Equity Commonwealth (NYSE:EQC) Q3 2015 Earnings Conference Call November 5, 2015 10:00 AM ET
Executives
Sarah Byrnes - VP, IR
David Helfand - President and CEO
Adam Markman - EVP, CFO and Treasurer
David Weinberg - EVP and COO
Analysts
Manny Cordesman - Citigroup
Peter Lunenburg - JMP Securities
John Bejjani - Green Street Advisors
John Guinee - Stifel Nicolaus
Operator
Greetings and welcome to the Equity Commonwealth Third Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the presentation. [Operator Instructions] As a reminder, this conference is being recorded.
I would now like to turn the conference over to your host, Ms. Sarah Byrnes, Vice President of Investor Relations. Please go ahead.
Sarah Byrnes
Thank you, Diego. Good morning and thank you for joining us to discuss Equity Commonwealth's results for the quarter ended September 30, 2015. Our speakers today are David Helfand, our CEO; Adam Markman, our CFO, and David Weinberg, our COO.
Please be advised that certain matters discussed during the conference call may constitute forward-looking statements within the meaning of federal securities laws. We refer you to these documents that we file from time-to-time with the SEC, which refer to risk factors that could adversely affect the Company's operating results and financial condition. The Company assumes no obligation to update or supplement any statements that become untrue day today that become untrue because of subsequent events or otherwise.
Today's remarks also include certain non-GAAP financial measures. Please refer to yesterday's press release announcing our third quarter 2015 results for a reconciliation of these non-GAAP performance measures to our GAAP financial results, which is available on our Web site.
With that, I will turn the call over to David Helfand.
David Helfand
Thanks, Sarah and thank you for joining us this morning. I will begin with an update on our progress since taking ownership of the portfolio and beginning to executing on our business plan. Adam will discuss our financial results for the quarter, David Weinberg will provide a summary of operations and leasing efforts, and then we will open it for Q&A.
Nationally, office fundamentals continue to show slow steady growth. Year-to-date occupancy has increased 30 basis points as a result of positive absorption of 110 basis points, offset by 80 basis points of new apply. In our markets conditions vary, but fundamentals are generally continuing to improve, demand in Austin, Denver, Chicago and Philadelphia continues to show strength. In most other markets in which we operate, the lack of new supply as a result of a slow steady occupancy improvement.
As of September 30th, our same property portfolio of 67 assets totaling 25.3 million square feet was 91.9% leased, a 20 basis point increase from last quarter and 130 basis points better than this time last year. We completed 1.4 million square feet of leasing transactions in the quarter, including 429,000 square feet of new deals, and 955,000 square feet of renewals. Looking ahead we have 765,000 square feet expiring, the balance of 2015 and expect roughly have to renew and have to vacate. Based on recent leasing trends and the strength of our pipeline, we expect all leased occupancy at year-end at roughly today's level.
Operationally our focus has been on leasing and managing the portfolio with the entrepreneurial mind set. We have enhanced broker and tenant engagement and emphasized responsiveness and execution in ordering to increase leasing velocity and drive internal growth. We are beginning to see the results of these efforts as evidenced by our leasing volumes. In addition to blocking and tackling, we have identified opportunities to reposition assets and reconfigure space to better address tenant demand, enhance our customers’ experience.
With respect to our disposition program our thesis is unchanged. We focused on executing on the sale of assets in a robust investment sale environment. Market volatility in the past few months has resulted in widening of debt spreads and we will continue to monitor activity levels and asset pricing in the investment sale market as we gear up to market additional assets in the new year.
During the third quarter we completed a sale of 5.5 million square feet comprised of 14 properties and 34 buildings with a leased rate of 70.9%. Gross proceeds from these sales were $637 million and they sold at a weighted average cap rate in the upper 5% range. The buyers in these transactions were local investors and private real estate companies. Subsequent to quarter-end we closed on a sale of seven additional office properties totaling 1.3 million square feet with a 79.7% leased rate for a gross sales price of $131.2 million. These dispositions represent all the properties classified as held for sale at the end of the third quarter.
