CommonWealth REIT's CEO Discusses Q4 2011 Results - Earnings Call Transcript

| About: Equity Commonwealth (EQC)

CommonWealth REIT (NYSE:CWH)

Q4 2011 Earnings Call

February 23, 2012 01:00 pm ET


Tim Bonang - VP, IR

Adam Portnoy - President & Managing Trustee

John Popeo - Treasurer & CFO


John Guinee - Stifel, Nicolaus & Company

Michael Bilerman - Citigroup


Good day and welcome to the CommonWealth REIT Fourth Quarter and Year-End 2011 Financial Results Conference Call. This conference 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. Please go ahead, sir.

Tim Bonang

Thank you and good afternoon. Joining on today’s call are Adam Portnoy, President and 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. I would also note that the recording and retransmission of today’s conference call is strictly prohibited without prior written consent of CommonWealth.

Before we begin today’s call, I would like to read our Safe Harbor statement. Today’s conference call contains forward-looking statements within meaning of the Private Securities Litigation Reform Act of 1995 and other securities laws. These forward-looking statements are based on CommonWealth’s present beliefs and expectations as of today, February 23, 2012.

The company undertakes no obligation to revise or publicly release the results of any revision to the forward-looking statements made in today’s conference call other than through filings with the Securities and Exchange Commission or SEC regarding this reporting period.

In addition, this call may contain non-GAAP numbers including funds from operations or FFO, normalized FFO and cash available for distribution or CAD. A reconciliation of FFO, normalized FFO and CAD to net income is 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 10-K which we expect to file in a few days with the SEC and in our Q4 supplemental operating and financial data package found on our website at

Investors are cautioned not to place undue reliance upon any forward-looking statements.

And now, I would like to turn the call over to Adam Portnoy.

Adam Portnoy

Thank you, Tim and good afternoon and thank you to everyone for joining us on today’s call. For the fourth quarter of 2011, we are reporting fully diluted normalized FFO of $0.76 per share compared to $0.88 per share during the same period last year.

Fourth quarter 2011 normalized FFO includes approximately $4 million or about $0.04 per share of non-recurring items which John Popeo will discuss in more detail in a few minutes. Excluding these non-recurring items, normalized FFO for the fourth quarter would have been about $0.80 per share. Remaining decline in normalized FFO per share primarily relates to weakness in our suburban office portfolio.

Although, our normalized FFO was less than anticipated, we are starting to see some positive signs in our operating metrics and especially in our CBD office and industrial portfolios.

As of December 31st, our consolidated occupancy rate was 84.6% which is about a 0.5 percentage point higher than our occupancy rate on September 30th, which was 84.1%. It’s important to note that historical occupancy rates have been adjusted to include 27 properties which were previously included in discontinued operations.

Also during the quarter, we saw an uptick in leasing activity signing leasing for over 2.2 million square feet; 43% of our fourth quarter leasing activity were renewals and 57% were new leases. Leasing activity this quarter resulted in flat rents and $19.15 per square foot in capital commitments. The average lease term was 6.9 years and the average capital commitment per lease year was $2.78.

Our CBD office portfolio which represents our largest operating segment with about 45% of our consolidated NOI continues to perform well. Occupancy in our CBD office portfolio increased 20 basis points from 87.8% to 88% during the quarter and continues to track above the national average occupancy for CBD office buildings as measured by most independent third-parties.

During the fourth quarter, we signed leases for almost 500,000 square feet on our CBD office portfolio and about half were renewals and half were new deals.

Leasing activity in our CBD office portfolio resulted in an 8% rollup in rents and about $25 per square foot in capital commitments.

Our industrial and other properties portfolio also continued to perform well, with strong performance from properties in Oahu, Hawaii and Australia. Occupancy in our industrial properties increased 40 basis points from 86.6% to 87% during the quarter. In the fourth quarter, we signed leases for 740,000 square feet in our industrial portfolio and about one-third was renewals and two-thirds were new deals.

Leasing activity in the industrial portfolio resulted in an 8% rollup in rents and a very low $1 per square foot in capital commitments. Of note during the quarter, we signed a large industrial lease renewal and expansion in Australia for 300,000 square feet and about flat rents and we signed one new lease deal in Hawaii industrial land holdings for 35,000 square feet that resulted in 66% rollup in rents.

Our suburban office portfolio continues to struggle, although leasing velocity has clearly started to improve. Occupancy in our suburban office portfolio increased 80 basis points from 77.5% to 78.3% during the quarter.

