Franklin Street Properties Corp (FSP) 2019 Q4 法說會逐字稿

Good day, and welcome to the Franklin Street Properties Corp. Fourth Quarter and Full Year 2019 Results Conference Call. (Operator Instructions) Please note, this event is being recorded. I would now like to turn the conference over to Mr. Scott Carter, General Counsel. Please go ahead.

Good morning, and welcome to the Franklin Street Properties' Fourth Quarter and Full Year 2019 Earnings Call. With me this morning are George Carter, our Chief Executive Officer; John Demeritt, our Chief Financial Officer; Jeff Carter, President and Chief Investment Officer; and John Donahue, President of FSP Property Management. Also with me this morning are Toby Daley, Executive Vice President of FSP Property Management; and Will Friend, also Executive Vice President of FSP Property Management.

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, 2019, which is on file with the SEC.

In addition, these forward-looking statements represent the company's expectations only as of today, February 12, 2020. 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.fspreit.com. Now I'll turn the call over to John Demeritt. John?

Thank you, Scott, and good morning, everyone. On today's call, I'll begin with a very brief overview of our fourth quarter results. And afterwards, our CEO, George Carter, will discuss our performance in more detail and provide some of his remarks.

John Donahue, our President of the asset management team, will then discuss recent leasing activities; and then Jeff Carter, our President and CIO, will discuss our investment and disposition activities. And after that, we'll be happy to take your questions.

As a reminder, our comments today will refer to our earnings release, supplemental package and the 10-K, which were filed with the SEC last night and, as Scott mentioned, can be found on our website.

We reported funds from operations, or FFO, of $26.8 million or $0.25 per share for the fourth quarter of '19 and $97.5 million or $0.91 per share for the full year of 2019.

Turning to our balance sheet. At December 31, 2019, we had about $970 million of unsecured debt outstanding, and our debt service coverage ratio was about 4x. During Q4 and as of the end of the year, we continued to have no balance drawn on our revolver, and $600 million is available. We have no debt maturities until November 30 of '21, and about 95% of our debt is at fixed rates.

With our debt stack more termed out and our rates mostly fixed, we believe we've aligned our capital structure with the more long-term value-add type of properties that we have in our markets.

From a liquidity standpoint, we had $600 million available on the revolver, as I just said, and $9.8 million of cash on our balance sheet. So total liquidity is $609.8 million at year-end. With that, I'll turn the call over to George. George?

Thank you, John, and again, welcome to Franklin Street Properties' Fourth Quarter and Full Year 2019 Earnings Call. As John said, our FFO for the fourth quarter and full year 2019 was $0.25 and $0.91 per share, respectively.

For the full year 2019, we leased a total of approximately 1.417 million square feet of office space in our portfolio of 32 operating and 3 redevelopment properties, of which 534,000 square feet was with new tenants.

Over the last 3 years, we have averaged about 1.5 million square feet of leasing per year or about 15% per year of our approximately 9.9 million square foot property portfolio. Upcoming existing tenant lease rollover is now expected to average about 780,000 square feet per year for both 2020 and 2021, approximately 7.9% per year of our total office space.

While much of our leasing activity over the past 3 years has been focused on renewing or backfilling existing tenant lease rollover space, in 2020, we will seek to achieve meaningful net new absorption with the objective of increasing economic occupancy and average rental rates for years to come.

At this time, we are giving full year FFO guidance for 2020 to be in an estimated range of $0.81 to $0.87 per share. This guidance includes $26,556 of lease termination fees. If we achieve the positive net new absorption we anticipate in 2020, higher economic occupancies should positively impact FSP's future rental income levels. The longer-term value-add proposition that was such an integral part of the strategy of recasting our property portfolio over the last 10 years is, we believe, finally at an inflection point.

For commentary about activity in our property portfolio, I will now turn the call over to John Donahue, President of our Property Management Company. John?

