Elme Communities (ELME) 2012 Q2 法說會逐字稿

Welcome to the Washington Real Estate Investment Trust second quarter 2012 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 second quarter supplementary 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 the 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 pages 8 through 15 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.

First and foremost, as we announced last night we set a new quarterly dividend rate of $0.30 per share or an annual run rate of $1.20. This was a very difficult decision made by our Board after extensive deliberation and analysis. We estimate that this new rates will provide an additional investment capital of approximately $35 million per year which we plan to use to invest in new acquisitions, development or re-development projects, or debt reduction.

Ultimately, given our long-term commitment to fiscal discipline and financial strength, we felt it was in our shareholders' best interest to retain this capital in order to enhance our ability to grow earnings, as well as take advantage of opportunistic investments that we expect will emerge in the years ahead. The world we are facing today presents a future with many uncertainties and we want to ensure we are optimally positioned to take advantage of these opportunities as we continue to execute our strategic plan.

In other news this quarter, we acquired Fairgate at Ballston, a strategically located office building in Arlington, Virginia. We focused on taking measures to strengthen our balance sheet and we made progress leasing some of our most challenging spaces, particularly in the District of Columbia. In the Washington metro real estate market office fundamentals are soft and we expect them to remain so for the November election. Second-quarter net absorption region wide was positive but not enough to offset the negative absorption caused in the first quarter by BRAC relocations primarily in Northern Virginia.

In general, office markets continue to be adversely affected by business owners and managers who push off decision-making due to continued talk of the so-called fiscal cliff, sequestration and other macroeconomic threats. Bottom line, this results in little motivation to execute leases or expand business. Despite this gridlock, our own portfolio performed reasonably well with same-store occupancy improving sequentially. As we mentioned last quarter, we have had good activity at our downtown vacancies in particular, including 56,000 square feet of new leasing which should positively effects our numbers by early 2013.

On the good news side, overall our multifamily retail and medical office sectors are performing well. In multifamily, occupancy remains in the mid-90s with modest rental rate growth. Retail occupancy is up in the first quarter with strong NOI growth and good potential for continued increases for the rest of the year. The medical office sector faltered a little bit this quarter with some occupancy loss and higher expenses weighing on the NOI growth.

On the acquisition front, we acquired Fairgate at Ballston, a value add 147,000 square foot office building in Arlington, Virginia for $52.25 million in an all-cash transaction. This property is excellently located just a few blocks from the Ballston Metro stop and is 82% leased. We've had early strong interest in the vacant space and are pleased to added to our investments in this historically strong sub market.

As an update to our disposition plan, we currently have a 33,000 square foot medical office building in Bel Air, Maryland under firm contract with the expected closing in December, as well as two Maryland office properties actively being marketed that we expect to close by year end.

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 Paukstitus who will discuss our real estate operations.

Thanks, Skip. Good morning, everyone.

Last night we reported second quarter core FFO of $0.48 per share, $0.01 better than the first quarter. NOI improved slightly from the first quarter led by the retail sector. Core fab was $0.39, a $0.02 improvement for the first quarter. Overall, the second quarter performance met our expectations and we remain comfortable with our original earnings guidance of $1.87 to $1.97.

In terms of the balance sheet, we had a busy quarter. We repaid $50 million of 5.05% unsecured bonds using capacity underlined. We amended and extended both of our lines of credit, extending their maturities to 2015 and 2016, increasing the total capacity to $500 million. The new rate on the $400 million Wells Fargo facility is LIBOR plus the spread of 107.5 basis points, previously 122.5 basis points. The $75 million SunTrust facility was increased to $100 million and is also priced at the same rate.

Finally, we entered into a new at-the-market equity sale agreement with E&Y Mellon Capital Markets. The total issuing capacity under this agreement is $250 million, and it has a term of 36 months. We have not issued any shares under our after-market equity agreements since the fourth quarter of 2010. Our line of balance is $221 million. We plan to repay a small mortgage next week, which will bring the line balance up to approximately $242 million. We will likely look to refinance this balance in the capital markets before the end of the year to ensure that we have ample liquidity to fund acquisition opportunities as they arise.

