Whitestone REIT (WSR) 2010 Q4 法說會逐字稿

Greetings, and welcome to the Whitestone REIT fourth-quarter and year-end 2010 earnings conference call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. (Operator Instructions). As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Anne Gregory, Vice President of Marketing and Investor Relations. Thank you, Ms. Gregory, you may begin.

Thank you, operator. Good afternoon, everyone. Before we begin our prepared remarks, I would like to just remind you that this call is being recorded and is the property of Whitestone REIT.

Leading the call today is Jim Mastandrea, our Chairman and Chief Executive Officer, and Dave Holman, our Chief Financial Officer.

Please note that some statements made during this call are not historical and may be deemed forward-looking statements. Actual results may differ materially from those indicated by forward-looking statements due to a variety of risks and uncertainties. Please refer to the Company's filings with the Securities and Exchange Commission, including the Company's Form S-11 and Form 10-Q for a detailed discussion of these risks.

Acknowledging the fact that this call may be webcast for a period of time, it's also important to note that today's call includes time-sensitive information that may be accurate only as of today's date, February 28, 2011.

The Company's supplemental fourth-quarter operating and financial data package was filed with the SEC today on Form 8-K. The filing will also be posted on www.WhitestoneREIT.com in the Investors section.

Also included in the supplemental data package are the reconciliations from GAAP financial measures to non-GAAP financial measures.

And with that, I will turn the call over to Jim Mastandrea, Whitestone REIT's Chairman and CEO.

Thank you, Anne. I'd like to welcome everyone, and, particularly thank you to those who are joining us on today's call and our investors for your continued confidence and support in Whitestone REIT. I'm pleased to provide today's overview of our progress. Whitestone continues to deliver increased results year over year and quarter over quarter.

In today's call, I will highlight our progress, and we will begin by providing some color on our community center business model. I will also touch on Whitestone's business relative to the ongoing challenges in the economy and its effect on the commercial real estate market. Our CFO, David Holeman, will then provide an update on our fourth-quarter financial results, and then we will open the call for questions.

The key to Whitestone's business model, the Community Centered Properties, ours is quite unique approach, especially for a public company, it evolves around what we do within our properties and how we position the buildings that we own. Our properties that are between 30,000 and 200,000 square feet in size are located in five of the nation's largest and higher growth markets -- Houston, Dallas, San Antonio, Phoenix, and Chicago.

The heart of our business model is our focus on Community Centers, which we define as visibly located properties in established or developing culturally diverse neighborhoods. We target primarily service-oriented tenants who provide needed services to their surrounding neighborhoods. We have a diversified base approaching 800 tenants. Tenant growth is a key measure of our overall business growth.

We proactively seek tenants that serve the needs of the residents near our properties. The businesses we have in our properties range from art schools to kidney dialysis, from dentists to doughnut shops.

We have a concentration of service providers that meet the day-to-day needs of families in the three- to five-mile local neighborhoods surrounding our centers. For example, medical, dental, consulting, and counseling services; casual dining such as doughnut and pastry shops; family-friendly restaurants and cafes, from franchise locations like Subways and Rizzotti's, to entrepreneurial mom-and-pop-owned and Indian-run, Asian, or African restaurants.

We also like to have in our tenant mix a variety of educational and tutoring services, and they too range from franchise businesses such as Kumon, to entrepreneurial studios offering dance or karate lessons, or driver's educational training. These tenants represent a solid base that as they grow and expand over the years, will need more space, which helps our business to grow as well.

Most of our tenants require a smaller space. At year end 2010, 71% of our nearly 800 tenants lease less than 3,000 square feat. One additional attribute is that we focus on underserved, culturally diverse populations within our markets, such as Asian and Hispanic, and we manage our local operations to the specific needs of the population surrounding each of our community centers.

Our Community Centered Property small space business model is one that works well in a good economy and proved successful through the most recent downcycle in the economy, as demonstrated by our upward trend fourth-quarter and year-end results.

Let me touch on some areas, for example, our progress. 2010 was truly an exciting year of accomplishment, especially marked by two milestones in our history. First, we completed our initial public offering, raising capital for the purpose of acquiring new properties and spanning our geographic footprint.

Secondly, since the IPO, we have completed two off-market property acquisitions at below market prices and are getting close on others from our pipeline that is in excess of $300 million.

