Piedmont Realty Trust Inc (PDM) 2016 Q3 法說會逐字稿

Greetings and welcome to the Piedmont Office Realty Trust third-quarter 2016 earnings call.

(Operator Instructions)

As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Mr. Robert Bowers, Chief Financial Officer for Piedmont Office Realty Trust. Thank you, you may begin.

Thank you, operator. Good morning. Welcome to Piedmont's third-quarter 2016 conference call. Last night we filed our Form 10-Q and an 8-K that includes our earnings release and our unaudited supplemental information for the third quarter, all of which are available on our website, piedmontreit.com, under the investor relations section.

On today's call, the Company's prepared remarks and answers to your questions will contain forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. Forward-looking statements address matters which are subject to risks and uncertainties that may cause the actual results to differ from those we discuss today.

Examples of forward-looking statements include those related to Piedmont Office Realty Trust's future revenues, operating income and financial guidance, as well as future leasing and investment activity. You should not place any undue reliance on any of these forward-looking statements, and these statements speak only as of the date they are made. We encourage all of our listeners to review the more detailed discussion related to risks associated with forward-looking statements contained in the Company's filings with the SEC.

In addition, during the call we will refer to non-GAAP financial measures, such as FFO, core FFO, AFFO and same-store NOI. The definitions and reconciliations of our non-GAAP measures are contained in the supplemental financial information available on the Company's website.

I will review our financial results after Don Miller, our Chief Executive Officer, discusses some of the quarter's operational highlights. In addition, we're also be joined today by various members of our management team, all of whom can provide additional perspective during the question-and-answer portion of the call.

I'll now turn the call over to Don.

Good morning, everyone, and thank you for joining us as we review our third-quarter operating results. As you saw on our filings last night, the third quarter was an active quarter for us from both a leasing and transactional perspective, as we continue to make good progress on leasing up currently vacant space within our portfolio and as we recycle capital into our eight strategic markets.

I'll start by doing our leasing activity for the quarter. It was robust and included activity in all of our major markets. Total square footage leased was over 700,000 feet with almost half of that related to leases with new tenants. The largest individual transaction for the quarter was a 12-year renewal and expansion by Synchronoss Technologies at 200 Bridgewater Crossing in Bridgewater, New Jersey, taking them from 78,000 square feet to almost 120,000 square feet.

Our largest number of new leases were in the Washington, DC and Chicago markets where we had the largest blocks available square footage. In Washington we completed 11 leases totaling over 180,000 square feet, 135,000 of which is new leases for vacant space. This activity included the technology division of a large multinational company who signed an 88,000 square foot 11-year lease at 4250 North Fairfax in Arlington, Virginia.

Also in Arlington the Cadmus Group signed an approximately 25,000 square foot 10-year-plus new lease at 3100 Clarendon Boulevard. And in the District of Columbia, the National Association of County and City Health Officials signed an approximately 23,000 square foot, 11-year new lease through 2028 at 1201 I Street. In Chicago we addressed much of our remaining largest vacancy in that market by signing Motorola Solutions to an additional 54,000 square feet, with a new 11-plus-year lease at 500 West Monroe, bringing their total square footage at that building to approximately 206,000 square feet and overall occupancy in the property to over 94%.

Obviously, since Washington and Chicago are two of the most expensive markets for tenant capital in the US, our capital cost for new leasing activity was higher in the third quarter than in previous quarters, but was more than offset by very low capital requirements in the renewal portion of our portfolio during the quarter. We were also able to accomplish two lease renewals of over 50,000 square feet with tenants in other markets, along with a sizable number of new and renewal tenants in the 2,500 to 15,000 square foot range which appears to be the strike zone in this part of the cycle. I'll refer you to the major leasing information detailed in our quarterly supplemental information and press releases for more details.

This leasing activity, combined with the effects of our capital investment transactions were key drivers in our growth and our in-service portfolios occupancy from 90.6% one year ago to 93.4% at the end of this most recent quarter. On a same-store basis, occupancy increased 150 basis points over the last 12 months. Also, please keep in mind that our reported portfolio-wide occupancy will be reduced by approximately 200 basis points when we consolidate our three current development properties into our in-service portfolio in January of 2017.

Looking more closely at our acquisition and disposition activity, as I said at the beginning of the call, the third quarter was a busy one for capital markets transactions. We think our disciplined strategy of leasing up assets and being patient for an optimal exit was demonstrated earlier in the quarter when we sold the 150 West Jefferson property in downtown Detroit for almost $82 million. This is an asset that would have been worth a small fraction of that amount just a few years ago.

