Equity Commonwealth (EQC) 2018 Q4 法說會逐字稿

Greetings, and welcome to the Equity Commonwealth Fourth Quarter 2018 Earnings Conference Call. (Operator Instructions) As reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Sarah Byrnes, Vice President, Investor Relations. Thank you, Ms. Byrnes. You may begin.

Thank you, Doug. Good morning, and thank you for joining us to discuss Equity Commonwealth's results for the quarter ended December 31, 2018. Our speakers today are David Helfand, President and CEO; David Weinberg, COO; and Adam Markman, CFO.

Please be advised that certain matters discussed during this conference call may constitute forward-looking statements within the meaning of federal securities laws. We refer you to the section titled Forward-Looking Statements in yesterday's press release as well as the section titled Risk Factors in our most recent annual report on Form 10-K for a discussion of factors that could cause actual results to materially differ from any forward-looking statements. The company assumes no obligation to update or supplement any forward-looking statements made today. We also post important information on our website at www.eqcre.com, including information that may be deemed to be material.

Today's remarks also include certain non-GAAP financial measures. Please refer to yesterday's press release and supplemental containing our fourth quarter 2018 results for a reconciliation of these non-GAAP performance measures to our GAAP financial results.

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

Thanks, Sarah. Good morning, and thank you for joining us. I'll begin with brief comments on market conditions, review our 2018 results, provide an update on the company's current activities.

U.S. economy continued to grow in 2018, adding 2.6 million new jobs. The unemployment rate at the end of the year was 3.9%, down from 4.1% at the end of 2017. Equity markets were volatile, with the S&P experiencing both record highs and sharp reversals. After 3 positive quarters, the S&P gave back its gains in the fourth quarter, ending the year down 4.4%. The NASDAQ was down 3.9% for the year, and the Morgan Stanley REIT Index was down 4.6%. With respect to interest rates, the yield on the 10-year treasury is currently 2.7%, down 50 basis points from its peak in November and down 10 basis points compared to a year ago. On the short end of the curve, 1-month LIBOR is currently 2.5%, up 90 basis points from a year ago.

Turning to office fundamentals. In 2018, across the U.S., roughly 50 million square feet of new supply was added to existing inventory. Positive net absorption resulted in vacancy declining 40 basis points year-over-year to 12.6%. Base rents grew just under 3% in 2018, though higher leasing and capital cost continue to weigh on lease economics. Looking forward, the new supply pipeline remains elevated with over 100 million square feet under construction nationally. Generally speaking, supply is concentrated in markets that currently -- that are currently characterized by reasonably strong demand.

With respect to real estate capital markets, office transaction volume totaled $111 billion in 2018, with activity picking up in the second half of the year, bringing volume in line with 2017. Cap rates were stable to up modestly across the country. Our discussions with leading investment sales brokers suggest more buyers are exercising caution as evidenced by thinner bid pools.

The real estate debt capital markets are healthy despite choppiness experienced at the end of 2018. Supply of debt capital is abundant with active fixed- and floating-rate lending programs from diverse sources, including CMBS, banks, life companies and debt funds. CMBS market seems to have stabilized, with the most recent securitizations pricing 10 to 15 basis points tighter than in December.

All-in borrowing costs for 10-year fixed-rate loans have decreased 30 to 40 basis points since the end of the third quarter, though they are 20 to 25 basis points higher than a year ago. In general, the supply of debt capital continues to exceed demand, and it remains a very liquid and borrower-friendly market.

Turning to EQC. Our team did an outstanding job in 2018 executing on our business plan on all fronts, including dispositions, leasing and asset management. Our operating metrics were strong, and our financial results continue to reflect the success achieved on the leasing front over the past few years. In 2018, we executed 976,000 square feet of leasing in our same-property portfolio, bringing year-end leased occupancy to 94.8%. Same-property cash NOI was up 11.8% for the year and up 8.4% for the quarter.

Turning to dispositions. 2018, we closed on the sale of 7 properties totaling 4.4 million square feet for a gross sales price of $1 billion. Pricing was in the high 5% cap rate range.

During the quarter, we closed on the sale of 97 Newberry, a 100% leased, 289,000 square foot industrial property in East Windsor, Connecticut, for $7.1 million. Last month, we announced we've entered into a contract to sell 1735 Market Street, a 93% leased, 1.3 million square foot downtown office tower in Philadelphia, for a gross sale price of $451.6 million. We continue to work on the previously announced sales process for Research Park in Austin, Texas and Bellevue Corporate Plaza in Bellevue, Washington. Including 1735 Market, we have a total of 2.7 million square feet in various stages of the sale process.

The EQC team has worked hard and efficiently to reshape what was a highly disparate portfolio in 2014. We've successfully executed on the sale of $6.1 billion of assets and over 70 transactions. We've repaid $3 billion of debt and preferred and created a unique balance sheet with tremendous capacity. Today, the company is well positioned for growth. We remain keenly focused on opportunities to invest capital where we can earn superior risk-adjusted returns. Our team has demonstrated its capability to execute and create value for shareholders. Our strategy will continue to be informed by market conditions, and we continue to believe that the pricing environment today for high-quality acquisition opportunities does not lend itself to achieving superior returns. Our objective is to be disciplined stewards of shareholder capital. To do so, we need to remain patient as we work aggressively to identify the right path forward.

