Education Realty Trust, Inc. Q1 2008 Earnings Call Transcript

Education Realty Trust, Inc. (EDR)

Q1 2008 Earnings Call

April 29, 2008  10:00 am ET

Executives

Bartley Parker – Investor Relations

Paul Bower - President and Chief Executive Officer

Randy Brown - Chief Financial Officer

Craig Cardwell - President, Allen & O Hara Education Services

Tom Trubiana - Chief Investment Officer

Analysts

Anthony Paolone - J.P. Morgan

Craig Melcher, CFA - Citigroup

Michael Bilerman - Citi

Karin A. Ford - KeyBanc Capital Markets

Napoleon H. Overton - Morgan Keegan

Alexander D. Goldfarb - UBS Securities LLC

Richard Paoli – APG Investments

Presentation

Operator

Ladies and gentlemen, thank you very much for standing by and welcome to the Education Realty Trust first quarter conference call. (Operator Instructions)

I would now like to turn the conference call over to Bartley Parker, Investor Relations. Please go ahead, sir.

Bartley Parker

Thank you. Good morning, everyone.

During today's call management may make forward-looking statements. These statements are based upon current views and expectations. Such statements are risks, uncertainties and other factors that could cause the actual results to differ materially from future results expressed or implied by these statements. Risk factors relating to the company's results and management's statements are detailed in the company's annual report on Form 10K and other filings with the Securities and Exchange Commission. Forward-looking statements speak only of expectations as of the date on which they're made. Education Realty Trust assumes no obligation to update or revise such statements as a result of new information, future development or otherwise.

It is now my pleasure to turn the call over to Mr. Paul Bower, Chairman, President and CEO. Paul?

Paul Bower

Thank you, Bartley, and good morning everyone.

Joining me on the call today is Randy Brown, our Chief Financial Officer. Also present today to answer any questions you may have about operations is Craig Cardwell, president of our management subsidiary, Allen & O Hara Education Services, and Tom Trubiana, Chief Investment Officer, here to answer any questions regarding the acquisition climate.

First I'd like to provide an overview of the quarter. I will then ask Randy to provide some additional details and discuss our guidance for 2008.

Our FFO of $0.30 per share for the first quarter of 2008 represents an increase of approximately 3.4% over the first quarter of 2007. Our results for this quarter do not include $5 million of the lease termination payment from Place Properties, Inc. Randy will provide additional detail on this in his comments, but we believe this accounts for the difference between our reported results and the average first call estimate.

Operationally, we are pleased that our Student Housing Leasing, Development and Third-Party Management Services each contributed to our core revenue growth for the quarter.

Our Student Housing Leasing revenue on a same community basis continues to demonstrate good net apartment rent growth of 3% and stable physical occupancies at approximately 95%. The 95% physical occupancy at the end of March when we opened the school year at 96% demonstrates very good resident retention for this business.

Our operating margins were impacted by some unusual items, which Randy will explain in further detail. Nevertheless year-over-year margin improvement continues to be a key component of our strategic plan, with our focus on improving both revenues and containing costs.

As we reported in our fourth quarter call in February, pre-leasing for the 2008-2009 school year is on plan and consistent with where we were at this time last year. As of April 24, 74.3% of our beds are preleased for the upcoming year. Fall 2008 rental rate increases are in the range of approximately 3%, which is also consistent with our prior guidance.

While on the subject of leasing, let me also bring you up to date on the status of the 13 Place properties. We took over management of these properties on February 1. As the property owner, we knew the condition of the properties was sound as we had been funding and observing capital improvements since the lease commenced in January 2006. Since taking over as manager, we have integrated the leasing systems with our own, retained nine of the 13 previous property managers, hired or promoted four new managers to fill the open positions, and worked with all staff to ensure that they are properly motivated through training and compensation.

The leasing activity for the Place properties is on track with our expectations, with 51.3% pre-leased for the 20082009 academic year as of April 25 compared to 52.1% for this time last year. While the occupancy and rental rates for these rental properties are below that of the other properties in our portfolio, we believe that with our management team and the changes we have put in place, along with some more refinements to come, we have a very solid internal growth opportunity in the coming years.

