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Executives

Tim Bonang - VP, Investor Relations

Adam Portnoy - Managing Trustee & President

John Popeo - CFO

Analysts

John Guinee - Stifel Nicolaus

Josh Attie - Citigroup

Rich Moore - RBC Capital Markets

Mitch Germain - JMP Securities

CommonWealth REIT (CWH) Q3 2012 Earnings Call November 7, 2012 1:00 PM ET

Operator

Good day and welcome to the CommonWealth REIT Third Quarter 2012 Financial Results Conference Call. This call is being recorded. At this time, for opening remarks and introductions, I would like to turn the call over to the Vice President of Investor Relations, Mr. Tim Bonang. Please go ahead, sir.

Tim Bonang

Thank you and thank you for joining us at an earlier time than originally contemplated. Joining me on today’s call are Adam Portnoy, President and Managing Trustee and John Popeo, our Chief Financial Officer.

The agenda for today’s call includes a presentation by management, followed by a question-and-answer session. I would also note that the recording and retransmission of today’s conference call is strictly prohibited without the prior written consent of CommonWealth REIT.

Before we begin today’s call, I would like to read our Safe Harbor statement. Today’s conference call contains forward-looking statements within meaning of the Private Securities Litigation Reform Act of 1995 and other Securities Laws. These forward-looking statements are based on CommonWealth’s present beliefs and expectations as of today, November 7, 2012.

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

In addition, this call may contain non-GAAP numbers, including funds from operations, or FFO, normalized FFO and cash available for distribution, or CAD. A reconciliation of FFO, normalized FFO and CAD to net income is available in our supplemental package found in the Investor Relations section of the company’s website.

Actual results may differ materially from those projected in any forward-looking statements. Additional information concerning factors that could cause those differences is contained in our Form 10-Q, which we expect to file shortly with the SEC, and in our Q3 supplemental operating and financial data package found on our website at www.cwhreit.com. Investors are cautioned not to place undue reliance upon any forward-looking statements.

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

Adam Portnoy

Thank you, Tim. And good morning and thank you everybody for joining us on today’s call.

For the third quarter of 2012, we are reporting fully diluted normalized FFO of $0.83 per share, compared to $0.86 per share during the same period last year. During the quarter, we signed 141 individual leases for 1.3 million square feet with 71% representing renewals and 29% representing new leases. The average term for leases entered this quarter were six years and the weighted average rental rates were 2% below prior rents for the same space. Capital cost commitments associated with leasing activity this quarter was $12.79 per square foot, or about $2.13 per square foot per lease year.

As of September 30, 2012 our consolidated occupancy rate was 84.5% which was flat with consolidated occupancy at the end of the last quarter. Our occupancy rate for our wholly-owned properties which excludes results from our majority owned subsidiary Select Income REIT was 79.7% or about 20 basis points lower in June 30th.

Generally, our CBD office properties which represent 54% of our wholly-owned portfolio NOI continue to perform better than our suburban office properties. The Metro Chicago market represents the company's largest market area with 12.6% of our consolidated NOI followed by our Metro Philadelphia market representing 10% of our consolidated NOI. In our Chicago and Philadelphia markets, almost 90% of the NOI comes from downtown office properties.

Within our other market segment, the stronger leasing areas are Australia, Austin, Texas, Seattle, Washington, Pittsburg, Pennsylvania, Boston, Massachusetts and Northern California. About 17% of our consolidated NOI was generated from these six market areas in the third quarter.

On a consolidated same-store basis, our occupancy declined 80 basis points to 83.3% and NOI declined by 2%. The decline in same-store NOI primarily reflects the decline in occupancy in our suburban office portfolio, including some expected declines in occupancy in our Denver and Washington DC portfolios.

Through year-end 2012, we have 1.9 million square feet scheduled to expire and our current estimate is that year-end consolidated occupancy will remain flat at 84.5% for the company. Also our expectation is that same-store NOI and occupancy will continue to be negative through the end of the year due to the softness in the suburban office market.

Looking forward to 2013, we have almost 5.7 million square feet scheduled to expire next year. Almost two-thirds of this expiry square feet is located in our CBD office portfolio and our industrial and other portfolio. We feel confident that we can renew or lease the space in the CBD and industrial properties at rental rates that equal to or higher than current in place rents.

