Franklin Street Properties Corp (FSP) 2011 Q4 法說會逐字稿

Good morning and welcome to the Franklin Street Properties Fourth Quarter and Year End 2011 Results Conference Call. All participants will be in listen-only mode.

(Operator Instructions)

After today's presentation, there will be an opportunity to ask questions.

(Operator Instructions)

Please note, this event is being recorded. I would now like to turn the conference over to Scott Carter, General Counsel. Mr. Carter, the floor is yours, sir.

Thanks, and good morning, everyone. Thank you for joining this call. With me this morning 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 purposes 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, the various important factors, including those discussed in the risk factors section of our annual report on Form 10-K for the year ended December 31, 2011, which is now on file with the SEC. In addition, these forward-looking statements represent the company's expectations only as of today, February 22, 2012. 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. Our reconciliation 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'll turn the call over to John. John.

Thank you, Scott. Welcome to our earnings call. We're going to be talking with you about our fourth quarter and year end results and we'll start with a short overview. Afterwards, George Carter, our CEO will further discuss 2011 and FSP.

I'm going to be brief and we'll be referring to our earnings release, the supplemental package and the 10-K that were filed last night. As of yearend, we had cash of $23.8 million and $151 million in availability on our line of credit, giving us about $175 million in liquidity. At 12/31 we had $449 million in unsecured debt and our total market cap was about $1.3 billion. We only have unsecured debt on our balance sheet and our total debt to total market cap ratio was 35.2% at December 31. This leverage ratio continues to provide an attractive loan to value for our lenders and it forwards our shareholders a significant and more conservative equity investment in our real estate.

On the income statement, we measure our performance with some key drivers which we have talked about before and include FFO and gains on sale of assets as well as the total of those two combined. FFO for the fourth quarter of 2011 was up about $1 million compared to our fourth quarter last year. We acquired a property on September 30 and another one on October 6, so there was a meaningful contribution from both of them during Q4. We also had the benefit of new leases signed over the last few months over the leases that had expired.

Also included in the fourth quarter were termination fees of about 325,000, but we also had about $379,000 in restructuring charges related to the activities with the investment bank. FFO for the full year was $4.3 million ahead of 2010, which is about $0.03 per share per increase. During 2011 we acquired five properties and we did sell two. We also increased occupancy about 3.1% during 2011 to end the year at 88.7% leased. These were factors in the increase in FFO this year compared to last.

As far as GOS is concerned, our gain on sale of our assets, we sold two properties this year. We had a total gain on sale of about $21.9 million or $0.27 per share and didn't sell any properties in 2010. When combined with FFO, our total profits therefore were $93 million or $1.14 per share this year compared to $0.84 in 2010.

So that's a brief overview of our financial performance. The earnings release, supplemental and 10-K filings go into a lot more detail about our results and we can also take more questions at the end if you want to discuss things further. So this concludes financial highlights and at this point our CEO, George Carter, will tell you more about FSP results and where we are. Thanks for listening. George.

Thank you, John. Welcome to Franklin Street Properties fourth quarter and full year 2011 earnings call. I will follow my written remarks in our earnings release last night, trying to put a little more detail and perspective to them in this call.

For the fourth quarter of 2011, FSP's profits as represented by FFO totaled approximately $18.5 million or $0.22 per share, an increase of approximately $2.1 million or $0.02 per share compared to the third quarter of 2011.

For the full year 2011, FSP's profits as represented by FFO totaled approximately $71.2 million or $0.87 per share, an increase of approximately $4.3 million or $0.03 per share compared to full year 2010.

For the full year 2011, FSP's profits as represented by FFO plus GOS, that's gain on sale, totaled approximately $93.1 million or $1.14 per share, an increase of approximately $26.2 million or $0.30 per share compared to full year 2010.

On a fully diluted per share basis, FFO increased by about 3.8% in 2011 while profits as measured by FFO plus gains on property sales, or GOS, increased by about 36%.

In the past, we repeatedly referred to 2010 as our hump year and commented that we anticipated that 2011 would be the first year of profit increases since the economic downturn in 2008. And so it proved to be. The one caveat to the 2011 forecast of a turn up in profits was that the economy would not sidetrack us by experiencing another significant downturn or double dip. In fact, the US economy did experience sort of a mid-year stall that clearly slowed down FSP as well as many other owners of commercial real estate. However, lately, many metrics are looking better for the general economy and a true double dip appears to have been averted at least for the time being.