Thank you, George. Good morning, everyone. The FSP portfolio, including redevelopment assets, was 86.1% leased at the end of calendar 2019 compared to 86.4% leased as of December 2018. Total leasing achieved for the full year in 2019 was approximately 1.417 million square feet. Approximately 534,000 square feet was with new tenants which is a record high for new leasing.

For the first time in approximately 3 years, the percentage of expiring leases measured by square feet in our total portfolio for the upcoming year is well below 8%. This sets up a terrific opportunity to make meaningful progress on leased occupancy during the next 12 months due to a relatively light year of expirations and known departures.

Due to recent progress thus far in Q1 2020 in regards to renewals, holdovers and lease extensions, there will likely be less than 7% in total tenant expirations during calendar 2020. There is a current pipeline of approximately 400,000 square feet of new prospective tenants, along with potential expansions of existing tenants that represent net absorption.

Many of the prospective tenants have shortlisted FSP assets and are either in the letter of intent stage or considered strong probability prospects. Thus far, in the first quarter of 2020, we have executed approximately 20% or 80,000 square feet of the potential 400,000 square feet. Barring any surprises, we expect to execute a significant percentage of those new leases during the next 3 to 6 months.

We continue to make progress with gross rents and net rents in the FSP portfolio. In terms of in-place or occupied weighted average rental rate, the portfolio finished the year at $29.88 per square foot compared to $29.01 per square foot at the end of 2018. The weighted average GAAP gross rental rate achieved on leasing activity for the year was $31.78 per square foot.

On a net rent basis, the weighted average for total leasing activity was $19.65 per square foot as compared to $18.95 in 2018. We believe the demonstrated progress on net rents, along with fewer expirations in the short term and executing longer-term leases translates to added value in the FSP portfolio. With that, I will turn it over to Jeff Carter.

Thank you, John. Good morning, everyone. Franklin Street Properties owns high-quality office properties in amenity-rich locations within the U.S. Sunbelt, Mountain West as well as several opportunistic markets. Job growth statistics, population growth trends, cost of living data and quality of life information with respect to the Sunbelt and Mountain West regions continue to demonstrate positive potential for future upside performance where our largest markets reside.

By focusing on delivering our customers excellent service in compelling locations, we believe that our portfolio is well positioned to generate the conditions for value creation and is indeed, as George referenced, poised to experience an inflection point.

FSP's regional focus has continued to show encouraging signs relative to the U.S. national office market. More specifically, data from the U.S. Census Bureau continues to show that the south and the west regions of the country are enjoying the strongest population and job market growth.

On the disposition and asset recycling front, Franklin Street's decision several years ago to substantially refocus our portfolio into several U.S. Sunbelt, Mountain West and opportunistic markets has resulted in higher quality, more infill-oriented properties that are attaining higher rental rates and longer lease term on average than our past portfolio.

FSP worked to reshape our portfolio by completing dispositions and/or mortgage repayments of over $351 million since 2014. Presently, the investment sales market nationally remains open and liquid with positive pricing for quality assets and quality locations. At FSP, we currently view our directly owned portfolio as broadly possessing upside potential that we are striving to capture. We will keep the market posted though and up-to-date as appropriate should circumstances warrant.

On the acquisition front, we continue to track all suitable investment opportunities within our markets. Generally though, we continue to see stronger IRR potential organically on value-add efforts within our existing portfolio than externally through new purchases. We will continue our efforts though to identify infill and urban properties within our markets that possess the ability to add value over the short to intermediate term.

And with that, we thank you for listening to our earnings conference call today. And now at this time, we'd like to open up the call for any questions. Operator?

(Operator Instructions) The first question comes from Dave Rodgers of Baird.

John Donahue, I wanted to start with you on the 400,000 square feet of backlog of leasing activity that you talked about. And I think you mentioned about 80,000 of that was already executed. Can you give us an update on the 80,000 and kind of where that is? And then can you also dovetail the other 400,000 and how that might impact the lease-up at the redevelopment assets which you expect to kind of stabilize by the end of this year?