The operating results of our Community Centered Property business model have continued to build on the positive trends that have emerged. Occupancy and growth is strong. We started the 2010 year with a physical occupancy of 84% and finished at year end of 86%. Our business model has proven that it is fairly recession-proof given our occupancy level has never dropped below 82% in the last four years, even in the midst of one of the worst recessions in our country's history.

As the national economy has started to stabilize, our market growth is starting to reemerge and our leasing results continue to strengthen. Our team of talented leasing associates is gaining more experience, and our tenants appreciate how we serve them.

FFO-Core increased 18% over the quarter. The increasing rent premiums we receive on spaces that are less than 3,000 square feet further validate our Community Center Property business model is working by driving margin improvement. The leases we signed with similar small space tenants carried a 57% premium when compared with the average rent for spaces larger than 3,000 square feet.

Our redevelopment projects -- during the fourth quarter, we initiated two redevelopment projects, Windsor Park Centre, which is a 200,000 square foot community center in San Antonio, Texas. This is a great example of where we had a 35,000 square foot vacancy and successfully turned it into multi-tenant space. We were able to give the University of Phoenix, the largest private university in North America, a lease for 20,000 square feet of space that they signed back in July.

We also have redevelopment plans that include adding new architectural and landscaping features and redesigning the parking and street plans to accommodate additional traffic plots in our parcel.

While this community center includes tenants that lease over 3,000 square feat of space, such as Michaels, Cavender's Boot City, Office Depot, and PetSmart, and some other small-space tenants, we've managed the property to make sure it is integrated into the surrounding community along with the philosophy and culture that we've applied to all of our Community Centered Properties.

Lion Square is the other community center for which we announced a transformation in late 2010. This is a 119,621 square foot Asian community center located on Houston's west side with the International Management District. A new Asian supermarket concept is in development, and as it unfolds, our redevelopment plans here include new architectural and landscaping features to enhance the internationally-themed culture within the Lion Square Center.

To give you some idea of the services offered to the surrounding community from this center, the other tenants at Lion Square include an Asian tea room, a Chinese dance studio, and several small mom-and-pop Asian restaurants.

With regard to our acquisition strategy, real estate values remain suppressed, which creates opportunity for Whitestone to purchase relatively new properties in growth markets at prices below replacement costs. We source opportunities at one-off transactions from title companies, regional banks, and small brokerage offices. Our pipeline of potential acquisitions continued to grow in excess of $300 million with most of this activity in Arizona. We are focused on value-add transactions with existing cash flow similar to our two most recent off-market acquisitions that we completed, both at the low replacement cost in the fall of 2010.

We have deployed $9 million of the IPO proceeds in the acquisitions of the Citadel and Sunnyslope Village. We expect to invest an additional $6 million in these properties in the form of capital improvements, improvements to tenant spaces, and leasing costs.

This additional investment of $6 million will bring our total cost per square foot to approximately $100 million, well below the replacement cost or cost of the land and the building. The remainder of our IPO proceeds will be deployed in additional acquisitions we hope to announce very shortly.

Let me touch on 2011 go forward. We discussed the 2010 growth initiatives, which include deepening our geographic footprint. Given our size, Whitestone is positioned to accelerate our growth both organically and from our existing portfolio and externally through acquisitions of new community centers. We have the advantage of a seasoned management team with over 120 combined years of commercial real estate and capital market experience.

Another competitive edge we possess is our vertical management infrastructure that directly leases, markets, and manages our properties. Our focus remains on acquisitions primarily in the Phoenix area; internal growth through driving occupancy up beyond our current 86% level; and redevelopment to enhance the value of our core properties.

Our acquisition focuses on properties that meet our Community Centered criteria, which we directly own, manage, and lease to small tenants. We look for properties that range in size from 50,000 to 200,000 square feet, and given this size, which is outside the criteria bounds of most larger REITs, we expect to continue to source off market deals from financially stressed sellers who are unwilling or unable to spend money on tenant improvements to drive occupancy. Because we are outside of this space with other REITs, we find little competition in this market space.

We seek a balance of properties with stable, in-place cash flow and properties with high value creation potential through value add-on initiatives, including redevelopment, repositioning, expanding or re-tenanting.

Internal growth will be driven through our continued leasing efforts. We're very pleased with our fourth-quarter occupancy growth of 300 basis points of improvement and we'll continue to stretch to meet or exceed our goals.

Our team that is driving these initiatives lives in our local communities and spends a great deal of time with our existing tenants in addition to sourcing potential new tenants.

