Elme Communities (ELME) 2013 Q2 法說會逐字稿

Welcome to the Washington Real Estate Investment Trust second quarter 2013 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 website at www.writ.com.

Our conference call today will contain financial measures such as core FFO and NOI, that are non-GAAP financial measures, as defined in Reg G. Please refer to the definitions found in our most recent financial supplement. 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 pages 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, and Laura Franklin, Executive Vice President and Chief Accounting and Administrative Officer.

Now, I'd like to turn the call over to Skip.

Thanks, Kelly, and thank you, everyone, for joining us on our call today.

We continue to see positive signs that our portfolio is benefiting from our enhanced organizational structure, our capital spending projects at several of our properties, and improving market fundamentals.

For the fourth quarter in a row, we are seeing overall leasing volume increase in our commercial buildings, with continued strong GAAP rental rate increases. The improvement in leasing continues to be driven by our activity in the office and retail divisions.

For the second quarter in a row, we have experienced an overall occupancy increase of 50 basis points, to 89.1%. We signed 417,000 square feet of leases in the second quarter, following the 388,000 square feet we signed in Q1. We currently have a backlog of 173,000 square feet of leases for tenants who have executed leases but not moved in.

In the office sector over the past couple of quarters, Tom Regnell, the head of our Office Division, has implemented structural changes to include increasing the number of asset managers covering our portfolio, reorganizing our Leasing Department by turning our internal leasing focus to tenant retention, and then signing all office vacancy to third-party leasing agents, and quickly and aggressively making decisions regarding capital spending to improve our tenants' experience in our buildings.

These measures have steadily increased the number of tours and general leasing activity to the highest level we have seen in a number of years.

Sequentially, occupancy has increased 90 basis points this quarter, after improving 90 basis points in the first quarter. In the second quarter, we continued our trend of positive net leasing absorption with 60,000 square feet. We currently have backlog of approximately 115,000 square feet of office leases that have been signed, but have not yet impacted our numbers. We signed 180,000 square feet of lease transactions this quarter, with 94,000 square feet for new transactions.

Rents continue to be slightly down on a cash basis, but positive on a GAAP basis, consistent with past quarters. Tenant improvement costs and leasing commissions remain elevated, but also are consistent with past quarters.

The office market fundamentals remain challenging, particularly outside the District of Columbia, but this is as good as the office sector has felt since the downturn started in 2008. Leasing activity region wide is by no means at the level of the good old days, but we are seeing improvement.

During the quarter, we announced a major renovation and repair of 7900 Westpark Drive office building, our largest asset in the portfolio in Tysons Corner, Virginia. We are excited for the potential upside of this asset, giving its location 4 city blocks from the new Tysons I and II Metro Station, its prominence on the beltway, and with direct access to the new I-495 express lane. Construction is projected to commence in the fourth quarter of this year, and at a total project cost of approximately $35 million.

We are anticipating some tenants may choose to move out when their upcoming leases expire. This was anticipated when Bill gave guidance earlier this year.

Our retail portfolio performed very well this quarter, increasing occupancy by 80 basis points. Market conditions region wide are generally good, as vacancies are being filled, tenants are being retained, and well-located centers are increasing rent. With that as a backdrop, we successfully reduced our 2013 rollover exposure by 50% this quarter.

In total, we signed approximately 180,000 square feet of leases in the quarter, which is almost double our volume from the prior 4 quarters. Over 96% of all leasing were renewals where we achieved rental rates 12.3% higher than in-place rents.

This past quarter, we significantly improved our credit loss position, as we took a more aggressive stance with select tenants. The retail division continues to be our best performing sector.

Our multi-family portfolio is performing well. We continue to achieve rental rate increases overall, including 3.8% year-over-year.

At our Connecticut Avenue properties, lower occupancy persists, but we are beginning to see positive trends at 3801 Connecticut, as we refocus asset management and capital improvements at the property. I am happy to report that occupancy at this property, which had dipped into the high 80% area earlier this year, is back up to 91% leased as of this week.