Sure, Dave. I'll start off with the 80,000 square feet, and that's a combination of new leasing and expansions, extensions. It is evenly distributed across the portfolio with occupancies across the year. No significant spike in any given quarter, but we believe that those will start immediately, some of it in the first quarter and then spread out amongst the year.

And then in terms of the entire 400,000 square feet, as you recall, we had forecasted that we would anticipate almost 200,000 square feet of new deals in the fourth quarter, and we were able to execute about half of those. And we haven't lost the balance of those prospects, many of them have just drifted into 2020.

And we're optimistic that we'll have a high batting average and land a good percentage of those over the next 3 to 6 months. We are anticipating that because those deals have been delayed a bit that a large percentage will take occupancy in the back half of the year towards the end of the year. So there could be some impact -- some meaningful impact as the year goes on.

And I guess maybe just addressing the redevelopment assets, particularly is that where a bulk of that demand is today?

No. I wouldn't characterize it as the bulk being in the redevelopment portfolio. We have about 200,000 square feet of remaining vacancy in the 3 redevelopment properties. So that's a relatively small portion compared to the entire vacancy in the portfolio. We do have a few strong prospects at Forest Park in Charlotte. We can't fit all 3 prospects. So we're hoping to land 1 or 2 of those and get that property stabilized over the next couple of quarters.

We have 2 strong prospects in Minneapolis, 1 in particular that we've been working with from 9 to 12 months that has been in an acquisition and not certain of how much space they need. We're very anxious to get that deal done. And we believe that we'll be able to do so shortly. And so that will be a nice step in getting the top 2 floors of Marquette multi-tenanted, which has been our focus here over the last couple of quarters.

And then last but not least, at Blue Lagoon, we are projecting the building to be delivered in the fourth quarter, and Lennar to take occupancy. Then the garage should be done by then. And we're talking with a group of smaller prospects that we hope will ramp up here over the next quarter or 2 as they're looking at occupancies, most likely either at the very end of the year or into the first quarter of 2021.

Great. John Demeritt, on the guidance. Can you reiterate for me the -- what George has said -- I missed it, I apologize -- in terms of lease termination fee income in the guidance for this year and the timing of that?

And then the second component of the guidance question, can you talk about how much of the FFO, especially this kind of back-half ramp from a $0.19 number in the first quarter, how much of that is speculative leasing versus how much of that do you already know today?

I think on the back half of that question, I'll probably need to refer to John Donahue on that. But on the front half, as George said, we have $26,556 of termination fee income in the guidance, and that's all in the first quarter. That's based on what was known in the portfolio as of today.

I think we have sort of lighter lease maturities this year and next. So I think that reduces the likelihood of significant termination fees. But we'll look at this quarterly as we go through the year and talk about guidance. The back half of the year does have more leasing assumptions in it. But John, maybe you can talk a little bit more about that.

Sure. Dave, I think the way to look at this is that we're anticipating that we'll have a ramp-up of occupancy and FFO over each successive quarter during 2020. There are a handful of contributing factors to consider, including executed leases that will take occupancy during the year, approximately 370,000 square feet or so such as Lennar, and those will be contributing as the year goes on.

We have recently executed holdovers, extensions and exercised options, such as Jones Day, that will now last throughout 2020 or into 2021. And then we have recent early renewals such as Somerset executed in the last half of 2019 with longer-term lease terms at higher rents that will contribute with FFO pickups in 2020.

And then last but not least, the pipeline of 400,000 square feet of prospects that I mentioned earlier. So what we're expecting, barring any surprises, that we will see successive ramp-up in each quarter.

Last question for me. George, as you kind of set the strategy going forward, a lot of vacancy to fill up, a lot of TILC dollars to spend. How comfortable are you kind of filling up the portfolio on your own versus how do you weigh that against maybe selling some of the vacancy and just getting focused on the assets you want to own long term?

