Franklin Street Properties Corp (FSP) 2013 Q3 法說會逐字稿

Good morning, and welcome to the Franklin Street Properties Corp. 3Q 2013 results conference call. (Operator Instructions) Please note that this event is being recorded.

Now, I would now like to turn the conference over to Scott Carter, General Counsel. Mr. Carter, please go ahead.

Good morning, everyone, and thank you for joining us this morning. With me are George Carter, our Chief Executive Officer; John Demeritt, our Chief Financial Officer; Jeff Carter, our Chief Investment Officer; and Janet Notopoulos, President of FSP Property Management.

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 of 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, 2012, which is on file with the SEC.

In addition, these forward-looking statements represent the Company's expectations only as of today, October 30, 2013. While the Company may elect to update these forward-looking statements, it specifically disclaims any obligation to do so. Any forward-looking statement 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'll turn the call over to John. John?

Thanks, Scott. Good morning, everyone. Welcome to our third quarter earnings call. I'll start with the quarter's results and then I'll go over the balance sheet and liquidity. Afterward, George Carter, our CEO, will provide his thoughts on the quarter and our results in more detail. As a reminder, our brief remarks today will refer to our earnings release, our supplemental package and 10-Q, all of which were filed yesterday, and can be found on our website.

For the third quarter of 2013, we continued to generate strong results, benefiting from the growth in our portfolio, as well as the strengthening of our balance sheet. For the quarter, our FFO was $0.27 per share, which is an increase of $0.03 compared to the third quarter of 2012. This increase was driven by higher property income due to five acquisitions completed since July of 2012, and improved portfolio occupancy and partially offset by lower interest income as a result of secured loan repayments and increased G&A costs.

Additionally, our per-share growth of 12.5% year-over-year includes the impact of our equity offering completed in May.

Regarding our balance sheet and current financial position, at the end of August, we closed on a term loan with our banking group to lock in attractive long-term interest rates. The $220 million unsecured loan has a term of seven years and provides us with significant flexibility. We fixed that rate at about 4%.

At quarter-end, we had about $952 million worth of debt on our balance sheet and a total market cap Of about $2.2 billion, with cash on hand of $26 million, and $168 million available on our $500 million unsecured credit facility. Providing us with total liquidity of approximately $194 million.

Our debt to total market cap a ratio was 42.7% as of the end of September and our debt service coverage ratio was about 6 to 1 for the third quarter. At this point, about 65% of our debt is at a fixed rate and all of our debt is unsecured.

As a reminder, all this information, including our supplemental, is available on our website. And we're happy to answer your questions after George's remarks on the portfolio and results. Thanks for listening to me. George?

Thank you, John. Good morning, everyone, and thank you for taking the time to listen to Franklin Street Properties' third quarter 2013 earnings call. As usual, my remarks today will generally follow my written commentary in yesterday's earnings press release. After my comments, we will open the call for questions.

For the third quarter of 2013, FSP's profits, as represented by FFO, rose approximately $5 million to $27.1 million or $0.27 per share, compared to $22.1 million or $0.24 per share in the second quarter of 2013.

Relative to funds from operations, FFO, this third quarter of 2013 is the first quarter of the year that reflects the integration of a majority of our additional capital inflows during the year, with our three additional office property acquisitions for the year. That would be 1999 Broadway located in Denver we acquired in May; 999 Peachtree, located in Atlanta, we acquired in July. And most recently, 1001 17th Street in Denver acquired on August 28.

Our directly owned real estate portfolio of 40 properties, totaling about 9.8 million square feet, was approximately 93.8% leased as of September 30, a decrease from 94.4% as of June 30. The drop in lease percentage for the third quarter was primarily attributable to the acquisition of 1001 17th Street in Denver, a 655,000-square foot office building that was 88.5% leased at the time of its acquisition. We believe this property offers a great opportunity to increase occupancy and rental income stream within a very vibrant and growing Denver CBD office market, creating incremental value for the Company.

Our portfolio has a relatively modest lease expiration schedule for the balance of 2013 and 2014. And we continue to proactively address future years' scheduled expirations where it is financially advantageous to do further lease renewals.

