Equity Commonwealth (EQC) 2010 Q1 法說會逐字稿

Good day everyone, and welcome to the HRPT Properties Trust Fund quarter 2010 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 the Vice President of Investor Relations, Mr. Tim Bonang. Please go ahead, sir.

Thank you, and 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 a question-and-answer session. I would also note that the recording and retransmission of today's conference call is strictly prohibited without 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, May 6, 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 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 calculation AFFO, TAD 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 10-Q which we expect to file shortly with the SEC and in our Q1 supplemental 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 now 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 first quarter of 2010, we are reporting fully diluted FFO of $0.26 per share compared to $0.27 per share during the same period last year.

As many of you know, in March 2010, we issued 34.5 million common shares, raising net proceeds of approximately $240 million. We used the proceeds from this offering to repay debt and fund acquisitions. This was our first trip to the equity markets in over two years and as a reminder, we did not issue equity in early 2009 when many of our peers completed extremely dilutive equity offers.

As we discussed during our meeting with investors during the March equity offering, we believe it is currently a great time to be purchasing property at good valuations. With this in mind, at the end of the March we acquired two properties and we have entered agreements to purchase 12 additional properties for an aggregate purchase price of $192.5 million.

In April 2010, we acquired a class A office property located in Denver, Colorado with 248,000 square feet. This property is a recently constructed build to suit for ReMax Realty as its corporate headquarters. ReMax sold us the property and then entered an 18 year lease term for 100% of the property. The purchase price was $75 million, and the going in cap rate was 10.5%.

In April 2010, we also acquired an office property located in Colorado Springs, Colorado, for 77,000 square feet. This property is 100% leased to two tenants for a weighted average lease term of approximately 4.7 years. Purchase price was $10.8 million and the going in cap rate was 11.6%.

In May 2010, HRP entered a purchase and sale agreement to acquire two office properties located in Carson, California with approximately 212,000 square feet. The properties are 100% leased to Northrop Grumman for approximately six years. The contracted purchase price is $27.9 million, and we expect to close on this acquisition in the second quarter. Of course, this acquisition is subject to closing conditions and no assurance can be given that this acquisition will occur.

In May, we also announced an agreement to acquire MacarthurCook Industrial Property Fund for $79.2 million. This fund is an Australian listed property trust that trades on the Australian securities exchange under the symbol MIF. If we're successful in closing this transaction, MIF would become a wholly owned subsidiary of HRP that would initially own 10 industrial properties with approximately 1.4 million square feet.

Although the possible investment in MIF would be modest compared to our total property investments of over $6.6 billion, we believe that this investment may create a platform for additional acquisitions of Australian commercial real estate. We also believe that Australian properties and the Australian economy generally are well positioned by geography and natural resources to benefit from the economic growth in the Asia-Pacific region in the future.

We expect this acquisition may close by the end of 2010. However, this acquisition is conditioned upon approval of MIF's unit holders and other conditions and as a result, this acquisition may not close.

Moving to our operations for the quarter, we had 2 million square feet expire and we signed leases for 1.5 million square feet. 72% of our first quarter leasing activity were renewals and 28% were new leases. Leasing activity this quarter resulted in a 2% roll-up in rents and $11.27 per square foot in capital commitments. The average lease term was 6.4 years, and the average capital commitment per lease year was $1.76.

At the end of the quarter, our occupancy rate was 86.6% compared to 87.4% at the end of 2009. 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 effective rents at our properties through the end of 2010.

Tenants continue 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 first quarter declined by 3.3%.

As many of you may know, we operate in over 60 markets in 34 states and Washington, DC. And 41% of our NOI comes from suburban office properties and 37% comes from CBD office properties and 22% comes from industrial properties. Furthermore, about one-third of our CBD office property NOI comes from Philadelphia, Pennsylvania about one-half of our industrial property NOI comes from Oahu, Hawaii. Because of the size and diversity of our portfolio, our occupancy rates tend to track closely to national office occupancy rates. Nevertheless, generally speaking, our CBD office properties are performing better than our suburban office properties, and our Oahu industrial properties are performing better than our industrial properties located in other markets.

Some of our strongest markets are CBD office in Washington, DC, DBD office in Philadelphia, Pennsylvania, suburban office in Austin, Texas and industrial in Oahu, Hawaii. We have 6.2 million square feet scheduled to expire during the remainder of 2010, which represents 10.4% of our total annualized rents. The majority of 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.

