Equity Commonwealth (EQC) 2011 Q1 法說會逐字稿

Ladies and gentlemen, good morning, thank you for standing by and welcome to the Commonwealth REIT first quarter 2011 financial results conference call. At this time all lines are in a listen-only mode. Later there will be an opportunity for your questions and instructions will be given at that time. (Operator Instructions) As a reminder this conference is being recorded. I would now like to turn the conference over to our host, 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, President and 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 CommonWealth.

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 CommonWealth's present beliefs and expectations as of today May 6, 2011. The Company undertakes no obligation to revise or publicly release the results of any revisions in 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, and cash available for distribution or CAD. A reconciliation of FFO and CAD to net income is available in our supplemental package found in the Investor Relations section of the Company's website. Actual results may differ materially from those projected in 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 package found on our website at www.cwhreit.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 and thank you for joining us on today's call. For the first quarter of 2011 we are reporting fully diluted FFO of $0.85 per share compared to $1.03 per share during the same period last year. The decline in FFO per share reflects decline in occupancy and the repayment of debt to the issuance of common equity in 2010. FFO for the first quarter of 2011 includes about $0.03 per share of non-recurring environmental charges and higher than normal expenses related to utilities and snow removal.

As of March 31, our occupancy rate was 87.5% which is 20 basis points lower than the 87.7% we reported at the end of last quarter. During the quarter we signed leases for almost 1.5 million square feet. 53% of our first quarter leasing activity were renewals and 47% were new leases. Leasing activity this quarter resulted in an 8% roll up in rents and $10.71 per square foot in capital commitments. The average lease term was 6 years and the average capital commitment for lease year was $1.79.

Capital commitments per square foot this quarter were modestly higher than the recent historical averages because of the higher percentage of new leases versus renewals in the second quarter. As a result of the current market conditions year-over-year same-store consolidated NOI for the first quarter declined by 7.8%. Generally speaking, our CBD office portfolio is performing better than the Company average and our better performing market areas are Philadelphia, Oahu, Hawaii, Washington DC, Denver and Australia. As many of you may know, we operate in over 60 markets in 31 states, Washington DC and Australia.

Because of the size and diversity of our portfolio, our leasing results tend to track closely to market but we also have good visibility into what is happening on the ground across a large amount of the country. Generally speaking, leasing market conditions have remained stable since the beginning of the year in about 50% of our markets. About 25% of our markets are starting to see improvements in leasing terms and about 25% of our markets are still experiencing weakening conditions.

As of March 31, we had 4.3 million square feet scheduled to expire during the remainder of 2011. On average, the leases scheduled to expire through year end have in-place rents that are around 1% above market. As a result we expect that same-store NOI may decline further until the economy begins to show sustainable improvement and job growth increases significantly for an extended period.

Since January 1, we have acquired 10 properties with approximately 2 million square feet for a combined total purchase price of approximately $350 million, and the weighted average going in cap rate for these acquisitions was 9.2%. These properties were on average 95.7% leased for 10.8 years at closing. We also currently have 11 properties with about 3.1 million square feet under agreement to a purchase for a combined total purchase price of approximately $624 million, which includes the assumption of approximately $322 million of mortgage debt.

One group of properties under agreement to purchase for approximately $25.7 million involves four office properties in Stafford, Virginia with a combined 149,000 square feet. These properties have been under agreement since November of 2010 and the closing has been delayed because of issues concerning the assumption of a $15.3 million mortgage loan. Nevertheless we expect to finally close on this acquisition in the second quarter.

As of today we also have four properties located in Folsom, California with about 269,000 square feet under agreement to purchase for approximately $46.3 million, which includes the assumption of approximately $41.3 million of mortgage debt. These properties are 92% leased to 10 tenants for a weighted average lease term of 3.6 years. We expect to acquire these properties during the second quarter.

