Elme Communities (ELME) 2007 Q4 法說會逐字稿

Welcome to the Washington Real Estate Investment Trust fourth-quarter 2007 earnings conference call. As a reminder, today's call is being recorded.

Before turning over the call to the Company's President and Chief Executive Officer, Skip McKenzie, [Kelly Shiflett], Senior Manager of Finance, will provide some introductory information. Ms. Shiflett, please go ahead.

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, please contact me at 301-984-9400 or you may access the document from our Web site at www.WRIT.com. Our fourth-quarter supplemental financial information is also available on the Web site.

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. Other 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 the interest rates, 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.

Participating in today's call with me will be Skip McKenzie, President and CEO; Sara Grootwassink, Executive Vice President and Chief Financial Officer; Laura Franklin, Executive Vice President and Chief Accounting Officer; and Mike Paukstitus, Senior Vice President. Now I would like to turn the call over to Skip.

Thanks, Kelly. Good morning, everyone, and thank you for joining us today. We would like to take a few minutes to review our fourth-quarter results and provide some insight into 2008. Then we will open up the call for your questions.

We ended the year with an excellent year with solid fourth-quarter results. We are pleased to report FFO for the fourth quarter of $0.59 per share, up 5% over the prior year. FFO per year was $2.31 per share, an increase of 9% over last year. Core net operating income for the fourth quarter increased 7.1% on a cash basis compared to the same period a year ago. Rental rate growth was 3.2% and economic occupancy increased 100 basis points over last year, reaching 95%. For the year, core net operating income increased 4.5% on a cash basis and rental rates increased 3.4%.

Strong performance in each of the core components of our business contributed to this year's operating results. In 2007, we signed over 300 commercial leases for a total of 1.8 million square feet and an average term of five years. On average, rental rates on these leases increased 6.4% on a cash basis.

We continued to improve our portfolio quality through the acquisition of $319 million of assets, including two D.C. properties and the sale of Maryland Trade Center's I and II office building in Prince George's County. This $58 million sale resulted in a $25 million gain on sale and a 16.9% unlevered internal rate of return over the 11-year holding period.

We completed construction on two of our three development projects, Dulles Station West, our office development in Herndon, Virginia, was named the Best Suburban Mid Rise Office Building by the NAIOP Awards of Excellence. And Bennett Park, our apartment development, has been well-received by the market. We have good activity and leasing progress is on schedule. Shortly after year-end, we delivered the Claiborne Apartments in Alexandria, Virginia.

During 2007, we successfully amended our bond covenants, raised more than 200 million of capital and entered into a new credit facility. Early in 2008 we exercised a portion of the accordion feature on a second credit facility. The total capacity in our lines is now 337 million, and we maintained our favorable borrowing rate of 42.5 basis points over LIBOR. We have a strong balance sheet and plenty of dry powder, as Sara will discuss later in the call.

Although 2008 promises to be a challenging year, we anticipate that the economy and real estate markets in Washington D.C. will fare much better than the national markets. The federal government largely drives the Washington area economy and federal contract spending accounts for one-third of the region's commerce. Although near-term federal procurement spending will moderate, it is still increasing and our region's low overall vacancy rates, low unemployment rate and continued job growth will buffer the impact of a slowing economy on the D.C. metropolitan commercial real estate market.

The office market in our region is solid although leasing pace and absorption has been tempered somewhat from the pace achieved in recent years. In the District of Columbia, the market is still very strong, with vacancy rates at approximately 6% and increasing rental rates. While construction activity is robust and vacancies will inevitably increase, we do not anticipate a significant degradation of conditions in either rental rate or vacancy near term.

In the suburban markets, while there are clearly submarkets with weakness, such as the Dulles corridor, I would caution you not to paint the entire region with a broad brush. Large markets such as Tysons Corner, Rosslyn/Balston, Alexandria and Rockville are solid and performing well with low vacancy and reasonable construction deliveries. Although overall leasing activity and absorption are down. WRIT finished the year with good leasing momentum as we leased more space in the last quarter than any other quarter in 2007. An important contributing factor was the outstanding tenant retention we enjoyed in the commercial portfolio for the entire year. The overall retention for 2007 was 81.5%, and 82.7% in the office portfolio.

