PS Business Parks' (PSB) CEO Maria Hawthorne on Q2 2016 Results - Earnings Call Transcript

| About: PS Business (PSB)

PS Business Parks, Inc. (NYSE:PSB)

Q2 2016 Earnings Conference Call

July 27, 2016, 11:00 ET

Executives

Ed Stokx - CFO

Maria Hawthorne - President & CEO

John Petersen - COO

Analysts

Eric Frankel - Green Street Advisors

Manny Korchman - Citi

Operator

Good morning my name is Shelby and I will be your conference operator for today. [Operator Instructions] At this time I would like to welcome everyone to the PS Business Parks Second Quarter Investors Conference Call. [Operator Instructions] Thank you. Ed Stok, you may begin your conference.

Ed Stokx

Thank you. Good morning and thank you for joining us for the second quarter 2016 PS Business Parks investor conference call. I am Ed Stokx, CFO of the Company, and with me are Maria Hawthorne, President and Chief Executive Officer and John Petersen, Chief Operating Officer. Before we begin, let me remind everyone that all statements other than statements of historical fact included in this conference call are forward-looking statements.

These forward-looking statements are subject to a number of bits and uncertainties, many of which are beyond PS Business Parks control with could cause actual results to differ materially from those set forth in or implied by such forward-looking statements. All forward-looking statements speak only as of the date of this conference call. PS Business Parks undertakes no obligation to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.

For additional information about risks and uncertainties that could adversely affect PS business parks forward-looking statements, please refer to the reports filed by the Company with the Securities and Exchange Commission, including our annual report on Form 10-K and subsequent reports on Form 10-Q and Form 8-K. We also provide certain non-GAAP financial measures. Reconciliations to GAAP of these non-GAAP financial measures is included in our press release which can be found on our website at PSBusinessParks.com

I will now turn the call over to Maria.

Maria Hawthorne

Thanks, Ed and good morning everyone. Thank you for joining us. I will highlight a few areas we are focused on for the remainder of 2016, and then turn the call over to JP to discuss specifics on operations for the quarter in that Ed will wrap up with financial updates. The first half of 2016 is behind us and we continue to see strong customer demand in majority of our markets. This is driving positive performance on several key metrics including Same Park NOI which increased 5.7%.

During the quarter we saw 5.5% rent growth on executed leases as we continue to mark to market expiring rate throughout the Southeast, taxes and along the West Coast. Sequential occupancy within the Same Park portfolio declined 50 basis points to a still strong 93.6%. The decreases were mostly in our strongest markets where we will be able to release and higher rents. Non-Same Park is maintaining 95% occupancy. There is little to no need competitive product which means that is market occupancies improved we are often able to reduce consumption on production cost and increase cash flow. Our business Park concentrations in top-tier markets allow us to expand our earnings 10 a base while attracting new customers which help us to upgrade the rent roll, 79% of our business parks are 90% occupied or higher. Retention in the second quarter was 64.4%.

Washington Metro is the only area still battling the headwinds of government and large office tenant consolidation and remains the tenant market. PSB's balance sheet is in the best shape ever. We paid off the 250 million CMBS loan on June 1 eliminating the only mortgage debt on the balance sheet. We do not close on any acquisitions as we feel that many assets on the market are at extremely low CAP Rates with high occupancy and often at peak NOI. However, we continue to search for those undermanaged and value add opportunities.

The construction is proceeding well with our multifamily development in Virginia we are on track to deliver in mid-2017. Taxes continues to have good up as we residents move into the new and evolving city center. Decision has been made regarding the 123,000 ft.² building at this park that will vacate on September 30. We are still in the process of evaluating whether to retenant the office building versus redeveloping the site as another residential project. It is unlikely the decision will be finalized this year.

Lastly, I would like to acknowledge and thank Joe Russell who has moved on to become President of Public Storage. Joe lead the Company for nearly 14 years during which we had tremendous growth and success. We are grateful that he is remaining on our Board of Directors and will continue to provide wise counsel for the Management Team.

