Franklin Street Properties Corp (FSP) 2014 Q3 法說會逐字稿

Good morning, and welcome to the Franklin Street Properties Corporation Third Quarter 2014 Results Conference Call. All participants will be in listen-only mode. (Operator Instructions) I would now like to turn the conference over to Scott Carter, General Counsel. Please go ahead.

Good morning, and welcome to the Franklin Street Properties third quarter 2014 earnings call. With me this morning are George Carter, our Chief Executive Officer; John Demeritt, our Chief Financial Officer; Jeffrey 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 Factor section of our annual report on Form 10-K for the year ended December 31, 2013, which is on file with the SEC.

In addition, these forward-looking statements represent the company's expectations only as of today, October 29, 2014. 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'd like turn the call over to John. John?

Thank you Scott and good morning everyone. Welcome to our third quarter 2014 earnings call. On today's call, I'll begin with a brief summary of our quarterly results and also our financing update. After my remarks, our CEO George Carter will discuss the quarter in more detail and provide an update on our operations and overall strategy.

As a reminder, our comments today will refer to our earnings release, supplemental package and 10-Q, all of which were filed yesterday and can be found as Scott said on our website at www.franklinstreetproperties.com.

For third quarter, we reported an increase in funds from operations or FFO of about $300,000 to $27.9 million compared to the third quarter of 2013. The increases were driven by higher property income and were somewhat offset by higher G&A costs and interest costs. FFO per share was $0.28, which was flat year-over-year and also compared to the prior quarter. Year-to-date, our FFO was $0.85, which represented 9% increase over the same period last year. And the change was mainly driven by the same factors that affected the two quarters, which was, higher property income and somewhat reduced by higher interest costs and increased G&A. Our results this year have been in line with our expectations.

Turning to our balance sheet and current financial position. At September 30, we had approximately $905 million of unsecured debt outstanding and our total market cap was $2.03 billion. At quarter-end, we had a cash balance of $15.9 million and $250 million available on our $500 million unsecured line of credit, giving us about $231 million of liquidity to support our capital needs and growth strategies.

We remain comfortable with our leverage and our debt to total market cap ratio was 44.6 at the end of third quarter. Our debt service coverage ratio was above five times and our debt to adjusted EBITDA ratio was about 6.7. We became investment grade rated this past June and are currently working with our bank group on the credit facilities that we have, which consists of five and seven year term loan in our revolver.

We hope to announce the transactions soon that extends our revolving maturity out four years to 2018, with the one-year extension option like we have now, that would take us out to 2019 if we use that expansion. We think this is a good time to extend our bank maturities ahead of the potential impact of costs coming from increased regulations on banks.

Our rating also positioned us to obtain lower lending spreads on our revolver and lower facility fees. Once we do close the transaction, we will make the appropriate disclosures so the information will be available to everyone. We remain an unsecured borrower and 69% of our debt is at a fixed rate at September 30. We believe our balance sheet strategy provides flexibility to efficiently make real estate investments and to recycle assets when we feel it makes sense.

There is also a balance of having longer term debt and as they grow or as we grow, we expect to latter out these maturities. Lastly, in our press release last night, we updated our guidance, the tightening our range for FFO guidance to $1.10 to $1.12 per share from $1.09 to $1.12 per share, representing an increase of $0.01 at the low end of the range. As a reminder, our guidance excludes the impact of future acquisitions, dispositions, and capital market transactions except for those that we've already announced.

With that I'll turn the call over to our CEO, George Carter. Thank you for listening. George?

Thank you, John. Good morning everyone and thank you for taking the time to listen to Franklin Street Properties third quarter 2014 earnings call. My prepared remarks today will follow my written commentary in yesterday's earnings press release. And after my comments, we will open the call for questions.

