Office Properties Income Trust (OPI) 2010 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Government Properties Income Trust Fourth Quarter Conference Call. At this time all participants are in a listen-only mode. Later we will conduct a question and answer session with instructions given at that time.

(Operator Instructions)

And as a reminder, this conference is being recorded. I would now like to turn the conference over to our host, Mr. Tim Bonang. Please go ahead.

Thank you. Good morning. Joining me on today's call are David Blackman, President and Chief Operating Officer, and Mark Kleifges, Chief Financial Officer. The agenda for today's call includes a presentation by management followed by a question and answer session. I would note that the recording and retransmission of today's conference call is strictly prohibited with our prior written consent of the company.

Before I begin today's call I would like reiterate our Safe Harbor Statement. Today's conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and Federal Securities Laws. These forward-looking statements are based on GOV's present beliefs and expectations as of today, February 24, 2011. The company undertakes no obligations to revise or publicly release the results of any revisions to the forward-looking statements made in today's conference call other than through filings with the Securities and Exchange Commission, or SEC, regarding this reporting period.

In addition, this call may contain non-GAAP financial measures including funds from operations or FFO. A reconciliation of FFO to net income, as well as components to calculate AFFO, CAD, or FAD are available in our Q4 supplemental operating and financial data package filed in the Investor Relations section of the company's website at www.govreit.com. Actual results may differ materially from those projected in any forward-looking statements. Additional information concerning factors that could cause those differences is contained in our Fourth Quarter Form 10-Q, which will be filed with the SEC and in our Supplemental Operating and Financial Data package found on our website. Investors are cautioned not to place undue reliance upon any forward-looking statements. And with that, I would like to turn the call over to David Blackman.

Thank you, Tim. We are pleased to announce another solid quarter for Government Properties Income Trust. Since October 1, 2010, we have acquired four properties for aggregate purchase prices of $101.6 million. In October we replaced our $250 million senior secured revolving credit facility with a $500 million senior unsecured revolving credit facility, and in January we declared a fourth quarter distribution of $0.41 per share.

For the quarter ended December 31, 2010, we are reporting FFO of $19.2 million or $0.47 per share compared to $10.2 million or $0.48 per share for the same quarter last year. This decrease in our FFO per share primarily resulted from the -- de-leveraging the Company from year end 2009 to year end 2010 through the issuance of common equity.

For the full year we acquired 22 properties with 2.9 million square feet for aggregate purchase prices of $434 million. We also grew year-over-year FFO 46% and our equity market capitalization 120% to approximately $1.1 billion, while reducing book leverage from 29% at year end 2009 to 18% at year end 2010.

As expected, our portfolio statistics and balance sheet remain exceptionally strong. Our properties are 96% leased with a weighted average remaining lease term of four and a half years. 93% of our rental income was paid by the US Government and six State Governments. We had approximately $164 million of debt outstanding at year end which represented a conservative 17.8% of our total book capitalization and EBITDA covered interest expense almost ten times.

During the fourth quarter we had minimal leasing activity entering into eight leases for approximately 47,000 square feet for an overall roll up in GAAP rents. During 2011 we have leased maturities that represent approximately 13% of our annualized rents and we have made substantial progress in renewing a significant percentage of these maturing leases. 78% of our annualized annual income comes from the US Government and approximately 15% comes from six State Governments.

During the quarter we added the State of New Jersey as a tenant which now accounts for 3.3% of our annualized rents. The Commonwealth of Massachusetts remains our largest State tenant at approximately 5% of annual rents.

As previously mentioned, since October 1, 2010, we have acquired four properties with 611,000 square feet for aggregate purchase prices of $101.6 million. These four properties were acquired at a weighted average cap rate of 8.9% an average cost per square foot of $166, have a weighted average remaining lease term of slightly more than six years, and on average are 99% occupied.

In October we acquired an office property located in Tampa, Florida, with approximately 68,000 square feet. This property is 100% leased to the US Government and occupied by the Department of Veterans Affairs. The purchase price was $13.5 million which included the assumption of a $9.8 million mortgage loan. The going in cap rate for this acquisition was 9%. In December we acquired an office property located in Trenton, New Jersey, with approximately 267,000 square feet. This property is approximately 98% leased to 15 tenants of which 65% is leased to the State of New Jersey, and occupied by the New Jersey Department of the Treasury.