All of the team at Whitestone is incented by specific performance goals which are designed to keep all of us focused on the key growth metrics, occupancy and FFO. To that end, our real estate executive development, or REED program, provides each associate the knowledge to be successful in the Whitestone model. It works like an in-house university to ensure that we have a staff that is well-trained. The fact that this is done in-house ensures that the training is accomplished according to our core values. This is a time-consuming process, but the results are proving to be quite good.

The educational program leverages senior management's deep history of successfully navigating the ups and downs of the real estate cycle. This places a well-educated team on the ground and the result is our turnover is down, our employees are highly engaged and motivated, and our results on leasing are steadily improved. This adds to our confidence in our ability to execute our Community Centered Property business model and add value as we move ahead.

With that, let me pass the call to David Holeman, our Chief Financial Officer. David?

Thank you, Jim. Hello, everyone, and welcome. I will be sharing the highlights of our fourth-quarter and 2010 year-end financial results and investment activities. I encourage all of you to read the Company's Form 10-K and supplemental financial package, both of which have been filed or will be filed shortly with the SEC and are also available on our website. They contain greater detail on our business that I will be able to share with you today. Please note that 2010 and 2009 results, except funds from operations core, included in income a portion of an insurance settlement for damages to the Company's Houston communities from Hurricane Ike, which occurred in late 2008.

For the quarter ended December 31, 2010, we reported an 18% increase in FFO-Core to $2 million or $0.28 per diluted common share and OP unit. As stated previously, FFO-Core excludes acquisition costs and the insurance settlement received in 2010 and 2009 related to the damages to our Houston properties from Hurricane Ike. Our property net operating income, or NOI, for the fourth quarter of 2010 was $4.9 million, an increase of 4% from the same period in 2009.

Now, let's turn to expenses. At the property level, property operating expenses for the fourth quarter increased approximately $300,000 from the same quarter in 2009. The increases were primarily due to the timing of certain annual repair and maintenance items. Repairs and maintenance to our properties were up on a quarterly basis, but lower for the entire year.

We have also been very successful in fighting to keep our property taxes low and again have benefited from this effort in the fourth quarter of 2010, with an approximate $300,000 decrease over the same period in 2009. Once again, the large majority of our leases are triple net, and we have been able to pass these savings on to our tenants, helping their businesses have greater financial success.

At the corporate level, we continue our ongoing operational efficiency program. As a result, we have decreased our G&A costs in the fourth quarter of 2010 by approximately $200,000 as compared to the same period in 2009. This has been accomplished through a Company-wide salary freeze, which has been in place since March of 2008; additional Company-wide salary reductions that were implemented in October 2009; carefully monitoring our back-office staffing levels; and lower share-based compensation expense in 2000 as compared to 2009.

Our team participates in an ongoing operational efficiency program, seeking continually to turn creative ideas into operational efficiencies. The focus on individual tenants and creating communities is not costly when you have skilled associates, robust systems, and streamlined processes. Operational processes are in place to support efficiency and produce attractive returns without sacrificing customer service or property maintenance standards.

For example, we have a customized financial management dashboard and turn our books quickly to allow managers to see the previous month's results within seven days of month's end. This tight window, along with our property management and leasing team's high touch on our tenant's approach, provides a heightened awareness that helps us stay in front of issues before they develop.

Our leasing team enjoyed a very robust fourth quarter in 2010 year. In the fourth quarter, leasing activity remained strong. Our team's efforts resulted in an 18% increase in the number of new and renewal leases signed. In 2010, we signed 298 new and renewal leases as compared to 252 in 2009. We increased our square footage leased by 12% for the year as we signed 716,000 square feet of leases as compared to 639,000 square feet in 2009.

Some of our fourth-quarter leasing highlights that helped drive these improvement results include our Providence Plaza Center in Houston achieved 100% occupancy with the addition of four new tenants, including a pet store and a medical clinic. This center has been turned around from an occupancy low of 63% following the departure from the Houston market of the $0.99 Only store. The departure of $0.99 Only left a 21,000 square foot vacancy in this property. We successfully repositioned, with the implementation of our small space business model, in which we converted the 21,000 vacant space into smaller spaces that are now occupied by two national retailers, Dollar Tree and Tuesday Morning. In doing so, we have lowered the risk profile of the assets as we have diversified and increased the sources of our NOI.

