Equity Commonwealth (EQC) 2007 Q2 法說會逐字稿

Please stand by, we're about to begin. And welcome to the HRPT Property Trust second quarter 2007 financial results conference call. This call is being recorded. Now at this time, I'd like to turn the conference over to the Manager of Investor Relations, Tim Bonang. Mr. Bonang, please go ahead.

Thank you, Dwayne. Joining me on today's call are Adam Portnoy, Managing Trustee, and John Popeo, Chief Financial Officer. The agenda for today's call includes a presentation by management, followed by a question and answer session. Before we begin today's call, I would like to read our safe harbor statement.

Today's conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and Federal Securities laws. These forward-looking statements are based on HRPT's present beliefs and expectations as of today, August 7, 2007. The company undertakes no obligation to revise or publicly release the results of any revisions of the forward-looking statements made in today's conference call, other than through filings with the Securities and Exchange Commission regarding this reporting period.

In addition, this call may contain non-GAAP numbers including funds from operations or FFO. A reconciliation of FFO to net income is available in our supplemental package found in the Investor Relations section of the company's website. Actual results may differ materially from those projected in these forward-looking statements. Additional information concerning factors that could cause those differences is contained in our form 10-K filed with the Securities and Exchange Commission and in our Q2 supplemental and operating and financial data found on our website at www.hrpreit.com. Investors are cautioned not to place undue reliance upon any forward-looking statements.

And with that, I would like to turn the call over to Adam Portnoy.

Thank you, Tim. Good afternoon and welcome to everyone that is joining us on today's call. I just want to say before I begin that I may not sound a hundred percent like myself today. I have a little bit of a summer cold, so I apologize.

But for the second quarter, we are reporting FFO of $0.29 per share on a fully diluted basis, compared to $0.30 per share for the same period last year. The primary reason for this modest decline in FFO was higher financing costs.

From an operations perspective, we continue to see improvements with regard to increasing net effective rents and overall cash flow.

For example, although we experienced about a 1% decline in same store occupancy in the second quarter, rents on leases signed during the quarter increased by 3% in capital expenditures, which include tenant improvements, leasing commissions and recurring building maintenance, have decreased over 11% between the second quarters of 2006 and 2007.

These operating results are largely a reflection of the initiatives we have been speaking about for some time, where we are more focused on increasing cash flow at the expense of some of our occupancy.

With regard to what we are seeing across our markets, leasing metrics have largely remained unchanged in the last quarter, but we are becoming concerned with some of the reported changes in other real estate metrics.

For example, overall office occupancy rates on a nationwide basis seem to have stabilized and nationwide office net absorption is slowing. Although overall development activity has not increased nationwide, it has increased in several markets, including some of the markets where we operate, such as Washington, DC and Southern California.

With regards to our portfolio, we appear to be outperforming the market on many fronts. We have signed leases for almost 2 million square feet during the quarter and 58% were renewals and 42% were new leases.

Leasing activity during the second quarter resulted in a 3% roll up in rents and about $18 per square foot in capital commitments.

The average lease term was 7.9 years and the average capital commitment per lease year was $2.31. Both of these key metrics are improvements from the prior three quarters.

Overall company occupancy as of June 30th was 92.9%, which represents a 10 basis point increase in the first quarter of 2007. Again, I think we are doing a great job achieving some of the highest possible net effective rents when we are doing leasing, which will lead to an increase in our cash flows in expense of some of our occupancy.

Within our portfolio, all of our major markets are performing well, with Oahu, Hawaii and Southern California performing especially well.

In Oahu, the market for industrial property is the strongest in the country, with gross industrial rents approaching $40 per square foot in certain areas. As a result, the Oahu industrial real estate market is experiencing one of the most dramatic increases in rates among all real estate segments in the United States.

HRPT is largely benefiting from this market improvement, because we are the largest owner of industrial properties in the state of Hawaii.

During the quarter, same store NOI increased by 3.6% in Oahu, largely because of rent increases.

Southern California saw an increase in same store NOI of 10.4%, despite a decrease in occupancy by 2.5% on a same store basis. Our Southern California portfolio is largely benefiting from increases in rental rates in the region.

