HRPT Properties Trust Q3 2009 Earnings Call Transcript

HRPT Properties Trust (HRP)

Q3 2009 Earnings Call

November 5, 2009 1:00 pm ET

Executives

Timothy A. Bonang – Vice President of Investor Relations

Adam D. Portnoy – Managing Trustee

John C. Popeo – Chief Financial Officer, Treasurer & Assistant Secretary

Analysts

Mark Biffert – Oppenheimer

John Guinee – Stifel Nicolaus & Company, Inc.

Nick Pirsos – Macquarie Research

Analyst for James Feldman – Bank of America Merrill Lynch

Edward Okine – Basso Capital

Presentation

Operator

Welcome to the HRPT Properties Trust third quarter 2009 financial results conference call. This call is being recorded. At this time for opening remarks and introductions I would like to turn the call over to the Vice President of Investor Relations Mr. Tim Bonang.

Timothy A. Bonang

Joining me on today’s call are Adam Portnoy, Managing Trustee and John Popeo, Chief Financial Officer. The agenda for today’s call includes a presentation by management followed by a question and answer session. Before we begin today’s call I would like to read our Safe Harbor statement. Today’s conference call contains forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and federal securities laws.

These forward-looking statements are based on HRP’s present belief and expectations as of today, November 5, 2009. The company undertakes no obligation to revise or publically release the results of any revision to the forward-looking statements made in today’s conference call other than through filings with the Securities & Exchange Commission or SEC regarding this reporting period.

In addition, this call may contain non-GAAP numbers including funds from operations or FFO. A reconciliation of FFO to net income as well as components to calculate AFFO, CAD or FAD are available in our supplemental package found in the investor relations section of the company’s website. Actual results may differ materially from those projected in any forward-looking statements.

Additional information concerning factors that could cause those differences is contained in our Form 10Q which will be filed within the next few days with the SEC and in our Q3 supplemental operating and financial data found on our website at www.HRPREIT.com. Investors are cautioned not to place undue reliance upon any forward-looking statement.

With that I would like to turn the call over to Adam Portnoy.

Adam D. Portnoy

For the third quarter of 2009 we are reporting fully diluted FFO of $0.26 per share compared to $0.27 per share during the same period last year. During the third quarter we had two million square feet expire and we signed leases for 1.1 million square feet. 54% of our leasing activities were renewals and 46% were new leases. Leasing activity this quarter resulted in a 3% roll down in rents and about $6.32 per square foot in capital commitments. The average lease term was 4.6 years and the average capital commitment per lease year was $1.37.

The most notable change in our operations this quarter was the decline in occupancy. At the end of the quarter, our occupancy rate was 88% which was 110 basis points lower than the end of the second quarter. Same store occupancy was also down by 140 basis points to 87.6% at September 30^th as compared to the end of the second quarter. The primary reason for the decline in occupancy is the slowdown in the US economy and the continued high unemployment rate in almost all areas of the country.

As a result of these conditions tenants are generally reluctant to commit to expansion space or lease new space. In addition, renewal activity continues to be challenging because existing tenants are sometimes asking to downsize their space. These negative market trends are evidenced by the reported decline in office net absorption and occupancy rates across the country during the last few quarters. At the same time, the development activity has slowed but it is expected to continue in some markets.

As a result of these dynamics, same store consolidated NOI for the third quarter declined by 4.5%. In Oahu, same store NOI increased by 9.9% primarily reflecting the increases in rental rates. Although the economic downturn is starting to affect rental rates in Oahu, the industrial market is still strong and our in place rents continue to be significantly lower than current market rates.

With regard to our properties in Oahu, on August 14^th we commenced litigation in US federal court to dispute a state law which seeks to limit rental increases at certain of our leased lands in Hawaii. Our claim is that this law violates the United States Constitution. On September 28^th we filed a motion for summary judgment of our claims regarding this matter and a hearing on this motion is currently scheduled for December 7, 2009.

In Washington DC our same store NOI increased by 9.3%. Washington DC continues to be one of the strongest markets in the country and the strength in this market is primarily driven by job growth from the federal government and related industries. Southern California same store NOI was flat during the third quarter. This market continues to experience weakening fundamentals with negative net absorption and about two million square feet of new construction completed in the quarter.