The US Government also leases 10% of this property which is occupied by the Department of Justice and the Internal Revenue Service. The purchase price was $46 million and the going in cap rate was 8.5%. In February we acquired a two building office complex located in Woodlawn, Maryland, with approximately 183,000 square feet. The properties are 100% leased to two tenants of which 94% is leased to the US Government and occupied by the Inspector General of the Social Security Administration.

The purchase price for this acquisition was $28 million and the going in cap rate was 9%. Also in February, we acquired an office property located in Quincy, Massachusetts, with approximately 93,000 square feet. The property is 100% leased to three tenants of which 90% of the property is leased to Commonwealth of Massachusetts, and occupied by the Registry of Motor Vehicles as its headquarters. The purchase price for this property was $14 million and the going in cap rate was 10.2%.

During the fourth quarter GOV also terminated two acquisition as a result of certain findings during acquisition due diligence. The first terminated acquisition was for a 57,000 square foot property located in Fort Myers, Florida. The second terminated acquisition was for a 280,000 square foot property located in St. Paul, Minnesota. In aggregate the purchase price for these two acquisitions was approximately $45 million and GOV had approximately $224,000 in cost associated with these terminated acquisitions.

Consistent with 2009, the acquisition pipeline weakened at year end 2010. Also consistent with the first quarter of 2010 acquisition momentum has improved during the first quarter of 2011. Our pipeline of potential acquisitions include, numerous high-quality properties leased to the US and certain State Governments. Acquisition cap rates continue to fall within our targeted range of 8% to 10%. We remain upbeat about our opportunity to continue to grow the business and believe these results support our business strategy of providing a safe dividend to investors supported by our stable rental revenue coupled with the opportunity to grow through acquisitions at cap rates above historical average for government-leased properties. I will now turn the call over to Mark Kleifges, our CFO, to provide more detail on the financial results.

Thanks, David. First, let's review the results of operations for the fourth quarter. During 2010 we acquired 22 properties containing over 2.9 million square feet at a total cost of approximately $434 million, the majority of the quarter-over-quarter changes in our revenues and expenses are a result of this significant acquisition activity. For the 2010 fourth quarter operating income increased $5.3 million or 74.1%, the result of a $16.1 million increase in rental income and a $5.8 million increase in property-level expenses.

Our non-property level operating expenses which consist of acquisition-related cost, depreciation expense and G&A also experienced significant quarter-over-quarter increases due to our property acquisitions. Acquisition-related cost in the 2010 fourth quarter were $1.2 million compared to $825,000 in the 2009 fourth quarter, and G&A expenses in the 2010 fourth quarter were $2.1 million compared to $1.2 million in the 2009 quarter.

Property net operating income increased by 77.7% over quarter-- quarter-over-quarter to $23.5 million, and our net operating income margins were 64.1% for both quarters. Same-store revenue decreased quarter-over-quarter by $612,000 or 3%. However, same store NOI increased year-over-year by $347,000 or 2.7%. The same-store revenue decrease was primarily the result of the elimination of approximately $700,000 of non-recurring construction management fee income in 2009, and a $200,000 reduction in reimbursement income associated with real estate taxes.

These decreases were partially offset by a slight increase in same-store base rents. Despite the slightly lower revenues, same-store NOI margin increased 370 basis points to 67.7% versus the 2009 fourth quarter, due primarily to lower real estate taxes and the elimination of costs associated with the construction management fee income we earned in 2009. EBITDA in the fourth quarter of 2010 was $21.4 million compared to $12 million in the 2009 fourth quarter. Our EBITDA to fixed charges ratio was very strong at 9.9 times for the quarter.

Net income for the fourth quarter of 2010 was $6.5 million compared to $5.4 million for the fourth quarter of 2009. Net income for the 2009 quarter includes a $3.8 million non-cash loss on extinguishment of debt relating to our write off of amortized financing cost associated with our terminated secured revolving credit facility. For the current quarter FFO was $19.2 million which based upon weighted average share account of 40.5 million shares resulting in FFO per share of $0.47, compared to FFO of $10.2 million for the fourth quarter of 2009 which based upon a weighted average share account of 21.5 million shares, resulting in FFO of $0.48.

