first quarter at 94.4. We continue to make good progress at Westminster where we have under construction a 37,000 square foot Food Lion grocery store and expect timely occupancy before the holiday season. We have letters of intent serious -- or letters of intent or serious interest on all remaining vacancies at the center. This will complete Phase II of the renovation at Westminster.

During the second quarter, we re-leased 16,000 square feet of retail space, achieving a 7.3 percent increase in rents on a cash basis and 17.5 percent increase on a GAAP basis. Tenant improvement and leasing costs averaged $11.17 per square foot. Our retail portfolio retention rate for the second quarter was 21 percent. This figure is skewed adversely by the intentional termination by WRIT of a large tenant at Fox Chase in preparation for renovation of that center. For the year 2004, we continue to expect high occupancies and rising rents.

The apartment market, excluding condos for sale in the D.C. metro area, continues to be generally soft but improving. Market conditions vary by submarkets significantly. Overall, we feel optimistic regarding the continued improvement in D.C. and Virginia where 69 percent of our portfolio lies, but remained concerned about market conditions in suburban Maryland, particularly Montgomery County, where we have 19 percent of our portfolio. In D.C., absorption and conversion of condo regimes have kept the market reasonably healthy. In Virginia, activity has been good and absorption has generally kept demand on pace with supply. Maryland is another story as the I-270 corridor in particular has become overrun with supply and will remain in a very soft condition throughout the rest of 2004. WRIT has two properties, one at each end of this corridor, which will be impacted with vacancies likely in the 10 percent range.

The WRIT multifamily portfolio occupancy was 91.7 percent for the quarter, excluding units that have been taken off the market at (indiscernible) property for renovation. Including those units, our occupancy was 90.4 percent. Vacancies were most impacted by lease-up time for Ashby units coming off renovation and the soft market in Montgomery County, Maryland. As Virginia activity continues to improve and renovated Ashby units lease up, we should see occupancy's increase with nominal rent growth. The Washington region industrial flex market experienced steady growth in the first half of 2004. Absorption is up, vacancies are down and sublease space has declined significantly. Most progress has been seen in northern Virginia where activity is up substantially in flex properties in the Dulles corridor. Although some market's are spotty but not bad, we feel optimistic that occupancies will continue to improve and there will be with moderate rental rate growth.

WRIT's industrial portfolio continues to show solid improvement. Overall occupancy improved substantially to 92.6 percent from 87.2 in the second quarter of '03 and from 91.5 percent sequentially. We have seen significant gains at occupancy in our Ammendale properties in (indiscernible), Maryland and Pickett Industrial Park in Alexandra. During the second quarter, we leased 132,000 square feet with an 8 percent increase in rental rates on a cash basis and a 15 percent increase on a GAAP basis, $4.60 in TI and leasing costs and a 49 percent retention rate.

Looking forward for WRIT, we have commenced demolition on the site in Roslyn, Virginia, where we will construct 224 residential units and 6500 square feet of retail, which will deliver in the fourth quarter of 2006. We are progressing with plans for the approved 75 residential units and 4000 square feet of retail addition to our six (ph) 800 block of South Washington Street in Alexandria, Virginia. At our Foxchase Shopping Center, we anticipate commencing renovations in the spring of 2005 and we're working with the Alexandra city officials to secure approvals of our plans. We expect to receive our approval by year end 2004.

In summary, conditions in the region are improving. Leasing activity in the office and industrial sectors has increased and recent gains in northern Virginia are encouraging. Office activity in Maryland continued to be spotty and absorption in district has surprised many as demand has kept up with significant increases to supply. Rental rates will be flat for most submarkets in 2004, but occupancies overall will improve. The multifamily sector is improving in most areas, but Montgomery County, Maryland will continue to be soft. Industrial is improving throughout the region and retail is still extraordinary. Overall, we remain optimistic but cautious. Now, we will open your call to questions.

(Operator Instructions) Bill Camp, A.G. Edwards.

Hi, everyone. I have a question. Skip, this is probably more for you than anybody. I'm curious, do you feel like you're getting your fair share in office leasing, compared to the way the market is turning or not turning?

In general, I would say yes. One of the things that are skewing a lot of, like particularly in northern Virginia, are these big blocks of space. So as a percentage of the total base absorbed, we probably are not because we don't have the big blocks that would fit those tenants available. On the small tenant side, yes, we are seeing our fair share of the activity. But what we're seeing right now is a skewed absorption profile because so many of the space that has been absorbed in these first two quarters have been these big, giant tenants, particularly out in the Reston, Herndon areas where you have seen dramatic reductions in the vacancy rate, although it's still high.