As most of you know, for the last five years, we have been aggressively repositioning CommonWealth’s portfolio into high value CBD office properties with a focus on top performing downtown assets and secondary markets and second tier CBD office properties in gateway cities.

Since September 30, 2007 around the time the most recent recession began, we have acquired $3.8 billion worth of property and a majority of these acquisitions have been high quality CBD office properties. During the same five year time period, we have sold $1.5 billion worth of properties largely consisting of suburban office properties leased to medical related tenants and to government leased tenants.

Over the last several years, the most challenging part of CommonWealth’s portfolio has been on multi-tenant suburban properties. When the recession began five years ago, we knew that this segment of our portfolio was going to be difficult for the next several years. We also knew that there was little to no market to sell these properties for fair value given that the press fundamentals in the suburban markets.

The business strategy we embarked on five years ago was to largely grow our way out of the problem that existed in our multi-tenant suburban properties and to do it partially by selling some of our good performing suburban properties and replacing them with just as good, if not better CBD office buildings.

As part of this strategy, we also anticipated that suburban markets would recover within a reasonable period and that the recovery would benefit our suburban properties with better leasing fundamentals and increased property values.

Our plan has partially worked; CommonWealth has 37% more total assets as of September 30, 2012 as it did five years ago and the amount of cash flow generated from suburban office properties has decreased substantially.

During third quarter of 2012, suburban office properties generated 36% of CommonWealth’s wholly-owed portfolios NOI. Five years ago, suburban office properties generated almost 50% of our consolidated NOI.

Unfortunately, the economy did not recover nearly as strongly as we anticipated. We did not proceeded five years after the recession began, unemployment would still be hovering at around 8%, job growth would be weak; GDP would be only growing about 2% annually. And as a result, the suburban property markets would still be very weak. All this brings us to where we are today.

During last quarter’s call, I mentioned that it might be necessary to consider adjusting our dividend rate, because we were seeing any sustained improvement in the office market and especially the suburban office market during the summer months.

From our perspectives, things were steadily improving during the first six months of this year, but began with slowdown in late June and into the summer months. Since our last call, office market fundamentals have remained weak, and as a result in October, we declared a new dividend rate of $0.25 per share per quarter which represent a 50% reduction from our previous quarterly dividend rate of $0.50 per share per quarter. We decided to lower our divided rate in part because we felt that retaining more cash flow would enable us to more aggressively lease space and increase occupancy in the current difficult market environment.

As of quarter end, CommonWealth’s consolidated portfolio consisted of 526 properties with about 77 million square feet that generate about $149 million of NOI during the third quarter and had a combined net book value of $6.8 billion as of September 30, 2012. Of these 526 properties, we have currently identified approximately 275 wholly-owned multi-tenant properties located in suburban markets which we have classified as challenged in our opinion. These challenged properties have approximately 18.7 million square feet and where as a group 60% leased for an average of 3.8 years as of September 30, 2012. These properties generated approximately $17.1 million of NOI or about 11.5% of our consolidate NOI during the third quarter and they had a net book value of approximately $1.5 billion as of September 30, 2012.

Most of these properties are suburban office properties and many are located in business parks in second tier markets. Also if you removed all 275 properties we currently identify as challenged, our wholly-owned portfolio occupancy rate will increase by over 10 percentage points to 91% as of September 30, 2012. It is important to note that the current group of properties which we currently identify as challenged is not a static portfolio and this portfolio changes regularly over time as individual property and market conditions change.

Nevertheless, we want to give the market a sense of how it may further breakdown our portfolio as of September 30. Also its important to note that not all of our suburban properties are classified as challenged. There are many suburban properties which we own which are performing well. None of the properties which we currently characterize as challenged consist of CBD office properties. Said another away, if we are not embarked on our repositioning strategy five years ago these group of properties will represent a far larger percentage of our overall portfolio than it does today and CommonWealth’s operating performance would be much worse than it is today.

