Franklin Street Properties Corp (FSP) 2008 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q4 2008 Franklin Street Properties Earnings Conference Call. My name is Keisha, and I will be your operator for today.

(Operator Instructions)

I would now like to turn the call over to Mr. Scott Carter, General Counsel. Please proceed, sir.

Thank you, and good morning, everyone, and thank you for joining us this morning. With me are George Carter, our Chief Executive Officer; and John Demeritt, our Chief Financial Officer.

Before I turn the call over to John, I must read the following statement. Please note that various remarks that we may make about future expectations, plans, and prospects for the Company may constitute forward-looking statements for purpose of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those discussed in the risk factor section of our annual report on Form 10-K for the year ended December 31, 2008, which is on file with the SEC.

In addition, these forward-looking statements represent the Company's expectations only as of today, February 25, 2009. While the Company may elect to update these forward-looking statements, it specifically disclaims any obligation to do so. Any forward-looking statements should not be relied upon as representing the Company's estimates or views as of any date subsequent to today.

At times during this call, we may refer to funds from operations, or FFO. A reconciliation of FFO to GAAP net income is contained in yesterday's press release, which is available in the Investor Relations section of our website at www.franklinstreetproperties.com. Now I will turn the call over to John Demeritt. John?

Thank you, Scott. Welcome to our earnings call. We're going to be talking with you about our fourth quarter and year-end 2008 results, and we'll start with a short overview. After that, George Carter, our CEO, will further discuss the quarter at FSP. I'm going to be brief and will be referring to the earnings release that went out last night and our 10-K that was filed on Monday night.

The turbulence in the markets that we talked about last quarter continues and has affected the stock prices of most [office] REITs, and the price volatility of this has been dramatic. However, the strength of our balance sheet, as we go through this abyss, should serve us very well and enable us to grow as we move ahead.

As of December 31, 2008, we had cash of about $29 million and $183 million in availability on our line of credit to operate FSP and our [fuel] -- future growth. We finished the year with a leverage ratio of about 14.4%, with $142 million in debt outstanding and shareholders' equity of $849 million. Our shareholders' equity is held by our common shares only, as we do not have any preferred shares or other equity instruments on our balance sheet.

The $142 million in debt that we have is unsecured and consists of our outstanding line of credit of about $67 million that was drawn and an unsecured term loan of $75 million. Our line of credit matures in August of 2011, and our term loan can be extended to October of 2013.

I think this balance sheet paints a solid picture of FSP at a time when there is general concern about the availability of debt from financial institutions and debt levels of many companies. We may see some issues with leasing and investment banking as we move through the down part of this cycle, but we have the strength of our balance sheet as ballast.

As we've said before, we measure our performance with three key drivers, which are real estate operations, investment banking, and gains on sale of real estate or GOS. The real estate operations driver is our ongoing net leasing or rent revenues from our portfolio of properties, which is a recurring business.

By contrast, GOS and investment banking are transactional in nature, and even in normal markets, the quarter-to-quarter results from them can be very choppy. During 2008, we did not achieve any GOS, as the market for selling real estate has changed.

Investment banking profits come from fees earned on the value of shares of securities that we sell as private placements. The sale of these private placements are what we call gross syndication proceeds. Income derived from the sale of private placements is essentially syndication and transaction fee revenues on our income statement less the impact of direct expenses, which are commissions, some G&A expenses, and related income taxes.

Sales of private placements have been impacted by the financial markets, and we did not have any sales in the fourth quarter of '08 compared to about $28.3 million in proceeds that we achieved in the fourth quarter of '07. For the full year of 2008, we achieved $57.4 million in gross syndication proceeds compared to about $147.5 million in '07. George will be discussing this more shortly.

With respect to our performance in 2008, for the fourth quarter, we had GAAP net income of $6.6 million and EPS of about $0.09 per share. And for the year, we had GAAP net income of $32 million and EPS of $0.45 per share.

