Elme Communities (ELME) 2005 Q1 法說會逐字稿

Good morning and welcome to the Washington Real Estate Investment Trust first quarter 2005 earnings conference call. As a reminder, this call today 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. Please go ahead, ma'am.

Thank you and good morning everyone. After the market closed yesterday we issued our earnings press release. If there is 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 website at www.WRIT.com. Our first quarter's supplemental financial information is also available on our website.

Please bear in mind that certain statements during this call are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Although the statements and projections are based on 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 interest rates, leasing activities and other risks associated with the commercial real estate business, and is detailed into filings from time to time with the Securities and Exchange Commission. Now I would like to turn the call over to Ed Cronin.

With Sara and me today are Skip McKenzie, Executive Vice President of Real Estate, and Laura Franklin, Senior Vice President, Accounting, Administration, and Corporate Secretary. After my brief comments, Sara will provide a review of our financial performance for the first quarter of '05. Skip will discuss our portfolio performance, current development activities and general marketing conditions for the regions. And then we will open the call for questions.

With the exception of the general office sector, the other sectors in our portfolio are performing well through increased occupancies and rental rate growth. The general office sector is responding slower than we would like, but there is positive activity.

As you know, the vacancies in this sector over the last 18 months have generally been the result of large tenants in 3 of our properties leaving, downsizing and in one case, the acquisition of one large tenant by another. Additionally, that sector has been negatively impacted by rental rent roll-downs on renewals. Our plan is to backfill the vacant space with traditional smaller space users.

In regard to acquisitions, we're being very patient. The world we live in today is not one involving negotiations but instead an auction market. Therefore, as a long-term investor with the ability to acquire assets across several property sectors, we need to choose our spots carefully for long-term growth in income and value.

Even in a broadening market, with patience we will find our opportunities. Though prices for property are higher than we would like, we have several offers outstanding. I'm not speculating the price escalation is nearing an end, but it is interesting to note the extraordinary increase in both portfolio and individual property offerings over the last 30 days.

In regard to our current quarter performance, keep in mind that though we missed FirstCall numbers, we do not give quarterly guidance. And I suspect that the disposition on February 1 was not contemplated by analysts in their first quarter numbers. Indeed, based on our quarterly performance we're slightly ahead of our own projections. The annual guidance we provided of 2.07 to 2.11 FFO per share for the year still stands. Now I will turn the call over to Sara.

Thanks Ed. As you note, all per share amounts are on a fully diluted basis. Net income for the first quarter totaled 42.2 million, or $1.01 per share due to the $32 million GAAP gain on the sale of three office properties in Tyson's Corner.

Funds from operations for the first quarter totaled 20.7 million or $0.49 per share as compared to FFO for the first quarter last year of 21.2 million, or $0.51 cents per share, resulting in negative quarter-over-quarter growth.

Results for the quarter were lower in part due to higher operating expenses, primarily utility expense and real estate taxes. D&A was also higher due to increases in accounting costs, corporate salaries, and share grant vesting expense. In addition, annual report and proxy expenses were recognized in the first quarter this year, when in the past they have been recognized in the second quarter.

Our FFO payout ratio for the quarter was 80%. Our FAD GAAP ratio was 105% in the first quarter as weakened commissions and recurring capital expenditures were higher this quarter than in the same quarter last year. A reconciliation of net income to both funds from operations and funds available for distribution can be found in our earnings press release and the first quarter supplemental financial report, both of which are available on our website.

Same-store cash NOI for our overall portfolios decreased 0.7% compared to cash NOI for the first quarter 2004. First quarter same-store cash NOI for the office sector decreased 7%, driven by decreased occupancy in Maryland and Tyson's Corner plus increased operating expenses, primarily utilities and real estate taxes.

Third quarter same-store apartment cash NOI increased 4%, driven by rental rate and occupancy increases, partially offset by increased operating expenses, again primarily utility expense.

First quarter same-store NOI for the retail portfolio increased 1.4%, driven by occupancy gains in Westminster Shopping Center, and Chevy Chase Metro Center.

