Elme Communities (ELME) 2008 Q1 法說會逐字稿

Greetings and welcome to the Washington Real Estate Investment Trust first quarter 2008 earnings conference call. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Ms. [Kelly Shiflett].

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 at 301-984-9400, or you may access the document from our website at www.writ.com. Our first quarter supplemental financial information is also available on our website.

Please bare 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 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 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 on 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 and Administrative Officer; and Mike Paukstitus, Senior Vice President Real Estate. Now I would like to turn the call over to Skip.

Good morning and thank you for joining Washington REIT's conference call today. Much has changed in the U.S. economy in the real estate markets even since our last conference call. The economy continues to weaken, as evidenced by the loss of 80,000 jobs reported in March, and the national unemployment rate, which increased to 5.1%, a nearly three-year high. Although Washington is not immune from this nationwide slowdown, our region continues to remain very resilient and consistently outperforms the nation in almost all major metrics.

The Washington area's unemployment rate is 3.5%, the lowest in the nation, is actually below the national average, the average rate experienced in the '90s, which was 3.9% in our region. It has only increased slightly from 3.4% one year ago.

Payroll growth in our region over the last 12 months increased 27,600 jobs, which is approximately one-half the long-term average of 53,000 per annum. This slowdown is material and had a significant impact on the leasing absorption in our markets.

Our region typically absorbs 8 million square feet of office space per year, or 2 million square feet per quarter. For the first quarter of 2008 the net absorption was approximately 1 million square feet, or one-half the long-term average. While occupancies are generally healthy, when vacancy does occur the lease up time has significantly increased.

Overall vacancy in our region is up from a year ago, but I encourage you not to paint the region with a broad brush. While there are pockets of vacancy, most of the submarkets where we invest are solid. The District of the Columbia remains one of the best performing markets in the country. Rents are up and vacancy is actually down in this market. While there is some concern about the impact of the 8.7 million square feet under construction in the District, we expect single digit vacancy rates to continue over the next 12 months. The District is joined by most inside the Beltway submarkets, which enjoy strong occupancies and arduous development processes.

Market conditions in the (inaudible) markets, and specific to WRIT, the Dulles Corridor remain weak, and will continue to be the most challenging markets to navigate through this year. WRIT's only notable exposure to these markets is our Dulles Station development, as Mike will discuss shortly.

The dysfunction in the credit markets continues to impact the acquisition activity. Deal flow is down dramatically as sellers are generally reluctant to mark their assets to market, and buyers are either struggling to find financing or are waiting for the better deal on the horizon. Having said that, the D.C. region continues to be recognized as one of the top investment markets in the world, and ready capital continues to be aggressively deployed for select assets and high barrier to entry submarkets, such as downtown office, grocery anchored retail, and infill high-rise multifamily.

Over the past forty-seven years WRIT has weathered many numerous challenging real estate cycles. Our diversified portfolio, infill property locations, and hands-on management focus continue to provide superior results.

Our first quarter performance exemplifies our ability to succeed even in a challenging environment. I will now turn the call over to Sara to discuss this quarter's performance.

Good morning everyone. Adjusted funds from operations grew 2% to $0.59 per diluted share for the quarter, excluding the impact of the $0.18 per diluted share non-recurring charge related to extinguishment of debt. Including the charge, funds from operations was $0.41 per diluted share.

On a cash basis core net operating income increased 5.8%, and core occupancy increased 160 basis points to 95.2% compared to the same period one year ago. I would like to highlight that for the third consecutive quarter core occupancy is aboove 95%. Rent increases on lease rollovers where 7.1% on a cash basis, and 16.4% on a GAAP basis. Rental rate growth for the core portfolio was 2.9%.

By sector our performance is broken down as follows. Industrial properties' cash core NOI increased 6% compared to the same period one year ago. The increase was primarily due to rental rate growth of 3.1%. Multifamily properties' core cash NOI for the first quarter increased 5.4% compared to the same period one year ago. Rental rate growth was 2.5%, while economic occupancy increased 210 basis points to 92.7%.

Office properties' core cash NOI for the first quarter increased 6.6% compared to the same period one year ago. Economic occupancy increased 290 basis points to 95.4%, primarily due to leasing at 7900 Westpark Drive and the West Gude Office Building. Rental rate growth for the office sector was 2.5%.

Retail properties' core cash NOI for the first quarter increased 6.9% compared to the same period one year ago. Economic occupancy increased 90 basis points to 95.2% due to occupancy gains at Montrose Shopping Center.

Medical office properties' core cash NOI for the first quarter increased 1.5%. Rental rate growth was 3.4%, and economic occupancy remains high for the medical office sector at 98.4%.