Now, I'm going to turn the call to Mike to discuss operations.

Thanks, Bill, and good morning, everyone.

Our overall portfolio occupancy is 89.3%. Total commercial leasing volume was nearly 250,000 square feet, slightly up from our first-quarter levels, but still lower than historical averages. Over half of that activity was from vacant space. We were successful at signing leases for a significant amount of downtown office vacancy and many of our larger vacancies within our retail sector.

The office sector same-store NOI was flat from first quarter to second quarter, with a slight drop in occupancy offset by positive rental rate growth. As Skip mentioned, we leased several previously vacant spaces in some of our downtown office buildings where we have made significant common area improvements. Most of these new tenants have not yet moved in, so we expect our third and fourth quarter results reflect this activity.

In our multifamily portfolio, rental rate growth was 4.1% over second quarter 2011, as revenue growth was 3% but expense growth was 4.9% due to higher tax assessments at our Virginia properties. Occupancy hovered near 95% and we continue to believe occupancy will generally remain steady throughout the remainder of the year. We continue to see mid to high single digit asking price increases on renewal notices, which should lead to continued solid performance in this sector.

We continue our unit renovation program at 4 of our 11 apartment properties, and we are happy to report that so far we've upgraded 77 units for an average return on cost of 19%. We believe we will complete renovating a total of approximately 170 units by the end of the year. Keep in mind that while returns are strong for these renovations, our revenue growth slowed due to the additional down time necessary to turn these units around.

The office sector remains a challenge. Although we are seeing strong activity in our downtown vacancies where we signed 56,000 square feet of new leases in the quarter which will add over $2 million in annualized rent. Keep in mind this progress will be partially offset by the anticipated move out of the GSA from Braddock Metro Center later this year. While occupancy fell to 86%, leasing activity in the quarter in the future pipeline of transactions currently point to better occupancy levels in the coming quarters, more than offsetting some of our future known move outs.

In our retail portfolio, we signed nearly 100,000 square feet of leases and about half of that were leasesabsorbing vacancy. Occupancy improved 40 basis points compared to last quarter. We expect occupancy to fluctuate up and down in the next couple of quarters as we have some potential move outs as we prepare for these new tenants to move in.

We reported 15.7% same-store NOI growth for the sector. But, please remember, a portion of this growth was due to the prior year write off of orders, suppressing the NOI in the second quarter of 2011. We did not experience any significant right-off in this quarter which is the first quarter in a while that we have been able to make this statement. Hopefully, this is the beginning of a new trend of lower bad debt in the retail sector.

Finally, our medical office sector, occupancy declined 80 basis points from first quarter and NOI growth was negative due mostly to move out and decreased expense reimbursements. We are bullish on this sector long-term, but we know in the short-term there will be some headwinds due to the uncertainty surrounding healthcare reform and general competition from a fundamentally weak office market.

Going forward, we are continuing our focus on upgrading our properties to make them as attractive as possible to both attract potential new tenant and retain existing tenants. We have already had success doing so at various multifamily and office properties, and will continue to look for ways to maintain and grow occupancy. We believe our diversified strategy of owning and managing properties at four different sectors is helping us reduce operational volatility and maintain a balanced portfolio.

Now, I will turn the call back over to Skip.

Thanks, Mike.

Before I turn the call over for your questions, I would like to make one final comment. Almost two years ago we embarked on a strategic plan to grow our Company and create a better, stronger WRIT for the future meaning better earnings, better properties and a better balance sheet. We didn't expect that we would ultimately conclude to reduce our dividend, but finally came to the conclusion it was necessary to support the execution of our plan.

