Equity Commonwealth (EQC) 2010 Q2 法說會逐字稿

Good day and welcome to the CommonWealth REIT Q2 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 Vice President of Investor Relations, Mr. Tim Bonang. Please go ahead.

Thank you and good afternoon. Joining me on today's call are Adam Portnoy, Managing Trustee and John Popeo, Chief Financial Officer. The agenda for today's call include a presentation by management followed by a question-and-answer session. I would note that the recording and retransmission of today's conference call is strictly prohibited without prior written consent of CommonWealth REIT. Before we begin the 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 CommonWealth REIT's present beliefs and expectations as of today August 4th, 2010. The Company undertakes no obligation to revise or release the results of any revisions to the forward-looking statements made in today's conference call other than to filings with the Securities and Exchanges Commission, or the SEC regarding this reporting period.

In addition, this call may contain non-GAAP numbers including funds from operations or FFO and cash available for distribution or CAD. A reconciliation of FFO in CAD to net income is available on our supplemental package found in the investor relations section of the Company's web site. 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 10Q, which we expect to file shortly with the SEC, and in our Q2 supplemental operating and financial data found at our website at www.cwhreit.com. Investors are cautioned not to place undue reliance upon any forward-looking statements. Now I would like to turn the call over to Adam Portnoy.

Thank you, Tim. Good afternoon, thank you for joining us on today's call. Since our last quarterly conference call we initiated several changes at the Company.

First in June 2010, we announced the name change from HRPT Properties Trust to CommonWealth REIT. On July 1st, our shares began trading on the New York Stock Exchange under a new symbol, TWH. We adopted the new name in an effort to avoid any lingering confusion that the Company maybe a health care focused REIT. As many of you may know, we are a nationwide office and industrial REIT and we operate in over 60 markets in 34 states and Washington DC. As of June 30th, 2010, 41% of our property NOI, came from suburban office properties, 36% came from CBD office properties and 23% came from industrial and other property investments. Also affective July 1st, we implemented a one for four reverse stock split. An effort to reduce transaction costs for shareholders who paid brokerage commissions on a per share base. At the same time we announced these changes, we increased our dividend by 4% to $0.50 per share quarterly or $2 per share annually.

Turning to the operating results for the second quarter of 2010, we are reporting fully diluted FFO of $0.92 per share, compared to a $1.11 per share during the same period last year. The decline in FFO per share primarily reflects the issuance of 8.6 million new common shares in March of 2010. As some of you may have noticed, we also changed some of our disclosures in the supplemental operating financial data. In addition to reformatting much of the disclosure to focus on suburban office, CBD office and industrial and other properties, we also added the calculation of cash available for distribution or CAD. CAD was $0.75 per share for the three months ended June 30th, 2010. And the CAD dividend payout ratio was a strong 64%. On annualized basis, we generated about $69 million of CAD in excess of common share distributions in the second quarter.

During the last couple of years we have also taken advantage of the distressed market environment to upgrade our portfolio first class property acquisitions at great valuations. Since April 1st we acquired eight properties and entered agreements to purchase 11 additional properties for an aggregate purchase price of approximately $360 million. In April 2010, we acquired a class A office property located in Denver Colorado for 248,000 square feet. This property is a recently constructed build to suit for Remax Reality as it's corporate headquarters. Purchase price $75 million and the going in cap rate was 10.5%.

Also in April 2010, we acquired in office property located in Colorado Springs, Colorado with 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 the going in cap rate was 11.6%. In June 2010, we acquired two office properties located in Carson, California with a combined 212,000 square feet. These properties are 100% leased to Northland Groman for approximately six years. The purchase price was $27.9 million and the going in cap rate was 9.6%. Also in June 2010, we acquired two office properties located in Ann Harbor, Michigan with a combined 410,000 square feet. These properties are 88% leased to 16 tenants for weighted average lease term of 7.6 years. Purchase price $65.2 million, and the going in cap rate was 9.4%. In July 2010, we acquired two office properties located in Stafford, Virginia with 118,000 square feet. These properties are 90% leased to ten tenants for a weighted average lease term of approximately 2.8 years. Purchase price was $18.8 million and the going in cap rate 10.9%.