We also decided to sell our Shady Grove portfolio of three buildings which had all been recently vacated, two by Lockheed Martin and one by the US Food and Drug Administration. Although most of you know that we rarely like to cut losses by selling assets before we have achieved maximum leasing, we decided that our desire to focus our Washington area attention on those higher-quality assets with good amenities and transportation access meant that moving the properties at this point made sense to us.

Using the proceeds from these dispositions and availability on our line of credit, we purchased several assets that beautifully fit our strategy of concentrating in those markets and sub-markets that have strong corporate interest, good job growth qualities, strong amenities and transportation infrastructure and where Piedmont can take advantage of its local capabilities and competitive advantages. The largest of those transactions was the acquisition of a 99% interest in the entity that owns CNL Towers 1 and 2 in downtown Orlando, positioning Piedmont as the major trophy office landlord in this fundamentally sound and growing CBD.

We also leveraged our existing market presence in the Burlington sub-market of Boston and purchased the 1 Wayside Drive property, an approximately 200,000 square foot office building. This property is located physically adjacent to our existing assets at 5 and 15 Wayside and also across the street from our 5 Wall Street building. Besides providing a high yield, the addition of this property to our Burlington portfolio introduces synergistic opportunities to create long-term value for the shareholder. Purchase price, occupancy and other information on these assets can be found in the supplement.

Subsequent to quarter-end, we closed on another strategically located asset, the Galleria 200 building, a sister property to our Galleria 300 asset that we purchased less than a year ago. The Galleria development is widely regarded as the best class A office park in the northwest sub-market of Atlanta and the acquisition of Galleria 200 and 300 ensures us of a significant presence in this amenity-rich and highly visible office development. We have included a presentation of our acquisition rationale for these acquisitions on our website.

So far in 2016 we've acquired about the same amount of assets we've disposed of. However, we have a few disposition transactions we're currently evaluating and we plan to provide appropriate disclosure should we determine a move forward with those transactions. I will now turn it over to Bobby to review our financials, balance sheet and the outlook for the rest of the year. Bobby?

Thanks, Don. While I'll discuss some of the financial highlights for the quarter, I encourage you again to please review the 10-Q, earnings release and supplemental financial information which were filed last night for more complete details.

For the third quarter of 2016 we reported FFO and core FFO of $0.41 and $0.42 per diluted share, respectively. This is comparable to the same metrics last year, despite the sale of 12 assets since July 1 of last year, for a total of $1.2 billion, which included, by the way, the sale of Aon Center and the loss of its $0.20 per share FFO contribution alone.

The decrease in FFO associated with those sales has been offset by the growth and income from our remaining properties, as well as the acquisition of seven replacement assets for a total of $570 million over the same time period and a reduction in both our average outstanding debt and our weighted-average shares as a result of our stock repurchase program. No shares, however, were repurchased during the third quarter.

AFFO was $50.5 million for the quarter, comparable with the third quarter of 2015 and well in excess of our dividend pay-out rate. Same-store NOI for the third quarter of 2016 was up 4.5% compared to the third quarter of the previous year, primarily driven by the commencement of new leases and the expiration of rental abatements.

We continued to pay down secured debt during the quarter, repaying a $42.5 maturing mortgage with proceeds from property sales and from our line. Our average net debt to core EBITDA ratio is 6.4 times for the quarter ended September 30, down from 6.9 times at the beginning of the year.

Turning to our forecast for the year, regarding our estimates, we are raising our previously issued annual guidance for 2016 to a range of $1.64 to $1.66 per diluted share for core FFO. This has resulted from stronger income growth in our same-store portfolio, slightly under budget G&A expenses, and the timing of our acquisition and disposition activity. We'll follow our usual practice of issuing formal guidance for 2017 during the first quarter of 2017 after we've completed our annual budget process this December.

However from a broad perspective, we should see continued growth in our same-store portfolio, offset by the FFO impact of any sales. We project to continue to be a net seller in this environment, but of course strategic acquisition opportunities are hard to forecast in both their timing and the volume.

I'll now ask the operator to provide our listeners with instructions on how they can submit their questions. We'll attempt to answer all of your questions now, or we'll make appropriate later public disclosure if necessary. Please try to limit yourself to one follow-on question so that we can address as many of you as possible. Operator?

