Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Gramercy Property Trust (NYSE:GPT)

Q1 2014 Earnings Call

May 08, 2014 2:00 pm ET

Executives

Gordon F. DuGan - Chief Executive Officer and Director

Jon W. Clark - Chief Financial Officer, Chief Accounting Officer and Treasurer

Benjamin P. Harris - President

Analysts

Jason Ursaner - CJS Securities, Inc.

Mitchell B. Germain - JMP Securities LLC, Research Division

Daniel P. Donlan - Ladenburg Thalmann & Co. Inc., Research Division

Wilkes Graham - Compass Point Research & Trading, LLC, Research Division

Zev Nijensohn

Operator

Thank you, everybody, for joining us, and welcome to the Gramercy Property Trust First Quarter 2014 Financial Results Conference call. A reminder, presentation materials and a supplemental for the call are posted on the company's website at www.gptreit.com in the Investor Relations section under Events and Presentations. [Operator Instructions] Please note that this conference is being recorded.

The company would like to remind listeners that during the call, management may make forward-looking statements. Actual results may differ from the predictions that management may make today. Additional information regarding the factors that could cause such differences appear in the MD&A section of the company's Form 10-K and other reports filed with the Securities and Exchange Commission.

Also, during today's conference call, the company may discuss non-GAAP financial measures, as defined by the SEC Regulation G. The GAAP financial measure most directly comparable to each non-GAAP financial measure discussed and a reconciliation of differences between each non-GAAP financial measure and the comparable GAAP financial measure can be found in the company's press release announcing first quarter earnings, a copy of which can be found on the company's website at gptreit.com.

Before turning the call over to Gordon DuGan, Chief Executive Officer, [Operator Instructions] Thank you, and please go ahead, Mr. DuGan.

Gordon F. DuGan

Thank you very much, and thank you, all, for joining us this afternoon. We have -- Jon Clark, our CFO, is here with me; along with Ben Harris, our President; as well as Ed Matey, our General Counsel. We have a presentation that's posted on our website under the Presentation section that I'm going to walk through, that kind of summarizes how we've -- some of our thoughts about the first quarter and where we are. So if you haven't already, please pull that up. Jon's going to start by running through the numbers for Q1, turn it over to me and I'll take us through that presentation. I promise to be a little bit briefer this time than the last call. So why don't I turn it over to Jon, and let's get started.

Jon W. Clark

Thank you, Gordon. I just wanted to provide a few brief comments on the results of the quarter. We generated AFFO during the first quarter of $3.6 million or $0.05 per diluted common share. That compares to $3.4 million or also $0.05 per diluted common share in the prior quarter. FFO was $3.2 million or $0.05 per diluted share. That compares to a negative $947,000 or $0.01 per diluted common share in the prior quarter. We achieved these figures, even considering this was a particularly different -- difficult comparable. First of all on the prior quarter, we have recognized an additional $3.2 million of incentive fees, which represented the remaining portion of the incentive fees to earn under the prior agreement we have with KBS on our asset management business. Also in the first quarter, it reflects the full dilution of the private equity rates completed in the fourth quarter of 2013, whereas prior quarter was a weighted average of that issuance.

Turning to the income statement, we recorded total revenues of approximately $15.6 million, as compared to $17.7 million in the prior quarter. Our rental revenues increased to $7.5 million from $5.7 million recorded in the prior quarter, and that's due to the growth in the Real Estate portfolio, primarily related to acquisitions that occurred in the latter part of the fourth quarter of 2013. In the first quarter, we had one small acquisition.

Management fees declined quarter-over-quarter by $3.7 million, and that is primarily due to the $3.2 million of incentive fees that we recorded prior quarter, which represented the remaining portion of the old contract. That -- the incentive fee under the old KBS arrangement was capped at $12 million, and in previous quarters, we had already recognized $8.8 million of it.

In addition, there were incremental disposition fees that were received in the fourth quarter not repeated in the first quarter. And I'd just like to point out that our fee revenue on our asset management business is comprised of an asset management fee that's fixed, incentive and distribution -- incentive and disposition fees that are not and a property management fee that is actually based on cash collections, not on the rental income build. Accordingly, there is a certain amount of volatility related to our fee revenue on our asset management business. Conversely, expenses on the asset management business tend to be less volatile and are accrued for.

Just turning back to refresh you about the KBS contracts, in the prior year or in December, we executed a new agreement with KBS, which provides a for a new base fee of $7.5 million. The old contract was essentially a contact that had incentive fees that were back-end loaded. This new contract that we have in place, beginning in December of last year, we anticipate is going to provide us with more of a potential to earn incentive fees on the run and receive cash payments based on the resolution of underlying assets, as opposed to the old agreement. During the first quarter under the new agreement, we recorded approximately $630,000 of incentive fees. And that's related to the valuation on a specific asset or portfolio.

The -- because of the significance of our fee-based revenues and compared to our total revenues, as a REIT, we conduct most of these activities in a taxable subsidiary, and essentially that's where substantially all of our tax expense is derived from. This period, we did undertake a review of our tax expense associated with these taxable activities, and we primarily focused in on how we source our income for state tax purposes. The results of that review, combined with the change in Pennsylvania tax laws, which were favorable to us, leads us to expect that our effective tax rate will be about 37%, as compared to over 41% in the prior year.

Real quick jumping to the expense side, management general and administrative expenses were, for corporate, was $3.5 million. This compared to $3.8 million in the prior quarter. Total MG&A, which includes non-revenue producing overhead for our asset management business, was $4.3 million for the quarter, compared to $4.8 million in the prior quarter. One small item, just to point out is on our income statement, you see a negative expense for $115,000 referred to as a gain on derivative. This is actually the reversal of the prior carrying value of the CVR, which was associated with the pipe that was completed in the fourth quarter. It had a fair value of $115,000 as of December 31 [indiscernible] was prior to March 31 and what you see is basically the reversal of that fair value.