The industrial portfolio continues to perform very well, with same-store cash NOI increasing 14.7% over the first quarter last year. Same-store occupancy increased 320 basis points with a 3.6% rental rate growth. Sequentially, we experienced a decrease in same-store NOI. Same-store cash NOI for the overall portfolios decreased 2.1% from the fourth quarter of 2004.

Same-store NOI for multifamily decreased 1.8% with higher utility expenses. Same-store cash NOI for the office sector decreased 4.2% due to lower occupancy at 7900 West Park, 1700 Research Boulevard and 515 King Street, as well as increased utility expenses. Retail same-store cash NOI decreased 3.5%, with increased bad debt expense and non-pass-through expenses.

Industrial increased 5.8% with higher occupancy and a decrease in bad debt expense. At quarter end we had 608 million in total debt outstanding, with 198 million of secured fixed-rate mortgages, 320 million of unsecured fixed-rate notes, and 90 million of outstanding on our lines of credit. In total, our debt carried the weighted average interest rate of 5.8%, and a weighted average maturity of 6.6 years.

At March 31, our total market capitalization was 1.8 billion, resulting in a total debt to market capitalization ratio of 34%. The Company's debt service coverage ratio was at 3.2 to 1 for the first quarter.

I would like to reiterate our guidance for 2005 originally issued in November. As Ed noted, we expect to achieve FFO per share growth of 1 to 3%, ranging from $2.07 to $2.11 per share. This guidance assumes the following. As we stated in November, 50 million in acquisitions at June 30, and 50 million at December 31, with a 7.75% cap rate.

North (ph) Frederick acquisition at the end of the quarter puts us ahead of budget, less than 67.5 million disposition on February 1. We project that average occupancy will improve from 90.3% for 2004 to 93% in 2005. Same-store property NOI is expected to increase 1.7%. Tenant improvements are expected to decline slightly overall, as are recurring capital expenditures, resulting in an increase in FAD of 3 to 5%.

In addition, we anticipate funding approximately 30 million in ground-up development and 18 million in major renovations and expansions. Now I will turn the call over to Skip.

As of March 31 our portfolio totaled 67 properties consisting of 12 retail centers; 27 office buildings, of which 7 or medical office; 19 industrial properties; and 9 multifamily properties.

During the quarter we sold Tycon 2 and 3 and 7700 Leesburg Pike for 67.5 million, resulting in a gain of $32 million. We acquired the Frederick Crossing Shopping Center, a 295,000-square-foot center in Frederick Maryland, for 45.1 million. And subsequent to quarter end on April 8, we acquired the Coleman Building, a 60,000-square-foot flex building in the Dulles Business Park in Chantilly, Virginia for 10 million.

In the office sector, the Washington metro area office market continues to build on 2004's excellent performance during the first quarter of 2005. While overall demand for office space remains strong and occupancy has increased, activity pulled back slightly from the pace of the fourth quarter of 2004.

Overall vacancies in the region declined to 9.1%, and net absorption totaled 1.6 million square feet versus 11.6 million square feet for the full year 2004. Buildings under construction increased to 13.3 million, up from 12.5 million square feet one year ago.

Rental rate growth remained nominal and limited to specific submarkets. The WRIT office portfolio was 88% leased as of 3/31/05. The Northern Virginia market vacancy rates decreased from 11.1% at year-end, to 10.3% at 3/31.

Government contractors continue to be the engine for leasing activity in Northern Virginia. Familiar names such as SAIC, Accenture and Lockheed Martin signed large leases in the first quarter.

The impact of sublease space has diminished significantly in the first quarter, decreasing 600,000 square feet. Overall absorption tailed off somewhat from 2004's torrid pace, and the first quarter absorption totaled 900,000 square feet, while in the full year 2004 it was 6.6 million square feet of absorption.

While rental rate growth has been minimal, we expect rental rates to increase in the best submarkets in 2005. At quarter end, office vacancies within Northern Virginia submarkets ranged from 6.4% in Roseland (ph), 7.2% in Alexandria, to 12.1% in Herndon and 13.7% in Tyson's Corner. At year-end WRIT's Northern Virginia office portfolio consisted of 1.4 million square feet and was 87% leased.