We experienced mild dilution to FFO per share versus the prior year due to our 2010 equity offerings. In November we paid a dividend of $0.41 per share, our FFO payout ratio was 86.6% for the 2010 fourth quarter. During the quarter we spent $411,000 on tenant improvements and leasing costs, and $2.2 million for building improvements which, primarily, included energy upgrades and roof replacements. Turning to our balance sheet and liquidity at quarter end we held $2.4 million of unrestricted cash and had only $118 million outstanding on a $500 million unsecured revolving credit facility.

As David mentioned earlier, we entered our new unsecured revolving credit facility in October. The credit facility bears interest at LIBOR plus 210 basis points which is 90 basis points less than the interest rate on the secured credit facility that was retired. The facility matures in October 2013 and subject to payment of the fee we have the right to extend the maturity date for an additional year to October 2014. We believe we are compliant with all terms and conditions of our credit facility and are operating well within its financial institutions covenants. Today, as a result of our two property acquisitions earlier this month we have $158 million outstanding on the credit facility.

In closing, GOV remains a well capitalized company with great access to capital. Our properties are 96% leased and approximately 93% of our rental income is paid by the US Government and six State Governments. As a result our cash flow is stable to pay a consistent dividend. In addition to our stable base, we continue to have strong acquisition momentum and remain optimistic about the company's outlook for 2011. Operator, that concludes our prepared remarks, we are ready to open it up for questions.

Thank you.

(Operator Instructions)

And we go the line of Omotayo Okusanya, with Jefferies & Company. Please go ahead.

Hi, yes. Good morning, gentlemen. How are you?

Good.

Good, Tayo, how are you doing?

Very good, thank you; just a couple of questions. Should we be reading anything into the fact that you basically doubled the size of your line? Is that giving us an indication of just the kind of acquisition pipeline you're seeing?

Yes, I think our acquisition pipeline is very strong, Tayo. I think given the size of our company, and where we want to grow to, it makes sense to have a $500 million credit facility. You know, it allows us to keep $100 million plus or minus kind of frozen on the credit facility, which is a good way to grow our leverage, and it gives us adequate capacity to acquire assets without feeling like we have to rush to back to the capital markets.

Do you pay any fee on the unused portion of the line?

No, it's a facility fee, so we pay a facility fee based upon the entire size of the facility.

Okay.

Not based upon the unused portion.

Got it, okay. And then could you talk a little bit just in regards to pricing you're kind of seeing in the market right now. It sounds like you're still doing some deals at nine -- 9% cap rate.

Yes, we are seeing pricing kind of all over the board. I mean if you go to the District of Columbia --

Yes.

You're still seeing pricing anywhere from 6% to 7% on in place NOI, in some of the secondary and tertiary markets, depending upon the State that it may be located in, you could see cap rates as high as 10%. But most of what we see that we want to own given the credit risk that we like, it's kind of in that 8% to 9% range.

Okay, and then just -- last question -- anything in the new government budget that you think is a positive or negative for your overall business?

Well I think -- I mean there's still a lot to be seen as it relates to budgets not only with the US Government, but with State Governments.

Right --

I think -- I think given the current -- the current trend is to, clearly, reduce spending, and I think it's going to take a time -- a lot of time to agree on that, but what I take out of that is there will be less money allocated to build new real estate for the US Government in the near-term, and I think that's good for us in terms of keeping our buildings full and keeping our tenants in place.

Got it, okay. What about any risk of them trying to consolidate into a couple of buildings. You know, so rather than them leasing from two buildings, trying to cram everyone into one.

Yes, that's always a risk Tayo, but I have toured most of our properties, we don't have a lot of unused space in our buildings, and I assume that, you know, the other buildings that are leased to tenants -- to government tenants in the area are also relatively full. So, I mean, there is always a risk that State Governments will try to consolidate into state-owned buildings, but I don't see where there's a lot of excess capacity in existing buildings that are occupied in market.

Very helpful. Thank you.

Thank you.

(Operator Instructions)

And we go to the line of Mitch Germain with JMP Securities. Please go ahead.

Hi, good morning, guys.

Good morning.

Good morning.

Just with regards a follow-up to Tayo's comment. Are you seeing any change in the Government's approach in terms of the leases that you are negotiating right now?

I wouldn't say we are seeing specific change. What I will say is the process has gotten slower -- or gotten slower. It's -- it takes longer to get to OMB for approval, and then to get through both house and senate if it's a significant lease. So -- and I would say, until a new budget is signed and spending limits are agreed to, the process will continue to be slow.