Our Third-Party Management revenue for the first quarter of 2008 benefited from the solid work we did signing contracts in 2007 and the operating improvements we have been able to make to those properties. We did not sign any new management contracts during the quarter, though we remain active in the process of negotiating for work when and where the opportunity occurs. Naturally we will report any new contracts at the time they are locked down contractually.

Turning to our Development activity, our third-party development fees grew a very solid 71% for the quarter compared to the same quarter one year ago. This quarter we began work on the first phase of a 1,200 bed multiyear building project at West Chester University in Pennsylvania. This development will replace obsolete dormitories with a stateoftheart housing community that provides an integrated living and learning environment for their students. Additionally, the project helps us extend our development activity further into the Mid-Atlantic region and toward the Northeast, two areas that are important targets for future growth.

This project was financed by a $100 million tax-exempt bond issue on behalf of a subsidiary of the university's foundation. This bond closing represents the largest single project financing for a new development in our long history.

I would also like to point out that at the end of the quarter we had a solid base of $6.5 million in fees to be earned from our third-party development services and we are active in the RFP process for new work for new development work, though many of these projects take a year or two to work out the details from initial contact to a committed venture.

As we have stated, development for our own account is a high priority for us given that the yields these projects offer are higher relative to purchasing stabilized property. Early indications are that we have followed last year's successful development project at UNC Greensboro with a strong offering at Southern Illinois University in Carbondale, Illinois. The project remains on schedule to open this fall, on budget from a development cost standpoint, and was 87.1% pre-leased at favorable rates as of April 24. The success to date with this project encourages us to embark upon the second phase at the proper time. The second phase of 96 units or 240 beds is incrementally attractive due to the infrastructure funded with phase one.

With that overview on the key drivers of our performance in the first quarter let me now turn it over to Randy to provide some additional detail on our reported financial results and guidance for the year.

Randy Brown

Thank you, Paul, and good morning everyone.

Core revenue excluding expense reimbursements increased 13.6% year-over-year. Our Student Housing Leasing revenue this quarter includes two months of revenue from the Place properties, while our other leasing revenue includes only one month of revenue for the January least payment received from Place.

As Paul mentioned, we did not recognize $5 million of the lease termination fee from Place Properties this quarter as previously expected. We did recognize $800,000 of the termination fee and expect to recognize the remaining $5 million in the second quarter of this year when we finalize the release of the letter of credit we required Place to provide to secure the lease payments at the time the non-terminated lease was signed.

Our operating expenses reflect some unusual items that influence the comparison of this quarter to same quarter of last year. For example, as I discussed during our last earnings call, the first quarter of 2007 operating expenses reflected a $225,000 property tax refund, making the comparison to first quarter 2008 appear higher than usual.

Additionally, we recorded a non-cash loss of $512,000 on the sale of the parking garage and a parcel of land at University Towers in North Carolina. As was outlined in our IPO documents, the University Towers property, including the garage and adjacent land parcel, was contributed to EDR at the time of the IPO with the stipulation that the garage and land be sold back to our local JV partner, who originally owned the land, in exchange for cash and the redemption of his operating partnership units. However, since those assets were part of the original mortgage collateral, the lender was not willing to release the partial liens until the loan matured. Having paid off the loan during the first quarter, the leases were obtained and we were able to complete the sale.

In addition to normal closing costs, the cost of the sale reflects the difference between the operating partnership unit price, which was based on the IPO share price, and the market share price at the time of the sale.

The impact of this onetime loss is included in the Student Housing Leasing operating expense section of our financial statements and has been added back to net income for FFO calculation purposes.

Our G&A expense for the first quarter of 2008 increased approximately $450,000 on a year-over-year basis as part of our continued investment in the company's infrastructure to facilitate the growth and the development and management of our portfolio.

Lower debt levels and a favorable interest rate environment helped total nonoperating expenses decline 17% to $6.3 million in the first quarter of 2008 from $7.6 million in the same period last year. Interest expense, the primary component of non-operating expense, was the main driver of this reduction.

Looking at our same community operating results, revenue increased 3% for the first quarter of 2008 as compared to the first quarter of 2007 primarily driven by a 3% increase in rental rates.