Let me take a minute to provide some detail on the four deals we closed in October. We sold a four property 643,000 square foot, 81% leased portfolio in Atlanta, Macon and Marietta Georgia for $48.6 million at a cap rate in the mid 8% range. We sold One Park Square a six building 91% leased, 260,000 square foot property in Albuquerque for $34.3 million at a cap rate in the low 7% range. We sold One South Church a 241,000 square foot 69% leased property in Tucson for $32 million at a cap rate in the upper 4% range. And lastly we sold 775 Ridge Lake Boulevard, a 78% leased 121,000 square foot building in Memphis for $16.3 million at a cap rate in the mid 7% range.
Over the last 10 months we sold over half of our assets, a total of 89 properties 17.6 million square feet generating gross proceeds of $1.9 billion. These properties were sold at a weighted average cap rate in the low to mid 7% range. We have exited 64 cities, 5 states and even one continent. With these sales we believe we have significantly improved our portfolio and the quality of earnings it generates.
The pace of sales to-date has exceeded our original expectations and is largely due to the tailwind of very liquid equity and debt markets and strong execution by the EQC team. We expect velocity to slow towards the end of this year. We currently have four properties and one industrial asset totaling 2 million square feet that are 90.8% leased in various stages of market. At the same time, we are preparing the next group of properties for the sale process early next year.
We have generated significant proceeds from the disposition program and today have a current cash balance of $1.8 billion. We are positioned for growth when and if we identify investment opportunities that offer a compelling risk reward profile. We continue to actively look for and evaluate investment opportunities while remaining patient. We recognized that we may not find attractive acquisition opportunities without a significant change in current market pricing. In the interim, we will remain focused on executing our plan to create value, through active ownership of our portfolio, leasing of vacant space and preparing assets for disposition.
With that, I will turn the call over to Adam.
Adam Markman
Thanks David. Excuse me, good morning. I will cover our financial results for the quarter and provide a commentary on the balance sheet, the share buyback program and our perspective regarding capital allocation.
Same property cash NOI was down by 1% from a year ago. The decrease in same property cash NOI was largely a result of the non-recurring charge we took against revenues related to our parking tax matter. Without this charge, same property NOI would have increased by 1.2%. Same property GAAP NOI was down 1.2% from a year ago, or would have grown by 2.3% without the previously mentioned one-time charge, as well as a non-cash charge for space we recently took back from a ground floor retail tenant. Same property GAAP NOI in the quarter benefited from lower property management fees, offset by the impact of higher real estate taxes at our properties in Austin, Chicago and Denver.
FFO for the quarter was $0.19 per share compared to $1.59 per share a year ago. This decrease in FFO was primarily due to the $1.32 per share gain we recognized from the sale of our entire equity stake and select income REITs during the third quarter 2014. Normalized FFO was $0.36 per share compared to $0.44 per share last year. The decrease in normalized FFO primarily stems from property sales in 2015 that generated $0.22 per share of the decline. Partially offsetting this decline was $0.08 per share of lower interest expense and $0.07 per share of savings in recurring G&A. As we indentified since taking over, our disposition efforts are highly disruptive to earnings, but consistent with our strategic plan to rationalize the portfolio and maximize the Company’s net asset value.
Total G&A for the quarter was 16.2 million which was $31 million lower than what was spent in the third quarter of 2014. The savings was primarily due to the incentive management fee paid to RMR, the Company’s formal external advisor and the lower shareholder litigation incentives and expenses. We do not anticipate further legacy shareholder litigation related expenses as these matters have now been settled. G&A without the impact of items related to the transition total $32.4 million year-to-date, which is for lower budgeted amounts largely due to a continuation of a pattern we identified last quarter where our actually cost are coming in lower across the board. We currently believe 2015 will total in the mid $40 million range.
As David mentioned during the call that Company completed the sale of $637 million of assets. As the result of these sales we recognized the 39.8 million booked gain on sale. More importantly, the dispositions year-to-date have resulted in taxable loss and we expect this taxable loss for the full year 2015.
Turning to the balance sheet, in connection with the previously announced sale of Illinois Center, we prepaid our $141 million mortgage during the quarter. In addition, we repurchased $87.8 million of our own stock at a weighted average share price of $25.76 per share.