I'm seeing about 3% historical growth from the GSA, do you think that possibly comes back this year, or the next couple years?

Meaning do you think that that growth will elapse?

Exactly.

I think that -- I think that given the current budget environment, the growth in the government is going to probably wane. How much, it's hard to say at this point, but yes, I think there's a chance that that 3% growth in -- in government employees will -- will be less this year.

Good quarter, guys. Thanks.

Yes.

Thank you.

Thank you. Our next question comes from Young Hu with Wells Fargo. Please go ahead.

Hi, yes. Good morning, it's Young here with Brandon as well. David, I think you mentioned that a gap -- rents actually rolled up this quarter. Is that right?

Yes, we had actually a pretty significant roll up in GAAP rents but, you know, it's a relatively small amount of leasing. And we had some shorter term renewals in there which, I think, skewed the numbers so it's -- I would say it's comparable to what we expect to have across the portfolio in 2011.

And what was that number, just so that we have it?

Exactly -- like 34%. But again, I wouldn't say that's, you know -- what our expectations are for 2011.

And, I mean -- like you said, it's not going to repeat in 2011, so what kind of rent rolls should we expect for the year then?

Well, we've got -- a good example would be we've got -- we are working through lease renewals at Indiana Avenue which is in Washington, DC We are going to probably have $10 to $12 per square foot roll up in rent per property. I think Fresno, which is a big lease, we are going to be, you know, flat slightly down on that. Probably down $0.50 per foot in that lease. But then, again, we are not going to have any tenant improvement dollars spend there. So on an apples-to-apples basis it really is a roll up, but it's going to be maybe up slightly, dependent upon where we end with properties like Indiana Avenue.

Okay, that's helpful. And maybe if I can go to the credit facility a little bit, you guys have $118 million that has gone up to $150 million year-to-date. So with rates probably going up, that's a variable rate that -- how are you thinking about trying to minimize the interest rate based on that?

Well --

Or are you going to -- are you just going to leave it on the balance, or are you going to do something with it?

We don't have immediate plans to do anything with the $158 million that's out on the credit facility. You know, I think we will look to the capital markets at some point this year and we will consider raising, you know, unsecured notes. We will also consider equity. We tend not to hedge outstandings under our credit facility. We are fine floating, we have a relatively low leverage ratio, and even with an increase in rates, LIBOR is still incredibly low, and we don't want to be locked in to having to keep, you know, $200 million of floating rate debt outstanding all the time. So, you know, you have the risk that issuing bonds in the second or third quarter could be more expensive than issuing today, but we really don't have an appropriate use of proceeds right now to do anything.

Got it, that's helpful. And if you were to price your unsecured debt today what do you think could get for it?

That's a good question, I haven't gotten a quote from Capital Markets in a while, but given where treasuries have gone to, I would guess it's somewhere between 6% and 6.5%.

That's helpful.

For ten -- for ten-year unsecured.

Okay, thank you.

Thank you. The next question comes from David Rodgers with RBC Capital Markets. Please go ahead.

Good morning, guys. David, with respect to the leasing for the year, and I got on very late so I apologize if you did answer this, I can go back and read it; but your renewal expectation for this year, obviously you've got some big leases, especially toward the end of the year; but with your comments about negotiation was taking longer. Do you expect more holdovers, and what are you really looking for, I guess, in terms of renewals versus known move-outs for '11, and anything you know about 2012, for certain at this point?

Yes, I think there is always the risk that you're going to have holdover with, particular the US Government. Indiana Avenue is a good example, I mean, that's a great property; we've got a good tenant base. We've got tenants that want to stay in the property, but we've got a handful of tenants that are on holdover, just because they can't - they couldn't the process done in a timely fashion. So that -- that is a risk, our -- our leases tend to be a little bit back -- our lease maturities tend to be a little backend weighted towards the third and fourth quarter this year, so we've got time to continue to push it, but it's going to depend a lot on how efficiently the government can manage through their current budget process.

We have got -- we have one non-government tenant in Rockville Pike that we are not going to renew. They are consolidating a bunch of offices across that Rockville, Maryland District, and so we are going to have some vacancy but we've also had the FDA in that building and they've expressed the desire to expand. So I think we will backfill a lot of that space with the FDA. But other than that, you know, we really feel pretty good about out 2011 lease maturities. I think, you know, we don't have anybody that's indicated that they expect to vacate at this point.

