Equity Commonwealth (EQC) 2009 Q4 法說會逐字稿

Good day and welcome to the HRPT Properties Trust fourth 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. Please go ahead, sir.

Thank you, David. 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. I would also note that the recording and retransmission of today's conference call is strictly prohibited without the prior written consent of HRP. 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 HRP's present beliefs and expectations as of today, February 23, 2010. 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 & 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, CAD or FAD, are available in our supplemental package filed 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 10k, which will be filed later today with the SEC, and in our Q4 supplemental operating and financial data package found on our website at www.hrpreit.com. Investors are cautioned to not 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 thank you for joining us on today's call. For the fourth quarter of 2009 we are reporting fully diluted FFO of $0.27 per share compared to $0.27 per share during the same period last year. For the entire year we had 6.6 million square feet expire and we signed leases for 4.7 million square feet. And 68% of this leasing activity were renewals. During the fourth quarter, we had 1.4 million square feet expire, we signed leases for 945,000 square feet. 83% of our fourth quarter leasing activity were renewals and 17% were new leases. Leasing activity this quarter resulted in a 9% rollup in rents and about $9.89 per square foot in capital commitments. The average lease term was 5.1 years and the average capital commitment per lease year was $1.94. At the end of the quarter, our occupancy rate was 87.4%, which was 60 basis points lower than that at the end of the third quarter.

Same store occupancy was 86.7% at December 31st, as a result of continued weakness mainly in our national suburban office markets. We continue to believe that the current high unemployment rate and weak leasing market conditions in the US may lead to a continued decrease in occupancy and affective rents at our properties through 2010. Although nationwide office net absorption was positive in the fourth quarter of 2009, tenants continued to be reluctant to commit to expansion space or lease new space and renewal activity continues to be challenging because existing tenants are sometimes asking to downsize their space. As a result of these dynamics, year-over-year same store consolidated NOI for the fourth quarter declined by 2.3%. We believe that our occupancy should stabilize in the second half of 2010 and may begin to improve in 2011.

In Oahu same store NOI increased by 15.6%, primarily reflecting a nonrecurring charge for environmental remediation cost incurred in the prior year. The Hawaii industrial leasing market continued to soften through the end of the year, although the vacancy rate remained below 5%. Because the rents from many of our properties were set eight to ten years ago, our in-place rents continued to be significantly lower than current market rates. With regards to our properties in Oahu, in August we commenced litigation in US Federal Court to challenge 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. In September, we filed a motion for summary judgement of our claims regarding this matter.

On December 22, 2009, the court denied all parties motions for summary judgment and invited all parties to conduct limited discovery. We conducted some discovery and recently filed a renewal motion for summary judgment. Although we expect this case may be decided in the near future, we do not know when or how this case may be decided. In Philadelphia, our same store NOI increased by 6.3%, reflecting tenant and rent credits booked in the prior year and otherwise stable performance during the 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 that we are well positioned in this market. Boston same store NOI increased 3.8% during the quarter, reflecting tenant and rent credits booked in the prior year offset by the decline 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 Washington, DC our same store NOI decreased by 8.7%, reflecting some vacancy in suburban locations and delays in re-letting recently vacated space. Despite the modest decline in same store NOI during the quarter, 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. In our other markets located throughout the country, our same store NOI during the quarter decreased by 6.9%, reflecting a 4.6% decline in same store occupancy. The largest area of occupancy decline in our other markets incurred in some of our industrial properties located outside of Oahu. We have 7.7million square feet scheduled to expire during 2010, which represents approximately 12.5% 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. We expect that our occupancy rate may moderately decline further for the next few quarters or until the economy begins to show sustainable growth and employers start hiring again. 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 in 2009 are all class A buildings in good markets that have long-term leases with high credit quality tenants. More importantly, these acquisitions are being made at record high cap rates. Since the beginning of 2009, we have purchased 11 properties for $615 million for 3.2 million square feet, which are 98.1% leased for an average of 7.4 years. The weighted average going-in cap rate for these acquisition was 10%.

