Equity Commonwealth (EQC) 2009 Q3 法說會逐字稿

Good day. Welcome to the HRPT Properties Trust third quarter 2009 financial results conference call. This call is being recorded. At this time, for opening remarks and introductions, I would like to turn the call over to Vice President of Investor Relations, Mr Tim Bonang. Go ahead.

Thank you, Mandy. Good afternoon, everyone. 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 our 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 in Federal Securities Laws. These forward-looking statements are based on HRP's present beliefs and expectations as of today, November 5th, 2009. The Company undertakes no obligation to revise or publicly release the results of any revision to the forward-looking statements made in today's conference call, other than through filings with the Securities and Exchange Commission, or SEC, 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 as well as components to calculate AFFO or CAD or FAD are 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 any forward-looking statements. Additional information concerning factors that could cause those differences is contained in our form 10-Q, which will be filed within the next few days with the SEC and in our Q3 supplemental operating and financial data found on our website at www.HRPreit.com. Investors are cautioned to not to place undue reliance on any forward-looking statements. And with that, I would like to turn the call over to Adam Portnoy.

Thank you, Tim. Good afternoon, everyone, and thank you for joining us on today's call. For the third quarter of 2009, we are reporting fully diluted FFO of $0.26 per share compared to $0.27 per share during the same period last year. During the third quarter, we had two million square feet expire, and we signed leases for 1.1 million square feet. 54% of our leasing activities were renews, and 46% were new leases. Leasing activity this quarter resulted in a 3% roll-down in rent, and about $6.32 per square foot in capital commitments. The average lease term was 4.6 years, and the average capital commitment per lease year was $1.37. The most noticeable change in our operations this quarter was the decline in occupancy. At the end of the quarter, our occupancy rate was 88%, which was 110 basis points lower than the end of the second quarter. Same-store occupancy was also down by 140 basis point to 87.6% at September 30th as compared to the end of the second quarter. The primary reason for the decline in occupancy is the slowdown in the US economy and the continued high unemployment rate in almost all areas of the country. As a result of these conditions, tenants are generally reluctant to commit to expansion space or lease new space. In addition renewal activity continues to be challenging, because existing tenants are sometimes asking to down-size their space.

These negative market trends are evidenced by the reported decline in office net absorption and occupancy rates across the country during the last few quarters. At the same time, the development activity has slowed, but it is expected to continue in some markets. As a result of these dynamics, same-store consolidated NOI for the third quarter declined by 4.5%. In Oahu same-store NOI alongs increased by 9.9% primarily reflecting increases in rental rate. Although the economic downturn is starting to act rental rates in Oahu, the industrial market is still strong, and our in-place rent continue to be significantly lower than current market rates. With regard for our properties in Oahu, on August 14th, we commenced litigation in US Federal Court to dispute a state law which seeks to limit rental increases at certain of our leased lands in Hawaii. Our claim is that this law violates the United States Constitution. On September 28th, we filed a motion for summary judgment of our claims regarding this matter, and a hearing on this motion is currently scheduled for December 7th, 2009.

In Washington, DC, our same-store NOI increased by 9.3%. Washington, DC continues to be one of the strongest markets in the country, and the strength in this market is primarily driven by job growth in the Federal Government and related industries. Southern California same-store NOI was flat during the third quarter. This market continues to experience weakening fundamentals with negative net absorption and about two million square feet of new construction completed in the quarter. Same-store NOI in Philadelphia was also basically flat in the third quarter. The Philadelphia leasing market continues to show some signs of weakness with slight decreases in rental rates. The downtown office market, where we own a large percentage of assets, remains relatively stable, and we continue to believe we are well positioned in this market. Boston same-store NOI decreased 12.9% during the quarter because of declines in occupancy. Boston continues to be our only major market where we expect continued significant lease roll-downs and/or increased vacancy in the future. In our other markets, located throughout the country, our same-store NOI during the quarter decreased by 9.2%, reflecting a 4.4% decline in same-store occupancy, plus an increase in allowances for bad debts. The largest area of occupancy decline in our other markets occurred in some of our industrial properties located outside of Oahu.

