Elme Communities (ELME) 2012 Q3 法說會逐字稿

Greetings and welcome to the Washington Real Estate Investment Trust third-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's 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 web site at www.writ.com. Our third-quarter supplemental financial information is also available on our web site.

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've 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 statement 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 8 to 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'd like to turn the call over to Skip.

Thanks, Kelly, and thank you for joining us on our call today. Although in the Washington region, the third quarter was a quarter of limited market activity in terms of both leasing and investments, overall, the WRIT portfolio held up well with steady quarter-over-quarter occupancy trends. We finished the quarter at 89% occupied, same as the second quarter, and we achieved good positive rent spreads in the leases executed this quarter in all three commercial sectors. Our multifamily portfolio continued its solid performance with 95% occupancy and same store NOI growth of 3.6%.

Consistent with our previously announced plan to focus our dispositions on our suburban Maryland office buildings, we sold 1700 Research Boulevard, a suburban office building in Rockville, to a long-time tenant for $14.25 million. This is a property we have owned for 13 years and we generated a gain on sales of $3.7 million. We currently have the 80,000 square foot atrium office building in Rockville under contract for sale to a user, and we are marketing Jefferson Plaza, a 113,000 square foot office building, also in Rockville, both of which we expect to close on or about year-end.

Following these projected sales of our suburban office buildings, we estimate that only 8.8% of our total NOI will be generated from suburban Maryland office buildings going into 2013. In fact, we believe our total suburban office NOI contribution will reduce to approximately 19%. This number becomes 12.5% when we exclude Tyson's Corner, which we believe will be a strong market going forward with the completion of metro in 2013. We plan to continue to reduce our exposure to suburban office over the next several years.

Finally, we have our Plum Tree medical office building under firm contract, which should close in December. We expect property fundamentals to continue to be relatively slow in our region in the fourth quarter as our nation awaits election results, but we are confident that our portfolio is positioned well to continue its steady performance in these uncertain times. As we roll into 2013, we believe it is in times like these which our diversified strategy serves us best, and that more attractive investment opportunities will present themselves for well capitalized investors like WRIT in the years ahead.

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

Thanks, Skip. Good morning, everyone. Last night we reported third-quarter FFO of $0.48 per share, in line with the second quarter. Core FAD was $0.37, a $0.02 decline from the second quarter due to higher tenant improvement costs, as some of the more expensive jobs to fill our significant portion of our downtown vacancy moved through the system. We issued $300 million of 3.95% 10 year bonds in September, a transaction that was upsized from $250 million to meet strong investor demand. We used a portion of the proceeds from this transaction to pay down our line of credit -- our line balance from $221 million down to zero. We also prepaid, without penalty, two mortgages totaling $29 million and are planning to prepay another $50 million in mortgages before the end of the year.

We are well positioned to refinance our only other 2013 maturities, a $30 million mortgage due in February and a $60 million 5.125 bond coming due in March. The most important part of this refinancing activity is we are fully loaded and ready for any acquisition opportunities that come to market. Our $500 million of line capacity is fully available as is our $250 million ATM equity program, plus the proceeds from our planned dispositions over the next couple of months.

So where does this all lead? We continue to reposition the real estate portfolio by selling off assets and realizing significant gains that will be redeployed into assets that are better positioned to grow in the future. We continue to position the balance sheet to be ready to take advantage of acquisition and development opportunities in our market.

And as we look forward, we realize that we are going to end the year with less net acquisition volume than we originally forecasted in our guidance. We also know there will be higher interest expense compared to our original guidance due to the size and the timing of our recent bond deal. Therefore, we are narrowing our 2012 core FFO guidance to $1.87 to $1.90, which is at the lower end of our original range of $1.87 to $1.97.

We expect the fourth-quarter core FFO to be in the range of $0.44 to $0.47. Although we will announce formal 2013 guidance when we announce fourth-quarter results, we believe the range outline for the fourth quarter is a reasonable quarterly run rate until the acquisition market begins to pick up.

