Office Properties Income Trust (OPI) 2013 Q1 法說會逐字稿

Good day and welcome to the Government Properties Income Trust first-quarter and financial results conference call. This call is being recorded. At this time for opening remarks and introductions, I would like to turn the call over to Vice President of Investor Relations, Mr. Tim Bonang. Please go ahead, sir.

Thank you and good afternoon. Joining me on today's call are David Blackman, President and Chief Operating Officer and Mark Kleifges, Treasurer and 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 transcription, recording and retransmission of today's conference call is strictly prohibited without the prior written consent of the Company.

Before we begin today's call, I would like to read 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 other securities laws. These forward-looking statements are based on GOV's present beliefs and expectations as of today, April 30, 2013. The Company undertakes no obligation 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 numbers, including normalized funds from operations or normalized FFO. A reconciliation of normalized FFO to net income and the components to calculate AFFO, CAD or FAD are available in our supplemental operating and financial data package found on our 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 filings with the SEC. Investors are cautioned not to place undue reliance upon any forward-looking statements. And now I would like to turn the call over to David Blackman.

Thank you, Tim. For the first quarter of 2013, Government Properties Income Trust is reporting normalized FFO of $30.3 million, or $0.56 per share, compared to $25.2 million, or $0.54 per share for the first quarter of 2012. Our 20% year-over-year increase in normalized FFO is primarily the result of our accretive acquisition activity and a modest improvement in same-store results.

Since January 1, we have closed on the sale of two properties for an aggregate sales price of $18.5 million. We have executed six new and renewal leases for 199,000 square feet while rolling up rent by 14.8% and we also declared a $0.43 per share distribution.

As of March 31, GOV owned 82 properties containing 10 million square feet. Our properties were 92.8% leased for a weighted average remaining lease term of 5.3 years. In aggregate, our government tenants pay approximately 93% of our rental income and the US government remains our dominant tenant.

In addition to our strong property statistics, we also exhibited strong credit statistics at the end of the quarter. Our balance sheet was conservatively leveraged at 31.4% of total book capitalization. Our total debt to adjusted EBITDA ratio was 3.4 times. Our interest coverage ratio was 8.3 times and our $550 million unsecured revolving credit facility was 95% available to fund acquisitions and other working capital needs.

Turning to our leasing activity, as I already stated, GOV entered six leases for 199,000 square feet with a weighted average lease term of 3.8 years. Our executed leases represented approximately 99% of our quarterly lease expirations. Approximately 187,000 square feet of our leases were renewals for two US government tenants and one state government tenant and represented a 100% renewal rate on expiring government leases.

The largest lease for 126,000 square feet was a one-year renewal with the Department of Justice at 20 Mass Ave. This lease was intentionally short term in order to allow US CIS to expand in the space that DOJ currently occupies, but intends to vacate later this year. The building is expected to remain 100% leased during this transition. While this had a negative effect on our weighted average lease term for the quarter, this ultimately is the right approach for the property and our Company.

Quarterly leasing resulted in a 14.8% rollup in rent driven by a 23% increase in the renewal for DOJ at 20 Mass Ave. Our commitments for leasing capital were $4.6 million for the quarter, or $6.04 per square foot per lease year, which is above our historical trend for leasing capital. Approximately $4.4 million of our leasing capital was for a renewal with the Department of Justice in Buffalo, which equates to $7.37 per square foot per lease year for a 10-year lease.

While this capital expense is an outlier and not expected to recur, we believe the fact that this building was a build-to-suit for the US government, combined with the government's perceived long-term commitment to the property, justifies the substantial renovation and our high capital investment in the property.

Our vacant space across the portfolio is experiencing strong activity. In fact, we have entered into letters of intent or executed leases for approximately 150,000 square feet of new leases and expansions for existing tenants since quarter end. We are pleased with our renewal conversations with tenants for leases expiring during the remainder of this year such that we remain optimistic that renewal rates will be high at our properties.

As I mentioned in our previous earnings call, GOV intends to opportunistically recycle capital through the sale of certain properties. The program is expected to be modest and is intended to identify properties we are less confident in our ability to maintain the government's long-term occupancy at reasonable returns. We believe this program will result in the sale of one to three properties per year and return $20 million to $75 million in capital annually.

It is important to understand though that our capital recycling program will be fluid. As a result of our efforts, GOV sold two properties during the quarter for $18.5 million, excluding costs. In February, we sold an office property located in Oklahoma City containing 186,000 square feet for $16.3 million, excluding costs. The US government was the building's primary tenant and its lease was in holdover at the time of the sale. The US government did not have definitive long-term occupancy plans at the property, so we elected to opportunistically sell the building for a 4.5% cap rate.