Our largest vacancies remain at 7900 West Park in Tyson's Corner where we have 116,000 square feet vacant due to the downsizing of Xerox and the move-out of a 40,000-square-foot tenant late in 2004. We're experiencing good activity on this space and expect to reduce this vacancy significantly in 2005.

The downtown Washington D.C. office market continues to lead the region in overall occupancy and development activity. Rental rates remain generally flat to moderate increases in select submarkets. Vacancy rates increased slightly from 6% at year-end to 6.5% on 3/31.

Absorption totaled 675,000 square feet in the first quarter versus 1.1 million in the fourth quarter of 2004. Vacancy in the two largest DC submarkets is 6% in CBD (ph) and 8% in the East End. Approximately 6.8 million square feet of space is under construction in the district, and an estimated 53% of it is pre-leased.

1.6 million square feet commenced construction in the fourth quarter, versus 3.7 million square feet of new starts in all of 2004. The WRIT DC office portfolio consisted of 460,000 square feet and was 97% leased at quarter end.

During the quarter, World Bank renewed and expanded their lease at 1776 G Street, totaling 149,000 square feet, through December of 2010.

In suburban Maryland, overall leasing activity was lackluster during the first quarter of 2005. Overall vacancy increased slightly to 10.2%, from 10.1% the previous quarter. At quarter end individual submarket vacancies, including sublet space, ranged from 9% in Rockville to 9.7% in Silver Spring, and 11.4% in the I-270 corridor. Rental rates remained flat to down, dependent upon submarket.

Absorption for the first quarter was negligible at 20,000 square feet, versus 2.5 million square feet in the full year 2004. By County, both Montgomery and Frederick County experienced negative absorption, while Prince George's County absorbed almost 200,000 square feet.

At quarter end, WRIT's Maryland portfolio consisted of approximately 1.7 million square feet and was 87% leased. Our greatest leasing need is at Maryland Trade Center 1 and 2, where we currently have 93,000 square vacant. We have good activity on the vacant space and expect to make continued occupancy gains as 2005 progresses.

During the first quarter WRIT leased 330,000 square feet of office space, with an average roll-down of 1% on a cash basis and 6% increase on a GAAP basis. Tenant improvement and leasing costs averaged $17.48 per square foot. Concessions significantly biased by the World Bank transaction. Our office retention rate for the first quarter was 71%.

The retail market is in excellent shape in the DC region. With continued job growth throughout the region, retail occupancies and sales remained strong throughout the metropolitan area. The market continues to enjoy the expansion of existing retailers, combined with interest from new entrants who continue to view this region as the best animation.

Occupancy within WRIT's retail centers has remained strong at 98% leased at quarter end. During the first quarter we leased 37,000 square feet of retail space, achieving a 32% increase in rents on a GAAP basis and a 17% increase on a cash basis.

Tenant improvements and leasing costs averaged $14.16 per square foot. Both rental rates and concessions were affected by the inordinate amount of leasing to bank tenants this quarter. Our retail portfolio retention rate for the first quarter was 96%.

The apartment market in the DC and Northern Virginian region has continued its modest improvement in occupancies and rental rates. The best and most active market continues to be close to Northern Virginia submarkets, with DC a close second. By contrast, suburban Maryland, primarily Bethesda through Rockville, continues to lag due to excessive supply.

Rent increases over the past year throughout the region generally averaged 3 to 4% in the best submarkets, and absorption region-wide is strong at over 5000 units over the last 12 months.

Concessions continue to occur throughout the region, generally targeted to supply imbalances for specific units and average 7 to 8%. In the WRIT portfolio, we expect to see continued occupancy improvements as our renovations at Munson Hill, Ashby, Park Adams and Roosevelt Hill complete. The WRIT multifamily portfolio was 93% leased at quarter end.

The Baltimore/Washington industrial flex market continued to benefit from the region's strengthening economy, particularly in the DC region. In the Washington submarket of the region, first quarter vacancy averaged 9.8% overall, and absorption totaled 700,000 square feet. In the Baltimore submarkets, overall vacancy averaged 12.9%, and first quarter absorption was 560,000 square feet. The strongest submarkets continue to the ones where WRIT has a major presence, particularly Springfield/Newington and the Chantilly/Dulles airport area.