Results of our joint ventures this quarter were a contribution of $628,000, as compared to a deficit of $2.9 million in the prior quarter. The prior quarter was affected by 2 items in the Bank of America joint venture, the first of which was an impairment that we had reported for properties held-for-sale. That was approximately $2.4 million. And then the other is essentially an incremental charge to our JV of about $617,000, related to a change in our management contract between us and our joint venture. That, actually, charge to the joint venture, resulted in some incremental fees to us, which were recorded in the fourth quarter.

In the first quarter, we did record a small impairment inside the joint venture. It was approximately $130,000 related to the remaining assets held-for-sale. There were 5, all of which have been sold at auction.

One last thing I wanted to point out on the income statement. It's relatively small, but you'll see a cost that's classified in discontinued operations. This is the -- substantially comprised of interest on the 2 Harold [ph] matter. The 2 Harold [ph] transfer tax matter has been fully accrued for in a prior period, but we'll continue to incur and accrue interest expense on that until resolved, so you're likely to see some small amounts running through discontinued operations there.

Just turning quickly to the balance sheet, there's just a few additional items I wanted to highlight. At quarter end, we maintained liquidity of $153.4 million of liquidity. Included in that is cash of $61.9 million, and availability under our revolving secured credit facility of $91.5 million.

Although we had recently exercised an accordion to take the secured credit facility up to $150 million, we have only pledged and encumbered enough assets where we could draw down on $91.5 million of it today. At year end, we had $45 million borrowed under the facility. At one point during this quarter, the borrowings were -- did reach $68 million. But proceeds from our convertible debt offering were used to fully extinguish the amounts under the facility, and we have no amounts borrowed under the facility today.

Just pointing to our joint venture on our GAAP balance sheet, you'll see that balance continues to decline. It declines primarily because it does generate significant cash flow, so the cash flow that we receive and our partner receives reduces the GAAP presentation.

For the quarter, we received distributions of $3.7 million from the JV and to date, our distributions have been about $32.9 million. Servicing Advances remain substantially unchanged from the prior quarter. No amounts were received. You see a slight uptick in the balance and that is just the interest that we earned that's been accrued for. Our retained CDO bonds also increased slightly, just reflecting the basic accretion earned on those securities. A part of that accretion runs through the income statement and is reflected on the -- as investment income. The remainder runs through comprehensive income in the equity section of the balance sheet.

On the liabilities side, the increase in the balance of our mortgage notes payable just reflects the assumption of a $2.71 million first mortgage loan, in connection with a first quarter acquisition. I would point to the schedule that we put in the supplemental. We added a debt summary this quarter, which is on our website. We hope you find that schedule helpful. In that debt summary, you can see individual borrowings, the components of fixed and floating rate borrowings, as well as a summary of future principal payments.

Accrued dividend payment -- accrued dividend payable on our balance sheet's approximately $4 million, which just reflects the dividends declared prior to quarter end, which were paid on April 15. A reminder, our accrued dividends as of December 31 included the accrued preferred stock dividend, which was paid in full in January 2014. I think we take great pride in not having to talk about the accrued preferred dividends anymore.

I just wanted to make a few comments on the accounting for the exchangeable notes that we issued this quarter. Accounting for exchangeable notes and convertible debt is rather complex. First the, let's talk about the easy part. The cost associated with the convert appeared as deferred costs on the asset section of the balance sheet. These costs represent most of the increase in the deferred cost quarter-over-quarter. These costs get amortized over the life of the instrument and the amortization gets recorded in interest expense on the income statement.

The convert itself is issued at par for $115 million. The convert appears in 2 places on the liabilities section of our balance sheet. First, the exchangeable notes appear in long-term debt and our initial carrying value of those notes is $109 million. Then, for accounting purposes, the conversion feature of the instrument gets bifurcated. And it appears as a liability, basically shows up in the derivatives.

Now this is the interesting part, at least in an accounting sort of way. We expect the geography of this conversion feature to move. So it resides as a derivative today because the accounting rules only allow one bifurcation of features not typically associated with unsecured debt, and because of a New York Stock Exchange restriction that applies to all listed companies, and based on the number of shares of stock we have outstanding today, we could not issue enough shares today to fully satisfy the conversion option without a shareholder vote. However, we filed a draft proxy earlier this week, and a proposal for our shareholder meeting in June is to vote on just that provision, to allow us to issue shares to satisfy the convert, if and when the time comes to do that. So once that approval is received, the derivative portion of the convert will toggle out of the liability section and become a component of shareholders' equity. And this is really the preferred presentation for us. When that toggle occurs, there could be a potential for a noncash charge, just because the derivative will be mark-to-market on that day. I really don't have a way to be able to quantify what that would be, other than to say that if you have done that toggle today, there will be no charge at all.

Gordon, apologies for the accounting lesson there, but I just thought that was an important -- to discuss the geography of the convert, and how that's expected to change on the next statement that we issue. Gordon?

Gordon F. DuGan

Jon, thanks very much. If everyone's had a chance to pull up the presentation, I wanted to hit some of the highlights and give, really a little bit a view of how I think about the quarter, how we think about the quarter as a -- from our perspective.

Let's just start with pages 6, 7 and 8. These are pages you've seen before, so I'm not going to read them or go through them, but I did just want to remind people that we are updating these as we acquire property, and I would like to make just a couple of comments on Page 8. I think what's so interesting about the portfolio that we are putting together and have put together is that based on the standard, what I describe as net lease metrics, lease term, percentage of investment grade, occupancy, it's as high-quality a portfolio based on those metrics, as there is in any public company, but as many of you that I've met with know, our focus on quality real estate to me, is another piece of that. It's a higher-quality real estate portfolio than other net lease portfolios in our view, and yet it still has as high-quality of a metric, net lease metric that you could compare anybody else. So that's, that I -- was one thing I wanted to point out.