As we discussed on our last earnings call, in May we announced an agreement to acquire Mc Carthur Cook Industrial property fund, an Australian listed property trust that trades on the Australian securities exchange under the symbol MIF. If we are successful in closing this transaction, MIF would become a wholly owned subsidiary of CommonWealth, that would initially own ten industrial properties with approximately 1.4 million square feet, which are 90% leased to 16 tenants for a weighted average lease term of five years. Total consideration for this acquisition based on recent exchange rates is estimated to be approximately $80.6 million. We expect that this acquisition may close by the end of 2010. However this acquisition is conditioned upon approval of MIF unit holders and other conditions as a result this acquisition may not close. As previously disclosed in June 2010, we entered agreements with government properties income trust, to sell 15 properties majority leased to the US government with approximately 1.9 million square feet, with an aggregate sale price of $231 million.

In June and July 2010, we sold eight of these properties with approximately 248,000 square feet, for an aggregate sales price of $88.7 million and recognized gains of approximately $15 million. The remaining seven properties was 1.1 million square feet a subject to purchase and sale agreements for aggregate sale price of $142.3 million. The seven remaining sales are expected to close prior to March 31st, 2011, and are subject to various contractual contingencies typical of large commercial property transactions. Accordingly, we can provide no assurance that we will sell these properties.

At the end of the quarter, our occupancy rate was 86% compared to 86.6% at the end of the first quarter of 2010. During the quarter we had 1.7 million square feet expire and we signed leases for 1.3 million square feet. 77% of our second quarter leasing activities were renewals and 23% were new leases. Leasing activity this quarter resulted in a 6% roll down in rents and $9.99 per square foot in capital commitments. The average lease term was 5.4 years and the average capital commitment per lease year was $1.85.

Generally speaking the high unemployment rate and weak leasing marketing conditions in the US has led to decrease in occupancy and affective rents in our properties since the beginning of 2010. As a result of these dynamics year-over-year same store consolidated NOI for the second quarter declined by 6.4%. As mentioned before, we operate in over 60 markets, in 34 states in Washington DC. And only five markets individually represent more than 5% of total property NOI.

Also this quarter you may have noted that the number of major markets increased from four to five with the addition of Denver, Colorado. These five markets in total represent 41% of total property NOI in the second quarter of 2010. Philadelphia, Pennsylvania and Oahu, Hawaii represent the largest two market areas with about one-third of total CBD office property coming from Philadelphia and about one-half of total industrial property NOI coming from Oahu. Generally our CBD office properties are performing better than our suburbans office properties and our Oahu industrial properties are performing better than our industrial properties located in other markets. Some of our strongest markets are Philadelphia, Pennsylvania, Oahu, Hawaii, Washington DC, Denver, Colorado and Austin Texas.

We have 4.8 million square feet scheduled to expire during the remainder of 2010, which represents approximately 7.7% of our total annualized rents. The majority of leases scheduled to expire through the end of 2010, have in place rents slightly above current market rents. We expect that our occupancy rate may moderately decline further for the next couple of quarters or until the economy begins to show sustainable growth and employers start hiring again. It is our hope that occupancy will stabilize by end of 2010 and that it may begin to improve in 2011.

In summary although CommonWealth REIT is facing a difficult leasing environment, we are taking advantage of the current market to make acquisitions with high grade properties in once in a generation attractive pricing. I will now turn the call over to John Popeo, our Chief Financial Officer.

Thank you Adam. Looking first to income statement, rental income increased by 0.6% and operating expenses increased by 2 8%. The year-over-year quarterly change in rental income and operating expenses reflects $7.4 million decline in same store NOI, the 29 properties transferred to gov in June 2009 and the three properties sold to gov in June 2010, offset by increases in NOI from properties acquired since March 2009. The 5.1% increase in general administrative expenses reflects property acquisition and sale activities and additional legal fees and expenses including fees related to litigation in Hawaii. Cost incurred to acquire properties increased from $489,000 during the second quarter of 2009, to $1.1 million during the second quarter of 2010. Current quarter EBITDA declined by 2%, reflecting the decline in current quarter same store NOI property sales and transfer of properties to gov in June 2009 off set by property acquisitions.