And a final question. You talked about the pipeline of acquisition, that it's slowing at the end of the year, and at the end of the year, if you were to address that, picking back up and if our pipeline is getting bigger once again.

Yes, every year around Thanksgiving the real estate market tends to get more quiet, and people focus more on getting deals close by year end and then they do by brining new deals to market.

Right, right.

And we see that every year so you tend to start the New Year with a relatively small acquisition pipeline. But GOV does have over the last [side] of three or four weeks. We've seen some pretty good assets come to market. We've got a number of properties that we are writing up to present to investment committee, and it's -- it's kind of where we were in the first quarter of 2010. So I would say it's very comparable to what we saw last year at this time.

Right, thank you.

You're welcome.

Thank you. We will go to the line of Dan Donlan with Janney Capital. Please go ahead.

Thank you, and good morning. David, I guess, you know, Doug kind of asked that question a little bit, but do you think the backup in the ten-year treasury is -- do you think that's making some potential sellers a little more anxious about disposing of assets. You know, given how closely -- probably tied the government real estate is to the ten year?

You know, I think that's certainly a potential, but you also have a lot of interesting stuff going on in the world markets right now, which makes the US a safe haven, and I would think there's a lot of -- a lot of owners of real estate that would like to have the US Government as a tenant right now.

So I don't know, we haven't specifically seen cap rates move up at this point. Could it happen later year if rates continue to climb, yes, but I'm certainly not running a business plan based on expectation that cap rates are going to rise.

Right, I guess I was just curious the sellers might be a little bit more anxious maybe now, so -- versus where they were, maybe, the back half of the year. And then also kind of as you're looking at some of these acquisitions, what is your competition? Is it -- are you still kind of one of the bigger guys out there, or have you seen your competition for these assets pick back up or, you know, where do you see yourself there?

I mean, there's competition out there. I mean there is a couple of funds that are focused on owning buildings leased to -- particularly the US Government, and we tend to bump into kind of the same institutional buyers in certain markets. You know, the interesting thing is, you always have owners of real estate that kind of focus on individual markets, and you tend to bump into them in their markets; and so rarely do we ever see off-market opportunities that we are the only bidder on. But we also feel like we -- given some of our advantages in terms of our cost to capital, our access to capital, or ability to buy assets on an all-cash basis, we compete well with our market competitors.

Okay, and then lastly, on the acquisition front, is there -- any potential out there to, kind of, get a whole slug of assets at one point in time? Are there any portfolios that you are aware of that are being marketed right now that we -- that you might be interested in?

There are a couple portfolios in the market not currently for sale, portfolios that we, kind of, keep our eye on that could potentially show up some time this year.

Okay, and would you be willing to, kind of, deviate a little bit from your 8% to 9% cap rate range if you could get it, you know, kind of -- a larger slug of assets at one -- at one time?

I think it -- for the right properties and the right markets with a lot -- the right kind of remaining lease terms; yes, I think we are prepared to do that.

Okay. Alright, well thank you.

You're welcome.

Thank you. We will go to the line of Omotayo Okusanya with Jefferies & Company. Please go ahead.

Oh, yes, thanks for taking my follow-on call. David, there were a couple of deals that you had gone into in purchasing sale agreement on, but you eventually terminated those purchase and sale agreements. Could you talk a little bit about why exactly that happened?

I guess the answer would be vaguely. I mean, we are under confidentiality agreements on both of those properties, and I would expect that they probably will be both, kind of, back in the market of being remarketed.

Okay.

So, you know, there's only so much you can say about that, but you know, we tend to do a pretty detailed diligence as it relates to interviews with tenants, review of, you know, titles, survey, financial due diligence, and in both cases there were issues that we uncovered that made us feel like we either were not going to be able to keep the same yield under which we thought we were guying the asset.

Okay.

Or we felt like there was risk that the tenant was not going to be long-term at the property.

Got it, okay. That's helpful. Thank you.

You're welcome.

Thank you we have no further questions in queue.

Thank you, operator; and thank you all for joining our Fourth Quarter Conference Call. We look forward to updating everyone on our first quarter results in the spring. That concludes our conference call.

Thank you, ladies and gentlemen; that does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.