In March, we sold an office warehouse property in Tucson, Arizona containing 31,000 square feet for $2.2 million, or $71 per square foot, excluding costs. This property was formerly occupied by the US Drug Enforcement Agency prior to outgrowing the space and relocating within the market. The adjacent property owner desired to expand its business into this location, so we opportunistically sold the property for a price that we believe to be greater than the value of the property leased for investment purposes. At this time, we do not have any other properties identified for sale.

The acquisition pipeline is building and we have a number of offerings currently under consideration, but we have nothing specific to report at this time. While we remain confident in our ability to make accretive acquisitions this year, we are finding it more difficult to compete against the leveraged buyer that underwrites acquisitions with up to 75% leverage and high single to low double-digit leverage returns.

We do however remain committed to our business plan of providing a safe and predictable distribution to shareholders from our stable revenue, which we expect to augment with accretive acquisition growth. I will now turn the call over to Mark Kleifges, our CFO, to provide more detail on our financial results.

Thanks, David. First, let's review our consolidated property-level operating results for the 2013 first quarter. Because of our acquisition activity, we once again experienced significant quarter-over-quarter increases in both rental income and property net operating income. At the end of the 2013 first quarter, we owned 82 properties with 10 million square feet compared to 69 properties with 8.7 million square feet at the end of the 2012 first quarter.

For the 2013 first quarter, GOV's rental income increased $7.7 million, or 15%, to $57.7 million and property net operating income increased $5.6 million, or 17%, to $37.6 million, both compared to the 2012 first quarter. At March 31, our properties were 92.8% leased and our consolidated NOI margin for the 2013 first quarter was 65.2%.

Turning to our same-store operating results, at quarter-end, our 69 same-store properties were 91.8% leased, down 50 basis points from the prior-year quarter, but unchanged from the end of 2012. Our 2013 first-quarter same-store rental income increased by $1.1 million, or 2.1% compared to the 2012 first quarter and our same-store net operating income increased $1 million, or 3.1% compared to the 2012 first quarter.

Results for the 2013 first quarter include approximately $300,000 of retroactive rent increases related to the Department of Justice renewal at our Mass Ave. property in Washington, DC. Same-store operating expenses were relatively flat year-over-year with increased real estate tax and snow removal expenses offset by lower utilities, repairs and maintenance and insurance costs. Our same-store NOI margin in the 2013 first quarter increased 70 basis points from the prior-year quarter to 64.7%.

Turning back to our consolidated results, adjusted EBITDA in the first quarter of 2013 was $34.5 million compared to $29.2 million in the 2012 first quarter, a quarter-over-quarter increase of 18%. Our EBITDA to fixed charges ratio remained very strong at 8.3 times for the quarter and our debt to annualized EBITDA was only 3.4 times at quarter-end.

For the current quarter, normalized FFO was $30.3 million compared to normalized FFO of $25 million for the 2012 first quarter. First-quarter 2013 normalized FFO per share of $0.56 was up $0.02 or approximately 4% from the 2012 first quarter. During the quarter, we spent $2.6 million on tenant improvements and leasing costs and $655,000 on improvements to our properties.

Turning to our balance sheet and liquidity, at quarter-end, we had $470 million of debt outstanding, including $27.5 million outstanding on our $550 million revolver. Debt to total book capitalization was only approximately 31% at quarter-end leaving the Company well-positioned to fund acquisition growth with approximately $215 million of debt capacity before leverage would approach 40% of book capitalization.

In closing, GOV remains a conservatively capitalized company with a secure cash flow stream that we expect will allow us to pay a consistent dividend. In addition to our stable base, we remain optimistic about the Company's opportunities for further growth. That concludes our prepared remarks. Operator, we are ready to open it up for questions.

(Operator Instructions). Vance Edelson, Morgan Stanley.

Hi, thanks for taking the questions. The competition you are seeing on the acquisition front, any color you can provide on how this is impacting the asking price? Is it just that you are seeing more bidders or are the sellers actually taking advantage of this and meaningfully starting to raise their asking prices?

Well, I think there clearly, Vance, is an expectation in the market right now that cap rates have compressed somewhat and that pricing has gone up. And it is driven by the fact that lenders are willing to provide higher leverage and a fixed rate secured by real estate has gotten lower. Has it been material? I wouldn't say it has been material, but there clearly are transactions that we have seen that don't make sense for our pricing expectations as a result.