It is our hope that occupancy will stabilize in the second half of 2010 and that it may begin to improve in 2011. In summary, although HRP is facing a difficult leasing environment, we are taking advantage of the current market to make acquisitions of high grade properties at good valuations.

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

Thank you, Adam. Looking first to the income statement, rental income decreased by 1.5% and operating expenses decreased by 0.2%. The year-over-year quarterly decrease in rental income and operating expenses reflects the $3.7 million decline in same store NOI and 29 properties transferred to GOV in June 2009 offset by increases in NOI from properties acquired during 2009. The 5.2% increase in general and administrative expense reflects additional legal fees and expenses related to litigation in Hawaii.

Current quarter EBITDA was flat compared to last year, reflecting the decline in current quarter same store NOI, property sales and the transfer of properties to GOV last year, offset by property acquisitions.

Interest expense increased by 6%, reflecting the issuance during the fourth quarter 2009 of $125 million of 7.5% unsecured senior notes and $175 million of mortgage loans with a current interest rate of 5.66%, offset by the decline in average floating interest rates from 1.7% during the first quarter of 2009 to less than 1% during the first quarter of 2010 and the repurchase and retirement of $117 million of our debt early in 2009. We recognized gains totaling $7.5 million on early extinguishment of some of this debt during the first quarter of 2009.

Since its IPO in June 2009, 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 in FFO of GOV in our financial statements. Our percentage share of GOV net income and FFO for the first quarter totaled $2.4 million and $4 million respectively. We received close to $4 million in GOV dividends during the first quarter of 2010.

In January 2010, GOV issued 9.8 million new common shares in a public offering for $21.50 per common share before offering costs. As a result of this transaction, our ownership interest in GOV was reduced from 46.3% to 31.8%, and we recognized a gain under the income method of accounting totaling $16.4 million. This gain represents a partial mark-to-market value adjustment under GAAP that reduces the spread between our carrying value and the price of newly issued GOV shares. The carrying value of our 9.950 million GOV shares was around $15 per share prior to GOV's recent common equity offering and $17 per share as of March 31, 2010.

The decrease in gains on sales and income from discontinued operations reflects the sale of 10 properties with 616,000 square feet that were sold during 2009 for $215 million. Net income available for common shareholders for the first quarter of 2010 was $24.6 million compared to net income of $30.4 million for the first quarter of 2009. The decrease primarily reflects properties sold or transferred to GOV during 2009 and a $3.7 million decline in same store NOI during 2010 offset by property acquisitions during 2009 and gains on the issuance of shares by GOV during 2010.

Diluted FFO available for common shareholders was $0.26 per share for the first quarter of 2010 compared to $0.27 per share for the first quarter of 2009. Year-over-year results reflect the decline in same store NOI and the decline in earnings from properties sold or transferred to GOV offset by properties acquired during 2009.

In March, we issued 34.5 million common shares in a public offering, raising net proceeds of $240 million. Proceeds of this offering were used to reduce our revolver balance to zero and to fund property acquisitions subsequent to quarter end. The increase in shares outstanding is expected to reduce quarterly FFO by around $0.03 per share beginning in the second quarter of 2010 until proceeds are reinvested into higher yielding assets.

Because of our strong financial position, we avoided the need to issue equity at highly dilutive pricing when financial markets were suffering early in 2009. Had we issued new shares back in 2009 along with other REITs, the dilutive impact on our earnings would have been at least double the impact today.

In April 2010, we declared a dividend of $0.12 per share which represents 45% of our first quarter FFO. This dividend is expected to be paid in May 2010. During the quarter, we spent $11.6 million on tenant improvements and leasing costs and $760,000 or $0.01 per square foot for recurring building improvements including life safety, restroom, lobby and mechanical upgrades and other capital projects throughout the portfolio. We paid $679,000 on development and redevelopment activities during the quarter.

Turning to the balance sheet, on March 31, we held $139 million of unrestricted cash, reflecting residual proceeds from our equity offering in March 2010. Rents receivable includes approximately $165 million of accumulated straight line rent accruals as of March 31. Other assets include approximately $94 million of capitalized leasing and financing costs.

On March 31, we had $168 million of floating rate debt, $628 million of mortgage debt and $2.1 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 over five years. We have $50 million of senior unsecured notes maturing in August and October 2010 and $460 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 and Poor's. The unappreciated 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 6% of total debt.