And now I'd like to turn the call over to JP.

John Petersen

Thanks, Maria. I will take you through some specific market commentary from the quarter. Overall market fundamentals are strong, job growth is healthy, and small business America is alive and well. Aside from Washington Metro which were you mentioned, all of PSB's markets are experiencing a verbal tailwinds including increasing rents, lower concessions, positive net absorption and noncompetitive construction. Southern California was able to capture the benefits of strong market fundamentals and signed 392,000 ft.² in 100 in 192 deals an average of 202,000 ft.². Occupancy slipped 60 basis points to 93.7% primarily due to the loss of three user 10,000 ft.². I am encouraged by our ability to release these spaces quickly and take rents up to market. In Q2 the team managed to increase rents by 7% and retention was 67%.

In Washington Metro, despite continued government contractor consolidation, small tenants were active and I was pleased that we were able to find 100 leases too late 371,000 ft.². Once again are 3700 ft.² average deal size fell right in line with our targeted user base. This volume did come with a minus 7% change in rental rates. Occupancy in the quarter drop 60 basis points to 90.8% primarily due to the exit of one customer over 50,000 ft.². We are breaking this space down to small sizes to appeal to our core market of below 5000 ft.². While we are facing market challenges in Washington Metro, I am pleased that we are outperforming the market by 850 basis points of occupancy. Northern California remains the most robust market we operate in and Q2 results for this once again. Released 400,000 ft.² and 107 deals retention was 67% and cash rents increased 20%.

Occupancy remains solid at 96.4%. Our Northern California team is doing a great job of taking advantage of market conditions to push rents while maintaining high occupancy. In South Florida, we executed 300 In South Florida, we executed 336,000 ft.² with rent growth of 4.9% . Occupancy was down 220 basis points from 92.9% at two customers over 20,000 ft.² exited MIC see as they outgrew the park. We have good activity on these spaces and I am confident we will see quickly as cell phone economy is experiencing favorable metrics. In Texas, we completed 229,000 ft.² and grew rents 7.6% without occupancy of 92.2%, retention was 55%. Specifically in Austin we realize rent growth of 11.8% and Dallas rents were up 3.9%. As we look ahead to the rest of 2016, we have two point 8,000,000 ft.² for 11% expiring and of that 75% expire in accelerating markets.

Our opportunity is to capitalize on these expirations by extracting rent growth and pushing occupancy in California, Seattle Texas and Florida while working hard to maintain our position in Washington Metro. No alternate call over to Ed? They could JP. Adjusted FFO for the second quarter of 2016 was one dollar and 30 $0.06 per share compared to a dollars 20 since per-share for the second quarter of 2015. An increase of 13.3%. Total portfolio NOI increased 6.4% in the second quarter with Same Park NOI up 5.7%. Same Park revenue increased 4.1% as a result of higher comparative occupancy combined with improving rents.

Same Park operating expenses increased 0.5%. Reported FFO for the quarter was $1.30 $0.06 per share which includes a one-time non-cash charge of $2 million related to the accelerated cost of future stock grants that Joe Russell received under the Company's long-term incentive plan. Recurring capital expenditures were 14.1 million in the first six months of play 16 compared to a 21.1 million in the same period of 2015. This year-over-year decrease is in part due to the timing as well as the Company's focus on lowering transaction costs.

During the Company quarter the Company repaid the $250 million mortgage that had been assumed in 2011 with the Northern California folio acquisition. In mortgage was repaid with cash on hand as well as borrowings on our credit facility. As of June 30, the 54 million outstanding on the credit facility represent the only debt on the Company's balance sheet. Repayment of the mortgages reduces our quarterly interest costs by 3.3 million and increases FFO per share by $0.10 per quarter. Finally, with respect to the Highgate multifamily development in place in Virginia during the quarter we invested approximately $9 million and we anticipate funding an additional 65 million through completion.

We will now open the call for questions.

Question-and-Answer Session

Operator

Your first question comes from the line of Craig Mailman with KeyBanc Capital. Your line is open.

