Office Properties Income Trust (OPI) 2016 Q1 法說會逐字稿

Good morning and welcome to Government Properties Income Trust first-quarter financial results conference call. All participants will be in listen-only mode. (Operator Instructions) Please note this event is being recorded.

I would now like to turn the conference over to Christopher Ranjitkar, Director of Investor Relations. Please go ahead.

Thank you, and good morning, everyone. Joining me on today's call are President David Blackman and Chief Financial Officer Mark Kleifges. They will provide insight about our recent accomplishments and results for the first quarter. They will then take your questions.

First, please note that the transcription, recording, and retransmission of today's conference call are prohibited without the prior written consent of the Company.

Also, 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 28, 2016. The Company undertakes no obligation to revise or publicly release the results of any revision 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.

Additional information concerning factors that could cause those differences is contained in our filings with the SEC, which can be accessed from the SEC's website or the Investors section of our website at govreit.com. Investors are cautioned not to place undue reliance upon any forward-looking statements.

And finally, we will be discussing non-GAAP financial metrics during this call, including normalized funds from operations, or normalized FFO. A reconciliation of these non-GAAP figures to net income and the components to calculate cash available for distribution, or CAD, are available in our supplemental operating and financial data package which, again, can be found on our website.

Now I'll turn the call over to David Blackman to begin our quarterly discussion. David?

Thank you, Christopher.

Today Government Properties Income Trust announced solid operating performance for the first quarter of 2016, underscored by continued robust leasing activity, growth in average rents for new and renewal leases, and increases in both occupancy and NOI.

As of March 31, 2016, GOV owned 72 properties in continuing operations containing 11 million square feet that were located in 31 states and the District of Columbia. At quarter end consolidated occupancy was 94.9%, an increase of 40 basis points from the previous quarter. Same-property occupancy was 95.1%, growing 60 basis points from the previous quarter, both of which were driven by our robust leasing results.

GOV's weighted average lease term based upon annualized revenue was 4.8 years as of March 31. The US government remains our largest tenant and, when combined with 12 state governments and our other government tenants, contributed 92.8% of our annualized rent at quarter end.

As was the case in the fourth quarter, we were active leasing during the first quarter, dominated by new and renewal leases with government tenants. Consolidated leasing totaled 523,000 square feet for a weighted average lease term of 11.6 years, with leasing capital commitments of $3.38 per square foot per lease year and a 12.4% average rollup in rents.

Nearly 90% of our leasing activity was with government tenants, which included 9 executed leases for approximately 461,000 square feet that resulted in a 14.4% average rollup in rent, a weighted lease term of 12 years, and leasing capital commitments of $3.32 per square foot per lease year.

We also signed 11 leases with nongovernment tenants for 62,000 square feet, resulting in a 2.3% roll-down in rent, a weighted average lease term of 8.1 years and leasing capital commitments of $4.04 per square foot per lease year.

It's worth noting that we executed six leases containing 421,000 square feet during the quarter, with the US government for lease terms of 10 years or longer. We believe this is meaningful because GSA leased buildings with lease terms of 10 years and longer tend to achieve premium market valuations, and we believe this provides strong evidence that GSA is truly focused on moving away from short-term lease extensions.

Also during the quarter we were able to lease two vacant properties containing 65,000 square feet in Atlanta to the US government for 15 years. The buildings will be substantially renovated and they will be connected by a 25,000 square foot addition to create a modern, 90,000 square foot building with structured parking.

This is noteworthy because our creative solution to meet GSA's growth needs was the result of our experience as an active asset manager of office properties and our reputation with GSA of providing high quality customer solutions. The 15-year lease term also substantially enhances the value of what was two unleased buildings.

Moving on to our capital recycling and investment activity, during the quarter we entered an agreement to sell our property in Falls Church, Virginia for $14,750,000. The sale of this property is subject to completion of the buyer's due diligence and certain zoning entitlements. It is currently expected to close in the first quarter of 2017.

During the quarter we also entered an agreement to sell our 35,000 square foot office property in Savannah, Georgia for $4.5 million, also subject to the buyer's completion of due diligence. Assuming the deal transacts as expected, the sale of this property should close before we announce second-quarter earnings results.

I would also like to remind you of an acquisition we completed in January and announced on our fourth-quarter earnings call. This property is a 338,000 square foot LEED Platinum 28-story office tower located in downtown Sacramento that we acquired for $79.2 million, excluding acquisition costs. The property was 86% leased at the time of acquisition, majority leased to the State of California, and the acquisition yield was 7.2%.