In the fourth quarter, we signed leases for over $1 million square feet in our suburban office portfolio and about half were renewals and half were new deals. Leasing activity in our suburban office portfolio resulted in a 5% roll-down in rents and about $29 per square foot in capital commitments.

Unfortunately, current quarter same store occupancy and NOI declined by about 2.1 percentage points and 10.9% respectively compared to the prior year. Our CBD office portfolio had a 10 basis point improvement in same store occupancy during the quarter and excluding non-recurring items, CBD same store NOI growth would have been positive 1% versus the reported negative 1.6%.

Philadelphia was our strongest market during the fourth quarter with a 30 basis point increase in same store occupancy and a 1.7% increase in same store NOI. Philadelphia also happens to be the market area with the highest percentage of CBD office properties among all of our reported major market areas. The decline in same store NOI across the rest of the portfolio largely reflects same store occupancy declines in our suburban office and industrial portfolios.

In January 2012, we declared a dividend of $0.50 per share which represents 66% of our fourth quarter normalized FFO. During the quarter, we spent $35 million on tenant improvements and leasing costs and $500,000 or $0.01 per square foot for recurring building improvements. We generated approximately $25 million of cash available for distribution or CAD during the fourth quarter, resulting in a rolling fourth quarter CAD payout ratio of about 100% for the full year.

The increase in CapEx during the fourth quarter is similar to the increase in CapEx we have experienced in prior years during the fourth quarter and principally reflects the timing of certain leasing costs and capital projects that were budgeted to take place earlier in the year that ended up being completed in the fourth quarter.

Looking forward to 2012, we have 6.3 million square feet scheduled to expire. Close to half of this square feet is primarily located in CBD office buildings and industrial properties located in Oahu, Hawaii which we feel confident can be renewed or leased to new tenants at the same or higher rental rates.

The remaining half of this square feet is largely located in the suburban office buildings which we think can be renewed or leased to new tenants, but the cost to do so may be high based in the current market environment.

As most of you know, for the last few years we’ve been aggressively trying to reposition CommonWealth’s portfolio into high value CBD office properties with the focus on top performing CBD assets in secondary markets and second tier CBD assets in gateway cities markets.

Since the beginning of 2008, CommonWealth has acquired $3.3 billion worth of properties and the majority of these acquisitions have been CBD office buildings.

We have partially funded these acquisitions through the sale of $1.4 billion of largely suburban office properties. The remainder of these acquisitions have been funded through a combination of both debt and equity financings.

We believe this repositioning into CBD office properties has helped CommonWealth’s financial results during the last year and we think it positions the company well for the future.

However, during the fourth quarter our pace of acquisitions has slowed considerably. Since reporting third quarter 2011 results on November 2nd, we have entered one new agreement to acquire a downtown office building in Austin, Texas with approximately 172,000 square feet for $49 million including the assumption of approximately $29 million of mortgage debt. This property is 99% leased to nine tenants for a weighted average lease term of 4.3 years.

Also since November 2nd, we have closed on the previously reported acquisition of a downtown office property located in Chicago, Illinois with 1 million square feet for purchase price of $150.6 million including the assumption of $148 million of mortgage debt.

This property is 94% leased to 60 tenants for a weighted average lease term of 5.5 years. The going-in cap rate was 8.7% and the purchase price was well below replacement cost at $150 per square foot.

Also, we continue to pursue the previously reported agreement to acquire CBD office property located in Hartford, Connecticut with approximately 885,000 square feet for $99 million. This property is 98% leased to 20 tenants for a weighted average lease term of 7.5 years. Of course these pending acquisitions are subject to customary closing conditions and no assurance can be given that they will occur.

The company continues to actively market for sales several suburban office and industrial properties. However, during the quarter, we terminated a previously reported agreement to sell 16 industrial properties located in Dearborn, Michigan with approximately 570,000 square feet for $6.5 million. Also during the quarter, we reclassified 27 properties with close to $3 million square feet to continuing operations from discontinued operations, because we are no longer confident that these properties will be sold within a reasonable time and acceptable [prices].

Before I turn the call over to John Popeo, I want to mention our recently announced formation of our wholly owned subsidiary, Select Income REIT or SIR. In December 2011, SIR filed a registration statement with the Securities and Exchange Commission for initial public offering of common shares. SIR owns substantially all of CommonWealth’s commercial and industrial properties located in Oahu, Hawaii as well as 23 suburban office and industrial properties located throughout the US.