Page 9 is just the updated summary of what we own. I thought it was also interesting in Green Street's initiation of research on -- at least they mentioned that very few people, if anyone, gives full disclosure on every asset, including basis, location and market, and that's something we've been doing from the beginning, and it's there for all of our investors to see. Page 10, the pipeline, I'll come back to, on the next page, talking about acquisition volume, et cetera and our outlook on that. But I wanted to say a couple of things here: one, the pipeline is very similar in quality and return to the existing portfolio; and to me, it's an indication that we continue to execute on the plan that we set out to do, which is to build the highest quality industrial and office net lease portfolio. We continue to take advantage of our origination, our years, having -- doing this to find attractively priced, attractive assets in a marketplace that is arguably quite competitive.

Page 11, I wanted to pause on this. I have the acquisition activity pulled [ph] in this manner. It understates Q4 2012 a little bit for the BofA JV, but what I thought was interesting, I expected to see Q1 of last year a little bit lower than it was, and I'll come back to that. But a couple of things jumped out at me on this page: number one, it's not unusual to have a low acquisition volume quarter. Q3 of last year was roughly $18 million. Q1 of this year was $6.3 million. So far in Q2, it's $18.7 million, but if you'll recall the page we just flipped, in addition to that, we have $123 million under contract, $28 million under letter of intent. There's this odd thing in our business that Q4 tends to be the most active, Q1 the least active. It has to do with a lot of factors but generally people trying to execute sales or sale-leasebacks before year end, and then in Q1, things are getting teed up that will be executed throughout the rest of the year, but a lot of them just don't get closed in Q1, because conversations begin in January and it just takes a while to close a commercial real estate transaction.

It's so it's this -- there's this -- I've used the word seasonality. Obviously, it's not seasonality like a retailer, but it shows up in acquisition volumes that fit that way. So I thought a little bit of perspective on it. We're very happy with the pipeline we have. We feel very good about the deal flow that we continue to see. We are as busy, if not busier, on the acquisition front than we have ever been. And so Q1 is what it is. It's a little bit of an outlier. I would also point out that the acquisition timing and volume has a significant effect on our growth in rents and earnings. In Q1, there was very little new added to the rental pool, and yet we grew rents over 30% in Q1. So there's a nice ramp-up in rents that's occurring in any event. And as we get some more of these deals closed, you'll see an acceleration of that ramp.

Page 12, just 2 points to make here. The convert was closed at the end of March. Our thinking on that, and I've talked to you about that, some investors are happier than others with converts. But I would say this: It's a really nice piece of transitional capital for Gramercy. It's cheaper than equity, the conversion kicks in at 6 20. We were able to execute it in a 144A transaction. And it's a great piece of paper, if something goes bad in the world. So we felt it set us up well from a transitional standpoint. And then the other thing I would say is we're in a nice position from a liquidity standpoint. Our liquidity is very strong, our capitalization is very good, and we have nothing drawn on our credit facility and a nice pile of cash. So as we go into the second quarter of 2014, we just feel very good being in a position with a lot of financial flexibility.

Flipping ahead, I wanted to go to Page 14 and talk a little bit about the asset management piece. Jon walked you through those numbers. This is how they kind of break out. And there were a couple of things -- this is our view of how Q1 was. We saw a big decrease in incentive and disposition fees. Q4 was somewhat elevated; Q1 was depressed. So the truth is somewhere in between. And then on the property management side, we've broken that out so that you see there that was a significant swing in the net contribution, which tends to be slightly negative on the property management side. That is unusual for us. There are some onetime expenses that are involved there, as well as some -- the revenue, because these are third-party management contracts, the revenue doesn't always match up well with the expenses. It should, and it evens out over, let's say a 2-quarter period. So what we would expect in Q2 is a return to more normalized profitability, as those revenues and expenses are more in line. We view Q4 as a more normalized quarter for revenues and expenses and property management, and Q1 was a little bit off. So -- but the net effect of all of those was a much lower pretax contribution. So what does that mean on '15? We're exactly in the place we were before Q1 results. We expect a base profitability of at least $5 million from the asset management business. We do expect additional incentive fees during the year, although we can't predict now size or timing. We have the same expected range of investment, of -- excuse me, incentive fees that we expect to realize. Again, we took the KBS contract from an overall, an incentive fee on the overall value of the entire portfolio, and we broke it up deal by deal. KBS loves that we're highly incented to realize this, because it means more money for them, and we like it because it means more recognition, greater recognition of incentive fees. So we thought that was a big, big win for us, and we're going to continue to look to grow the profitability and the number of clients in that business.

16 is another, is kind of our reflection on our business as we go in through 2014. Because of the small denominator of our business, the fact that we're building a de novo, ground up portfolio with no legacy underwriting issues in it and we expect to have very high growth, a few things are going to impact our business as we -- both in Q1 and as we go forward. The -- to the extent we have onetime cost to optimize the asset management business, we saw a little bit of that in Q1. We don't expect a lot of it as we go forward. We did move offices for that business in Pennsylvania, from Jenkintown to Horsham. There will be a little bit of an expense running through that. But these other 3 are much bigger.

Acquisition expenses, you'll see in Q1, we had about -- it wasn't a big number, about $250,000 of acquisition expenses. Most of those related to some bills that came in from Q4 acquisitions that came in later and weren't recognized in Q4. We're going to try to match that up a little bit better. But we could have -- in a quarter where we have a significant acquisition pipeline, our acquisition expenses, as a percentage of earnings, could be a very large number. So I want to put that on investors' radar screens. Those acquisition expenses, in my view, should be capitalized, not from a GAAP standpoint, but just in terms of how we think about what they are, they're onetime expenses to gather future, recurring NOI.