We have 1.7 million square feet scheduled to expire during the remainder of 2009, which represents approximately 3% of our total annualized rents, and 6.9 million square feet scheduled to expire during 2010, which represents approximately 12% of our total annualized rents. The majority of the leases scheduled to expire through the end of 2010 have in-place rents that are slightly above current market rents. However, because leasing fundamentals continue to weaken, our occupancy rate is likely to decline further for the next few quarters, or until the economy begins to show sustainable growth, and employers start hiring again. Although occupancy is likely to decline for the next few quarters, we expect the rate of occupancy decline to moderate as compared to this quarter's 110-basis-point decline. We feel confident with this expectation, because even though we continue to operate in a difficult environment, leasing markets across the country have generally started to improve since the beginning of the year.

Although we continue to face a challenging leasing environment, we have taken the necessary steps to ensure that our Company is well positioned to take advantage of distressed acquisition opportunities. The properties we have purchased this year, are all class A buildings in good markets, and have long-term leases with high credit-quality tenants. More importantly, these acquisitions are being made at record-high cap rates. With this in mind, during the third quarter, we purchased two class A office properties with 761,000 square feet for about $208 million. We purchased these high-quality assets in Hoboken, New Jersey and Washington, DC , going with cap rate of around 10%, and these properties are 99% occupied with an average lease term of almost eight years. During the quarter, we also completed the final sales of the previously announced medical office clinic and BioTech laboratory buildings for senior housing properties trust. We sold the last two properties for $144.6 million and reported gains relating to the sales of about $50 million.

Subsequent to quarter end, in October, we also acquired one industrial property with 338,000 square feet for about $17 million. This building is 100% occupied with an average lease term of 15 years and the going end cap rate was almost 11%. As of today, we have an executed an agreement to buy one which is A office building with approximately 415,000 square feet for a price of $165 million. We also have one property under agreement to sell for $15 million, which is expected to close in 2010. Of course, these agreements are subject to closing conditions and the purchase or sale of these properties may or may not happen in the future.

Before turning the call over to John Popeo, I would like to recap HRP's current balance sheet and liquidity position. We currently have about $2.8 billion of debt outstandings, which represents a conservative 47% of total assets. We have no significant debt maturities until 2011. Our unsecured debt obligations have been rated investment grade for 15 years, and we continue to be comfortable in compliance with all debt covenants. As of September 30th, we had $241 million outstanding on our existing $750 million unsecured revolving credit facility. This facility is provided by a diverse group of close to 30 participating banks and matures in August 2010, and we currently pay interest at LIBOR plus 55 basis points. At our option, we have the right to extend this revolver for one additional year through August 2011. Through the June IPO of our former wholly owned subsidiary, Government Properties Income Trust, we have repaid $250 million of debt and currently own almost 10 million tradable shares of Gov. These shares have a book value of $156 million, and a current market value of about $240 million. Since the beginning of 2009 we have also lowered our dividends to a sustainable level, and repurchased $14 million of our common stock and over $100 million of our outstanding debt at significant discounts.

In summary, HRP is facing a difficult leasing environment. But the Company's balance sheet is very well positioned to both weather the current downturn and opportunistically grow the Company through the acquisition of high-grade properties at distressed prices. I think it's also important to note that we are navigating these challenging times while maintaining balance sheet flexibility and liquidity. In comparison to some of our peers, we are particularly proud of the fact we have maintained this balance sheet flexibility and liquidity during the last year without having to do an extremely diluted equity offering. I will now turn the call over to John Popeo, our Chief Financial