The Kenmore will experience heightened vacancy for the balance of the year, as we are beginning a major HVAC upgrade at the property that will affect every unit.

Overall, multifamily occupancy declined 70 basis points in the quarter to 93.1%. This has been a trend over the past 4 quarters. We are beginning to see occupancy improvements in the portfolio, particularly where we are having our biggest challenges. I am expecting our occupancy in the sector to improve in the third quarter and continue in the 93% to 95% range this year.

It should be noted that 70 basis points of physical vacancy can be attributed to an expired office lease in a commercial area of our apartment buildings and does not reflect the performance of our residential leasing operations. Excluding this commercial space, our multifamily portfolio was 93.6% occupied at quarter end.

Turning to our medical office portfolio and the potential sale, we are working on best and final offers with a select group of bidders, and are hopeful to be selecting the finalist in the next few days. After a standard period of due diligence, we currently expect to be able to move forward with closing the transaction in the next several months.

Regarding the CEO search process and the timing of placement of my successor, the Committee and Board have identified a short list of finalists. Deliberations and final interviews are ongoing, and I expect the process of selection will be complete by the end of the summer. We would be hopeful to have someone on board in mid-fall.

Now, I'll turn it over to Bill Camp, who will discuss second quarter performance and portfolio details.

Thanks, Skip. Good morning, everyone. Core FFO for the second quarter was $0.47 per share, an expected improvement over last quarter. The increase over the first quarter reflects leasing progress and operational improvements initiated for the past several quarters.

To highlight the quarter, same-store NOI improved 1.8%, or approximately $900,000 over last quarter. The majority of this improvement can be attributed to the medical and retail divisions, which achieved NOI growth of 9.1% and 4.2%, respectively.

Offsetting this strong NOI growth was the office and residential divisions, which decreased nominally. Decreasing NOI within the office sector was a function of seasonal or one-time expenses, and was enough to surpass the same-store revenue growth of $900,000 over the prior quarter.

For the overall portfolio, same-store rental revenue was up 1.8%, or $1.3 million for the year, while operating expenses increased $1.9 million. The real estate taxes accounted for almost half of this increase in operating expenses year-over-year. A big chunk of this was a one-time adjustment related to the 2010 tax appeal for one of our office buildings.

Core FAD resulted in $0.34 per share, below last quarter for 2 primary reasons, TIs and leasing commissions and higher recurring capital expenditures.

As Skip previously mentioned, concession packages to attract new tenants remain high, but consistent with recent quarters. The actual deployment of these TI dollars can be lumpy, however, and, as a result, we spent an additional $2 million in TIs this quarter for leases previously executed. With our increasing leasing volume, we expect this trend to continue for several more quarters.

Fortunately a large percentage of these expenditures are for tenants who are filling vacancy and have not yet started paying rent. We anticipate seeing the benefit of this leasing activity in our occupancy and our NOI numbers in the next few quarters. In addition, recurring capital expenditures increased over last quarter, which is typical for the seasonal adjustments that we do in the year.

Regarding our balance sheet, we continue to operate from a position of strength. We have balance sheet flexibility during the volatile interest-rate environment, with the next scheduled debt maturity of $100 million in January of 2014. This is our only debt maturity that we have next year.

Our line balance is now $70 million, in line with the first quarter, down from $75 million, as we reported for the second quarter numbers. Going forward, we have 354,000 square feet of leases expiring the remaining part of this year, less than 4% of our annualized rent, and both asset management and leasing are actively working to negotiate renewals.

Looking to '14, an outsized portion of our portfolio's rollover is within the office sector, much of which is being addressed as we speak. We expect that our newly implemented structure within the office division will allow us to continue the momentum and progress we are seeing.

In terms of guidance, we believe we will fall in the middle of our stated range of $1.82 to $1.90, without the effect of the anticipated MOB sale.

However, the components of the business are slightly different than we laid out at the beginning of the year. Operationally, we expect our office division to perform slightly better than the original 1% to 2% decline in same-store NOI growth we predicted. Offsetting this, we expect residential division to come in below our original 3% to 5% same-store growth estimate.

