Elme Communities (ELME) 2011 Q4 法說會逐字稿

Welcome to the Washington Real Estate Investment Trust's fourth quarter 2011 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, Director 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 of the release, please contact me at 301-984-9400; or you may access the document from our website at www.writ.com. Our fourth quarter supplemental financial information is also available on our website.

Our conference call today will contain financial measures such as core FFO and NOI that are non-GAAP measures, and in accordance with Reg G, we have provided a reconciliation to those measures in the supplemental. The per share information being discussed on today's call is reported on a fully diluted share basis.

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. Such statements involve known and unknown risks, uncertainties and other factors that may cause actual results to differ materially. We provide a detailed discussion of these risks from time to time in our filings with the SEC. Please refer to page 7 to 14 of our Form 10-K for our complete risk factor disclosure.

Participating in today's call with me will be Skip McKenzie, President and Chief Executive Officer; Bill Camp, 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.

Thanks Kelly. Good morning and thank you for joining the Washington Real Estate Investment Trust fourth quarter earnings conference call this morning.

At the beginning of last year, we laid out a strategic plan for our Company. This plan called for the increased investment through acquisitions and development in high-quality office, multifamily, retail, and medical office properties in excellent locations inside the Beltway or near major transportation nodes, and in areas with strong employment drivers and superior growth demographics. To help pay for this investment activity, we committed ourselves to a much more active asset recycling program such that we have a guideline to pay for approximately 25% to 33% of our investment activity through asset sales.

The largest part of this recycling program was the announced completion of the sale of our entire industrial flex portfolio. I'm proud to say that we executed this plan on all fronts and had a record year in terms of acquisition and disposition transaction volumes. We acquired five income-producing assets for a total of $360 million, including two downtown Washington, DC, office properties; a grocery-anchored shopping center in an affluent suburb; and two office properties located at Metro Station, and Alexandria and Tyson's Corner. In addition we entered into two joint ventures to develop two apartment projects at or near Metro Stations, totaling 430 multifamily units in Arlington and Alexandria, Virginia, two of the best sub-markets in the region. These 430 units will increase our total multifamily portfolio unit count by 17% over the coming years.

Finally, and most notably, we completed the sale of our industrial portfolio, along with three non-strategic suburban office assets, for proceeds of $409 million, resulting in $97 million in gains. While by my account, the team here did an exceptional job executing this record-setting volume of transactional activity, the fact of the matter is these transactions in total mean we are commencing 2012 as a $50 million smaller Company, which will have an adverse affect on earnings until this capital is reinvested. Bill will talk more about the details of our acquisition and disposition guidance in a few minutes, but from a strategic standpoint, we will focus more of our sales on non-strategic assets, primarily suburban office buildings in our portfolio, that do not fit our long-term vision.

This plan as a result of a thorough review of our portfolio wherein we identified a small subset of our portfolio, representing just under 10% of our total NOI, that does not fit our long-term strategic plan. While the specific timing and execution of these potential transactions will be dependent on a number of variables, such as market conditions, lease rollover exposure, and the use of proceeds, to name a few; we expect these dispositions to be completed over the next three years. In addition to these sales of non-core assets, we continue to look at creative ways to use our existing asset base to help competitively fund our strategic plan.

With that disposition framework in mind, in 2012 we anticipate recycling these disposition proceeds, plus the $50 million we are in the hole from last year, into assets which fit our new strategic plans. While I am hopeful we will be more acquisitive than that, those are the details we have modeled into our guidance, as Bill will discuss further. While deal flow has started the new year slow by historical standards, we are beginning to see some signs of an uptick, and we are cautiously optimistic offerings will increase over the next quarter.