The remaining three properties we have under agreements to acquire involves CBD office properties with a combined 2.7 million square feet located in downtown Chicago, Illinois. One of these downtown Chicago properties includes about 1.1 million square feet and is under agreement to purchase for approximately $162 million. This property is 85% leased to 60 tenants for a weighted average lease term of 6.6 years. We expect to acquire this property during the second quarter.

The other two properties located in downtown Chicago includes about 1.6 million square feet and they are under agreement to purchase for $390 million. This purchase price includes the assumption of $265 million of mortgage debt. These properties are 97% leased to 49 tenants for a weighted average lease term of 8.4 years. We expect to acquire these properties during the second or third quarter.

All of these pending acquisitions are subject to customer and closing conditions and no assurance can be given that they will occur. However, if we are successful in acquiring the three CBD office properties located in downtown Chicago, this market is likely to become a major market area for us because we already own nine properties with about 1.5 million square feet in the Metropolitan Chicago market area.

Since the beginning of the year, we have also sold seven properties with about 6 -- with about 800,000 square feet for a combined total sale price of approximately $98 million and recognized gains of approximately $35 million. We currently have 27 non-core office and industrial properties listed for sale with third-party brokers. All of these properties are older, suburban properties located in tertiary markets with high vacancy rates. We expect to complete the sale of these properties by the end of 2011.

In summary, Commonwealth REIT continues to work towards repositioning and improving its portfolio to the sale of non-core suburban properties and investing in high-quality CBD office properties. The pending acquisitions in downtown Chicago are a good example of this business plan. Also, CommonWealth is currently well-positioned to increase same-store cash flow as the economy improves because we have the financial resources to increase occupancy with a current dividend rate that is well-covered by existing funds from operations and cash available for distribution.

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

Thank you, Adam. Looking first to the income statement, rental income and operating expenses increased by 10% and 11% respectively. The year-over-year quarterly change in rental income and operating expenses reflects increases in NOI from properties acquired since January 2010, offset by the $8.5 million decline in same-store NOI and 15 properties sold between June and September 2010.

The 18% increase in general and administrative expense reflects property acquisitions and sales activities, and additional legal fees and expenses related to our investments in Australia. Current quarter EBITDA decreased by less than 1%. Interest expense increased by 6%, reflecting the issuance of $250 million of 5.875% unsecured senior notes in September 2010, and a 5-year term loan for $400 million entered in December 2010 carrying interest at LIBOR plus 200 basis points. These financing activities were offset by the prepayment of $266.7 million of mortgage debt in August 2010, the repayment of $50 million of senior notes in August and October 2010, and the repayment of $168 million of floating rate notes in March 2011.

We recognized $34.6 million of gains from the sale of seven properties during the quarter. We recognized $3 million of accelerated depreciation expense at one property in Atlanta, Georgia that we expect to take out of service and raze during 2011.

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 and FFO of GOV in our financial statements. Our percentage share of GOV net income and FFO for the first quarter totaled $2.7 million and $4.8 million respectively. We received over $4 million in GOV dividends during the first quarter of 2011.

Net income available for common shareholders for the first quarter of 2011 was $37.8 million compared to net income of $24.6 million for the first quarter of 2010. Diluted FFO available for common shareholders was $0.85 per share for the first quarter of 2011 compared to $1.03 per share for the first quarter of 2010. Year-over-year per share results primarily reflect the decline in occupancy, around $1 million of weather-related expense including snow removal costs, a $900,000 charge for additional environmental remediation costs at one of our industrial properties Hawaii, and the issuance of new common shares during 2010.

In April 2011, we declared a dividend of $0.50 per share which represents 58% of our first quarter FFO. This dividend is expected to be paid in May 24 -- on May 24. During the quarter we spent $14 million on tenant improvements and leasing costs, and $1.9 million or $0.03 per square foot for recurring building improvements including roof, mechanical, life safety and roadway upgrades and other capital projects throughout the portfolio. We paid $1.6 million on development and redevelopment activities during the quarter. We generated $5.8 million of excess cash flow during the quarter resulting in a cash available for distribution or CAD payout ratio of 86%.