Unidentified Analyst

This is [indiscernible] in here with Craig. First we want to start up by congratulating Maria on becoming CEO, you’ve had a long tenure with the Company so we were wondering now that you’re at the helm do you see anything potentially changing at the margin?

Maria Hawthorne

At this point we have a good machine going. We've always been disciplined in our acquisition and dispositions and trying to address best results to our operation while focus on small customer. It's a good formula and it's not going to change dramatically anytime in the near future.

Unidentified Analyst

Also wanted to ask you about preferreds, you have three tranches that are called in 2017 federal trading above part, so not sure how you think about those as legibly PSA recently issued for .95% so wanted to see what you're thinking about those upcoming tranches

Ed Stokx

We believe that those preferreds are going to be a great opportunity for the Company in terms of the redemption available to us. The preferred market as you alluded to is very, very strong very active right now. We believe that we could issue preferreds today inside of 5 1/2% which would be a very, very attractive rate.

So as you know we have three issuances with the first being in January of next year it's at 6.45% . Over the course of the next couple of quarters, we will deftly be focused on what opportunities are there and what options are available to us to take that out but we would fully anticipate taking advantage of those redemption opportunities.

Operator

Your next question comes from the line of Eric Frankel with Green Street Advisors. Your line is open.

Eric Frankel

Related to the preferred equity pricing I think it's pretty well known that everyone's cost of capital is expected to be kind of the last few month common equity in preferreds I would like to understand how you might do acquisitions a little bit differently given that environment so certainly cap rates of come down perhaps a relative basis been a piece of that to start by more assets.

Maria Hawthorne

In the acquisition market and especially the markets that we are in really do have some of the most compressed CAP Rates in thinking about Seattle Northern California Southern California and then Dallas Austin and South Florida, we are seeing pricing that is well beyond the peak and all of our product types and now we're seeing rent rolls, that where you have Pete pricing and peak occupancies so you know like I said we are still discipline when looking further opportunities, but even at a lower cost of capital, the CAP Rates are outpacing some of the pricing we feel we could see make accretive purchases.

Eric Frankel

It's interesting to know, any thoughts on suburban DC I think there's been a few more trade office properties there and not sure if pricing enticing enough for you to take another dip, obviously fundamentals are quite as strong as the rest of the U.S., but want to get your thoughts.

Maria Hawthorne

There isn't and what we've seen in DC because we do look at everything and if we found something that would work well in our markets, we would certainly buy, but some of the more stressed distressed assets that of come to market have been very large tenant and configuration that don't really slice up well for our formula but we are looking at everything.

Operator

Your next question comes from the line of Manny Korchman with Citi.

Manny Korchman

Just if we think about the large block of space that you said went dark and sort of contributed to vacancy, can you just help us think about your approach is your first sort of step to try to get another user or are you now automatically defaulting to break it up and just maybe your thoughts on going one way versus the other?

Ed Stokx

We knew that expiration was coming from month-to-month in advance and pretty obvious to us that we were going to break it down . First of all we were going to wanted to compete for 50,000 foot user is way too many options in that market is ultracompetitive with TIs and $60, $70, $80 range with year we ran et cetera et cetera and by the way there aren't users anyway for that kind of space. So for us it was very obvious, very early that we are going to break it up as I mentioned in my comments most of our deals are on a 5000 ft.² that's our sweet spot and we are confident in Westpark Tysons [ph] in those markets in those that will release that space relatively quickly in that market.

Manny Korchman

And can you just remind us what the difference in that, would be between that maybe it a lease does exist were you able to get a tenant and their what they would pay an TIs versus breaking it up and rents their NTS

Ed Stokx

You mean a big 50,000?

Manny Korchman

Let's say were able to fill that what would they be paying and what would you be giving up for that and then you break it down how much does that cost you? Where do you get in how much in TIs you’ve to offer?