I think as Jeff said, Dave, right now, we think the portfolio has got a lot of value-add potential, including the vacancy. And we would want to add that value-add potential before considering dispositions.

But when that value-add is completed, dispositions and repurposing those funds into acquisitions that we think have a lot more value creation to do and can be very accretive will definitely be done. But we're -- in almost every property that we see meaningful vacancy in now, we believe the opportunity to add value is so much greater over the near and intermediate term than simply selling that vacancy now at its price.

The next question comes from Rob Stevenson of Janney.

When I take a look at the slide deck 8 -- or excuse me, 9 of the supplemental, you guys lay out the tenant improvements, leasing commissions and the noninvestment CapEx for '19 and '20. If I look at that and I think about 2020, '19 was roughly $71 million, '18 was roughly $53 million, $54 million. Where are you guys expecting those 3 big sort of costs on the tenant improvement, leasing commissions and noninvestment CapEx to come in, closer to the higher level of '19 or closer to '18 for 2020?

This is John Demeritt. I'll try and answer that question. The capital expenditures are pretty fluid and are really based on a lot of leasing assumptions. But we do have a lot of leasing that we intend to do this year, so I think it would be closer to what we saw in '19 than '18.

Okay. And then straight-line rent in 2020. If I look at '19, it was roughly just under $9 million negative. In '18, it was a slight positive. How should we be thinking about that for 2020?

Actually, I don't have a number I can quote you on that one in the guidance, but I would expect it's going to be higher based on leases that would come online. I think John mentioned, we've got 378,000 square feet of leasing, which you can see on the NAV table on Page 28 that -- those are leases that are signed that didn't come online, and usually, they start with a few months of free rent. So the straight-line rent number should pick up this year.

Okay. And then can you talk about where you are on the U.S. government leases? I think there's a number of them that sort of have remaining lease term of, call it, a year or so or less. It seems like that given the current administration that there has been sort of lags in terms of how long it takes to get formal leases signed and back and for the whole process to be completed. Are any of those move-outs at this point or incremental move-outs? Or are you expecting them all to renew? And sort of what's the timetable on those?

Rob, it's John Donahue. I'll give you the big picture, and I might ask Will Friend to give you more color if you need it. When you look at Page 19 of the supplemental, we give you the expiration dates and square footage of the U.S. government leases. And we do still expect those near-term expirations to be vacates at some point.

However, I would say that a significant one that was scheduled to expire or downsize this year is going to be a holdover throughout the rest of the year and into next year. So we'll give you an update next quarter exactly how that turns out. But in our projections right now, the IRS is likely to stay throughout the rest of the year. And that's between 60,000 and 70,000 square feet of holdover. But the others really are expected to vacate at some point over the short term. And we'll -- again, we'll give you an update next quarter.

Okay. And what about the Randstad's mid next year expiration? Where are you guys on that one?

There's nothing to report right now. They have been off and on again with engaging. So because of their staggered expirations, we believe that they will be looking for at least a mid-term kind of a renewal, but too early to tell.

The next question comes from John Guinee of Stifel.

Okay. Great. Just a nice quarter and nice guidance. On Page 8, you have $4.4 million as nonrecurring. What is that? Is that a big lease term fee?

What page? Page 8 -- it's John Demeritt, John. Page 8 of what?

Page 8 under nonrecurring NOI.

Oh, the same-store?

Yes.

Yes. That's the termination fees, John.

And which fee is that? Which tenant is that? Or is that tenant sure now gone?

Go ahead, John.

I'm sorry, John. It's John Donahue. The lion's share of that number in calendar 2019 was ADS. That was a downsizing. They bought out [100%] of their rent for a portion of their space. they're still a tenant there.

Okay. And then Northrop Grumman moved out of Chantilly. What's the plan there? And big picture on Northrop Grumman, do you know what's going on in their minds as they're also giving back 254,000 square feet at Dulles Station in a brand new [one] realty asset?