Excluding the impact of the previously mentioned one-time items, net operating income increased 2% for the quarter of 2008 as compared to the prior year.

From a capital structure perspective our position remains very favorable with respect to our ability to execute on our growth plan. We had total debt of approximately $430 million, which amounts to approximately 50% of gross assets at March 31, 2008.

Of the amount outstanding on our line of credit, $19 million relates to the funds we used to repay the mortgage on the University Towers property. And while the rates on our line of credit are favorable given the decline in short-term rates, we are currently in discussions to secure permanent financing for this amount. And though the debt markets remain volatile, there continues to be the availability of financing for student housing communities from Fannie and Freddie Mae at very favorable pricing levels. We have ample resources on our line of credit and the ability to access the equity in our 13 unencumbered properties for additional financing to fund our growth plans as needed.

Turning to our overall earnings guidance, based upon our current estimates we continue to expect FFO per share in units to be in the range of $1.02 to $1.07 for the full year ended December 31, 2008. As a reminder, this guidance includes a net positive impact in 2008 of $0.12 to $0.13 per share in connection with the Place transaction.

While we continue to work on growing our business and creating value for our shareholders, in an effort to be conservative our guidance does not include the assumption of additional NOI from future acquisitions and developments.

Now let me turn the call back over to Paul for some closing thoughts.

Paul Bower

Thank you, Randy. Let me conclude by saying that with our portfolio's performance and steady business plan in today's turbulent economic environment, Education Realty is well positioned to outperform. When conditions improve we expect to participate in a more dynamic and aggressive growth cycle, but in the meantime we expect to make steady progress in improving the cash flow and the value of the company.

Though the media has reported the withdrawal of several lenders from the government's subsidized student loan program, which augments the ability of students and parents to pay for college education, we believe there remains good liquidity in the lending market. There are over 2,000 lenders still participating in the program according to the Department of Education. There is federal support for the student loan program and stepped-up financial aid from universities assuring that there will be sources of liquidity for students. It is important to remember that the student housing industry has demonstrated solid and consistent operating characteristics throughout a wide range of economic cycles.

We thank you for your interest and attention, and now we welcome the opportunity to answer any questions you may have.

Questions-and-Answer Session

Operator

Thank you, sir. (Operator Instructions)

Your first question comes from Anthony Paolone - J.P. Morgan.

Anthony Paolone - J.P. Morgan

Do you guys find yourselves having to make any rent concessions or other sorts of concessions in the Place portfolio to help in that lease up at this point?

Craig Cardwell

Tony, this is Craig Cardwell, and the answer is no.

Anthony Paolone - J.P. Morgan

So, for instance, in the now-consolidated portfolio it seems like the year-over-year occupancy difference is down about 200 bips, and I would assume that's because of Place. And so is that kind of where you think things should run out going forward, like that full impact of Place is kind of in those numbers?

Craig Cardwell

Well, we're pretty optimistic about the going forward opportunity with Place even to this fall. As we know, last fall they didn't have the strongest opening, and I'm sure they were as disappointed as we were. But we expect some definite physical occupancy improvement this fall compared to the last fall. And we're not ready fully to predict what the rents might be, but we're not giving any kind of concessions other than a spot concession here or there to an individual. So there's nothing that's broadly throughout any specific market for Place.

Anthony Paolone - J.P. Morgan

And then on the expense side in the portfolio, the 4.4% core expense growth, it seems to be a little bit above the normal inflation numbers. Anything driving that and any sense as to what that might look like going forward?

Randy Brown

Well, we still believe that we're going to be within the 2% to 3% guidance range on a full year basis. There are some up and down swings and variabilities within a quarter. We had a few one-time expenses here and there. But we still feel pretty comfortable that we'll be within our guidance on the operating expense side.

Anthony Paolone - J.P. Morgan

And then anything in the hopper for developments, starts, near-terms for potential deliveries for the '09-2010 school year?

Tom Trubiana

Tony, this is Tom Trubiana. In addition to looking at the second phase of Saluki Point, we currently are looking at six or seven different markets in sight. And whether anything would be delivered, there's potentially one that might be delivered for 2009, but candidly, we're getting to the point now where you're looking at more of a 2010 delivery because of lead time and construction time.