At the end of the first quarter, our ratio of debt to book capitalization was 48%. Our EBITDA and fixed charge coverage ratios were 2.6 times and 2.0 times respectively, and we expect some improvement to these ratios during the second quarter from our March equity offering. As of the end of the first quarter, we were comfortably within the requirements of our public debt and revolver covenants.

As of March 31 and today, we have nothing outstanding on our existing $750 million unsecured revolving credit facility. This facility is provided by a diverse group of close to 30 participating banks. It 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. We are currently discussing with some banks the possibility of entering a new revolver prior to August 2010. However, to date, we have not made a final decision whether to either pursue a revolving credit facility or exercise our one year extension option.

In summary, this quarter produced results we expected in light of a challenging market environment and in line with results reported by other national property owners. During the quarter, we raised $250 million of new equity which was used to reduce leverage and to fund the acquisition of additional fully leased and attractively priced property subsequent to quarter end.

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

Thank you. (Operator Instructions) We'll go to John Guinee of Stifel Nicholas.

Okay, thank you. John, can you again mention what -- you expected some near term dilution, and can you give the reasons for that and how much and how long?

Sure. Just by virtue of the fact that we issued 34.5 million new common shares, John, that has the effect, all things sort of steady state, based on the end of first quarter of diluting current quarter FFO by up to $0.03 per share.

The reality is though, as Adam mentioned, we acquired around $85 million of new properties at cap rates right around 10%. So that equates to roughly around 1% of improvement in FFO, so we're really looking at maybe a 2% dilution, net, after acquisitions that have already been announced.

Got you, okay. And then, Adam, where do you think you'll bottom out on occupancy? Is that another 50 bips, another 100 bips? What's your projections on that?

That's a great question, John. I think -- we think it's going to bottom out somewhere between 85% and 86%. And we believe it will probably bottom out somehow -- sometime in the second half.

And then last question, you guys have done a great job of between SNH and GOV of spinning off assets and creating -- or expanding or creating other entities. Is there -- two questions. One, other assets that can go to SNH or GOV? And then the second question would be other spinoffs in the pipeline.

Sure. The first question is yes, there are, roughly speaking $300 million or $400 million worth of assets that could be sold to SNH, and there's about $200 million or $250 million worth of properties that could be sold to GOV.

The way those agreements work, both those companies, SNH has a right of first refusal if we decide to sell them, sell the medical properties, and GOV has a right of first refusal.

It is something -- to be even more direct, it is something that, I'll be honest with you, is being discussed at the board level, and it is something that may happen. It could happen in 2010. One or both of those portfolios, we could think about selling. And if we were to sell it, we would think about maybe selling it to SNH and/or to GOV, given the rights of first refusal. Those decisions haven't been finalized, but I will tell you it is being discussed at the board level.

Great.

And then the other -- the second part of your question, is there another REIT that we could spin out? I think we were asked this by other investors in the past, and the obvious answer is given our portfolio of industrial properties, but I don't foresee us spinning out a separate REIT for industrial properties anytime soon. But it's an obvious asset -- group of assets that exist within HRP that we could consider doing it if we wanted to in the future.

The other thing that I -- I don't think we should be shy about talking about is the acquisition in Australia that we announced earlier this week. We made that -- we didn't make an $80 million -- we're not hoping to make an $80 million investment in Australia just to be an $80 million investment.

We're hopeful that we've set up -- we've established -- we're going to be establishing a platform there, and we hope that we'll be able to grow and make other acquisitions in that market. If we're successful in growing in the -- in Australia, there's a possibility -- we'll see what the world looks like in the future, but that may be a natural outgrowth or spinoff some day of properties separate from what we have at HRP currently.

Just to talk a little bit more about the investment in Australia. A lot of companies have raised money in Australia, invested in the US. But I think we're the first REIT to take public institutional money, invest in institutional real estate in Australia, to go that way. And the reason we did it was, yes, we thought -- we think there's a lot of opportunities in Australia directly, but we've been looking at generally Asia-Pacific and the growth that's occurring over there for some time and trying to figure out a way to tap into that growth.