Our strategic plan pushes us towards making continued investment in our property sectors, focusing on higher quality properties inside the Beltway and near demand drivers such as Metro stations, BRAC consolidations and major hospitals. With the issue of the dividend level now behind us, we expect to aggressively move forward and develop an even better WRIT.

Now, we'd like to open up the call for your questions.

Thank you. (Operator Instructions) Our first question is coming from the line of [Blane Heck] with Wells Fargo.

Hi, guys. So, first looking at the balance sheet you guys mentioned that the line of credit is going to be soon up to $240 million. So, I kind of wanted to get a sense of kind of where your comfort threshold is for the balance and what options are you guys looking at, at this point to refinance that?

Yes, I think the comfort level is always a moving target. Tell me where interest rates are going in the future and I will be able to give you a little better answer. But right now we are comfortable where the line is. We're comfortable next week after we pay off a $20 million loan. Certainly, the discussions with the rating agencies and various other entities suggests that once you get past halfway in your line availability that you got to start thinking about it. So, obviously we are starting to think about it and that's why I said in the comments that by the end of the year we will kind of look for something.

Right now is in the debt market is extremely attractive and the unsecured market. The bank market is still very attractive. The preferred market is very attractive. So, there are plenty of options out there. And we will assess those options as we move forward with some kind of financing.

Okay. And what sort of rates do you guys think you could get on each of those at this point?

In no particular order, preferreds are probably somewhere around 5.75% to 5.875% at least according to investment bankers that I have talked to. The 10-year unsecured paper market is probably -- we're somewhere around 2.25% to 2.5% over. So that would put you in the high 3% to 4%, somewhere in that range. And if you go to the bank market, the bank market actually might beat the 10 year, but you are going to be shorter in duration. You'll probably be a five or seven year piece of paper which doesn't interest me quite as much, but it is definitely a lower interest rate. The last one out there is potentially looking at a 30 year bond issue, the baby bonds of $1000 denoms and those things trade inside of preferreds. So, that's another option.

Okay. And then moving on to acquisition market. I wanted to get a sense of what the environment is looking like at this point and kind of whether the dividend cut that you guys took might free that up to pursue some more value add opportunities than you may have before?

To answer the first part of your question, there is still plenty of activity out there, although I would admit that it's down a little bit, but we evaluated and underwritten quite a few opportunities just in the last several weeks. So, there's plenty of really good opportunities out there. We are seeing still really higher pricing for very high quality properties. There was just an announcement the other day for a property Carlyle that was purchased by JPMorgan for over $500 a foot. Carlyle is in Old Town Alexandria by the Carlyle Metro station. So, there's still very aggressive pricing for quality properties.

With regards to your second question, certainly having the dividend cut give us a lot more flexibility to attack value add properties, not that it was an obstacle in the past, but it certainly gives us a lot more latitude. And it gives us more capital at the cheapest loan of capital which is your own.

And on the Fairgate acquisition, did you guys give a cap rate for that?

No, we did not. And that is not consistent with our past practice where we generally do. But in this particular transaction, the seller made a personal -- made a request that we are abiding by.

Okay. And then last one for me. As you guys are redeveloping the apartments, are you taking those out of your same-store numbers?

What was that?

As you are redeveloping the apartments, is that being taken out of same store?

No, it's not a significant number. There are several down at every given property at any time.

At it only really takes about 10 days to turn those things. But that 10 days about 10 days longer than it takes us to just paint and put carpet in. So, we lose 10 days in a month of occupancy basically when we turn those units and it might be as much as two weeks.

And it is all dependent upon retention. We can only do them if the tenant vacates.

Okay great. Thanks.

Our next question is coming from the line of John Guinee with Stifel Nicolaus.

Hi. Sad day but I guess a necessary day. A question, and I missed this, Skip. Did you go into any depth on the Fairgate deal, kind of talk about the ingress/egress parking ratio, what differentiates that from other buildings in that particular sub market?