Turning to the balance sheet, on March 31, we held $25 million of unrestricted cash. Rents receivable includes approximate $169 million of accumulated straight line rent accruals as of March 31. Other assets include approximately $103 million of capitalized leasing and financing costs. On March 31, we had $670 million of floating rate debt, $356 million of mortgage debt, and $2.3 billion of fixed rate senior unsecured notes outstanding. The weighted average contractual interest rate on all of our debt was around 5% at the end of the quarter and the weighted average maturity was around five years.

Our senior unsecured notes are rated Baa2 by Moody's and BBB by Standard and Poor's. The undepreciated book value of our unencumbered property pool totaled about $8.6 billion at the end of the quarter. Our secured debt represents 5% of total assets and floating rate debt represents 20% of total debt. At the end of the first quarter our ratio of debt to book capitalization was 51%.

Our EBITDA and fixed charge coverage ratios were to 2.5 times and 2.1 times respectively. As of the end of the quarter we were comfortably within the requirements of our public debt and revolver covenants. As of March 31 and as of today, we had $270 million outstanding on our credit facility.

In summary, this quarter produced results we expected in light of a challenging market environment. Our strong balance sheet, solid annual dividend payout ratio, and $480 million of availability on our revolving credit facility position us to opportunistically grow cash flow. That concludes our prepared remarks. Operator, we are now ready to take questions.

Thank you. (Operator Instructions) Thank you. John Guinee, Stifel Nicolaus.

Hello. A couple of things. First, Adam, it looks like you have got -- every quarter you tend to announce rent roll ups, positive mark-to-market 3%, 5%, 8% this last quarter, but on page 20, your same-store NOI is going down by the opposite amount. Any explanation for that?

Yes. Some of it is due to timing. We are announcing -- when we show leasing activities, we show that we've entered into some of those leases have delayed starts. But the other thing that's going on is if you look at how much we lease versus how much is expiring, you'll notice that, for example, this quarter we had 1.8 million square feet expire and we had only leased about 1.5 million square feet.

So part of what's going on is we are not keeping track with the amount of activity as it's come -- the amount of leasing activity as it's -- we are not keeping track with the expirations basically. Occupancy which has -- which you saw on a same-store basis and on a Company-wide basis has declined modestly. So that's -- technically that is what is going on in same-store.

Okay, and then in Chicago, the 1.07 million square feet building, $162 million. I'm assuming that is 233 North Michigan?

John, I wish I could confirm that for you but because we are subject to confidentiality, I cannot confirm which building it is. I know there has been a lot of press reports on it but I'm trying to balance my requirements subject to confidentiality agreements, and trying to balance that with trying to give the investor community as much information as we can, but I cannot confirm the address.

Could you also not confirm that one of the other two buildings is Leo Burnett building, West Wacker?

I cannot confirm that building. No. The other building I cannot confirm. I just -- I cannot confirm which addresses there. Look, when we close on it we will disclose everything about them. I would like to talk more about the buildings in detail. It's just as you know we are in diligence, and the truth is, we have not closed on every deal that is ever in diligence.

We may not close on them, we have to complete our diligence and I just think -- I think we gave the appropriate amount of information. I wish I could tell you more but we are bound by confidentiality agreements. And look, you can guess, and you might be right but I can't tell you.

Maybe if you whisper it and just you and I heard it.

(laughter). I cannot -- John, I cannot tell you. I'm sorry.

Then the third question is, historically whenever you have gotten above 49% or 50% debt to total book capitalization, you go back to the equity markets. This time, do you think you'll do preferred or do you think you'll do common?

A good question. I can tell you that we have a lot -- you can do the math and you have done the math. We have -- if we close on everything in the pipeline just on our revolver loan, we will be between about $550 million and $600 million out on a $750 million revolver . We probably would look to do some refinancing of that later this year. We have lots of options.

I'd point you to the fact that we also own just under 10 million shares of GOV. That's a possible source of liquidity for the Company. I point you to the fact that we are selling some properties and there is an -- we may be selling more properties as the year goes on, and I think that we would. I don't take equity off the table, but I obviously look at where our common stock price is and don't feel great about it showing equity at this price, but obviously I don't rule out anything.