Our only concern with the market is the increase in development activity during the last two quarters. Although Washington, DC is currently going through a lot of changes, it performed well for us in the second quarter. Even though our occupancy declined by 5.2% year-over-year, our same store NOI increased by 1.2% in the second quarter.

One of our concerns with this market is the large amount of development activity, with between 1 and 2 million square feet coming on line per quarter.

Our Austin, Texas portfolio continues to post strong leasing results with double digit rent growth on leases signed during the quarter, offset by the expiration of the 300,000 square foot Tyco lease. We are happy to report that over 100,000 square feet of this space was re-let during the quarter and demand for space in this region continues to support prospects for continued gains.

Our Philadelphia portfolio is also performing well. Somewhat surprisingly, the Philadelphia leasing market has shown steady improvement during the last few quarters, especially in the downtown market where we own a large percentage of assets.

As announced during the last quarter's call, we have pre-leased over 50% of the space Comcast will vacate in 2008 and we hope to report additional progress with this re-leasing effort in the next few quarters. We continue to believe that we are very well positioned in this market with less than 1% of our square feet rolling through the end of 2007 and in place rents equal to or below market rents.

Boston continues to perform better than expected, with stable to improving market occupancy and limited new development activity, especially in the downtown market. This improvement is being driven by strong economic activity in the region. Unfortunately, development activity may increase in 2008 and 2009 in this market and this is our only major market we may have some lease roll downs and occupancy declines during the remainder of this year.

In our other markets located throughout the country, our portfolio has generally experienced modest decreases and same store NOI, primarily as a result of lower occupancy. Looking forward, we are planning on our portfolio to remain stable and we are continuing to focus on increasing our net effective rents and operating cash flows to achieve maximum returns.

We have 2.2 million square feet scheduled to expire during the remainder of this year, which represents approximately 4% of our total square feet and annualized rents. This lease roll is spread out evenly throughout our portfolio, with no market accounting for a disproportionate amount of lease expirations.

Furthermore, excluding Boston and our other markets, the remaining leases scheduled to expire through the end of the year have in place rents that are below current market rents, which may lead to some additional rent roll ups in the future.

With regards to second quarter investment activities, we purchased one office building located in a Chicago suburb and 14 industrial properties, with a total of 3.4 million square feet for $143 million. The weighted average going in cap rate was 8.7% for all of these acquisitions and the buildings were 100% leased for 9.5 years on average at closing.

Going forward we will continue to focus on purchasing high quality and well-leased office and industrial properties located in less high profile markets, as well as look for opportunistic development and redevelopment projects in select markets. We also continue to actively look at selling some of our B and C class properties located in lower tier markets where we are unlikely to grow our portfolio.

Subsequent to the end of the quarter, we purchased one hotel property for $13 million. We purchased this hotel because it sits adjacent to several properties in a business park located in Atlanta that HRPT currently owns. We are currently in the planning and approval stages regarding a potential large redevelopment project involving several properties at this location. Until we begin the redevelopment of this site, this hotel will continue operations under a short term lease agreement with a hotel operating company.

Also as of today, we have executed purchase agreements for five additional properties with an aggregate of approximately 271,000 square feet for a total purchase price of $35 million. Of course, these agreements are subject to closing conditions and the purchase of these properties may or may not happen in the future.

As we end the quarter, the company's focus on increasing net effective rents and cash flows has started to show some positive results and we expect this focus will allow HRPT to outperform the market in the future. In looking at our portfolio dynamics, HRPT continues to be very well positioned among the highest occupancy rate, longest average remaining lease term and highest credit quality tenants in the office REIT sector.

Furthermore, the diversity of our portfolio holdings and tenant base adds to security and stability of our cash flows and dividend payments.

I'll now turn the call over to John Popeo, our CFO.

Thank you, Adam. Looking first to the income statement, rental income increased by 6.1% and operating income increased by 1.1% during the second quarter of 2007. The year-over-year quarterly increase in rental and operating income reflects increases from properties acquired between April 1, 2006 and June 30, 2007, partially offset by modest declines in same store NOI and depreciation and amortization related to building improvements and leasing costs incurred during the same period.

