Columbia Property Trust Inc. (NYSE:CXP)
Q2 2016 Earnings Conference Call
July 28, 2016, 05:00 PM ET
Matt Stover - IR
Nelson Mills - President and CEO
James Fleming - EVP & CFO
Brad Burke - Goldman Sachs
John Kim - BMO Capital Markets
Lauren Delmore - Morgan Stanley
Good afternoon and welcome to the Columbia Property Trust Second Quarter 2016 Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded.
I would now like to turn the conference call over to Matt Stover. Please go ahead.
Good afternoon. Welcome to the Columbia Property Trust conference call to review the Company's results for the second quarter of 2016. On the call today will be Nelson Mills, President and Chief Executive Officer; and Jim Fleming, Executive Vice President and Chief Financial Officer.
Our results were released this afternoon in our earning press release and filed with the SEC on Form 8-K. We have also posted a quarterly supplemental package with additional detail in the Investor Relations section of our website.
Statements made on this call regarding expected operating results and other future events are forward-looking statements that involve risks and uncertainties. A number of factors could cause actual results to differ materially from those anticipated including those discussed in the Risk Factor section of our 2015 Form 10-K. Forward-looking statements are made based on current expectations, assumptions and beliefs, as well as information available to us at this time. Columbia undertakes no obligation to update any information discussed on this conference call.
During this call, we will discuss certain non-GAAP financial measures. Reconciliations to comparable GAAP financial measures can be found in our earnings release and supplemental financial data.
I’ll now turn the call over to Nelson Mills. Please go ahead.
Good afternoon, everyone, and thank you for joining us. We continue to execute our plan for 2016 with a particular emphasis on completing our non-core dispositions and on key leasing opportunities. We're making great progress on both fronts and that is clearly unlocking value in the portfolio.
We've made a number of announcement since our last earnings call that demonstrate the value of being focused in the best high-barrier markets and the benefits of having experienced and motivated teams in each of those markets.
The largest lease completed in the quarter was the 390,000 square foot NYU lease signed in late April, which we discussed at length last quarter. This new lease stabilized our New York portfolio and eliminated our largest near term lease expiration. With the accelerated timeframe for this lease commencement, we've also been able to ensure a very positive impact on FFO.
The other major leases signed in the quarter include a new 35,000 square foot lease with Winton Capital at 315 Park Avenue South, and 130,000 square foot renewal with Toyota Motor Credit at SanTan Corporate Center. Both of these were rate roll ups with the 315 Park Avenue South lease at record levels for Midtown South.
The largest remaining near term leasing opportunities are at 650 California Street in San Francisco, 116 Huntington in Boston, and Market Square in Washington D.C. We still have some leasing to do at 315 Park Avenue South, but we can't get to the majority of that space until Credit Suisse expires in 2017.
These key opportunities are with very attractive assets, well located within markets with strong leasing fundamentals. We have experience improving teams in those markets and have established significant leasing momentum in each.
I'll briefly summarize our successes and opportunities in these markets. Our San Francisco portfolio was 89% leased at quarter end, which as expected dropped a few points due to the expiration of the Littler Mendelson lease at 650, California.
After initially exploring one large potential user for this space, we're now focused on smaller tenants and have several proposals in hand all with terms better than our acquisition underwriting.
CBD San Francisco is still one of the strongest markets in the country with healthy demand and constrained supply and we remain relatively bullish about our leasing prospects there. In addition to our long-term single tenant lease at 333, Market Street, we’re also 94% leased at 221 Main Street, and 95% leased at our University Circle property in Palo Alto. That property has the highest net rents in the portfolio.
Manhattan continues to have strong leasing fundamentals as well, and our team has worked hard to take advantage of them. Two of our three buildings are fully leased; 222 East 41st and 229 West 43rd. And our value-add opportunity at 315 Park Avenue South continues to live up to its ability. We have a 170,000 square feet occupied by Credit Suisse that expires in late 2016 and early 2017 with rates well under market.