Growth in FSP's real estate asset base and balance sheet continued in the third quarter of 2013. On July 1, we acquired a 622,000-runable square foot office building at 999 Peachtree in the midtown submarket of Atlanta, Georgia for about $158 million. On August 28, we acquired the 655,000-runable square foot building at 1001 17th Street in Denver central business district for about $217 million.

Both Atlanta, Georgia and Denver, Colorado are core markets for FSP. And we believe both markets have strong, sustainable macro-economic growth drivers that offer the potential to really drive leasing demand and rental increases above average levels that are likely to be achieved for the broader US office markets.

As I'd said on other calls, and in meetings with many of you, we continue to believe that the most likely scenario for the broader US economy is that we are in the very early innings of a long up economic cycle and 15 years or more. And that this cycle most likely will be a slow growth cycle than other traditional cyclical recoveries.

There will be significantly slower stretches and some quarters that will hiccup badly in terms of growth. But the likelihood of a big, deep, long recession or another financial crisis, we believe, is not the most likely scenario.

We also believe that there is a reasonable chance that in the latter stages, or second half of this longer, slower growth up cycle in the economy, that some level of real inflation will present itself, broadly speaking, in the economy. We certainly haven't seen that in the last few years. But we think that has a real chance of happening again as this recovery continues to go along.

Looking forward, we have very strong growth plans within the Company. And certainly, the existing portfolio, occupancies and rental (inaudible) gains, particularly on some of the newer properties that we've acquired, we think will be a major part of that growth plan.

But when you look at our occupancies, near term, real growth in FSP is going to come primarily from additional property acquisitions. And again, if you have a core, most likely scenario of a long up economic cycle that we are in the early innings of, you would want to acquire as much in those early innings as you can, where you found good opportunity. And we have some good opportunities.

We have a pipeline of properties that we're pursuing and looking at. We're trying to acquire properties where we believe there are good, long-term macro-economic growth drivers. Energy is certainly one of those drivers, both international and domestic. The domestic energy business in the United States has, as you all know, really taken off and provided some interesting opportunities.

US housing, we think, will be a major driver. Food also is a major driver for both US and globally. The production of food, the processing of food, the distribution of food, I think, is going to become a bigger part of particularly global driver of growth. Technology, its creation and innovation, has always been an important part and will continue to be. And we continue to look it places and locations, general areas and specific areas, that have the logistical infrastructure in place to facilitate these growth drivers.

Our primary markets that we continue to focus on are Houston, Dallas, Denver, Atlanta and Minneapolis. As I mentioned, we do have opportunities to acquire there. Owners of properties have pretty much gotten to the other side of this canyon, which started in 2007, 2008 and 2009. They did not anticipate, in a lot of cases, being illiquid for as long as they have been. Whether or not they believe that the most likely scenario is a long-term growth cycle or not, they're looking for liquidity as the properties have gotten stabilized.

And we're getting those calls from them directly, or from their representatives, non-market sales as well as market sale opportunities. These properties, we believe, we can acquire at tremendous values, where current rent levels are below -- in property are below current rent levels in the market. And prices per square foot are meaningfully below replacement costs.

We will continue to pursue those acquisitions, again, as I mentioned before, continuing to build the portfolio with more infill, CBD and larger property type acquisitions going forward.

To help facilitate this acquisition growth program, on August 28, as John mentioned, we did close a new $220 million seven-year unsecured term loan with certain members of our bank group to lock in a longer term attractive interest rate, and improve the financial flexibility of our balance sheet as we continue to pursue these acquisition opportunities.

Going forward, we would anticipate our future debt components of our capital structure to keep two main characteristics. One is flexibility. We are currently all unsecured. We would anticipate staying that way and continuing to stagger maturities.

The other characteristic is really fixing rates and lengthening maturities. We're of a size now that we believe it is prudent to, in the coming months, begin work with rating agencies on a possible credit rating. And we would hope to achieve that in the future. And again, a credit rating would lower our costs and improve our capital markets access and efficiency, particularly on longer maturity debt.

As the fourth quarter of 2013 begins, our property portfolio is well stabilized with a balanced lease expiration schedule. For those of you have been watching, you will know that we have been making progress in the out years on our percentage lease role. Most of our largest property markets are now experiencing positive trends in both occupancies and rental rates.

We have a very simple and flexible balance sheet that provides an access to a variety of capital sources to support our ongoing growth objectives. As we approach 2014, we are seeing many potential opportunities for our consideration. We are very, very optimistic about our future growth potential.