The other 2 points, obviously timing and volume of acquisitions, has an effect. And then lastly, straight-line rent adjustments. If you flip to 17, this is a very interesting analysis that we thought through -- that we've included here, at least we think it's interesting. Basically, it shows that the straight-line rent adjustment on a de novo, fast-growing portfolio is much, much greater than that on a mature, lower growth portfolio. And so there are 2 ways to look at this: either we have an inherently greater internal growth through what's already contracted NOI increases, which is a perfectly legitimate way to look at it, and then take the straight-line rents and don't cap those straight-line rents, but realize that we have much greater potential NOI growth from it. Or the other way to look at it is that with the quality portfolio we have, with the tenant credit profile that we have, that we should get more credit for the straight-line rents. And as I looked at it on Page 18, what I wanted to get a feel for on this was the ramp in the business, and what we see in Q1 is the business is indeed ramping from an earnings standpoint. Although the headline number didn't show that, there's already inherent ramp in those numbers. You see the straight-line rent number, the second piece of this is Preferred Freezer. If you'll recall, Preferred Freezer is a $25 million build-to-suit. We do not get any earnings off that build-to-suit, until it's placed into service. It will be placed into service on May 15. We had almost $20 million invested in Preferred Freezer, so we've received no rental income recognition on Preferred Freezer. We did book for AFFO purposes, we charge a small amount of construction interest that's capitalized for GAAP. We do include that in the AFFO, but even if we just take the amount of capital that we've invested into Preferred Freezer, you see a nice pickup in rent. And Preferred Freezer, when it goes into service on May 15, will start kicking in $600,000 a quarter of rent. We'll only get half of that for the second quarter. But the point of all of this is that, as I looked at Q1 and acknowledged that the asset management contribution came in unusually low, we don't expect that going forward, and with the low acquisition volume to contribute new NOI and rents, even with those 2 things impacting the results, there's a built-in ramp that's already in the numbers, that will be realized in the coming quarters. And that's how -- that's what that $0.07 [ph] number is. So the point that there is a ramp in place is very much true, and that, that ramp will continue to be recognized as we go out.

If we go to Page 19, that's one of the reasons why, when we did our guidance originally, we did it to Q3 and Q4, which gives us time for the ramp to come into the numbers. And we are reaffirming that guidance. From everything we know today, we are comfortable that, that guidance is correct, and that the ramp that we're seeing will ramp into this range by Q3 and Q4.

Moving on to Page 21, a number of you have heard me talk about this quite a bit. We have this really interesting platform from both an acquisition capability and an asset management capability.

Page 22, I talk a little bit about growth opportunities for Gramercy outside of the base business, core business plan of buying assets and growing NOI.

On Page 23, our first example. In a number of investor meetings I had -- I talked about the potential for OP unit deals. We did announce an OP unit deal. It's subject to some loan assumption and certain approvals, including one on our side. But what you see here is a transaction where the seller of these assets chooses to sell to Gramercy. They are tax motivated so that -- or tax sensitive, I should say, so that they want to take back illiquid OP units, and so they -- while they sell, they don't gain immediate liquidity, because they're taking back OP units. And so they tend to be very sensitive to which OP units they're willing to take back. They'll distinguish between the REITs that they want to take shares in and the REITs that they don't want to take shares in, which a cash seller won't do. A cash seller, obviously just looks for the highest price. A seller of assets for OP units is very, very sensitive to the quality of the portfolio and management teams, that they're taking illiquid interest back in. Mike Fascitelli, when he was at Vornado, did a good job talking about this, when they did the Mendik acquisition years ago in New York. They were a differentiated buyer. It wasn't who had the most cash. And this transaction itself is almost 10% of our asset base. So they're complicated, they are difficult to do, but these opportunities are out there to grow our asset base without -- while putting stock in the hands of long-term shareholders who are going to be less price-sensitive and more sensitive to whose shares they're taking back in exchange for their assets.

24 -- the next few pages are a little bit of expanding upon the basic theme of investment management. We've talked about Gramercy getting into investment management, and let me lead by saying we are intensely focused on the execution of everything we're doing, the blocking and tackling of the assets we are buying each day, getting the pipeline closed, building up that pipeline again, and nothing we do on this side will distract us from that. And I think our track record proves that we've done absolutely everything we said we would do. But there are some really interesting aspects in the Investment Management business. And the 2 reasons that I wanted to highlight it is, myself, Ben and others have experience in this sector, so it's an area that we have a lot of experience with, both from a retail investor and an institutional investor standpoint. And then the second thing is, it's a really interesting source of internal growth. So in addition to external growth opportunities, we see really interesting and compelling internal growth opportunities that we think we could be very well positioned to capitalize on. And before I jump into it, let me also say, we don't expect this to impact 2014 positively or negatively, but it builds on a base for internal growth for the future.

In terms of the criteria for what we would do off balance sheet as we think about it, versus on balance sheet, assets that don't have high current cash flow, high occupancy, longer lease terms, would not go onto our balance sheet. We need to find an opportunity that we think is compelling near- and intermediate-term, so it has to be something that we've identified, that there is a compelling opportunity. And then thirdly, and these are "and" -- this is an "and" equation, not an "or" equation. We have to have experience in underwriting so that there's some palpable and/or identifiable competitive advantage for Gramercy to be in that business.