Aside from our strategic accomplishments in 2011, we are seeing the beginning of what we hope is an upswing in the leasing market. Our same-store occupancy improved by 60 basis points from the third to fourth quarter, with improvements in every sector except for medical office; and the fourth quarter was our busiest of the year in terms of leasing [velocity]. We fully recognize that we are not out of the woods yet, and the market conditions are far from the good old days. We expect generally flattish market conditions at least until next year's election -- this year's election -- but we are cautiously optimistic that we have reached an inflection point and occupancy will continue to slowly improve.

The really good news is that for WRIT, we have a relatively low rollover year, with only 10% of our NOI expiring in 2012, protecting us in the event market conditions slip. To insure that we are maximizing our potential to retain and attract the best tenants, we have identified a number of opportunities to add value to our existing portfolio through capital improvements, and have commenced a number of very significant value-add projects that we believe will ultimately reduce vacancy and drive an enhanced rental rate growth. Mike will discuss these projects more specifically later on the call. Overall, we believe our repositioning in 2011 has shaped the stronger and more secure portfolio, and with our strong balance sheet we are positioned to capitalize on opportunity in the years ahead.

Now I'd like to turn the call over to Bill Camp, who will discuss our financial results, guidance, and Capital Market activities; and then to Mike, who will further discuss our real estate operations.

Thanks, Skip. Good morning everyone.

Last night we reported 2011 core FFO of $1.95 per share, which included a one-time $0.01 charge in the fourth quarter related to the lawsuit with a former tenant at our Westminster shopping center. Excluding the charge, these results were at the low end of our original guidance range of $1.96 to $2.08, which we narrowed in to $1.96 to $1.99 on our third-quarter call. These results were driven by two primary factors -- first and foremost, the timing and the volume differences between the sale of industrial in the three office buildings compared to our asset purchases throughout the year brought our numbers lower than our original projections. Secondly, leasing fundamentals proved much more challenging in the second half of the year than we anticipated.

At the beginning of 2011, we saw improvement in the national and Washington, DC, economies, and it appeared that leasing activity was beginning to take hold. The momentum built throughout the first half of the year, and then a combination of headline events, including the downgrade of the federal government debt, the congressional debate over the national debt, the European financial crisis that still tops the news, national news of the potential of a double-dip recession, and the continuous ramp-up of the 2012 election banter, slowed the momentum in the Washington, DC, real estate market.

With all that said, we believe we had a very solid year on the operational side of the business, executing over 350 lease transactions throughout the year, ending the year with the highest same-store occupancy since the end of the first quarter, generating lease increases in rents on renewals and new leases throughout the year, and positive same-store NOI growth compared to last year; not to mention ending the year with an uptick in occupancy.

To focus a bit on the fourth-quarter performance, core FFO came in at $0.47 per share. This number includes the $0.01 charge I had previously mentioned. Excluding this charge, the fourth-quarter core FFO was the same as the third quarter. Core FAD was $0.37, consistent with our expectations of higher tenant improvement at leasing commission costs in the third and fourth quarters. We expect higher levels of TIs and leasing commissions going forward, as leasing market remains competitive. Over the past few years, the spread between core FFO and core FAD has consistently hovered around $0.35.

The 2012 core FFO guidance range that we introduced in the press release is $1.87 to $1.97. We ended the year with essentially a $0.48 run rate for core FFO. We have modeled same-store occupancy to remain roughly flat for all sectors in 2012, with same-store NOI growth projected to be minus 1% to positive 2%.

As we have discussed last quarter, we are entering the year with some headwinds. First, Skip noted that we are a smaller Company than we were at this time last year. We calculate this impact to be approximately $0.01 per quarter in lower NOI. Remember, in the fourth quarter we sold some of the industrial in the fourth quarter, so it did not fully reflect the downdraft in non-same-store NOI. Second, occupancy ticked up nicely in the fourth quarter, only to start the year down with already announced 65,000 square-foot move-out of Oracle from one of our Tyson's buildings.