For FSP and most other suburban office owners, we believe that the possibility of significant future rental growth in our existing portfolio and, more generally, in most suburban office assets, will be directly tied to US employment growth. At the end of the fourth quarter of 2011, the suburban office vacancy rate in the US stood at a disappointing 19.6%, while FSP's vacancy rate stood at 11.3%. We believe that the fundamental de-levering of a US economy that generated much of its previous growth with too much debt capital has not yet been accomplished.

We also believe that broad based sustainable and meaningful US employment growth has been much slower to get started since the technical end of our country's recent recession when compared to other past cyclical recoveries.

Profit growth in FFO for Franklin Street Properties in 2012 is likely to be affected primarily by two factors, one, occupancy levels in the existing portfolio and, two, additional real estate investments that are accretive to FSP's cost of capital. We believe that longer term profit growth and broad based office value appreciation are not likely to occur until rental growth and net operating income have sustainable demand driven advances generated by higher employment and the corresponding need for more office space. We do expect to continue to grow our profits in 2012 over 2011 levels.

During 2012, FSP will continue to focus on increasing occupancy in its existing portfolio of office buildings. We experienced a high level of tenant lease flow over and vacancy in 2009 and 2010 within a relentlessly weakening overall office leasing market. Occupancy in the FSP portfolio dropped from approximately 93% to a low point of approximately 82% during that time frame.

Along with generally stabilizing rental markets during 2011, we succeeded in raising overall occupancy in our portfolio to 88.7% as of year-end 2011 and up from 88.1% as of the end of the third quarter of 2011. In addition, we have only 4.1%, 6.3% and 6% of tenant lease expirations scheduled for 2012, 2013 and 2014 respectively. We have as our objective to move overall occupancy levels to the 90% plus range during 2012.

There was one new real estate investment completed in the fourth quarter of 2011 for a total initial capital contribution of approximately $76.2 million. The investment is a two year bridge loan secured by a first mortgage on a CBD office retail property in Minneapolis, Minnesota. The property is owned by FSP 50 South Tenth Street Corp., a single asset REIT affiliate of FSP. The loan also includes a revolving line of credit component for up to $30 million to be used for lender approved, tenant improved across leasing commissions and other incentives necessary to lease space at the property.

Consequently, the total loan commitment amount is $106.2 million. The property is a 12 story class A multi-tenant office retail property built in 2001 containing approximately 499 thousand rentable square feet of which approximately 90% is office space.

FSP sponsored the syndication of shares of preferred stock in FSP 50 South Tenth Street Corp. between November 2006 and January 2007. The property has maintained an average occupancy in excess of 98% over the past five years and, as of December 31, 2011, was approximately 98.8% leased. The property is located between and connected by a sky bridge directly to the Target Corporation and US Bank Corp. corporate headquarters buildings in downtown Minneapolis. FSP has four office properties in the greater Minneapolis area, either owned directly or through affiliates totaling approximately 1.4 million square feet.

We believe the 50 South Tenth Street loan to be one of the best risk reward adjusted real estate investments we have ever made. The opportunity was afforded Franklin Street Properties by our original sponsorship of the 50 South Tenth Street syndication five years ago and our intimate and proprietary knowledge of the situation of the property gained through the assets management by FSP since that time.

During the fourth quarter of 2011, we completed the full $62 million subscription of our private placement offering, FSP Union Center Corp., which began in March. On December 15, 2011, we announced that FSP Investment LLC, our broker dealer subsidiary, will no longer sponsor the syndication of preferred stock in newly formed single property companies. FSP Investments LLC may sponsor other types of real estate investments in the future.

FSP will continue to manage all the affairs of the 16 existing single property companies that set outside of FSP. And FSP has meaningful equity in first mortgage loan investments in many of these entities and receives ongoing asset management fees from all of them. Original capitalization of these 16 single property companies was in excess of 900 million.