I can. I did not. The LD issues that really make it a very attractive acquisition to us. It's right on Glebe Road, it's right off of where 66th comes in so it has an excellent vehicular access. It has a drop-off area in front of the properties which is incredibly unique for properties in the sub market. And if it doesn't have the highest parking ratio in the sub market, it's one of the top three. It has a very high parking ratio and all of which made this what we thought a very unique asset in the market that we love long term.

Right. Thank you. And then one other question. You had mentioned again the assets you have on the market right now, how much color did you give on those

Okay. Well, there's three that we have on the market. I will give you a little more background. We have a small medical building up in Bel Air, Maryland which is under a firm contract. It's a 33,000 square foot building that is leased that we have a firm deposit on. And the reason it's going to hang out there little bit is because it has a mortgage that's paid off in December. So, no one wants to pay the prepayment penalty. So, that's going to be hanging out there under a firm contract in December. But it's a leased property with a good buyer, so that's going to happen.

The other two properties we have the atrium building which is right here on Executive Boulevard that we can see outside of our conference room that we are very close to a deal on. That is a relatively small office building that has the NIH in it among other tenants. And then the other building we have on the market, which is a little bit earlier on that we're collecting bids on is 1700 Research Boulevard which is up in the 270 quarter and we're actually in the process of collecting the offers and evaluating and assessing a buyer.

Got you. Okay. Okay. Thank you very much.

Our next question is coming from the line of Michael Knott with Green Street Advisors.

Good morning, guys. It's [David Anderson]. So, in light of the dividend cut, I just wanted to get a sense of how that changes your disposition strategy for some of those assets? Obviously you just touched on the two that you are looking at. Do you sense it's a feeling now that maybe you could be a little bit more aggressive getting rid of some of those I guess higher cap rates cash flowing assets now that -- ?

The short answer to that is it doesn't impact our program at all. We are evaluating the properties that we want to sell. We want to take the optimal time on a return basis to sell those assets, and that was before we kept a dividend and after we kept the dividend. So, I would say it has literally no impact.

Okay. Can you remind me in terms of the magnitude of the portfolio percentage that you are looking to ultimately market?

Yes. We have never really given an exact number, but just to give you some sort of general parameters around it. Pretty much the assets that we are looking at our all suburban office buildings mostly, pretty much all, and pretty much in the Maryland suburbs and only 11% of our NOI is Maryland office buildings and we're not selling all of them. So, some single digit percent of our NOI. I don't have the exact number, but maybe 50% of our Maryland portfolio type thing, 5% to 6% or 7%, something like something like that. But I'm just giving you round numbers. I don't have an exact number. But that will give you the general idea of what we're looking to pare down.

Okay. Thank you. Just one other follow-up question. Do you have -- for medical office, just in light of the healthcare ruling, do you have any sense how that will impact demand there, particularly from major tenets of yours like [ANOVA]? Is that a consolidation play or are they looking to be an aggregator of practices? How does that play out?

ANOVA has been a significant aggregator for years in our region, for a number of years, I should say, last few years and as a major -- it's one of our top 10 tenants and we continue to see them active on that front. On a going-forward basis, hopefully in recent past there has been a little bit of a slowdown in that activity, but I would expect that to ultimately continue in the months and years ahead but, more importantly, in terms of how it's affecting our operations, without question we've seen a slowdown in leasing vacant space in the medical field. Not so much people are still getting sick and doctors are still in business and it's not bad, but when you have vacancy in medical mal, it tends to last longer because we don't see a lot of folks expanding like we have in the past.

I think people are still and medical systems, individual doctors, all of the above are still wanting to see the smoke clearing on this to see the chips are falling. So, we still anticipate slow leasing, in particular for vacant space, not horrible but slow.

Great. Great. And just one final quick question. The GSA lease, you said it's expiring at the end of the year. Can you remind me the size of that?