As we detailed last quarter, we expect to grow our acquisition yield to around 9% over time as we stabilize building occupancy and generate meaningful event parking revenue from the new nearby arena. The business plan for this property is beginning to take hold as we entered two new leases during the quarter for 7,300 square feet for a weighted average lease term of 8.1 years and a 4.6% average rollup in rent. Occupancy is now 88%, so we still have room to grow.

As with past earnings calls, we will continue to provide insight into our expiring leases for the next 24 months. As of March 31, 2016, we have leases contributing 26% of GOV's annualized rent and covering approximately 2.4 million square feet that are subject to expiration.

Based on our latest tenant discussions, we currently expect tenants contributing 1.85% of annualized rent to vacate, with the vast majority occurring before the end of 2016. This compares to 1.96% of annualized rent categorized as to-vacate during the previous quarter.

Reconciling the two quarters, nongovernment tenants contributing 10 basis points of annualized rent vacated during the fourth quarter, as expected, while we added one new nongovernment tenant contributing 5 basis points of annualized rent this quarter. Note that the math does not perfectly reconcile due to a change in our aggregate annualized rent from year end to the end of the first quarter.

The tenants we have identified to be at risk of downsizing or vacating this quarter increased from 86 basis points at year end to 3.43% this quarter. The new at-risk tenants include the Department of Justice at 20 Mass Avenue and the National Institutes of Health in Bethesda, Maryland. Both of these tenants are at risk to vacate in the latter half of 2017 and were added because we believe the tenants' space needs are greater than the available space in our buildings.

Note that we continue to include the Bureau of Land Management in Cheyenne for the full building, even though we expect the tenant to downsize by about 25%.

As a reminder, these figures are the best information we have available today based upon our current lease negotiations. As negotiations with our tenants evolve, we expect our disclosures to evolve as well.

Similar to our retention rate, which we believe will remain well above the norm for our office REIT peers, we believe the level of insight that we are providing about our lease expiration schedule demonstrates best-in-class disclosure practices.

Tenant retention and attracting new tenants to our buildings remain significant areas of focus for GOV, as evidenced by our continued strong leasing results.

Now I'd like to turn the call over to Mark Kleifges to provide more detail on our financial results.

Thanks, David.

Let's begin with a review of our property-level performance for the first quarter of 2016.

When compared to the first quarter last year, GOV's rental income grew by approximately $952,000 to $63.6 million. On a same-property basis, our first-quarter rental income increased by $953,000, or 1.6% year over year, to $62.1 million, reflecting an increase in occupied space at certain of our properties and higher escalation income.

Consolidated first-quarter net operating income, or NOI, increased by $405,000, or 1.1% year over year, to $38.9 million. Consolidated cash basis NOI for the first quarter increased by $827,000, or 2.2%, to approximately $38.9 million.

Our consolidated GAAP and cash NOI margins for the 2016 first quarter were 61.1% and 61%, respectively. From a same-property perspective, our GAAP NOI increased $424,000, or 1.1% year over year, to $37.9 million, and our cash basis NOI increased by $880,000, or 2.4%, to $38 million. Our same-property GAAP NOI margin was 61.1% and our same-property cash basis NOI margin was 61% for the 2016 first quarter.

Normalized FFO for the first quarter was $44.4 million, which is up from $40.8 million from the 2015 first quarter. This increase was due primarily to an increase in our share of SIR's normalized FFO, the increase in our same-property net operating income, and lower G&A expense. Normalized FFO per share for the 2016 first quarter was $0.62, which is up $0.04, or 6.9%, from the 2015 first quarter.

Adjusted EBITDA was $47.9 million for the 2016 first quarter, and includes approximately $12.5 million of cash distributions received from our SIR investment.

We paid a $0.43 per share dividend to shareholders during the first quarter, which equates to a normalized FFO payout ratio of approximately 69%.

We spent approximately $3 million on recurring building improvements and $6.3 million on tenant improvements and leasing costs in the 2016 first quarter. As of quarter end we had approximately $22.8 million of unspent leasing-related capital commitments. As a result of these unspent commitments and the level of leasing activity forecasted for the remainder of the year, we expect our 2016 TI and leasing spend to exceed 2015 amounts.

Turning to our balance sheet and liquidity, both our adjusted EBITDA to interest ratio and our total debt to annualized adjusted EBITDA ratio remain strong at 5.1 times and 6.4 times, respectively. And total debt to the gross book value of real estate and the market value of our SIR investment was 48% at March 31.

At quarter end we had significant liquidity with $439 million of availability under our revolving credit facility.

Before turning the call over to Q&A, I'd like to bring your attention to the newly published Sustainability section on our website. GOV has implemented this section because government tenants have the right to favor LEED-designated and Energy-Star-labeled buildings over those that aren't. As a result, corporate environmental sustainability is important to our long-term success and it is an area of focus for us and our manager.