And we've looked at thought about making investments in China. We've looked at thought about making investments in other parts of Asia to tap into that growth but it's obviously very difficult to invest in those markets with institutional money. But it is possible to invest with institutional money in a country like Australia. It's a first world country, it has a mature legal system, it has a mature REIT market, and it gets the indirect benefit of being associated -- being very close to Asia and basically, it's an export-driven economy that's feeding the growth of Asia.

Australia, what they do is they export food materials and they export minerals, which is all being used to fuel the growth in China and India and other parts of Asia. So I know that wasn't exactly what you asked about, but I felt it sort of led to that discussion about what we're doing in Australia.

Good insight. Thank you.

Yes.

(Operator Instructions) We'll go to [Michael Arian] of Sun Life Financial.

Hey, guys. Sorry, I missed the first part of your call, so my question might be a tad repetitive. But in terms of the recent acquisition in Australia, can you just discuss how you're going to manage those assets? Is it going to happen there or is RMR going to manage it? I would imagine there would be some challenges to that, given that it's not in US.

I guess you have -- obviously you have Hawaiian assets that you've managed. You can make an argument that from a distance standpoint, it's kind of the same thing. But if you could touch upon that a little bit.

And then piggybacking on John Guinee's question about the spinoffs, I want to give you something from a debt perspective. Do you find that number of spinoffs that you've been doing at all endangers your perception from the ratings agencies as being -- trying to be sort of a bread and butter REIT.

And maybe you're not trying to be one, but I think as has been discussed before, your business model is a little bit atypical from what you'd see in a normal office industrial REIT, and I just wanted to see -- I'm assuming you guys talk about these things before you do them, but if there's ever any risk of there being a concern among the agencies as to what you guys are doing.

Sure, let me talk first -- I'll take both those questions. First, talking about how we're managing the assets in Australia. It's a very good question.

We would never do this without having a partner in Australia that could help us manage it. We're going to be jointing managing the assets with a company called -- it's called MacarthurCook. It's a wholly owned subsidiary of a group called AIMS Financial Group. It's a private company in Australia.

AIMS Financial manages a portfolio of three different publicly traded companies -- publicly traded REITs in Australia and Singapore, as well as manages unlisted real estate funds, as well as manages security funds. They currently are the outside advisor, the manager for this REIT and after we acquired the company, they will -- we're going to enter into a joint management arrangement where they'll continue to manage the properties for us.

Now that being said, we plan on sending some personnel from our home office here to Australia. But -- to help assist in managing that, but they currently manage about $1.5 billion worth of real estate and real estate and securities in specifically Asia -- specifically Australia, but as well as Singapore. And so we feel pretty good about their ability to continue to manage it.

And we're hopeful that we can grow the portfolio and as we grow it, we would intend to do it on this partnership basis where we would be jointly managing. We would be managing it and they would also be assisting us in managing the properties on the ground.

With regard to your second question, with regard to the rating agencies, is there risk in doing spinoffs? I suppose there are risks involved, but I'll be honest. It's not something that has been a particularly big issue for the rating agencies. I think they are fair -- they're very comfortable with what we did.

For example, last year, about a year ago when we spun off GOV, or Government Properties Income Trust. I think they were actually very supportive of the transaction, thought it added -- it was a great way to add liquidity for the Company in an otherwise illiquid market. And so I think on balance, they like the transaction.

So to be perfectly honest, I don't see spinoffs as we have done to date being particularly worrisome for the rating agency.

Okay. Well, I hope you're right. I hope you're right.

Well, I can just tell you in our conversations -- just it's not a topic that generally comes up doesn't mean we talked about it, but it's not something that they have particularly focused on.

Right.

But we do discuss it with them and when we -- of course, when we spun off GOV, we spent a lot of time discussing with the rating agencies and they had a lot of questions. And I think maybe their first inclination -- they had a lot of questions and were nervous about it. But then once we explained the benefits to HRP by doing it, I think they tended to generally agree with our conclusions. Maybe not on every point, but they generally agreed with us.

Right, yes. Well yes, seems like you've done a pretty good job from an equity perspective, you know what I mean? Just something that sort of came to mind, and I just don't see a lot of other REITs doing that. So, but no, that's fair. Thank you so much.

You're welcome.

At this time, I'll turn the conference back to Mr. Adam Portnoy for any additional remarks.

Thank you all for joining us on our first quarter conference call. We look forward to updating you on our second quarter call in early August, and we look forward to seeing some of you at the NAREIT conference at Chicago in June. Thank you.