I'm happy to answer your questions about guidance during the Q&A. Now I'll turn the call over to Mike to discuss operations.

Thanks, Bill, and good morning, everyone. Our overall portfolio occupancy remains steady at 89%, unchanged from second quarter, demonstrating the advantage of a diversified portfolio and a challenging market. Total commercial leasing volume was 221,000 square feet and office leasing was 145,000, our highest quarter this year.

In our multifamily portfolio, NOI growth was 3.6% over third quarter 2011 with revenue growth of 3.4%. Occupancy was a healthy 95% for the fourth consecutive quarter. This sector continues to be our best and we expect this trend to continue, given the still limited supply in our market. Our unit renovation program is ongoing with 155 total units upgraded for an average return on costs of 14%. We are on track to complete a total of approximately 170 units by the end of this year.

The office sector, while challenged, also has some bright spots. Occupancy improved this quarter as some of the tenants that signed leases in our downtown spaces begin to move in. This will continue over the next several quarters and will offset some of our known move-outs like GSA at our Braddock property. Rental rates on office leases signed in the quarter had positive spreads to the expiring rents. At the same time, the leasing packages to attract those tenants in this quarter were less than the last quarter.

The office market is one that we believe is bouncing along the bottom and we expect those conditions to continue for a while, but despite this, our portfolio continues to generate stable performance. In terms of our downtown office buildings, we are proud to announce that two of our buildings have recently been certified LEED-ED Gold by the US Green Building Council. 1901 Pennsylvania Avenue and 1220 19th Street met the sustainability and energy efficiency requirements for the certification.

In our retail portfolio, NOI grew 5.9% year-over-year to a 0.9% rent increase and occupancy gains of 110 basis points. This sector continues to be one of our best performers with strong occupancy levels and rental rent growth. Our medical office sector on average is steady. Although occupancy is down, rental rates continue to grow. NOI growth was negative year-over-year, primarily due to higher real estate taxes.

The past five quarters have shown us that this is a business of declining cash rents and increasing GAAP rents. And when -- and coupled with the competition from nearby suburban office buildings for tenants, this sector has slowed compared to its historical growth. But we have executed several significant leases for vacancy subsequent to quarter-end and good activity on other vacancy.

So we expect occupancy to pick up in the quarters ahead. Long-term, we think with the aging population and longer life expectancies, there is embedded growth in this property type.

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

Thanks, Mike. Our portfolio of real estate spending multiple distinctly different products types continues to produce very stable results, and reduces the volatility to our investors from the challenging economic and real estate market conditions that prevail in the Washington, DC market. It is important to note that these challenging market conditions primarily relate to one of our sectors, office buildings. When we look at the other 50% of our portfolio, we see significant better activity and more stable results.

Our multifamily portfolio continues its strong occupancy at 95%, retail is at 93% with almost 6% year-over-year NOI growth, medical office occupancy is in the high 80s with 1.4% rental rate growth. So this other half of the portfolio was working well, providing the diversification benefit that it was designed to do in these challenging times.

With that, we'll open the call to your questions.

(Operator Instructions) Our first question comes from the line of Michael Knott with Green Street Advisors.

Skip, just curious -- I know you guys aren't finding a lot to acquire right now, but just wondering two things. One, if you can just talk about the overall investment market -- is it really kind of very slow as it sounds like you said? And then, two, could you just maybe give yourself a short report card on some of the acquisitions you guys have done over the past 1.5 years? And maybe, in particular, how the DC leasing is going on some of the Vornado office properties that you acquired?

Sure, okay. Start from the first part of your question, DC market is -- I would say in the extremely slow mode right now. There's not a whole lot of product on the market. I think it's indicative of sellers seeing that prices -- pricing has changed and buyers reluctant to jump into assets that have any significant amount of leasing risk. So there's a reasonable bid as spread that needs to be adjusted in the months ahead. So what's resulting is not a lot of transactions occurring. But there are some.