Thank you, Adam. Looking first to the income statement, income decreased by 2.4%, and operating expenses decreased by 0.9%. The year over year quarterly decrease in rental income and operating expenses reflects the $4.9 million decline in same-store NOI and 25 properties transported to Gov in June, offset by increases in NOI from properties acquired between July 2008 and September 2009. Depreciation and amortization increased by 3.4%, reflecting depreciation and amortization related to building and tenant improvements. The increase in general and administrative expense reflects timing of legal and other fees and expenses. We also paid $1.5 million in fees and expenses related to the acquisition of two properties during the quarter. Our consolidated NOI margins were 57.3% and 57.9% for the third quarter of 2009 and 2008 respectively. Current quarter EBITDA decreased by 5% compared to last year reflecting the decline in currently quarter same-store NOI. Interest expense decreased by 7.5% reflecting the repurchase and retirement of $117 million of our outstanding debt and the decline in average floating interest rates from 3.2% during the third quarter of 2008 to 1% during the third quarter of 2009.

Since its IPO in June, our investment in Gov has been accounted for using the equity method of accounting. Under the equity method, we record our percentage share of net earnings and FFO of Gov in our financial statements. Our percentage share of Gov net income and FFO for the second totaled $2.9 million and $4.6 million respectively. We expect to receive close to $16 million of cash dividends annually from Gov beginning in the fourth quarter in 2009. Net income available for common shareholders for the third quarter of 2009 was $59.5 million compared to $73.1 million for the third quarter of 2008. The decrease reflects occupancy declines and a $4.9 million decline in same-store NOI, and $57.7 million on gains on property sales during the prior year versus $50.1 million during the third quarter of 2009. Diluted FFO available for common shareholders was $0.26 per share for the third quarter of 2009, and $0.27 per share for the third quarter of 2008. Year over year results primarily reflect a decline in same-store NOI and a decline in earnings of properties sold transferred to Gov, partially offset by properties acquired since July 2008.

In October 2009, we declared a dividend of $0.12 per share, which represents 44% of our third quarter FFO. During the quarter, we spent $14.6 million on tenant improvements and leasing costs and $1.6 million or $0.02 per square foot for recurring build improvements including lobby and facade renovations, elevator upgrades and other capital projects throughout the portfolio. We paid $3.3 million on development and redevelopment activities during the quarter.

Turning to the balance sheet on September 30th, we held $33 million of unrestricted cash. Rent receivables includes approximately $156 million of accumulated straight-line rent accruals as of September 30th. Other assets include approximately $84 million of capitalized leasing and financing costs. On September 30th, we had $409 million of floating rate debt, $449 million of mortgage debt, and $2 billion of fixed rate senior unsecured notes outstanding. The weighted average contractual interest rate on all of our debt was under 6% at the end of the quarter, and the weighted average maturity was five years. We have no debt maturing in 2009, and only $50 million of senior notes maturing in 2010. Our senior unsecured notes are rated Baa2 by Moody's and BBB by Standard and Poor's. The book value of our unencumbered property pools totals about $5.6 billion at the end of the quarter. Our secured debt rep presents 7% of total assets and floating rate debt rep represents 15% of total debt. At the end of the third quarter, our ratio of debt to book capitalization was 49%. Our EBITDA and fixed-charge coverage ratios were 2.7 times and 2.1 times respectively. As of the end of the third quarter, we were comfortably within the requirements of our public debt and revolver covenants. As of the end of the third quarter, we had $241 million outstanding on our revolving credit facility with $509 million of additional borrowing capacity at a current interest rate of less than 1%. As of today we continue to have $241 million outstanding on our revolver and one property under contract to buy for $165 million.

In summary, this quarter produced results we expected in light of a challenging market environment. Our dividend cut in January has significantly improved our dividend payout ratio and financial flexibility. We own 9.95 million tradable Gov shares with a currently market value of around $240 million, and we continue to make accretive leverage-neutral acquisitions by reinvesting proceeds from the sale of assets in office and industrial properties, with going-in yields of around 10%. That concludes our prepared remarks. Operator, we are now ready to take questions.

Thank you. (Operator Instructions) We will proceed in the order you signal us and take as many questions as the time permits. We'll take our first question from Mark Biffert of Oppenheimer.