And then to talk about preferred, it's something that I think that we would look at. It's something we would probably look at doing before we would think about common but I cannot guarantee we would do it before we do common. But I agree that deferred is probably higher up the list of things we would consider before we would do common,

Could you get preferred pricing at a dividend yield below your current common dividend yield?

The short answer is I believe so. We have done it historically when we've issued preferreds and commons in years past and in my conversations -- general conversations with the market makers, it is my expectation that we could be able if we chose to.

Great. Thank you.

Yes.

(Operator Instructions) Mitch Germain with JMP Securities. Please go ahead.

Good afternoon guys. Just curious, Adam, about the progress of the sale of the non-core assets. Where do we stand today? How would you -- how do you characterize the progress so far?

I characterize the progress as good. I think with half the properties we are making I would say robust progress, meaning we have got at least a handful of bidders involved. I would say that the other half, it's a little tougher. I think have as I said in the last call we do have parties interested in everything, it is safe to say but the level of interest is maybe it's just a couple of folks for some of the buildings. But I guess I can tell you that the good news is there's interest in all of them and I would say fairly robust interest in at least half of them.

And you previously alluded in our conversations to a slowdown in acquisition activity. We have obviously seen a pick-up here. Is it the number of assets in the pipeline is down but since you are investing in CBD markets they tend to be bigger deals? Or would you say that following the closing of the deals in your pipeline right now, activity levels have come down a bit?

Yes, I think a little bit of everything you said. Yes. I mean, one of the deals that we announced that is pending, it has been pending since November. One of the other deals that -- the one in Folsom, California is a deal that we looked at mid-last year and or late last year, I'd say in the third quarter last year. And basically we did -- it got away from us and then it ended up coming back to us at more attractive pricing. So it's something that we have been looking at for quite sometime. I think is fair to say that the vast majority what we've been looking at since the beginning of the year have been CBD properties like the properties that we currently have agreement in Chicago, and that's probably going to be the majority of what we look at going for the rest of the year as I look out today.

And I think you are right, CBD assets tend to be a little bit more chunkier and a little larger. And so that's why I think it may have surprised some folks to see the amount of acquisitions we have under agreement and specifically the numbers we have in Chicago under agreement this quarter. So yes, I think you are right on all fronts.

Going forward, obviously there's -- I think because of what's going on in the market in terms of pricing, I think it is going to be hard for us to keep this pace up, and I think pricing especially in CBD markets where we seem to be more focused, across the country, is getting more competitive. And so it is going to be harder and harder for us to be competitive going forward. That's not to say we won't do things, but it's just going to be hard.

Understood. And then just last question quickly. An update on Australia please?

Well, as you can see we have not got anything under agreement, we have not bought anything since the beginning of the year in Australia. I'd say the existing portfolio is doing very good, very well. I will tell you what has been interesting about Australia is we have just under $300 million invested in Australia, and if we turned around and sold everything we had there today at the same price as we bought, we would have today close to over $60 million gain just on the currency exchange has moved so much in our favor.

I still think we're going to be looking eventually to do some more acquisitions down there. I think we have had a little bit of a pause in the last couple of months and part of that pause has been driven by the exchange rate and getting comfortable making investments at the current exchange rate, which is close to 110 Australian to US which is pretty high. And so I think that has been what has been slowing down our valuations in Australia over the last -- over the last few months. But the existing portfolio's doing well. I think we will be making some more investments eventually there. But that's where we stand.

There are no further questions at this time. I would now like to turn the conference back over to Adam Portnoy for closing remarks. Please go ahead.

Thank you all for joining us on our Q1 conference call. John looks forward to seeing some of you at the JMP conference in San Francisco next week. We also look forward to the NAREIT conference in New York City in early June. Thank you.

Ladies and gentlemen, that does conclude the conference for today. Thank you for your participation and for using the AT&T Executive Teleconference. You may now disconnect.