Ed Stokx

In our view it's a lose the rent gets compressed let's say markets for the sake of discussion our mid-20s, range that would go down to low 20s, let's say market for a bigger user like that on a five-year deal is a wanted to months three months per year and without question TIs has been well documented in all kind of research would be anywhere between 58 years of square foot to do a deal like that so even if be giving an aggregate 6 to 8 months of free rent on a five-year deal maybe stretching out to 5 1/2 but it would be significant free rent $50-$80 an TIs full commission so on and so forth and lower rent as well.

So if you do a smaller three or 4000 ft.² space assuming a normal be which as I mentioned you're talking below $10 and TI may be an month of free rent maybe three to five-year term depending on the situation in space and you get higher rents and you may or may not pay a broker fee because often times those smaller represented by brokers.

Operator

[Operator Instructions]. Your next question comes from the line of [indiscernible] with JPMorgan. Your line is open.

Unidentified Analyst

So would with Joe's departure and Maria's promotion, what you guys expect for like a G&A run rate fully loaded with [indiscernible].

Ed Stokx

Gene, I don't think that there will be significant change to our G&A run rate. It's running and kind of in the three and kind of in the 32 to 3, 35 range per quarter including Delta and I would expect that to continue may be something on the tighter side of that range going forward.

Unidentified Analyst

And on page 16 of the us you have same-store NOI trends that exclude LTIP amortization but then you identified the LTIP amortization that's a piece that's flowing through the operating expenses, so what are your thoughts on excluding that and why exclude it?

Ed Stokx

We exclude just because we believe that excluding it gives a better perspective on the true operating trends of the property and the compensation for the expense of the people that run the assets and manage the assets is included in cost of operations always has been. So from an accounting standpoint, we have to kind of match that with the LTIP expense but we believe to show the true operating results of the property, that that's the best approach.

Unidentified Analyst

And on the dividends, what percentage of taxable income are you guys currently paying out and how often do revisit the common dividend?

Ed Stokx

I would tell you that the Board looks at the dividend and kind of the Outlook of the dividend really on a quarterly basis to be always aware of where we are. Our focus is to keep the dividend where it needs to be from a tax standpoint so I would tell you that we're pretty close to paying out 100% of taxable income as required, I don't see any dividend change in the dividend philosophy going forward.

Unidentified Analyst

Okay. And then it looks like there's about a $0.06 Delta between your same-store operating expense and the first quarter and the second quarter of this year, is there any kind of one-time items that are impacting that?

Ed Stokx

Well it is a onetime item in the first quarter we had about $1.8 million of snow costs that were incurred and we had in the second quarter I think less than $10,000 of snow removal costs so it was all heavy burden in the first quarter for snow removal.

Operator

Your next question comes from the line of Eric Frankel with Green Street Advisors. Your line is open.

Eric Frankel

Just a follow-up on the DC and the DC area, JP do you have any sense of when releasing spreads are going to bottom?

John Petersen

When they going to bottom I would like for us as we roll through our lease expirations to see at the end of mid-single-digit we need to from the market clearly to stabilize we need some help from competitive land lord behavior to stabilize rents. In our view we can holds in Washington Metro in terms of our occupancy and I be pleased with that. I just don't see them overall market fundamentals there improving anytime soon as long as the government and government contractors continue to consolidate that puts pressure on concessions and rents as you well know.

Eric Frankel

Is there any pressure on the supply side from our inventory is taken out and converted to something else orders similar to what you guys are doing in Texas

John Petersen

Yes if the margins are there some of that but I don't think it has a material impact on suburban DC at all a material impact but yes you're right at the margins there are some high and better use that’s going on and we have seen some of that and we have participated in some of that obviously. So we think that's a good thing you know to the extent it does happen and multifamily is certainly on mixed-use that’s going on quite a bit there which we would take up more competitive space.

Operator

There are no further questions at this time. I'll turn the call back over to Mr. Stokx.

Ed Stokx

Thank you, Shelby. Thank you everyone for joining us and we appreciate your interest in the company and we will talk to you in the near future. Take care.

Operator

This concludes today's conference call. You may now disconnect.

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