The $100 per square foot lease we recently signed for the top three quarters a building was well above our underwriting.
In D.C., Market Square’s occupancy ticked down during the quarter with the expiration of the Sherman & Sterling lease on March 31. We had substantial momentum here with the capital improvement to lobbies, common areas and fitness center driving substantial leasing traffic and proposals.
Market Square continues to be a top destination for Fortune 500 companies, particularly for their lobbying groups and trade associations. The leases tend to be smaller now until we had moved away from the larger law firm footprint, but we expect to report a few new signing at attractive terms in the second half of the year.
At 80 M Street in D.C. we recently signed a 15,000 Square foot lease and are negotiating other sizable leases there, which is reflective of the substantial improvement in that submarket. We hope to announce notable progress there soon.
Turning to dispositions. We completed the sale of 800 North Frederick two weeks ago for $48 million in gross proceeds, that's slightly more than we'd anticipated. Combined with the 100 East Pratt sale in Baltimore in late March that brings us to $235 million in dispositions completed to date in 2016.
Since we began our portfolio transition a few years ago, we’ve sold 50 assets totaling $2.4 billion redeploying almost all of that capital into value creation opportunities and some of the best long-term office markets in the country.
While we're very proud of pace, efficiency, and the pricing of these transactions, it's important to note that we've been focused on maximizing shareholder value throughout the process.
In many cases, we were able to renew and extend leases prior to sale creating substantial value prior to our exit. In the case of our most recent sale, 800 North Frederick for example, we spent 18 months exploring and negotiating a variety of options to maximize the value for this functionally obsolete property.
This ultimately resulted in the sale to a special use to a special use developer at a price substantially higher than other alternatives.
We delivered on our commitment to transition to a growth oriented portfolio centered around some of the best performing and most liquid markets in the country. That said, we have a bit more work to do.
We have two large sales underway; Key Tower in Cleveland, and 80 Park Plaza in Newark, New Jersey. Both have been awarded to local buyers and the 80 Park Plaza contract has now gone hard backed by a substantial earnest deposit.
The process for these two asset sales has taken longer than originally anticipated. The nature of the two assets and their individual markets combined with a less than favorable CMBS market has narrowed the depth and breadth of potential buyers. We still expect to get them done and within our targeted range of proceeds.
Consistent with what we announced in NAREIT in June, we're also marketing our three suburban, Dallas, Denver, and Phoenix office properties. We've already received very strong interest for the four building campus in Denver and with the recent long-term lease with Toyota at SanTan and Phoenix, we expect that asset to appeal to a number of buyers as well. Sterling Commerce in Dallas is well leased and should also attract good demand.
With addition of these three disposition targets, we now expect a total of $700 million to $1 billion in gross disposition proceeds for 2016. Our updated guidance accounts for this activity.
On the acquisition front, our regional teams continue to actively pursue opportunities in our target markets. We're particularly focused in Manhattan and West L.A. where we are beginning to see more compelling opportunities. No deals are on the board today, however, as we continue to focus on these last few dispositions and leasing across the portfolio.
As many of you know, we've been intentional, consistent, and focused on building a stronger portfolio in the top office markets in the country as well as developing experienced and motivated teams within these markets.
We're seeing the benefit of the strategy in our results, particularly in the recent leasing we've achieved but also we're nearing the inflection point for generating year-over-year growth in total cash flows. We expect 2016 to be our lowest FFO year and we are poised for significant FFO growth in 2017 and beyond.
We've established significant embedded growth and high quality portfolio and have the talent, resources, and determination to continue to grow value. We're set up to compete with any other office REIT and expect to leverage a strong balance sheet and competitive platform to produce strong returns for our shareholders over the next several years.
With that, Jim, why don’t you walk through the results and our 2016 guidance, and I’ll come back at the end for a couple of remarks.