Also during 2009, we sold 10 properties for $215 million for 617,000 square feet and realized gains of $79 million. Through the June IPO of our former wholly owned subsidiary, Government Properties Income Trust, we've also repaid $250 million of debt and currently own almost 10 million tradable sales of Gov. These shares have a book value of $154 million and a current market value of about $230 million. During the fourth quarter we purchased 1 class A office property with 415,000 square feet for about $165 million and one industrial property of 338,000 square feet for about $17 million. We purchased these high quality assets in the Seattle Minneapolis market areas at going-in cap rates of around 10% and these properties are 99% occupied with an average lease term of almost 12 years. As of today we have an executed agreement to buy one addition class A office building with approximately 77,000 square feet for a price of $10.8 million.

In 2008, we agreed to sell one property to a third party for $15 million. This sale contract expired and we retained the $750,000 previously paid by the buyer when it was unable to meet its obligation to close in January of 2010. A new sales contract with this buyer is currently being considered. 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 $3 billion of debts outstanding, which represent a conservative 49% of total assets. During the fourth quarter we raised $300 million of new debt and used net proceeds to reduce amounts outstanding on our revolving credit facility. We have $50 million of senior notes maturing in 2010 and $468 million of mortgage debt and unsecured floating rate notes due or prepayable in 2011.

We expect these cash on hand, drawings on our revolving credit facilities, proceeds from asset sales, or proceeds from new debt or equity offerings to repay debt maturing during 2010 and 2011. Our unsecured debt obligations have been rated investment grade for 15 years and we continue to be comfortably in compliance with all debt covenants. As of December 31st, we had $110 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. We currently pay interest at LIBOR plus 55 basis points. In our option we have the right to extend this revolver for one additional year through August 2011. We continue to monitor the bank market conditions and to date have not made a decision to either pursue a new revolving credit facility or exercise our one year extension option.

Since the beginning of 2009, we've also lowered our dividend to a sustainable level and repurchased $14 million of our common stock and over $100 million of outstanding debt at significant discounts. In summary HRP's 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 with the acquisition of high grade properties at distressed prices. I'll now turn the call over to John Popeo, our CFO.

Thank you, Adam. Looking first to the income statement. Rental income decreased by 2.3% and operating expenses decreased by 5%. The year-over-year quarterly decrease in rental income and operating expenses reflects the $2.5 million decline in same store NOI and 29 properties transferred to Gov in June, offset by increases in NOI from properties acquired between October, 2008 and December 2009. A 7% increase in general and administrative expense reflects close to $1 million in legal fees and expenses related to litigation in Hawaii. We also paid $2 million in fees and expenses related to the acquisition of properties during the quarter. Current quarter EBITDA decreased by 2.6% compared to last year, reflecting the decline in current quarter same store NOI. Interest expense decreased by 4.5%, reflecting the repurchase and retirement of $117 million of our outstanding debt and the decline in average floating interest rates from 3% during the fourth quarter of 2008 to less than 1% during the fourth 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 fourth quarter totaled $2.7 million and $4.9 million respectively. We expect to receive close to $16 million of cash dividends annually from Gov and we received close to $5 million in Gov dividends during the fourth quarter of 2009. Net loss available for common shareholders for the fourth quarter of 2009 was $22.9 million compared to net income of $50.8 million for the fourth quarter 2008. The decrease primarily reflects a $31.9 million asset impairment charge recognized during the fourth quarter related to four office and four industrial properties located in our other market segment.

Occupancy at the four office properties had deteriorated to between zero and 40% and weakening market conditions have negatively impacted prospects for lease renewals and on going negotiations for releasing vacant space. The writedown at the four industrial properties primarily results from the recent tenant bankruptcies in weak markets with no near-term releasing prospects. The year-over-year decline in net income also reflects portfolio-wide occupancy declines and a $2.5 million decline in same store NOI and $39.5 million of gains on property sales recognized in the prior year. Diluted FFO available for common shareholders was $0.27 per share for the fourth quarter of 2009 and 2008. Year-over-year results reflect a decline in same store NOI and a decline in earnings from properties sold or transferred to Gov, offset by properties acquired since October, 2008. In December 2009 we declared dividend of $0.12 per share, which represents 43% of our fourth quarter FFO. This dividend was paid in January, 2010.