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

Thank you, David, and good morning, everyone. I will begin by reviewing our fourth quarter and full year leasing activity and giving an overview of our largest markets, then I'll cover our lease roll in 2019. Our same-property portfolio at the end of the quarter comprised 10 properties totaling 5.1 million square feet. The portfolio was 94.8% leased, up 110 basis points from the third quarter and up 420 basis points year-over-year. Commenced occupancy was 91.2%, up 40 basis points from the third quarter and up 480 basis points year-over-year.

In the quarter, we signed 173,000 square feet of leases consisting of 80,000 square feet of new leases and 93,000 square feet of renewals. Rental rates increased 22.5% on a GAAP basis and 10% on a cash basis. For the year, we signed 976,000 square feet of leases, consisting of 757,000 square feet of new leases and 219,000 square feet of renewals. Rental rates increased 14.8% on a GAAP basis and 3.4% on a cash basis.

Most of our leasing this quarter was at Bellevue Corporate Plaza. We signed 87,000 square feet of leases, including renewing 6 tenants totaling 76,000 square feet. This property is 98% leased, and the Bellevue CBD continues to be one of the strongest markets in the country with a vacancy rate of 6.9%.

Bridgepoint Square in Northwest Austin is 92% leased. We continue to see good leasing activity at this property, which should help backfill the 45,000 square feet of space we expect to get back during the year. Capitol Tower in Downtown Austin is also 92% leased and has no leases expiring this year. The Austin market continues to do well with a vacancy rate of 9.6%.

17th Street Plaza in Downtown Denver is 89% leased. This market remains competitive with a total vacancy rate of 16.8%. In 2018, the CBD's net absorption was 835,000 square feet, which is the highest annual net absorption level since 2005. However, the vacancy rate continues to be elevated due to 1.4 million square feet of new supply that delivered last year. At 17th Street Plaza, we have seen an increase in leasing activity the past few quarters.

Finally, I would like to comment on lease roll in 2019. For the year, we have 484,000 square feet rolling. This lease roll is skewed by a few larger tenants. In 2020, we have 115,000 square feet roll. The largest expiration in 2019 is Georgetown University's 128,000 square foot lease at the Harris Building in Washington, D.C. This lease expires on September 30. We continue to speak with Georgetown about its plans while also working to backfill its space should it vacate. Of the remaining 356,000 square feet rolling this year, we expect to get back 250,000 square feet. This includes Aberdeen's 57,000 square foot lease at 1735 Market and 45,000 square feet at Bridgepoint Square, which has good activity, and also includes BT Americas' 59,000 square foot lease at 109 Brookline in Boston. This lease expires on July 31, and this is a great property in a very strong submarket.

As David said, we are working on a few dispositions and continue to aggressively lease space while seeking attractive investment opportunities.

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

Thanks, David. Good morning. I'll review our financial results for the quarter and the year. Funds from operations were $0.21 per share compared to $0.19 per share in the fourth quarter of 2017. The FFO growth was generated despite a decrease of $0.12 per share from $1.1 billion in asset sales since the fourth quarter of 2017. Offsetting the effect of the dispositions was $0.06 per share of higher interest and other income, $0.05 per share of lower interest expense, $0.02 per share from a decrease in G&A and $0.01 per share of increased FFO from improved results in the same-property portfolio.

Normalized FFO was also $0.21 per share compared to $0.18 a year ago. As with FFO, the growth in normalized FFO was achieved due to increased interest income, interest expense savings from debt repayments, lower G&A, increased same-property cash NOI and despite a decrease of approximately $0.12 per share resulting from dispositions.

FFO for the full year was $0.59 per share compared to $0.92 in 2017. Asset dispositions were responsible for a per share decline of $0.69, with losses related to debt repayments causing an additional $0.05 per share drop, along with a $0.02 decline from higher state and local income taxes. Offsetting these declines was $0.21 per share of lower interest expense, $0.17 of higher interest income and $0.03 per share of lower G&A. Better same-property results also added $0.03.

Normalized FFO per share for the full year was $0.69 compared to $0.83 in 2017. Asset dispositions were again the primary cause of the decline, with higher interest income and lower interest expense and G&A providing offsets. Normalized FFO per share benefited from a lower share count following our buyback earlier in the year. Improved same-property performance added $0.06 per share.

Net operating income in the same-property portfolio was up 7.3% in the fourth quarter compared to a year ago. The increase was largely due to higher commenced occupancy, with the largest contributions coming from Philadelphia and Austin. Partially offsetting higher GAAP revenues were real estate tax increases also in Philadelphia and Austin and increases in other nonrecoverable expenses.

Same-property cash NOI was $25 million, 8.4% higher than in the fourth quarter of last year driven by higher rental income, again primarily in Philadelphia and Austin where several tenants are now through their free rent periods and thus paying both rent and escalations.