Thanks, Nelson and good afternoon, everyone. I'll take a few minutes to address our financial performance for the quarter, our updated guidance for 2016, some changes to our supplemental disclosures and some thoughts on our balance sheet.
Our financial results for this quarter were affected by the Jones Day lease at 222 East 41st Street in New York. As you may recall this lease was scheduled to expire October 31 and we indicated on our last call that you should expect a replacement lease with NYU to begin about January 1 of next year after a couple of months of downtime.
We were able to improve on this by terminating Jones Day on June 30, which will allow us to complete our base building work and begin the NYU lease before the end of the year.
The agreement with Jones Day included a lease termination payment of $6.2 million, which would equal the four months' rent and we now expect the NYU lease to begin by November 1 and possibly as early as October 1. So we will have essentially no downtime between the two leases.
Since the lease termination happened June 30, the termination payment was included in income in the second quarter, which increased our FFO and our NOI for the quarter by $0.05 per share.
But there will be no rent from this building in our income in the third and fourth quarter until the NYU lease begins. In other words our financial results for the year will be improved overall but about $0.05 per share of income was shifted from the third and fourth quarters into the second quarter. Without this termination income, our FFO for the second quarter would have been $0.43, which is in line with our expectations.
The portfolio continued to perform well with good dividend coverage, our office space at 91% leased and our overall leverage just under 36%. This quarter’s results included contributions from our recent acquisitions including 229 West 43rd in New York, which we acquired last August that did not include any contribution from 100 East Pratt, Baltimore which we sold on March 31.
We’ve made a number of changes to our supplemental package this quarter. Some of these changes are in response to the SEC’s recent announcements on non-GAAP financial measures and as a result, we've reordered some of the pages in our packages to present the GAAP information first.
We’d modified certain turns and definitions and we’ve added some reconciliation to net income and to cash flows from operations. We don’t think those changes will be difficult to understand but will be happy to go over them after the call if there is any confusion.
This quarter we’ve also begun providing more information on our portfolio on Pages 17 and 18 of our supplemental package. We're now showing our net operating income by property on both a cash and GAAP basis and we’re also providing our leased, commenced and economic occupancy percentages for each property. We hope this helps provides more transparency about the leasing and income at each of our properties.
One thing to keep in mind as you review these new schedules is that for properties with significant current vacancy, if you simply divide the current net operating income by the lease square feet, you generally don’t get a true picture of the employee’s net rents.
The reason is that the NOI also takes into account the operating expenses for the vacant portion of the building and the reverse is also true as vacancy is leased up, the NOI increases by more than just a net rent on new leases because the new tenants also pick up their share of operating expenses.
Same-store NOI based on cash rents for the second quarter was up 2.6% compared with the prior year and up 8.9% from the first quarter. The increase was driven by the lease termination fee of $6.2 million associated with Jones Day's early departure at 22 East 41st Street in New York and $1.9 million in other lease termination fees offset by explorations at 650 California Market Square and 800 North Frederick, the downsize of KeyBank and Thompson Hine in Cleveland and the CH2M renewal in Denver.
We want to have more than 500 basis point difference between our percent leased and our average economic occupancy. Until this gap narrows over the next several quarters as a leases commences and free rent burns off, we do not believe our same-store figures are good indicators of our performance.
However as the economic occupancy climbs in the next several quarters and as we sign new leases that capitalize on the substantial difference between the end point lease rates and the market rates in many of our properties today, we anticipate meaningful increases in same-store NOI, normalized FFO and ultimately AFFO.
The GAAP net roll off in the quarter was over 15%, but the cash flow down was heavily influenced by the NYU lease. This lease has substantial rent bumps average 30-year term that even factoring in the pre rent period produced a GAAP and FFO roll off of $6 per square foot and another 10% increase in the total space leased.