Sure. We'll give you some color on that. When we bought the Braddock Metro building last year, we knew at that time it had a 63,000 square foot lease with a division of the GSA that was relocating down to Quantico. They were -- actually, they were relocating at the time we were buying the building, so we were well aware of it, we factored in for our numbers. And it's that unit, and to be honest with you, there is some jockeying going around. If anything, it may not be as big of a reduction as we thought. I can't say for certain because there are some negotiations that may or may not happen. But we are actually optimistic that it may not be as significant as we once thought. But we have long since advertised and factored in a $60,000 square foot move -- or 60,000 square feet, excuse me, sorry, reduction on that in that property.

Okay. Thank you, guys.

(Operator Instructions) Our next question is coming from the line of Mitch Germain with JMP Securities.

Good morning. Skip, are you seeing any change in asset values in the DC market?

The answer I would give to you on that is yes. I think -- and it all depends. You can't give a generic answer across all property types, but certainly with respect to suburban office assets you've have seen a diminution of value, and I'll point to some comps even. I think this week or maybe last week there was a really nice building that (inaudible) bought out in the Chantilly area. It is a class A building. It's not near metro. It's a little bit out in no man's land except for it's near a CIA facility. They got an A cap on there. Well, a year ago we sold Dulles Station for 6.2 cap. I think those buildings were built at the same time. You can see that cap rates out there as you moved out have definitely moved up.

But I would say that as represented by the comp I mentioned earlier, if you have a really good, very well leased property in DC or at a major metro station in the metro area as referenced by that Carlyle deal that sold for I think $20 a foot. There is still aggressive pricing for that, there's still aggressive pricing for good multifamily properties. I think if anybody were to even push a good shopping center on the market, you'd get good pricing for that. So, you have to pick and choose, but for the better quality properties there is still a pretty good strike price.

In your previous comments about calling some of the suburban Maryland change your timing on that at all?

We have to manage it. We have to be very mindful of the leasing. What our expectations are for leasing and how we package that for sale. And that's why we don't just throw the whole list on the market immediately.

Great. And you guys mentioned some downturn office leasing. I might have missed who signed the leases. Maybe some background as to whose in the market today and what sort of -- whether it be private or government agencies you are talking to?

Yes. We signed about 55,000 square feet for vacant space in the district just over the last quarter and it was a litany of the typical DC tenants. There wasn't one giant 55,000 square foot tenant. There were some 15,000 and 19,000 and sizes like that. And there were trade associations and your typical kind of DC tenant base. So, there wasn't any --.

I think the key is they were private versus public. They weren't government deals.

No. And I'd also note for you, even though we had a great quarter in leasing DC and we're really proud of it and it's going to be very positive going forward. But in my initial comments, the activity in the district as a whole isn't that great. We were aggressively going after these deals. We made some significant CapEx to these properties that made them more attractive. We had some promotional leasing commissions that we paid and that was reflective in some of the higher cost you saw in putting these tenants in place. So, we went out and got them. The market downtown is okay, but it's not -- I wouldn't put it as a supercharged market by any means.

And are you seeing outside of those one-time expenses or concessions or -- that you had to pay for this leasing this past quarter? Are you seeing a negative trend in concessions across the market?

I think certainly in markets, the softer markets you're going to see higher concessions. I mean, if you are in a suburban office building with a big vacancy pretty much anywhere in this metropolitan area, you better be ready to go after it.

Thanks, everyone.

Our next question is coming from the line of Anthony Paolone with JPMorgan Chase.

Okay. Thanks and good morning. I think probably for Bill. Some of these leases that you said some you got done but just haven't commenced and so forth. Can you maybe just walk us through kind of the in and out of NOI over the next few quarters and when those come in and that sort of thing?

Yes I can probably do that.

At least the big ones.