Operator

Your next question comes from Michael Bilerman - Citi.

Craig Melcher, CFA - Citigroup

It's Craig Melcher here with Michael. Paul, I just want to go back to the comment, I think you said at the beginning you'd said there's 3% rent growth so far in the pre-leasing. Is that correct?

Paul Bower

Yes.

Craig Melcher, CFA - Citigroup

And I think last quarter you were saying you were targeting 3% to 4%, so are things coming in at the lower end of expectations or am I reading into that too much?

Paul Bower

Well, I think it's too early to make that judgment. I think 3% to 4% is still a pretty good range.

Craig Melcher, CFA - Citigroup

And on the Place properties leasing, what's the rent growth you're achieving on that so far?

Craig Cardwell

This is Craig Cardwell. We're looking at 3% for the Place portfolio.

Michael Bilerman - Citi

This is Michael Bilerman speaking. Could you talk a little bit about the refinements that you're planning in the Place properties?

Craig Cardwell

Yes. Once again, this is Craig Cardwell. A lot of the things that we're doing have to do with actually increasing the operating expenses. You may know that their operating expenses run considerably below ours, about 10% below ours, and their rev path runs 25% to 30% below ours. And frankly, their expenses are a little too thin. They did not have enough Internet bandwidth, for instance, and that doesn't help you lease.

They were very focused on the kind of technology side of leasing, and we're focused very much more [oneonone] leasing and we think that we'll have a better absorption and take rate from that. There's a number of advertising things that we've done, some training platforms that we've put in place.

So it's very much of a broad menu of all of the characteristics that we introduce into a property of a portfolio of properties when we take over, and those are just a few examples of it.

Craig Melcher, CFA - Citigroup

And then on the University Towers, getting a new mortgage for that, what type of rates could you get from Fannie and Freddie today, and how's the LTV compare to the existing loan?

Randy Brown

This is Randy Brown. We're currently looking to reduce our all in interest rate by at least 100 basis points from what the rate previously was. The previous rate was 6.7%, so we feel pretty confident that we're going to be able to secure financing from Freddie and Fannie at probably 100 basis points below that.

Michael Bilerman - Citi

What sort of leverage levels would you be targeting?

Randy Brown

Well, you know, our comfort level overall is between 45% and 50%. Right now we're at, given today's share price, we're closer to like 51%. So on that particular property we're looking to put no more than 50% to 60% leverage, and any excess that we derive we'll use to pay down our credit facility.

I think overall the question is really overall towards what is the market condition for leverage right now just on a oneoff situation. I think that most of the agencies are still comfortable lending up to 65% is what I'm seeing right now. Now, obviously that's down from the LTVs that we saw this time last year, but they're still active.

Craig Melcher, CFA - Citigroup

And in terms of the 2009 debt maturing, the $285 million, do you see any potential issues there and what type of leverage do you think you'd get on those? What would you need on those to get the proceeds out?

Randy Brown

That really has about 14 to 15 months to go, so it's really very early in the process of looking to refinance that right now. We have had preliminary discussions with a couple of different lenders on strategies to refinance that, but it's early right now for us to be coming up with definitive plans on that right now. I don't know of any problems, though.

Operator

Your next question comes from Karin A. Ford - KeyBanc Capital Markets.

Karin A. Ford - KeyBanc Capital Markets

I wanted to follow up on Craig's question about pre-leasing. It seems like from the last call to this call, while preleasing still seems really good, it just seems like you're not pushing rents quite as hard as you were and you're not quite as ahead as you were on the fourth quarter call. Would you say that the leasing environment's getting a little more difficult as you're pushing through the leasing season? Is that accurate?

Randy Brown

That would be inaccurate. I think the leasing is going just fine. It's about where we would expect it to be. You'd always like to be a little more ahead. But if you broke it down by individual properties, we have some that are pushing ahead just fine, some that are lagging a little bit. There's always little variabilities in the market.

It's just like if you're on one end of the beach or the other end of the beach. The waves move in to the shore just a little bit differently, but they all get to the shore. And so we still feel pretty comfortable that we're going to get home this fall at about the same occupancy we did last fall.