During the quarter we refinanced our only debt maturity in 2008. We completed an extinguishment of debt on a $60 million 10 year mandatory par put remarketed securities that came due for remarketing in February. The MOPPRS were issued in 1998 with an option to the underwriters to remarket the bonds in 2008 with the 10 year treasury rate or (technical difficulty), plus the current market spread.

We evaluated remarketing, as well as other long-term debt alternatives. Both would have resulted in unattractively priced capital. Therefore the MOPPRS were refinanced with a $100 million two year term loan, which was swapped at a fixed-rate of 4.45%.

The remaining proceeds were used to refinance a portion of the line outstanding. This refinancing saved an estimated $5.6 million over the two year period -- the first two year period, compared to the estimated remarketing coupon, and will allow time for the credit markets to settle out before issuing long-term debt.

Consistent with our earnings guidance, the extinguishment resulted in an $8.4 million net charge, or $0.18 per fully diluted share. The net loss is calculated as net present value of the difference between fixed 10 year treasury rate that we would have achieved at the time of issuance versus the current treasury rate.

We also exercised a portion of the accordion feature on one of our unsecured revolving credit facilities. Our total borrowing capacity was increased to $337 million, with no increased in spreads. The ability to continue to borrow at LIBOR plus 42.5 basis points puts us in a strong position as we evaluate future investment opportunities.

We're contemplating other methods of financing due to the continued volatility in the credit markets. We will continue our strategy of maintaining a conservative balance sheet with the lowest possible cost of capital. With that, I will turn the call over to Mike to discuss operations.

Good morning. Leasing activity this quarter was on target. We have less than 1 million square feet, or about 10% our total portfolio, expiring during the remaining of the year. We have already renewed, or have prospects to lease, much of the this expiring space. This quarter we signed 61 leases at an average term of 4.75 years for a total of 270,000 square feet. Tenant improvements averaged $5.65 per square foot.

We renewed 61,000 square foot of expiring space at 1776 G Street with the World Bank. The lease is for a five year term. It is on as-is basis with a 12% increase in cash rents.

In February we converted the garage lease at 2000 M Street to a management contract, resulting in an expected increase in annual parking revenue at that property of 24%. At our industrial property, Albemarle Point, we renewed 29,000 square feet for the U.S. Federal Air Marshalls for a five-year term.

Leasing activity at our development properties is moving along. Upon its completion in February we began leasing units of the The Clayborne Apartments in Old Town Alexandria, Virginia. The property consists of 74 units, with 2,700 square feet of retail space, And has been well-received in the marketplace. Rents are averaging more than $3 per square foot, and the property was leased 15% at quarter end.

Bennett Park, our apartment development in Arlington, Virginia, was completed in December. As of quarter end we leased 88 of the 224 units in high and midrise buildings. Rents are averaging $2.61 per square foot.

As reflected in our 2008 guidance, we do not have any leases signed at Dulles Station, our 180,000 square foot office development in Herndon, Virginia. The market in the Dulles Corridor continues to be soft. However, we are cautiously optimistic that the property will be leased soon.

Dulles Station, which NAIOP awarded the best suburban midrise office building in Northern Virginia, continues to stand out among the competition due to its superb visibility along the Dulles Toll Road, its mixed-use environment, and WRIT's sponsorship known for our local presence and expertise in the D.C. Metropolitan region.

As we indicated last quarter, we continue to evaluate our portfolio for opportunity to change or increase density where local governments are considering revisions to the county growth plans. We have now filed two formal requests for projects in close proximity to Fort Belvoir, just south of the Capital Beltway, where the Department of Defense is projected to begin relocations to the government facilities in December of 2011.

Additionally, we are very active in two other governmental jurisdictions considering revisions to their master plans due to close proximity to existing or proposed metro sites.

This quarter we entered into an agreement to acquire Lansdowne Medical Office Building, a five-story 85,300 square foot medical office development for $19.5 million. The project is located at the intersection of Riverside Parkway and Lansdowne Boulevard in Loudoun County, Virginia directly across from the Inova Loudoun Hospital. The site is currently under construction. Loudoun County is both one of the most affluent and rapidly growing counties in the country. WRIT will purchase the property upon its completion, which is estimated to be in the first quarter of 2009.

Also, this quarter we acquired 6100 Columbia Park Road, a 150,000 square foot industrial warehouse in Landover, Maryland for $11.2 million. The property is located just inside the Capital Beltway adjacent to Route 50, between Interstates 95 and 495 and the Baltimore-Washington Parkway. With lease stabilization we expect the second-year cash return to be 8.2%. With immediate access to major roadways in this region, the location is excellent for small and big industrial. We will continue to look for industrial opportunities in this marketplace.

