Equity Commonwealth (EQC) 2015 Q3 法說會逐字稿

Greetings, and welcome to the Equity Commonwealth third-quarter earnings conference call.

(Operator Instructions)

As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Ms. Sarah Byrnes, Vice President of Investor Relations. Please go ahead.

Thank you, Diego. Good morning, and think you for joining us to discuss Equity Commonwealth's results for the quarter ended September 30, 2015. Our speakers today are David Helfand, our CEO; Adam Markman, our CFO; and David Weinberg, our COO.

Please be advised that certain matters discussed during the conference call may constitute forward-looking statements within the meaning of federal securities laws. We refer you to these documents that we file from time to time with the SEC, which refer to risk factors that could adversely affect the Company's operating results and financial condition. The Company assumes no obligation to update or supplement any statements made today that become untrue because of subsequent events or otherwise.

Today's remarks also include certain non-GAAP financial measures. Please refer to yesterday's press release announcing our third-quarter 2015 results for a reconciliation of these non-GAAP performance measures to our GAAP financial results, which is available on our website.

With that, I will turn the call over to David Helfand.

Thanks, Sarah, and thank you for joining us this morning. I will begin with an update on our progress since taking ownership of the portfolio and beginning to execute on our business plan. Adam will discuss our financial results for the quarter. David will provide a summary of our operating and leasing efforts, and then we will open it up to Q&A.

Nationally, office fundamentals continue to show slow, steady growth. Year to date, occupancy has increased 30 basis points as a result of positive absorption of 110 basis points, offset by 80 basis points of new supply. In our markets, conditions vary but fundamentals are generally continuing to improve. Demand in Austin, Denver, Chicago and Philadelphia continues to show strength.

In most other markets in which we operate, the lack of new supply has resulted in slow, steady occupancy improvement. As of September 30, our same-property portfolio of 67 assets totaling 25.3 million square feet was 91.9% leased, a 20-basis-point increase from last quarter and 130 basis points better than this time last year.

We completed 1.4 million square feet of leasing transactions in the quarter, including 429,000 square feet of new deals and 955,000 square feet of renewals. Looking ahead, we have 765,000 square feet expiring the balance of 2015, and expect roughly half to renew and half to vacate. Based on recent leasing trends and the strength of our pipeline, we expect to hold leased occupancy at year end at roughly today's level.

Operationally, our focus has been on leasing and managing the portfolio with an entrepreneurial mindset. We've enhanced broker and tenant engagement, and emphasized responsiveness and execution in order to increase leasing velocity and drive internal growth. We're beginning to see the results of these efforts, as evidenced by our leasing volumes. In addition to blocking and tackling, we have identified opportunities to reposition assets, and reconfigure space to better address tenant demand and enhance our customers' experience.

With respect to our disposition program, our thesis is unchanged. We focused on executing on the sale of assets in a robust investment sale environment. Market volatility in the past few months has resulted in widening of debt spreads, and we'll continue to monitor activity levels and asset pricing in the investment sale market as we gear up to market additional assets in the new year.

During the third quarter, we completed the sale of 5.5 million square feet, comprised of 14 properties and 34 buildings with a leased rate of 70.9%. Gross proceeds from these sales were $637 million, and they sold at a weighted average cap rate in the upper 5% range. The buyers in these transactions were local investors and private real estate companies.

Subsequent to quarter end, we closed on the sale of seven additional office properties totaling 1.3 million square feet with a 79.7% leased rate for a gross sales price of $131.2 million. These dispositions represent all of the properties classified as held for sale at the end of the third quarter.

Let me take a minute to provide some detail on the four deals that closed in October. We sold a four-property, 643,000 square foot, 81% leased portfolio in Atlanta, Macon, and Marietta, Georgia, for $48.6 million at a cap rate in the mid-8% range. We sold One Park Square, a six-building, 91% leased, 260,000 square foot property in Albuquerque for $34.3 million at a cap rate in the low 7% range. We sold One South Church, a 241,000 square foot, 69% leased property in Tucson for $32 million at a cap rate in the upper 4% range. And lastly, we sold 775 Ridge Lake Boulevard, a 78% leased, 121,000 square foot building in Memphis for $16.3 million at a cap rate in the mid-7% range.