Our consolidated NOI margins were 61.3% for the second quarter of 2007 and 61.6% for the second quarter of 2006.

Current quarter EBITDA increased by 5.7% from the same period last year, primarily reflecting property acquisitions since March 2006.

Interest expense increased -- decreased by 1.1%, reflecting the repayment of debt with proceeds from our preferred share offering in October 2006, offset by property acquisitions and a 30 basis point increase in weighted average interest rates on our floating rate debt from 5.6% during the three months ended June 30, 2006 to 5.9% during the three months ended June 30, 2007.

Net income available for common shareholders for the second quarter of 2007 was $16 million, compared to $22 million for the second quarter of 2006. The decrease reflects depreciation and amortization related to building improvements and leasing costs incurred since March 2006, and a modest decline in same store NOI, partially offset by earnings from properties acquired during the same period.

Diluted FFO available for common shareholders was $0.29 per share for the second quarter, compared to $0.30 per share for the prior year. The decrease primarily reflects the slightly diluted impact of our Series D convertible preferred shares issued in October of 2006 and a small decline in same store NOI, partially offset by earnings from properties acquired since March 2006.

This quarter's FFO results represent a good run rate for the company for the third quarter. In July 2007 we declared a dividend of $0.21 per share, which represents 70% of our second quarter FFO. Our board considers the dividend level on a quarterly basis and they are comfortable with this current payout ratio.

During the quarter, we spent $23 million on tenant improvements and leasing costs and $3 million, or $0.05 per square foot, for recurring building improvements, including lobby renovations, elevator upgrades and other capital projects throughout the portfolio.

We paid $16 million on development and redevelopment activities during the second quarter, which included self-storage development and leasehold acquisition costs in Hawaii.

Turning to the balance sheet, on June 30th we held $29 million of unrestricted cash.

A $10 million increase in rents receivable reflects straight line rent accruals during the first half of 2007. Rents receivable includes approximately $146 million of cumulative straight line rent accruals as of June 30th.

Other assets includes approximately $91 million of capitalized leasing and financing costs.

In June, we repaid $200 million of our unsecured floating rate senior notes by drawing on our revolving credit facility. We subsequently issued $250 million of unsecured senior notes in June, with a maturity of June 2017 and a fixed interest rate of 6.25%. We used the proceeds of this offering to reduce amounts outstanding on our revolving credit facility.

During the first half of 2007, we sold 1.9 million common shares through a controlled equity offering program, raising net proceeds of $24 million at a weighted average share price of around $13 per share.

On June 30, 2007, we had $412 million of floating rate debt, $411 million of mortgage debt and $1.8 billion of fixed rate senior unsecured notes outstanding. The weighted average contractual interest rate on all of our debt was 6.3% at the end of the quarter and the weighted average maturity was 6.9 years.

Our senior unsecured notes are rated BAA2 by Moody's and BBB by Standard & Poor's.

The book value of our unencumbered property pool totaled about $5.3 billion at the end of the quarter.

Our secured debt represents 7% of total assets and floating rate debt represents 16% of total debt.

At the end of the second quarter, our ratio of debt to market capitalization was 46%.

Our EBITDA and fixed charge coverage ratios were 2.8 times and 2.1 times, respectively. As of the end of the second quarter, we were comfortably within the requirements of our public debt and revolver covenants.

As of the end of the quarter, we had $212 million outstanding on our revolving credit facility, with $538 million of additional borrowing capacity.

In summary, we continue to believe HRPT's strong tenant base, limited near term lease expirations, strong balance sheet and current annual dividend yield of almost 9% make HRPT a logical choice for long term, income-oriented investors.

That concludes our prepared remarks. Operator, we're now ready to take questions.

Very good. (OPERATOR INSTRUCTIONS) Our first question will come from John Guinee with Stifel.

John Guinee here. How are you?

Yes, John. How are you?

Good, good. Questions, a few questions. Do you still have your continual common offering vehicle active in the third quarter, given where the share price is?