Over the next several quarters, our business plan is to more aggressively address our challenged properties. Part of this plan may involve selling some of our most difficult properties in the short term to remove properties from the portfolio with high vacancy and negative NOI. We have already started this process. Since the beginning of the year we have sold three suburban office buildings with almost 300,000 square feet for a combined $11.7 million.

While these sale prices may seem small, all three of these properties were 100% vacant and are producing negative NOI. Also we sold these properties at deep discounts at about 29% of their original gross investment amounts of approximately $40 million, which is calculated as before impairment charges or depreciation. Over the next six months, we plan to more aggressively explore selling some of our worst performing properties.

Over a longer period of the next one to two years, we plan to aggressively invest in the remaining properties we currently characterize as challenged in order to lease them to tenants. The increased cash flow generated from our recently lowered dividend enables us to more aggressively lease base and increased occupancy especially in our multi-tenant suburban properties. In broad brush strokes, we estimate that about 20% of the portfolio of properties that we currently characterize as challenged, maybe considered for sale in the short term in order to improve the company's overall occupancy and cash flow.

Up to a further 50% of the properties we currently characterize as challenged maybe sold over the next one or two years after we lease them. Said differently, there's a much healthier market to sell suburban properties, if they are well leased, and part of our strategy is to consider selling many of our challenged properties in the future after we get them well leased at prices we hope will be at or exceed their current net book value.

We also expect that some of these challenge properties maybe held long-term, after they are well leased because of the improved marked conditions in the future. The obvious question I know we ask is, why not sell all of the challenged properties today and get it behind us. The answer to this question is that we would seriously consider selling the entire portfolio if we felt that we can get the price that was anywhere close to their fair value in the current market environment.

With regards to acquisition, since announcing second quarter results, we have acquired three previously disclosed CBD office properties with a combined 1.4 million square feet at an aggregate purchase price of $255.5 million, including the assumption of $156.3 million of mortgage debt. These three downtown office buildings were placed under contract in the spring and it took a long time to close these acquisitions because of the process of assuming mortgage debt.

We’ve also not entered in to any new agreements of the purchased properties since May 2012. Going forward, I expect that the level of our acquisition activities will be less than in the past few years and any acquisitions in the foreseeable future will be focused on CBD office properties and will likely be funded with the proceeds from asset sales.

Finally, before turning the call over to John Popeo, I want to point out that that as of today, we have $535 million of availability under our $715 million revolving credit facility and no near-term debt maturities or committed acquisitions. We also own about $785 million worth of marketable securities in government properties income trust and our consolidated subsidiary Select Income REIT. This liquidity provides us with more than adequate financial flexibility to fund future capital requirements.

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

John Popeo

Thank you, Adam. Net loss available for CommonWealth fleet common shareholders for the third quarter of 2012 was $122,000 compared to net income of $14.7 million for the third quarter of 2011. The decline primarily reflects asset sales and investment gains recognized in the prior year. As our income increased by 8.2% reflecting rental income from properties acquired since July 2011 offset by the decline in occupancy in same store revenue from our suburban office properties.

Property operating expenses increased by 7.5% primarily reflecting property acquisitions. Other operating expenses decreased by 3.7% reflecting impairment charges and higher acquisition cost in the prior year, offset by increases in depreciation and amortization and an increase in general and administrative expense related to SIR operating as a separate public company.

Current quarter EBITDA was flat compared to the prior year, interest expense increased by 3.5% primarily reflecting acquisitions that took place over the past year. Our percentage share of government properties income trust or GOV’s net income in normalized asset fall for the third quarter totaled $2.6 million and $5.4 million respectively. We received over $4 million in GOV’s dividends during the third quarter of 2012. We recognized gains on issuance of shares by GOV totaling approximately $11 million in the prior year representing our proportionate share of the difference between GOV’s equity issuance price and the carrying value of our GOV shares.

We recognized the $5 million loss on the redemption of all $6 million of our 7.18% series C preferred shares during the quarter. Net income and normalized assets all attributable to the non-controlling interest in select income REIT or SIR totaled $4.6 million and $6 million respectively during the quarter.

Today, CommonWealth continues to own $22 million or 70.4% of SIR common shares. And because of our retained interest in SIR exceeds 50%, we continue to consolidate SIR’s financial position and results in our consolidated financial statements.