With that I would like now to turn the call back to Sara.

In conclusion, guidance for 2008 FFO per diluted share remains unchanged at $2.11 to $2.21, and $2.29 to $2.39 excluding non-recurring items. We would now like to open the call for questions.

(OPERATOR INSTRUCTIONS). Chris Lucas, Robert W. Baird.

Just a couple of questions to follow up on the leasing front. In terms of what you have remaining for the remainder of the year are there any significant leases that you're concerned about? I know United Communications is set to expire in May. Is there anything else beyond that that is disconcerting at this point?

Of significant size?

Yes, of significant size.

Just so that everybody knows the page you are on there, Chris had referenced the United Communications Group lease, which is at One Central Plaza in North Bethesda. That is approximately 60,000 -- I think it is 62,000 feet. At the present moment we're actually -- we're talking to one user for approximately 9,000 square feet of that space. So the balance at this point is uncommitted.

Other than that, that is really the only large office user that we're looking at in terms of exposure right now. As Mike had mentioned in his comments, the World Bank was 60,000 square feet and we early renewed them.

The remainder of the year really is more small tenant expirations and things --.

Largely, largely.

Then just in terms of there was a comment related to the retail same-store NOI, the cash and GAAP variance, and there was a comment about an increase in bad debt reserves. Is there any more color you can shed on that?

Well it is generally consistent with our reserve policy.

So nothing specific? It was -- it is more of a function of your general policy.

That is exactly right, based on historical reserve ratios.

Then just are you guys seeing any pressure on the expense side, either from local property tax issues or utility issues going forward for the remainder of the year?

There has been significant increases in property taxes and utilities. We have already experienced that. Arlington has announced, for example, that they are increasing their tax rate, among others. We're hopeful that with declining property valuations that there would be some progress made on some of the tax issues, but at this moment, no, we have not seen any relief on those particular matters.

Skip, just more generally about the current conditions in the market as it relates to opportunities. Can you provide any more color in terms of the kind of deal flow that you're looking at, and what of what -- in terms of property type and what your sense is about where cap rates are?

Acquisition opportunities?

Yes.

Specifically?

Yes.

That is the $100,000 question, where cap rates are today. The first observation I would make is that acquisition activity and just properties on the market is dramatically down. You could ask any of the -- I have talked to many of the prominent brokers in the market, and I will tell you anywhere from 40 to 80% reduction in activity.

Now where cap rates are, a lot of it depends on the property type. We're still seeing very aggressive cap rates on downtown office buildings, some of the more prominent downtown buildings. We have made a pretty hard run at some retail properties, and were disappointed to find the cap rates were still sub 6% range.

I do think sort of as you move out into the suburbs and the more commodity type properties, you probably have seen cap rates in the 50 to 100 basis points. But to be quite honest with you, the data set out there isn't extensive, so it is tough to put a bullseye on it.

Is there any more flow of data -- flow of deals at this point just in terms of product being offered?

No. I would say it is very thin. I would quantify it as very thin deal flow. There are deals out there, but it is relatively thin.

Then I guess just the last question just has to do with the interest expense for the quarter. Sara, I guess your floating-rate number remains relatively high compared to where expectations I guess would have been, given the drop in LIBOR. Can you give us a sense as to what that number should be, or when we should expect some improvement in that floating-rate number?

Sure. Earlier in the year the yield curve on 1, 3 and 6 month LIBOR was inverted pretty steeply. And so we went out with longer LIBOR contracts early in the year. Unfortunately, we haven't participated in the last couple of months decrease in LIBOR. Most of the contracts are expiring in June, July, and so we will be able to pick up a little bit of savings there when we roll those over, assuming that rates are below where they were in January.

Michael Knott, Green Street Advisors.

A question on your office expiration schedule. It looks pretty heavy in 2009 and 2010. Can you just talk about the composition of that rollover and any large tenants in those two years?

Wow, 2009. I couldn't tell you right off the top of my head. Mike, would you know?

2010 would be Lafarge.

2010 is Lafarge, which is the large tenant out in the Dulles Corridor. I am trying to think right now. Honda in 2009. I can't think of any major tenants off the top of my head. GSA, I believe has a lease out in our Picket Street property for 120,000 feet. That is -- who knows where that would be. It is currently leased by the FBI for storage. I am sort of looking through some papers right now as we're thinking through this.

Then can you give a little more color, Mike, on your comment about the optimism for Dulles Station, is there more activity recently? I know you have been doing a lots of tours, etc. Has there been a change in your outlook for the leasing of that building?