Rental rate growth was moderate in the Washington region, but flat to down in the Baltimore region. There are 2 million square feet under construction in the Washington area, versus 2.6 million in the Baltimore region.

WRIT's industrial portfolio continues to perform well, ending the quarter at 95% leased. Lowest occupancies, at 81%, are at Ammendale properties in Beltsville, Maryland where we currently have excellent activity. Based on this activity, we expect these properties to be over 90% leased by the end of the second quarter.

During the first quarter, WRIT leased 186,000 square feet of industrial space. Rental rates decreased 0.5% on a cash basis, and increased 5% on a GAAP basis. TI and leasing costs were $1.61 per square foot. Tenant retention was 66% for the quarter.

On the development side, our construction on our Roseland Towers project in Roseland, Virginia is under way, and plans for the development of the 800 block for South Washington Street are almost complete. We expect to commence demolition of existing structures late in the second quarter.

At the Foxchase Shopping Center, our last tenant in the development area will vacate in April and we will begin demolition shortly thereafter. We anticipate the opening of Harris Teeter to occur late in 2006.

WRIT is experiencing improved market conditions in all property types. Rental rates are moving modestly upward in most submarkets and property types. We expect to see continued improvement in the property markets and the WRIT portfolio for the balance of 2005. Now we will open the call for your questions.

(OPERATOR INSTRUCTIONS). Scott Sedlak.

Actually, Scott's line disconnected, we have Jessica Tulley.

I have a couple of questions. One, could you give a little color on G&A and what you expect trends to be this year in that area?

Jessica, Laura Franklin. We expect our run rate for 2005 to be 2 million a quarter. And basically that compares to last year where we ended at about 6.2. Those increases are primarily due to long-term incentive compensation, and retirement plan comps and increases in personnel cost. It is interesting to note, on the personnel front we actually had probably almost pulled back in Q4 last year. So the overall increase basically compares to Q1 and Q2 of last year when we were understaffed.

The increase won't be as strong in other quarters?

Right.

Could you talk a little bit -- I think Ed in the very beginning of the conversation, in year prepared remarks you mentioned -- and I wasn't sure if it was extraordinarily good or extraordinarily bad, but you said something about pricing and demand for properties in the last 30 days had been -- I think you almost said an extraordinary increase in prices in the last 30 days?

No, what I was saying in the last 30 days we have seen an extraordinary volume of portfolios coming to the marketplace, obviously CalPERS, everybody has been talking about. But in this region JBG is putting their entire portfolio on the market, which is estimated to be $2.2 billion of primarily office in the downtown area, some in Rockville, and the balance in Virginia.

On top of that, Westreich (ph) which is a major developer out of New York who has major positions here, they have been in this area since about 1980, are putting all of their office buildings on the market for sale. That is another about $2.5 billion in estimates.

For those who are not generally familiar with that portfolio, when you fly into National airport, you'll notice where (indiscernible) headquarters used to be, the two very large buildings. Those are their signature buildings, I would say, that you can see flying into town. But they own buildings through Roseland, Ballston and downtown Washington. It's a significant, first-class portfolio.

In addition to that, a couple of major other owners of properties, not quite to that same level, are putting up properties for sale as well. And we are seeing that in other areas; we are seeing it also in multifamily, mostly national owners of properties who are putting their entire portfolios up.

My comment there is frankly, thinking in terms historically, usually when people put a lot of property up for sale it is time for people to buy to a certain degree, meaning there's something going on in the market. We are in an extreme and unusual period where we have had very poor performance from the real estate portfolios, not only here but nationwide, in a down market. What we have seen are the cap rates falling, rather than what historically has occurred with the increase in the opportunities when you buy.

A good example is our own properties which we recently sold. They were sub-5% returns with about 28% vacancy in them. A lot of CapEx necessary and cost to lease up, and a relatively flat to down office sector market in the Tyson's area where we sold those properties. So I just think you have to exercise care and that is what I was meaning. I didn't -- I don't mean to -- sorry about a long answer, but I think there are a lot of questions out there, most to me being driven by a lot of very smart people deciding this may be the top of the market.