On the expense side, we saw increases from the previously mentioned real estate taxes and from operating expenses related to occupancy. Cash NOI for the quarter does not include $1.4 million of revenue from leases in free rent. Growth will also benefit from 184,000 square feet of leases signed but not commenced on spaces that are currently vacant and therefore are not in cash or GAAP NOI. These leases will eventually generate $7 million in annual rents. In addition to tenant move-outs, dispositions will have a meaningful impact on how much of this future growth flows through in the form of NOI over time or is monetized through asset sales. We continue to anticipate solid cash NOI growth in our same-property portfolio.

NOI for the full year was up 3.4%, and cash NOI increased 11.8%. Improved occupancy was the key driver for growth, which resulted in higher rental income and expense reimbursements, somewhat offset by higher real estate taxes and occupancy-related operating expenses.

Turning to the balance sheet. Since 2014, we've repaid over $3 billion of liabilities and preferreds, and our debt now totals just $275 million as compared to $21 per share or $2.7 billion in cash and marketable securities. Given our liquidity and limited leverage, we chose not to extend our credit facility, saving over $2.5 million in extension facility fees this year. We're confident that our balance sheet and long-term relationships will provide access to debt capital when needed. We continue to look for opportunities where our team, liquidity and financial strength will provide a competitive advantage.

Thank you. And with that, we will open it up to Q&A.

(Operator Instructions) Our first question comes from the line of Manny Korchman from Citigroup.

Just looking at your G&A in 4Q versus 3Q, looked like there's a big sequential decline. Is this 4Q a good run rate going forward? Or was there something else onetime in there? And how do we just think about the G&A level going forward?

Well, the run rate for the fourth quarter, while we don't provide guidance, was down certainly year-over-year, and that was a result of severance expenses that hit the fourth quarter of a year ago. We also saw a significant decline as the special dividends and grants that were provided -- excuse me, grants that were provided to the executives and employees of the company in 2014 have now rolled off. So you're seeing the benefit of lower expenses from those grants flowing through in the fourth quarter. I think just generally on G&A, we continue to do what we can on the margins. Regarding overhead, we've seen a steady decrease as the portfolio has gotten smaller. And we've said a number of times that ultimately the G&A will be matched up with a larger portfolio or it will go away.

And then turning to the buyback. You guys haven't done anything since the first half of the year, but recently, the stock was sort of near those same levels. Why wouldn't you have done more buyback? Kind of what are your bookends for doing more buyback?

Well, to date, we've repurchased almost 9 million shares, about 8.9 million shares. And the average price of that, adjusted for the dividend, is $25.10. The most recent buyback was the first quarter. We repurchased just under 3 million shares. And the price, again adjusted for the $2.50 special dividend, was $27.17. And we've talked about current authorizations, $130 million. And we're always thinking about buybacks as one of the potential uses of the cash that we have on the balance sheet.

Our next question comes from the line of John Guinee with Stifel.

Great. A couple of quick questions. Can you go into any more depth on the 2 other assets you have for sale and what the dynamics are of the assets and ultimate pricing? And then how do you unwind the preferred shares?

Sorry, John, you broke up for the last part of your question. Can you please repeat that?

How do you unwind the preferred shares?

So this is David. Let me take the first question. So the 2 other assets for sale, one of them Research Park in Austin, Texas; and the other, Bellevue Corporate Plaza in Bellevue, Washington. I'd say we're pleased with the marketing of both those assets. For each of these properties, it's been a competitive process with multiple bidders. But both of them also include, I'd say, unique features. They're both in great markets, and both of them feature development opportunities. So they've attracted buyers who would value those types of investments, and they're just taking a little longer than perhaps they otherwise would take given the unique features. But so far, everything is going well.

I missed the part, David, about the ultimate proceeds on those deals.

Yes. We're looking forward to that day, too.

How about unwinding the preferred shares, Adam?

Yes. If we go away, the preferreds are redeemable at par. They are convertible at the option of the preferred shareholder at a price that's approximately $48 per share. But we can't get to them, really, unless they're converted at that price, again barring the company going away.

(Operator Instructions) Our next question comes from the line of Mitch Germain with JMP Securities.

I know 1735 was announced under contract. Curious if you can provide some sort of perspective on that process and how it played out.

Hey, Mitch. It's David again. Very, very pleased with that process. That's a unique asset, one of the best in Downtown Philadelphia. And once again, like the other deals, it was a competitive process with multiple bidders. In fact, we're actually pleasantly surprised, knock on wood, with the speed of execution to date. Hasn't closed yet, but so far, it's been going very well.

Great. And then last one for me. I know that you've got that lease that is under, I guess, negotiation or discussions with Georgetown. Historically, have they kind of been late in terms of their willingness to renew? Is this kind of typical with them? Or maybe just some color around kind of how you think that process plays out.

Yes. Well, so calling it a lease under negotiation would be an exaggeration. We had discussions with Georgetown. Look, they're a large tenant. They're a university. They own a lot of property. They occupy a lot of assets, and it's just taking longer to get the retention.

There are no further questions in the queue. I'd like to hand the call back to David Helfand for closing comments.

We thank you for your interest and your time this morning. Have a good day.

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time, and have a wonderful day.