This operational success has continued into 2008. A few notable transactions to provide some color. Subsequent to year-end, we renewed an expiring portion of the World Bank space at 1776 G Street for 61,000 square feet, as is, on a five-year term an 11.8 increase in cash rents and a 20.6% increase on a GAAP basis. At the end of this month, the garage lease at 2000 M Street, our recent acquisition, expires. We converted this lease to a management contract, which will increase garage revenues 24% per annum at this facility.

In our office portfolio, we are approximately 97% occupied. And in 2008, we only have 10.6% of our office portfolio rolling and nothing rolling in the soft Dulles market. Our biggest leasing challenge in 2008 in the core portfolio will be the releasing of the 60,000 square foot United Communications Group space at One Central Plaza North Bethesda, and we have good activity on it to date.

We continue to keep a close eye on the multi-family rental market. Although market conditions remain reasonably healthy, vacancies have increased and the ability to raise rents have been impacted by the increases to supply both from the projects originally conceived as condominiums for sale now switched to rentals, as well as competition from the difficult to track shadow rental market of individual condo owners renting their investment units.

Acquisitions activity in the region has slowed dramatically as buyers and sellers struggle to find cap rate equilibrium. While empirical evidence is sparse at this point, in general, conventional wisdom is that rates have moved 50 to 100 basis points, with the exception of properties traditionally in high demand such as well located D.C. office assets, grocery-anchored shopping centers and high-rise residential and affluent sub-markets. With capital being precious these days, we plan to be strategic about which assets we will acquire and sell in 2008 with a focus on continued improvement and portfolio quality and diversification.

In our earnings guidance, we assume significantly reduced acquisition activity for the year. Subject to market conditions, we anticipate recycling capital through more aggressive but tactical asset sales and are focused on raising well-priced capital efficiently, mindful of the need to keep dry powder on hand.

Sara will fully discuss our 2008 earnings guidance. But first, I would like to turn the call over to Mike to discuss the results in each of our sectors and our acquisition and development activity.

Thanks, Skip, and good morning to everyone.

On a portfolio level, we've seen an increase in market rents that have maintained very low vacancy. In the fourth quarter, core NOI in our Retail portfolio increased 13.8% on a cash basis, driven by rental rate growth of 3.2% and 120 basis point increase in economic occupancy. Our retail centers were 97.6% leased as of year end, which is on par with the region's overall vacancy rate of 2.3%. We continue to see excellent rental rate growth in this sector. This quarter we signed new and renewed leases at rental rates 24.3% higher than the expiring rates.

In the Industrial sector, core NOI for the quarter increased 6.8% on a cash basis, rental rate growth of 3.6% and 150 basis point increase in economic occupancy. As of year end, the portfolio was 95.1% leased. By submarket, our Industrial portfolio was 97.2% leased along the I-395 corridor, 95.8% leased in Maryland and 91.5% leased in Chantilly, Virginia. This quarter, we signed 320,000 square feet of new and renewed lease at cash rental rates 7.4% higher than rates on expiring leases.

The Medical office sector increased revenue 6.3% and increased rental rates 3%, leading to a 6.7% increase in cash over NOI in the fourth quarter. We signed an additional 42,000 square feet, making the portfolio 97.5% leased at year end. Forecasted demand for Medical office space remains high, especially with the aging baby boomer population. This, coupled with a limited supply of high-quality assets near hospitals allows us to continue to push rents at our properties in the upcoming year.

The Office sector's core NOI increased 5.5% on a cash basis in fourth quarter with rental rate growth of 2.4% and a 320 basis point increase in economic occupancy. This quarter, we closed on 142,000 square feet of lease transactions, making this sector 96.7% leased at year end. By submarket, our Office portfolio was 96% leased in northern Virginia, 95.6% leased in suburban Maryland and 100% leased in the District of Columbia.