So everyone has some guidance as to the potential sale of MOB. The portfolio we are selling generates approximately $0.04 to $0.05 of NOI monthly. We'll have to determine what the timing is. But I'll be happy to answer any more questions you have at the time in Q&A.

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

Thanks, Bill. We continue to see progress in our numbers, as occupancy and leasing activity increases. As we move towards the sale of our medical office portfolio, we will narrow our focus to a live-work-shop strategy, and streamline our decision-making processes. Or live-work-shop strategy will lead Washington Real Estate Investment Trust to higher-quality assets in premium urban locations. We believe this will result in higher and more consistent earnings growth going forward.

Now we'll open up the call for your questions.

Thank you. We will now be conducting a question-and-answer session. (Operator Instructions) One moment please while we poll for questions.

Our first question comes from the line of Dave Rodgers with Robert W. Baird. Please proceed with your question, your line is live.

Wanted to follow up on the comments, I guess, about 7900 Westpark, as well as the recent CapEx improvements that you've been making to the asset and the success that you've had with those leases.

I guess a couple thoughts is, do you see enough activity in the market and is that what's giving you confidence to put more money to work in these properties. Should we expect that to continue? And then maybe kind of tie that into comments around the rollover that you're looking at in office in '14. How you feel about that, as well as spending some money around there?

Okay. As we'd stated really over the last couple quarters, we've been pretty aggressively upgrading our properties. It's been very successful both at 2000 M Street, many of the properties downtown, 1220 19th Street. So we have had some good success with that.

With regards to 7900 Westpark, it's a big project for us. And those of you who are familiar with the market, it's one of the most prominent buildings in northern Virginia. It's right on the beltway. You almost look like you drive into the building. And it has an old -- the taller of those buildings has an old '70s facade, which we expect to turn into an A building when this is done. So it's a big project for us.

And we think that the activity in the market that exists even today, we're having very good interest in the property. Now, we have obviously nothing firm. But some of the discussions we're having now are very promising. And we feel like we can achieve significant rental rate increases above what we're achieving in today's market, which will provide an attractive return on our investment. So we're very positive about that.

With regards to projects on our other properties, continued CapEx, we expect that process to continue, but we don't have anything of that magnitude that's currently planned right now. Did I answer everything there, Dave?

Yes, I think you did. And just one follow-up to that. It looked like, from an economic perspective, the office leases that you had signed in the first half of the year, first quarter was really kind of the low point in terms of the economic value of the deal. Do expect that you hit the bottom there and can continue to push higher on the economic value of the leases?

We'd like to think that. Let me just caution you a little bit there. A lot of it depends on where we're doing leasing. When you're leasing downtown, it's a much stronger market. And we actually had earlier in the cycle, we had more vacancy downtown and it's a stronger market, so we've seen some positive momentum.

Some of the holes we have now, for example, if we do a bunch of leases in this building that we're sitting in, 6110 Executive, this is a tough market. You might see declining fundamentals.

So I guess what I'm getting at is, there could be lumpiness going forward, depending on where we're actually doing leasing. If we're leasing vacancy in a suburban Maryland building, it'll look fairly ugly. If we're doing leasing downtown, it'll look a lot better. And it's hard for me to telegraph exactly where that's going to come from.

Let me also comment on something else you were asking about. You did ask, I think, on your first question about our prospects on next year and what we're looking at, in terms of our rollover. I know you have the supplemental, and you can see in there next year is a little bit of an elevated year for us from a dollar perspective. For 2014, our office portfolio's rolling 19.4%. I mean, I would characterize that as a little bit high. 15% is probably more of like an average number. So it's a little bit elevated.

And I can say to you we are already having discussions with a number of the larger tenants. And nothing is firm at this point. But we have, in some cases, a handshake on a couple fairly good transactions.

So I feel good about it, nothing is firm. And a lot of spadework needs to be done for next year. But I feel good about our ability to meet that challenge, which is, admittedly, a little bit higher than we normally see in the office sector.

I appreciate the color. Thanks.