The inception of this section underscores our efforts in fostering programs that uphold our philosophies of environmental stewardship and stakeholder engagement. Through our environmental stewardship programs, GOV has advanced as a green leader, earning the designation as a Green Lease Leader for the past three consecutive years, as well as achieving Energy Star and LEED designations for a large portion of our portfolio. We believe these designations differentiate GOV properties and allow our existing and prospective government tenants to favor GOV as a landlord.

We further believe this new section provides crucial information for investors to evaluate our environmental and social responsibility metrics as part of their investment due diligence. We encourage you to visit the Sustainability section on our website.

Operator, that concludes our prepared remarks. We're ready to open up the call to Q&A.

(Operator Instructions) Jamie Feldman; Bank of America Merrill Lynch.

So I guess just in terms of incremental information, can you talk more about the risk of downsizing and then the known move-outs? I think you had said the known move-out is now 1.85% in 2016. Are there any in 2017?

Yes, so Jamie, the 1.85% includes all the expected move-outs that we have over the next 24 months. The vast majority of that is going to occur in 2016. We have just a couple of tenants that we expect to move out in 2017.

Okay. And then you feel good that you can renew the rest in 2017?

Well, we have -- yes, I think you have to look at the to-vacate and the at-risk together. Recall that we said that our at-risk was increasing to 3.43%. That includes a couple of new additions and really substantially all of our at-risk tenants are for expiration in 2017.

Okay. So you said that went up to 3.43% from 0.9%. And then I think you mentioned two specific leases. Can you talk more about those and what makes you put them on the at-risk? And is there a chance they're really not that much at risk?

We've added them both at risk because they have come out with prospectuses for leasing that exceeds the amount of available space in our buildings. So we have a degree of concern that if they move forward with their existing requirements, we will not have sufficient availability in our buildings to meet those needs. Both of those occur in the second half of 2017, so we still have a lot of time to work through that.

And one of the things that we want to be very careful of is until we know for certain that a tenant is vacating, we are not putting them on the [at] vacate list, which is why we created the at-risk list.

Okay.

That make sense?

It does. Thank you for the disclosure. So you said one is 20 Mass Ave. And what was the other?

The other one is the National Institutes of Health in Bethesda. It's a pretty good building. It's right next to NIH's campus. So even if we lose them, there's a chance that they're going to need to find another part of NIH that needs to occupy space there. And there's obviously a lot of other tenants that want to occupy space near NIH's campus.

So we feel pretty good about both of these buildings. 20 Mass obviously is a great building located right across from Union Station in Washington, DC. So both good quality buildings that are attractive to tenants. We may have some downtime as we re-lease the space, but we feel pretty confident in our ability to re-lease both of those buildings.

Okay. And then you said the nine government leases are really what drove the stronger leasing spreads. Those were big leasing numbers. Are there a couple that were really chunky and some smaller? Or was that total square footage spread evenly across in the leasing spread, spread across?

The spreads were pretty well spread across the portfolio. So we had one 93,000 square foot lease in San Diego. That was probably -- that was our largest lease. The rest of them -- and I guess of course we had the CDC lease that I talked about which is 90,000 square feet, which is really the 65,000 plus the 25,000 for the connector addition. But everything else tended to be more moderate size lease. We just had a lot of activity.

Okay. And do you expect to maintain leasing spreads like that for the foreseeable future?

No, I don't think we can say with definitive confidence that we're going to continue to have low-double-digit increases in rents. I think we're going to have some quarters this year where we have nice rollup in rents; we're going to have some quarters where we may not have rollup of rents at all.

So, leasing tends to be lumpy. They tend to be very market dependent. But I think by and large what you'll see in our Q is over the next 12 months we expect to be modestly down in our leasing spreads.

Okay. And then, same-store NOI, how do you think that might trend for the rest of the year? You had a nice pop there also.

Yes. This is Mark. We benefited from a decline in expense growth this quarter. So that was driven by both our focus on managing and controlling expenses. But we did have a favorable comp to the prior year first quarter because we had a much milder winter in several parts of the country this year and we benefited from lower utilities and snow removal costs at a number of our properties this quarter.

But I think for the year we expect expense growth to moderate it when you compare it to -- we had almost a 5% increase in expenses last year. Our current expectation is our expense growth will be closer to inflation, 1.5%, 2% area. And so we would hope that we will be able to maintain positive NOI growth for 2016.

Okay, but maybe at slower rate.

Yes, I think a slower -- we won't have that same favorable comp on the expense side next quarter.

Okay. All right, great. Thank you.

(Operator Instructions) Sumit Sharma; Morgan Stanley.