Karin A. Ford - KeyBanc Capital Markets

Is there a particular geography or type of market that is doing better or worse within your portfolio today?

Randy Brown

Not really. Some people have suggested maybe the Midwest is not the place to be, but by and large our Midwestern group of properties, like at Penn State and Missouri, those places are doing fine, and Florida's doing just fine. So we're not finding any overwhelming strength or weakness. These are students going off to college, and the colleges that we've decided to do business at are doing well and so we're generally doing well.

Karin A. Ford - KeyBanc Capital Markets

The last question is just on your Third-Party Contracts Management Development, I know you said you'll tell us when you sign new contracts. Can you just talk about what your pipeline is, how many RFPs you guys are working on these days?

Paul Bower

Well, it's hard to give you a count. They seem to come in every other day or so, several a week quite often, at different times of the year. So I don't have a list or a count right now, but there are a number that are in various stages of discussion.

Karin A. Ford - KeyBanc Capital Markets

Are any of those looking for potential on-campus ownership by EDR?

Paul Bower

Yes.

Operator

Your next question comes from Napoleon H. Overton - Morgan Keegan.

Napoleon H. Overton - Morgan Keegan

Craig, you may have already answered this question but the 2% same store NOI growth in the first quarter net of the unusual charges was a bit below the 3% to 6% range that was a part of the guidance for the year at the end of the fourth quarter. Is that still waves coming in on the ocean answer?

Craig Cardwell

It is.

Napoleon H. Overton - Morgan Keegan

It is?

Craig Cardwell

Good perception. That was just a little bit anomalous. And there'll be a little bit of variation from month to month and quarter to quarter, but we still think that the operating expense increase range and the guidance of the 2% to 3% is still right there.

Napoleon H. Overton - Morgan Keegan

And could you explain, is there a holdup in collecting a portion of that $5.8 million fee from Place? And what was the $800,000 that was recognized in the first quarter, how did it get split?

Randy Brown

Nap, this is Randy. The termination fee was $5.8 million. $5 million of that centered around our release of a $5 million letter of credit that we required Place to put up when we entered into the lease transaction. It's our understanding that that letter of credit was collateralized with a $5 million certificate of deposit. So part of the agreement in terminating the lease was that we would release the letter of credit back to Place so they could then take their funds out and pay us the $5 million.

Now when the lender, which, by the way, we had to go to the lender to get approval to enter into the lease transaction, when GMACC gave the okay to do this lease they saw this letter of credit that we had required and they said well, we'd like to be a co-beneficiary on that letter. The last thing we would want was for you guys to pull down $5 million and then default on the mortgage. So we said that would be appropriate and we allowed that. And unfortunately, being the large institution that they are, it's just taken longer for us to get their approval and their release so we could then get the letter of credit and give it back to Place.

So it's a matter of just timing. We've already gotten two of the three needed levels of approval within the loan servicer, so it's just a matter of timing to get them to finish their paperwork and get the letter of credit back to us.

The $800,000 that we recognized was basically just tied to installment payments that we had agreed that Place could make. And they've made those installment payments in accordance with what we had agreed to, so we went ahead and recognized the $800,000. And, as I said, we're just waiting on the final release of the letter of credit so we can wrap up the $5 million.

Napoleon H. Overton - Morgan Keegan

Over what period of time would the $5 million - is that on an installment basis also?

Randy Brown

No, no. At the time that we surrender the letter of credit back to Place then we get $5 million back from them at that point.

Napoleon H. Overton - Morgan Keegan

And then your follow up on the Third-Party Development Management revenue question, did you provide some guidance or would you provide any guidance on what you expect the Third-Party Development income for the year to be?

Randy Brown

Well, Nap, I'm sure you've got the information there. We've talked about Third-Party Development Management fees on a combined basis and $8.5 to $9.5 million. I think you could prorate that in the same percentage as how we recognized management fees and development fees for 2007. I think that would be appropriate.

Napoleon H. Overton - Morgan Keegan

And can you share any information with us on what the full year revenue and net operating income and maybe rev path was for the Place portfolio last year?