Normalized diluted FFO available for CommonWealth REIT common shareholders was $0.83 per share for the third quarter of 2012, compared to $0.86 per share for the third quarter of 2011. Year-over-year per share results primarily reflect the declined in occupancy, property sales, the SIR IPO in March 2012, and issuance of new common shares in 2011 partially offset by acquisitions.

During the quarter we spend $29.7 million on recurrent capital expenditures, which include tenant improvements, leasing cost and recurring building improvements. We generated $33.5 million of cash available for distribution or CAD during the third quarter resulting in a rolling fourth quarter CAD payout ratio of about 119% based on the all dividend rate of $0.50 per share per quarter.

After giving effect to our recent dividend reduction, the rolling fourth quarter CAD payout ratio would have been about 60% at September 30, 2012. Turning to the balance sheet, on September 30, 2012 we held $73 million upon restricted cash. During the quarter, we redeemed $191 million of 6.5% senior notes. We used the net proceeds of our $175 million offering of 30 year 5.75% senior notes in July to redeem all $150 million or our [7.18%] Series C preferred shares in August.

Rents receivable includes approximately $220 million of accumulated straight line rent accruals as of September 30. Other assets improved approximately $153 million of capitalized leasing and financing costs. On September 30, we had $1.2 billion of floating rate debt including the $350 million short-term loans and $92 million outstanding on service revolver.

At the end of the quarter, we had $842 million of mortgage debt and $2.1 billion of fixed rate senior unsecured notes outstanding. The weighted average contractual interest rate on all of our debt was around 5% at the end of the quarter and the weighted average maturity was around 5.5 years.

The senior unsecured notes are rated BAA 2 by Moody’s and BBB minus by Standard & Poor’s. The [undepreciated] book value of our unencumbered property pool totaled about $7.6 billion at the end of the quarter. At the end of the quarter, our ratio of debt-to-gross book value of real estate asset and equity investment was 48%. Our EBITDA and fixed charge coverage ratios were 2.6 times and 2.1 times respectively. As of the end of the quarter, we were comfortably within the requirements of our public debt and revolver covenants.

In summary, despite a challenging market environment, we continue to make meaningful progress towards repositioning our portfolio to be more heavily weighted to high value CBD properties. With the strong balance sheet and $535 million available on our revolving credit facility as of today, we are positioned to grow cash flow as the economy improves. That concludes our prepared remarks. Operator, we are now ready to take questions.

Question-and-Answer Session

Operator

(Operator Instructions) we will go to the line of John Guinee [Stifel Nicolaus]. Please go ahead.

John Guinee - Stifel Nicolaus

Well, Adam I have to say this, you've spent a lot of time blaming the problems on others and I guess it worked very well for someone yesterday who just got reelected, your leverage is up debt plus preferred is now over 80%, your G&A quarter-over-quarter went from $12.7 million to $14.6 million. You are on a $58 million run rate for G&A. You have concluded that greater than 50% of your assets are challenged and CommonWealth’s year-to-date performance is down 14.7% versus the [RMZ] which is up 11.2%. I don't have any questions. Thanks.

Operator

We will now go to the line of Josh Attie [Citigroup]. Please go ahead.

Josh Attie - Citigroup

The strategy that you outlined of selling and leasing out to some of the challenged suburban office properties, it seems to make sense but the environment that you described of weak leasing fundamentals and little demand for assets that have vacancy that environment doesn't really seem conducive to executing on that strategy, what, I guess what you have in the works and what gives you the confidence that you will be able to execute on any of that plan over the next six months to 12 months?

Adam Portnoy

Sure, over the short-term I think what we've been talking about is, we're going to be looking at selling some properties that are currently 100% vacant or have significant vacancy. And what we will be doing there is doing something we've been trying to resist doing for a last couple of years and we will probably have to sell on that pretty steep discount. That’s why I mentioned the properties we sold to-date although not a lot of numbers in terms of growth sales, $11.5 million, we had sold the properties at about 29% of what we originally had invested in them. So there is a market to sell vacant buildings and difficult buildings (inaudible) you going to have to sell them at a pretty steep discount.