Okay, that's very helpful. And maybe just one more question from me. At the state level, it wasn't too long ago that the state governments were shedding workers pretty quickly. How would you characterize the latest on that trend? Has it kind of turned the corner at all and they are starting to hire at all?

Yes, I don't know that I have specific insight for hiring. I think the expectation this year is that there probably will be more hiring at the state level as the US government doesn't rehire people as they retire and kind of goes to more flexible time with their employees to manage sequestration. But if you look at the financial profile of state governments, they really turned the corner in 2012 and their tax bases are up, revenue as a result is up and they are generally across the board state financial positions have improved.

Very helpful. Thanks.

(Operator Instructions). Michael Carroll, RBC Capital Markets.

Thank you. What are you guys seeing on the investment side? Is the pipeline growing right now? I know I think a couple or last quarter, you said that it started picking up a little bit, but do you expect that that increased pipeline size is being offset by increased competition, which continues to make it difficult to acquire?

Yes, the year started out, Mike, with a lower volume of offerings and those offerings that came out I think tended to be of lesser quality. I think a lot of that was driven by acceleration of offerings at year-end to get deals done before changes in the tax laws, which were anticipated. Over the last 30 days or so, the volume of activity has increased pretty substantially and the quality of the offerings have also improved. I would say our pipeline today approaches $500 million in offerings that we think fit within our investment criteria and pricing where we have the ability to be competitive. So I am optimistic that we will have specific acquisitions we can talk about next quarter.

Okay. Then you think the 2013 actual acquisition volume, will that be more similar to 2012 or 2011?

I would expect that, absent a portfolio or real large deals, I think it is going to be much more representative of 2012's activity.

Okay. And then what drove the NOI outperformance in the first quarter of 2013 and the margin expansion?

Mike, this is Mark. On the -- revenues were up about 2.1% quarter-over-quarter driven in large part by the renewals at our Mass Ave. property where revenues quarter-over-quarter were up about $1.3 million, but remember that includes $300,000 of retroactive rent adjustments back to September for part of -- for one of those renewals.

And then the other side of the equation was that expenses were flat more or less quarter-over-quarter. We experienced increases in real estate taxes, as well as snow removal costs during the quarter, but we were able to offset those costs through lower utility costs, which was driven by both lower usage, as well as some lower negotiated rates in certain of our markets and then lower maintenance and repairs expense, which was driven in large part by the fact that, in the 2012 quarter, we had some flooding at one of our properties, so we had some outsized costs in the 2012 quarter.

And then the last cost-savings item that has been more significant in the first quarter was insurance. We were able, when we renewed our policy last year in the third quarter I believe it was, we were able to do that at a lower cost due to our favorable claims history.

And how much do you expect revenues to decline I guess in the second quarter related to I guess the additional rent you received in the first quarter?

The incremental piece is $300,000.

Okay, okay. And then you expect the margins to kind of fall back down to the 62%, 63% range?

Our margins tend to fluctuate throughout the year. I have to go back and look at the supplemental, but I think our second quarter tends to be a higher margin quarter for us.

So would it be higher than the first quarter that you already recorded of what, 65%?

I think traditionally the first and fourth are going to be the higher quarters, Dave.

Are they?

Yes, because you're going to -- yes, the first and fourth are typically -- I think if you go back and look at NOI percentages, you will see first and fourth are typically the highest during the year.

Okay, great. And then my final question is can you remind us how many leases that are currently signed, but have not yet commenced yet?

How many? Well, we had about -- since quarter-end, we have got about 150,000 square feet of leases that are either under LOI or have been executed.

And those will commence in the second half of '13?

Yes, I mean you don't want to always turn 100% LOIs to executed leases, but I think -- I think we have got pretty good momentum in our leasing right now and what we have I think tend to be real deals. So yes, I think that obviously our occupancy will improve I think second quarter and we should have some revenue take effect probably in the second half of the year as a result of that.

All right, great. Thanks, guys.

Mitch Germain, JMP.

Good afternoon, guys. That 150,000 you just referenced, is that all government tenants?

It is not all government tenants. I would say it is about half government tenants and half non-government tenants. We have got a couple of expansions at our properties with some existing government tenants. We have got one new government tenant and the rest of it tends to be non-government tenants.

And have you seen any change in tone with regards to the way the government is approaching their real estate?

I wouldn't say there is a change in tone. I guess really the question is are we seeing a change in leasing activities as a result of sequestration, is that where you are headed with that, Mitch?

Yes, I mean are they being a bit more aggressive or is it still to seek for new efficiencies, etc.?

First of all, we haven't really seen a change in attitude from government tenants as a result of sequestration. I mean they continue to take a long-term perspective on leasing and if there is any benefit whatsoever, it continues to be the fact that there really isn't money available for new buildings, so they are looking at existing inventory for their occupancy needs.