We measure performance of real estate operations and investment banking by FFO, which Scott alluded to earlier. For the fourth quarter, FFO was $16.2 million or $0.23 per share. And for the year, we achieved $69.2 million or $0.98 per share.

Comparing the fourth quarter of '08 to 2007, EPS was about $0.04 lower, pretty much entirely as a result of lower contribution from our investment banking segment. For the full year, EPS decreased $0.41 per share, which has three parts to it. The first, and most significant, is we had no gain on sale of assets in 2008 compared to $0.34 per share in 2007. So that was $0.34 of the $0.41 decrease, year to year.

Second, our investment banking segment return decreased $0.10 per share from where we were in 2007. Those two decreases were partially offset by a $0.03 increase in contribution from our real estate recurring segment, which was from property acquisitions and leasing activities we have completed in the last two years.

Moving to FFO, for the fourth quarter of 2008, our FFO per share decreased $0.03 to $0.23 compared to the fourth quarter of '07. On a dollar basis, this was a decrease of about $2.4 million. And the reason for the decrease in FFO was also lower contribution from our investment banking segment, which was about $2.7 million or $0.04 of this and was partially offset by an increase from our real estate recurring FFO of about $0.01 -- with rounding -- compared to the quarters.

For the full year of 2008, FFO decreased $0.08 to $0.98 compared to 2007. The decrease on a per share basis follows the same reasoning as the quarterly comparison where essentially, $0.11 was attributed to the decrease from our investment banking segment and was partially offset by $0.03 of an increase from our real estate segment.

That covers our financial performance. The press release and 10-K filing go into further detail about our results. I also wanted to point out that the press release has our supplemental schedules, [inputting] information about the 12 single asset REITs that we manage and include two that we currently have investments in. There is also a current owned real estate portfolio there if you're interested, and I also wanted to point out that we'll be filing our supplemental package in the next week.

That concludes financial highlights. And at this point, our CEO, George Carter, will tell you more about FSP, the results, and where we are. Thanks for listening. George?

Thank you, John. Good morning, everyone, and thank you for taking the time to listen to our fourth quarter 2008 earnings call. My comments on the call this morning, as usual, will follow and expand upon my written comments in our earnings press release.

As John has said, for the fourth quarter of 2008, FSP's profits, as represented by funds from operations plus gain on sale, totaled approximately $16.2 million or $0.23 per share. Dividend distributions for the fourth quarter of '08 totaled approximately $13.4 million or $0.19 a share. As John has also said, we had no GOS, or gain on sale, for the fourth quarter. We had none for the full year.

We really didn't have any properties listed for sale formally during the course of the year. You might ask why you even include GOS, or gain on sale, in terms of your calculations. And I would tell you, as I've said many times, that we are a real estate investment firm, and gain on sale is an important part of our total return objective on each and every property we buy.

We are not a highly leveraged firm, and consequently do not leverage our FFO with increasing debt, but rather gain increase in FFO from sale proceeds in this very cyclical asset class that we are a part of -- that is, real estate, and specifically, office buildings. There are clearly good times of a cycle to sell properties. '04, '05, '06, and the first half of '07 would have been excellent times. In retrospect, we did sell quite a few properties during that period of time. We used mostly 1031 exchanges, tax free exchanges, to help us reinvest those proceeds into upgraded assets, and I think those upgraded assets are serving us well right now.

It's hard to tell when a strong market for sales will come back -- property sales, that is. You -- when you look out there right now, what we see is not just that prices of real estate have generally gone down and cap rates have generally gone up, but that it is a very inefficient market. There are not a lot of bidders. There's a lot of waste of time and money that goes on trying to sell properties in this market, because the markets are moving so fast.

Now there will be opportunities to sell properties in whatever part of the cycle we're in. It's just that this period right now, which really -- fully '08 and as we head into '09 -- really is marked by a very inefficient marketplace. And this certainly has to do primarily with the uncertainty and inability to access the capital debt markets and more traditional mortgage markets.