That's very helpful.

Scott Sedlak.

Ed, just comment and briefly on acquisitions. Can you maybe talk about who you see as your biggest competition right now, and briefly in terms of cap rates as well?

To start with, we have made probably for us a really aggressive move on a property in Ballston. And going into a little under a 7 cap rate for a fully leased -- just a great, really a terrific property. We lost out to someone coming out of a 1031 who bought it on 5.5% return on our numbers. I am sure there have been other stories similar to that.

The other has really been opportunity funds and very few REITs have been -- primarily funds coming in, when we come back and take a look at the debt they put on the property, they're loading it up with debt through Mez and with anywhere between 5 and 15% equity, and hoping to hold it for 2 or 3 years and flip it out at these extraordinary price increases we have seen.

So they have been the two areas that we have found to be the most aggressive. The next or the third most aggressive area where we have seen opportunities, not unlike what we sold, where we see substantial vacancy in properties that we would like to acquire, and an opportunity to grow them from historical sense, people are paying sub-6 and 5% returns for these properties with vacancies. And I don't see the rental rate growth taking off maybe the way they do.

I apologize if I missed it, I was just coming back online when I think you guys were referring to G&A. Can you maybe just recap what was said before?

Go ahead Laura.

We expect our G&A run rate to be 2 million a quarter for 2005. And that compares to -- we had 6.2 for the year last year. The increase is primarily due to long-term incentive on retirement comps expense as well as personnel costs. And I made note about that basically in Q1 in Q2 last year we were not at full staff. So the increase in personnel cost isn't just increased staff and salary increases this year, it is obviously comparing to a not fully staffed last year for two quarters.

And that is already factored into the 2.07 to 2.11 guidance?

Correct.

Skip, can you maybe just go through what your rent expectations are by property type, just kind of briefly?

You said rent in our budget?

Yes, I mean in terms of the same-store, what are you expecting for instance in the office portfolio as a whole this year?

Let me just go through where we expect to stand in terms of our occupancies. Generally when we went through our budget this year, we expect an improving market. And when we began the year, we began somewhere in the neighborhood -- let me talk about the office sector because that is really the one that has the most impact.

The office sector we assumed the year was going to begin around 11% occupancy, 11 to 12% is where we are when the year started. (multiple speakers) Vacancy -- did I say occupancy? I'm sorry. 11 to 12% vacancy at the beginning of the year. And we have that trending down throughout the year to approximately 4 to 5% at the end of the year with an average vacancy over the year of 8%. Okay?

In terms of rental rates, we generally have been remaining -- when we budget, we pretty much don't assume any rental increases. So we pretty much use the rental rates that we were incurring at the end of the year, if that answers your question.

So no rental rates are budgeted in, but you're expecting --.

No rental rate increases.

No rental rate increases. But you are expecting vacancy to go from 11% at the beginning of the year, down to 4 to 5% at the year-end?

With an average vacancy over the year of 8%. That's correct.

That is just through the lease up of Maryland Trade and 7900?

And the others. But that is essentially correct.

And 1700.

Okay. And then lastly, just in terms of the yield on the Coleman Building, did you guys disclose what that was?

I don't know if we specifically talked about the yield, but let me just talk about that for a second. The Coleman Building was the building that was only 65% leased when we bought it. So the going in yield on the Coleman Building was actually lower than we would normally expect. The going in yield is approximately -- hold on I have that on a piece of paper here -- was below 8%. It was 7.3%, and that is assuming some lease up over the year.

And let me explain to you what the balance of the space is and where that is going. That building, as I said, was 65% leased at acquisition. We actually have a lease out for signature for the balance of the space, and I expect it to be least at the end of this week hopefully. So let's assume it takes an extra week because those things always tend to. I would expect this to have yield in excess of 7 -- whatever I said -- 7.3%.

(OPERATOR INSTRUCTIONS). David Rogers. (ph)

This is Chris Chapman (ph), actually, with Dave Rogers. KeyBanc Capital Markets. I just wanted to ask how new supply in each of your different property types in the area is going to impact you?