Thank you. Our next question comes from the line of Brendan Maiorana with Wells Fargo. Please proceed with your question, your line is live.

Thanks. So, Skip, the MOB sale process, my recollection was maybe that you would have had a bidder selected early July, and then would have been under contract by late July. It sounds like maybe the process has been elongated a little bit. Is that accurate? And can you maybe provide a little more color on where we stand?

Yes, I agree with that observation. I would say that it's been elongated a little bit. Clearly, we were sort of targeting that sort of time frame. But I admit it, admittedly, when the capital markets changed a bit, we sort of distressed the project, because we didn't want any aftershocks after the system. We wanted everybody to digest what was going on in the world and come in with their best number. We didn't want to renegotiate after-the-fact with anybody.

So I would say the process has elongated, but I wouldn't call it negative in any way. It's just we don't want people to come to us after-the-fact and say there's been a change in the world.

So, yeah, I'd say that we elongated a little bit, but we still feel really good about it. So I don't even believe we're significantly behind where we expect closings to occur.

Part of the problem is here, and one of the other reasons why we weren't radically rushing to push the button is that we're trying to manage the other side of this transaction in the acquisitions world. So we're working both sides of this. So we felt it was in our best interest just to sort of stretch it out a little bit. But we're at the point now where we're very, very close to moving forward with a particular group.

Yes. Has there been, I know it's sort of hard to talk about because you guys haven't been -- you've obviously been reluctant to give specifics around pricing. But given that there's been a move up in terms of interest rates and the nature of the MOB sector [to] largely be impacted by rates in terms of what buyers assume and [prices] willing to pay, has there been any change in pricing expectations internally from where the bids are shaking out relative to what you might have thought at the beginning of the process?

Yes. Well, I think that what's happened in the world and interest rates in particular, affect different people in different ways. And it affects -- and again, I can't speak for every single individual bidder, because I don't know what's going on in everybody's head. But clearly, some people were affected more than others and some people weren't affected at all. And the people that probably weren't affected at all rose to the top, and that's probably the group that we're probably going to be with at the end of the day.

But again, I can't say I know how people adjusted their own numbers. But I can say in terms of rent, I mean, we're well within where we expected this thing to be. It's right in our neighborhood.

Okay. Great. And just from my understanding, the way the process will work, you'll select a bidder sometime, I think as you said over the next couple of weeks, hopefully. At that point would there be deposit money down, and you guys would announce that there is a material transaction?

No, it won't be until they go firm. So it'll probably be at the end of August.

Yes, after our due diligence period.

Okay. So you'd select a bidder, there'd be a month due diligence period, then it'll be -- okay. Got it.

Something like --

Thanks. And just last one, Bill, I know you mentioned kind of the office expenses that were up, and you had the tax impact that I gather was a little bit unforeseen. It seems like tax -- I mean, expenses were higher in multifamily and retail as well. Is that something that, from an operating expense standpoint, you think normalizes a little more in the back half of the year for all your segments?

Can I say I hope so?

(Inaudible) that much confidence.

Yes. A lot of it in the quarter, a lot of the recurring kind of capital-type expenditures in the OpEx category were a little bit seasonal. I mean, you have in residential, for instance, just to give you an idea, you're doing landscaping across the entire portfolio in the spring, you're filling up all the pools, you're doing all that kind of stuff. So there is one-time type regular operating expenses that happen in the second quarter all the time.

And I think that -- but the biggest move has been taxes, even with the one-time thing in office. But the biggest move has been taxes, and they're painful. They're a little bit painful. And that's not going to level out in the second half of the year. That's probably only going in the other direction, especially as we start filling vacancy.

Okay. Bill, if I just think about your guidance, you did, I think you did what $0.91 in the first half of the year. Your implied guidance for the back half of the year, at the midpoint is $0.96. But that's about in line with your second quarter run rate. That's kind of broad strokes the way to think about it?

Yes. Yes. In broad strokes, yes, I agree with that. Now, keep in mind, as I mentioned in prior calls, we have a compensation plan that pays out, it's very subjective and it pays out at the end of this year, half of which will be expensed in either the second half or the final quarter of this year, depending on estimates. So it could be lumpy, especially third to fourth quarter.