Good afternoon. Adam, I was wondering if you can talk a little bit about pricing that you are seeing for both office and industrial, and what kind of range you're targeting for yourselves? And if you could speak specifically, I don't know if you mentioned the cap rate you're paying on the class A building that you are under contract for the fourth quarter yet.

Yes, sure. Basically, transaction volume, as everyone knows, has declined quite a bit, compared to a couple of years ago, and so there are not a lot of opportunities out there. What we are finding is that usually if someone is selling something, they have a reason they're selling it, meaning they have some sort of liquidity need, and we're actually finding that most sellers, in order to raise that liquidity are looking to sell some of their better assets versus some of their more struggling assets, because they think they will get the most interest in the assets. And the truth is there just haven't been a lot of buyers in the marketplace looking to buy those assets. In fact, I know, for the assets that we -- I know that the two assets we bought in this quarter, both in Washington, DC and in northern New Jersey, we were not the highest bidder. We just had -- we were just the bidder that the seller felt the most comfortable about and we had the certainty of closure with.

And the second part of your question relates to the cap rate we were looking for. I would say between 9% and 11%. That's both for office and industrial. Generally speaking, we're not looking at stuff that has much of a roll near-term, and we're really using -- we think this is a great opportunity to buy fantastic assets. A lot of people -- a lot of competitors, whether they're other REITS or other private buyers make a big deal about talking about how -- the bottom hasn't come yet, we need to wait, and 2010 will be the real opportunities. Well, there are opportunities today you just have to look; and if I buy a building today for a 10% cap rate, if I waited another 6 months, maybe I could buy a comparable building for 10 and a quarter or 10 and a half maybe. But the 10% cap rate we're getting today we all feel really good about, because these are buildings that honestly, everyone who's selling these buildings are taking losses on them, meaning they bought them 2, 3 years ago, at substantially higher prices than what we're paying, and these are buildings that you would have seen trading 6, 7 or lower cap rates in the past. So I think, we're being very selective, and I think, in our acquisition -- but, again, between the 9% and 11% cap rate, and I'm not comfortable disclosing the cap rate on the building for the fourth quarter yet because we're still in diligence.

Okay. And just in terms of looking at other opportunities, how would you look to go out and finance these things? Would you look at the unsecured markets, secured debt, are you seeing improved flow from the Lifeco companies?

I would generally say that all of the markets, with maybe the exception of the preferred market, is generally open to HRP right now. On the secured side, the market is definitely open. In fact, we've looked at some secured financing as a possible -- as a possible alternative. And I'd say life companies have come more back into the fold since the beginning of the year. That's no question. Banks are also lending much more again. It's not robust, but they are lending more than they used to six month ago. The unsecured markets available to us; and from HRP's perspective, we have other alternatives in terms of raising capital rather than raising debt capital, we can sell assets, if we felt we wanted to. Or we could sell securities. The securities we own in Gov. I would point out that I would say selling the securities in Gov would probably be a second choice today, would not be our first choice, but it's clearly something that we could do to raise capital if we needed to.

Okay. And, John, I just want to clarify this. Did you say Gov would start paying you a dividend $4 million a quarter starting in 4Q?

That's correct.

Okay. And was there a dividend not paid in the third quarter?

There was no dividend.

No, they didn't pay a dividend in the third quarter, but what they did, Gov went public on June 22nd or June 20th, around there. And basically when they paid their fourth quarter dividend or their third quarter dividend, which they were paying in the fourth quarter, it's a little bit higher than the normal dividend, because it includes -- I may have gotten the dates wrong. About 20 days of dividend from the second quarter. So --

Okay.

So there was a second dividend, but it was being paid in the third quarter dividend.

Okay. And then, lastly, on the leasing expirations that you have coming up in 2010, roughly 12% of your space, have you had conversations with the tenants? What percentage of that do you think will renew versus lead to space, and kind of give us an idea of what you think the spreads will be on those as they expire.

