Thomas Properties Group, Inc. Q3 2008 (Qtr End 09/30/08) Earnings Call Transcript

Executives

Jim Thomas – President & CEO

Diana Laing – CFO

Analysts

David Loeb – Robert W. Baird

Mitchell Germain – Banc of America Securities

Thomas Properties Group, Inc. (TPGI) Q3 2008 Earnings Call November 4, 2008 12:00 PM ET

Operator

Good day ladies and gentlemen and welcome to the third quarter 2008 Thomas Properties Group, Inc. earnings conference call. (Operator Instructions) I would now like to turn the presentation over to your host for today’s call, Ms. Diana Laing.

Diana Laing

Good morning and thank you all for joining Jim Thomas and me for our earnings conference call for the third quarter.

Certain statements made by the company during this call that are not historical facts are forward-looking statements. These statements include management’s expectations with respect to future events and trends that may affect the company’s business and results of operations and are subject to risks and uncertainties. Actual results may differ materially from those expected in the forward-looking statements.

Persons participating on this call are advised to review the reports filed by Thomas Properties Group, Inc. with the Securities and Exchange Commission for additional information regarding some of the factors that may affect the company’s business and results of operations.

Now Jim Thomas will discuss our business environment and initiatives.

Jim Thomas

Thank you Diana, and good morning. With respect to our overall business overview, our office property fundamentals are generally continue to be very healthy particularly in Austin, downtown Los Angeles, Houston, and Philadelphia.

Occupancies and rental rates are basically strong for our existing properties. So at this point we’re not incurring the deteriorating leasing conditions that many have projected as a result of the weakening economy. However the credit crunch and economic meltdown continues to adversely impact our acquisition and disposition business which in turn has affected our investment advisory business.

I’ll talk about each of these, first with respect to our existing office properties, or overall occupancy rate increased slightly from the end of the second quarter. We were 86.4% and at the end of the third quarter we went to 86.7%. Of our 25 properties, 12 increased in occupancy and seven remained unchanged, and six decreased.

The details are on page 15 of the supplemental package. First let’s talk about the Austin CBD, its been about a year since we acquired this portfolio and it continues to outperform our underwriting both in terms of rent increases and occupancies. The downtown market has been especially strong.

The CBD is projected to absorb over 300,000 square feet this year which is the highest in the past 10 years. Vacancies have fallen from 22.6% at the end of 2005 to 12% currently. Class A occupancies dropped to about 11%.

In the PPG portfolio our average gross rents are approximately $41.00 a square foot as [inaudible] to $35.00 in mid 2007. Market wide average rents have increased from $34.00 to $38.00, almost $39.00 in the past three quarters.

We leased about 84,000 feet in the third quarter compared to 73,000 in the second quarter. Year-to-date, in the downtown portfolio we’ve leased about 242,000 square feet of which 147,000 is new or expanded space.

At Frost Bank, we increased occupancy to 89%, up from 77.8% in the second quarter and we recently signed a couple of leases at $30.00 net. At 300 West Sixth Street we increased our occupancy about 100 basis points and our recent leases are $26.00 to $27.00 net.

At One American Center, our occupancy is up almost 400 basis points and we’re doing our leases basically at $24.00 net. At One Congress Plaza, occupancy up again over 200 basis points at the end of the third quarter and our net rents are ranging from $22.00 to $25.00 a square foot.

With our final property in downtown our occupancy increased a little over 100 basis points with rents ranging from $22.50 to $24.00. In the suburbs our existing properties are basically performing well. Research Park Plaza and Stonebridge Plaza are basically fully leased.

At Great Hills Plaza occupancy increased over the third quarter as did occupancy at Park 22 which slipped a little. The recent deals at Research Plaza are $22.00 net, Stonebridge is at $21.00 and the other three properties are running $2.00 to $3.00 lower.