I might add, Bill, also because the way those numbers work, as Skip points out, there are not a lot of deals. When these guys, taken 300 or 400,000 square feet at a crack, (indiscernible) all finished, you might have 12 or 15 transactions for the entire year.

Do you think the smaller tenants are feeling the rebound in the economy at the same pace as maybe some of the bigger guys, or are they still struggling a little bit?

We talk a lot about that around here and I sort of touched on that with my opening remarks. What we are seeing, both one, is we have a number of small space users in our own buildings and others looking at our buildings from elsewhere where they're thinking about expanding and they keep talking about it. And they tend to be doubling up their space. And we know even our own buildings where tenants are thinking about expanding and they are doubling up, they're just not making quick decisions right now. And so I don't think they're comfortable that this economy is moving very quickly and their own operating costs are going up.

Secondly, to give you a good example of what has happened, I also briefly alluded to or touched upon, we had a tenant for two floors, without going into names, for 1600 Wilson. And what happened there, they were all set to go. This is an ongoing contract that they have with one of the government agencies. The government told them stay where you are, dance (ph) through those rents, but in November, we will issue you the contract. That was what we thought -- it was a done deal. Everything's done. All the space planning it was a last-minute and that is not unusual in this market when you get towards the end of a fiscal year that certain agencies start planning without they're going to commit their dollars. So we're seeing some of that. And it's just a combination of things. But bottom-line, I think that as far as the general marketplace is concerned, I don't think they're comfortable yet that they want to expand.

In terms -- this is probably more for Sara, but in terms of the numbers, I see revenue kind of growing quarter-over-quarter and I see expenses rising faster, including G&A. Can you give me an idea of what is going on there?

In terms of historical or looking forward?

Well, both. I mean historical I think, we're seeing margins compress. So the question is do they continue to compress in the future, or do we see kind of a correction of that trend going forward?

Well, I think that you see a correction of the trend on the property side a little bit as occupancies increase. In terms of G&A, what we had in the second quarter was some timing differences with shareholder expenses. We had some increases in compensation expense across the board between adding a few people and annual increases. There were generally several small items that added up to a fairly decent number. But I would say that 1.7 million is a little bit high for a run rate. I don't think that our run rate in the third and fourth quarter will be that high.

Alright, thank you.

(Operator Instructions) Timothy Gobel, Reese.

Hello there. (technical difficulty)

That question has been withdrawn. Jessica Tulley (ph), Credit Suisse First Boston.

Good afternoon. I just wanted to ask how things are going in terms of the re-leasing at Xerox and the SunTrust space, the two blocks you need to deal with.

Actually, there are two blocks we have to deal with and the other is at Maryland Trades I and II. Let me turn it over to Skip because he's dealing with it every day.

There's two what I would call substantial SunTrust blocks. I'm not sure which one you are referring to. There's 53,000 square feet at Tysons Corner, which I think we probably even announced at the last conference call, but we know they're leaving. And that occurs on November 30th is the last day of their lease. We have shown that space -- we don't have any commitments for it. We're seeing a lot more activity in terms of viewing in our Tysons Corner properties, but we don't have anything committed for that. So as of right now on November 30th, that space will come back to us, that 53,000.

We have an additional approximately 40,000 square feet in Alexandria with SunTrust. I don't know which one of these you're talking about. I think you're talking about Tysons. But in Alexandria at 515 King Street, we have SunTrust both in what I would call a large branch bank, as well as some upstairs office space. And that upstairs often space they are actually going to give back to us. As far as the consolidation, this is actually related to the other space. So that will be about 15,000 square feet and the balance of that will be re-leased by us, they will renew there. Was there a second part of that question I'm not remembering?

I think also the Xerox space.

The Xerox space. The Xerox is a 90,000 square foot tenant that we renewed for 45,000 square feet. The nature of the way that lease was done is that they are actually going to lease pretty much the 90,000 square feet that they are currently in until we finish the construction for the 45. So it is kind of difficult to forecast when that 45,000 is coming back to us as vacant, when we're going to get it because actually to the benefit of us right now, it's being stretched out and they're paying rent on the entire space. But right now, I would say that 45,000 for that is going to some vacant towards the end of the year. And due to the nature of the complexity of the buildout, we are sort of strapped in releasing that right now so we don't have any particular prospects.

Thanks, Skip.

Timothy Gobel, Reese.

Skip, actually, on the leasing costs, I try to look at them as what they are costing in terms of the revenue. And as a percentage of revenue, they jump back up again to some of the high levels we were seeing last year. And obviously, you respond to what the tenants are telling you. And I just was hoping you could comment on what they are telling you.

Are you focusing on a particular sector, or just in general?

It seems pretty much across the board. Office was up a little bit. Retail was up sharply, and then obviously your industrial flex was up quite a bit.