Now, I think that’s what we're going to do as part of our portfolio, small part of it. Our goal there is as we talked about to try to just get the occupancy up and get rid of some of the negative NOIs in some of those properties. That’s not majority of what we classify as challenge. It's what I talked about before, which represents, again, what I described and outlined before is challenge only represents about 11% of our consolidated NOI and about 20% of our net book value. So I don't think, as John said before, half our portfolio but within that portfolio, as I said, about 20% of that, still call it, maybe 4%, 5% of the entire CommonWealth portfolio will be considering about just sort of selling at maybe distressed prices. Then the remaining call it, part of our challenge portfolio which sees round numbers maybe it's about $1 billion of net book value.

When I talk about turning those around, we are talking about very aggressive leasing and what I mean by that, that means entering leases that might be upside down, meaning that as many people on the call probably recognized that’s doing a deal that’s far below market but gets tenant in the building and then if you cap out the NOI two years out, you can get a value that’s close to what you have invested in the building. And so doing things a little differently than they we have done it before in trying to sell some of those buildings and I don’t think we will sell all of those buildings that we have classified as challenged, I think some of them we have been very for this first time that I have ever dissected and sliced and diced the portfolio this way for people, we are pretty liberal. There are properties in that group that I think we will be able to lease up and we will probably end up holding the long-term.

But currently challenge in the sense that they have a high amount of vacancy and the market is weak, but the fundamentals of the building are fine, the fundamentals of where it’s located are fine, its just we are in a weak market. And so that’s how I think we will execute on it. We’ll have to be very aggressive in terms of getting rid of some of the portfolio that is just sort of bleeding and then being very aggressive on another part of the portfolio that (inaudible) it up with an eye towards selling some of them over the next few years.

Josh Attie - Citigroup

And how you think about that in the context of to leverage as John mentioned it’s close to 80% with preferred’s where do you want leverage to be and how do you plan to get there?

Adam Portnoy

Well 80% on a market value obviously if you look at our book base it’s far less.

Josh Attie - Citigroup

Alright, you mentioned a lot of these assets are going to resell for less than book?

Adam Portnoy

Not a lot, not a lot. Remember, remember the numbers we are talking about, I got to be very specific, I said there is $1.5 billion of net book value with properties that we characterized as challenged. I say maybe 20% of that so let’s say $300 million; I am using [round] numbers, an estimate so around $300 million on the portfolio, remember our total assets are $8 billion total assets for the company. So keep in mind, when I am talking about, so if we sold then I am just using again round numbers, we sold that $300 million, I don't know, as what we sold the last group of properties $0.30 on the dollar and we are selling into a couple of $100 million less than what their gross book value is.

Our company can withstand that. Our hope is over the next one year to two years as we turn around some of the more challenged properties with aggressive leasing, we will be able to sell them and we are close to their net book value, so we won't be taking a write down or a loss on the sell, that's the strategy we are going to be deploying over the next couple of years. So, does that answer for your question?

Josh Attie - Citigroup

Yeah, and you mentioned in your prepared remarks, it sounded like acquisition, I just wanted to clarify your view on acquisitions or all acquisitions completely on hold until you recycle capital or is that not the case?

Adam Portnoy

And everyone say never, but I can tell that we are not putting anything on the agreement and we virtually have looked at nothing in the last six months and I expect that we are very, its very hard for us fund any acquisitions other than two assets sales at this time. So for all effective measures acquisitions are virtually on hold but does that mean I don't look at anything sure if a building happens to come up, it’s right next to the building we own, and adds a lot of synergies and just makes a lot of sense that we would own that building because its right next to a building we may already own and sure we might look at it. But again, we haven't looked at anything in six months. I think there's going to be very far view acquisitions over the next let's say at least six months to a year until we sort of straightened out and get the portfolio stabilized.

Josh Attie - Citigroup

And then you mentioned in your prepared remarks that you feel good about the CBD expirations next year, can you specifically address Glaxo in Philadelphia, it’s a big expiration, its earlier in the year, it’s a big building, what are your plans for that asset?