(Operator Instructions)

Jed Reagan, Green Street Advisors.

Good morning, guys. I'm sorry if I missed this, but can you provide a going-in cap rate for the Atlanta and Boston acquisitions?

Yes, the going-in cap rate, you're talking about cash cap rate, not GAAP yield, right?

Correct. Maybe both.

Give us a minute, we'll pull that up. If you have a follow-up question we'll pull that up while you're looking.

Okay. Can you talk a little bit more about any assets you might have out on the market for sale? And then in general how much is left in the portfolio at this point that you'd consider clearly non-core?

Yes, those are hard definitions because I think things change over time, obviously. We have, we mentioned, about $800 million that we're looking to sell over the next couple of years, some of which I would think, we would call non-strategic, some of which we would still think of as in our strategic markets but opportunities to realize maximum value.

So it's a little bit hard to distinguish what's core and what isn't. For example, there's been things rumored in the marketplace right now that would be clearly within our strategic plan but we think we'd maximize value on. That's a little bit harder to say. I would say $400 million to $500 million, but I'm swagging it admittedly, Jed.

Okay, that's good.

I'd say the cash cap rates going in on the two deals are 7%s on Galleria, around 7% on Galleria and around -- a little higher than that on Wayside. But the GAAP yield is meaningfully higher. I think we reported almost an 8% GAAP cash rate on Wayside and a little under 7% going in.

Galleria is a little odder because part of the reason for that price per pound being so low was that there was some free rent on the major tenant's lease to begin with. If you look at cash cap rate first year, it's low single-digits. But if you look at a GAAP cap rate when you add in that free rent, it moves up into the 7% range. And then a stabilized cap rate is probably closer to 9%. So it's -- I almost got to giver you three numbers because of that free rent.

Okay, that's helpful. Just one more, if I may. What are you seeing on the general trends from larger corporate users these days? Would you say there's been any changes in the decision-making thought process from that group of tenants this year?

I would say the activity level seems to be comparable, but I'd say the decision-making process seems to be slower. And I think we can all suspect that may have something to do with the election and worries about interest rates and things like that. I'm not sure we've come to a definitive conclusion about what our assessment of that is. But it seems like the decisions are taking a little longer to be made but there's still a reasonable amount of activity level out there.

That would be slower versus last year, let's say?

Yes, slower, say, versus 2015.

Great, that's helpful. Thanks, guys.

Michael Lewis, SunTrust Robinson Humphrey.

Thank you, good morning. You withheld there's four leases here that are more than 1% of your revenue each, expiring through 1Q 2018. They're all in different markets. It looks like all four are giving you back a substantial amount of the space.

What can you tell us in terms of what you expect for downtime, potential capital needed? Or is it too early to give those kind of estimates?

It's not, but each story is a different one and there would probably, Michael, take quite a while to go through. But if you think about it, real quickly, Towers Watson is giving back 125,000 feet next year. That gives us a block of about 150,000 feet.

I think Wiberg is on the phone, we'd be glad to have him give some color. I think we'd tell you we think that's the best block of space, certainly in Boston, but maybe in all of Arlington, in terms of quality, contiguous space, so we feel good about that. When you feel good about it you probably suggest there's 6 to 12 months of downtime, then obviously some free rent after that.

The National Park Service, likewise in the district in a very high-quality building. We've already leased some of the space. This is the remaining spaces yet to be leased.

Activity level is good. They depart in the third quarter of 2017. And similarly, because we feel good about where things are there, that's probably a 6 to 12-month downtime on average after they depart.

The Galleria situation is different in that they are already moving a substantial part of that operation out of the building soon. And we're working together to try to get that space leased to, hopefully, ameliorate some of their costs before they leave. But also then that would also help us potentially with downtime thereafter. A lot of it depends on how much activity we get going forward on that space between now and obviously the time that the lease expires.

So I think there will be some component of that will have no downtime. In fact, we've already done a 20,000 foot lease that took one floor of that space with no downtime. And then there will be some that will have downtime.

I'd say that market is slower than the other two I've mentioned already. Maybe you'd apply for the part of the space that we get back without having already leased it. It will have a little more downtime t it, say 12 to maybe a little more than 12 months.

Then the Goldman Sachs space, we're not sure that it's leaving yet. They have not signed a lease that we're aware of anywhere else. But they have indicated and it's been reported in the press that they may be moving to downtown to a building there.