During the quarter we spent $16.4 million on tenant improvements and leasing costs and $6.3 million or $0.09 per share foot for recurring building improvements, including lobby and facade renovations, elevator upgrades and other capital projects throughout the portfolio. We paid $5.4 million on development and redevelopment activities during the quarter. Turning to the balance sheet. On December 31st, we held $18 million of unrestricted cash. Rents receivable includes approximately $162 million of accumulated straightline rent accruals as of December 31st. Other asset include approximately $94 million of capitalized leasing and financing costs. On December 31st, we had $278 million of floating rate debt, $631 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 6% the end of the quarter and the weighted average maturity was almost 6 years.

In November we issued $125 million of ten year unsecured senior notes bearing interest at 7.5%. In December we closed a mortgage loan for $175 million with a ten year term secured by one of our properties located in Philadelphia. Interest on this loan is payable at a spread over LIBOR, but was fixed for the first seven years with a cash flow hedge that sets the rate at approximately 5.66%. Net proceeds from both of these financings were used to repay amounts outstanding on our revolving credit facility. We have $50 million of senior notes maturing in 2010 and $468 million of mortgage debt and unsecured floating rate notes due or prepayable in 2011. We expect to use cash on hand, drawings on our revolving credit facility, proceeds from asset sales or proceeds from new debt or equity offerings to repay debt maturing during 2010 and 2011.

Our senior unsecured notes are rated Baa2 by Moody's and BBB by Standard & Poor's. The undepreciated book value of our unencumbered property pool totaled about $5.4 billion at the end of the quarter. Our secured debt represents 10% of total assets and floating rate debt represents 9% of total debt. At the end of the fourth quarter our ratio of debt to book capitalization was 51%. Our EBITDA and fixed charge coverage ratios were 2.7 times and 2.1 times respectively. As the end of the fourth quarter we were comfortably within the requirements of our public debt and revolver covenant. As of the end of the fourth quarter we had $110 million outstanding on our revolving credit facility with $640 million of additional borrowing capacity at a current interest rate of less than 1%. As of today we have $156 million outstanding on our revolver and one property under contract to buy for $10.8 million. In summary, this quarter produced results we expected in light of a challenging market environment.

During the quarter we acquired two properties for $182 million at cap rates averaging 10% and we raised $300 million of new debt at an average coupon rate of 6.4%. Our dividend cut in January, 2009 has significantly improved our dividend payout ratio and financial flexibility and we own 9.95 million tradable Gov shares with a current market value of around $230 million. That concludes our prepared remarks. Operator, we are now ready to take questions.

(Operator Instructions) We'll go first to Jamie Feldman with Bank of America.

Thank you and good afternoon. I was hoping you guys could talk a little bit more about the acquisition pipeline, kind of what you are seeing out there, what types of assets, what types of markets and then where you think yields would be at this point.

Sure, Jamie. The acquisition pipeline, as you may gather from what we said in our prepared comments, has slowed. We only have one building for $10 million or $10.8 million under agreement now. I think there are more properties actually to review in the marketplace than there were second and third quarters of 2009. But there are also an expediential really higher number of potential buyers in the market than there were in mid 2009. So I think cap rates are actually compressing from where they were in 2009. I mean everyone knows that there was very little activity in 2009. We bought -- we were a pretty active buyer in the marketplace and we bought stuff at pretty healthy cap rates. A lot of our competitors and our peers talked about how they wanted to wait on the sidelines because they thought there would be more distress and better opportunities in 2010, 2011.

I think in four or five years when people write the history books about what happened after -- in terms of the great recession and the distressed opportunities, I think we are going to be seen very favorably as one of the few companies that actually took advantage of some of the distress in 2009. But in 2010 I think it's a different market. I think cap rates are coming -- I think it's going to be tougher to buy. We bought some fantastic buildings at 10% cap rates that I think today, just a month or two or months after we bought them, have gone up in value where the cap rates have compressed at least 100 basis points if not more on some of these properties. There is more activity than there was in 2009, but there is a lot more buyers and I think cap rates are -- I think they are compressing. I don't know if they are going back to 2006, first half of 2007 levels, but they are certainly coming in from where they were last year.