Over the last 10 months, we've sold over half of our assets, a total of 89 properties, 17.6 million square feet, generating gross proceeds of $1.9 billion. These properties were sold at a weighted average cap rate in the low- to mid-7% range. We've exited 64 cities, five states, and even one continent. With these sales, we believe we've significantly improved our portfolio, and the quality of earnings it generates.

The pace of sales to date has exceeded our original expectations, and is largely due to the tailwind of very liquid equity and debt markets, and strong execution by the EQC team. We expect velocity to slow towards the end of this year. We currently have four properties and one industrial asset totalling 2 million square feet that are 90.8% leased in various stages of marketing. At the same time, we're preparing the next group of properties for the sale process early next year.

We've generated significant proceeds from the disposition program, and today have a current cash balance of $1.8 billion. We're positioned for growth when and if we identify investment opportunities that offer a compelling risk/reward profile. We continue to actively look for and evaluate investment opportunities while remaining patient. We recognize that we may not find attractive acquisition opportunities without a significant change in current market pricing. In the interim, we'll remain focused on executing our plan to create value through active ownership of our portfolio, leasing of vacant space, and preparing assets for disposition.

With that, I'll turn the call over to Adam.

Thanks, David. Good morning. I'll cover our financial results for the quarter, and provide some commentary on the balance sheet, the share buyback program, and our perspective regarding capital allocation.

Same-property cash NOI was down by 1% from a year ago. The decrease in same-property cash NOI was largely a result of a non-recurring charge we took against revenues related to a parking tax matter. Without this charge, same-property NOI would have increased by 1.2%.

Same-property GAAP NOI was down 1.2% from a year ago, but would have grown by 2.3% without the previously mentioned one-time charge, as well as a non-cash charge for space we recently took back from a ground-floor retail tenant. Same-property GAAP NOI in the quarter benefited from lower property management fees, offset by the impact of higher real estate taxes at our properties in Austin, Chicago and Denver.

FFO for the quarter was $0.19 per share, compared to $1.59 per share a year ago. This decrease in FFO was primarily due to the $1.32 per share gain we recognized from the sale of our entire equity stake in Select Income REIT during the third quarter of 2014.

Normalized FFO was $0.36 per share compared to $0.44 per share last year. The decrease in Normalized FFO primarily stems from property sales in 2015 that generated $0.22 per share of the decline. Partially offsetting this decline was $0.08 per share of lower interest expense and $0.07 per share of savings in recurring G&A. As we've emphasized since taking over, our disposition efforts are highly disruptive to earnings, but consistent with our strategic plan to rationalize the portfolio and maximize the Company's net asset value.

Total G&A for the quarter was $16.2 million, which was $31 million lower than what was spent in the third quarter of 2014. The savings was primarily due to the incentive management fees paid to RMR, the Company's former external advisor, and to lower shareholder litigation and transition expenses. We do not anticipate further legacy shareholder litigation-related expenses, as these matters have now been settled.

G&A without the impact of items related to the transition totaled $32.4 million year to date, which is below our budgeted amount, largely due to a continuation of a pattern we identified last quarter where our actual costs are coming in lower across the board. We currently believe 2015 will total in the mid-$40 million range.

As David mentioned, during the quarter the Company completed the sale of $637 million of assets. As a result of these sales, we recognized a $39.8 million book gain on sale. More importantly, the dispositions year to date have resulted in taxable loss, and we expect a taxable loss for the full-year 2015.

Turning to the balance sheet, in connection with the previously announced sale of Illinois Center, we prepaid a $141 million mortgage during the quarter. In addition, we repurchased $87.8 million of our own stock at a weighted average share price of $25.76 per share. As discussed on prior calls, we have nearly $1 billion in debt and preferred stock that we can repay or prepay at par through 2016.