Looking at each sector independently, multifamily same-store NOI is modeled to grow 4% to 6%, with occupancy remaining in the 94% to 95% range. Office same-store NOI is expected to be slightly negative, in the minus 2% to 0% range, driven by significantly higher real estate tax expense. Occupancy is expected to move around throughout the year, but essentially remain flat. Medical office same-store NOI is expected to remain in the 0% to 3% range, as it has for years, and occupancy is projected to remain relatively steady. Retail same-store NOI is modeled to grow 0% to 3%, excluding the effects of the one-time write-offs we realized in 2011. Occupancy is expected to remain fairly steady in the 92% to 93% range. As Skip mentioned, we expect the acquisition disposition activity to be a net positive $50 million, and we are modeling $130 million in acquisitions and $80 million in dispositions. We hope that we will be able to achieve a higher acquisition level throughout the year.

This is a good lead-in to our capital needs for 2012. We anticipate that we need to pay for the following -- the $50 million in net acquisitions, or more if we find more deals; the $50 million unsecured bonds that come due in May; a $20 million mortgage that comes due in November that we can prepay in August; $20 million to $25 million in capital improvements that Mike will discuss in more detail; and approximately $15 million in development costs related to our two apartment JVs.

This $160 million of capital needs can be financed on line of credit for a period of time without creating any liquidity problems, since our current line balance is only $89 million. However, as the line balance builds and the bank lending and the capital markets cooperate, we will look at the options available to finance all or a portion of these requirements with debt and/or equity. Our smaller line also matures this summer, and we are just beginning discussions to refinance the $75 million facility. We certainly do not anticipate any problems in renegotiating this line.

There are few more details about guidance in our press release, and I will be happy to answer your questions in a few minutes. Now, I will turn the call over to Mike to discuss operations.

Thanks Bill, and good morning everyone.

We ended 2011 on a strong note. Overall, portfolio physical and economic occupancy ended the year higher than it has been since second-quarter 2010. The same-store occupancy numbers [approved] in the final quarter of the year, driven by the improvement of three of our four property types. Combining this occupancy improvement with GAAP, rent increases in these property sector continues to demonstrate the resilience of our portfolio.

While our same-store internal pools of properties are over 90% occupied, we want this number to be better. We have a number of capital projects, promotional plans, and additional manpower underway to support our objective of superior occupancies. While Bill mentioned that we are projecting generally flat results for 2012 compared to 2011, we believe we are beginning to see small signs of market improvement and are cautiously optimistic the momentum in the market will build up fourth quarter.

Now let's take a closer look at each of our four sectors. Starting with Multifamily, this sector continues to be our strongest. It is important to remember we felt the typical seasonal slowdown in the fourth quarter. With that said, we still successfully improved occupancy over the third quarter, while still achieving solid rental rent growth and NOI growth. On a full-year to full-year comparison of 2011 to 2010, NOI improved 6.5%, which is outstanding given a portion of our portfolio is older DC product that is rent-controlled. Going forward, we continue to expect strong performance this year as new deliveries in the market remain further out into the future.

We have started a unit renovation program at four of our 11 apartment properties. These improvements include upgraded kitchens, bathrooms, and finishes. Our total program encompassed 20% of our overall units by the end of the project. Since our largest number of expirations happened in the third quarter, we expect to see increases in rents on these units beginning in the fourth quarter, with the majority of impact in 2013. In addition to these renovations, our two development projects are on track to break ground by the first quarter of 2013. We are excited about these two Class A development projects in two of the best sub-markets inside the Beltway -- Arlington and Alexandria.

As we previously forecasted, our Retail portfolio picked up occupancy in rental rate growth this quarter as well. Leasing volume in the quarter was nominal, but the rent increases of 30% were very strong. We still would characterize this sector as a little choppy, with a few smaller vacancies and continued elevated levels of bad debt expense. The one-time charge we took this quarter at Westminster Shopping Center was related to a tenant who vacated several years ago, and not indicative of any litigious trend that we would expect to carry forward. Without this one time charge, the Retail same-store NOI growth in the quarter would have been positive compared to the third quarter. Going forward, we are seeing a relatively good activity at many of our larger vacancies. As with most of our Retail activity, it remains a typical or very likely process to actually get a deal to the goal line.