While I’m talking about Austin, it’s a good time to talk about the Lehman situation. As you know Lehman entities are both a 50% and a lender to the partnership of which TPG is the general partner. We are advised that the Lehman partner has not been placed in bankruptcy. The partnership has an outstanding $192.5 million term loan that also includes $100 million line of credit from a Lehman affiliate, Lehman Commercial Paper Inc. and this entity has been placed in bankruptcy.

We had not drawn down on the line of credit until Lehman announced bankruptcy at which time we called for entire $100 million to be funded which we were entitled to do. To date they have not funded any portion of the line of credit and we are taking steps to require funding if such is possible.

We’ve been advised by Lehman representatives that our Lehman partner intends to meet its obligations. We and our other partners are proactively pursuing this matter. Should any portion of the Lehman interest become available we and our partners are keenly interest in acquiring such positions.

In Houston, as I’ve previously reported our rents have doubled since our acquisition. Year-to-date Houston has absorbed the market generally, a little over one million square feet whereas in 2007 the absorption was five million feet so its down considerably.

The CBD has had a negative absorption of 150,000 feet so all of the absorption has been in the suburbs where our properties are located. Two million square feet of new space is scheduled to come on the market in the CBD by late 2010.

Three of our four Houston properties are basically fully leased and we are quoting rents of $25.00 net with $3.00 bumps at two of our properties and at CityWestPlace we’re at $30.00 net with $3.00 annual bumps.

Brookhollow II and III are 90% and 81% respectively leased. We’re quoting rents at $14.00 net with $3.00 annual bumps. At Brookhollow I we’re in the midst of remodeling so that building is empty while we’re remodeling and we are seeking a lead tenant and for that property we’re quoting net rents of $18.00.

This Northwest Houston market year-to-date absorption has been about 220,000 square feet and has about 20% vacancy. The recent hurricane in Houston, our buildings incurred only very minor damage. At Brookhollow I which I indicated we’re under construction, the roof blew off but in total, we incurred about $1.2 million of damage, all of which is below our insurance minimum.

At City National Plaza in Los Angeles, we only need about 270,000 feet to reach stabilization. We only have about 430,000 feet vacant of which 157,000 is expansion space for existing tenants leaving us with unencumbered space of only about 274,000 feet.

Year-to-date we’ve leased about 92,000 feet, 15,000 in the third quarter. Given the magnitude of our lease-up we’ve increased our net rents to about the $27.00 net range. Year-to-date in downtown Los Angeles Class A we’ve had negative absorption of about 190,000 square feet. The current vacancy is about 12% and the asking rents are $23.00 net.

Even so these rents pale compared to the rents on the west side which are in the high $40.00 net rents. So this disparity bodes well for downtown.

The Philadelphia, at Two Commerce, we lost a 90,000 square feet tenant to the suburbs and 375,000 feet of the [Conrail] lease expired. So we’ve had a lot of leasing to do there. Much of the Conrail expiration was handled by tenants rolling to direct leases with us pursuant to transactions that we did back in the early 2000s.

Year-to-date we’ve leased 68,000 square feet of new space and we have a vacancy of about 128,000 square feet. In One Commerce Square we’re basically fully leased at over 96%. At both of these projects we’re quoting $25.00 to $29.00 gross rents. Year-to-date the absorption in downtown Philadelphia is 235,000 feet and the gross rents are running $24.00 to $30.00.

The Philadelphia suburbs, in our three Philadelphia suburban properties, Oak Hill Plaza increased occupancy to 95%, the other two properties remained flat, 77% for Four Falls and 86% for Walnut Hill.

At Walnut and Oak Hill we’re doing deals at about $21.00 a square foot and at Four Falls we’re doing deals at about $28.50. The vacancy rate in the King of Prussia where Walnut and Oak Hill are located is almost 13% with asking rents of about $28.00, $29.00. The vacancy rate in the Four Falls market is about 10% with gross rents at almost $33.00.

In northern Virginia at Centerpointe I and Centerpointe II a portion was occupied by a single tenant who we knew was moving out when we acquired the property so this left us with about a little over 200,000 feet in Centerpointe I and 50,000 in Centerpointe II.