Randy Brown

Well, we haven't shared that. We haven't provided that. And keep in mind a lot of that information was basically maintained by Place themselves. There has been audited financial statements that we included historically with some of our filings, so you can kind of get a sense there what the revenue stream was. But since Place was primarily responsible for calculating that, we haven't released that.

Napoleon H. Overton - Morgan Keegan

And then the $512,000 loss, is that number in the $12,085,000 in the leasing operating expenses?

Randy Brown

It is. It was recognized as an operating expense on the University Towers operating property statements, so it is in that operating expense number.

Operator

Your next question comes from Alexander D. Goldfarb - UBS Securities LLC.

Alexander D. Goldfarb - UBS Securities LLC

Just a question, I'm sort of getting to the capital side of the equation. What are you guys' thoughts on maybe bringing in a JV partner for a sizeable stake in the company to help alleviate some of these capital needs, like, for example, the '09 roll, and help provide you guys with a bigger capital base to do more things?

Paul Bower

Well, we've chosen to this point to bring in a JV partner on a one-off transaction, and we've done four of them so far with two separate JV partner. And that's a strategy we're pursing at this point in time. We will give consideration to what you've suggested, and we do always think of things like that as alternatives. But to this point in time we think it's more favorable to do it on a one-off basis.

Alexander D. Goldfarb - UBS Securities LLC

Are you actively engaged in talking on more one-off bases?

Paul Bower

Oh, yes. Yes.

Alexander D. Goldfarb - UBS Securities LLC

Is there anything that you think may get announced in the next six months or so, six to 12 months?

Paul Bower

Well, it's just hard to say. As Tom said earlier, time of the year has a lot to do with it. If it's a new build then probably not because of the time it takes to put that in place. If it's an acquisition, it very likely could happen.

Operator

Your last question comes from Richard Paoli – APG Investments.

Richard Paoli – APG Investments

Just a follow-up question on the rent growth for the year, well, at least for the upcoming school year. Did I get it right that you said that you have on average about 3% increases baked in the 74% that's pre-let?

Randy Brown

Well, in our guidance, and we still are following through on our belief in this and basically the way it's leasing up, it's in the 3% to 4% range with Place being more at the 3% end of it.

Richard Paoli - APG Investments

Right. I thought somebody had mentioned in their commentary that for the 74% of pre-leasing that is done for the upcoming school year that you were seeing rent increases of 3%. Was that just a rounding number?

Randy Brown

Yeah. It was rounding, rounded down a little bit.

Craig Cardwell

It was approximately 3%, I think, is what the comment was.

Randy Brown

Yeah, right.

Richard Paoli - APG Investments

Because if I just do some quick math for the 26% left to lease in order to get to the midpoint of that 3% to 4%, you'd have to do somewhere around 5% increases. And I'm just curious, is that a normal flow? I mean, do the rent increases pick up momentum into, I guess, the latter stages? Is that when you tend to press the accelerator? What is the strategy in terms of what do you normally do with respect to the lease up? When do you really step on the gas?

Craig Cardwell

Basically you put the gas in the tank and you step on the gas in about November or December. And you just kind of keep pushing and you push it a little bit more as you go through the season. And that's certainly going to vary by market. Some markets lease up a little earlier than others; most people in the industry would I think chime in on that matter. And overall we still feel fine with 3% to 4%. It tends to move a little bit more toward the end, but it doesn't go to 6% or 7% or 8% or 9%, typically. So you've still got to fill all the beds.

Richard Paoli - APG Investments

Would it be safe to say at this point you're signing leases or getting leases [except for] increases that are greater than 3% at this point?

Craig Cardwell

Yes.

Operator

Thank you. At this time there are no further questions. I'd like to turn it back to Mr. Bower for his closing comments.

Paul Bower

Well, we appreciate everybody's attention, your good questions and continued interest in EDR. 2008 is off to a good start. All signs point in the direction of an exciting year growing the business and creating shareholder value. And we thank you for joining us today and have a great day.

Operator

Thank you. Ladies and gentlemen, this does conclude the Education Realty Trust first quarter conference call. You may now disconnect, and thank you for using ACT teleconferencing.

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