There's still a lot of things that have to happen for that to work well. But we didn't want to have that in the press in Dallas that they're leaving and have us not acknowledge it. But we don't have full knowledge yet of what exactly that's going to happen there and what the timing of that is, so it's harder to make an estimate on that.

That's very helpful. So you guys have just one mortgage maturing in 2017. Did I just hear Bobby say that you intend to pay it down or is there going to be a refi there?

The intention would be to pay that secured loan off.

Okay, I thought so. Then my last one is on leasing at the two developments that are in lease-up. I was in Houston in the Enclave, talked to some brokers at the Enclave, sounds like a great building, obviously in a tough market. Is there a point where in 2017, do you have to bite the bullet? Or are you seeing signs of maybe a little bit of improvement or people poking around that asset?

And then on 3100 Clarendon it looks like there's been some activity. Maybe you could talk a little about that as well.

I think clearly we're more optimistic on 3100 Clarendon. We're already seeing nice progress. I think we're into -- for the office tower we're already into the 45% range, if I've got that correct. Signed another nice lease this quarter.

I would say there's a lot of good small tenant activity in that building, so we feel like we'll make nice progress on that. That's not one that we spend a lot of time being concerned about.

The Enclave building, probably a different situation all together. There's virtually no activity in the far west part of the corridor in Houston. Obviously all of Houston is very difficult.

So we're going to continue to try to be creative in ways to -- is there a buyer that comes along that wants to own the building as a user, or is there a synthetic lease that could be done, or is there a way to expand the existing tenant we've got next door, whatever. We're working on all those options. But as I've told you in the last couple quarters, I wouldn't start plugging in income streams from that asset any time soon.

Thank you.

Dave Rodgers, Robert W. Baird.

Good morning, guys. Maybe Don or Bob could tackle this, but a little more color on the DC market. It seems like everybody that operates in DC feels like the market is definitely getting a little bit better and strengthening a little bit.

Is that relative to where it was or is that relative to what you're seeing in the rest of the country? Some incremental examples would be helpful.

I'll throw that to Bob. Just to lead off, I'd say we, frankly, have exceeded our own expectations this year in terms of whacking away at the activity that we're getting done. 130,000 feet of new leases in one quarter is a pretty nice chunk of space to knock out.

However, we do have a couple spaces coming back to us. So we're going to have to do -- it's two steps forward, one and a half steps back. But I think overall we do feel like activity is picking up, particularly among associations, technology companies and to a lesser degree we're starting to see some government activity as well again for the first time in a while.

Bob, do you want to give more detail to that color?

Sure. I think we're continuing to see good job growth numbers here which is the building block for absorption, about half of the new jobs are office using. That's a positive as well. The offset, like with our Towers Watson deal, is a lot of the big tenants are compressing. You advance on one side with some job growth and some of that is taken away by the densification.

But I'd say overall we're feeling better about the properties. The RB corridor is pretty active on the tour side right now.

As Don mentioned, down in the southwest which had been dormant, we're definitely seeing more activity in that sub-market. Our buildings in the east end have always had pretty good activity and we continue to see that.

Goes without saying, Dave, that obviously concessions are high but base rates have held, so I think hopefully that gives you a good summary.

It does. Maybe a touch on the asset sales, you addressed the strategic versus non-strategic. I think you said $400 million to $500 million in total. Would you put 500 West Monroe, now that you stabilized it, in there in that bucket of something you might want to move out?

No, I don't think so yet. There's certainly lots of term left in the leases in that building. As you've seen, if we were to ever consider putting something on the market, it usually means we're -- it's either non-strategic or we feel like we have gotten the lease terms down closer to that 10-year mark.

As we told everybody in the market, we don't see a lot of change in cap rate from the 10 to 12 or 13-year mark in most assets. As a result, we like to hold them from the 13-year term hold period down closer to 10 before we want to sell them, because we think we've captured the income without paying the price on a cap rate basis.

So we're probably not inclined to do anything with that asset any time soon. And frankly, it's been a great asset for us. It's worked really well and it's a pretty core holding in some respects. I don't think that's an asset we'll put on the market any time soon.

Okay, thanks. Last question for Bobby. I think the economic lease percentage had a nice recovery in the quarter, up quite a bit.

What the question ultimately is, is that going to make its way in to same-store cash NOI to AFFO? Or was that impacted at all by the asset sales? And thanks.

