Northstar Realty Europe Corp (NYSE:NRE)
Q4 2015 Earnings Conference Call
March 22, 2016, 09:00 ET
Trevor Ross - General Counsel and Secretary
Mahbod Nia - President & CEO
Scott Berry - CFO
Sam Warwood - Bank of America Merrill Lynch
Frank Lee - UBS
Ross Nussbaum - UBS
Welcome to the NorthStar Realty Europe Fourth Quarter 2015 Conference Call. Today's conference is being recorded. At this time I would like to turn the conference over to Trevor Ross, General Counsel and Secretary of NorthStar Realty Europe. Please go ahead.
Good morning and welcome to NorthStar Realty Europe's fourth quarter 2015 earnings conference call. Before the call begins, I would like to remind everyone that certain statements made during the course of this call are not based on historical information and may constitute forward-looking statements. These statements are based on management's current expectations and beliefs and are subject to a number of trends and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. I refer you to the Company's filings made with the SEC for a more detailed discussion of the risks and factors that could cause actual results to differ materially from those expressed or implied in any forward-looking statements made today.
The Company undertakes no duty to update any forward-looking statements that may be made in the course of this call. And, finally, this call will discuss certain non-GAAP measures. For a reconciliation of non-GAAP measures to the most directly comparable GAAP measure, please see our press release and disclosure supplement issued this morning and posted on our website.
I will now turn the call over to our CEO, Mahbod Nia. Mahbod?
Thank you, Trevor, and thank you, everyone, for joining us today. In addition to Trevor, I'm joined by Scott Berry, our CFO. NorthStar Realty Europe or NRE is a New York Stock Exchange-listed REIT focused on prime office properties. We're in 48 properties, predominantly prime offices in key cities across nine countries, with a concentration in Germany, the United Kingdom and France. Our objective is to create shareholder value by generating a stable and recurring income stream supplemented by capital growth potential over time. Before I delve further into the business, I would like to say a few words regarding the macroeconomic environment and the European commercial real estate markets.
As we're into the fourth consecutive year of economic growth in the European Union, we remain optimistic about the prospects of a gradual and sustained recovery across the region. In 2015 gross domestic product in the European Union and the euro area grew by 1.9% and 1.6%, respectively. For the euro area, the European Union central bank forecast 2016 GDP growth of 1.4% which is broadly in line with annualized average quarterly growth rate during the past 20 years. 26 of the 28 members of the European Union reported positive GDP growth last year, with Greece and Finland reporting zero growth. A significant portion of economic trade within the European Union is intra-community, and as the economic health of each member state gradually improves, the region on the whole stands to benefit.
The downward trend in unemployment has continued, reaching 8.9% in January 2016 from 9.8% a year earlier for the European Union as a whole which coupled with rising real disposable incomes, should continue to fuel private consumption. Governments are to varying degrees regaining control of their finances and reducing their levels of national debt to GDP. Our expectation emerging from the global financial crisis has always been that a recovery is likely to be gradual and nonlinear. It is reasonable to suggest that this is what we're witnessing today. The European Union is certainly not immune from the well-documented economic and geopolitical risks that are collectively giving rise to uncertainty and pose a threat to the outlook for global economic growth. However, fundamentals remain strong in our view and governments and central banks appear responsive to combating the threat of external forces that could pose a risk to the recovery.
Our expectation of a gradual and sustained economic recovery is supported by the belief that the fundamentals remain strong. And a combination of factors that are generally conducive of economic growth, including low energy prices, low interest rates, a weaker euro, and ECB stimulus have increased in both magnitude and duration. Switching to the real estate markets, total European investment volume grow in 2015, reaching EUR273 billion, of which approximately 40% was in the office sector. Germany, the United Kingdom and France together represented approximately two-thirds of total transaction volume. Tenant demand continued to show signs of improvement across most major markets, resulting in increased demand for office space. This coupled with a limited supply of prime office stock and little or no development pipeline in all but a few cities across Europe, is likely to result in continued downward pressure on vacancy rates and gradual upward pressure on rents in several key office markets. Property yield in most asset classes and markets continue to decline but still remain at a significant premium to sovereign yields.