If we go to 25, near-term opportunities in this area, institutional JV to buy financial institution real estate. We have, by far, the most experienced and capable asset management team. It's that white box of that platform slide that I showed. There are a lot of assets that could be targets for value-add opportunities that don't have a high cash flow. They either require capital investment or repositioning. Our team knows exactly how to do that. We've been doing it on behalf of other clients, and it's very additive to what we're doing. If financial institution real estate has the characteristics that meet our balance sheet, we want to buy it and put it on our balance sheet. If it doesn't have those characteristics, rather than pass up a very compelling investment opportunity, we think there's institutional capital that would love to partner with our team as the operating partner to buy these assets and create returns for those partners. And the beauty of it, is it leverages the existing asset management platform, without adding a single cent to the G&A or needing to add people. We have the existing platform already in place to do this.

The second opportunity we've identified is the build-to-suit fund. This is something we've been doing for many, many years, going back to our days at WP Carey. I worked on what I believe was one of the first -- certainly the first build-to-suit that I know of. In 1990, we did a build-to-suit in Colorado, in between Boulder and Denver. There was no capital available for development. A company needed to expand its business, and we stepped in and created a build-to-suit structure for them. So this is a business we helped pioneer back at WP Carey. We get calls all the time from our contacts, developers, investors, looking for build-to-suit, for us to team up with them on build-to-suit investment opportunities. Construction's been very depressed for a while. And the reason we don't like these on balance sheet is exactly the reason I pointed out with Preferred Freezer, where we have nearly $20 million of capital into it and it's not producing any earnings immediately. The earnings will click on 100% May 15. But this is a very interesting opportunity. And again, it completely leverages an existing team and platform without the need to add people or capabilities or anything else. These are already dialed in and in place. So if you go back to that platform slide, these are a couple of opportunities we've identified.

26, I don't want to spend a lot of time on it. We do not expect this to be an immediate initiative. It certainly will not be a distraction for us. Our #1 focus remains execution of our base business plan, in blocking and tackling. But I did want to flesh out a little bit. I've received a number of investor questions about why would we or why wouldn't we do Europe, and I think this sets that out. Again, 2014 effects of any investment management activity should be limited. But the ability to put in place future internal growth is something that I think is very compelling and something that I personally plan to be very involved with on these initiatives.

Let me just go right to 27, 28, finish up and turn it over to questions. You've heard this before, but we remain a believer that there's an opportunity to be a leading industrial office net lease REIT for Gramercy, on 27, as we segment it. 28 was an interesting slide that shows the -- on a pictorial basis, what we believe the opportunity is. That opportunity exists if we are able to execute, if we're able to keep our focus and we're able to take advantage of opportunities that we've identified and continue to do the blocking and tackling that we need to do.

With all of that, I'll turn it over to Q&A.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Jason Ursaner from CJS Securities.

Jason Ursaner - CJS Securities, Inc.

Gordon, so you reaffirmed the forecast for run rate AFFO in the second half and obviously, that includes the ramp in NOI that you're going to need to get to get you there. Just for the past quarter, though, wondering how the growth in rental revenue came in relative to internal expectations. Obviously, it grew significantly, and I understand the commentary you made on straight line impacting the bottom line and the timing of Preferred Freezer impacting both top and bottom. But just for the rest of the properties you acquired in Q4, because there was a significant amount of activity, did those generally layer in how you expected?

Gordon F. DuGan

They did. The portfolio came in relative to our expectation. Just a little bit light, and the only lightness was on new acquisitions. The existing portfolio had a nice, very nice uptick in performance, both at the Bank of America JV, as well as the 30%-plus growth in rent. So that was right on. We were a little bit light on acquisition volumes, so we didn't get the benefit of new acquisitions, really, in Q1 at all. It was basically a 0 acquisition quarter from a contribution analysis, but that will change this quarter.

Jason Ursaner - CJS Securities, Inc.

Okay. For the acquisition program for the full year, obviously, from a funding perspective, you do have a significant amount of liquidity at this point. But just on finding the deals, besides the pipeline you have, what do you think is either the biggest risk or opportunity to sellers coming out and having properties available or, on the other side of that, not wanting to go forward at this point?

Gordon F. DuGan

Yes, I think the supply of investment opportunity is -- and Ben, chime in if you see something. But the supply of opportunity is as strong as we've seen it. Part of that is the commercial market, real estate market's fully recovered, so any investment fund that had a finite life period to it, and so much of commercial real estate is owned in finite life private vehicles that just by their terms, liquidate at some point. And I think that if you're managing one of those, you view today as a good time to liquidate. So there's a lot of products in the market. We continue to see just terrific opportunity in our focus of 5 million to 30 million. We'll be very curious to see if the larger portfolios continue to trade at very, very tight cap rates. It would not surprise me if people start backing off paying such aggressive prices for large portfolios. And overall, we see it as a very good environment where we're focused. Large portfolios have traded at much, much tighter cap rates, and I'll be curious to see if there's just that kind of continued activity.

Benjamin P. Harris

I think from a risk standpoint, the big risk would be a big compression in cap rates, which -- we talk about sort of last May being an important inflection point with respect to pricing in our market. And it really sort of stalled out what was playing out to be a pretty aggressive cap rate compression, and we haven't seen that start back up in the space that we're playing in. But if you want to think about a risk, that would be a big risk.

Gordon F. DuGan

Yes, I agree with that.

Operator

Our next question comes from Mitch Germain from JMP Securities.

Mitchell B. Germain - JMP Securities LLC, Research Division

So Gordon, just to follow-up on that comment. I mean, last quarter you talked about some discipline within the investment markets. Is that not the case, and is it still kind of frothy?