As discussed on prior calls, we are nearly $1 billion in debt in preferred stock that we can repay or prepay at par through 2016. With approximately $1.8 billion or over $14 per share in cash on the balance sheet and additional assets in the market to be sold, we are evaluating all usage of proceeds including debt repayments, share buybacks, distributions and new investment opportunities. To-date the acquisition opportunities we have evaluated have been priced at historically low yield and values per share are -- excuse me per square foot that are at or above replacement cost. Given this environment, we will be cautious in our pursuit of new investment opportunities.
In the meantime, our balance sheet and access to capital are both healthy and we believe we are well positioned for the future.
With that I’ll turn call over to David.
David Weinberg
Thank you, Adam and good morning everyone. I will now walk you through the latest on operations and update you on our top markets. Over the last four quarters, in addition to highlighting our disposition goal, we have emphasized our focus on taking responsibility for our properties and being active and engaged owner. This focus starts with leasing, including understanding our inventory, embracing the brokerage community and building relationships with our tenants. David, Adam and I, along with the rest of the EQC team have been meeting with brokers and attending broker events. We have also met with tenants and prospects in our offices and theirs. We believe we are now beginning to see these efforts payoff.
Looking at the same property portfolio during the third quarter, we signed 84 leases totaling 1.4 million square feet, the highest volume of leasing since we took over last year. As David mentioned, office fundamentals in all market are generally continuing to improve. I would like to cover a few of our markets, starting with Bellevue. Bellevue CBD is 8 million square feet and has a vacancy rate of 11.4 %. Year-to-date, the market has had 190,000 square feet of negative absorption with the primary contributor being Microsoft vacating 170,000 square feet. Our two properties in Bellevue total 660,000 square and are 99% leased. This past quarter we signed three leases totaling 30,000 square feet with cash allowance rolling at 3.5%. As we have said before, we like this market long-term but with 1.5 million square feet under development, it is based on supplier works in the next few years.
In the Denver area, we are on four properties totaling 1.6 million square feet to the 97.6% leased. Our largest asset in Denver is 1225 17th Street also known as 17th Street Plaza, a 672,000 square foot 98% leased Class A office tower. Denver CBD is 26 million square feet and has a vacancy rate of 13.3%. Some new supply has been delivered in Denver CBD this year, and there is some subleased space on the market related to the slowdown in the energy factor, but overall the market is doing well. We like to fundamentals of Denver and 17th Street Plaza is considered one of the best buildings in the market.
Chicago CBD is 128 million square feet and has a vacancy rate of 12.8%. This market continues to hike with year-to-date positive net absorption of 500,000 square feet. The trend in Chicago has been the movement of tenants from the suburbs into the city, including Kraft Heinz, Motorola Solutions, Baxalta and Kraft Heinz. All suburban tenants have signed third quarter leases in the CBD.
In recent years we have also seen several suburban tenants over the satellite offices downtown. Year-to-date suburban companies have leased over 800,000 square feet in the CBD, 11% of Chicago’s 2015 leasing activity. The largest lease we signed this quarter was a 375,000 square feet early renewal at 600 West Chicago, which includes a 60,000 square foot expansion. We also executed four other leases totaling 128,000 square feet here during the quarter. This unique 1.5 million square foot property is located in Chicago's tightest submarket River North.
It was originally the Montgomery Ward's warehouse building. It is located on the Chicago River, offering exposed brick, large windows, high ceilings and large open floor place that cater to today's new economy companies. In connection with the leases we signed at 600 West Chicago, we have developed a business plan that will ensure and enhance its competitive position. This plan includes adding more elevators, upgrading amenities, including building a 5,500 square foot rooftop deck and taking a fresh look at the onsite retail offerings. This property is 99.7% leased and as we stated previously, we will be getting back 117,000 square feet from Level 3 during the fourth quarter
In Austin our 10 properties totaling 2.5 million square feet are 95.6% leased. This market continues to be one of our top performers. This quarter we have done 21 leases totaling 180,000 square feet with cash rents rolling at 19%. The Austin market is 45 million square feet at a vacancy rate of 10.9% we had year-to-date positive net absorption of 1.6 million square feet. However, there is a significant amount of supply coming online which will likely impact the market.
Indianapolis’ CBD is 12 million square feet. The market is trending in the right direction with year-to-date positive net absorption of 180,000 square feet although it still has a vacancy rate of almost 19%. We own two of the best office towers in the market which total 1.7 million square feet and have a leased occupancy rate of 87.2%. This quarter we signed three leases totaling 35,000 square feet including 20,000 square feet of new leases.