I think that we feel the project has been positioned very well. So the tours that we are moving through the marketplace we certainly see everything that is coming through. We have narrowed down several that we're very close on the short list. And we see some activity that -- we see some decisions being made pretty imminently on those transactions.

Then on your multifamily developments, are the current percentage lease statistics, are those behind your pro formas, or are they basically on schedule, or how would you describe that?

I would say Clayborne is just a little bit behind schedule because it came online a little bit later. But Bennett Park is pretty much on or about -- pretty close to schedule. We have had really good leasing activity at Clayborne. We're expecting to catch up. We expect both of them to be more or less on sort of glide slope here soon.

Especially as we move more into the peak season now too.

My last question, can you just talk a little bit about your strategy for acquisitions and dispositions? I think the guidance had previously assumed some capital recycling in the second and third quarters to fund some of that.

That's right. Let me just give you just a quick snapshot on dispositions. We do have some properties on the market for sale. They are actually in a due diligent period with a good perspective purchaser. We expect that property to close sometime in the second quarter. Later (technical difficulty) two properties to close in the later part of the second quarter.

With regards to acquisitions, I think we just would reiterate our previously disclosed guidance of $100 million to $120 million. Obviously we've got a lot of work to do to get that done, but certainly to the extent we need to replace the disposition income we intend to do so.

Dave Rodgers, RBC Capital Markets.

On the leasing activity in the multifamily have you had to increase concessions or incentives at all over the last couple of months?

We have had a short burst in there, right, Mike, where we -- for about a month where leasing activities seemed a little dormant.

In the new development. But I would say too that there is several pockets in the marketplace where we have experienced a lot more supply that is moved into the marketplace. And we have aggressively moved forward to meet the competition in those sectors.

The good news is that rental rates have generally been holding out multifamily.

Good. Along the same lines, for Sara maybe. Because of the later completion of Clayborne, have you pushed some of the dilution that would have expected in the first quarter from that completion into the second quarter, or is it still pretty much in line with your expectation?

In terms of revenue or in terms of expense?

I guess a combination of the both. From the later completion you obviously would have been capitalizing up until the completion, and then after the completion expensing. I guess if you are a little bit behind on leasing and you finished a little bit later, I guess a combination of the both.

In terms of Bennett Park that was all online at the beginning of the quarter, so we would have been expensing throughout the entire quarter. Clayborne came online I believe in February 11, and so that has about six weeks of interest expense that would have been capitalized -- was capitalized prior to the middle of February. Within the quarter there is about $800,000 in interest expense that would have been capitalized in the previous quarter.

Thank you. That's helpful. In terms of an office -- well, I guess across the commercial portfolio, are delinquencies anywhere concerning you at this point? I know there was a question about the bad debt reserve in retail, but anywhere overall are you looking at delinquencies or is your watch list growing?

Our bad debt expense has grown up -- grown above our historical standards. Typically we were in that sort of 0.7 to 0.8%, and we are up around 1 now. We have seen just sort of on a macrolevel. I can't identify any specific major tenants.

We have one tenant that we were in a condition of a write-off, but that has been resolved where cash will be coming back to reversal on that as well.

That already occurred in Q1.

Okay, that did, all right. Good.

I think as a general rule, yes, we have seen slightly increased delinquencies, and particularly as it relates to the retail sector. There has been workouts that has occurred, and as a general rule we have incurred higher bad debt expense.

On the Lansdowne acquisition is that preleased or will you be able to do preleasing on that asset?

Basically just to make sure everybody understands that we're on the same page, basically on the Lansdowne acquisition we're working with the developer who is basically responsible for completing the base shell. We're assuming all the leasing risks. We have actually engaged a third-party sort of medical leasing broker to assist our in-house team in a marketing process. And we basically aggressively out there today trying to prelease as much of the building as possible.

Now keep in mind, medical office building is a little more difficult to get a huge preleasing commitment because there is just not that many big tenants for medical Office buildings. But we feel confident that we have some perleasing on that when we actually close on the property, which we expect to be in early 2009. Does that give you the right color?

Yes, that's helpful. Then last question for me. Skip, do you feel good enough or do you think that the fundamentals are at least healthy enough to begin thinking about any redevelopment opportunities in 2008, or is that something that you're just going to put on the back burner until -- evaluate it later?

There is no -- there's not going to be any material impact in 2008 from further redevelopment. We're concentrating on leasing up the development projects that we have on our plate right now. Now having said that, there's a lot of work going on in the entitlement process, and some fairly significant redevelopment projects. Mike had mentioned a number of them as they relate to the BRAC initiatives down in Fort Belvoir area. We also have one spitting distance of our corporate office here at Randolph, Montrose. But those are not going to happen in 2008. Really they are not going to happen in 2009. So they are fairly longer-term initiatives.