Interest expense increased by 5%, 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 1.4%, during the second quarter of 2009, to less than 1% during the second quarter of 2010. And repurchase and retirement of $117 million of our debt early in 2009. We recognize gains totaling $13.2 million on early extinguishment of some of this debt during the second quarter of 2009.

The $21.5 million loss on asset impairment recorded during the quarter reflects the write down to estimated fair value of four of the 15 office properties that are currently under contract for sale to gov. Impairment losses were partially offset by $11.5 million of gains recognized from the sale of three office properties to gov in June 2010, excluding $5.3 million of gains we're required to defer under GAAP that are attributable to 31.8% ownership interest in gov. Properties sold or held for sale to gov are not considered discontinued operations under GAAP because of our retained equity interest in this former subsidiary.

Since this IPO in June of 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 and FFO of gov in our financial statement. Our percentage share of gov net income and FFO for the second quarter totaled $2.3 million, and $4.5 million respectively. We received close to $4 million in gov dividends during the second quarter of 2010.

The decrease in gain on sale and income from discontinued operations reflects the sale of two properties that sold during 2009 for $50.5 million. Net loss available for common shareholders for the second quarter of 2010 was $2.7 million, compared to net income of $46.9 million, for the second quarter of 2009. The decrease primarily reflects the loss on asset impairment in 2010.

Diluted FFO available for common shareholders was $0.92 per share for the second quarter of 2010, compared to $1.11 per share for the second quarter of 2009. Year-over-year results primarily reflect the issuance of 8.6 million new common shares in March 2010, the decline in same store NOI and the decline in earnings from properties sold or transferred to gov offset by properties acquired during 2009 and 2010. In July 2010, we declared a dividend of $0.50 per share, represents 54% of our second quarter FFO and 67% second quarter CAD. The dividend will be paid later in August of 2010.

During the quarter we spent $11.9 million on tenant improvements and leasing costs and $943,000 or $0.01 per square feet, for recurring building improvements including light safety, restroom, lobby and mechanical upgrades and other capital projects throughout the portfolio. We paid $7.4 million on development and redevelopment activities during the quarter.

Turning to the balance sheet, on June 30th, we held $33 million of unrestricted cash. Rents receivable includes approximately $165 million of accumulated straight line rent accruals as of June 30th. Other assets include approximately $91 million of capitalized leasing and financing costs.

The decline in real estate properties reflects the sale in June of three of the 15 properties we recently agreed to sell to gov and reclassification to held for sale of net book value of remaining 12 properties. This decline in real estate properties was partially offset by approximately $179 million, properties acquired during the first half of 2010. On June 30th, we had $168 million of floating rate debt, $626 million of mortgage debt, and $2.1 billion of fixed rate senior unsecured notes outstanding. Weighted average contractual interest rate on all debt was under 6% at the end of the quarter, and weighted average maturity was over five years.

In August 2010, we repaid $30 million of 8.875% senior unsecured notes when they matured. In August we also paid off $267 million of CMBS debt in place since 2001, with affective interest rate of approximately 7.5%. We funded these payments with borrowing under our revolving credit facility. We expect to use cash on hand, drawings on credit facility, proceeds from asset sales and proceeds from new debt for equity offerings to repay debt maturing later in 2010 and into 2011.

Our senior unsecured notes are rated BAA2 by Moodies and BBB by Standard and Poors. The undepreciated book value of our unencumbered property pool totaled about $5.6 million at the end of the quarter. The secured debt represents 10% of total assets and floating rate debt represents 6% of total debt. At the end of the second quarter, our ratio of debt to book capitalization was 48%.

Our EBITDA and fixed charged coverage ratios was 2.6 times and 2.0 times respectively. As of the end of the Q2, we were comfortably within the requirements of our public debt and revolver covenants. As of June 30th, we had nothing outstanding on existing $750 million unsecured revolving credit facility. This facility is provided by a diverse group of participating banks and it matures on August 22nd, 2010.