Our largest market is Philadelphia, where we own four properties totaling 4 million square feet that are 86% leased. This 43 million square feet CBD market continues to strengthen almost 500,000 square feet of year-to-date positive net absorption and a vacancy rate of 10.6%. While it is still a competitive market, supply is in check, price has been growing and the CBD is down to see more demand and activity from out of market tenants. The city is also benefiting from residential development which brings with it more restaurants, a better retail mix and a growing downtown population.
In terms of leasing we have been very active in filling, especially at 1500 Market also known as Centre Square. This is a two tower property totaling 1.8 million square feet that is located across the street from City Hall where the new Zoe's Park. Our largest new deal this quarter was a 67,000 square foot lease at Centre Square. This space has been vacant for nearly 10 year. Subsequent to quarter-end we also executed another new lease at Centre Square for 151,000 square feet, a space that have been vacant for seven years. At year end 2014 the property was 79.5% leased. We have two more leases in our pipeline totaling 69,000 square feet and if signed this property’s leased occupancy would be in the low 90s.
Our largest property in Philadelphia is the 1.3 million square foot Trophy tower 1735 Market. The property is 88% leased. As we have discussed on previous calls, through May of 2016 we will get another 350,000 square feet backed. To-date we have been pleased with demand of this building. Year-to-date we have signed 171,000 square feet of leases including 68,000 square feet of new leases and we have another 85,000 square feet of new leases in negotiations. We have an active pipeline with most tenant prospects ranging from 25,000 to 50,000 square feet. It will take some time to backfill this space but the activities to-date has been encouraging.
In summary, Bellevue, Denver and Austin are strong markets where our assets are well occupied, but exposed to supply work. Chicago and Philadelphia where we have some vacancy are continuing to strengthen and we have had good leasing results to-date. And in Indianapolis we have nice property but the overall market has a high vacancy rates and deals are competitive.
With that, we will open it up to Q&A.
Question-and-Answer Session
Operator
Thank you. At this time we will conduct our question-and-answer session. [Operator Instructions] Our first question comes from Manny Cordesman with Citi. Please state your question.
Manny Cordesman
May be if we just think about your share buyback, you almost exhausted your first tranche you put another 100 million. How do you think about buyback and what levels are you comfortable buying back at?
Adam Markman
Yes, hi, it’s Adam. So we have talked I think on every one of these calls about our desire to be opportunistic and to be nimble. And I think that when the share price weakened we were able to show up what we mean by that. We were able to buy back a significant chunk of shares pretty quickly. Obviously the stock ran. In the future if there are opportunities that come up because of volatility we will again drop on them.
Manny Cordesman
And then I appreciate your comments on acquisitions and acquisition environment. May be you can just help us understand what your primary metrics or primary spending criteria are when you are thinking about acquisitions, maybe geographies, are they new, did they overlap your 50 portfolios, and then CBD is a suburban, are they large building, small building, just give us an idea of even the expensive deals that you haven't down, what has sort of inspired getting to look at those deals?
David Helfand
Manny, it’s David, I’ll take that. I think we have covered that in meetings with investors and discussed it on previous calls, we would -- as Adam said hope something opportunistic, there is probably a dozen markets that offer the type of fundamentals, type of growth that we would want to see long-term and will be active in those markets if the opportunity were there. Some of those overlap are existing markets, we have talked about that before Bellevue lost in Denver, Chicago but there is others that we would invest capital if values are rising and when we think about value I think on a per count basis as well as on yield basis.
Operator
Thank you. Our next question comes from Mitch Germain with JMP Securities. Please state your question.
Peter Lunenburg
Hi guys this Peter on for Mitch. Just kind of curious, given that you guys don’t think there would be anymore litigation charges is what we saw this quarter kind of a best gauge of G&A heading into 2016?
David Helfand
I think that the recurring G&A that we see this quarter and the mid-40s kind of number that we talked about in our prepared remarks are the best thing for you to say utilize if you are gauging G&A. It of course have one last chance core back related potential charges that will hit the non-recurring SG&A file, no news there that is just the same situation that the shareholder voted on when we laid the core back to control of the litigation fees.
Operator
Thank you. Our next question comes from John Bejjani with Green Street Advisor. Please state your question.