It's still effective, but I can tell you we've raised, I think, what, a total of $24 million in the last six -- in the first six months of the year. And the average price in which we executed was around $13 a share. So, if the question is, am I -- are we raising money right now at $9.50, the answer is no.

Where do you turn it on and where do you turn it off? What share price are you buyers and what share price are you not buyers?

You know, that's a good question. I haven't, I know right now we're not buyers, but again, we haven't raised a lot of money through that program. It's not a big, doesn't represent a large amount of the equity that were ever raised for the company. But, I'm not, John, honestly, I don't know where we turn it on. We have to see how things shake out in the marketplace. I know right now where the stock price is it doesn't make sense. But, we just have to see where things shake out.

I mean, you, like everybody else on the call, understands that there's a lot of volatility in the market lately. I don't think we make a decision about what to do with that until some of that volatility quieted down.

Okay. Last question, if you take your preferred shares and look at that as debt, like a lot of people do, at $8.90 odd cents, you're at a 65% debt plus preferred to total market capitalization per page 9 of your key financial data. Does that bump you up against any of your, your rating agency issues? And how much debt can you continue to issue, given where we are right now?

We don't have much. We're comfortable right now with the rating agencies. They -- we get a lot of equity credit for those preferreds, because they're perpetual and there's no, there's no put right by the holder.

From -- if you look at our covenants, and specifically the public debt covenants, which we also have in our supplemental and you see we have plenty of room as well, I would say that right now where we are I think we're comfortable with the rating agencies. There is a point, you're correct, at some point if we continue to just put more debt on the company, we would hit a point at some point where we'd have to consider doing something, if we decided that we, if we want to maintain the rating. I don't think we're there yet. Could we do -- I don't think we could put a billion dollars more of debt on the company, but we can put more debt on the company. I just don't know what the exact amount is.

Okay. And then the last question, John had mentioned that the third -- the second quarter FFO was a good proxy for the third quarter. Per our numbers, your CAD came in a relatively positive 20 and $0.18 a share for the first and second quarter. Is that a good proxy for the third and fourth quarter or do you expect something different, John?

Well, first of all, my reference to the $0.29 rent rate is mainly because of the $140 million or so of acquisitions that we completed in the second quarter. Around 90% of them were completed around April 2nd, so that refers to the $0.29 run rate.

To answer your question, yes, CAD has run right around $0.17, $0.18 a share for the first two quarters. I think that may be a little bit low, John. That equates to a run rate of around, or a payout ratio run rate of around 124, 125%, right around 120%. My guess at this point and, again, it's a tough figure to nail down with any degree of certainty because it's just too difficult to predict what the mix is going to be between new and renewed leases, but, it could be somewhere all the way up to 130%.

Great. All right. Thank you.

(OPERATORS INSTRUCTIONS) We'll next go to Philip Martin with Cantor Fitzgerald.

Good afternoon.

Good afternoon, Philip.

First of all, you talked about new development creeping into some of your markets and being a concern. In terms of the new development that is occurring in your markets, how much does it really compete with your product that's there and do you think it will impact your ability to increase rents or from a tenant retention standpoint?

Well, in DC I think it definitely affects us out in the suburbs. It hasn't really affected us in the downtown market. In Southern California, we haven't seen the effect yet. You know, in my prepared remarks I talked about development activity was being concern there. The other concern is probably the only mark -- an indirect concern is maybe what's going on in the sub-prime market and the residential mortgage market in Orange County in Southern California. That might have some indirect effect there. We haven't seen it yet in Southern California.

In Boston, that's the only other market. There's no development activity really to speak of in Boston right now, but there's a lot of stuff planned for 2008, 2009, especially in the metropolitan area, in the downtown area. I think that is going to have an effect a little bit on the market here in Boston going forward.

But probably the place where it's having the biggest effect is in DC.

And, a lot too, DC as a market, in terms of the rents, the net rents expected on the development product coming out of the ground there, where are those rents compared to the rents in your existing portfolio and what's up for renewal, let's say in 2008?