On Page 11 of our supplemental you'll see that our total interest expense, which includes our share of the interest-related to the joint venture debt on Market Square was $17.7 million for the second quarter compared with $18.2 million in the first quarter and $22.3 million in the second quarter a year ago.
The sequential and year-over-year decreases were related to the pay down of mortgage debt and the fourth quarter 2015 transfer of the Market Square property and related $325 million mortgage to a joint venture with Blackstone.
Total capital expenditures in the quarter were $24.1 million compared with $11.8 million in the first quarter and $28.3 million in the second quarter a year ago. The capital this quarter included leasing commissions and tenant improvements for new leases at 315 Park Avenue South in New York, and San Tan Corporate Center in Phoenix.
As we discussed last quarter on the NYU lease details, we expect our capital expenditures to move up substantially over the 24 month build out that NYU expects to commence in the fourth quarter of this year.
We did not make any share repurchases in the second quarter. As we noted last quarter, we have been unwilling to use capital to purchase stock until we complete our large pending dispositions. However, we have $159 million remaining in the current stock repurchase authorization. We can certainly allocate a meaningful amount of capital when these dispositions are completed.
With the new timing of the NYU lease and the fact that the key center and 80 Park project dispositions have yet to close, we are increasing our 2016 guidance for normalized FFO to a range of $1.57 to $1.62 per share and net income to a range of $0.19 to $0.24 per share. For the second half of the year the largest uncertain item will be the timing of the two large dispositions in Cleveland and Newark.
We've completed $235 million of dispositions so far this year, with the $49 million mortgage on the suburban Chicago asset still expected to be come off the books in mid fourth quarter. We're also now marketing our suburban assets in Dallas, Denver and Phoenix and if we're able to complete those additional sales this year, we would increase our disposition proceeds for the year, although those sales are not expected to have a meaningful impact on our FFO for 2016.
As a result of all this as well as the strong performance of our portfolio, we're comfortable raising the range on both the high and low end as well as narrowing that range considerably.
Turning to our balance sheet, first I want to note that our debt to EBTIDA ratio of 5.78 times this quarter was partly driven by the Jones Day $6.2 million termination payment. Without this termination fee the ratio would have been 6.3 times which is consistent with last quarter's level. We do anticipate lowering our leverage a bit from where we are today as we complete some of our larger asset sales.
During the quarter, we used the proceeds from the 100 East Pratt disposition to pay off the $119 million remaining on our bridge loan. We also pay off $39 million of mortgages secured by San Tan Corporate Center in Phoenix with borrowings on the line.
And the sale of 800 North Frederick for $48 million right after the end of the quarter, we were able to pay the line down again. Today we have $273 million outstanding on our unsecured line of credit.
With the San Tan payoff, we have only five mortgage loans left today. We will likely be down to three by the end of next year, one Greenlake 650 California and our joint venture share of Market Square.
Today our preferred source of debt capital is unsecured debt. We can always fall back to mortgages if necessary as we have an unencumbered asset pool of over $4 billion. Unsecured bonds however remain our preference provided the churns in pricing are favorable.
We have some 2018 bonds outstanding with a coupon well where we believe we can get pricing today. We'll keep a close eye on what's available in the debt capital markets as we continue to work to drive down our cost of debt capital.
As Nelson mentioned, most of our efforts today are on leasing and dispositions. But our acquisition pipeline remains active with a focus on our target markets and value add opportunities.
As we continue to work through dispositions we'll approach acquisition opportunities selectively to ensure that our new investments will line up well with all of our strategic objectives. We're well positioned to take advantage of them with our balance sheet, focused portfolio and our teams on the ground.
With that I'll turn it back to Nelson to finish up.
Thanks Jim. Halfway through this very important year I'm proud of our team and what we've accomplished. Leasing is still the top priority and we are also committed to getting these dispositions done. We've generated solid momentum in every area of the company and in each market. This forward lean as we like to call it is producing results and we expect much of our sales for the second half of this year and beyond.