With that, I will open the call for questions.

(Operator Instructions) The first question comes from Dave Rodgers with Robert W. Baird.

Maybe you can talk to some of that growth that you just mentioned, George. I think you've got a leased percentage of about 200 basis points above the occupied percentage. Maybe you can run us through when that occupancy starts to take shape for you and impact your financials.

Yes, I'll let Janet do that.

Unlike other quarters, I think we've got that lease (inaudible) occupied spread shrinking. And we expect that most of that spread is actually going to close out very quickly in the future two quarters.

Okay, great, thank you. And then on leasing economics this quarter -- and I realize there's not much left to lease in the portfolio as the occupancy and lease percentage is relatively high compared to your competitors. But leasing economics, by our calculations, did come under a bit more pressure this quarter. Is that something to do with leasing up maybe more stubborn vacancy, different kind of spaces? Or anything in the presentation there that we should be aware of that drove those TIs and free rent higher?

I think when we first started showing these numbers, we talked a little bit about how they were going to be a little bit hazy because of the GAAP accounting and the different kinds of portfolios that we have. So the biggest change really this quarter is doing some larger leases, which obviously, had more free rent, have higher economic costs than the previous quarter when we were doing small renewals. So that's probably the biggest change. And you're going to see that from time to time.

The other piece is that we still are reporting gross leases, net leases, and true triple net leases. So even the GAAP numbers don't always tie. From one quarter to the other, you may have one type of lease expiring or renewing in one quarter in a different kind than the other. But the major driver of the change this quarter is that we did some larger leases compared to the other quarters.

Okay. With respect to 2014, can you talk about where any of the unknowns are? You've got a little over 500,000 square feet between now and the end of 2014 expiring, including the month to month. Anything that you're just unsure about there that you just can't handicap that we should be aware of?

I don't think I can handicap any. But I can tell you that just looking at our biggest expiration tenants expiring in 2014, they are, for the most part, clustered in the markets that we're really bullish about. So Denver, Houston and a touch of Dallas. But really a lot in those two markets that we've been seeing the increases in rents and that we think are going to continue.

So while I can't handicap what's going to happen with those leases, I think we're in good markets for reaching the point of being able to decide that they'll get balanced between taking the opportunities and keeping the tenants (inaudible).

Great. And last question for me, either for John or for George. Leverage, pushing higher with the recent acquisitions of the high-quality assets you bought, both Denver and Atlanta. Can you talk about -- it's been about a year since you sold the building. I know that you've only sold a couple over the last two or three years. Would you look to recycle more assets here? Clearly, leverage still is cheap. But how do you think of financing these acquisitions and the external growth you talked about, George?

So we've been a little quiet on dispositions for a while. I would anticipate dispositions probably -- again, everything being equal; markets being equal -- picking up in the coming quarters. We have a number of smaller properties that are not fitting with our new, bigger infill core market acquisition strategies. These properties have been with us for a while. Most of these properties now have stabilized to a point where pricing makes some sense.

We just closed yesterday on -- you look at a property in the portfolio called East Renner. We just closed on that property yesterday, sold that in north Dallas. So there, for example, is a property that's in a market we like, but it's not a core property. It's not one that fits the new strategy. Pricing was great on it and we have a number of those around the country.

So that's definitely a process of recycling that will bring debt down, capital in, for acquisition work. And of course, depending upon the markets and specific opportunities, the broader capital markets we'll consider again next year as well, as we did this year.

Okay, great. Thank you.

The next question comes from Rich Anderson with BMO Capital Markets.

So George, you mentioned the real opportunity right now is to buy and buy as much as you can, prudently of course. But when does the switch flip, do you think? Based on what you've seen in history, when do you get to the point where the real opportunity becomes the internal growth? Do you think you have a two or three-year window left in front of you to be the buyer? Or is it shorter or longer than that?

That's a great -- I'd like to have those classes. Your great economist, Brian Belski, is somebody that we actually agree with a lot at BMO. And Bryan says this up cycle, he agrees that this is probably a long up cycle. It's got the three traditional phases in it. One is the phase that we're in now is the uncertainty phase or the denial phase. Then you have the phase where everybody agrees that we are, in fact, a good up trend. Then you have usually the euphoric face where underwriting and lending gets a little nuts at the end.