The Office sector picked up occupancy from third quarter to fourth quarter. The same-store pool added 40 basis points to the quarter, and compared to the third quarter, same-store NOI was up 0.3%. We have a few vacancies that we are working hard to lease, including the former Oracle space at 7900 Westpark, located in Tyson's Corner, in close proximity to one of the new Metro stations; and the former Lafarge space at Monument 2, located directly on the toll road near Dulles Airport. We have good activity at both of these spaces. In fact, Oracle vacated its 65,000 square feet at the end of the year, and we already have 15,000 square feet of that space re-leased, but one of our existing tenants looking for expansion space. With that said, this move-out will likely result in Office vacancy ticking up again when we report first-quarter earnings.

We continue to evaluate the positioning of our Office portfolio, and we are embarking on several capital improvement projects to upgrade certain assets, particularly our downtown properties located in the heart of the CBD. We are in the planning or construction phase of many projects in our Office portfolio, such as fitness centers, conference centers, modernized HVAC systems, as well as lobby, restroom, and common area improvements. Specifically, these projects are under way at 2000 M Street, 1140 Connecticut Avenue, and 1220 19th Street. Additionally, we are in the planning stages of reskinning a few of our best-located assets. These projects are longer-term in nature, but have the potential of repositioning these assets into higher quality product in their respective sub-markets.

Medical Office lost 70 basis points in occupancy from third quarter to fourth quarter. As Bill has stated on previous calls, we are somewhat a victim of our own successes, as we have the best product and the highest rents in the markets. This is putting pressure on our occupancy, as competitors offer much more aggressive deals to lure tenants from our buildings. Coupling with the dynamics of indecision on the part of government terms of healthcare bill, doctors are struggling to plan and commit to leasing space, particularly expansion space. Our same-store occupancy is still above 90%, but we know that we are losing a full-floor tenant in a few months. Children's Hospital is outgrowing its 19,000 square feet at Prosperity Medical Center, and we are unable to accommodate their additional space needs, since this property is otherwise fully leased. We are already working on back-filling the space, and due to the excellent quality and location of the property, we do not anticipate much downtime. We expect our Medical Office portfolio performance to remain relatively flat throughout 2012.

Now I'll turn the call back over to Skip.

Thanks, Mike.

We have all heard speculation over the last six months regarding the potential for adverse impact to our region from possible government cutbacks, and the negative effects of our dysfunctional legislators on Capitol Hill. No one can say for certain what the short-term effects on the region may be at this time. But notwithstanding these short-term concerns, I could not be more optimistic about the future of the Washington, DC, region.

The undeniable facts are, we will always be the capital of the free world, one of the great cities of the world, home to the most powerful person, the most powerful legislative body, the headquarters of the strongest military and intelligence services. And over the past decade, we have added approximately $10 billion to major transportation initiatives of our region, including, but not limited to, a new bridge across the Potomac, a massive highway interchange of the Beltway in I-95 and Virginia, a new Metro line, new high-occupancy transit lanes on the Beltway in Virginia, the inter-county connector in Maryland, in addition to enhancements at our three major airports. Beyond that, in the last several years, we have added corporate headquarters for Hilton, Volkswagen, Northrop Grumman, Computer Sciences Corporation, and SAIC, to name a few.

And under-pinning it all is the most affluent and most intelligent resident base and workforce in the United States. I truly believe the best days are ahead for our region, and I'm excited to face the future with our $3 billion investment portfolio of 71 real estate investment assets, all within a one-hour drive of the very spot from which we are making this call.

With that said, let's open the call for your questions.

Thank you. (Operator Instructions) Michael Knott with Green Street Advisors. Please proceed with your question.