Same store NOI in Philadelphia was also basically flat in the third quarter. The Philadelphia leasing market continues to show some signs of weakness with slight decreases in rental rates. The downtown office market where we own a large percentage of assets remains relatively stable and we continue to believe we are well positioned in this market. Boston same store NOI decreased 12.9% during the quarter because of declines in occupancy. Boston continues to be our only major market where we expect continued significant lease roll downs and/or increased vacancies in the near future.

In our other markets located throughout the country, our same store NOI during the quarter decreased by 9.2% reflecting a 4.4% decline in same store occupancy plus an increase in allowances for bad debts. The largest area of occupancy decline in our other markets incurred in some of our industrial properties located outside of Oahu. We have 1.7 million square feet scheduled to expire during the remainder of 2009 which represents approximately 3% of our total annualized rents and 6.9 million square feet scheduled to expire during 2010 which represents approximately 12% of our total annualized rents.

The majority of the leases scheduled to expire through the end of 2010 have in place rents that are slightly above current market rents. However, because we see fundamentals continue to weaken our occupancy rate is likely to decline further for the next few quarters or until the economy begins to show sustainable growth and employers start hiring again. Although occupancy is likely to decline for the next few quarters we expect the rate of occupancy decline to moderate as compared to this quarter’s 110 basis point decline.

We feel confident with this expectation because even though we continue to operate in a difficult environment, leasing markets across the country have generally started to improve since the beginning of the year. Although we continue to face a challenging leasing environment, we have taken the necessary steps to ensure that our company is well positioned to take advantage of distressed acquisition opportunities. The properties we have purchased this year are all Class A buildings in good markets and have long term leases with high credit quality tenants.

More importantly, these acquisitions are being made at record high cap rates. With this in mind, during the third quarter we purchased two Class A office properties with 761,000 square feet for about $208 million. We purchased these high quality assets in Hoboken New Jersey and Washington DC at going in cap rates of around 10%. These properties are 99% occupied with an average lease term of almost eight years.

During the quarter we also completed the final sales of the previously announced medical office clinic and biotech laboratory buildings to Senior Housing Properties Trust. We sold the last two properties for $144.6 million and recorded gains relating to these sales of about $50 million. Subsequent to quarter end in October we also acquired one industrial property with 338,000 square feet for about $17 million. This building is 100% occupied with an average lease term of 15 years and the going in cap rate was almost 11%.

As of today, we have an executed agreement to buy one Class A office building with approximately 415,000 square feet for a price of $165 million. We also have one property under agreement to sell for $15 million which is expected to close in 2010. Of course, these agreements are subject to closing conditions and the purchase or sale of these properties may or may not happen in the future.

Before turning the call over to John Popeo, I would like to recap HRP’s current balance sheet and liquidity position. We currently have about $2.8 billion of debts outstandings which represents a conservative 47% of total assets and we have no significant debt maturities until 2011. Our unsecured debt obligations have been rated investment grade for 15 years and we continue to be comfortably in compliance with all debt covenants.

As of September 30^th we had $241 million outstanding on our existing $750 million unsecured revolving credit facility. This facility is provide by a diverse group of close to 30 participating banks. It matures in August 2010 and we currently pay interest at LIBOR plus 55 basis points. At our option, we have the right to extend this revolver for one additional year through August 2011.

Through the June IPO of our former wholly owned subsidiary Government Properties Income Trust, we’ve repaid $250 million of debt and currently own almost 10 million tradable shares of GOV. These shares have a book value of $156 million and a current market value of about $240 million. Since the beginning of 2009 we’ve also lowered our dividend to a sustainable level and repurchased $14 million of our common stock and over $100 million of our outstanding debt at significant discounts.

In summary, HRP is facing a difficult leasing environment but the company’s balance sheet is very well positioned to both weather the current downturn and opportunistically grow the company through the acquisition of high grade properties at distressed prices. I think it is also important to note that we are navigating these challenging times while maintaining balance sheet flexibility and liquidity.