Well, they're higher in many cases than what we have, but it's a newer product. And so, sometimes a newer product can afford the higher rent, or can demand the higher rent. It's also a little bit location, where the property is located. Again, in the downtown market, specifically, let's say a medical office buildings in downtown and our GSA buildings in downtown DC, they're performing very well. There's no issue there. It's really just out in the suburbs, particularly the Maryland suburbs, where we're seeing a little bit of softness in the market specifically.

Okay. Okay. So, it's reasonably competitive then with your product. And, are your tenants playing the negotiating game with you somewhat on this? Is that what is giving you concern or is it just the development?

It's just the development generally. It's just the amount of, you know, DC, just the amount of coming on line just, it's more staggering at times when you look at it all.

Okay.

And you can't help but think it's going to have some sort of effect on us.

Okay. Okay. Now, in terms of the NOI was down year-over-year primarily due to occupancy. I was assuming a slightly higher occupancy rate going forward for this quarter. When can you better drive occupancy and thus the same store numbers? When does that inflection point occur? We've been hearing the last, well, let's call it almost a year and I think it's been a good play to hold out a little bit as we've seen the recovery here. But, when does that inflection point hit where we can drive occupancy and thus same store growth?

I'm hoping by the fourth quarter, it may take into the first quarter of 2008, but that's what I'm hoping for, we start seeing something in the fourth quarter. I mean, it's a balancing act, as you know, Philip. It's like we can drive occupancy if I want to and I could probably even drive NOI a little bit, I'm just going to have to pay a lot for it. So, I'm trying to -- you know, John talked a little bit about FAD or FFO payout ratios. Try to be mindful of that. At the same time, I don't want to give up too much occupancy to maintain a decent payout ratio. So, you've got to -- if all I'm concerned about was occupancy and maybe NOI and I didn't care about payout ratios, I could drive that faster.

Okay. Okay. Well, that's fair enough. Now, in terms of your, you know, you mentioned this, I know, last quarter and now this quarter, again, but a little more emphatically maybe here. I don't want to put words in your mouth. But where do you think your development and redevelopment pipeline could be in a year?

I could see it easily be a couple of hundred million dollars within a year. That's the outside. It could be somewhat, it could be a lot smaller than that. What I talked about on the call was this project out in Atlanta. That's, for anyone, it's actually the executive park, business park we have down there. You can see it on our website pretty easily. It's an older business park. We're considering a mixed use development down there.

And that alone, that project alone, if we succeed in getting all of the approvals and everything goes the way we think it's going to go, that itself could be a couple of hundred million dollar project down there. I'm not sure it will come to fruition in the full project, but I think that we'll -- I feel very comfortable they'll do something down there, or else we wouldn't have bought the hotel. Just a matter of how big a project it's going to be, but it could be as big as a couple of hundred million dollars, that project alone.

And then to be honest with you, I mean if all things hit on all cylinders, there's that project and then there's a few other projects around the country that are in even earlier stages. So, it could be in excess of $200 million by next year, or a year from now, if you're asking me.

And these projects are largely associated with existing assets or next door or contiguous to existing?

That's correct. That's correct. It's all around existing assets. It's tear down -- it's development in the sense that we're tearing down something that exists and redeveloping it. And with the idea that we're not doing this, we're not known for redevelopment primarily in the marketplace, but -- and so when we do do redevelopment it's stuff that it's got to be, the returns have got to be in the low to mid teens for us to even really consider it. We're not doing development projects to shoot for a 9% IRR, that's not what we're doing. We're shooting for development projects where we feel pretty good we can get mid to low teens on the returns.

Okay. I mean, obviously, that's driven by a pretty low cost basis probably with some of these assets that can drive those returns.

Some of that, but it's also, that's part of it, but it's also got to be can we have a successful project? We're going to put a lot of money to work and you've got to make sure you can get the tenants, you feel good that you will be able to get the tenants.

Okay. Okay. Perfect. Thank you again.

And with that, this will conclude today's question and answer session. I'd now like to turn the call to Adam Portnoy for any additional or closing comments.

Okay. Thank you, thank you very much. And I appreciate you listening to our second quarter conference call. Thank you.