For the third quarter of 2014, FSP's funds from operations or FFO totaled approximately $27.9 million or $0.28 per share. And as John said, that's flat year-over-year to the quarter as well as flat against last quarter. For the nine months ending September 30, 2014, FSP's FFO totaled approximately $84.9 million or $0.85 a share, a 9% increase over the same period last year about $13.3 million. Our directly-owned real estate portfolio of 39 properties, totaling approximately 9.7 million square feet was approximately 93.3% leased as of September 30, 2014, that's down from about 94% leased at the end of last quarter and our comparative same-store rental growth continues to total approximately 2.8% through the first nine months of 2014. Currently, we are in active efforts to lease existing vacancy, future portfolio lease-rolls and to potentially dispose of several of our suburban office assets that we believe are no longer core to our long-term strategy.

On the disposition side, we are currently marketing six non-core properties with an estimated market value of about $150 million. We may sell all of these, none of these or some of these properties likely in the fourth quarter of this year and the first quarter of 2015. We are also pursuing a number of potential new property acquisitions within our primary markets. And I will tell you that the world has come to our primary markets over the last 12 months with a vengeance and they are looking to purchase the kind of properties that we have been purchasing and are continuing to look to purchase that is urban infill CBD properties that have real value relative to replacement costs, current market rate -- current market rents in the properties relative to the market rate that we could roll up to. And between that competition, cap rate compression and so on, we have seen on particularly fully-marketed heavily big deals, prices really start to rise and some of the underwritings has gotten too rich, broad, bright and we have backed out of them. We still have several projects we're working on which Jeff can talk about later.

And we particularly are focusing on our relationships where we have an opportunity to pursue properties that are not fully marketed that are half marketed, they are not getting this bid process that seems to be driving the prices up to areas that we do not feel comfortable with. And we also are continuing to analyze with our development team, the best opportunity for the anticipated future repositioning of our 801 Marquette Avenue South office building located in Minneapolis, Minnesota. This if you remember is the smaller of two buildings, 170,000 square feet, approximately a four-storey building that TCF Bank will vacate starting in 2016. We have been working with our teams, talking to potential Minneapolis tenants, seeing what the demand is for the kind of space and the amount of space, trying to scope out the size and cost of project relative to tenant interest. We do not anticipate new repositioning until we have some pre-leasing done with tenants but have a lot of activity there and are very excited about future opportunity.

As we begin the fourth quarter of 2014, our property portfolio is operating smoothly and our markets are generally steady or are improving in terms of their rental conditions. And while the third quarter was fairly quiet, there was a lot of effort in activity behind the scenes on leasing property dispositions and acquisitions that should make the coming quarters noisy.

With that, I will open it up for questions.

(Operator Instructions) John Guinee, Stifel.

Great, great. Hi George, thank you very much. Can you expand a little bit on noisy, sort of what do you see happening and are you considering equity raise as part of all the moving pieces?

Hi John, noisy will basically be defined as dispositions and acquisitions, I think that's the level of noise. We hope to also be able to announce something specific on our Minneapolis potential develop, so that would be the noise level.

I think right now, everything is on the table in terms of capital structure, so we never take anything off, but the acquisitions and disposition funding I think right now as we look at it could balance out all of our needs, but you just don't know until in fact, you dispose [out and until you] acquire, whether those capital structures will match up, right now, they're looking like they will.

Great, thank you.

Dave Rodgers, Baird.

Hi, good morning, guys. Just maybe could you give us a little more color on the acquisition volume, the pipeline that you're looking at kind of what types of deals are in there and then maybe more specifically put a range around any type of dilution or cap rate spread between the dispositions you talked about and the acquisitions that you're kind of underwriting today?

Hey, good morning Dave. In terms of acquisition pipeline and volume, I've been pleased all year with the pipeline and the volume, it's been steady both on a marketed and an off-market basis. As George indicated, there is a lot of capital chasing prospective deals in our five core markets and the types of properties we're looking in our acquisition pipeline at the moment is about $558 million in deals, and all those deals are within our core five markets. The profile of the deals we're looking at and that you're likely to see from us will look very similar to what you saw us acquire last year in terms of downtown, urban, infill CBD for all of the assets.