If the SIR registration statement becomes effective and the IPO is completed, SIR would primarily own and invest in net leased single tenant properties. And CommonWealth will continue its efforts to reposition its portfolio at the high value CBD office properties.

CommonWealth plans the use the IPO proceeds to repay debt and is expected that CommonWealth will continue to own a substantial majority of SIR’s outstanding common shares upon completion of the IPO. Of course, there can be no assurance that the SIR IPO will be completed.

Finally, I want to point out that as of today, we have $172 million outstanding on our $750 million revolving credit facility which is largely the result of redeeming about $156 million of senior notes and a mortgage since year end that was scheduled to mature in 2012.

This liquidity provides us with more than adequate financial flexibility to fund the $119 million of cash required to close on pending acquisitions as well as fund any other capital requirements in the future.

I will now turn the call over to John Popeo, our CFO.

John Popeo

Thank you, Adam. Net income available for common shareholders for the fourth quarter of 2011 was $1.1 million compared to $6.7 million for the fourth quarter of 2010.

Rental income increased by 20.4% reflecting rental income from properties acquired since October 2010 offset by the decline in same store rents and properties sold during the same period.

Total expenses decreased by 38.7% primarily reflecting accelerated depreciation for properties taken out of service, Australian acquisition cost and asset impairment charges during the prior year.

Current quarter EBITDA increased by 7.3%. Interest expense increased by 8.8% reflecting property acquisitions.

Our percentage share of GOV’s net income and normalized FFO for the fourth quarter totaled $3 million and $5.5 million respectively. We received over $4 million in GOV dividends during the fourth quarter of 2011.

In December 2010 we began marketing 28 suburban office and industrial properties for sale and we began classifying operating results for these properties in discontinued operations. We sold one of these properties in February 2011.

Based on declining prospects for sales of the remaining properties at reasonable prices, we reclassified all 27 properties previously reported in discontinued operations to continuing operations during the fourth quarter of 2011.

Income from discontinued operations in the prior year reflects operating results from 43 properties sold in 2010 and 2011. We recognized gains of $133 million on the sale of 22 properties during the prior year. We also recognized acquisition gains in the prior year totaling $20.4 million, representing the difference between our purchase price for properties acquired in Australia and their fair market values.

The increase in preferred distributions reflects distributions on $11 million of our 7.25% Series E preferred shares issued in June 2011 offset by the redemption of $7 million of our 8.75% Series B preferred shares in October 2010.

Normalized diluted FFO available for common shareholders was $0.76 per share for the fourth quarter of 2011 compared to $0.88 per share for the fourth quarter of 2010. Year-over-year per share results primarily reflect the decline in occupancy in same store NOI at our suburban office portfolio and the issuance of new common shares in 2011.

FFO for the fourth quarter declined by $6 million or $0.08 per share compared to the third quarter of 2011 reflecting $167 million of suburban property sales on September 30, 2011 and non-recurring charges during the fourth quarter including approximately $2 million of demolition cost at one of our Atlanta Office Parks and approximately $2 million of retroactive rent adjustments related to restructured leases.

Turning to the balance sheet, on December 31, 2011 we held $193 million of unrestricted cash reflecting $100 million borrowed on our revolving credit facility on December 31st.

Proceeds plus cash-on-hand were used to redeem $150.7 million of our 6.95% senior notes on January 3, 2012 and $4 million of mortgage debt in February.

Rents receivable includes approximately $191 million of accumulated straight line rent accruals as of December 31st. Other assets include approximately $130 million of capitalized leasing and financing costs.

On December 31st, we had $657 million of floating rate debt, $620 million of mortgage debt and $2.3 billion of fixed rate senior unsecured notes outstanding.

The weighted average contractual interest rate on all of our debt was around 5.4% at the end of the quarter and the weighted average maturity was around five years.

Our senior unsecured notes are rated Baa2 by Moody’s and BBB minus by Standard & Poor’s.

The un-depreciated book value of our unencumbered property pool totaled about $7.3 billion at the end of the quarter. Our secured debt represents 9% of total assets and our floating rate debt represents 18% of total debt. At the end of the fourth quarter, our ratio of debt-to-book capitalization was 50%.

Our EBITDA and fixed charge coverage ratios were 2.6 times and 2.0 times respectively. As of the end of the quarter, we were comfortably within the requirements of our public debt and revolver covenants.

As we discussed on last quarter’s call, in October 2011 we amended our existing $750 million credit facility to extend the maturity date to October 19, 2015 and reduce the interest rate to LIBOR plus 125 basis points. The amended facility provides us the option to extend the maturity date for one year to October 19, 2016. As of December 31st, we had $100 million outstanding on our credit facility.