In comparison to some of our peers we are particularly proud of the fact we have maintained this balance sheet flexibility and liquidity during the last year without having to don an extremely dilutive equity offering. I will now turn the call over to John Popeo our Chief Financial Officer.

John C. Popeo

Looking first to the income statement, rental income decreased by 2.4% and operating expenses decreased by .9%. The year-over-year quarterly decrease in rental income and operating expenses reflect the $4.9 million decline in same store NOI and 25 properties transfer to GOV in June offset by increases in NOI for properties acquired between July 2008 and September 2009. Depreciation and amortization increased by 3.4% reflecting depreciation and amortization related to building and tenant improvements.

The increase in general and administrative expenses reflects timing of legal and other fees and expenses. We also paid $1.5 million in fees and expenses related to the acquisition of two properties during the quarter. Our consolidated NOI margins were 57.3% and 57.9% for the third quarter of 2009 and 2008 respectively. Current quarter EBITDA decreased by 5% compared to last year reflecting the decline in current quarter same store NOI.

Interest expense decreased by 7.5% reflecting the repurchase and retirement of $117 million of our outstanding debt and the decline in average floating interest rates from 3.2% during the third quarter of 2008 to 1% during the third quarter of 2009. Since its IPO in June our investment in GOV has been accounted for using the equity method of accounting. Under the equity method, we record our percentage share of net earnings and FFO of GOV in our financial statements. Our percentage share of GOV net income and FFO for the second quarter totaled $2.9 million and $4.6 million respectively. We expect to receive close to $16 million of cash dividends annually from GOV beginning in the fourth quarter of 2009.

Net income available for common shareholders for the third quarter of 2009 was $59.5 million compared to $73.1 million for the third quarter of 2008. The decrease reflects occupancy declines and a $4.9 million decline in same store NOI and $57.7 million of gains on property sales during the prior year versus $50.1 million during the third quarter of 2009. Diluted FFO available for common shareholders was $0.26 per share for the third quarter of 2009 and $0.27 per share for the third quarter of 2008.

Year-over-year results primarily reflect a decline in same store NOI and the decline in earnings from properties sold or transferred to GOV partially offset by properties acquired since July 2008. In October 2009 we declared a dividend of $0.12 per share which represents 44% of our third quarter FFO. During the quarter we spent $14.4 million on tenant improvements and lease in costs and $1.6 million or $0.02 per square foot for recurring building improvements including lobby and façade renovations, elevator upgrades and other capital projects throughout the portfolio. We paid $3.3 million on development and redevelopment activities during the quarter.

Turning to the balance sheet, on September 30^th we held $33 million of unrestricted cash. Rents receivable includes approximately $156 million of accumulated straight line rent accruals as of September 30^th. Other assets include approximately $84 million of capitalized leasing and financing costs. On September 30^th, we had $409 million of floating rate debt, $449 million of mortgage debt and $2 billion of fixed rate senior unsecured notes outstanding.

The weighted average contractual interest rate on all of our debt was under 6% at the end of the quarter and the weighted average maturity was five years. We have no debt maturing in 2009 and only $50 million of senior notes maturing in 2010. Our senior unsecured notes are rated BAA2 by Moodys and BBB by Standard & Poors. The book value of our unencumbered property pool totaled about $5.6 billion at the end of the quarter.

Our secured debt represents 7% of total assets and floating rate debt represents 15% of total debt. At the end of the third quarter our ratio of debt to book capitalization was 49%. Our EBITDA and fixed charge coverage ratios were 2.7 times and 2.1 times respectively. As of the end of the third quarter we were comfortably within the requirements of our public debt and revolver covenants.

As of the end of the third quarter we had $241 million outstanding on our revolving credit facility with $509 million of additional borrowing capacity at a current interest rate of less than 1%. As of today, we continue to have $241 million outstanding on revolver and one property under contract to buy for $165 million.

In summary, this quarter produced results we expected in light of a challenging market environment. Our dividend cut in January has significantly improved our dividend payout ratio and financial flexibility. We own 9.95 million tradable GOV shares with a current market value of around $240 million and we continue to make accretive leverage neutral acquisitions by reinvesting proceeds from the sale of assets and office and industrial properties with going in yields of around 10%.