The assets that we're looking at has a range of profile from true last mile value add to deals that are relatively well leased that have some existing leasing to do but also rents that are on-balance below today's market and can roll upward, also some deals we're looking at have good vacancy right now or occupancy right now, may have a couple of tenants that we think are opportunistic for either expansion or recapture with new tenants. In all cases, we're looking at deals that have low replacement cost pricing and it's again in our five core markets.

Our cap rate ranges we're looking at continue to be in the 5.5% to 6.5% cap rate ranges. And in terms of the deals that we're looking at dispositions where that George referenced, it would be too early for me to comment on cap rate spreads.

Okay, that's helpful. Maybe for George or Janet. Looks like the West region, the lease percentage continues trailing below the occupied percentage. I guess one question is, how far out are you looking on that lease percentage number and can give us any color on kind of the activity in the West region?

I'm sorry, the leases is merely leases that we have already executed that. I think you have not yet commenced, so you don't say the FFO or the cash, is that your question, because I think we disclosed that spread in the supplemental as to what is --

I guess in the West region, the lease percentage is trending below the occupied percentage. So I was wondering on any text of potential move out that you're seeing in that particular region that would drive the lease percentage below the occupied percentage.

You're saying on a trend basis, not on an actual basis.

Just quoted in the supplement.

Could you -- I'm sorry, could you just direct me to this.

Page 16.

Sorry to take the time. And you are looking at --

The West Region subtotal for lease percentage 84.7 --

Oh, okay. One is weighted average for the nine months versus the percentage lease. So, if you look at the total, I believe on those pages, they don't tie to what we reported lease for the portfolio as of the end of this quarter.

Okay, maybe a follow-up on that, maybe another question, RGA --

It's (inaudible). I'm sorry.

We'll develop on that I guess and understand it better. But with regard to the RGA Reinsurance space, any color on the back sale or the ultimate outcome there?

We still -- we did not find any leases yet, they are still scheduled to move out December 31 and we should be able to have the space back and ready to show in January. We continue to have a number of prospects in different sized categories, personally I think the activity is going to pick up once we get control of the space and we can get people through and show it. For those of you who don't, there are three buildings in the Timberlake project, RGA has been the middle one and in part of the third building. They're good buildings, attractive buildings with great highway access and visibility in desirable sub-markets, St. Louis market has recovered, and it's fairly stable. So I think we would get those buildings leased and that the activity will begin once the move out takes place. And I don't have anything to report right now.

Finally, George on Minneapolis, can you talk about whether you'd go ahead with that, is a spec project or you specifically marketing to users before you move forward for any capital spending?

I'll let Jeff talk to you about that Dave.

Hi Dave, again Jeff. We would be not looking to move forward on anything until we have a substantial amount of pre-leasing. And so we are gauging tenant demand with our development team on the leasing side (inaudible) and we are underwriting a variety of potential development scenarios there that include peer office as well as most recently we've been approached by hotel groups that have expressed interest in the site. So we are also exploring the potential of a mixed use development that would include hotel and office. And hope to have more information to report in the fourth quarter, but we will keep the market posted as we continue to underwrite a number of opportunities.

Great, thank you.

Yes.

Tom Lesnick, Capital One Securities.

Hi, good morning. Thanks for taking my questions. I just wanted to touch on leasing for a second. On page 20 of your supplement, you obviously show leasing on a year-to-date basis but in backing out the first six months of the year, it looks like rents and rent spreads were the highest in the past few quarters, whereas the average lease term was a bit lower. So I was wondering maybe you could just touch on kind of what was in leasing for the quarter?