In October, we also amended our existing term loan to increase borrowings from $400 million to $557 million. The amendment extends the term to December 15, 2016 and reduces the rate of interest on $500 million to LIBOR plus 150 basis points. The $157 million of new proceeds from the term loan amendment and proceeds from the sale of properties on September 30th, we used to reduce amounts that were outstanding at that time on our credit facility.

If the SIR IPO is completed, we expect to continue to own a majority of SIR’s common shares after the completion of the offering and because of our retained majority interest in SIR we expect SIR will remain one of our consolidated subsidiaries.

In summary, despite a very challenging market environment, we continue to make meaningful progress towards repositioning our portfolio to be more heavily weighted to high value CBD properties. Our strong balance sheet and $578 million of availability on our revolving credit facility position us to opportunistically grow cash flow as the economy improves.

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

Question-and-Answer Session


(Operator Instructions) Our first question today comes from the line of John Guinee [Stifel, Nicolaus & Company]. Please go ahead.

John Guinee - Stifel, Nicolaus & Company

I have a few just clarifications comments here. If I look at page 7 of the supplemental, Oahu fourth quarter annualized rental income of 7.7%, fourth quarter NOI 10.5%; what’s the reason for that big disparity?

It shows up a few times here. Fourth quarter down to 11% annualized, 7.7% of NOI and 4Q 2011 NOI about 10.5% and the answer isn’t easy, just I’ll get back to you on that?

John Popeo

No, I think it’s basically because of the nature of those properties. They are mainly triple-net. Even though there are some reimbursements, the NOI margins are somewhat higher in that portfolio than the others. So you have less relative revenue to the entire portfolio, but a higher percent of NOI.

Adam Portnoy

That’s correct. That’s right; they are almost all net leased properties.

John Guinee - Stifel, Nicolaus & Company

Page 25, historically, your building improvements versus your improvements that supposedly add value is about 45% maintenance CapEx and 55% value-add CapEx; in this quarter, it went from of the $18 million you spent, $539,000 is perceived as maintenance CapEx and $17.3 million is value-add. Any idea what happened there?

John Popeo

John, I can tell you that and I think we've made this clear in the past that there really is no trending this analysis or the amounts we spent for in the various categories and the CapEx schedule is always going to be lumpy. It’s basically timing; that's all that's reflected in the fourth quarter building improvement number of roughly $500,000.

John Guinee - Stifel, Nicolaus & Company

My question is why is it only $500,000 of building improvement and $17.3 million of value add capital?

John Popeo

Again, it all has to do with timing. When we compare when we came in for the full year, it's in line with what we budgeted. It's just in the various categories and in various quarters there is no way of really predicting it with any high degree of certainty. It did come in as we expected.

John Guinee - Stifel, Nicolaus & Company

Let me rephrase it; $17.3 million, can you describe what that was such that it added value versus just being maintenance CapEx?

Adam Portnoy

Well I would say John, look, I think what you're trying to imply is that we play with the numbers and let me explain to you pointblank, there is no playing with the numbers here. These numbers it’s just the timing issue. All that happened is the numbers -- the amount of capital we plan to spend for the entire year got spent. We spent more of it in the fourth quarter, just happens to be more of it was development and redevelopment.

Do you want to move on to your next question or should we just go to the next person?

John Guinee - Stifel, Nicolaus & Company

And do you think on page 26, what do you think is a good run rate; shall we think of this as $10 per square foot and $1.50 to $2 per square foot per lease year as it was for four or five quarters ago or do you think $19.15 and $2.78 per square foot per lease year is appropriate?

Adam Portnoy

John I think, probably what we have been experiencing the average for the last four quarters is probably a good number to use. Take the last four quarters and average it.

John Guinee - Stifel, Nicolaus & Company

And then on page 28, you have a variety of different lease expirations here for some fairly significant tenants and I am just looking at the 2012; one of the three US government leases; John Wiley & Sons, PNC, Wells Fargo, we already know GlaxoSmithKline is out in 2013, Royal Dutch Shell in '12, Jones Day, Ballard Spahr; can you kind of walkthrough who is going and who is staying on this page?

Adam Portnoy

The only tenant that’s at risk on this entire page is GlaxoSmithKline, which we do know is vacating in 2013. There is nobody else on this list that we have any concerns about.


And we do have a question from the line of Michael Bilerman [Citigroup]. Please go ahead.