Congratulations on the great quarter. So quick question on the CDC and sort of the nine big leases you signed. How much of the asking rent was -- or how much of the TI and leasing commissions were as a percentage of the asking rent? Would you be able to share that me? I just want to get a sense of, I guess, what sort of capital commitment or expenditure you're looking at for these new leases.

Are you asking just on the CDC? Or are you asking on new leases?

The new leases, but actually CDC was my follow-up question, but you can answer both of them if you want.

You know, it's interesting. I've never really thought about TI and leasing commissions as a percentage of asking rents. I don't think I've ever done that calculation. Maybe we can look at that and have a follow-up on it, but I honestly don't know.

We tend to think about leasing capital in terms of the dollars per square foot per lease year. Because, particularly when you think about leasing commissions, leasing commissions tend to be the amount of annual rent times the number of years times, call it, 5% or 7%, depending upon whether there's two brokers involved or one broker involved.

So longer-term leases tend to have higher commissions. So I'm not sure it's really fair to think about the commissions in particular as a percentage of the rent, at least on an annualized basis.

Fair enough. I guess I was just trying to understand the economic value of the leases in question. But it sounds like things are definitely turning a corner around the government leasing market. I was interested in getting your perspective. Even the at-risk tenants that you point out are actually for (inaudible) for the right reasons, which is that they want to expand space. I'd imagine they're probably going to increase utilization per employee and all of that stuff. But does it seem to you that your primary tenant category is actually sort of at an inflection point and showing signs of positive growth?

Well, I would definitely say that our primary tenant, the US government, is at an inflection point as it relates to a focus on extending their lease durations. The US government has a tremendous amount of leases maturing over the next three years. And their goal is to extend as many of those as possible to lease terms of 10 years and longer. So we hope to benefit from that and we hope that the results will be that we'll have a longer weighted average remaining lease term across our company.

It's hard to say whether the government is really growing right now. We're in an election year. I think a lot of it's going to depend upon the next administration. And I think it's really kind of too early to tell how the government employment and their need for real estate will change, say, over the next couple of years.

Well, thank you very much for answering the questions.

Mitch Germain; JMP Securities.

I just wanted to just touch on the Falls Church transaction. I know we've been through this. I think this might be the third time it's been under contract. Maybe just provide some perspective about maybe why this time might be different.

Yes, it's a good question. You're right. This is the third time we've had this under agreement. The first time I think the developer that was planning to do multifamily, he missed the market. He was trying to build an ultra-high-end apartment community in a market where there isn't a lot of high-end multifamily around it. Shame on us for not recognizing that and deciding to move forward with him.

The second one was actually an owner/user. And for one reason and another they elected not to move forward. But they were actually planning on using the building as is.

What we have right now is a group that is looking at what we think is a market-appropriate mixed used development. They are long-time Washington, DC-area-based developer. They have very strong relationships in the township where the property is located, and have credibility in kind of managing through the rezoning process.

A big portion of the entitlement was done the last time around. The big piece was getting the town plan reconfigured to allow for a mixed use program. So there's a lot less heavy lifting that needs to be done here. And I think the most important thing is I think the economic analysis for the current buyer is more appropriate for the asset. So knock on wood, we're optimistic. But only time will tell.

Should -- any change in the development dynamics for government properties or is that really still pretty much slowed down at this point?

Yes, there is not a lot of new building for government properties right now. What we tend to see in terms of build-to-suits have really been kind of border protection, sort of relatively small buildings in tertiary markets that don't meet our investment criteria.

And you see a lot of building with the VA right now. The VA tends to have 15-year leases and they tend to be assets that trade at 6% and below cap rates, which also are properties that we're not actively buying.

So the stuff in between there, we're really not seeing a lot of requests from the US government for new buildings.

Great. Last one for me, I think you guys are just a tad under 50% in terms of leverage. And I'm just curious. Maybe, Mark, you can offer some perspective how you want to manage leverage on a forward basis.

Yes. So, Mitch, we're obviously at a high level of leverage versus where we've historically operated the Company. And at some point we'd like to bring it back down to closer to past levels. But given the state of our stock price -- and while we've had a pretty good run this year of the stock, we're still trading at a dividend yield of slightly over 9%. It's just -- we're not going to sell equity at this price. So I think the timing of bringing leverage back down is really going to be dependent on the performance of our stock price.

And from the leverage perspective, though, you're kind of basically in your mind around the cap that you want to be at?

Yes, we have a little bit of flexibility, Mitch, but not -- we don't have the ability to go do a large -- to acquire a large portfolio of government-leased buildings at this point. We've got some -- we can increase it a little bit, leverage, but not by a significant amount.

Thank you.

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

Thank you for joining us this morning on our first-quarter earnings call. We look forward to seeing many of you in New York in June at the NAREIT convention.

Operator, that concludes this call.

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