Gordon F. DuGan

No, I think it is the case, with the exception of these multibillion-dollar merger deals. But within the context of one-off deals, I continue to see a relatively disciplined marketplace, certainly among the public REIT competitors. If you look at what -- if you listen to commentary from Stag or Realty Income, these are disciplined investors, and so we've seen that continue, no change there at all. I think that there's always the concern that the non-traded REIT investors get more aggressive or start to compete in our niche, but I think the odds of that are very low. They just have so much capital coming in the front door that they -- and only a few of them are raising it, that they need to push it out so quickly. So they've been very focused on big office building deals and some other things. Big office building deals are portfolios where you can buy chunky, chunky things. So we haven't seen any -- if we see that creep, we'll let people know.

Mitchell B. Germain - JMP Securities LLC, Research Division

And with regards to some of the new ventures you're considering, just, I mean, you're doing such a great job in turning around the story and growing this nice net lease portfolio, clearly, metrics that are above the peer group. Why look to maybe increase the risk and why not try to gain additional scale before kind of veering off into new ventures?

Gordon F. DuGan

It's a great question, Mitch. I think the way we think about it is if there is additional growth that can be achieved without adding -- we have a platform that we've invested heavily in an MG&A level. I remember I met with one investor and I said, that our -- a small cap REIT, by its nature, the MG&A is high. And the investor said, no, you're just investing in MG&A. And I said that's a much better answer. And the way we think about it in this context is there are additional opportunities without adding to the MG&A load. I promise you, Mitch, nothing will distract us from the task at hand. I was at WP Carey when we decided to shut down all fund-raising in 2007 for the non-traded REIT business. That was a very difficult decision to make at the time. People look back and say, "That must have been easy to do." It was a very difficult decision for a company that's judged on growth in earnings and their AUM. And the decision was made in large part that short-term goals would have to be sacrificed for long-term good. So we're very aware of that fine balance, and I think, if I might, I think that we will be thoughtful and disciplined enough about anything we do that it won't interfere with the blocking and tackling of the core business. It's additional growth. And it's nice to have a source of potentially very strong internal growth. The thing I didn't mention that's on the deck is if the capital markets were, for whatever reason, to shut down, we still have a source of growth in this business. It's just going to come from internal growth.

Benjamin P. Harris

The way to think about it, Mitch, what we're really trying to do is build out capabilities to take full advantage of our origination efforts. And as we are today, we have great deal flow in our core net lease business. We have a ton of deal flow on the build-to-suit side and we're pretty limited to the number of build-to-suits we can do today because of some of the things that Gordon highlighted. We have great insight and access to value-add opportunities on the, both in the legacy AFR portfolio and also in the other. There are some of those deals that actually do fit on our balance sheet, and we've been buying those. If you look at the Morristown, New Jersey, asset that we bought last year, that's a great example of it. But that asset fits because it's fully leased and had an attractive yield with a great redevelopment play layered on top of it. There are opportunities that we see day in and day out with our existing platform where they're value-add opportunities -- they're still terrific opportunities, but they're not current return focused. So if we could set up an institutional JV or a sidecar or an institutional fund to be able to take advantage of that, and then it really is just leveraging the existing platform, it's not adding a bunch of staff or...

Gordon F. DuGan

I'll give you the example, Mitch, that gave us this idea. There's an office building in a major metro market. We are the asset manager. There was a potential sale of that building and a potential redevelopment. The buyer wanted us to continue to be the asset manager. And that's a lower margin business than being the actual operating partner in a deal. We saw that -- the pricing of that asset at a very attractive level, but we don't have a pocket of capital. So it's an asset we're already asset managing that was going to trade away at an attractive price. And then we continue to asset manage it and we were going to lose the potential margin that the investor was going to gain by buying it right and repositioning it. The seller in this case ended up backing away from the sale, but we realized that if we had a JV or a sidecar that we could have bought at an attractive price, continued all of the asset management work, but then also receive the upside that we see in the repositioning. So it's a small example, but we hear you loud and clear.

Mitchell B. Germain - JMP Securities LLC, Research Division

Great. And then last one for me. It seems like you said that the deal pipeline is still robust. I mean, I guess, where you are with regards to what you've done so far, what's under contract LOI, you guys are still confident in that 400 of one-off deals on the year, I'm assuming, correct?

Gordon F. DuGan

Yes, we are.

Operator

Our next question comes from Dan Donlan from Ladenburg Thalmann.

Daniel P. Donlan - Ladenburg Thalmann & Co. Inc., Research Division

Just wanted to -- I guess, maybe a question for Jon here, on the G&A, is what you guys did for the -- at the corporate level for the first quarter, is that a fairly good run rate for the rest of the year? Because I was assuming it was going to tick up a bit after this.

Jon W. Clark

It's a pretty fair run rate.

Gordon F. DuGan

Yes, it's a pretty fair -- yes, I think it is a pretty fair run rate.

Jon W. Clark

I think not on the corporate side, but in the asset management side, Gordon did mention, we did move offices down in Horsham, so we're going to have a little tick up on the asset management G&A. A fair run rate for corporate.

Benjamin P. Harris

And that move actually is, net-net, results in savings on a going forward basis, but still one-time...

Gordon F. DuGan

Yes, substantial rental savings.

Benjamin P. Harris

Unfortunately, one of the advantages of being small is we can grow this entity. The disadvantage is small things like moving an office is a noticeable expense.

Daniel P. Donlan - Ladenburg Thalmann & Co. Inc., Research Division

Sure. And then to that point, you talked about $500 million -- $5 million of profitability from that unit. Are you still expecting that for the year or that's the new -- that's basically the quarterly run rate, essentially $5 million divided by 4?

Gordon F. DuGan

Yes, that should be the base run rate, and then incentive fees that they recognize will push that number off.

Benjamin P. Harris

But just so -- just for, Dan, for -- to be very specific about it, we still expect the business to do $5 million of base profitability pretax for 2014. So that $5 million is incorporating the first quarter.

Benjamin P. Harris

Yes, I'm sorry, yes. But it does incorporate the first quarter, meaning we'll make up for Q1 lower levels of profitability in later quarters.