Okay. Great. Thank you.

Thank you. Our next question comes from the line of Michael Knott with Green Street Advisors. Please proceed with your question, your line is live.

Skip, can you just elaborate on your comments that office was feeling good? I had to jump on the call a little late. But I'm curious just a little more color there.

Yes. And I'd even emphasize, one of the other lines I use, I mean, it by no means is the good old days. I mean, we're not seeing the level of absorption in our market that we saw when, historically, we've been used to over the last 20 years.

But, no, we definitely are seeing better activity in our properties. Some of it, I think is a reflection of some of the CapEx and the changes we've made sort of organizationally, and some of it, I think, has good market fundamentals. I think just about any of the, whose ever market report you follow, whether it's Delta or Cassidy Turley or Jones Lang, they're showing modest improvement in absorption in the area.

Of course, we're comparing that to a bad last year. So maybe some in some regards it's not much. But we are seeing good levels of activity, not great, but good levels of activity, particularly in the District. Less so in the Maryland suburbs, it's okay in Virginia. It still has a heavy negative impact by the defense industry. But there are deals to be made, I guess is the best way to put it.

Okay. And is there talk around town of maybe a renewed bout of uncertainty if you get more political bickering later in the year over budget or anything else?

You're right, Mike. I mean, still, this is Washington, there's still a tremendous amount of uncertainty out there over what Congress is going to do or if they're going to do anything. So that's a wildcard, that I don't think any of us know exactly how to react to.

I mean, it's right now federal government workers are having to furlough, they're taking one day off a week. And how is that going to be reconciled at the end of the day when the new budget passes? There's so many unknowns, and none of us know how it's all going to unravel.

But I think, to some degree, we've gotten back to work a little bit, but there's still a little bit of an overhang in sort of the market persona, if I could put it that way.

Okay. But it sounds like it's still healthier in DC than in Virginia, and Virginia's better than Maryland. Is that about right?

I would say so. Now, again, there's pockets everywhere. It's better in Virginia, but Crystal City is still kind of ugly and places like that. But it's very submarket dependent.

And maybe give us some color on where your thoughts are in terms of redeploying the MOB proceeds. What inning are you in? And sort of are there specific things on your radar that you're looking at? And then also, I think a couple quarters ago, or maybe last quarter, you had mentioned that there were some sizable deals you were looking at.

Yes. It is, it's a little bit of a juggling act here. I mean, we're -- and I sort of alluded to it when I was responding earlier to Brendan's question. We're juggling what we think, where we're going to end up on the sale of the portfolio. We're juggling some significant 1031 gains and how we're going to [bucketize] it and [close some] tranches, very similar to what we did in industrial.

And we're trying to figure out where acquisitions are. It's still a very competitive acquisition market. The straight-up answer is we don't have anything firm right now. We have several things in due diligence, again, none of which are firm.

So I think that we have a little bit of a head start, and we have work to do. So where are we looking at properties? We have some multifamily properties that we have in due diligence. We have some office buildings that we're looking at, not necessarily in due diligence, that we feel confident that we'll be successful on. Some are big. Some are medium-size. And we also have a retail property that we're looking at, but it's a smaller size.

So the short answer is it runs the gamut from what we stated our going-forward strategy is, but nothing is firm at this point. We've got a lot of balls up in the air right now, honestly, and we're all working hard to navigate this little bit of a complicated sort of transactional environment.

Hey, Michael. On that note, I think last quarter we talked just kind of more generically about some of the really large deals that are in DC, especially in the office sector.

And you really do have to stop and think that do you really want to put all your eggs in one basket and take all the proceeds? I mean, some of these deals are big enough that they would take basically all the proceeds. And that doesn't sound like -- it doesn't sound like a well-diversified strategy to take out a portfolio of 19 properties and just buy one building.

Anyway, I hope we answered your question, Michael. I know we wheeled around there a little bit, but that's sort of the scenario.