So while it certainly has slowed down, there is activity out there. We've looked at a number of things. We've passed on the good majority of them based on pricing, but there are some things we actually have some offers out on. And, while I can't say that anything's going to close between now and year end, there are acquisition opportunities that I think will materialize, certainly, maybe in the next six months.

That was the first part. The second part of your question was report card -- downtown office specifically and how we did on our Vornado acquisitions, specifically. As a general rule, I mean, I think they've done well. With respect to the Vornado one specifically, the 1140 Connecticut acquisition that we bought -- it had some choppy leasing in the first 12 months, which we anticipated. That's why the cap rate was in the low 6s.

But we've had excellent -- as you know on our prior calls, we reported a decent amount of leasing activity downtown. And that was reflected in that building among some of the others, and 1140 Connecticut is about 8.4% vacant. So maybe we're slightly behind where we had hoped to be, but a lot of that has to do with just the activity in DC. But we're very pleased by that. We think it's a long -- great long-term asset and a building that's 92% leased is not so bad.

On the 1227 25th Street, that was a property which we didn't project to do any leasing because there was a tenant -- there was one floor vacant in that building. The fifth floor of that building was vacant. We didn't project leasing it, although we were hopeful to lease it in the interim, because a tenant in the building had a call on the space through year-end this year. We actually have tenants to lease that space. We're just having a problem to break through the gridlock.

And also, I don't know if you recall that the primary reason we bought that building is because we own the adjacent building and we have a tenant in there, the Advisory Board, who's growing rapidly, and we need expansion space for that tenant. And we feel very optimistic that was a wise decision to buy that building, not only for the near term, but for the long-term, because we need to accommodate the growth needs of that tenant going forward. So we're pleased with it, although we do not have that space leased as we talk right now.

I think that answers all your questions, unless there's something else I missed.

I guess just one other aspect would be sort of the Alexandria area office properties that you guys have acquired. What's sort of the early report card on some of those, like Braddock and some of the other ones?

Braddock was the only one we acquired recently in Alexandria. Braddock was one where we announced -- when we bought the building that we knew upon acquisition that the GSA was moving out of there in November, so that -- they haven't even moved out yet. We actually -- am hopeful that what we projected to vacate is not going to vacate -- some of it. We were projecting 63,000 square feet was going to vacate. We think it may be slightly less than that. It's still going to be a substantial move-out.

So we do have activity on that building, but as you know there's a little bit of adjacent cancer from the Crystal City area that spills over into Alexandria. It is a distinctly different market, but still you get a little bit of that overflow because Crystal City is really difficult right now. But I'd say it's going well. We have leasing activity, but we do have that hole that's going to occur in November.

And last question from me would be, can you talk about what you think are your biggest risks heading into next year, maybe with the fiscal cliff, maybe defense contractors or --?

Broadly market or specific to our portfolio?

For the Washington REIT portfolio.

We're concerned about -- other than to give you anything specific, we're certainly worried just about the continued ability to lease space in Washington in general. I mean leasing volume and activity has fallen dramatically in our region. I don't know if I've ever seen consecutive quarters of overall negative absorption market-wise that we've seen this year. I mean, we've seen -- obviously, we have negative absorption in every jurisdiction year-to-date in Washington on a broad basis. I'm not sure I've ever seen that before in the 25 years or so that I've been in this market.

So that's the -- risk number one is are we going to continue to have this sinking curve ball in terms of leasing activity occur for an extended period of time? Certainly with respect to the defense contractors throughout Northern Virginia in particular, that would sort of be subset A of that concern.

Then we have, for example, a couple decent sized tenants. I don't think we're as exposed to them as some people are, but we have SAIC in Arlington that leases 60,000 feet that we have to be keeping our eye on. We have General Dynamics out in Herndon for 50,000 feet keeping our eye on. So while we don't have a huge exposure to GSA, we do have some of these other defense contractors, particularly Northern Virginia, you got to keep your eye on. But the biggest risk is just the overall leasing malaise that will affect virtually everything.

Okay. Thanks.

John Guinee with Stifel Nicolaus.