We believe FSP continues to be in an excellent position to achieve meaningful long-term profit growth. Our company will continue to use its capabilities and strong balance sheet to take advantage of competitive tenant leasing requirements and attractive real estate investment opportunities that are presenting themselves as a results of the current cyclical softness in the economy and certain commercial property markets. We are very much looking forward to 2012 and beyond. With that, I would be happy to open it up for questions.

Thank you, sir.

(Operator Instructions)

The first question we have will come from Thomas Hackett of Capital Investment Counsel. Please go ahead, sir.

John, George, good morning. Did FSP receive a one-time benefit on the 50 South Tenth Street financing that was recorded in 2011 sometime in the fourth quarter? And will there be some ongoing benefit from that loan over and above the cost of your funds?

Yes, Tom. This is John Demeritt. It was part of the loan we received the 1% commitment fee up front that we received in cash, which is about $762,000. The accounting rules you know have us amortize that into income over the period of time we have the loan, so it's not in our fourth quarter numbers to any degree. We might have amortized two days of that fee into 2011. And we have a 50 basis point approximately exit fee at the end of this loan that we'll get when that loan is repaid. So that's about 1.5% above the stated rate of about 6.5%. So on a two year loan I'd say the return is about [7.25], you know if you want to look at how it affects us in 2012 and beyond.

All right. Secondly, you're now 32% leveraged. George talks about buying more properties. Do you expect to increase that leverage by borrowing more money going forward above the 32% that you currently have?

We're actually [35.2], the way I had it calculated, but maybe George might want to talk about acquisitions and that.

Yes, Tom, I think we could definitely go up in leverage for a short period of time. Again, for longer periods of time I think our leverage will stay modest and I think it will stay in the 20% to 30% area over long periods of time, but there may be short-term opportunities that our leverage could spike up to the 40% plus level. I don't see it any higher than that.

All right. Thank you.

Thanks, Tom.

John Guinee of Stifel Nicolaus.

Hi, John Guinee here. Let me drill down a little bit more on the 50 South Tenth Street. First, the big picture appears to me that your loans to affiliates now represents a little over 10% of total enterprise value. Is that a correct number?

I don't know how you calculate total enterprise value, John, but it certainly is a substantial amount.

But basically your equity cap plus your debt comes out to about $1.3 billion and your loan to affiliates is about $140 million, so you're a little over 10%. What do you see happening there? Is that a max out or do you see that increasing?

It's George, John. Our loans to affiliates are just on a property by property basis. They are wonderful investments for us. They match short term with sort of major on up our line. Most of them, other than 50 South Tenth Street, are real low loan to value type loans. They're much better risk reward adjusted for time frames than any place else we can get a return. We know these properties intimately and on a property by property basis, if the entities that own those properties require financing, we would consider them at any time. At the present time, we don't have any additional plans to make additional loans, but additional loans could be in the future if they made sense for FSP.

Okay. So on 50 South Tenth Street, just drilling down a little bit, it looks like there is a $76 million B of A loan, $70 million worth of equity syndication proceeds, $146 million to about $292 a foot. The B of A loan matured. What was your options with B of A to rebalance that loan, pay it down a little bit or extend it with B of A and then what other things did you look at on this particular asset?

So this is sort of a view from 10,000 feet and again we have to be a little careful here in that 50 South Tenth Street Corp. is a public reporting company and so it's under all the rule reg FD and all that sort of stuff, so I want to try to give you again a little bit higher view of this, but it's not much different I think than many other people find themselves in today with office buildings. We bought and syndicated this building in 2006, 2007, and took out a fairly high loan to value at that time, about 60%, which again for FSP, particularly back in that time, would have been extremely high leverage.

We didn't really have much of any leverage back then. So here's the single property. You took out a 60% loan to value. It was a five year loan with B of A, a five year loan interest only. And low and behold, you go through this downturn and the property is just a magnificent piece of real estate. It's performed beautifully over the time frame, always 98% or better occupied during the time frame. Paid big dividends to the 50 South Tenth Street shareholders, but as you got to the maturity of the B of A loan, with the downturn, we talked to B of A. 50 South Tenth Street talked to B of A to see if they would be interested extending the loan and, like most lenders, they said, well, now the loan to value has potentially changed to where we wouldn't want to extend the loan for that amount.