Daniel P. Donlan - Ladenburg Thalmann & Co. Inc., Research Division

Okay. Perfect, perfect. And then to that point, I can't remember -- Jon, I know you said this, I think, but I missed it. Are your incentive fees -- or are any incentive fees baked into that back half guidance that you gave?

Jon W. Clark

No. There's no future incentive fees backed into that number yet. We earned $630,000, first quarter. But that's all that's in there so far.

Daniel P. Donlan - Ladenburg Thalmann & Co. Inc., Research Division

Okay. Okay. Perfect. And then as far as, was there any free rent that was given in the quarter, or it might have been a de minimis amount but...

Benjamin P. Harris

I don't believe -- so there was one asset that we acquired last year that had free rent, but I believe it burned off in the fourth quarter.

Jon W. Clark

That burned off in October.

Gordon F. DuGan

I don't -- Dan, we'll look -- if there is, it's de minimis. We don't believe so.

Daniel P. Donlan - Ladenburg Thalmann & Co. Inc., Research Division

Okay, yes. The property [indiscernible] came in a little bit last [ph]. And I thought it might have been that, but no worries on that. And then how much do you -- as of the end of the first quarter, how much did you have left to fund [indiscernible]

Gordon F. DuGan

$5 million, just over $5 million.

Daniel P. Donlan - Ladenburg Thalmann & Co. Inc., Research Division

Okay. And then the Cardinal closing date for modeling purposes, when do you think that hits?

Benjamin P. Harris

It's subject to a lot of moving parts, and it's not -- it's actually 4 separate transactions. We -- we're sort of referring to it as a single portfolio. But it -- it's 4 different -- it's 4 individual processes and they'll close at different points.

Gordon F. DuGan

Probably all in June.

Benjamin P. Harris

Yes, we're expecting closings sort of throughout the month of June.

Daniel P. Donlan - Ladenburg Thalmann & Co. Inc., Research Division

Okay, okay. And going back to Mitch's question on the guidance, you're still reiterating $600 million, though, in terms of full year guidance in terms of acquisitions, right.

Gordon F. DuGan

That's correct. $400 million of one-offs and $200 million of 1 or 2 or 3 portfolios.

Daniel P. Donlan - Ladenburg Thalmann & Co. Inc., Research Division

Okay. All right. And then last but not least, can you maybe talk about the structure -- and if you don't want to go into detail, that's fine. I know we're getting pressed for time here. But the structure of maybe a build-to-suit fund or this financial fund, I mean, is it something where you put in 5% equity? I mean, how would that be structured from your standpoint?

Gordon F. DuGan

Yes, there might be a small co-invest. I would assume a 5% to 10% co-invest with a large partner, either a fund or an individual institution. And then ongoing fees and then back end participation.

Benjamin P. Harris

If you think about it, we sort of did a similar thing with the BofA JV. We brought in a capital partner, acquired a portfolio, we got fees, we have a promote in our transaction, and it allowed us to access the transaction that we were not comfortable taking on to our balance sheet in whole at that time, at the end of 2012, just given the size of the transaction and the size of the portfolio. But not that, that's a template, but the only reason I bring that up is this isn't something that we haven't -- that's so far afield from what we're already doing [ph].

Gordon F. DuGan

Yes, we know how to do it.

Operator

Our next question comes from Wilkes Graham from Compass Point.

Wilkes Graham - Compass Point Research & Trading, LLC, Research Division

So just 2 questions from me. One, when you gave us the $600 million of guidance, and particularly, when you gave us the $200 million of guidance on portfolios at, I believe, it was a 7.5 cap rate, did you have the Cardinal portfolio in mind? And does that leave you some room to perhaps beat that weighted average cap rate number on the guidance or were you -- did you have it in mind and maybe...

Benjamin P. Harris

We don't include Cardinal. Cardinal is -- we consider Cardinal a one-off -- in the one-off basket.

Gordon F. DuGan

Because they are 4 separate deals. We just had -- yes, it's offset in the one-off category. Yes, it's offset in the one-off category, and then we're still portfolio hunting.

Wilkes Graham - Compass Point Research & Trading, LLC, Research Division

Got it. Got it. Okay. And then the Bank of America loan is coming due in December. I know it's extendable, but do you have any sort of new thoughts about or updated thoughts about refinancing that?

Gordon F. DuGan

Yes, our expectation is we'll term that out at some point this year. So we'll want to get that floating rate obligation fully termed out. And just so in terms of the risk of that. It's -- currently, the debt yield is roughly a 14% debt yield. So by typical lending metrics, which would -- lenders are looking for 9 to 10 debt yields, depending on the assets, maybe a little bit lower, it's a very high coverage, low leverage portfolio.

Wilkes Graham - Compass Point Research & Trading, LLC, Research Division

Okay. And with that refinancing, is there an opportunity to perhaps buy the rest of the portfolio, or is that something you'd be interested in?

Gordon F. DuGan

We're always interested in opportunities so...

Operator

Our next question comes from Anthony Proglisi [ph], private investor.

Unknown Attendee

Gordon, I have a question on Southern California, on your held-for-sale. Is there any update on that?

Gordon F. DuGan

Well, in our held-for-sale portfolio -- so there are 2 -- in the Bank of America joint venture, we have a series of properties in California. And those properties are in our core portfolio. At this point, we have no more held-for-sale assets, and all of the California assets we have are in our core long-term hold portfolio.

Operator

Our next question comes from Zev from Pine Cobble Capital.