We're now operating from a position of strength with a focus on a strong high-barrier market and an exceptional flexible balance sheet. We will continue to improve on these measures as we sell the remaining non-core assets and strengthen our financial position even further.
Thank you for your time this afternoon. Before we turn it over Q&A I would like to remind everyone of our upcoming Investor Day on September 12, at our 229 West 43rd Building at Manhattan. That’s the historic New York Times building just off Times Square.
We’ll present the current state of the company, progress in our key markets and our plans and financial expectations for the next 18 to 24 months. We will also introduce you to our Senior Team and tour the property.
Thanks again for your time. With that operator we are ready for questions.
[Operator Instructions] The first question is from Brad Burke at Goldman Sachs.
Hey Good afternoon, guys. I just want to be clear on the increased disposition guidance. The only changes are that you're adding Dallas, Denver and Phoenix to the list?
That’s right, Brad. That’s the difference, there is something out there Jim.
So Brad, we have actually widened the range. Hey, Brad. We’ve left the lower end at 700 and we've increased the top to $1 billion and the reason for that is the uncertainty about timing. We’ve got some -- we had to go in the market just now, but yes, we are marketing, still you're correct. We're still marketing – we’ve got the two properties that we mentioned Cleveland and Newark and then we got these other three in the market today.
Got it, okay. So, the low end would be if you weren't able to execute the sales by the end of the year for those three that you just put on, and the high end would be if you sold all of them?
Got it, okay.
It would be a combination, but that’s right.
Any one of those pieces could -- there are -- none of them are done until they're done. So it could be, we get those three done, but we don’t get key done or something. But yes, that’s the range. That’s why we increased the range.
Well, our guidance indication of $200 million to $400 million, and we think that’s a reasonable range. We’ll update that quarter-to-quarter. As we said there is nothing -- there are no acquisitions currently, they're close or on the Board today. The team is actually looking but wouldn’t be out of question for us to do acquisitions in that range.
We’ll also -- we'll look at share buybacks as well as always, but in the near term we'll repay debt and that’s the best we can do on guidance at this time.
Okay. And speaking of guidance, and I realize you're usually conservative with FFO guidance, but even taking the high end of the range, it looks like it implies $0.35 quarters for the remainder of the year.
And presumably it's just due to the timing and dispositions, Q3 would actually be higher than Q4. Are there just too many moving parts to take that number, that $0.35 number and make a reasonable conclusion about the run rate?
Brad there are a couple of things going on, as I mentioned in my remarks, we shifted -- our GAAP essentially shifted about $0.05 of FFO into the second quarter from the third and fourth. So you would expect $0.05 or so between the two quarters lower than what you would normally have. So that’s just a little piece of it.
The other is we are going to, once we sell those assets, have a run rate that’s a good bit below where it’s been and then we’re going to build substantially from there and that’s what we've been trying to telegraph to the markets. We got good, both in terms of cash and FFO. We've got leases that haven’t commenced, you can see that in our supplemental, we have leases that have commenced, but have free rents and we had a number of those things going on.
So yeah, we do actually expect the third and fourth quarters to be a good bit lower than where it's been earlier in this year and then build up to where next year is higher than that.
The most impactful factor of course is the timing of the disposition. Second to that would be if we were able to get an acquisition done, which may or may not happen, but that’s the bulk of the movement off of norm.
Okay. And it sounds like, based on your comment that 2017 FFO would be higher than 2016, that you would expect that from that run rate in the back half of the year that things would accelerate pretty quickly even considering the three assets that you're now marketing for sale that I guess you had indicated would impact 2017 quite a bit more than 2016?
That’s correct Brad, that’s exactly right. And you are correct that if the asset sales get delayed until a later point in this year, we could wind up having the increase our range of FFO for this year and then that would change the math a bit going forward. But really where we are as assuming we got to these assets sold, we're going to have a portfolio with good growth that will build into next year.