These comments apply to like A, B and C market. If you think about some of the acquisitions you've done in the past like in a market like Cleveland, for example, even in those markets you are seeing an uptick in competition.

Yes, I'd say across the board. Now there is more -- you are right in when you look at different markets, A and B markets are getting more competition, but even in the C markets there has been so much money sitting on the sidelines, investors their confidence is building. And so people are starting to put money to work. And even in those -- even in some of those tertiary markets, we are seeing more competition. In fact, I think one piece of data that is telling us, you are actually seeing properties in tertiary markets come to market, whereas in, I think, 2009 the seller wouldn't even have put something up to market that wasn't, they thought, was going to attract maybe the best pricing and the best pricing was A and B markets -- A markets and B markets. So now you are starting to see things across the board. Again, it's not a flood gate. I'm not -- by no means is there a flood gate at all. There is more, there's just more than there was in 2009, is a little bit of an uptick, but there is a lot more competitors across the board.

So given that, are you looking into maybe some of the more nontraditional real estate types.

No, I think we are still looking to try and do things. I mean if we bought things in 2009 at 10 cap rates or better, some of these buildings, maybe in 2010 it's going have to be a 9% cap rate. Those are still, for some of these assets, great cap rates. But the truth is we may not be as big a buyer in 2010 as we were in 2009. We may just sit on the sidelines more than we have in 2009. We bought $615 million of properties in 2009. That's a lot of property in a year where not a lot even came to market. We were one of the few buyers in the market. We were one of the few companies that actually had the liquidity and the discipline with our balance sheet so we could afford to take advantage of those opportunities. In 2010, we may not, we may just not buy as much.

Okay. And then can you walk us through the, both the 2010 and 2011 expiration schedules in terms of like what the biggest leases are and any risk to those leases.

Sure. 2010 we have roughly 7.7 million square feet expiring and our current projections are that occupancy will drop at least 100 to 150 basis points by the end of the year 2010. We are hopeful that market conditions will stabilize by the end of 2010 and that we'll actually begin to see stabilizing or increasing occupancy at some point in 2011. We are currently projecting around two-thirds renewals versus one-third new leases for 2010. We do expect roughly 2 million square feet of the 2010 expirations are situations where tenants will actually leave. Where we've actually gotten notice that tenants will leave. But when all is said and done, when you take into account new and renewed leasing of over 6 million square feet, the results is around 100 to 150 basis point decline in occupancy to somewhere around 86.5%, 86%.

Are those third new leases are they signed or you are just saying you think you can get those done.

No,this is all based on projections.

We think we can get them done. We think we can get them done. John is giving you sort of a guesstimate as where we sit today. I mean, if the economy gets better in the second half of 2010, obviously, things will look better. If things continue to be difficult throughout 2010 into 2011, maybe worse than what John said. There is not -- your question was are there any big specific leases. The portfolio is of a size where there is not one lease per se that's going to do it or have a meaningful impact on occupancy across the Company. It's really -- it's several smaller to mid-size leases across the country that we are focused on. So the best answer we can give you is that, as John said, as we look out today, 100 to 150 basis point maybe decline in occupancy is maybe what we will experience in 2010 based on the existing portfolio. But that sort of says if the world is exactly the way it is today, that's what it might look like, it might obviously change.

Okay. Thanks. And then finally you had mentioned some bankruptcy in the fourth quarter. What is your outlook for 2010, do you think you've pretty much worked through the potential bankruptcy risk or there is --- you still a lot that you are watching.

We think we've worked through it. The watch list has gotten actually smaller than it was six months ago. We think we've worked through the majority of it. I don't think the economy is out of the woods yet and so we, obviously, continue to watch things and monitor things closely. But it feels like all the big bankruptcies and companies going out of business that we -- that were on our watch list either have happened or they are not going to happen. But so it's getting better. The trend is getting better.

Okay, thank you.