(OPERATOR INSTRUCTIONS). John Guinee, Stifel Nicolaus.

Either Skip or Sara, I guess. You have been running the business at $0.58 to $0.59 a quarter through 2007 and then this quarter after taking into effect the cash charge on the debt. At the same time, occupancy is up 150 bps, same-store numbers look good, mark-to-market looks good. Your debt cost is coming down. It sure feels as if you ought to be running the business at a little more than $0.58 or $0.59 with all those positives. Yet your guidance still implies a $0.58 to $0.59 runrate in the rest of 2008.

Any sense for what is dragging things down? Is it capitalizing versus expensing Dulles Station? Is it a higher OpEx number? Is it other things that we can't readily identify?

I would say it is capitalized interest, pretty much 100% of its. Not only do you have the Dulles factor, which is going to kick in I believe August 1. Correct me if I'm wrong. But also just flying against -- and I know your back tracking to 2007, the capitalized interest in 2007 was significantly different than what we're recognizing today in the first quarter of 2008 and as we move forward.

So I don't know if Sara has any more amplification to that. But essentially we're flying through a little bit of headwind with the capitalized interest. And I actually think it is pretty amazing that we have been able to maintain $0.59 as we have sort of taken this interest expense down.

Right.

Do you have anything to add to that Sara?

No, I think that we were conservative in how we modeled the UCGs, what happens in that space. We have modeled no revenues for Dulles Station. So you know, I would say this is a very good quarter if you look out through the rest of the year from the standpoint that, as Skip mentioned, interest expense is ramping up. We have got a vacancy coming -- relatively small overall -- but a vacancy coming up with UCG. And you know a somewhat uncertain economy. I just don't think it is prudent to raise guidance at this point.

Second question, on page 5 it looks like your real estate expenses are climbing sort of in the 31 to 31.5% range, and they bumped up to 33 this quarter. Is that a good runrate? Also are OpEx numbers increasing greater than gross rents are increasing?

There is some seasonality to operating expense, but I think that that is a fairly good runrate.

Sara makes a good point. Certainly with respect to the residential portfolio as you go into to the summer season, it starts -- you start experiencing higher expenses. Mitigated by the lack of snow removal which would be only in the fourth quarter in general. But I think it is a fairly good runrate. I can't think of anything large and material.

The first quarter '07 was about 31.2, and this quarter, first quarter '08 is about 33%. Last question. It is dividend increase time. When do you usually do that?

We usually do it in our next (multiple speakers).

Historically it is in the second quarter.

Yes, second quarter.

Actually last question. I know you just did a big ground lease deal in the CBD. How many assets do you have with ground leases, and do you bifurcate that anywhere in your SEC disclosures?

Technically we have several of them, but we own the [fee] in the ground lease. But there's only one property, the one you mentioned, where we just own the ground lease.

Paul Puryear, Raymond James.

We feel like we're losing a little NAV in our calculation here. I think we have -- maybe we have identified it. Sara, could you tell us a year ago you had about $150 million in CIP, now you're down to almost $50 million, so $100 million in is gone out of that line item?

Yes, we took out both Bennett Park and Claybourne.

How much income are you getting on that?

Little, as they are just leasing up now, so very little.

So what is little, $1 million, $2 million?

I can get you that number after the call. But if you think about how many units we have leased and the average rental rate, you can come up with the number.

I would almost think you could just assume on average for the year 15% occupied, because essentially in round numbers we're leasing them for pretty close to 0 in January to 95% at year end. So it is almost you could come pretty close to assuming a 50% revenue for that property for this year in round numbers.

What are the pro forma yields for that $100 million?

It is sort of a mixture of different assets, the $100 million. I don't think they just relate to those apartment buildings. If it was just the apartment buildings it would be in that 6% range.

One more sort of minor detail here. What is the minority interest on your balance sheet?

With property does it relate to or --?

Is it a property?

Yes, Northern Virginia Industrial Park is a very small minority interest, and the other one is Alexandria. Is that correct?

Right, Kenmore.

Last year, I guess it was the middle of the year, we bought that land parcel. It is a small acquisition. It was a land parcel across from Inova Alexandria Hospital. It was like $3 million -- I think $3.7 million. So there's a minority interest in that.

And then we had a very small minority interest in Northern Virginia Industrial Park, which has been around for 10 years or more. That is it, those two properties.

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

Thank you everyone for your interest in the Company. Have a good week, and we look forward to talking to you in another 90 days.

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.