Michael Bilerman - Citigroup

Adam I wanted to talk a little bit about sort of the strategy of sales versus spin-off of assets. And obviously, you pulled the asset sales in the quarter and you’re still embarking on the spin-off.

I guess why not if the assets that you’re targeting for the spin-off could be sold in the private market to third parties than arguably demand for net lease and Hawaii could be there relative to the suburban office assets. But why not try to get full value and sell those outright rather than listing their entity, holding onto the shares, waiting time and doing all these things; and can you just walk through how you sort of think about that?

Adam Portnoy

Sure. I think it’s important to note that it’s anticipated that CommonWealth will not own a substantial majority of SIR after offering. So I think the way we thought about it is that in terms of the spin-off we were hoping to achieve is what we hope will we achieve very similar with the government properties income trust spin-out a couple few years ago.

And again these are very good assets in Hawaii. We don’t want to sell them outright, but we think the current market is not valuing them appropriately in CommonWealth. And so we are considering spinning them out in IPO and again retaining a substantial majority of it.

Now with regards to the sale of suburban properties, just because we move properties from discontinued ops back into continuing ops, we made a point of saying that it’s still several of those properties are being marketed for sale. We just from an accounting standpoint, we couldn’t say definitively that they will absolutely be sold in the next year and that’s what we have to say.

And there is also some properties that we've talked about in the past. For example, properties in Australia that we are considering selling that were never in discontinued ops.

So, just because we moved them from discontinued ops to continuing ops doesn’t mean they won’t be sold and there are also other suburban properties that we are looking to sell that never even were mentioned or listed in discontinued ops by the company as well.

Michael Bilerman - Citigroup

I guess if we go a little bit on the spin-off, you said that these are assets that we want to hold on to and I guess we is that, are you talking from an RMR perspective or we from a CommonWealth perspective?

Adam Portnoy

CommonWealth; I am speaking from CommonWealth’s perspective.

Michael Bilerman - Citigroup

But I guess, if you have a strategy of turning into a CBD office company and you think about GOV, when you spun that off, you’re obviously a much lower shareholder today relative to when you had done that transaction and the stock is a couple of bucks higher than where it was IPO’d.

I guess, why not instead of doing something where it’s an entity that’s still within the RMR wheelhouse trying to maximize value on a more immediate basis and selling those assets outright, because ultimately they don’t fit what you want to be owning because you’ve said repeatedly that where you want to take this company is to be a CBD office company?

Adam Portnoy

That’s correct; that’s where we want to take the company, but it’s a very large business, close to $8 billion in assets and these properties in Hawaii contribute significantly to cash flow and NOI growth and occupancy.

And as John said, we’re going to -- they will be consolidated into our financial results and we are not selling – we’re not selling a majority of it. We’re only planning on selling a minority portion if we are successful and if we complete the IPO for SIR.

So again, it's a matter of and it's very hard given our financial results to sell assets that are performing well. We are trying to hold on to the assets that are performing the best in the portfolio to help us in the transition to be a CBD focused REIT.

Michael Bilerman - Citigroup

And how do you think about you know, you mentioned your payout I think you said it was above 100 I think, on our numbers with the fully loaded CapEx, it's higher than that. But how do you sort of think about the dividend going forward, especially with the higher CapEx needs, the weak run rate coming out of the fourth quarter from an NOI perspective. But also, a spin-off transaction would certainly affect payout ratio as well given the fact that of where things using, effectively deleveraging would reduce cash flow?

Adam Portnoy

Sure. Well, I want to point out, I know you’re talking about CAD, but from an FFO perspective, we are only 66%, but also I can tell you that there has been no discussion at the board level at all to do anything with the dividend in terms of cutting it or reducing it.

It’s our current intention to maintain the dividend and that’s what we foresee for the foreseeable future. And again there has been no discussion about reducing the dividend at the board level at all.


And now, let’s turn the conference back over to Adam Portnoy. Please go ahead, sir.

Adam Portnoy

Okay. Thank you for joining us on the Q4 Conference Call. We look forward to seeing many of you at the Citi Global Real Estate Conference in Florida in March. Thank you.


And ladies and gentlemen, that does conclude your conference for today. Thank you for your participation and for using the AT&T Executive Teleconference Service. 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 All other use is prohibited.


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

About this article:

Tagged: , REIT - Office,
Error in this transcript? Let us know.
Contact us to add your company to our coverage or use transcripts in your business.
Learn more about Seeking Alpha transcripts here.