That is a question we spend a lot of time thinking about, Mark. I would say the best way to answer that is, what is expiring in in 2010, we are currently working on today, at least a third of it today, already. The goal for the Company really going in this market environment is a hundred percent focused on renewals. I expect there to be some further occupancy declines based on same-store basis, going through 2010, into and through 2010. I do not expect the decline to be as great as what we experienced this quarter, the 110 basis point in one quarter, quarter over -- trailing quarter next to quarter. I do expect that to moderate. But -- and that's just where I think -- that's the market we're in, and in terms of the rental rates, look, it's clearly a tenant's market, in almost every market in the country. The only two areas where we're going to see some roll-ups is in Hawaii and possibly into the Washington, DC area with some of our expirations. I think basically everywhere else, likely to see roll-downs.

Okay. Thanks.

Yes.

(Operator Instructions) We'll take our next question from John Guinee of Stifel Nicolaus.

Hi. John Guinee here. Excellent presentation. Thank you. A couple comments. At what -- at what point do you access the equity markets again?

Sure. We have no current plans to access the equity markets from where we sit today. I think the multiple we trade at would still be a fairly dilutive transaction for us, a very diluted equity offering for us, and frankly, just a very high cost of capital. I think we would think about alternative sources of funding, either through asset sales, debt offering of some sort or another, or possibly selling securities in Gov and from where I sit today. So, I'm sure at some point, HRP is going to do another equity offering, but it's not on the near-term horizon.

Okay. The second comment, I guess, for John Popeo. Is anybody else sort of ignoring [narrate's's] definition of FFO and adding back acquisition costs as opposed to continuing to deduct those?

That's a good question. Unfortunately, I'm not sure there's a whole lot of precedent out there. First of all, HRP is probably more active in acquisitions, since the new accounting pronouncement went into effect in January 2009. I just don't know. You may know better than me, John.

It just makes it complicated. I guess third question is that, you've got 8 million square feet of vacant space, and a lot of your peers are taking this opportunity despite the fact that the market is very, very thin, to sell the permanently impaired assets, the ones that you can just let someone else take the lease up risk. Are you ever considering just dumping some of the bottom quartile assets?

Today, I don't think that's something we're considering today. We're pretty active in the acquisition and in the marketplace. We have a pretty good sense of what people are willing to pay, and I just think that, one, you're not going to find a lot of buyers willing to take on that risk, and if you do, you really are giving the property away. So it just doesn't -- it's not something we're currently considering.

Great. Thank you.

Yes.

We'll take our next question from Nick Pirsos of MacQuarie.

Good afternoon. A couple questions. First, I think you characterized the nature of the sellers that have been selling more of their better properties rather than distressed properties. I guess they're still able to get the best properties at a north of 10 cap rate. I just want to make sure I'm understanding that correctly.

Yes, that's correct.

And do these properties require any rehab going in?

No, these are not -- there's nothing I'm trying to hide the ball here, there's no cap -- receiving any CapEx. These a really quite -- the buildings really this year in Denver, the 17th Street Plaza, the building in northern New Jersey that is in Hoboken, the two buildings we just bought in Washington, DC , which are leased to Georgetown University. These buildings have either been recently constructed or recently, extensively rehabbed by the prior owner and have long-term leases in place. There's nothing unusual here. It's really -- everyone talks about being able to take advantage of opportunities. But from the distressed sellers, and this is really what this is. This is taking advantage of opportunities.

Some of our competitors won't feel comfortable jumping into this, because we're buying things at 10% current cap rate; and based on where it is today I can't constantly model out 30% returns over a 5 or 10 year return on those properties, but I have different return hurdles than, let's say, a lot of money on the side lines. So maybe there is. A lot of people talked about fund that had been raised, but they're still looking to try to get a 30% return, and that's not very -- and then there's not a lot of debt capital out there, and if it does exist, they're not going give you a high loan to value ratio. So we're just -- we see this as a unique opportunity to buy some great assets at great

Great. Just two further clarifications. The commentary around expectant occupancy trends for the upcoming quarters. Is that really for the existing portfolio, and to the extent you remain active as an acquirer, presumably you're buying at higher occupancy levels going in, so there should be some offset to that. I just want to make sure I understand the colors surrounding occupancy.