We are currently in negotiations with lenders for a new unsecured revolving credit facility, prior to the August 22nd maturity date of our existing facility. If we do not enter a new facility by August 22, we intend to exercise our option to extend the maturity date of our existing facility for one year to August 22nd, 2011. As of today, we have $300 million outstanding and $450 million available under our revolving credit facility.

In summary, this quarter produced results we expected in light of a challenging market environment. Our strong balance sheet, solid dividend payout ratio and $450 million of availability on our revolving credit facility positions us to opportunistically grow cash flow. That concludes our prepared remarks. Operator, we are now ready to take questions.

(Operator Instructions) We will take our first question from John Guinee with Stifel Nicolaus.

Just a couple of quick ones, John, any of your preferred equity available to be paid off or do you still have call protection there?

Actually, John, we have seven million shares of series B preferred shares that are callable and they are currently carrying a coupon rate of 8.75%.

Any reason why you guys haven't called that yet?

It's something we are looking at in our over all capital finance planning. It has the high on the radar screen because it does have that high coupon. We are just weighing a number of different alternatives right now.

Okay. Then the Australian deal I guess sounds kind of interesting. One of your peers is doing a little bit bigger one. It's about $3.4 billion. But why bother investing $80 million on the other side of the world?

Sure, John, this is Adam. We announced the deal last quarter. Fortunately, it hasn't closed yet. As we talked about on the last quarterly call, the primary reason is not just to do $80 million. We believe that we are setting up a platform. And this will be the first of what we hope to be more investments in that region. For many of the same reasons we described on our call last quarter I think Brookfield also mentioned in their announcement of the transaction, which is that Australia really is a derivative on what is going on in Asia on the growth in the Asian markets. That's primary reason we are interested in that market. I agree with you if it's only $80 million, if that's all we end up doing, it would be a, that doesn't make a lot of sense. Our hope is to grow the portfolio.

Then last, a number of your peers are just biting the bullet and selling or even depolishing old tired functionally challenged or obsolete assets. By that I mean selling largely vacant industrial at $10 and $15 a foot, selling largely vacant office at 20 or $30 a foot, knocking down some tired flex buildings. And we haven't seen you guys do that yet. Any of that on your radar screen?

It is something we are considering, John. We know that other people have been doing it. We are also looking at it seriously as well.

Okay. Thank you.

(Operators Instructions) We will take our next question from Michael Bilerman with Citi.

Hi guys. It's David Shamas here with Michael. Looking at your suburban office leasing, it went from 86.4% last quarter to under 80% this quarter. I was just wondering what drove that. Was that something that you expected? How much of that was due to the acquisitions and dispositions to gov?

It had a little bit to do with the dispositions to gov. But more largely in line with what we expected to happen. Obviously our occupancy rate especially occupancy rate in the suburban markets has been disappointing.

I can tell you that leasing activity or at least velocity, meaning showings and so forth have picked up in the last couple of months. And it does feel like there is a little bit more activity in the market today than there was maybe in the middle of the second quarter. We are obviously disappointed with the occupancy results for our suburban portfolio. And I think we are still hopeful we are not going to see much more drop in occupancy. I think we will probably will see some more drop in occupancy through the end of the year. But as stated on the last call, we hope it's not going to go below 85% through the end of the year. And our hope is that if we can get into 2011, things will start to pick up.

Okay. Then the cap rate you guys quote on your acquisition. It's around 10%. It looks like that's on a GAAP basis. What's the cash cap rate?

Anywhere from 50 to 100 basis points inside there. Depends on the deal. But generally 50 to 100 basis points.

Alright. Thank, guys.

Yes.

At this time there are no other questions in queue. I will turn it back to Adam Portnoy for any closing remarks.

Thank you all for joining us on our Q2 conference call. We look forward to updating you on our third quarter call in early November. Thank you.

That concludes today's conference call. We appreciate your participation.