With greater ECB stimulus facing downward pressure on bond yields and financing costs and the leasing market continuing to improve, it is conceivable that we may see further yield compression in 2016, though this may be at a slower rate. Turning the discussion back to NRE, we're pleased to celebrate our entry into the public market and to report strong earnings in our first quarter since our spinoff from NorthStar Realty Finance Corp. NRE is a European-focused REIT listed on the New York Stock Exchange, with a strategy targeting prime office properties, predominantly in Germany, the United Kingdom and France. Our $2.6 billion portfolio of 48 properties is leased to blue-chip and other high-quality tenants in key cities across Europe. As of December 31, 2015, the portfolio had a combined lettable area of approximately 495,000 square meters, an average occupancy of 87%, and remaining weighted average lease term of approximately 6 years.
Our core portfolio has a value of approximately $2 billion and comprises 25 properties in key cities within our core markets of Germany, the United Kingdom and France represents 76% of the overall portfolio by value and generates approximately two-thirds of the total rental income. It has a combined lettable area of approximately 249,000 square meters, an average occupancy of 92%, and a remaining lease term of approximately 7.1 years as of December 31, 2015. Looking forward, our strategic focus remains the creation of shareholder value through the generation of a stable and recurring income for distribution, supplemented by capital growth over time. It is for this reason that we regard Germany, the United Kingdom and France as our core markets. These are not only the largest economies in Europe, but the largest, most established, liquid and among the most stable office markets in Europe. The remainder of our portfolio comprises primarily office properties in major cities within six other countries, as well as a small number of non-office properties.
We regard these properties as nonstrategic and plan to gradually divest them and, over time, create a business that is even more focused. During the past year we've made significant progress managing our properties, resulting in increase in occupancy from 93% to 95%. That's like a 5% increase in rents, an increase in the weighted average lease term across our core portfolio. In December 2015, Cushman & Wakefield, a leading real estate valuation and service provider, performed an independent valuation of our real estate portfolio on our behalf which resulted in a valuation of $2.6 billion, an 11% increase over the purchase price, equating to an implied net asset value of $18 per share. This reflects a significant premium to NRE's current share price as ascribed by the public market and we remain focused on ensuring that the current discount is eroded and on unlocking this embedded value for our shareholders through a number of initiatives, including the monetization of primarily nonstrategic properties at attractive valuations and further repurchases of our common stock.
More recently we implemented a number of value-enhancing corporate initiatives, including the repurchase and cancellation of $150 million of our stock-settable notes at a slight discount to their par value, resulting in an approximately $6 million interest saving through December 2016, and the partial refinancing of another loan, resulting in a reduced blended margin from 2.7% to 1.9%. We also executed approximately 40% of our stock repurchase authorization at the end of 2015. We own a desirable collection of prime office properties with a strong income profile that positions us well to benefit from the continued economic recovery in Europe while simultaneously possessing certain defensive characteristics that have the ability to weather unforeseen market volatility.
With that, I'm pleased to announce that NRE delivered strong operating results during the fourth quarter and partial-year 2015 and will now handover to Scott Berry, our Chief Financial Officer, to further discuss the financial results. Scott?
Thank you, Mahbod. Good morning, everyone and thank you for joining us on our first earnings call. Before we discuss our performance, I would like to mention that the fourth quarter represented the first quarter in which we owned our real estate properties as one portfolio, and as such, we do not report like-for-like property results for the third quarter of 2015 or the fourth quarter of 2014 for comparative purposes. In fact, we were a stand-alone company for only two months in the fourth quarter. NRE reported first fourth quarter CAD of $13.9 million or $0.22 per share. We believe CAD is a good indicator of our operating performance and, among other metrics, is an important factor when evaluating our dividend and operating strategy. We reported net operating income or NOI, of $34.8 million for the fourth quarter 2015. And we project the 2016 NOI to be in the range of $128 million to $132 million.