Yes.

(Operator Instructions) We will go next to the line of John Guinee with Stifel Nicolaus.

First, Adam, your capital stack, if you look at just under $3 billion of debt and then $700 million of preferred, 223 million shares at about $7 a share, your debt plus your preferreds right at 70%. How much more will you acquire and how much will you drive up that leverage.

I think we are hitting the outer limits of our leverage and in terms of how much more leverage we feel comfortable with. I'm not saying we won't add anymore, but I think we are getting near the top. Your next follow-up question is you're probably going to ask so what are we going to do. And I think in our prepared remarks, both I and John said that we are looking at a host of things. We might -- if we, one, if we continue to buy things. We may not buy much in 2010. That might be what we end up doing because we don't like the pricing. We also could consider asset sales as well as a way to repay debt. That's something that on -- that we've done in 2008 and 2009. It's something we could consider in 2010 as well. And I'm not saying we never would do an equity deal, but at some point this Company will probably do an equity deal again, but something that's not on the short-term horizon.

Okay. This is probably a question for John. On page 11 of your supplemental, you've got non-cash straightline rent adjustment of about $6.44 million, which I'm assuming means that cash is higher than GAAP.

It is actually just the opposite, John. These are straightline rent accruals. In other words this is something we add to rental income to flatten out or straightline the rent over the lease term.

So you are saying that the difference between the cash is $6.44 million less than GAAP.

Correct. That is correct.

So the factor is not a bracket there shouldn't throw us off. Okay. So essentially the difference between -- and then I should add lease value amortization of another $1.96 million, deduct that from GAAP to get to cash.

No, that you add.

Okay, that goes the other way. Got you.

That's correct. That's correct.

Perfect. And then the last question would be is there a reason that you guys want to continue to provide an FFO number, which is not NAREIT defined.

I think, yes, I think we talked about this last quarter. I think you are referring to the new FAS 141-R rules, where I guess -- it was formally called FAS 141-R, but the requirement that we now expense acquisition related costs like transfer taxes and consulting fees and things like that. I don't know if there are many other office REITS that are acquiring properties at the rate we are, so as I mentioned last quarter, I'm not really sure how much precedent there is out there, but we just think it's in the spirit of the original white paper. We, I guess, are going to keep a close eye on the situation and I've actually had discussions with people over at Mary before we made this decision. They have actually posted some letters on their website in the past that indicate their position, which seems to be in line with the way we are doing our accounting right now. So all things considered we think it's a more appropriate presentation and more meaningful to investors.

And we break it out, John. We clearly break it out, so if you don't want to, if you want to include it, obviously, you can just add it out. We don't hide it in any way.

I degree. Last question. If I look at the Expedia lease or I look at the Bellview, Washington deal, you paid about $397 a square foot. Does this translate to a, I'm guessing, maybe a $50 gross, $38 net number on rents or what's the right --

It's not far off, it's not far off.

Any idea why the rents are that high for that building?

Well, it was a build to suit for Expedia. It's a gold lead certified building, so it's probably one of the new -- it was built in 2008. It is probably one of the newest buildings on the west coast. It's a very, very, very nice building. It's got a lot of amenities, a lot of specialty buildout and that's was built to specifications that Expedia wanted in their building in terms of the buildout and the amenities and the type of gold lead certified product is what they were looking for. And so to build a building of that caliber you have to -- it's not cheap. And that's what Expedia wanted. And so that's what they got and that's pretty much the reasons behind it. It's a fantastic building. That's a clear example of where in 2009 where we were able to buy something at a fantastic cap rate that, I mean, even after we got that -- after we got it under contract, there were people that we know of that approached the broker after we had it under contract that were interested in buying it for more than we were, had it under contract for. That's how fast the market was changing around us. So we feel like it's a great transaction.

Great. All right, thank you. Yes.

It appear there is are no further questions at this time. Mr. Portnoy, I would like to turn the conference back over to you for any additional or closing remarks.

Thank you all for joining us on our Q4 conference call. We look forward to updating you on our first quarter call in early May. Thank you.

This concludes today's conference. Thank you for your participation.