With approximately $1.8 billion, or over $14 per share, in cash on the balance sheet, and additional assets in the market to be sold, we are evaluating all uses of proceeds, including debt repayments, share buybacks, distributions, and new investment opportunities. To date, the acquisition opportunities we've evaluated have been priced at historically low yields, and values per square foot that are at or above replacement cost. Given this environment, we will be cautious in our pursuit of new investment opportunity. In the meantime, our balance sheet and access to capital are both healthy, and we believe we are well positioned for the future.

With that, I will turn the call over to David.

Thank you, Adam, and good morning, everyone. I will now walk you through the latest in operations, and update you on our top markets.

Over the last four quarters, in addition to highlighting our disposition goal, we have emphasized our focus on taking responsibility for our properties, and being active and engaged owners. This focus starts with leasing, including understanding our inventory, embracing the brokerage community, and building relationships with our tenants.

David, Adam and I, along with the rest of the EQC team, have been meeting with brokers, and attending broker events. We also have met with tenants and prospects at our offices and theirs. We believe we are now beginning to see these efforts pay off.

Looking at the same-property portfolio, during the third quarter we signed 84 leases totaling 1.4 million square feet, the highest volume of leasing since we took over last year. As David mentioned, office fundamentals in all our markets are generally continuing to improve.

I would like to cover a few of our markets, starting in Bellevue. Bellevue CBD is 8 million square feet, and has a vacancy rate of 11.4%. Year to date, the market has had 190,000 square feet of negative absorption, with the primary contributor being Microsoft vacating 170,000 square feet. Our two properties in Bellevue total 660,000 square feet, and are 99% leased. This past quarter, we signed three leases totaling 30,000 square feet with cash rents rolling up 3.5%. As we have said before, we like this market long term, but with 1.5 million square feet under development, it is facing supply risk in the next few years.

In the Denver area, we own four properties totaling 1.6 million square feet that are 97.6% leased. Our largest asset in Denver is 1225 17th Street, also known as 17th Street Plaza, a 672,000 square foot, 98% leased Class A office tower. Denver CBD is 26 million square feet, and has a vacancy rate of 13.3%. Some new supply has been delivered in Denver CBD this year, and there is some sub-lease space on the market related to the slowdown in the energy sector, but overall the market is doing well. We like the fundamentals of Denver, and 17th Street Plaza is considered one of the best buildings in the market.

Chicago CBD is 128 million square feet, and has a vacancy rate of 12.8%. This market continues to [tighten] with year-to-date positive net absorption of 500,000 square feet. The trend in Chicago has been the movement of tenants from the suburbs into the city, including Motorola Solutions, Baxalta, and Kraft-Heinz. All suburban tenants have signed third-quarter leases in the CBD.

In recent years, we've also seen several suburban tenants open satellite offices downtown. Year to date, suburban companies have leased over 800,000 square feet in the CBD, or 11% of Chicago's 2015 leasing activity.

The largest lease we signed this quarter was a 375,000 square foot early renewal at 600 West Chicago, which includes a 60,000 square foot expansion. We also executed four other leases totaling 128,000 square feet here during the quarter. This unique 1.5 million square foot property is located in Chicago's tightest sub-market, River North. It was originally the Montgomery Ward's warehouse building. It is located on the Chicago River, offering exposed brick, large windows, high ceilings, and large, open floorplans that cater to today's new economy companies.

In connection with the leases we signed at 600 West Chicago, we have developed a business plan that will ensure it maintains its competitive position. This plan includes adding more elevators and upgrading amenities, including building a 5,500 square foot rooftop deck and taking a fresh look at the on-site retail offerings. This property is 99.7% leased; but as we've stated previously, we will be getting back 117,000 square feet from Level 3 during the fourth quarter.

In Austin, our 10 properties totaling 2.5 million square feet are 95.6% leased. This market continues to be one of our top performers. This quarter we signed 21 leases totaling 180,000 square feet, with cash rents rolling up 19%. The Austin market is 45 million square feet, has a vacancy rate of 10.9%, and had year-to-date positive net absorption of 1.6 million square feet. However, there is a significant amount of supply coming online which will likely impact the market.