During the fourth quarter of 2008, our investment banking group raised no equity, as John has said, and that as compares to $4.8 million in the third quarter of '08, $49.9 million in the second quarter, and $2.7 million in the first quarter of '08. Again, that is about a third of what we raised last year; and clearly, those markets have been impacted by the current economic situation.

Concern and uncertainty continues to surround the potential impact on commercial real estate, emanating from the US recession and financial credit crisis; and our established investor clients continue to sit on the sidelines until a clearer sense of stability returns to the broader capital markets before considering significant investment purchases. The lack of equity-raising activity resulted in our investment banking business segment operating at a loss for the fourth quarter, that loss totaling about $620,000 or about $0.01 a share. For the full year, again, as John said, our banking business did generate about $0.03 in profit.

We anticipate this business to remain very, very volatile quarter-to-quarter as long as the broader investment market activity and financial events continue to meaningfully sway investor confidence and sentiment. We are committed to maintaining our investment bank. We have wonderful infrastructure there, real great professionals that are part of that bank, and most importantly, a very loyal and long-term clientele that has been with the firm -- investment clientele that has been with the firm for a long time.

It is a tremendous business in the up part of the investment cycle, and I think the thing to watch for in '09, and as we go forward, is when the knives stop falling. It's -- the issue now is no one wants to catch the falling knife. I think a lot of our investors have traditionally been more than willing to invest in a good property for the future. It's just that prices are moving so fast, and the downward push, particularly in the fourth quarter of '08, has been so strong that everybody has just backed down.

While profits continued to suffer in the fourth quarter of '08 from our two transactional businesses -- that is, sale of real estate and investment banking -- our real estate portfolio of 29 properties maintained its overall 93% occupancy and provided steady rental income. FFO for the fourth quarter of '08 was $0.23 per share, all of which came from real estate operations, and that is net of the cost of maintaining our investment banking capability.

I'm very proud of our portfolio and how -- of properties and how well it did regarding rental and leasing during '08. We handled the small amount of roll we had -- lease roll we had in '08, I think, very, very well. We do have substantially more lease roll occurring in the second half of 2009 and going into '10. We're working on that now and, I think, making some very good progress, but obviously, we and every other office owner in the country is going to be subject to the marketplace and the business cycle employment and business capital spending, et cetera.

In late December of 2008, just a couple weeks before the end of the quarter, FSP invested approximately $40 million to purchase two additional properties for its portfolio. Full quarter operations from these two additional investments will be reflected in the first quarter results of 2009.

As the capital markets and US economy work through the current recession and financial credit crisis, we will continue to pursue additional commercial property investment opportunities. Our plan is to continue to use our balance sheet strength and very low leverage which, as John mentioned, that year-end is about 14.4%, to acquire properties.

Again, I think it is important to understand that every bit of ownership of FSP is in the common stock. There are no preferreds or preferred dividends to pay, no convertibles, and there is no property secured debt. We have been, in '08, very, very patient with the acquisition process, and I think it has paid off.

We purchased three new properties in 2008. In May, we purchased a property in Houston that we had actually developed in one of our single asset REITs, 157,000 square-feet -- square-foot office building for about $35 million. And again, these last two properties, in late December, that we purchased, approximately $20 million in the St. Louis area, 127,000 square-foot office building, and about $19 million in the Washington, DC, northern Virginia market, about 135,000 square feet.

These three acquisitions totaled about $75 million in total. And all three of these acquisitions are in existing markets, markets that we have been in and a part of for years. We know these markets. We have contacts in these markets, an inside view of, in our opinion, what is real value and what is not. And we would anticipate continuing to acquire, in '09, properties that we believe are good near term and long-term values in markets that we are already in.

We continue to be very optimistic about FSP's position in the current commercial real estate investment market and the opportunities that are presenting themselves to acquire commercial properties at better pricing and value metrics as we have -- that we have seen in the last few years. We think that this part of the cycle really allows FSP strengths to come to the forefront in terms of positioning the Company for the next part of the cycle, which, hopefully, will be a strong move to the upside, once we get past this economic and credit canyon that we're all facing. With that, I would be happy to open up for questions.