Hello guys. Hello, Skip, can you talk little bit more about the -- I think you said about 10% of your NOI is slated for sale over the next few years? I might have missed some of your comments on that. But can you just maybe flesh that out a little bit more?

Yes, I do not know if I would use those exact words, slated for sale. But as we look through our portfolio -- and this is not, I don't think this is a newsflash in general, but as we have visited our strategic plan, we have identified assets that we don't think are what I would call long-term keepers. May or may not be long-term keepers, depending on a number of variables including what the timing of the market is, how the leasing is at a given property, and a lot of external variables. And those assets are primarily certain suburban office buildings. In one case, we have a small medical office building that we might sell as well. So that's pretty much it. It's just something we have been saying over the last year that we have a number of -- a small number, I'd like to add, of some suburban office assets we would like to lighten up on over the next, as I said in my comments, three years.

It seems like you guys are focused on being net acquirers in 2012. Would you expect that to be the case over the next couple of years, too, as you finish out that strategic plan that you just mentioned?

Absolutely. We absolutely expect to be net acquirers. As Bill and I mentioned in the comments, this year in the guidance numbers, we only have a net of $50 million. That is not necessarily what we are hopeful for. We are hopeful to be much more acquisitive to that. But the number that is baked into the acquisition -- net acquisition number that is baked into the numbers that Bill outlined is $50 million.

Okay. And then in general, how much sort of non-recurring CapEx are you guys talking about? It sounded like there was some various capital improvement plans for the multi-family portfolio, the office portfolio, and maybe some re-skinning projects downtown? I didn't hear which ones in particular that that is slated for, but how much higher is the CapEx budget than normal?

Normal CapEx budget is usually around -- in terms of FAD, Michael, so there are two separate capital buckets that everyone uses. The FAD one is the recurring capital. That one is going to be pretty consistent. It's the major CapEx that we think is revenue enhancing that is generally in the $12 million to $15 million, it is probably going to bump up to $20 million to $25 million.

Okay. Thanks.

Our next question comes from Erin Aslakson from Stifel Nicholas. Please proceed with your question.

Hello; thanks for taking the question. I just want to ask about the dividend policy going forward again given the additional CapEx needs going forward?

Well obviously I can't -- what we announced our, I guess it was 201st consecutive dividend as of the Board meeting last week, or this week. I can't tell you what the Board is going to say going into the future, but you understand that this is in a very important part of the WRIT story. The track record is part of our franchise. It is something that we look at. So our expectation is that it will be more of the same. But it all depends on what happens in the future.

Okay, thank you.

(Operator Instructions) Our next question comes from Mitch Germain with JMP Securities. Please proceed with your question.

Good morning guys.

Hi Mitch.

Just curious, are you seeing fewer bidders for properties in the region?

That, that question has two parts to it. With respect to high quality properties inside the Beltway, shopping centers, residential, high-rise residential properties, from properties like that the answer is no. There is still pretty robust environment for those. If you're talking to commodity things in the Netherlands. It depends on the specific asset and its lease status.

Are you seeing a shift in underwriting assumptions? To the negative?

I would say that the jury is out on that. It's hard to tell. And the reason I'm hedging a little bit there is over the last -- from the fourth quarter to the first quarter, the activity has been down quite a bit. And there have been several properties that have been pulled off the market. I can't say why I know what the sellers were thinking. Perhaps maybe they did not get the numbers that wanted. But it is an interesting period. I'm not sure exactly if underwriting is changing. But as I said to start is response off, I think still for the really high demand properties, it is still a pretty robust environment for the seller, really.

Thank you.

(Operator Instructions) We have a question comes from Mr. Chris Lucas with Robert W. Baird. Please proceed with your question.

Good morning guys.

Hello Chris.