We have also signed our first lease at our Citadel property, a 28,000 square foot Class A community center in Scottsdale, Arizona, which, as Jim mentioned earlier, was acquired in September of 2010. The signed lease is with a financial services company that committed to a 1500-square foot space. While it is a relatively small lease, it bodes well for the asset, given the lease was signed prior to our redevelopment and repositioning efforts. We plan to announce redevelopment and repositioning plans for this center shortly.

We also have a very active prospective tenant pipeline. It is our practice not to announce new tenants until a lease is fully executed. As such, we would like to give you greater detail on our leasing activity at this center today, but that will have to wait until a further date. We continue to believe that this property is a great addition to the Whitestone portfolio that will add significant value to our shareholders.

We also have a very active prospective tenant pipeline at Sunnyslope Village, our second post-IPO acquisition, which is located in central Phoenix. As Jim mentioned earlier, we acquired these two properties representing approximately 140,000 square feet for $9 million. We expect to invest an additional $6 million in these two properties in the form of capital improvements, improvements to current and future tenant spaces, and leasing costs, to acquire new tenants.

All in all, we will own these two assets for approximately $100 per square foot, which is well below replacement cost and should allow us to provide very attractive returns on these two recent acquisitions. These investments will add value to our Company and its shareholders. I would also like to note that both of these acquisitions were sourced off market.

Now let's turn to our balance sheet. We have continued to maintain a conservative management approach, ensuring liquidity through cash balances and unmortgaged properties. We have a solid balance sheet with 15 unencumbered properties with a non-depreciated cost basis of approximately $55 million, giving the Company the financial flexibility it will need as it continues to grow and execute on our business plan.

As of year end, our undepreciated real estate assets were $205 million and our total property debt was $101 million. We had no debt maturities until late 2013, and as of the end of the quarter, 75% of our debt is at a fixed rate. Our total blended interest rate on all of our debt for 2010 was approximately 5.6%, and our fourth-quarter interest coverage ratio, which we define as EBITDA divided by interest expense, was a very stable 2.5 to 1.

This concludes the review of our results, and operator, we will now take questions.

(Operator Instructions). Paul Adornato, BMO Capital Markets.

Good afternoon, everyone. Jim, I was wondering if you could describe for us any changes that you might have noticed in the acquisition environment over the last few months, perhaps in terms of the number of properties, the demands of the sellers, whether the properties are coming from financial institutions. What's changing out there?

That's a good question. And thank you for tuning in. We have been building up the relationships for about three years in the particular markets that we have a lot of concentration in. And, we have more deals in our pipeline today then we had a year ago. And they are in excess of $300 million.

What we are seeing is the sellers are willing to negotiate. The sellers that we are dealing with are not -- were direct sellers usually with regional banks or title companies. And we are finding that very few are going to what I would call the auction type of selling. In other words, one -- just to give you an illustration, one property that we had a letter of intent on that narrowed down to four or five finalists, and of course, the process as they follow is to come back to each one and say okay, would you like to negotiate with yourself and increase your price before we're going to do a last round here. And we said no, we would just stay right where we were.

And to make it a little more humorous, we made a bet that the other competitors that were in the deal, none of them were public companies. And of course we were right. There was a fairly -- there was a size probably large enough for the -- to have a public company and they're competing with us. Turns out there were four private companies, one public company bidding on it. And it surprised us that there were four that got down to the finish, and it still hasn't been decided as yet.

But what we are seeing is we are seeing more private activity coming in. The private activity has some debt available, so the debt market is loosening up just a bit. And, we are seeing that the sellers that are the regional banks are not that sophisticated, but they are putting a lot of emphasis to close deals by like the end of each quarter. For example, close deals at the end of last quarter, fourth quarter, close deals at the end of third quarter. And what they are doing is they are looking at buyers to try to ensure that it will close without getting it tied up or hung up on due diligence.

But we are seeing some changes. Number of properties seem to be loosening up. More buyers, but not too many public in our space, and then sellers trying to get quick closes.

Okay. And, was wondering if you could comment on some of the other cities where you don't have a lot of properties but you have targeted for expansion. Should we expect activity in those places? Or will you concentrate where -- in Phoenix and Houston where you already have a lot of assets?

Dave, you want to jump in?

Sure. Hi, Paul. This is Dave. We are concentrating on Phoenix; it's important to us to build the scale in that market. We've put in place the infrastructure. We've moved the senior management person from our team to Phoenix, and she is building us a small staff of people, so we're going to focus on the Phoenix market and maybe some surrounding markets right around it and really build that division up.