I think, there are two sort of different things going on. We do a lot of renewals, we have one building that has a lot of very small tenants, so the volume of leasing and renewals is very high there. We have tenants there who have been there for 20 years with 17 one-year lease extensions. So that drove some of the volume and especially in lower volume leasing quarters. The rent increases by and large are coming from having moved into these major markets and to the extent that we've been doing leasing in the hot Houston market for example or some Atlanta, Dallas, Denver, those rents are not only increasing, but they are larger than the rents that we were achieving in some of the other markets that weren't the core markets.

So I think that -- you'll probably continue to see those trends. And we have been being disciplined about leasing and trying to achieve those rents. We think that those have been strong markets and we are holding firm to try to achieve the rents that we think that they deserve.

Great, thank you. And then just following up on other side of leasing, with regard to occupancy, obviously a decrease sequentially. I'm just wondering if you could talk about maybe whether that was a couple larger blocks of space or just a bunch of smaller spaces that did not renew and then what if any lease termination income you guys realized from that?

So, I think you're hitting on the point of the termination income, when we first started, we are still 93% occupied, I mean leased. But the termination income as you can see was higher in the early part of the year, so what we're seeing the early -- first two quarters and then much smaller in this quarter. So what we're seeing for vacancy is in part being driven by those terminations, where the tenant was still in place not actually vacating to a larger extend until this current quarter. So we're starting to see the vacancy from those terminations and that's part of what was driving and that was a couple of mid-sized tenants that moved out.

And the good news is, most of them were concentrated in the Denver market, we had some in Houston, they haven't been in top market. So we amortized those termination fees over the remaining terms of lease, so we get that drop off in occupancy and termination income all at the same time.

Okay, great. Yes, that's very helpful, thank you very much.

Jamie Feldman, Bank of America.

Great, thank you and good morning. I'm hoping you guys can talk a little bit more about Minneapolis, just to help frame the opportunity. But what do you think would be the potential size of any development, I know it's a little early, but just so we can help think about what's the comp potentially to come?

Hi, good morning Jamie, Jeff Carter here. We're looking at a whole range of options with our development team, that include on the small end, just looking at peer office, anywhere from 175,000 square feet all the way to 500,000 plus or minus square feet. We are also looking as I indicated, as we've had some expressions of interest from the hotel operators. We are also looking at mixed use developments that would be potentially in the density range or square footage range of up to 600,000 square feet. We haven't picked a path, we are hoping over the next quarter that, that path will be clear and we'll announce that path, but right now, all those options are truly on the table as we work with our team to determine what the best risk reward and return parameters could be for us.

And how do we think about the cost to build, so like, let's say, you did a 175,000 square foot office versus 600,000 square foot mixed use, what's the range of potential capital you need?

I mean, I don't have good enough numbers that I would feel comfortable sharing with you those estimates across yet, when I do and we have a better sense of what direction we're going, we'd be happy to share that with the market. At this point, it would be fairly meaningless to do that.

Do you have a general -- like for recent construction, do you know what construction costs have been, I'm just trying to get a sense.

It depends on which size project you're talking about and the complexity of the project. So again, I wouldn't want to speculate, 175,000 square feet is definitely different than 600,000 square foot option. And so if you bear with us until we choose a path, we can give you a really good sense of the numbers.

Okay. And then can you talk more about just what the leasing pipeline looks like in Minneapolis, are there a lot of tenants looking for maybe a headquarters type deal or kind of just what's the -- if a broker was talking about kind of tenants in the market, what would they be talking about?

But as you probably know, this is Janet. As you probably know, there is some big development going on in Minneapolis right now and that has some big tenants. We are talking, we have (inaudible) as part of this development project talking to all sizes that's obviously part of the whole development process. And so for the smaller building we've got some -- there is a number of mid-size to large-size law firms that are looking, we haven't really -- until we decide exactly what we're going for, we're probably going be in that mid-size range, not necessarily looking for one giant prospect. Leasing activity for tower has been going -- for the existing tower has been going well. And we've been pushing rents there and doing a lot of improvements in anticipation of doing the development. So that's a little bit of a flavor that we're getting but as far -- we're not building a building for a big tenant in the market.