Yes, Nick, absolutely. What we were commenting on is on the existing portfolio about the declines. You're right. The buildings we are buying and as we continue to be active as an acquirer, they will likely be very highly occupied buildings, and that will have an offsetting effect on our occupancy numbers going forward. So that's correct.

And just lastly, on your comment with regard to the dividends, I think you said something to the effect that, in the third quarter, there was no payment, but there was 20 days worth of dividend, but the implication there being that dividends accrue much like a bond, but dividends typically declare so you don't need to own it for the entire period? You have it on the day, you get the whole thing? So I guess I was confused by the commentary on the dividends.

We were talking about dividends in Gov. Not our dividends.

Right. I understand that, but I think you said there was no payment made in third quarter, but the fourth quarter might be larger because of an additional 20 some days in the third quarter that would go into fourth quarter to make it a larger amount. I guess that's what I was confused about.

Yes. To be perfectly clear, Gov went public -- I guess it was the 8th or 9th of June. I said the date wrong before. It wasn't the 22nd. It was the about the 8th or 9th of June. We did not declare a second quarter dividend -- or they did not declare a second quarter dividend for Gov. Instead when they declared a third quarter dividend, that was for $0.50 a share. Included in that dividend was $0.40, which was the regular quarterly dividend for the third quarter, plus $0.10, which was the pro rata portion of that 22 days in the second that was paid out as part of that give depend. Is that clearer?

Yes, I understand now. Thank you.

We'll take our next question from Jamie Feldman from Banc of America, Merrill Lynch.

Hi. This is [Yana Galen] for Jamie Feldman. Good afternoon.

Good afternoon.

I was just curious, could you give a little more color on your Boston market commentary and kind of why you expect it to be a little weaker than the other markets you're in?

Okay. First of all, the majority of our Boston properties are in the suburbs. We do have a handful of properties in the CBD as well as in the Longwood medical area. Those properties are performing just fine. But again, the majority are in suburbs, including Foxborough and Mansfield, and those are just difficult markets right now. We lost tenants that were occupying around 300,000 square feet at the beginning of 2008. About a quarter ago, we thought we were -- we were actually very pleased with some activity for potential tenants, but those tenant prospects have basically disappeared right now. It's just a difficult market. The buildings are fine. They're in some cases, class A buildings, but in class B and C markets.

Okay. Great. Thank you.

We'll take our next question from Edward Okine of Basso Capital.

When you take your November dividend -- that will be almost a year since you -- you were that dividend. I'm just trying to find out if there's any thought about what to do about the dividend going forward?

Well, -- The current dividend rate is $0.12 per quarter or $0.48 per year. As we mentioned, in January 2009, we had announced a dividend cut from the prior $0.84 per year, down to about $0.48. That saves the company around $80 million in free cash flow. Our dividends are paid on a quarterly basis. The board -- the full board reviews and approves the dividend level on a quarterly basis; and as of right now, I don't believe there is any intention of reducing the dividends. But again, it's something that is reviewed every quarter.

Okay -- so no intention of reducing it, what about increasing it?

That's the goal of this Company, is to increase cash flow and ultimately increase the dividend rate, but at this point in time, it's probably not prudent.

Yes. I think it would be difficult to justify a dividend increase in the current office market environment that we're currently going through.

Okay. Thank you.

That concludes the question-and-answer session today. At this time, Mr Portnoy, I will turn the conference back over to you for any additional or closing remarks.

Thank you, everyone for joining us on our Q3 conference call. John Portnoy and others here are looking forward to seeing some you at the upcoming Narrate conference in Arizona. Thank you.

That concludes today's conference call. Thank you for your participation.