We’ve leased 50,000 feet in Centerpointe I and in Centerpointe II we’ve leased about 35,000 year-to-date. At Fair Oaks Plaza we’ve leased 28,000 feet and in the market where these three properties are located, the Fairfax market, the vacancy rate is a little over 13% and asking gross rents are about $30.00.

With respect to our acquisition and disposition business, first I’ll talk about City National Plaza, at our last earnings call I indicated that we had hired Estill Secured to market 49% to 75% limited partnership interest in City National Plaza. We got into the market in early July and there was a lot of interest that we received and we targeted offers for September.

Then the credit crunch and the economic meltdown hit and the activity has slowed almost to a standstill. We still have several interested buyers indicating a willingness to proceed but a number of other buyers had gone to the sidelines.

We are anxious to bring a new limited partner into this partnership but neither we nor [Calsters] is willing to sell an interest at a distressed price. We both believe the project is one of the best if not the best property in downtown Los Angeles and we’re prepared to wait until the market normalizes.

In Houston we also announced that we were placing a 50% to 75% partnership interest on the market in early July and again, we got hit with the credit crunch and the economic meltdown and so just as in City National Plaza, the level of interest decreased but not to the same extent as City National Plaza.

We still have several investors interested in acquiring a partnership interest in the Houston portfolio. We think its highly unlikely that we’ll be able to complete a transaction in the fourth quarter but we’ll continue to market both interests expecting that the credit crunch and economic meltdown will subside at some point and we’ll be able to get a transaction done in the first or second quarter of 2009 with respect to the Houston portfolio.

With our acquisition business, it has been impacted by the same economic circumstances that’s affected our disposition business. We’re seeing fewer properties come on the market and many are getting withdrawn when their price targets aren’t met.

Basically the market is frozen. We’ve made a few offers in both the UBS fund and the high performance fund but we’ve not been able to reach an acceptable deal. These two funds have combined buying power of $1 billion and we’ll continue to survey the market for attractive deals.

Development construction in general, as I explained in our last earnings call, we have an attractive well-positioned development pipeline which we’ve been able to assemble at very low cost with high potential profits while minimizing our downside risk.

We’ve minimized our land costs by buying at the right time and selling off pieces to reduce our remaining land costs. This allows us not to be pressured to develop until we’re satisfied with market conditions.

We have a couple of projects under construction, the Murano in Philadelphia is complete and we’ve sold 126 units as of the end of October and we’ve closed 101 units paying down our construction loan by $60 million.

So we’ve still been closing some deals during this economic meltdown. The strongest demographic recently has been young professionals and first time homebuyers. Our customer traffic remains good and we’re optimistic that we’re going to continue to get deals done. We see a reluctance to commit and we see customers coming back four and five times and delaying their decision to buy.

Four Points Center, we’ve recently completed two office buildings of 100,000 square feet each in the northwest section of Austin. The northwest market is the fastest growing market in Austin and in several years has absorbed over one million square feet. However at the present time there’s about three million square feet of newly built projects on the market with another 1.5 million square feet in the pipeline.

We expect this market to be soft for at least several years. We think that our buildings are a superior product. We have a [Green’s lead] rated building and it’s the only one currently in the market and we think this green feature will be very helpful in the Austin market since the city government is one of the leaders in the green movement.

Currently we have two projects in pre-development in Los Angeles, the Metro Studio project and the El Segundo project which total about 1.7 million square feet of which 950,000 square feet is in the process of being pre-leased.

The Metro Studio project at Universal City we continue to complete the design and the lease with NBC Universal for the entire first phase. The project is located on a subway site and we will have a ground lease with the MTA. We commenced the EIR process, the public portion, on August 25 of this year.

This is a terrific transit oriented green project which we’re very proud of and we have scheduled completion of the EIR process around August of 2009 with the commencement of construction in September, and with NBC U taking occupancy in late 2011.