Core NOI in the Multifamily portfolio increased 2.8% on a cash basis with 4.9% rental rate growth and economic occupancy of 90.5%. Our residential units, not including Bennett Park and Claiborne, our new development projects, are 94.6% leased. We anticipate overall occupancy and rental rates will continue to increase as renovated units come online and our apartment developments are added to the portfolio.

On the acquisition front, this quarter, we acquired leasehold position of 2000 M Street, located in the Central Business District of Washington D.C. for $73.5 million. This off-market acquisition was a phenomenal investment, and we expect near-term upside as rents are well below market when we acquired this property in December. As Skip mentioned, we are projecting a 24% increase from garage revenues for 2008 by converting the facility from a lease to a management contract. The property is well positioned for high-quality tenants and long-term has significant redevelopment potential.

Our three development projects have all been delivered as of this date. Bennett Park, a 224-unit high rise/mid rise multifamily property in Roswell, Virginia was 31% leased as of year end. This is exceptional, considering that we delivered the majority of these units at the very end of December. Rents are averaging $2.61 per square foot. We are forecasting the property will be 60% occupied at mid-year and 95% occupied by year end.

We began delivering units of the Claiborne Apartments in Old Town Alexandria, Virginia in early February 2008. The property consists of 74 apartments, so we are projecting the property will be 55% occupied by mid year and 96% occupied at year end.

As you know, we delivered the Dulles Station Phase I office tower of 180,000 square feet last summer. As Skip indicated, we're very proud of the Virginia Chapter of NAIOP awarding the building the Best Suburban Mid Rise Office Building in all of northern Virginia. The Virginia chapter of NAIOP is one of the largest in the country with over 800 members, including some of the best-known developers and architects. This competition for this coveted award was very stiff.

The Herndon, Virginia market, located near Dulles Airport, continues to be challenging, as new projects come online. However, we are experiencing very good activity and this project is one of the best located of our competition with direct visibility to the Dulles Toll Road. Furthermore, we are uniquely situated in a mixed-use project with office, retail, residential, and two new hotel properties now under construction.

We are in active discussions with several prospects and have frequent tours of the property. At this time, we are assuming no rental income from Dulles Station until 2009.

On the development front, we are currently evaluating several WRIT properties where respective county growth plans are being considered for revision. These projects are being considered for plan review due to the proximity to existing or proposed metro locations or in several cases due to the Base Realignment and Closure Act, better known as BRAC, in and around Fort Belvoir, located just south of the Washington Metro Beltway. We expect that a major portion of our work will be performed during the summer and fall with entitlement determinations made in late 2008 and early 2009.

While several of these projects have long-term development horizons, the BRAC initiative in Fort Belvoir is projected to begin Department of Defense relocations to the government facilities in September 2011. Significant demand for the private sector contractors who service the Department of Defense is projected to follow the implementation of BRAC. More than $3 billion is expected to be spent by the Department of Defense on the Fort Belvoir BRAC initiative and construction is well underway.

I will now turn the call over to Sara.

Thanks, Mike. Mike and Skip have covered our 2007 results in detail so I can take the opportunity to discuss our strong capital position in 2008 [current] earnings guidance.

As Skip mentioned, in January, we exercised a portion of the accordion feature on our syndicated credit facility. We increased capacity an additional 62 million to give us $337 million in capacity overall. With no increase in spread, we continue to borrow at the very attractive rate of 42.5 basis points over LIBOR. Yesterday, we closed on [$100 billion] term facility with a fixed rate of 4.45% for two years.

In 2007, we completed several transactions that further strengthen our balance sheet. Early in the year, we completed a $150 million convertible bond issue with a 3+7/8 coupon and a $49 conversion price. In May, we issued $59 million of equity at $37 per share. During the summer, we completed a bond consent to modify our bond covenants, providing much more flexibility on our balance sheet. In the fall, we entered into a new four-year revolving credit facility with pricing again of 42.5 basis points over LIBOR.