Indianapolis's CBD is 12 million square feet. The market is trending in the right direction, with year-to-date positive net absorption of 180,000 square feet, although it still has a vacancy rate of almost 19%. We own two of the best office towers in the market, which total 1.7 million square feet, and have a leased occupancy rate of 87.2%. This quarter we signed three leases totaling 35,000 square feet, including 20,000 square feet of new leases.

Our largest market is Philadelphia where we own four properties totaling 4 million square feet that are 86% leased. This 43 million square foot CBD market continues to strengthen with almost 500,000 square feet of year-to-date positive net absorption and a vacancy rate of 10.6%. While it is still a competitive market, supply is in check, rents have been growing, and the CBD is starting to see more demand and activity from out-of-market tenants. The city is also benefiting from residential development, which brings with it more restaurants, a better retail mix, and a growing downtown population.

In terms of leasing, we've been very active in Philly, especially at 1500 Market, also known as Center Square. This is a two-tower property totaling 1.8 million square feet that is located across the street from City Hall where the new Dilworth Park just opened. Our largest new deal this quarter was a 67,000 square foot lease at Center Square. This space had been vacant for nearly 10 years.

Subsequent to quarter end, we also executed another new lease at Center Square for 151,000 square feet in a space that had been vacant for seven years. At year-end 2014, the property was 79.5% leased. We have two more leases in our pipeline totaling 69,000 square feet and, if signed, this property's leased occupancy would be in the low-90%s.

Our largest property in Philadelphia is the 1.3 million square foot trophy tower, 1735 Market. The property is 88% leased. As we have discussed on previous calls, through May of 2016 we'll get another 350,000 square feet back. To date, we've been pleased with demand at this building.

Year to date we have signed 171,000 square feet of leases, including 68,000 square feet of new leases, and we have another 85,000 square feet of new leases in negotiations. We have an active pipeline, with most tenant prospects ranging from 25,000 to 50,000 square feet. It will take some time to backfill this space, but the activity to date has been encouraging.

In summary, Bellevue, Denver and Austin are strong markets where our assets are well occupied, but exposed to supply risk. Chicago and Philadelphia, where we have some vacancies, are continuing to strengthen, and we have had good leasing results to date. And in Indianapolis, we have nice property, but the overall market has a high vacancy rate, and deals are competitive.

With that, we will open it up to Q&A.

(Operator Instructions)

Manny Korchman, Citi.

Good morning. Maybe if we just think about your share buybacks, you almost exhausted your first tranche -- you put out another $100 million. How do you think about buybacks and what levels are you comfortable buying back at?

It's Adam. So we have talked, I think, on every one of these calls about our desire to be opportunistic and to be nimble, and I think that when the share price weakened we were able to show what we mean by that and we were able to buy back a significant chunk of shares pretty quickly. Obviously, the stock ran, but in the future if there are opportunities that come up because of volatility, we will again jump on them.

And then, appreciate your comments on acquisitions and acquisition environment. Maybe you can just help us understand what your primary metrics or primary screening criteria are when you're thinking about acquisitions. Maybe geographies -- are they new, do they overlap your existing portfolio, is it CBD, is it suburban, are they large buildings, small buildings? Just give us an idea of even the expensive deals that you haven't done? What has inspired you to even look at those deals?

Manny, it's David. I'll take that. I think we've covered that in meetings with investors and discussed it on previous calls. We would, as Adam said, focus on being opportunistic. There are probably a dozen markets that offer the type of fundamentals, type of growth that we would want to see long-term, and we would be active in those markets if the opportunity were there. Some of those overlap our existing markets. We've talked about that before. Bellevue, Austin, Denver, Chicago, but there are others that we would invest capital if values were right, and when we think about value we think on a per pound basis as well as on a yield basis.

Great. That's it for me. Thank you.

Mitch Germain, JMP securities.

Hi, guys. It's Peter on for Mitch. Just curious given that you guys don't think there are going to be any more litigation charges, is what we saw this quarter the best gauge of G&A heading into 2016?

I think that the recurring G&A that we see this quarter, and the mid-$40 million number that we talked about in our prepared remarks are the best thing for you to utilize as your gauging G&A. We of course have one last chunk of Corvex related potential charges that will hit the nonrecurring G&A pile. No news there. That is just the same situation that the shareholders voted on when Related and Corvex took control of the board of trustees.