In El Segundo, we continue to position the first phase of this 250,000 square foot project so that we’re in a position to start construction as soon as we reach 50% level of pre-leasing and we’re negotiating with Marriott regarding a renaissance sports center hotel which is a great amenity for the project.

The remaining six million feet of our development pipeline as I indicated earlier is held at very attractive low prices and will not be developed without substantial pre-leasing.

That takes me to our investment advisory business, in general as I indicated earlier our investment advisory business has been adversely impacted by the fact that the acquisition market is frozen which has eliminated acquisition fees year-to-date.

As you can see on page 14 of the supplemental package for the nine months ended September 30, we had gross fees before accounting eliminations of almost $33 million, down from $34 million for the same nine-month period in 2007.

Our joint venture agreement with UBS Wealth Management Fund is fully activated and has made several offers, none of which have been accepted, to date. This fund has initial target of $250 million of which we will invest 15% where there’s leverage of less then 60% and 25% for transactions over 60% leverage.

This fund is focused on acquiring core and core plus properties. The vision plan at NBC Universal back lot continues to go well. We expect the public portion of the EIR process to be filed in early 2009 for 3,000 residential units with a target to complete the entitlement process by 2010 and infrastructure by 2012.

We anticipate being the master developer of this project when we complete the entitlements but we will not be acquiring any interest prior to the completion of entitlements up until that point. We continue to work on a fee basis.

The high performance Green Fund has been activated with $180 million in commitments and we have soft commitments of another $25 million, and I indicated earlier we’re in the process of transferring the first phase of the project to the Green Fund.

But we’ve made several offers in the Green Fund but just as the other portion of the market, this market is also frozen so we’ve not been able to successfully complete a transaction.

Our joint venture with [Calsters] continues to be our main investment vehicle and currently the joint venture is focused primarily on completing the value add projects and we’re determining the feasibility of greening the entire portfolio.

Finally we have the joint venture with Lehman Brothers entity and a Middle East [Southern] fund which generates investment management fees and I spoke of this partnership earlier.

With that I’ll turn it back over to Diana.

Diana Laing

I’m going to discuss the results of operations which you can find in the supplemental financial information that’s available in the Investor Relations section of our website. Generally we look at the pro rata financial statements where we consolidate the unconsolidated properties at our ownership interest and these statements start on page seven of the supplemental package. I’m actually going to walk through a few things and I’ll let you know what page I’m on.

On a pro rata, on page seven, revenue from our operating properties decreased less then a half a percent from the third quarter of 2007. Our share of the revenues from the joint venture properties increased about $1.6 million but revenue at the wholly owned properties most notably Two Commerce Square decreased by $1.3 million.

Jim mentioned the [Conrail] lease, about 375,000 square feet at Two Commerce Square that expired in June, about 245,000 square feet of that amount is leased to former sub tenant whose leases went direct with us but the remaining 130,000 or so square feet are actively being marketed.

Property operating expenses increased about 15% or $2 million over the third quarter of 2007. About half of that is marketing and other expenses related to development properties and that would be the Murano Four Points and Campus El Segundo.

Our revenues from the investment management business as shown on page 14 of the supplemental, gross revenues from this business decreased by about $5.8 million for the third quarter of 2008 compared with 2007 and that is primarily or almost singularly because we didn’t earn any acquisition or disposition fees this year.

Page seven, in the third quarter we recognized gross profit from sales of Murano Condominiums of about $500,000 in the third quarter of 2008. Year-to-date we’ve recognized about $17.5 million in gross profit from these sales and we’re using the percentage of completion method of accounting.

Through the third quarter we’ve recognized profits from the sale of 125 units, 101 of which had been closed and 24 of which were under binding contracts at September 30.

Year-to-date G&A expense has increased about 4% from the first nine months of 2007. Just to touch on hurricane Ike in Houston, Jim mentioned that we incurred approximately $1.2 million in total of damage to our Houston properties, of this total amount about $850,000 related to Brookhollow I which is under construction and those costs will be capitalized as part of this renovation.