We believe NOI is useful measure of the operating performance of our real estate portfolio. In terms of liquidity, NRE received $250 million of contributed cash from NRF at the completion of the spinoff on October 31, 2015. We announced a $100 million share repurchase program in November and repurchased approximately 3.7 million shares of NRE common stock for $41.4 million by the end of the year. During the fourth quarter we incurred $1.3 million of nonrecurring CapEx and $8 million of costs which were primarily deployed to maintain the quality of our assets in the years to come. In addition, we repurchased approximately $150 million of stock-settable notes in February 2016 through open-market purchases. As of March 17, 2016, NRE had an unrestricted cash balance of $133 million. On March 15, 2016, we declared a cash dividend of $0.15 per share of common stock.
This dividend is expected to be paid on April 1 to stockholders of record as of the close of business of March 28. Based on the closing share price of NRE on March 21, 2016, NRE's dividend yield is approximately 5.2%. Overall, we're very pleased with our quarterly financial results and the diligent execution of our operating strategies. We believe we're well positioned for long term growth. We look forward to updating you on our progress in the months and quarters ahead.
This completes our formal remarks for today. Operator, can you please open the line for analyst questions? Thank you.
[Operator Instructions]. We will take our first question from Sam Warwood with Merrill Lynch.
Just a couple of questions, firstly, in terms of the occupancy performance of the portfolio which I think you quoted 87%, it looks as if the core portfolio is more like 95%. Can you just touch on the vacancy position and performance in the non-core assets? And what in particular are the risks or opportunities in that segment?
The vacancy in the nonstrategic part of the portfolio is spread across a number of assets, but there's one in particular that I would note that is a substantial percentage of that. And it's a logistics asset that we own in Paris that is a very large, modern logistics facility and is 50% vacant. It contributes probably around 4%, 5% to that occupancy number but substantially less to income, given the vast disparity between logistics rents and office rents.
And in terms of opportunities across the markets that you look at, I mean, in terms of the UK, is the Brexit debate having an influence on how you look at opportunities? Do you think that that might throw up some opportunities in the UK? Or more generally which of the core markets do you think have got the most interesting propositions at the moment?
Yes, so I do believe the Brexit will and perhaps to some degree already created an element of uncertainty and illiquidity that that brings in transactions. We don't know which direction the boat is going to go, and come June 23, either it's a vote to remain or leave. If it's a vote to leave, then there is likely a prolonged period of uncertainty while the UK either negotiates a different deal with Europe or negotiates bilateral agreements with its trading partners. From our standpoint, we're fortunate to own a portfolio of very good assets in the UK that the majority of the value is in two trophy assets in London in Portman Square and Condor House. We have the remaining lease term of eight years across the portfolio.
So by that time, pretty comfortable that however the vote goes, the issue would have resolved itself. In terms of opportunities, quite honestly, we do see attractive investment opportunities across the market. But the most attractive opportunity we see right now is the opportunity to buy back our own stock. If you look through to the quality of assets that we own and the implied yield at which the Company's trading, it's just not possible to buy assets of this quality in the private market at these levels. And so near term, our focus is really very much on our own Company.
And yes, touching on that issue and I think the idea of repurchasing shares in this position is a very sensible one and one that I probably wish a few more companies would occasionally pay attention to as well -- but I'm just curious, what factors do you guys see driving that discount, in terms of whether it's something that can structurally be fixed? And I've noticed there's a bit of sort of governance concerns being raised with NorthStar Asset Management itself in the U.S. Do you think any of that feeds into the perception of NorthStar Realty Europe as well that might drive thoughts around the strategy in that linkage with NorthStar in the long term in the future?