That concludes our prepared remarks. Operator we are now ready to take questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Mark Biffert – Oppenheimer.

Mark Biffert – Oppenheimer

Adam, I was wondering if you could talk a little bit about pricing that you’re seeing for both office and industrial and kind of what range you are targeting for yourselves? And, if you can speak specifically about I don’t know if you mentioned the cap rate you’re paying on the Class A building that you’re under contract for the fourth quarter yet?

Adam D. Portnoy

Mark basically transaction volume as everybody knows has declined quite a bit over compared to a couple of years ago and so there are not a lot of opportunities out there. What we are finding is that usually if someone is selling something, they have a reason that they’re selling it. Meaning, they have some sort of liquidity need and we’re actually finding that most sellers in order to raise that liquidity are actually looking to sell maybe some of their better assets versus some of their more struggling assets because they think they’ll get the most interest in those assets.

The truth is there just hasn’t been a lot of buyers in the marketplace looking to buy those assets. In fact, I know that the two assets that we bought in this quarter both in Washington DC and in northern New Jersey we were not the highest bidder we were just the bidder that the seller felt the most comfortable about and we had the certainty of closure with. The second part of your question relating to sort of the cap rates that we’re looking for, I’d say between 9% and 11% and that’s probably both for office and industrial.

Generally speaking we’re not looking at stuff that has much rent roll near term. We think this is a great opportunity to buy fantastic assets. I mean, a lot of competitors whether they’re other REITs or other private buyers, make a big deal about talking about how the bottom hasn’t come yet and we need to wait and 2010 will be the real opportunities. Well, there are opportunities today, you just have to look. If I buy a building today for a 10% cap rate, if I waited another six months maybe I could buy a comparable building for 10.25% or 10.5%, maybe.

But, the 10% cap rate we’re getting today we all feel good about because these are buildings that honestly everyone who’s selling us these buildings are taking losses on them. Meaning they bought them two, three years ago at substantially higher prices than what we are paying and these are buildings that you would have seen trading 6%, 7% or lower cap rates in the past. I think we’re being very selective in our acquisitions but again between the 9% and 11% cap rate and I’m not comfortable disclosing the cap rate on the building for the fourth quarter yet because we’re still in diligence.

Mark Biffert – Oppenheimer

In terms of looking at other opportunities, how would you look to go out and finance these things? Would you look to the unsecured markets, secured debt, are you seeing improved flow from the life co companies?

Adam D. Portnoy

I would generally say that all the markets with maybe the exception of the preferred market is generally open to HRP right now. On the secured side, the market is definitely open in fact, we’ve looked at some secured financing as a possible alternative and I’d say life companies have come more back in to the fold since the beginning of the year, there’s no question. Banks are also lending again much more. It’s not robust but they are lending more than they use to let’s say six months ago.

The unsecured market is available to us. From HRP’s perspective we have other alternatives in terms of raising capital rather than raising debt capital. We could sell assets if we wanted to or we could sell securities, the securities we own in GOV. I would point out that I would say selling the securities in GOV would probably be a second choice today, it would not be our first choice. But, it’s clearly something that we could do to raise capital if we needed to.

Mark Biffert – Oppenheimer

Then John, I just want to clarify this, did you say GOV would start paying you a dividend of $4 million a quarter starting in 4Q?

John C. Popeo

That’s correct.

Mark Biffert – Oppenheimer

Was there a dividend not paid in the third quarter?

Adam D. Portnoy

No, they didn’t pay a dividend in the third quarter. What they did is GOV went public on June 22^nd or June 20^th around there and basically when they paid their third quarter dividend which they’re paying in the fourth quarter it’s a little big higher than the normal divided because it includes about – I may have gotten the dates wrong, about 20 days of dividend from the second quarter. There is a second quarter dividend but it’s being paid in the third quarter dividend.

Mark Biffert – Oppenheimer

Then lastly, on the leasing expirations that you have coming up in 2010 roughly 12% of your space, have you had conversations with the tenants? What percentage of that do you think will renew versus leave the space and kind of give us an idea of what you think the spreads will be on those as they expire?