The economic lease percentage actually grew because of the abatements burning off. What I'd originally projected that it would narrow down to 2% or 3%, with all this leasing activity, I think it's going to stay a 5% gap to our overall occupancy for the next year or so.

Okay. Thanks, guys.

(Operator Instructions)

Barry Oxford, D.A. Davidson.

Great, thanks, guys. Real quick, getting back onto the development, you guys are going to be consolidating that Jan. 1. Does that mean that pro rata interest from the capitalized interest is going to be running through the P&L? Is that how to think about it?

Yes, that's correct. What we thought we'd try to do is since the -- and I know not everybody does it this way, but since we are fully op CO'd on both 3100 Clarendon and Enclave and been actively trying to market them for some time, with obviously some success at 3100 Clarendon and no success at Enclave, we felt like the only right thing to do was bring them in to the same-store pool starting January 1 of 2017.

Then on top of that, the 500 Town Park asset that is scheduled to deliver -- we think we'll get a CO in the next few weeks in Orlando. And so the tenants will then be obligated to commence before the end of the year, we believe. As a result, we might as well go ahead and put that into the same-store pool since it's 80% leased.

I know others wait a little longer to do that and keep capitalizing expenses. We just didn't feel like that's the right thing to do so we went ahead and threw them all in to the pool right away.

Okay, great. In 2017 do you guys see starting any new developments?

I think the best opportunity we would have would be substantially pre-leased opportunities in the southeast where we are chasing build-to-suit activity. Orlando, Atlanta, to a lesser degree Dallas, we're seeing activity in each of those markets. But I would say Orlando is probably the highest chance of opportunity and we're actively pursuing multiple things along those lines there. Yes, it's possible, but I wouldn't say we would say that the highest -- a really high likelihood.

Right. Thanks, guys. Appreciate it.

Anthony Paolone, JPMorgan.

Thanks, good morning. Basically following up on Barry's item about the couple of developments and the redevelopment coming in and perhaps being a drag into 2017. I guess on the flip side you also have very little lease exposure compared to prior years.

What do you think the net of that is as you look out in to next year? I understand you haven't given guidance yet but trying to understand how manageable that drag is against the opportunity to lease in a low-expiration year.

Tony, are you asking for occupancy, same-store or FFO lease-back?

Really earnings, I guess when it comes down to it, because some of the drag is interest expense.

I think if you look at our early takes, and obviously we're not providing guidance 'til next quarter or maybe a little earlier than that. I would say our early take is if we were to stand pat with where we stand today, we've got a pretty nice growth in FFO going in to next year.

However, as a prospective net seller going in to next year, it's possible that we sell enough that we may not grow FFO next year meaningfully, because of the number of sales activity. A lot of it depends on how much net sale activity we get done. But I think our range is no worse than where we are for this year and maybe a pretty nice growth pattern if we don't get a lot of dispositions done.

You say no worse than this year, meaning the level of earnings, not necessarily the growth rate of --?

Correct. The absolute level of earnings. Obviously if we only maintain our level of earnings in 2017, our balance sheet will have improved dramatically.

Right. And I know these things can change and you still have to give guidance and stuff, but when do you think you'll come to any major conclusions on sales in terms of whether it's a bigger number or smaller number?

That will be a series of events over the course of the next six months as we have things in the market and they either get done or they don't. I think you've probably got a pretty good feel for how we go about those things now. If we feel like we've gotten our price, we'll sell it. If we don't, we'll back it off.

We have a pretty steady flow of things coming to the market over the next six months. That will probably indicate how successful we'll be in that process.

Okay. Thank you.

Thank you. Mr. Miller, there are no further questions at this time. I'd like to turn the floor back to you for any final remarks.

Thank you, Melissa. Before everyone drops off, I just have one thing I want to announce. In addition to going to NAREIT in Phoenix in a couple weeks, for those of you who have not contacted us yet about a time, we still have a few times open so we'd be glad to try to fit you all in.

But maybe more importantly, we're going to try to do an Orlando Investor Day the day after Martin Luther King Day in January, so January 17 and 18. We may have a co-host on that. Some of you, most of you should be getting an announcement on that event here in the next week or two.

But we plan on touring everyone through our downtown assets and then taking them out to Lake Mary and showing them our build-to-suit and other activity going on out there. We hope it will be a very good use of your time and you want to get it on your calendar early. So you should be getting a save-the-date in the near future.

Thank you for attending the call and we look forward to catching up with everyone. Have a good day.

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.