John Guinee here. Thank you. Hey, a couple questions, Skip. Obviously there's a lot of headline news on the apartment world in the DC market. Do you have any statistics on the average price point of your apartments, either on a per-unit or a per-square-foot basis? Because my sense is that you're a lower price point and not as affected by new product delivering with a pro forma lease up at $3 a square foot.

Yes, I agree with what you just said. As you know, we have 2,500 units, approximately -- a little over 2,500 units in our apartment portfolio. And certainly we have two assets that would be in the Class A neighborhood, which is the Bennett Park in Clayborne, which is about 300 of those 2,500 units. So those compete with Class A product. They complete with new buildings -- so 300 of the 2,500. But all the other units, as you correctly surmised, are infill older assets that are well positioned at much lower price points. So for example, in the assets we have in Northern Virginia such as Monson, Country Club, Roosevelt Towers, those are in the -- they're less than $2 a foot on average; generally in the high $1.80s, $1.90s per square foot.

In Montgomery County, Walker House in about the $1.70 a foot range; Bethesda Hill, $1.70 -- that neighborhood. And the buildings on Connecticut Avenue that we own, the older 3801 Connecticut, the Kenmore Building, those rents tend to be a little bit higher in the mid-$2, but a lot of those units are constrained by rent control. So you probably have in place rents a little bit less than that, but they're not really threatened by new construction because certainly those guys are going to take advantage.

So I do agree with your premise. We probably have 300 units out of the 2,500 that are exposed, but other than that, I think we're at least $1 a foot below what new product will be delivering at.

Great. Okay. And then, second -- and maybe this is too much to educate people on this call, is when the GSA gets back in the market, assuming they do, do you have a sense for what locations they'll focus on, where the tenants want to be on the next cycle, what the true reduction in square foot per employee will be, and how price sensitive they will be when they send out their RFPs?

Boy, that's a tough question to call. But certainly GSA has indicated that they're going to much more efficient footprints. They're focusing much more on transportation oriented locations. It's hard to give you an answer on all of those because there's still a lot of smoke out there, but certainly they're in a downsizing 25%-ish sort of neighborhood and focusing on transportation oriented locations. I mean that's sort of broadly all I can tell you on that.

Okay. Great. Thank you.

Brendan Maiorana with Wells Fargo.

Hey, Skip. Just to follow up on the apartment discussion, is there any -- are you guys still comfortable with the initial yields that you put out for the two JV projects -- multifamily projects, the one with Trammell and Old Town and the one with Crimson and Arlington?

Yes. In fact we recently looked at all of those and we still feel that they're in the neighborhood that we broadcast when we went out with those.

Okay. That's helpful. Is it -- hearing your comments about the concerns over leasing that are out there, is it fair to say that from an office perspective on an acquisition standpoint, you'd be reluctant to look at lease up projects now?

I think it -- I think it depends on the location. But I think on a very broad basis, you have to be very conservative in underwriting lease exposure. You have to be extremely conservative. So to say we would never look at it, I think is a long stretch, but certainly if you see significant rollover, certainly outside the Beltway, you have to be extremely conservative. And the issue is, sellers probably aren't quite there yet unless they're being forced by a bank to sell something, which hasn't occurred in great supply yet.

But I think perhaps for well located CBD downtown office buildings, you'd be a little more accommodative to taking some leasing risk. But the issue now is that the buyers, including us, are being a little more reluctant to use aggressive underwriting terms to underwrite some of these things. And the sellers haven't quite got religion on a lot of that in many cases unless, perhaps, they have a gun to your head, which is out there. There are some buildings that are being sold under the pressure of lenders.

So I think there are some scenarios where buildings can be bought, but there is certainly a little bit of a disconnect that I think will be closed, hopefully, in 2013. But you know, the answer -- the activity speaks for itself. There are just significantly less activity in the last several quarters in the investment front than we've seen in a while.

So is it your view that -- do you think there is price -- that transaction pricing, investment pricing, is likely to go down over the next 6 to 12 months?

Yes.