Great, thank you.

John Bejjani, Green Street Advisors.

Good morning, guys. The markets rightly rewarded you for selling assets and closed the gap between your share price and NAV. If the gap were to close further, such that you're trading at NAV plus or minus, what does the capital allocation game plan look like at that point moving forward?

Good morning, John. We acknowledge your question and we think about it in similar ways, but it would really depend on what the environment was when the stock approached our view of value.

Okay, I guess how long are you willing to sit on your cash balance then and wait for opportunities to arise?

The start of my answer to that is we are really mid-stream in our disposition program. We still have plenty of hard work on that front to do. It's going to take time. We're going to work our way through it methodically and carefully. When we get to the end we're going to look around and see what the environment looks like. I think as David has had a number of times, it's going to be not as long as we'd like and longer than you'd like. That's probably where we are will comprise on the outcome.

Sure. Sure. How large of a war chest do you think it makes sense to maintain and what are your thoughts, especially since you have more dispositions moving forward, what are your thoughts towards a special dividend of some of the proceeds moving forward?

We'll -- as we have been on an ongoing basis, we'll discuss distribution with our Board of Directors and when we get to a conclusion there, we'll obviously be telling the market.

All right. Thanks, guys.

John Guinee, Stifel.

John Guinee. Thank you. It appears to me that -- by the way, wonderful job year to date. Adam, you said your mid-stream in your disposition program. Does that imply that your $1.9 billion sold and $1.9 billion more to sell?

No. You took it too literally. The point is we still have plenty of work still that needs to be done to sell the $3 billion of assets that Sam identified the last time he was on our call. Assets that just don't make sense in a publicly traded real estate company.

Got you. Okay. And then my recollection is that the Board was selected largely by shareholders in this case, which gives us as shareholders a decent chance that maybe the Board will act as a fiduciary to shareholders. If you asked the shareholders, a lot of whom are the event driven guys, what they wanted to do with a tremendous amount of cash proceeds what would they tell you?

Good morning, John. I can assure you with 100% certainty that our Board will act with fiduciary duty, so you can rest easy on that one. Your question was what would some of our investors like us to do with the capital?

Exactly. The big guys.

We have had great support from shareholders. We have an ongoing dialogue. We try to be transparent and we continue to say the same thing which is we think it's an environment to sell, particularly the assets we have in this portfolio. We are hopeful that we'll have an opportunity to redeploy the capital because we built this spectacular team here and we think that given the right situation we could add a lot of value. We are also sober about the fact that it's a difficult time to invest capital, and if it turns out we can't find that opportunity, we've been clear in saying we'll return the capital to shareholders.

Okay. And then if I look at your outline disposition plan, another billion and change, that probably gets you down to a 10 million to 15 million square foot portfolio, maybe half the assets. That is a $20 million G&A business if I look at the comp. Is that a fair way to look at the run rate once you get yourselves down -- get through the next $1 billion of asset sales?

I think, John, we have had this discussion before. We have different views of reasonable G&A which we will agree to disagree. But, yes, there are numerous assets we continue to focus on the sale, particularly the non-office assets moving forward to next year, and then we'll address the question of G&A. But we are, and continue to feel, that maintaining the team and curing the capability to expand the platform is an important part of the optionality embedded in the Company.

Okay. My last question is Vineyards. You wrote that, it looks like your net book value is about $29.3 million. Did you take in impairment charge on that? Is that a good assessment of value right now?

We haven't taken an impairment charge on the Vineyard, but I couldn't tell you that book value is a good assessment of current value.

Great. Thank you very much.

Thank you. There are no further questions at this time. I will turn the floor back to David Helfand for closing remarks. Thank you.

Thank you again for joining us. We've made substantial progress since our first call with you about this time last year. We've taken active ownership of the portfolio, as evidenced by our leasing performance to date, and our team has been focused and efficient in executing our business plan. We built a platform that can serve as a foundation for value creation within our existing portfolio and for future growth. We appreciate your support and thank you for taking time to join us today.

This concludes today's call. All parties may disconnect. Have a good day. Thank you.