Adam D. Portnoy

That is a question we spend a lot of time thinking about Mark. I would say the best way to answer that is what is expiring in 2010 we are currently working on today, at least a third of it, today already. The goal for the company really going in this market environment is 100% focused on renewals. I expect there to be some further occupancy declines based on the same store basis going through 2010 in to and through 2010. I do not expect the decline to be as great as what we experienced this quarter, 110 basis points in one quarter, trailing quarter next to quarter.

I do expect that to moderate. That’s just the market we’re in and in terms of the rental rates, look it’s clearly a tenant’s market in almost every market in the country. The only two areas where I think we’re going to see some roll ups is in Hawaii and possibly in the Washington DC area with some of our expirations. I think basically everywhere else is likely to see roll downs.

Operator

Your next question comes from John Guinee – Stifel Nicolaus & Company, Inc.

John Guinee – Stifel Nicolaus & Company, Inc.

A couple of comments, at what point do you access the equity markets again?

Adam D. Portnoy

We have no current plans to access the equity markets from where we sit today. I think the multiple we trade at we’d still be a fairly dilutive transaction for us, a very dilutive equity offering for us and frankly there’s a very high cost of capital. I think we would think about alternative sources of funding either through asset sales, debt offerings of some sort or another or possibly selling securities in GOV from where I sit today. I’m sure at some point HRP is going to do another equity offering but it’s not on the near term horizon.

John Guinee – Stifel Nicolaus & Company, Inc.

The second comment I guess for John Popeo, is anybody else sort of ignoring NAREIT’s definition of FFO and adding back acquisition costs as opposed to continuing to deduct those?

John C. Popeo

That’s a good question but unfortunately I’m not sure there’s a whole lot of precedent out there. First of all, HRP is probably more active in acquisitions since the new accounting pronouncement went in to effect in January 2009. I just don’t know. You may know better than me John.

John Guinee – Stifel Nicolaus & Company, Inc.

I guess the third question is you’ve got eight million square feet of vacant space and a lot of your peers are taking this opportunity despite the fact that the market is very, very thin to sell the permanently impaired assets, the ones that you can just let someone else take the lease upper risk. Are you ever considering just dumping some of the bottom quartile assets?

Adam D. Portnoy

Today I don’t think that’s something we’re considering. We’re pretty active in the acquisitions and in the marketplace so we have a pretty good sense of what people are willing to pay and I just think one, you’re not going to find a lot of buyers willing to take on that type of risk today and if you do I mean you really are giving the property away. So, it’s not something we’re currently considering.

Operator

Your next question comes from Nick Pirsos – Macquarie Research.

Nick Pirsos – Macquarie Research

A couple of questions, first I think you characterized the nature of the sellers as selling more of their better properties rather than their distressed properties and yet I guess you’re still able to get these better properties at a north than 10% cap rate. I just want to make sure I’m understanding that correctly?

Adam D. Portnoy

Yes, that’s correct.

Nick Pirsos – Macquarie Research

Do these properties require any rehab going in?

Adam D. Portnoy

No. There’s nothing I’m not trying to hide the ball here guys. There’s no cap ex, these are really quite – the buildings earlier this year the Denver, the 17^th Street Plaza, the building in northern New Jersey that is in Hoboken, the two buildings we just bought in Washington DC which are leased to Georgetown University, these buildings have either been recently constructed or recently extensively rehabbed by the prior owner and have long term leases in place.

There’s nothing unusual here. It’s really everyone talks about being able to take advantage of opportunities from distressed sellers and this is really what this is, taking advantage of opportunities. Some of our competitors won’t feel comfortable jumping in to this because we’re buying things at 10% current cap rate and based on where it is today I can’t constantly model out 30% returns over a five or 10 year return on those properties. But, I have different return hurdles than let’s say a lot of money on the sideline.

A lot of people have talked about funds that have been raised but they’re still looking to try and get a 30% return and that’s not very – then there’s not a lot of debt capital out there and if it does exist they’re not going to give you a high loan-to-value ratio. We see this as a unique opportunity to buy some great assets at great prices.