It's John Donahue again, John. So Northrop did vacate that space. That is a market that has quite a few government contract vendors, and we are seeing activity in that field -- that sector. We do have one strong prospect for between 50% and 75% of the building that we are working with and waiting for a government decision on the use of that property. I'm not aware of all of Northrop Grumman's contractions and consolidations in the market, but we have heard about them.

Okay. And then I guess a big picture question. When you look at your guidance, right now you're at 86% leased, 83% occupied in the entire portfolio per Page 16. What's your model say for year-end '20? Where will you be as a percentage leased and percentage occupied on the roughly 9.9 million square foot portfolio?

I'll speak in terms of the entire portfolio, John, including the redevelopment properties. We're expecting lease commencements to really ramp up towards the end of the year. So we would expect those economic occupancies to be in the range of 85%, give or take. That really depends on us being able to work harmoniously with the tenants to get them in on time. So that could fluctuate between early Q4 and then into Q1 of 2021. But I'd say that the occupancy will be in that 85% range, and we hope even better.

Okay. I mean essentially, if you just take your redevelopment properties, that 370,000 square feet, and you subtract out Chantilly, that -- Northrop Grumman, that gets you there to 85%, but okay.

(Operator Instructions) The next question comes from John Kim of BMO Capital Markets.

I was wondering, can you just remind us how long it takes typically on new leases for -- leases that are signed to take physical occupancy?

John, it's John Donahue. So the broad-brushed answer to that is that the smaller the tenant, typically it's a faster delivery. For example, we've signed a handful of leases here in early 2020, less than 5,000 square feet. And some of those tenants are going to take occupancy within 30 days, and some of those are going to take occupancy within 3, 4 months. So the smaller the tenant, the faster the occupancy.

When you're talking about prospects between 100,000 square feet and 200,000 square feet, such as Lennar, that could be 12 months, could be 24 months. It kind of depends on the type of space and what needs to be done.

And then the answer for the prospects in between, anywhere from 5,000 up to 100,000 square feet, it's really a wide range depending on the quality and readiness of the space in terms of what they want and when their existing lease expires and when they want to get in. So an average, for our portfolio, it's probably just under 12 months, somewhere in the 6- to 12-month range as an average. That's a rough estimate.

Okay. So I mean I realize the leasing pipeline is healthy today, I'm just wondering, like a quarter from now, are we going to get a better sense of whether or not you're going to be able to hit your occupancy target for the year?

I would expect so, yes. We certainly hope that a lot of this will be happening between now and the next time that we speak with you. But yes, we'll have a clearer picture as every month rolls by.

Okay. And then maybe a question for John Demeritt. The modest termination fees that are in guidance, typically, over the last couple of years at least, termination fees have averaged $7 million per year. Can you just remind us, is this typical of how you provide guidance only on what you foresee today? Or do you think this is actually what you're going to recognize during 2020?

Well, we -- when we prepare guidance, we consider a number of things, the probability of what we think might happen when we come up with it. If you look at the last 2 years, John, they were pretty significant, but there was some fairly significant ones in there, Burger King in 2018, and we had one other fairly substantial one. And this past year, ADS was an unusual one as well.

And when we look at guidance for 2020, we looked at what we actually had, which is what -- the number that George quoted. But just generally, with the sort of lighter lease maturities this year and next, I thought that reduced the likelihood of significant termination fees. But we'll look at this quarterly and we'll see -- if we see something happening, if a tenant triggers, something like that, we'll include it in guidance when we update each quarter.

In your history, do the termination fees typically happen towards the end of the lease?

Typically, it's within the last year or 2 before the end of the lease, a tenant might have a termination fee option that they execute and then we'll start to record fees that we earn from that through the period of the end of the lease. That's typically how it works.

Showing no further questions at this time, we will conclude our question-and-answer session. I would like to turn the conference back over to Mr. George Carter for any closing remarks.

Thank you, everyone, for tuning into our earnings call. Appreciate it very much and look forward to speaking with you next quarter. Thank you.

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