Let me think about it now. On the retail sector, most of our properties are in-filled. So with exception of a couple of recent acquisitions, even though in Frederick today it is becoming in-filled, because the development that is taking place up there is really blooming up for us, Hagerstown, and North and South, a couple of other areas you guys probably never heard of.

On the retail side, I don't -- new development is not going to impact us probably at all. On the industrial side, there again much of our properties is in-filled and I don't see a lot of impact their.

The only negative impact that we typically see, particularly in NVIP, which is our largest 800,000-square-foot portfolio with several buildings in that park, down at the end of Route 95, we are seeing a lot of development taking place down in the Fredericksburg area. So that new development will have some impact. So far, the impact from that area that is being developed has been a result of tenants deciding to go before a -- build to suit for their own use and ownership.

On the office sector, there again we are in-filled. I don't see in a lot of negative impact with new construction in that regard. So I think about the question you just asked, across the portfolio, due to our in-filled nature of our portfolio, I don't see a lot of new construction impacting us.

But one area that might be a question is something that we think about -- we talk about around here. We're building, as you know, a high-rise in Roseland and we have 75 units that we're going to start in Alexandria here shortly on the apartment side.

And what concerns us there, in both of those areas, we are seeing a lot of new construction. Most of it is going condo and the vibes and the words that we get from a lot of the condo developers -- many of these units are being sold to speculative buyers. And there is one building we're familiar with and Ballston which is just west of our property in Alexandria that we're building, virtually turned over 100% from the time the developers starting selling units to the time that he finished the property.

And the concern I really have there long-term is probably twofold. One, there really are -- and I have seen this before -- the people are buying these things speculatively, and that has happened in this town in the past. All of a sudden you have a lot of new rental coming on that you had not anticipated before, along with a lot of foreclosures, because a lot of these people bought these things and can't carry the debt they put on them.

Right.

Does that answer your question?

Yes it does, and leads to another one. Have you guys considered doing the condo thing yourselves then?

No. Number one, I find it very interesting on the condo side, one of the things I watch closely is the construction loans that are being made on these condos. We're building this unit that can easily be condo from a quality standpoint, high ceilings, just first-class materials throughout.

Our costs are going to run us a little over $250,000 a unit. And the loans that are being put on the condos for construction purposes are running anywhere from a low of 315,000, I have seen them as high as $360,000 a unit. So from my standpoint, maybe a foreclosed lender might be able to compete with us, but they're not going to be able to.

(OPERATOR INSTRUCTIONS). Dan Gluck. (ph)

Just a quick follow-up. As far as all the new supply you're seeing in your market for sale in the last 30 days, what's [sic] your thoughts as far as the impact on cap rates?

Good question. I have been in business over 40 years and somewhat of a student of economy going back for a long time. And we have gotten through a period that I can't answer your question very well. The reality is that cap rates should go up; a combination of interest rates and the volume of property that is on the market for sale.

On the other hand, we have seen all of us over the last two years, three years, not only here but across the country, very weak fundamentals in this business, and the cap rates keep falling.

I could understand it to a certain degree, with the lower interest rates, but on the other hand, I guess part of that question from those who can go into alternative investments to real estate, if that world starts looking better or even near the kind of returns you could expect from real estate, that should raise cap rates. But at the moment, I don't know.

I think that from our standpoint we've got to do what we're doing now, which is trying to come in under the screen. We have a couple of offers out that we hope will be accepted. We're working on a one-on-one basis with some private owners of property who are less oriented at putting their properties out to the marketplace, but that doesn't mean our cap rates will be any different. These guys are sophisticated. But it may enable us to move more quickly in acquiring assets that we want, and I don't feel uncomfortable that will be able to meet our projections for the year in that regard.

(OPERATOR INSTRUCTIONS). At this time there are no further questions about. Ms. Grootwassink, are there any closing remarks?

Yes. Ed.

I want to thank everybody up for joining us. As always, we greatly appreciate your participation and support. All of us are available to answer any other questions you may have, and we look forward to seeing you personally on some of these trips as well as hearing from you. Again, thank you very much.

Ladies and gentlemen, we do appreciate your joining us today. This does conclude today's Washington Real Estate Investment Trust first quarter 2005 earnings conference call. You may now disconnect.