On Monday, we will complete an extinguishment of debt on the 60 million of 10-year Mandatory Par Put Remarketed Securities that come due for remarketing. This extinguishment will result in a net $8.4 million charge. The MOPPRS were issued in 1998 with an option to the underwriters to remarket the bonds in 2008 with a 10-year treasury rate of 5.6% plus the current market spread. The net loss is calculated as the net present value of the difference between their fixed 10-year treasury rate and the current 10-year treasury rate.

Due to the volatility in the credit markets, we decided to redeem the bonds rather than allowing the remarketing. We believe that both the remarketing as well as other debt securities issuance alternatives we evaluated would've resulted in unattractively priced long-term capital. Therefore, we decided to refinance the bonds for two years with a credit facility we closed yesterday. This refinancing saved an estimated $5.6 million over the two-year period compared to the estimated remarketing coupon, and that should allow time for the credit markets to settle out before issuing long-term debt.

We believe that all of the aforementioned transactions have further strengthened our balance sheet and provide tremendous flexibility going forward. Last night, we announced 2008 earnings guidance of $2.29 to $2.39 of FFO per diluted share before non-recurring items and $2.11 to $2.21 per share after non-recurring items. Funds available for distribution are projected to be $1.65 to $1.75 per diluted share before non-recurring items and $1.47 to $1.58 per share after non-recurring items.

Our assumptions for the earnings guidance are summarized as follows. We assume our core portfolio will remain 95% leased and we will achieve 1.5% to 2.5% core portfolio NOI growth. Net operating income for the overall portfolio is expected to increase 7% to 9% over 2007. We project that Bennett Park and Claiborne developments will lease ratably throughout 2008. We assume Bennett Park will be 95% occupied and that Claiborne Apartments will be 96% occupied by year end. Due to weakness in the northern Virginia market, guidance assumes no rental income at Dulles Station until 2009.

Projected interest expense will increase 13% to 16% over the prior year. The increase is primarily due to interest recognition on the completion of the three development projects, which had previously been capitalized. General and administrative expense is projected to decrease 9% to 11%, primarily due to onetime expenses in 2007, including compensation for retiring executives and bond consent (technical difficulty).

The loss resulting from the put option on the MOPPRS will be accounted for as a non-recurring item. The net $8.4 million loss, which is roughly $0.18 per share, will be recognized in the first quarter.

We look forward to the year ahead and believe we are well positioned to take advantage of the opportunities in the market. We would now like to open the call for questions.

(Operator Instructions). Matthew Konrad.

Maybe if you could touch on what you're hearing from your tenants? I would expect that if I had to kind of have a spectrum of where the most risk is I would think that it would be in some of the ma-and-pa places in the retail centers and in some of the industrial. I just wanted -- and where they are situated with consumer or with housing. I just wanted to see what you're hearing from them, if there was anyone that you were adding to your watchlist.

I think you are hitting upon a good point. I mean, certainly, as the economy gets a little bit rougher around the edges, those are exactly the sectors where you will see some weakness. We have the ability to push rents, particularly in the retail properties, with respect to those smaller tenants, is getting more difficult, especially on some of the core properties we have, like particular our Bradley Shopping Center, Foxchase Shopping Center those shopping centers where we really push rents in that 50, 40, 50 $60 triple net range, it is getting tougher, I have to admit. And we've sort of dialed back our expectations in that area.

I would say, however, that our -- we really haven't seen increased delinquencies at this point. In fact, our delinquencies for the year were quite low if you look at our earnings. So, we are remaining cautiously optimistic. But we are watching the particular tenant types that you had highlighted.

Great. And then, trying to keep a gauge on what's going on with Dulles Metro, even kind of being in the mix is tough. I guess the only property that that really affects for you is Dulles Station; that would be eight years out anyway. Can you try to handicap what's going to happen there and how that affects the region and your properties?

You are talking about the --

Dulles rail extension.