John Bejjani
The market has rightly rewarded you for selling assets and closed the gap between your share price and NAV, if the gap were to close further such that you are trading at NAV plus or minus, what does the capital allocation game plan look like at that point moving forward?
David Helfand
We acknowledge your question and we think about it similar ways but it would really depend on what the environment was when the start approached our view of value.
John Bejjani
Okay I guess how long are you willing to sit on your cash balance and wait for opportunity to arise?
David Helfand
I guess the start of my answer that is we are really midstream in our disposition program. We still have plenty of hard work on that front to do, it's going to take time. We are going to work our way through it methodically and carefully when we get to the end we are going to look around and see what that environment looks like, I think it's -- David has said a number of times it's going to be not as long as we’d like and longer than you’d like, it's probably where we will comprise on this -- on the outcome of that.
John Bejjani
Sure, sure I guess, how larger workshops do you think it makes sense to maintain and what are your thoughts especially since you have more dispositions moving forward, what are your thoughts towards a special dividend of some of the proceeds moving forward?
David Helfand
We will as we have been on an ongoing basis, we will discuss distribution with our Board of Directors and when we get to a conclusion there we will obviously be telling the market.
Operator
Thank you. Our next question comes from John Guinee with Stifel. Please state your question.
John Guinee
John Guinee, thank you. It appears to me that by the way wonderful job year-to-date, Adam you said your mid-stream and your disposition program, does that imply that you are 1.9 billion sold and 1.9 billion more to sell?
Adam Markman
No, you took it too literally, really the point is that we have got planning of work still that needs to be done to sell the $3 billion of assets that Sam identified the last time he was on our call as assets that just don’t make sense in a publically traded real estate company.
John Guinee
Got you, okay. And then my recollection is that the Board was selected largely by shareholders in this case which gives us as shareholders a descent chance that maybe the Board will act as a fiduciary to shareholders, if you act the shareholders a lot of whom are the event driven guys, what they wanted to do was a tremendous amount of cash proceed, what would they tell you?
David Helfand
Good morning John, I can assure you with 100% certainty that our Board will act if we do so you can rest easy on that one, your question was what would some of our investors’ license to do with the capital?
John Guinee
Exactly, the big guys. It was very good.
David Helfand
I think we have had reached the quarter from shareholders we have an ongoing dialogue, we try to be transparent and we continue to say the same thing which is we think it’s an environment to sell particularly the assets we have in this portfolio. We are hopeful that we will have an opportunity to redeploy the capital because we have built a spectacular team here and we think that given the right situation we could add a lot value. We are also sober about the fact that it’s a difficult time to invest capital and if it turns out we can’t find that opportunity we have clear in saying we will return the capital to shareholders.
John Guinee
Okay. And then if I look at your sort of outline of a disposition plan another 1 billion and change. That probably gets you down to a 10 million to 15 million square foot portfolio, maybe half the assets that’s kind of a $20 million G&A business if I look at the comp. Is that a fair way to look at the run rate once you get yourselves down, I guess through the next $1 billion of asset sales?
David Helfand
I think John we’ve had this discussion before. We have different views of reasonable G&A which we will agree to disagree but yes there are numerous assets we continue to focus on the sale of particularly the non-office assets looking forward to next year and then we will address the question of G&A. But we are and continue to feel that maintaining the team and ensuring the capability to expand the platform is an important part of the optionality embedded in the Company.
John Guinee
Okay. And then my last question is vineyards you wrote that, it looks like your net book value is about 29.3 million. Did you take an impairment charge on that? Is that a good assessment of value right now?
David Helfand
We haven’t taken an impairment charge on the vineyard but I couldn’t tell you that book value is a good assessment of current value.
Operator
Thank you. There are no further questions at this time. I will turn the floor back to David Helfand for closing remarks. Thank you.
David Helfand
Well thank you again for joining us. We have made substantial progress since our first call with you about this time last year. We have taken active ownership of the portfolio as evidenced by our leasing performance to-date and our team has been focused and efficient in executing our business plan. We have built a platform that can service a foundation for value creation within our existing portfolio and for future growth. We appreciate your support and thank you for taking time to join us today.
Operator
This concludes today’s call. All participants may disconnect. Have a good day. Thank you.
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