Okay. So you guys are -- and it sounded like you were reasonably confident that you'll get some acquisitions completed over the next couple of quarters. What's sort of the flavor of what you guys are looking at now? Is it more stabilized assets that you're getting at a reasonable yield? Is it -- are you taking some lease up? Or is it outside of office and it's stable retail or multifamily or what have you?

Yes. So, I mean, for example, we've seen a couple -- there's a couple multifamily properties we've seen that have some value-added component. There's some office buildings that have some good leasing in place that might have a little bit of vacancy. For a particular reason, you think you might be able to lease over the next two years, but even if you can't, you have a reasonable yield; a few downtown properties that look interesting from a long-term perspective, where you may have to just grin and bear it for a couple years.

I mean, that's general -- generally what we're seeing, but, again, we're not seeing a tremendous amount. A little -- couple MOBs out there but not many. No retail at all. There's essentially no retail out there. That's pretty much the general landscape.

Okay. That's helpful. And then just last one for Bill. I appreciate the comments on sort of the run-rate going into next year. As far as the capital plan is concerned and how we think about it, is it fair to say that the unsecured raise that you did was to prefund the debt repayments that you're doing -- that you did thus far in the fourth quarter and the ones that you'll do early into next year?

And then if we take that, are you comfortable -- just wondering kind of where you're comfortable running the line balance up to, given that you've got 500 million of capacity plus the cash on the balance sheet?

Yes. I mean, I'll take the first part first. I think that the deal that we did was certainly mostly to term out the line -- to clean that up and then, obviously, to provide new liquidity to do whatever I need to do. That was goal number one. It was probably done a little -- well, we thought it would be -- when I initially modeled it, I thought it was going to be a first quarter or second quarter next year transaction, so we were up three or four quarters from where we initially expected that transaction to happen.

In terms of how much on the line will I be willing to do? I will tell you, I have no problem taking that line up to 250 million or right around 250 million, but once I get up there, then I'm starting to look for the next bond deal or taking out with some kind of form of financing -- permanent financing.

(multiple speakers) Can we use, like, a mid-cycle line balance -- 100 million, 150 million -- somewhere around there?

Yes.

Okay.

Probably reasonable. I mean between 100 million and 200 million.

Okay. That's great. Okay. Thank you.

Dave Rodgers with Robert W. Baird.

Hey, Skip. I wanted to follow up on one of your initial comments in your prepared remarks about kind of office being the laggard. You had talked about maybe medical office looking better. You've lost 250 basis points of occupancy in the last six months in MOBs. Is there something there that's looking to you better than what it shows to us?

Yes. I mean, part of the problem is we lost Children's Hospital in our Prosperity buildings, and that was because the tenant was growing. We couldn't accommodate the growth. It wasn't a downsizing or bad story. We had them in 19,000 feet and I think they needed almost 50,000. So while that was certainly a loss on our portfolio, that was a fairly significant downdraft. And we've lost a couple other smaller tenants, but subsequent to that, we've -- subsequent to this quarter, we signed a 14,700 square foot tenant for vacancy up in our Pikesville medical office building. I just signed another almost 5,000 square foot tenant for vacancy for Landsdowne and we have a couple others in the pipeline.

So while I don't want to say it's an avalanche of new leasing for medical office buildings, I expect steady progress over the next couple quarters as not only we begin to fill up Prosperity -- that 20,000 square feet we just talked about the Children's moving out of -- but I think we're going to get some others here and there. But I think it's going to moderately get better. It's not going to be dramatic, but, yes, I do think it's going to moderately get better.

Hey, Dave. One thing on that, just don't lose sight of the fact that 250 basis points in occupancy in medical office is only around 30,000 feet. It's not a huge number.

True. That's a good point and thank you for that color. I guess you've given a lot of color on the acquisition market that you're looking at, but, again, tying back to some of your original comments in the longer term strategy of spinning out of the some of the suburban office. How do you tie together the disposition strategy with the acquisitions now that you have some room with the dividend? I'd kind of be interested to think you've had this longer term view that cap rates should rise or that pricing should come back to you as a buyer. How do you think about that today? And as you go into '13, about maybe accelerating some of the asset sales to take care of that?