The extension of Metro. I mean we believe that Metro will occur. It is hard for us to handicap it specifically. Virginia particularly seems committed to moving this initiative forward, the state. And I think most of the people who are closest on this believe that the state is going to come through if the federal government doesn't ultimately provide the funding. So we remain reasonably optimistic.

Now, the second part of your question, how does that impact us specifically? I would say that it does impact all of the buildings in the Tysons area. Our 7900 Westpark property, which is our largest office building, is over 500,000 square feet. That property is very close to what would be one of the Tysons Metro stops. And if in fact this does occur, that property actually has long-term significant redevelopment potential. So, we remain optimistic that it's going to occur and we feel that there are some very positive influences it will have on our properties when it ultimately occur.

Great. And then just my final question is just, has to do with TIs and leasing commissions and the trends there, I know weaken the economy if -- what your expectations are, especially for office and kind of improvements.

In general, we've seen TIs going up and particular as with regards to concessions, and some of the deals we've looked at particularly out in the Dulles Toll Road, TI improvements have increased without a doubt. And we really haven't seen an influence from free rent, but I would say that there have been increases in tenant improvement allowance, particularly for new properties. Downtown office buildings, tenant improvement packages can be huge, although as I mentioned in my comments that we were very fortunate to do a very big renewal with the World Bank actually in the first quarter in 2008 with the World Bank, as is. But those type of deals in the District of Columbia can very easily be 30 to 40 to on a 10-year basis, even $50 in TIs.

Michael Knott.

Skip and Sara, can you just comment on your thought process behind forecasting some acquisitions as opposed to maybe considering buying back your stock, given that you can buy it at a big discount to NAV?

We were very conservative, and as I mentioned, we've completely dialed back the acquisition activity. I guess our thoughts with -- first of all as it relates to buying back stock, the short answer is, we don't have approval from the Board to do so.

But from a strategic perspective, we have made the decision we're not going to lever up our balance sheet to buy back stock. Now, that's not to say if we were to sell a property at the appropriate time if we didn't view acquisition activity it isn't in the realm of possibility. But to be honest with you, we still see tremendous ability to grow and find assets out there that we think are good investments for the property and grow the portfolio. A good example of that is -- and Mike referenced and I referenced the 2000 M Street acquisition. That property has tremendous upside from a number of areas as well as it has long-term redevelopment potential. At the time I guess you could make the argument we could've bought back stock. But our focus is on growing the business and not getting smaller.

Can you talk more about that acquisition? What types of unlevered return expectations do you have over maybe a five or seven-year time period?

Yes. That property has significantly below market rents in there. The average rents in place in that building are in the 30s. So, we've gone in actually at a relatively low yield in the low 6's, but as Mike had mentioned and I had mentioned, it had a very large garage in that facility that we're able to renegotiate the lease. That's going to have a significant impact getting us over the 7% range early; as well as a number of leases that are coming up. We have three-quarters of a floor who is expiring this year, which have rents that are probably $10 below market. In addition to that, one of the things we like about this asset, long-term, it has potential to grow -- to redevelop over time. So, it is a type of asset that not only has near-term positive accretive effect on our revenues but also has the ability to make a significant impact long term from a redevelopment perspective.

Any thoughts on what type of IRR that translates into? 6.2 -- do you get to an 8 or a 9?

Actually we don't run IRRs on our properties. We look at the annual returns over the first five and 10-year basis. So I don't have a specific answer for you. But I would expect that it would be significant, given the redevelopment potential long term from it.

Okay. And then I have two other quick questions. One, can you talk about the Bennett Park mid rise? It looked like it only increased 2% incrementally from fourth quarter -- from third quarter to fourth quarter? And then my other question is, your outlook for the Industrial portfolio occupancy, given the -- that looks like where you have the most rollover in 2008 and 2009.