And I don't know the timeframes here, but I do believe that when you start to see, in office particularly, significant speculative construction coming on board. And when you start to see employment hit that point where employment is starting to actually push the inflation gauge a bit, those are two great signals. We're not seeing those signals yet, not on speculative construction and certainly not on employment.

But that would be the tip-off for us that we're starting to hit the mid part or the meaty part of the up cycle. And then you start to probably acquire less or more strategically acquire or more strategically dispose of and re-acquire. We did that in the last cycle, I think, very effectively as a company. And we certainly are focused on it this cycle. But if you said to me, Rich, two to three years, I wouldn't argue with that.

But again, opportunity comes in many places at many different times for many different reasons. And regardless of the part of the cycle, if you find the right opportunity, we'd certainly take it. But right now, you're seeing significant properties in markets that we want to be in, that we have these drivers that we think are really going to push the needle faster than the averages, coming to market.

And people are calling us on these. And these are properties now that are fairly stabilized, 80% to 90% leased, with rents below the markets and replacement costs just excellent, excellent values. So that will and. Whether it's two years, three years, or five, it will end if the cycle continues.

Maybe the litmus test is bank lending activity. I know we've seen some uptick in the banks' commercial real estate loan activity is on the uptake, but largely in the residential area. Is that something that you watch, dove-tailing off of those comments?

Yes, absolutely. That would be another really great metric to keep your own eye on. And you are right, in terms of office property --

Right.

-- that lending has not certainly hit a red flag that this point

Okay. In terms of the pipeline, can you give any color on the size of the volume that you're looking at least in the range of possibly happening?

Yes, I will let Jeff do that.

Jeff Carter here. Our pipeline continues to be active and robust as it's been for the last 18 months. Currently, I am underwriting a number of deals. I would say the approximate size -- the range of deals that I'm underwriting is approximately $300 million. None of those deals are made. But they are deals that are both on-market and off-market potential transactions that have the profile that's very similar to what you've seen us acquire over the last 18 months and that George described, anywhere from that 75% to 80%, 90%-plus-or-minus leased primarily in our five core markets. Those are the most watched right now for us.

So $308 million, so that is what, two assets?

That's (inaudible).

That's a lot, actually.

And then Jeff, maybe a follow-on to that for you, in the summer, I suppose maybe you saw some impact from rising rates and how that may have impacted or slowed the transaction market. First of all, can you confirm that you did see some impact? Second, are we past that now? And are sellers more comfortable with where we are from an interest rate perspective?

It's a great question. I'd say that I saw a very modest impact in my world on what I was working on. Again, I've had a healthy mix of work both on off-market deals where I'd be able to comment a little less on that. The on-market deals that we've looked have had a healthy amount of competition associated with them. The pricing has been, we think, advantageous and opportunistic. But the pricing held up, I thought, reasonably well through it all.

Okay. And then last question for me, and maybe this is more conceptual for George. Do you think of the Company as more of an asset aggregator or more of a targeted market strategy or some combination in between? And I'd like you to tell me what you think is better or worse about one or the other type models, depending on what you think you are.

I'm not sure what you mean by asset aggregator.

You have a local sharpshooter type of company that maybe has a lot of market share in a given market. Whereas you have focused markets, but you own a few assets in each. Just curious if you feel yourself getting into more of a clustered story from a market exposure perspective.

About 70% of our assets are in five markets. These five markets are markets that we really believe are going to outperform in general. Then when we get within those markets, these are all large markets. Denver, Huston, Minneapolis, these are huge markets.

Right.

The submarkets within those, we are definitely sharpshooting within those submarkets, specific situations. And I don't think we are -- we're certainly not looking forward to simply aggregating properties in general markets to aggregate them. We certainly are not doing that.

But we are looking to acquire significant new properties in our core markets where the particular location submarket, the physical characteristic of the property, really sharp-shoots to a point of growth that we think will be exceptional when compared to the broader office market.

Okay. That's great. Thank you.

Thank you. There are no more questions at the present time. So I'd like to turn the call back over to George Carter for any closing remarks.

Thank you, everyone, for tuning into the call. We appreciate it and we look forward to talking to you next quarter.

Thank you. That concludes today's conference. You may now disconnect your phone lines. Thank you for participating and have a nice day.