Okay. And finally, I was wondering if you could just perhaps reflect on your time as a public company since you raised equity publicly, and just comment on the pace of putting that money to work, and what we should expect over the next couple of months.

What was the first part? I think there were three parts to that. The pace, what you can expect. What was the first part?

Just -- yes, have you been satisfied with the timing of acquisitions so far?

We have found that the timing is about where we thought it would be. [It's easy] because there's a period of time when you have -- you go through certain due diligence and we don't like to buy things that we know that we can't have. We're just accustomed to very, very good returns on what we buy. So -- but we have always been patient investors, and so we haven't really timed ourselves to jump into the market too fast.

The pace that we are on is one that we are making systematically in terms of what we're buying. We feel the pace works for us. And what it does is that we have -- we set aside so much money for TI and leasing commission. And one of the keys that we found, Paul, is that what's missing in the marketplace is these small banks and/or developers or previous owners, they just don't have the TI money to increase the -- to do the TI work. And we find that the tenants are there; it's just nobody has the TI money to invest. And so we find that that gives us truly a competitive advantage, knowing that we can negotiate a deal with someone and we have the TI dollars to bring them into the space. So that pace is moving along as well.

We expect that pace to pick up even more so because once we completed our IPO, we had talked about taking a key person who is an important part of the culture and philosophy of the Company who has been here in Houston with me since 2006, and she agreed to move to Phoenix. And so we didn't want physically make that move until we completed our IPO where we could really turn on the spigot and let it start running. So she now has made the move to Phoenix and we have a leasing person that will be in place in about a week, and we have a property manager that will be in place in about three weeks. So we will now have a full staff there and you will start to see some things start picking up the momentum. But we've always tried to be a patient investor, and I think that's paid off for us.

Okay, great. Thank you very much.

(Operator Instructions).

Okay. Well, if there --

(Operator Instructions). Mark Lutenski, BMO Capital Markets.

Just a quick question. Could you guys give me a sense for what rent roll was for renewed leases signed -- and new leases signed during the quarter?

Yes.

Yes. Thanks, Mark. This is Dave. Really, one of the great attributes of our Community Centered Property strategy is that we focus on the smaller tenants. I think as we've discussed before, we quote those tenants at a flat rate as opposed to a square foot rate. Those tenants tend to not be represented by brokers. So we've been very successful in maintaining and increasing our revenue per square footage over the last several years.

We have had a little bit of pricing pressure in 2010, but really not that much on our small space tenants. Our revenue for 2010 versus 2009 was down slightly, really driven by more by reimbursements from the tenants of expenses, because we did a really nice job of decreasing expenses, primarily property taxes.

So we have not seen significant pressure one way or the other really on our new leases versus our base. We have continued to see rents about in the same range on our new leases as our base.

Okay. And sorry to make you repeat yourself; I think you commented, but I missed it. Why was there a sequential increase in operating expense for the quarter. I think it went up roughly about $200,000.

In operating expenses, are you comparing the fourth quarter to the third quarter?

Yes.

Really just timing of expenses, as Paul, I'm sorry, Mark, if you look at the yearly results, we were down for the year. So many of the -- there's many repair and maintenance-type activities that you do toward the end of the year. So really just the timing of expenditures.

So is the -- is that an appropriate run rate do you think going forward, or (inaudible) amount?

I guess I would say annual results are probably a better run rate to look at than a quarterly rate. We had two small -- two acquisitions in the fourth quarter, but really did not significantly impact our results in 2010. So, but 2010 is pretty much the same store rate.

Okay. And just a quick question on the occupancy. 86% at the end of the quarter -- is that occupancy or leased space?

That is -- we are at 86% physical occupancy in our operating portfolio. That does exclude two properties which were recent acquisitions that we just acquired and have not stabilized. But that is physical occupancy.

Okay, great. Thank you.

(Operator Instructions). It appears there are no other questions. I would like to hand the call back over to management for closing comments.

Okay. Well, thank you, again, for tuning in with us today and having the opportunity to follow our progress. We're very pleased with the way things have been going and will continue to go.

Know that for those of you who are our investors and our investor base here that we do stretch ourselves and we hope to have this call again next quarter and provide more of the same type of news to you.

With that, Dave, if you have anything you'd like to add or we'll just say good bye and thank you very much.

Please feel free to go to our website. We try to keep it freshened up on a regular basis, and call and with short notice, come on by and say hello to us. I thank you all for joining the call. With that I will say good bye.

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time and have a wonderful day.