I think the government sector is really not a whole lot different from the corporate sector in that everyone is trying to be more efficient with their space and they are doing that in a couple of ways. One, they are forcing agencies to be very critical of what their real requirements are and they are also combining occupancy of agencies that can cohabitate together. So I think our benefit is, particularly with our buildings that are 100% occupied by government tenants, they continue to favor those types of buildings versus buildings where they are only 30%, 40% or 50% of the space in a building.

Great. And just last question on the acquisition pipeline, is the increase in pricing possibly causing you guys to shift maybe buying more state tenanted properties or properties that possibly have shorter term left in lease because those are the ones that might be better deals today? Or are you going to stick with kind of trying to find the bread-and-butter federal government tenanted assets?

Yes, I think you will see us staying with the bread-and-butter type acquisitions. We certainly haven't done. We have done a handful of state deals, but we continue to look at state leases for reasonable quality real estate, but really more strategic in nature of where is the building located, who is the agency that is in occupancy and how strategic is that long-term basis. We will buy some buildings that have less than 10 years in remaining lease term when we believe there is a commitment from the agency to that real estate. And we tend to gauge that commitment through capital invested, as well as our conversations with those agencies during diligence.

Thanks.

Young Ku, Wells Fargo.

Great, thank you. David, just following up on that 150,000 square feet of new leases, is that net new leases or is that some of the -- is that partially some backfilling potential of some moveouts that you are expecting?

Well, the 150,000 square feet are either new tenants or expansions with existing tenants. So it would be a net 150,000 square feet of new occupancy in our properties.

Okay, okay, got it. And in terms of your commentary about Q2 possibly occupancy going up, what kind of assumptions are you putting in for the CDC space? And I don't know if you can provide any update on that.

Well, the CDC -- I don't anticipate that the CDC will be moving out of anything during the second quarter. We are having active conversations with them right now for all four of the buildings that currently have expirations. Really I guess they were all kind of April 25. The CDC is probably the most difficult agency for us to handicap with any real confidence because they have changed their mind on a number of occasions and so with them, we never know -- we never feel like it is done until the ink has dried on the signature page of a lease or a renewal. But I think at least for the second quarter, we expect that they will not have any effect on our occupancy.

Can you remind me how big that space was?

Well, we have four separate buildings. I believe it is -- I believe it is about -- it's I think just under 200,000 square feet.

It is about 202,000 square feet. So it represents call it 2.2% of our total square feet and it is about 1.4% -- the four leases are 1.4% of total annualized revenues.

Great, thank you. And one last question. I know last week government approved some of the lease proposals in the metro DC area. Could you comment on whether that might have some impact in your new leasing potential?

I know the Congress or the House or the Committees did approve some prospectuses last quarter. I don't think we had anything with us in either the House or the Senate Committee. So I don't think that that has an immediate impact on us right now.

Wasn't 20 Mass Ave. part of the -- wasn't the 20 Mass Ave. space with the US Justice, was that in the prospectus?

I think that prospectus had already been approved because our lease obviously has already been executed.

Okay, got it. Thank you.

Tayo Okusanya, Jefferies.

Hi, good afternoon. You may have covered this already, but I was a little bit late on the call. But just kind of curious what you are seeing cap rate wise in the market right now.

Well, I would say for US government leased properties with 10 years or greater remaining lease term, strategic properties, you are probably seeing cap rates in the high 6%s to low 7%s. And for buildings with less than 10 years, I think it is going to depend a lot on people's assessment of the agencies' strategic need for that real estate, where it is located. But from there, you can probably see cap rates going anywhere from an 8.5% to a 7.5% depending upon who the agency is, where it is located, quality of real estate, etc.

That's helpful. And just kind of given where cap rates are at this point, how should we be thinking about future acquisitions and the use of leverage?

Well, I don't expect that we will change our use of leverage at the corporate level. I think we will continue to run the Company kind of 35% to 45% leverage. I think we will continue to try to buy quality assets with as high of cap rates as possible. We will continue to do -- our desire is to continue to buy buildings at cap rates that are 8% and above. There may be the occasional building that we buy that is slightly below an 8%, but I don't know that you will see us go materially below that for a lot of acquisitions.

Great, very helpful. Thank you.

Okay, and back to David Blackman for closing remarks.

Thank you for joining our first-quarter conference call. Operator, that concludes the call.

Okay, thank you. That concludes the conference for today. Thank you for your participation and for using AT&T executive teleconference service. You may now disconnect.