Nick Pirsos – Macquarie Research

Just two further clarifications, the commentary around expected occupancy trends for the coming quarters is that merely for the existing portfolio? I guess that I’m getting at is to the extent that you remain active as an acquirer presumably you’re buying at higher occupancy levels going in so there should be some offset to that so I just want to make sure that I understand the color surrounding occupancy.

Adam D. Portnoy

Yes Nick, absolutely. What we were commenting on is on the existing portfolio about declines, you’re right the buildings we’re buying and if we continue to be active as an acquirer they were likely be very highly occupied buildings and that will have an offsetting effect on our occupancy numbers going forward so you are correct.

Nick Pirsos – Macquarie Research

Then just lastly, on your comment in regard to the dividends, I think you said something to the effect that in the third quarter there was no payment but there was 20 days worth of dividend but the implication there being that dividends accrue much like a bond but dividends are typically declared so you don’t need to own it for the entire period. If you have it on that day you get the whole thing so I guess I was confused about the commentary around the dividend.

Adam D. Portnoy

We were talking about our dividends in GOV not our dividends.

Nick Pirsos – Macquarie Research

I understand that but I think you said that there was no payment made in the third quarter but the fourth quarter amount might be larger because there was an additional 20 some odd days in the third quarter that would roll in to the fourth quarter and you might get a larger amount. I guess that’s what I was confused about.

Adam D. Portnoy

Yes, to be perfectly clear, GOV when public I guess it was the 8^th or 9^th of June. I said the date wrong before it wasn’t the 22^nd it was about the 8^th or 9^th of June and we did not declare a second quarter dividend, or they did not declare a second quarter dividend for GOV. Instead, when they declared a third quarter dividend that dividend was for $0.50 a share and included in that dividend was $0.40 which was the regular quarterly dividend for the third quarter plus $0.10 which was the pro rata portion of that 22 days in the second quarter that was part of that dividend.

Operator

Your next question comes from Analyst for James Feldman – Bank of America Merrill Lynch.

Analyst for James Feldman – Bank of America Merrill Lynch

I was just curious can you please give a little bit more color on your Boston market commentary and kind of why you expect it to be a little bit weaker than the other markets you’re in?

Adam D. Portnoy

First of all the majority of our Boston properties are in the suburbs. We do have a handful of properties in the CBD as well as in the Longwood medical area. Those properties are performing just fine but again, the majority are in suburbs including Foxboro and Mansfield and those are just difficult markets right now. We lost tenants that were occupying around 300,000 square feet at the beginning of 2008. About a quarter ago we thought we were actually very pleased with some activity for some potential tenants but those tenants prospects have basically disappeared right now. It’s just a difficult market. The buildings are fine, they’re in some cases Class A buildings but in Class B and C markets.

Operator

Your next question comes from Edward Okine – Basso Capital.

Edward Okine – Basso Capital

When you pay your November dividend and it’s been almost a year since you brought the dividend down, I’m just trying to find out if there’s any thought at all about what to do about the dividend going forward?

Adam D. Portnoy

The current dividend rate is $0.12 per quarter or $0.48 per year. As we mentioned in January 2009 we announced a dividend cut from the prior $0.84 per year down to the $0.48. That saves the company around $80 million in free cash flow. Our dividends are paid on a quarterly basis. The full board reviews and approves the dividend level on a quarterly basis and as of right now I don’t believe there is any intention of reducing the dividend but again it’s something that is reviewed every quarter.

Edward Okine – Basso Capital

So no intention of reducing it, what about increasing it?

Adam D. Portnoy

That’s the goal of this company, to increase cash flow and ultimately increase the dividend rate but at this point in time it’s probably not prudent.

John C. Popeo

I think it would be difficult to justify a dividend increase in the current office market environment that we’re currently going through.

Operator

That concludes the question and answer session today. At this time Mr. Portnoy I will turn the conference back over to you for any additional or closing remarks.

Adam D. Portnoy

Thank you everyone for joining us on our Q3 conference call. John Popeo and others here are looking forward to seeing some of you at the upcoming NAREIT conference in Arizona. Thank you.

Operator

That concludes today’s conference call. Thank you for you participation.

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