The remaining $350,000 in loss will be expensed at the other Houston properties. We expect to recover about half of that amount from the tenant at those properties. So the net expect to the TPG Calsters joint venture is approximately $175,000 and our share of that is 25%.

I want to talk a bit about liquidity and the balance sheet, we believe we have adequate capital to get us at least through 2009. Our debt maturity schedules are on page 19 and 20 of the supplemental and all of the 2009 debt maturities are extendable at our option and we intend to extend them, with the exception of a less then $5 million loan to a former partner at Campus El Segundo.

Our unrestricted cash balance at September 31 is $75 million and our current commitments of that cash include commitments to our Calsters joint venture of about $6 million, costs we expect to incur to complete Four Points Murano and the El Segundo pre-development of about $8 million, and that $8 million includes repaying that note I mentioned earlier, costs we expect to incur for the entitlement of Metro Studios at Lankershim of about $10 million, and up to roughly $15 million in leasing commissions and tenant improvements at Commerce Square as we lease the space.

After those commitments we still have approximately $36 million in cash. To look at net asset value, starting on page 15 of the supplemental we provide information about our portfolio properties to assist you in analyzing the value of the assets.

There are four components of net asset value, and I’ll go through each one. On page 15 we show you the estimated stabilized net operating income of the existing portfolio and you can assume a cap rate and calculate the value of those assets as stabilized.

You should probably reduce that amount by the amount of capital expenditures that we expect to spend to stabilize the assets which we also give you on that page.

Secondly the development assets on page 17 we show you the current book value of the development assets. Just one thing to note on the Murano we’re currently recognizing revenues of approximately 28% more then our cost at the Murano. If you apply that percentage to our cost incurred to date, and we give you an estimate of the total sales value of the project.

We’ve effectively sold 125 units as of September 30 so you’d want to reduce the amount you just calculated by the gross profit we recognized on those sold units which is about $18 million. The cost mixes of the other development projects is shown on page 17.

The third piece of net asset value is our investment management platform and we’d recommend applying a multiple to annualize net revenues. On page 14 you can extrapolate from the first nine months results this business is generating annualized net revenues of about $20 million, again not including any transaction fees.

And finally the fourth component of the net asset value is our net current assets which you can find on the pro rata balance sheet that’s on page nine of the supplemental. So once you’ve been through this analysis you have the value of the four components that make up our net asset value and those are operating properties, development properties, investment management business, and the net assets.

You’d want to reduce that value by our mortgage debt which is also shown on the balance sheet on page nine and then divide that number by the number of shares and OP units outstanding, which is 39.1 million shown on page 21.

Jim now has a few concluding remarks before we open the call for questions.

Jim Thomas

I’d like to conclude first by emphasizing what Diana said with respect to the fact that we have adequate capital to fund our operations through 2009 without raising additional capital. We’re very focused on executing our strategic initiatives. The projects that we have underway are fully financed. We’ve recently extended the City National Plaza loan maturity for a year with an option to extend for an additional year.

With respect to the El Segundo loan, which matures in October of 2009, we’re currently seeking to increase and extend the maturity date by financing a portion of the $30 million of infrastructure which we have in place.

Our other 2009 maturity date is the Murano construction loan which we expect to be able to extend for a year.

Finally in these challenging times experience and reputation are very important. Every member of the TPG senior management has at least 23 years of real estate experience and the operating team has been together for an average of 22 years.

We’ve recently added Paul Rutter to our management team and he is someone that I have worked with for over 33 years. TPG’s reputation as the best in class developer and operator of real estate has given us access to attractively priced private equities that seeks out a lead developers, operators, properties, and projects.

We continue to receive superior real estate opportunities that only the best in class developers can execute. I think our experience and reputation will help us through this economic downturn just fine.

With that we’re ready for your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of David Loeb – Robert W. Baird