Even if you did the larger, it would still be more of a mid-sized tenant it sounds like?

I think, these are multiple tenants.

Okay. And then, just in terms of large expirations. If you look out through I guess 2015, what are the largest expirations in the portfolio and you're poised to renew?

Well, the largest one coming right at us is RGA and St. Louis that we just talked about and that's immediate. We then have some other fair-sized ones that scattered throughout the portfolio and some of those going back to the conversation that we had earlier about rent. We don't expect to renew, because we have had conversations about renewals and we haven't been able to agree on the rent, what we think is the value of the leases. So we may see some more terminations or expirations than we would otherwise see, but I think we will -- we're doing that because we believe that we can lease that space reasonably quickly and at better rates and better overall returns.

But there is enough space in those markets, so the tenants can find somewhere to go?

Or they've been hanging on and had one or two downsize before they have lease commitment.

Okay. So do you think --

We're talking about big markets and medium sized tenants. So, in Dallas, I'm talking about 40,000 square foot and 50,000 square foot tenants they will have. They [were thought to] have a difficult time but they will have places to go.

And in the comments earlier in the call about more capital flowing into your (technical difficulty).

--zero, because the big tenant was (inaudible) there, they were leaving at the end of their lease. So that's leasing up very rapidly at very good rents, it's in a wonderful area of Houston, and we feel very good about the remaining space on that being leased very quickly and when that space gets leased, we're likely put that property on the market like 385 Interlocken and again similar with the (inaudible) it is like it is then now, we should be very well there.

Okay. So essentially between those two loans, $75 million of sources of cash, okay. And then just to clarify, if I'm looking at page 19, which is your 20 Largest Tenants. TCF National Bank that looks like a net number $11 dollars per square foot, I'm assuming that's a net rent, correct me if I'm wrong, and then RGA Reinsurance Company looks like about $22 a square foot and I'm debating whether that's a net or gross number, do you know the answer to that?

This is Janet. And TCF is net, and based in that is also the lower building the one we're talking about for development has a very low rent. And RGA is confusing because of the three buildings that we have and the building that RGA controls completely is a net lease, a complete triple net lease and in the third building, where they occupy substantial amount of space is what's the rest of the building. So you got a mix in there and actually in both of those things you got a somewhat of a distorting mix.

Okay. And then just on the run rate John, I think your guidance essentially at the mid-point directs us to about $0.26 FFO in the fourth quarter, should we then also address and make appropriate adjustments for our RGA moving out in the first quarter of 2015?

Well, I think the $0.26 is probably the bottom of the range, right.

Is it the bottom?

I believe it is. And so that's subject to some potential real estate taxes we still may increase with the value of buildings have been increasing, so we wanted to price some on that in the bottom end of the range, more top end of the range would be if the real estate tax number was not that significant and leasing does affect that somewhat. In terms of first quarter of 2015, I don't really have anything I can guide you to yet, I think we've got a few months to go before we'll do our 2015 guidance and that would give us a little time to see where RGA really looks to give out better -- to give better information.

And just on the -- going back to RGA and the run rate. Well, RGA is the big block of space, it’s going to go vacant in January, we have a far larger square footage that is available to lease just sitting in the current vacancy. So I think it's going to be -- so depending upon how successful we are on leasing some of what we have remaining forth -- vacant space that may offset the RGA.

Okay. And then John just -- so I understand this is really simple math, I thought your guidance -- your guidance is about 10 to about 12 for the rest of -- for the full year. So $1.11 minus $0.85 year-to-date is $0.26 at the midpoint for the fourth quarter?

Yes. That's correct.

Okay, got you. Thank you.

This concludes our question-and-answer session. I would like to turn the conference back over to George Carter for any closing remarks.

Thank you very much for listening to our earnings call and maybe next week in [ALAS], we hope to see some of your there. Thanks again.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.