Yes, the mid rise -- let me go to the first part of your question. The mid rise at Bennett Park. The mid rise specifically, if you bifurcate the property into the mid rise and the high rise, that had phenomenal leasing progress early and that project has some very unique two-story units in it that we've been holding off to achieve the highest possible rents. And that's why you've seen a little bit of a tailing off on that property. And it's really been offset by the -- positively, by the leasing progress that's picked up in the mid rise -- or high rise, excuse me. But if you looked at it and bifurcated on a property basis, it may look like it's tailed off. It's only because we've held off leasing these two-story units really trying to achieve the highest rents in the marketplace.

In addition to that, we're looking at some corporate rentals on those units as well. What was the question about Industrial?

It looked like out of all your commercial property types, that's the sector where you have the most rollover in '08 and '09. I was just curious on your outlook for maintaining your occupancy there, given that rollover.

Yes, I think the market is still very strong on the Industrial sector. And I have no particular knowledge one way or the other, but I'm very positive about it.

(Operator Instructions). John Guinee.

Nice job. Question -- on 2000 M Street, can you talk through the ground lease and how that all came -- what the terms and conditions are on the ground lease?

Sure. The ground lease is for 64 years, I believe, in round numbers, and it's a fixed-rate ground lease. I believe it's $250,000 a year; it has a participating element to it.

So that's really what kept the price per pound so low and the cap rate relatively high.

That's exactly right.

Yes because you can't get 6.2, 6.7 yields in the CBD.

No, but also I would point out that that property was not marketed to the market. We had sort of an inside connection with the owner and we were able to buy that property off market. That was not exposed to the marketplace.

Right but you are a smart guy and you know that there are no dumb sellers in the Washington CBD.

I will take that as a statement and I won't comment on it.

You are a smart guy, Skip, come on. Question on guidance. It's basically $0.58 or $0.59 run rate, which it was last year, excluding the one quarter where Ed retired. And what you've got is you've got $0.03 in G&A said savings; you've got positive spread investing on a couple hundred million dollars worth of investments; you've got core NOI growth of 1% to 2%. All of this translates to much higher than essentially a 1% or 2% year-over-year FFO growth and a $0.58 to $0.59 quarter. What are we missing on the downside, Sara?

Well, I don't know exactly what you are missing. You know, we could talk about it but (multiple speakers)

One of the things we are flying against is the interest.

Well, right. Did you factor in the higher interest expense from the standpoint that you know in 2007 we had $6.2 million of capitalized interest related to our development projects? And the vast majority of that is hitting our interest expense this year.

Yes, and also Dulles Station as well. We start expensing interest on Dulles Station I believe in July.

We're looking at about $0.15 to $0.16.

Right.

Yes, Laura just mentioned, I don't know if you heard that, John, that we're looking at $0.15 to $0.16 in interest expense as it relates to the development property -- with development projects with probably average occupancy, if you looked at it on a year basis, less than 50%. Certainly, when you throw Dulles Station in there it would be less than 50%.

So, Laura, you are saying -- when are you going to start expensing versus capitalizing the interest?

Some of that has already begun because we've placed in service Bennett Park and Claiborne, as well as, as you know, we have a above-ground garage at Dulles Station. That's already placed in service. And so, the balance at Dulles Station will be placed in service in July of '08.

And so, is the garage just sitting there vacant? Is there any use for the grudge?

It would have use if there was a tenant there.

Okay, so there's no other apartment use or anything like that.

Not right now.

Not at Dulles Station.

So you are basically eating the cost of all three phases of the garage plus the vacant building.

That's true. I mean again, the building is starting in July I believe is the date when the interest expense is expensed on the garage or on the building.

When is the last time you raised your dividend and what was that?

John, we raised it in the second quarter of '07 and we raised it $0.04 on an annual basis.

Is that a good run rate?

I think it's a fairly good run rate. But that decision is made by the Board.

All right. Great, thanks a lot.

There are no further questions at this time. I'd like to turn the floor back over to management for any closing comments.

Thank you for listening today. We thank you for your interest in the Company and we look forward to talking to you again in the end of the first quarter.

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.