Zev Nijensohn

It's Zev Nijensohn. So we've talked about this before, and we happen to be in the camp that the convert that you just did is a very good deal and we applaud it. Frankly, we're puzzled by the lack of response that the market gave your shares, and we also -- we like the concept of using equity-linked product as a piece of your acquisition currency, so to speak. But that being said, you've rebooted this company. You've kind of beaten all expectations on all accounts. Arguably, you're still flying under the radar screen. And my question really revolves around when is the right timing and where does the demand sit for a more "institutional roadshow" and bigger type equity offering. Obviously, there's some inherent value that could be created by giving more exposure to Gramercy.

Gordon F. DuGan

Yes, it's a very good point. I would say that the journey with Gramercy has included getting us back to being a normal way potential issuer. So we've gone through that hurdle. And as we seek to grow the business, we are very much focused on high-quality institutional investors. A couple of small points in the net lease sector, we have a quarterly dividend and we have a low payout ratio. So we're very focused on getting in front of and exposure to high-quality names, as we go forward, to build this business. We think the support of the right institutional investor base to grow the business is absolutely necessary. So we've had -- that's very much a part of the plan. So -- and we'll do so as necessary and needed as we go forward. But just in terms of thinking about what -- how we should be thinking about the growth and the support of investors, I think, we think very much alike on that.

Zev Nijensohn

And is there a threshold asset level or market cap level or something where the game theory, the probability there, just speaks really highly to going and doing something more broad?

Gordon F. DuGan

The way we always think about capital is what's our use of capital and use of proceeds. And so we like that we're seeing a lot of deal flow and as and when needed, they're -- it's a sort of as and when needed kind of opportunity.

Zev Nijensohn

Okay. And then I guess along the same lines but a little different question, but we've spoken in the past about the private REIT sector and the willingness of some private REIT owners to find liquidity. Are those deals still out there? You talked a lot on the call already about the one-off deals in the $5 million to $30 million range. But what about the truly transformative or at least the deals that could create a step function in growth, is that still out there?

Gordon F. DuGan

Yes, I like the term step function. I think the transformative deals that we've seen executed, we've been a witness to all of them, either very up close or not, go at very low cap rates, low 6 cash or below or -- and 6.5 GAAP kind of cap rates. And they just don't price -- we see so much more value in being able to buy at higher yields and grow that way. So the very, very large "transformative" stuff to date is not priced at levels that we find attractive. That having been said, there are so many of these privately held portfolios where there could be an opportunity for, as you describe, a step function in growth that may or may not be considered transformative. But there are many, many, many private portfolios. One of the interesting things that Green Street pointed out in their initiation on net lease is that of all the sectors they cover, the leased [ph] owned in public security form is net lease. Their estimate was 3% to 5% of net lease assets are in public company hands. And on the far side of that, obviously, regional malls, where 80% are in public company hands. So as you think about Page 28, I think it was, in our presentation, that's really where we see the future to be able to -- our goal is to grow into that blue-chip industrial and office REIT. And there's so much in private hands that there's going to be plenty of opportunity, we hope.

Benjamin P. Harris

I think one thing to add to that. We're -- as an investor, we're somewhat size-agnostic. But our reaction to the current marketplace and the opportunity set has driven us to focus on smaller transactions because, in our view, that's the best relative value or relative risk return. And so that's where we are focusing our time. It doesn't mean that we -- if some -- if a great portfolio came along and you could acquire that at a value that was attractive, that we wouldn't take advantage of it. I would just say that in the current capital market, there's no real shortage of capital or shortage of buyers. So Gordon alluded to it earlier. The bigger the transaction, the more buyers and the more competition and the tighter pricing. That's not always the case. There are moments in time where that relationship is completely inverted and having -- being able to take down large portfolios leads to very high returns. I think from a strategic standpoint, we're really trying to maintain as much financial flexibility as we can to position the company in a way where we can take advantage of the greatest opportunities that we see. So the convert for us was a big step in that direction. We appreciate that you noticed it, but it was $115 million of unsecured debt capital at less than 4% coupon with a conversion feature that was 20% out of the money at pricing, which we think -- it allowed for a lot of benefits, not just in terms of interest cost but in terms of financial flexibility as we build this company up. So that's a big part of -- every opportunity we look at, we're trying to evaluate each and every component of value. In the current market, we think the best value is in aggregating small, individual transactions and building a portfolio that way but that's very sort of...

Gordon F. DuGan

And/or -- yes, and then linked to that, situations where if we can use our currency to buy something, we're going to have a very different process in order and opportunity to buy things because the sellers will be very keenly differentiated -- the buyers will be very keenly differentiated.

Zev Nijensohn

Yes, I think that always make sense. What I was alluding to more was just the 3.5% that you talk about. That's a fascinating number. Because to the extent that more of this is going to be owned publicly and institutionally, call it, it's just a question as to how much education has to be done in order to drive that demand or if that demand already exists, what's the form that you need to take in order for them to really bite?

Gordon F. DuGan

Exactly. That's what makes -- that's one of the really exciting things about this business that gets us up early in the morning. That potential is absolutely 100% there.

Benjamin P. Harris

Some people think it's silly that we make the differentiation between sort of retail net lease and office and industrial net lease. But I think that's a reflection, a, of how big the potential market we see is; and b, a fundamental underwriting and fundamental investment strategy difference between the 2 types of assets.

Zev Nijensohn

When you add to that the growth profile that you'll have relative to just the general REIT space and then your more direct comps, there's going to be -- there will be a lot of points of differentiation.

Gordon F. DuGan

Yes, agree.

Operator

We have no further questions at this time.

Gordon F. DuGan

Thank you, all, for joining us. As usual, the Gramercy calls are long. I apologize for that. But we cover a lot, and we want to make sure we're as interactive with our investors as possible. Thanks very much.

Operator

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Gramercy Property Trust's (GPT) CEO Gordon DuGan on Q1 2014 Results - Earnings Call Transcript
This Transcript
All Transcripts