Skip, I missed the beginning so I apologize. But I guess I just wanted to understand, what are your thoughts about the acquisition environment today as it relates to just the quality of the product and the amount of availability out there of stuff that you guys would be interested in? And maybe if you could talk a little bit about the buckets in terms of the property types that you guys currently own in terms of the relative amount of availability there?

Yes. I think I touched on softly that the offerings are down. There's no question that the fourth quarter and coming out of the chute this year, offerings are down by historical standards. There's -- I think that is something that there would be very few people that would dispute that. Having said that, I've talked to a number of the better place investment brokers in our region, they tell me that it is going to be picking up. So I think we are seeing a few more offerings coming out of the chute. But I would say, without a doubt, that it is down from what we are used to by historical standards. And I think I said specifically in my comments that I was cautiously optimistic that it was increasing, and that is based on what the brokers are telling me.

And then with regard to the second part of your question that said, that commented on the specific categories. Certainly the most --- the broadest market is still office buildings. And we are really seeing very light activity in areas like medical office buildings, specifically. Residential is still -- you could buy any number of residential assets, but the ones inside the Beltway are still selling at still very aggressive cap rates.

The other thing I wanted to understand a little bit is, everybody's concerned about sort of budget issues, but what is your historic take on election year activity in the DC market? This is obviously a big election year.

Yes we certainly get asked that question every year about what is the takeaway? What's the market reaction to different parties and all these different things? And I think the biggest impact that we see, and I think we are seeing it this year and I think we see it every election cycle, is that you do tend to see a slowdown in activity leading up to an election. Especially a big election. As people are trying to underwrite where they think the direction of the world is going, who's going to be the winner, who's going to be the loser. And the period before an election tends to be characterized by the uncertainty of what's going to happen from that election. And I think, if anything, we are seeing that in the -- I don't want to say magnified, but maybe a little bit more than we normally do that yes, market activity is somewhat slow because tenants and sellers, and everybody is concerned, I don't want to say concerned, but uncertain. It's uncertain of what is going to happen. And you typically after an election, we know who the winner is and things tend to pick up. So hopefully that will be the case this year as it is historically.

And then, Bill, just a question on the guidance. As it relates to some of the component pieces for your NOI guidance, can you give us a sense as to what sort of maybe tenant retention, rent expectations, and leasing velocity is for the office, medical office and retail side?

Yes, I can. Rent expectations, I think, pretty consistent with what we posted this year, Chris, is that just kind running through it by sector.

Office, we generally think it is single digit down on a cash basis and single digit up on a GAAP basis throughout the portfolio. Obviously, that will vary by location, and building, and various other things. The thing in office that we are seeing is with the competitive market and kind of the slowness in the market that we have experienced the last -- at least the last couple of quarters, is that TI packages are elevated. Tenants are asking for more. And they're getting it. So that's on the negative side of the, on the leasing front in the office. But activity-wise, we are seeing more -- maybe Mike can comment too -- we're just seeing more people interested in pretty much since the beginning of the year. It has just been more tours. So that is the good side of the office.

The medical office, it's the same, same as we've been in, and Mike said it in his comments, it's just a, it's a market where our buildings are the best -- kind of the best buildings out there with the highest rent, and people are cherry picking us. But the tenant itself is very reluctant to make any kind of decisions right now. Given the election year, given the healthcare bill debates, all kinds of things are just going into that mode. We are seeing a little shift in medical office in the fact that more and more doctors are joining the big practices, and so that's -- it's changing the dynamics little bit in that marketplace.

In retail, it's, it's kind of hanging in there. We think there is pretty good activity on most of our bigger vacancies in our portfolio. There are some that are leased that are building out space that are not in the occupancy numbers yet. We thought they'd be open by now, but retail is retail. They kind of do the things on their own pace.

So does that answer your question?

Yes that's helpful, Bill. Thanks a lot guys.

You bet.

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

Okay, thank you, everyone. Have a great long weekend. Look forward to talking to you at the next conference call.

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