Thanks for the color.

Thank you. (Operator Instructions) The next question comes from the line of John Guinee with Stifel Nicolaus. Please proceed with your question, your line is live.

Great. Thank you. The big picture on your whole reinvestment, Skip, is that if you're going to buy the kind of assets you really want to buy, it's probably going to be neutral to dilutive to FFO. But if you go out the risk curve or you go out the quality curve a little bit, it can be accretive.

Have you got the basic strategy down as to whether you're just going to buy core product in A locations, which might be dilutive to FFO, but generate a really great portfolio? Or you going to go after risk and quality curve a little bit and take a [flyer]?

Very perceptive question, something we ask ourselves as we sit around looking at a lot of these investments. John, I think the short answer to your question is, there's probably going to be a blend in there. You may see some stabilized, particularly if they're multifamily, we might throw a couple of those in there. We're looking at some office assets that have some risk to them. And as you stated, we get a little bit better return and we're willing to assume some risk going on in the curve in terms of leasing.

And then there's some stable office assets that we're probably less competitive on. As you know, some of these, I wouldn't even call them trophy, even quasi-trophy buildings that are all locked up, they're going for very aggressive cap rates. And we're not necessarily super competitive on those.

So we tend to be, I think we're tending to look more at properties that have some manageable level of risk of varying degrees, whether it's taking upfront leasing, where space is actually vacant today, or taking space that we know might be coming available over a period of time that we feel like we can manage through a lease process and get higher returns to mitigate that dilution.

So I think there's going to be a blend. And hopefully, we'll come out close to even is [where] we're thinking. Right, Bill?

Yes. I mean, we've got a --

I think that's --

-- a model.

-- what we're saying at the end of the day.

We've got a model that it's going to be slightly dilutive as we trade out all [those] proceeds. But it won't be -- it won't be a massive amount of dilution.

But, of course, since we don't have anything locked up yet, it remains to be seen. But I feel pretty good about the way I laid it out.

Quite honestly, John, the only place you can go out and get accretive, truly accretive, higher risk things are the exact thing we don't want to buy, which is suburban office.

Oh, I know. I know. Okay. Second question is, Public Building Saving and Reform Act, basically freeze the footprint, working its way through the House, will most likely go through the Senate. Really, I think puts even more handcuffs on the GSA.

Can you walk through what's happening there and how that works, specifically with your assets? For example, if you look at your portfolio, how many of these assets would fail the basic standards for age, quality, et cetera? And how many of your assets still will be leasable to the GSA?

Yes. Right now, we've diminished our GSA exposure tremendously. And most of our GSA exposure are in smaller leases. We have a fairly big lease down in Quantico, which I think is a newish building, which wouldn't be impacted.

But we haven't gone -- to answer your question directly, we haven't gone through a spreadsheet, because we don't believe that it's material to our operations. Our GSA exposure is so diffused through the portfolio now, that, to us, honestly, GSA rolling out is going to affect the market, less so us individually.

Great. Thank you.

Thank you. Our next question comes from the line of Michael Knott with Green Street Advisors. Please proceed with your question, your line is live.

Just wanted to ask about the redevelopment at Tysons. Just curious if that's better characterized as a defensive, revenue-maintaining exercise or do you feel like there's going to be a return on the incremental capital there? And if so, what type of return are you thinking about?

I think it's both, Michael, honestly. I mean, to stay out there with that building -- I mean, it's a decent building, but it's sort of a brutal market to just stay and -- we think it's a phenomenal location and it's gone from a B-plus location to an A location.

But it is, in one respect, it's defensive, because if we keep it in its current state in that market, it's going to be a little bit of hand-to-hand combat. At the same time, we think we can bring this building up to maybe not A, but A-minus. I'm not suggesting that this building is going to be equal to Macerich, for example. But, we think we can have a very attractive return on the $35 million. So it is going to have a positive return. So it really has elements of both.

Okay. Thanks.

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

Okay. Thank you, everybody, for listening to our call. Have a great summer, and look forward to catching up with you at the end of the third quarter.

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