(Operator Instructions) Your first question comes from the line of Justin Webb with Robert Baird.

Hi, guys.

Hi, Justin.

George, a quick question on [rent renewal]. You touched on it in the prepared remarks, and is there any more information given how critical it's going to be to '09 results with the transaction business being relatively muted? Any more information in terms of maybe what's been renewed, what you expect to lose? I know a lot of it is back half weighted, maybe what kind of rent growth you're expecting there?

Yes, we do have in the press release, as you know, what portion of our leases are expiring in each year. In 2009 and 2010, you can see those numbers -- 11% and 14%, respectively. And again, 2009 is pretty much back half weighted.

If you were going to say [to me], Justin, what do we think will happen, the honest answer is, I don't know. The economy is certainly moving very fast, and a lot of companies out there that are trying to make decisions on space really seem to be somewhat frozen in terms of their ability to make a decision either to renew, expand, contract, et cetera.

So it's a very uncertain market. I'm reminded of -- I think it was Jamie Dimon at JP Morgan was talking the other day about his business, and he said, it's war out there. And I don't mean to be dramatic, but the reality of owning a diverse portfolio of office properties around the country with hundreds of tenants is that it is war, and the war is renewals at what rate -- what rental rate, at what terms, how much TIs, tenant improvements, leasing commissions you have to pay for that. You throw in on top of that bankruptcies that many times are just totally unforeseen, and it really becomes -- it really does become a war.

The -- at the end of the day, the war will be won by those companies that, number one, have good properties in good locations. We certainly believe we're one of those companies. And companies that have the staying power to deal with whatever comes at them relative to vacancy and relative to rental rate.

For us, Justin, I can't give you a good feel at this point, and I will try in the coming quarters to do that, as we get closer to expirations and deals that we're working on now -- where we are, but we will have some push and pull or offset from new acquisitions. Most of the new acquisitions that we are looking at and trying to acquire, very much like the three that we acquired during '08, are properties that are -- tend to be more fully leased, tend to have credit tenants that in this economy you can count on, and longer term leases.

So occupancy and rental rates -- and, obviously, the cap rates you can buy the new properties at --are going to sort of counterweight or balance what is going on in the existing portfolio. That's pretty longwinded and not real specific, but it's sort of the best I can do.

No, no, that's helpful. You mentioned cap rates there. In terms of cap rates that you're seeing out there, and I know, obviously, it's very market specific, but maybe on a more general basis. Like we all know, they're going up. But is there any sort of range, maybe, you're seeing, like in 8% to 10% range? Anything along that line?

Yes. Again, all real estate is local, and cap rates vary a lot in different markets. So broad based statements are not too pertinent when you're talking about a specific property in a specific market. But generally, for suburban or in-fill office buildings -- around the country, generally, we have seen during '08, cap rates rise by anywhere between one to 1.5 points. So if they were at 7% to 7.5% cap rates, they are now at 8.5% to 9% cap rates, and we're seeing that fairly consistently.

The problem, both -- as I mentioned earlier in the prepared remarks as a potential seller and as a potential buyer -- is that that market is moving so fast that if you're a seller, you're chasing the price of real estate down. And if you're a buyer, you're chasing that same price, and there still is, in a lot of cases, a disconnect between sellers and buyers. And the longer the process takes, the more -- the wider that gap tends to get, and both sides are having to back and fill to try to make deals. And then, of course, when you deal with the mortgage market at the same time, it becomes real tough sledding.

Right, right. No, that's definitely very helpful stuff. And then one more quick question, more of a technical question. But -- the G&A run rate, is maybe 4Q something more likely to be expected to defer. For '09, it came down a little bit and just wondering there what your thoughts are?

I think you're probably better off just using the full year.

Okay.

On average.

Okay.

That --

Sounds good. Yes, thank you.

Thanks.

Okay, Justin.