And on 50 South Tenth, there was a specific issue which affected that loan to value and that was that about half of the square footage of that property, between a sub-lease and a primary lease, is leased to one company, the Target Corporation. And those leases expired or do expire in about two to three years. So when you look at the possibility of the office space portion of this property, going 50% vacant if you don't release that space, that same 60% loan value that was given five years ago is not available today, at least from a conventional lender.

And so the 50 South Tenth Street board, knowing this was the case early in 2011, commissioned a survey from a third party to check out all possible lenders to replace this loan. And 50 South Tenth Street commissioned a survey, got a survey of over 30 lenders. Most of these lenders are what you would call sort of unconventional lenders. Some of the names are big names, but they have sort of an unconventional monetary component to some of their lending capabilities. And the survey sort of priced out where you might be able to do a bridge loan of the type that FSP provided.

And so for the 50 South Tenth Street shareholders, the average of all of that survey was exactly what the market rate was or market terms were and FSP felt that was a great loan because we really know this property and know what the potential is to lease that 50% of that space on a longer term basis. Again, it's leased fully for the next couple of years, so you're really talking about a longer term extension to put the loan to value back in its proper perspective. So FSP was more than willing to make that loan based upon 50 South Tenth Street's commission of a survey to determine what the potential lenders would be and what rates they might charge.

So of the 30 lenders, the average loan was $76.2 million and the average interest rate was 6.5% plus fees?

That's correct.

Yes.

And so what you're telling me is someone is willing to lend $152 a foot on a low-rise building in the Minneapolis CBD that may go to 50% leased in about 24 months and that same lender is willing to write a check or have an accordion feature of the loan of $30 million, which gets you up to 212 a foot in the Minneapolis CBD?

Yes. The $76.2 million was the loan amount that 50 South Tenth Street commissioned the survey for, which again is about $152 a square foot, which is a fantastic price for a CBD building in Minneapolis. The $30 million revolver again is only used if, in fact, you get a lease extension or new tenants in the property. In other words, it's only used if you're going to extend the rent period. So that's a different sort of pile of money, but it's in the same loan as a revolver on top of the $76.2 million. But the answer to your question is yes.

In this day and age, a lender who is willing to spend $76 million, $152 a foot, so why would FSP make this loan? You're not really in the lending business. You're in the equity investment business.

No, John, we're in the lending business, too. We're in the real estate business and we do lots of different types of real estate business. We've been making loans for a lot of years. It's part of our income. This is a wonderful real estate investment. We are willing to make this. We wanted to make this because we think it's one of the best risk reward adjusted investments we've ever made. We've been managing this property for five years. We really believe that we will be able to recoup all of our loan, a fantastic interest rate on a short-term loan and that the future value of that property will give tons of flexibility in terms of financing out with a more traditional third party long-term loan or an outright property sale.

This property is located in really one of the best locations in the whole Minneapolis CBD. It's right on Nicollet Mall, which is not a mall the way you think about it. It's a street. And it's the only building that is connected directly by skyway to Target's World Corporate headquarters. And most of the other tenants in the building - Target is the tenant that has the 50% position on the building. And again, Target's headquarters is right next door. Target's flagship retail store is actually part of our building. We don't own that store. It's separately deeded. But if you know like Bentonville, Arkansas with Walmart or any of these big retailers, the vendors who want to sell their goods to Target to carry in their stores, want to be as close as they can to Target. And so the rest of the space is basically leased to vendors and vendors are all over Minneapolis and they have a great desire to be in that property. So even if Target were not to extend, we feel very, very confident that vendors would come in there quickly and efficiently and make good the value of that property in our loan.

In fact, Target has made a real commitment to downtown. They actually purchased the land, an older building, right across the street and again, with all of our discussions with Target, with their purchase of the Canadian outfit, I believe it's called Zellers, if you look at their plans for employee growth, it's significant. And we believe their commitment is to downtown. We believe this property figures into their commitment. And it is that knowledge, it is that unique proprietary knowledge that you can only gain by owning and managing a property for the time that we've owned and managed it, that gives us the insight into the value of this loan, which we just think is extraordinary. We think it's one of the best investments we've ever made.

And Oracle or Target's lease expires 3/31/2014. Your loan expires 12/31/2013?

Right.

Your loan matures 90 days before the lease expires?