Got it. All right, I appreciate the details guys. Thank you.
The next question is from the John Kim at BMO Capital Markets.
Good afternoon. With the Yahoo Internet business now officially sold to Verizon, what's your views on what happens to that space?
Well, we have been in touch with Yahoo! throughout and as far as we know, as far as we can tell at this time, as far as they're telling us, we don’t see any impact to that business unit. They're actually in the process of still mounting on their sign on the buildings, so all indications are that we can tell at this point is that, that unit stays intact. We don’t really know how that’s going to play out.
The good news is on that lease commitment is backed by strong financial position. Yahoo! now to be Verizon, and so we are confident that there is not a credit issue there. But we will monitor that closely and we're staying in close touch and we'll figure that out hopefully in the next couple of months, but there is nothing that we see to be concerned about at this time.
Do you have any sense if there is a lot of shadow space in the Yahoo space that they're leasing?
No. Not at this time. It seems to be fully occupied and planned to be -- they’ve plans to occupy as far as we know.
Q –John Kim
Got it, okay. Can you provide some probabilities around closing your current group of dispositions this year? It sounds like 80 Park Plaza is probably close to 100%, but maybe you can provide the same for Key Center and some of the other assets?
Yeah. So 80 Park Plaza in Newark, New Jersey is -- you are right is the most certain, they’re never done until they're closed, but we have the due diligence period has expired, there is substantial earnest money deposit at risk, our limitations are that buyers are on track to get that closed. So we're confident on that one and we feel good about that one.
Key Tower in Cleveland also as you know has been out there in the market for a while, we awarding that to a very credible buyer as well diligence period doesn’t expire for few more weeks. And again we feel pretty good about that one. But buyer is still finishing diligence pulling together capital and so forth, so not as certain about that one, but we're very hopeful about it, that’s why we awarded it to that particular buyer. So that’s feels okay.
Then the other three are earlier stage, the Denver asset we will likely award that deal in the next couple of days, can get a lot of interest and good pricing, we are very pleased with that process, feeling good about that one, but that one will just get awarded in the next couple of days and then we'll have a diligence period.
Phoenix and Dallas assets are just now coming out, strong early interest but it's very early in the process but all five of those we feel pretty good about keeping the -- probably the most largest one, but still some uncertainty there.
Okay, thanks, Nelson. And, Jim, thank you for the improved disclosure. I might as well ask you a question about it now. With the Key Center, I know this a noncore asset, but there is a big difference between the cash and GAAP NOI, and most likely that's due to a lower economic occupancy. But can you just describe what that is?
John, generally across the portfolio that’s exactly what it is. I haven’t -- I can’t answer that question specifically, but Jim and I can get back to you on that one specific if you want but that’s generally what’s happening across the portfolio.
We’ve got the straight lining of rents, that does effect and there is also leases that are on free rents. So it's some of that -- we've just done some leasing within last couple of years there and you will see that in some other properties as well.
So, generally that would be an earlier part of the lease?
Yes, it’s true. We removed Key, we removed Deloitte, we've done some other leasing there to shore that up. We're selling that property but we've got very good lease time remaining with our major chemist there and those leases were redone very recently.
We also when Key renewed they gave back a couple 100,000 square feet as you may recall, and we leased over 100 of that to a law firm. So we have a number of leases that are pretty early on in the lease process.
Okay, great. Thank you.
All right. Thanks John.
The next question is from Lauren Delmore of Morgan Stanley.
Lauren, do you have your line on mute.
Hi, I don’t have a question. Thank you though.
Yeah. Thanks a lot.
[Operator Instructions] There are no further questions. This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Mills for any closing remarks.
Okay. Well thank you very much for participating on the call today. We really appreciate your time, and attention. We're available for follow-up calls with any of you at any point of course. And we really hope you can join us for our Investor Day in New York on September 12. Until then take care. We'll see you soon.
The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.
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