We're looking at -- I think it's a good point. We are looking at a lot of those things. One of the things either we've been good or lucky or strategic on, I mean we've had a number of sales that we've been able to sell to users, which we've gotten premium pricing on. So we sold the building out in Gaithersburg last year to MedImmune, which was adjacent to their campus and we had a huge number for that. We sold 1700 Research, which was our most recent sale, to the major user of the building -- Westat was in a partnership to buy that. The building -- atrium building we have for sale, we actually are selling it to -- who's not in the building, a user who's not in the building.

So we're employing those strategies where we can. It's harder to do in buildings that you have significant leasing in such as Jefferson Plaza, which we have on the market now. But yes, I concur with your observation that we might need to accelerate the process a little bit. And we're evaluating all of those tactics as we go into the end of the year and going into 2013.

Okay. Thank you.

Mitch Germain with JMP Securities.

Just curious about Braddock. Is that going to go to another government user in your view? Or are you going to market that to private sector?

Well, we're marketing it to everybody. Today, all hands on deck. You don't get too specific. So could it go to another government user? Yes. Nobody's looking at it right now. The GSA leasing is awful right now. So I don't see the GSA leasing that anytime soon, but could it? I mean, it has a lot of the things that government users want. It's on a Metro. It's in close. It has Metro proximity to both the Pentagon and all of the BRAC activities that are going on down into Springfield, but I'd say right now we don't have any GSA prospects that are looking at it.

But on a long-term basis, I think that that will always be attractive to GSA users. But of the activity we're looking at currently, they're all private users.

And the key there is it's directly across from the Metro and it's well below the price points for the government -- their maximum requirements.

Great. And when you look at your leasing pipeline, whether it be the proposals or showings, how would you characterize the levels today versus where they were maybe three, six months ago?

Rental rate levels?

No, the leasing pipeline. The actual discussions you're having with tenants.

Leasing velocity -- I'd say it's about equal. I mean, I don't see it significantly less or more than it's been over the last six months. I mean, some buildings we have -- in fact, I was just talking to one of our agents today, and 51 Monroe Street, for example in Rockville, he's got a lot of activity on for whatever reason. I can't speak to exactly why. And in other buildings, it seems to have slowed down.

So it's very -- we're in this weird period where it's just very choppy. I think it's indicative of the uncertainty out there. I mean, we still have a fairly reasonable robust economy in terms of -- we've got a lot of folks here that still work. It's a big economy but -- and people still have to run their businesses. So tenants sign leases, particularly in the private sector from time-to-time, but then we seem to go through these swoons where everybody's concerned. And I think that's going to continue until we get some of these fiscal -- these national fiscal issues off the table.

So it just seems like we have good periods for a few months and then you scratch your head and wonder why all of a sudden no one wants to lease for two months. It's very weird.

But I would say, especially in DC, we've really geared up our renovation efforts. And, for example, two buildings alone, I mean, it -- 2000 M Street and 1140 Connecticut Street, we've done over 100,000 square feet of deals down this there this year. So we are seeing good reaction to some of the amenities that we're putting into the products down there.

And we're being very aggressive, quite honestly. I mean we're spending a lot of CapEx in our buildings, as Mike indicated. I mean, we -- in 2000 M Street, we put a health -- a fitness center in there that looks like it's out of Hollywood. And a conference room, we spent -- these things have -- we spent a lot of CapEx in these buildings. We have increased commission plans that we're spending. We're spending a lot on TIs and you've seen that. If you look at our numbers over the last several quarters, while to generate good activity, there's a cost to do it. So we're going after these deals and we're doing what we have to do. But it's tough to generate activity right now.

Thanks, guys.

There are no further questions at this time. I'd like to hand the floor back over to Skip McKenzie for closing comments.

Okay. Thank you, everybody. Have a great weekend and a great Halloween, and we'll look forward to catching back up with you at the end of the fourth quarter. Thank you, everyone.

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