Generally speaking, this is not going to be any exact science, of course, but kind of projections in the office sector specifically, Tony. We think NOI is probably going to creep up $150,000 to $200,000. Next quarter it probably creeps up maybe close to $400,000 in the fourth quarter. And that is net -- obviously net of the things that we think are moving out. So, a lot of it is timing of the TI packages and things. But net-net, like Skip said, the downtown -- or Mike said in his prepared comments, it's basically $2 million total of new revenue on things that were zeros for a pretty long time. So, it is positive, but there is some stuff moving out too. So, I think net-net right now, right this minute, we're basically $750,000 to $1 million up.

On the office space.

In the other stuff, it's positive generally speaking, but the other ones are pretty small, moving around. Medical is actually a little bit down because we're losing, as I think everyone on this call knows, we're losing Children's Hospital and 19,000 feet. For medical, for a portfolio of 1.3 million feet, moves in the 19,000 that pays a pretty good rent and you'll see it in the numbers next quarter.

Okay. And then just my bigger picture question. You and others all point to the election as being a key item that hopefully stops the log in block in sort of leasing and so forth. Is there any outcome to the election that you think is better or worse for leasing?

Honestly, I'm not smart enough to know that. Really, the outcome would be if we get the legislative body on the same page to make decisions and I'm not sure how that happens, but that's the key critical variable. We can't continue -- we can't go forward with these continuing resolutions because the contractors, the tenants, they need to know what the answer is. And the analogy I have given is we've got like 100% of the market waiting for whatever 20% cuts or whatever they are. But we need some resolution. And honestly, I don't know the political calculus that's going to be required to get to that point. Honestly, I'm not sure anybody knows that, but we're hopeful that cooler heads will prevail and people will get together and realize that this is not the way to run a country and they will make decisions and then our tenants can make decisions. And it is a hope and that's all it is.

Okay. Thank you.

Our next question is coming from the line of Mike Roarke with McAdams Wright Ragen.

Hi. Good afternoon. I wanted to just go back to the dividend. That payment has been made or had been made through all sorts of political economic and interest rate environments though I just wanted to try to get a sense on whether or not there's a shift in your thinking about the stamina of the DC metro area. And is this time different or would that be too far of a read into the dividend decision?

Well, the short answer is we don't know exactly what the future is. I don't think anybody knows. There are so many macroeconomic variables out there. Whether it's the Europe crisis and how that's going to trickle through the world economy. Whether it is dequestration if whether it actually occurs in DC or whether it is that we cannot get a budget for however long. Our view is that if something bad happens, we want to be the strong guy on the sidelines here ready to jump on opportunity and we think that this positions us to do that.

If it's back to business as usual and things are great and fantastic, well that's great, too, because that would be raising the dividend again at a much better rate. So, we just think it's in keeping with -- one of the other hallmarks of the Company other than the dividend is fiscal responsibility and financial strength. And overpaying your dividend for extended period of time is not representative of someone with fiscal responsibility and financial strength. I think that was underpinning everything under the Board's decision.

We want to be the strongest guy out there to take advantage of the disruption if it occurs. We want to be able to withstand what the future brings, no matter what it is. And we think this is a good step in getting to where we need to be.

Okay. And as a follow-up to that it looks now that the new payment is well covered by the funds available for distribution. So, barring a string of severe negative developments, is it safe to think that you're not going to need to cut the dividend further in order to accomplish your strategic objectives going forward?

We're right at -- we believe it's right taxable income. So, if nothing else, as taxable income goes up, we're going to have to raise the dividend to cover taxable income. We feel very confident and obviously we don't know what the future brings. We are very confident that we are at a very, very safe dividend level and the bias would certainly be towards dividend increases on a going forward. And we believe it's extremely safe at this level, extremely safe, I'd underline that word.

(Operator Instructions) It appears there are no further questions. I'll now turn the floor back over to management for closing remarks.

Thank you, everyone. Thank you for listening to our second quarter call. We look forward to catching back up with you in the third quarter. Have a great weekend.

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