You know, it's hard to say. I can't really comment on the process that is ongoing at NorthStar Asset Management Group. I think from our standpoint, we're a relatively young company. We have a lot to do and there's an onus on us to ensure that we do the right thing and make sure that we're focused on driving shareholder value for NRE shareholders. And I see that primarily as doing our day-to-day job which doesn't in any way get impacted by matters elsewhere within the structure. So we have a very clear strategy that is aimed at driving shareholder value and bridging the discount. And our focus as management day-to-day is 100% on that.
[Operator Instructions]. And we will take our next question from Frank Lee with UBS.
Looks like you guys have a couple larger leases expiring this year, mainly the Ernst & Young lease. Can you remind us if these expirations have been addressed and if there any other kind of larger known move-outs in the portfolio?
Sure. So we're an office company, we own a portfolio with an average lease term of six years. And within that, there will be years when there are tenants vacating. We generally so far have had a very good retention ratio. Our objective is to deliver a stable income, supplemented by capital growth. To be able to generate that capital growth, we need to actively manage the portfolio. One you mentioned is Ernst & Young that is vacating. There's another tenant that is vacating this year as well in [indiscernible]. They are great opportunities for us to be able to generate value for shareholders by re-leasing that space. When we bought those properties, we expected that this tenant would vacate. We reflected that in our purchase price and in our underwriting. And as I said, it's a great opportunity for us now to be able to re-lease this space on a longer lease and create value for shareholders in doing so.
And then if I look at the 2016 NOI guidance and I compare it with the 2015 pro forma, what are the kind of primarily the drivers for the decrease?
It's a mix, but the fact that you've got the two tenants that were mentioned vacating, and the timing of the departure of those tenants which is later on in the year, and how that ties in with year-end 2016, and the releasing of those properties. There's an element of that.
And additional asset sales baked into the 2016?
Just one other point, Frank, on that is the $136 million that you have seen as the pro forma 2015 number, I would also just highlight that that is a pro forma number. So it's subject to the positives and negatives of pro forma. So it's not a direct comparable to the 2015. Sorry, your question was?
Yes, I was just wondering if the 2016 NOI guidance -- if there were any additional asset sales baked in there.
Not in that guidance, no.
Okay. And then just one last question, for the asset sales in the fourth quarter, do you guys happen to have the cap rates for those?
I don't have those down Frank, but I can get those to you.
And we will take our next question from Ross Nussbaum with UBS.
I see that you repurchased $150 million of the senior stock-settable notes that are due later this year. What is the game plan for refi-ing or buying the remainder of those?
We don't publicly disclose intentions that we may have with regard to matters such as that one. But they will be repaid. Our expectation is in cash prior to or at maturity.
Okay. And how do you think about the overall leverage profile of the Company vis-a-vis stock purchases? And maybe related to that question, where do you see the longer term leverage level of the Company?
Well, the longer term leverage market that we have stated is the 40% to 50% loan to value and I believe we will achieve that range. The fact that we're rationalizing the portfolio and further focusing in on our core markets and that involves a number of asset sales, that involves deleveraging, as we repay allocated loan amounts and for lease premiums and should bring the leverage down in time to within that range.
Okay and I guess the final question is, clearly there's a lot of what I would call noise around your sister company and your external advisor. And I guess the question I would have is, your sister company's independent Board members, I guess, have separated to evaluate some alternatives, including a recombination with NSAM. Why aren't your independent members thinking the same thing as your U.S. sister company?
I don't believe that a recombination of NRE into any other entity makes sense. So that's something that we're not, frankly, currently evaluating and kind of think is an outcome. Again, I can't really comment on what's happening elsewhere in the structure. And I'm not involved in that. Our sole focus is the operation of NRE and driving shareholder value through the operational performance of that Company.
Do you think it's worth consideration of strengthening the independence of your Board of Directors such that there is no overlap to any of the affiliated entities?
So we have two independent, non-overlapping directors at NRE. We take corporate governance very seriously throughout the structure and target best practice in that respect. So I can't really comment beyond that.
And there no further questions at this call. This does conclude today's conference call. We appreciate your patience and participation. Have a good day.
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