Right.

So I guess the intent is to have a new lease recast?

That's the intent.

And if you don't have a new lease recast, what's the building worth relative to your $76 million loan?

I think a whole bunch more.

After lease, no cash flow?

I think a whole bunch more.

I need to go on record, George. This feels like a really good deal for your single asset REIT, but not at all the business you should be in.

Well, John, you know I don't think it's your job to tell us what business we should be in. We are in the real estate business. This is a great real estate investment. If you don't think so, that's your business. But our business is real estate investing and this is one of the best investments we've ever made for our shareholders.

How many other publicly traded office REITs are making 2 year bridge loans that mature 90 days before a building has a potential to goes 50% occupied?

You know that better than I would.

I do. That's my issue. All right. Thanks.

You're welcome.

Jeff Lau of Sidoti.

Hi. Good morning. I guess I'm going to back up and just more on a general perspective, I guess could you put it into words a little bit more how you viewed the suburban office market in 2011 and how that's going to kind of compare to 2012 and how it's going to affect the company?

Yes, Jeff. Good morning. Well, in 2011 we generally saw in all of our markets truly what you would call a broad based stabilization of both occupancies and, in general, rent levels. Now again, it varies from market to market somewhat and it varies certainly from sub-market to sub-market somewhat, but broadly speaking we think we've bottomed on at least the markets where our suburban office are in and I think probably suburban office in general has bottomed.

Now depending on where your leases were originally written and when they expire, you could still have some rent roll down. We've had a lot of ours expire. We've taken our biggest roll downs. And as you know, we don't have much lease roll or expiration coming in the next three years. So if you're in a stabilized market, which we are in, and we don't have a lot of lease roll, then we have an opportunity I think for increased occupancy and somewhat increased rental rates in some of our markets on some of the leases that are expiring. Some will still roll down a bit.

But I think the question for us and I think for probably every suburban office owner is what is the pace of climb out here? I mean you're still almost 20% vacant nationwide in suburban office and there's only one way that you climb out and that's via employment growth and demand. And until you can get sort of general vacancy across the country down into that 10%, 12% level, it's hard to push rents at all. So I think looking forward for FSP, the FFO growth is really going to come primarily from increased occupancy rather than current leases that are rolling in terms of rental increase and obviously increased property investments that are accretive to our cost of capital.

So looking at 2012 and believing that you probably still have a fairly sluggish climb out of the recession and fairly sluggish employment growth, again although statistics have been somewhat better recently, you should look I think for occupancy increases at FSP and property investments at FSP to push the FFO or profit growth.

And would you say the negotiations I guess on new leases, are they easier in certain regions, harder in certain regions at all or is it fairly similar?

No, it can vary quite a bit. I mean there are markets, for example, one of the markets in Texas we're in is Houston. And the sub-markets that we are in in Houston and properties that we're in are actually fairly hot right now. I mean Houston is energy driven and there's tightness in energy corridor and energy related areas. You can go over to Dallas, another Texas market that we're in, and certain sub-markets in Dallas actually are still very slow and very, very tough. So there is difference between cities, between sub-markets. I mean in greater Dallas if you go up to far north Dallas, that market is actually really strong right now. If you go over to the Las Colinas market in Dallas, that market is still very weak. So within the same metroplex you have huge differences in dynamics.

Okay. Great. And what's left in terms of financing availability, like the credit facility? What's left on it?

We have about $151 million left on the $600 million line that we have currently. And the banks have expressed a willingness to do some other types of debt transactions with us if we were interested in doing that.

When is the maturity date on that facility? Did you guys just recently restructure that or is it --

That one matures in '14 with a one year extension option.

You said 2014?

Yes.

Okay.

Yes. I think it has a 1 year extension feature to it that we can take it out another year to '15.

All right. Thanks.

No problem, Jeff. Thank you.

At this time we will go ahead and conclude the question and answer session. I would now like to turn the conference back over to George Carter for any closing remarks. Mr. Carter.

Well, just thank you to everyone for tuning into the earnings call and I look forward to speaking to you all in the next quarter.

And we thank you, sir, and to the rest of management for your time. The conference is now concluded. We thank you all for attending today's presentation. At this time you may disconnect your lines. Thank you.