Your next question comes from the line of Eric Anderson with Hartford Financial. Please proceed.

Yes, good morning, George. Was wondering if you could just elaborate a little bit further on -- you mentioned the lease roll that's coming up, '09 and 2010, totals a little bit more than -- I guess, around 25% of the total. In terms of, is there a geographic concentration at all in some of the properties that are -- or the leases that are up for renewal, and are you starting to see any effect from the lower oil prices in the Houston-Dallas markets from last summer's decline?

Yes, I think our roll, Eric, is pretty much in concert with our concentrations. So I think we're fairly evenly spread relative to where our properties are concentrated. They're not -- the roll is not -- doesn't tend to be concentrated in one particular area. And again, rolling -- if you think of suburban office, which is our primary product type, and you think of an average lease of five to seven years in length, having an average roll of anywhere between 10% to 15% per year is pretty much the norm.

In other words, we don't have in '09 or '10 much more than a normal roll. What's abnormal is what you're rolling into, which is a -- just a tougher market. The Houston properties that we have, and I would say in any of the energy belt, in general, have done extremely well, in terms of occupancy and rental rate over the last couple of years. But clearly, growth and leasing activity in those markets, the energy markets -- and that, really, will include Houston and the Texas markets, Dallas, for that matter, and Denver -- clearly, energy is a component of leasing activity there.

What we're not seeing in those markets -- we're not seeing dramatic breaks in property prices. We're not seeing dramatic increase in vacancy or dramatic drop in rental rates. So occupancies, rental rates, prices of properties are holding pretty well. But what we are seeing is a real slowdown in new leasing activity. Definitely, the energy markets have affected that aspect of the energy belt.

With some of the deals that you're working on now, assuming they were signed five to seven years ago, are the per square foot rates that are being talked about higher or lower than the initial terms?

It really varies. I'm not trying to be evasive. It really varies, property to property and lease to lease. I will tell you, though, in general. And again, this is the same for -- no matter what anybody tells you, this is the same for everybody that owns office. It has turned into, during '08, a tenants' market. And tenants, particularly tenants that have any credit behind them, are calling the shots. They have plenty of choices. Their tenant reps and so on are back in the driver's seat, and it's much tougher to be a landlord and sign a new tenant at a good lease rate today than it was a year ago.

Having said that, what we are finding, in general, out there is that a lot of tenants, not all, but a lot -- a majority are willing to sacrifice lease rate for a bigger TI package , tenant improvement package, and lease terms, so that when you look at it in the individual office property and you try to think two or three-year or four years down the road in the other part of this cycle, and you say, am I going to compromise the ultimate value GOS, gain on sale, of that property on the back end when we go to sell it?

If you have capital, which FSP does, if you have cash, which FSP does, to pay TIs, leasing commissions, those up-front costs to get those tenants in the space, you can hold rate or increase rate, which makes the back end value of the property, obviously, much more enhanced. And as you -- as we look out there right now, against all of our competition, which is all of the other office buildings and all of the other owners, one of our strengths -- and we're seeing it day-to-day -- is that we are able to approach a tenant, existing or new, and offer a very, very attractive package in terms of TIs and leasing commissions because of our liquidity and our balance sheet. And that is making the difference, both in terms of occupancy and in terms

So as a corollary, then, you would be more inclined to let a tenant go if they were demanding a huge concession in rent, as opposed to trying to keep the building full at all costs?

I think, generally -- and it's a very general statement -- that's correct, Eric, and I think it flows, not only from our view of how important sale proceeds are on properties -- gain on sale and how compromising a lower rent stream can be to that, but it hits to something more near term and something that's really important, and that is, if you own an office building where you are, let's say, 60% leveraged with a mortgage, and you are facing that mortgage payment. In other words, if you don't pay that mortgage, you don't get to see that property two or three or four years from now. You are likely to take any rent to service that mortgage, because if you can't stay, you can't play.