First of all, let me break down easy ones. Retail is such a small sample set. It's 16,000 square feet, you really have to toss that out. That has one quirky -- that was way overweighted by two pad (ph) sites that we're doing out in Westminster -- or Agerstown (ph) for Panera Bread and Starbucks. We had some pretty big TI's in it. So the retail number is really just ridiculously skewed because of the small sample size and the particular deals that are in place. The industrial TI's are also higher than we normally see. We see much lower per square foot numbers. But those particular deals there are also skewed because we did a fairly large lease at our Pickett industrial park, which we gave a lot of TI's on extraordinarily. And we also did two fairly large flex deals that had some high TI's. So I am not sure that on that particular category, that is indicative of a long-term trend. It is just in industrial properties, it really depends what type of deals you're doing during that timeframe. If you're doing for whatever reason a large number flex deals that require an office component, you will see a higher TI component. And I think that is what we saw this quarter. On the office sector, $9.94 might be slightly higher, but I don't think that is an unreasonable number.

Right. But I'm also looking at the term that is only a 3.6 year --.

I don't think that $2.50 to $3 a foot per year is a horrible number going forward.

Absolutely, and it's well down from last year, just wondered if that was --.

I think that number is reasonable. Like I said, the other two categories -- retail industrial -- I think are skewed and they're not reliable predictors of the future. But I think that the office one is a fairly reliable sort of average.

On Ashby, Sara or Ed, what is the assumption as far as the lease-up of those units go to get you to the 208 for the year?

Is the question specifically how fast are we going to lease them up?

Yes. What do you have built-in to the 208, as far as Ashby units go?

Let me just tell you what we have in general for the balance of the year in terms of overall occupancy for the Ashby. For Ashby, we're predicting around 11 percent overall vacancy for that property for the balance of the year while we're still leasing up.

What does that represent of the units that you took off-line that are now available?

Right now in terms of the status of the units, we're really only down for like one or two units that were still left under construction. So we have -- actually we have one. We have one unit that we are combining two old units into one new unit. So we have one unit under construction, everything else is available for lease and I am very confident that we will have -- meet those goals at 10 percent.

Okay. Great.

Did I fully answer that question, or was there --.

I will take it off-line.

Okay.

(technical difficulty) Scott Sedlak, A.G. Edwards.

Ed, can you comment on what you're seeing, in terms of acquisition opportunities? And what type of returns do you anticipate for the remainder of the year on acquisitions?

Well on the acquisitions, number one as I mentioned, our pipeline is in pretty good shape. The property types are medical office buildings and one -- primarily medical office buildings -- but one office building over northern Virginia in the courthouse area, which we like the property. And the answer to the returns on average across the several properties we're looking at right now is somewhere in the 7.25 to 7.5 percent overall cap rate. And that obviously is reflected on whatever pro rata return that will give us for the balance of the year as we close these between September and December.

Are there any value-add opportunities in those?

In a couple of those, there are value-added opportunities from very interesting vacancies in a couple of the buildings in which we are interested.

Skip, in terms of leasing, at what point do you become more aggressive maybe than what you have been on rents and concessions in order to fill some of the vacancies that you have, specifically obviously in the office area?

To be honest with you, we (indiscernible) aggressive as we needed to be. We have not let anybody walk away for want of a rental rate. So if we think we can make a deal, we are about as aggressive as we need to be. I cannot think of a single instance of the top of my head where we were some amount of money away from a lease, where we let a tenant walk away.

It's just primarily because of the size of the tenants?

It's because of what they needed, what the tenants needed and the holes we have. In one regard, when you are re-leasing large amounts of space of smaller blocks of space, there is only a limited number of ways that they can be subdivided. When you have an entirely vacant building, you can cut it up a lot of different ways. But when you have 25,000 523 (ph) square foot spaces, there's only a number of limited number of tenants that can fill that particular space. So that makes the algorithm a little bit more complicated. But just so you can be assured that we recognize -- it's a very demanding market. Like I mentioned on my comments, Tyson's Corner still has over 4 million square feet of vacancy. So when we see a deal that we think we can make, we are not holding our rental rates to make another 50 cents or $1. We go full guns to try to make that deal. Because as Ed tells me I think every day, we're here to collect or rent and we're not going to let deals walkaway for 75 cents or $1 or $1.50 even.

Okay, sounds good. Thank you.

There are no further questions at this time. Do you have any closing remarks?

Yes. Thank you again for joining us today. As always, we greatly appreciate your participation and support. All of us are available to answer any other questions you may have. As a reminder, we intend to hold our third-quarter conference call on October 28th. Thank you and as I said before, any further questions, give anyone of us a call.

This concludes the Washington Real Estate Investment trust second quarter of 2004 earnings conference call.