We are not in that position. Now only time tells whether positions that we're taking with tenants, occupancy versus rate, as you would say, will pay off, but our 35 years of experience would tell us that that is the case and that cycles are cycles, and while this one may be deeper and wider than most, the back end of this cycle will be very, very opportunistic for those that keep the discipline and can afford to keep the discipline during this downturn.

Okay. Thanks, George. I appreciate it.

Welcome.

Your next question comes from the line of Mike Burke with Mutual Fund Management Systems. Please proceed.

Hi. Good morning, George. How are you doing?

Mike, good morning.

I just had one quick question on leasing and things like that. The LandAmerica financial lease -- since they're in bankruptcy, do you have a contingency plan for that? I believe it's coming up in -- at the end of the year or something.

Right. We have a property -- just to -- so everybody is on the same page. We have a property in Richmond, Virginia. That property is actually leased currently to Cap One -- Capital One Financial. And that's leased into the fourth quarter of 2009, whereupon the lease with Cap One ends and a direct lease with LandAmerica was scheduled to begin. In effect, Cap One has been subletting space in that building to LandAmerica over the last year -- year and a half. LandAmerica declared bankruptcy.

The acceptance or rejection of that lease is with the bankruptcy courts right now. So we will not know until the bankruptcy court decides on whether or not to accept or reject that lease. So contingency is, obviously, to release the property if the property were to go vacant. However, LandAmerica -- this is their corporate headquarters. LandAmerica has -- is trying to reorganize under Chapter 11, not seven. All of their computers and files and so on are there.

They have several businesses. Some of their business has been sold to another title company, Fidelity. Fidelity is on site there. There are three buildings that are associated with this particular property. What, if any, of those buildings and square footage LandAmerica may want may be accepted in the bankruptcy that is going on, what, if any, of those buildings and square footage Fidelity may want, which is, again, a purchaser of part of LandAmerica's assets, is a real question mark.

In addition, there are some other subtenants, or at least one other subtenant, that is there, along with LandAmerica. And where that subtenant goes and what space they require is still a question mark. So it is one of these moving targets that -- it's been almost two months now in bankruptcy courts. So we don't have a final answer on the lease.

We probably will get one within the next month or two is my guess. And as soon as we do, we will inform everyone about that particular property. But it's a little bit of a moving target, Mike, like -- by the way, like most Chapter 11 bankruptcies are.

Right. But currently, I would imagine Capital One is still paying on it through --

Oh, yes, it's 100% leased, and Capital One is paying and --

Okay.

Full rent.

Okay. Well, we have a pretty strong economy down here in Virginia, so it'd probably get leased up pretty quick, I would imagine. So thank you very much, George.

It's a -- you're welcome. It's a wonderful property in probably the best sub-market of the Richmond area, and so we're real optimistic about it, but have to deal with it. And again, these are the things -- again, you talk about war. I mean, it's war, and these are the things that you deal with in war.

Oh, yes. No doubt. Well, thank you very much.

You're welcome.

We have a follow-up question from the line of Justin Webb with Robert W. Baird. Please proceed.

George, just following up on the LandAmerica. Do you have any updates on the IBM lease that, I guess, comes due in July or the Staubach, which, I guess, has now been renamed, officially, to Jones Lang LaSalle, that comes due in April?

No update on IBM. That's a property in Detroit, and again, I don't have to tell anyone it's our only property in the Detroit area; there's Southfield, Michigan. But I -- but there's a question that surrounds IBM's future needs that is still not yet totally solved, so I don't have any update on IBM, probably will by next quarter.

Staubach, now Jones Lang, is in our Addison Circle property, which is Dallas on the toll way. And they've been a great tenant of ours for many, many years, and we're very sorry to see them go. They're moving down the road a bit. But we have very good leasing activity at that property, so we feel real confident there.

Super. Sounds good. Thank you.

Right.

We have no further questions in queue. I would now like to turn the call over to George Carter for closing remarks.

Thank you, everybody, for attending the call, and I will look forward to speaking with you on next quarter's earnings call. Thank you.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.