Adam Portnoy

Sure Glaxo, right now we are currently talking to potential tenants about leasing Glaxo. Our hope is that we will be able to make very positive announcement about that, hopefully by next quarter. Nothing’s done yet, but we are cautiously optimistic that we can lease it.

Josh Attie - Citigroup

The full building?

Adam Portnoy

At this time the full building, yes.

Operator

We will now go to the line of Michael Carroll [RBC Capital Markets]. Please go ahead.

Rich Moore - RBC Capital Markets

Yeah hi, good mornings guys, it’s Rich Moore, how are you? Actually, Adam it sounded like a pretty decent strategy to me to do what you are trying to do with the asset sales, so I was a little taken aback by the disappointment expressed so far. My curiosity is the $300 million roughly that you want to sell, should we throw that into our 2013 numbers, is that a reasonable thing to do?

Adam Portnoy

I can't guarantee it, but that's not an unreasonable number to look at, I mean maybe its $200 million, maybe its $350 million, I mean its somewhere in that ballpark that we are looking to sell over the short term, somewhere around there.

Rich Moore - RBC Capital Markets

Okay, and if I were to put a cap rate on that I mean I'm guessing most of this stuff is kind of vacant, so it doesn't have a lot of NOI, would I put a low cap rate when I sell it or is some of it actually leased up and you just don't want to keep it anymore?

Adam Portnoy

Most of the stuff we are thinking about divesting over the short term, its negative NOI, it is not going to be sold on a cap rate basis. Its going to be sold through an owner user or somebody, a local developer that has some vision that they want to do something different with the property. That's what they are going to be sold for. So its really maybe price, they are going to be sold on a price per foot basis and again using the benchmark of what we sold to-date, 29% of the gross book value, that's probably a good benchmark, it could be less, could be more.

Rich Moore - RBC Capital Markets

And then the 50% that you want to lease, is that a sort of a ‘13 activity, 2013, and then we sell all of that stuff in ’14, so I get another $700 million of asset sales in 2014?

Adam Portnoy

Yeah, I think my hope is its spread out between 2013 and into ’14, and maybe I can tell you that this leasing strategy I have outlined is not they wanted the strategy, this strategy should have been migrating in this direction for several months, but I think we went into full gear with this strategy about after the second quarter. So we've been, its already started and I expect we will start to see some of it in the fourth quarter numbers that really come into play in 2013. But I think you will, I don't think its just going to be, we do all the work in ’13 and so in ’14 my hope is that we do some of it this year and sell some of it in ’13 and so sell some of it in ’14.

Rich Moore - RBC Capital Markets

Okay, and then, how are you marketing this stuff? Are there packages you are putting out that maybe haves multiple assets in them or you just sort of seeing the brokers, there’s a whole bunch of assets, go at it, do what you want to do. I mean, what's the basic strategy behind getting rid of 200 plus assets?

Adam Portnoy

Right, again of the 275, I am not sure we will get rid of all of 275. I was very rude when I characterize this as challenge. But first step is a step process. First the properties that are, they got 100% vacancy and negative NOI. Luckily, that’s not a lot of properties, but certainly as we talked about the numbers, we have been throwing around the call, around 300 million of gross investment values. Those properties, they are going to be sold in many different ways. They are going to be sold one-off. They could be a couple that could be packaged together, but they are really sold at the very much the local level.

I don’t expect that they would be sold as a package because the type of buyer is really, again it's the local owner user or local redeveloper or developer thinks they can do something with it. As you enter ‘13 and ‘14, as we think about some of these properties, it could be some packages and portfolios that we put together that we would then take market in a marketed sales efforts. But I think that before we can do that, we got to execute on some of the leasing and that’s where we got to do now and even in to 2013, but it's sort of very different the way we will be selling some of these properties over the short-term versus how we envision selling some of these properties later. I think we're a little bit more organized. You know, through a brokerage maybe, a sub-portfolios in ‘13 and ’14, but over the short-term, it's going to be much more one-offs.

Rich Moore - RBC Capital Markets

Just last thing on this, if you sell 20% of 250 assets that you sell, 50 assets over the next year or so. Is it going to be a fair question when we get on the call next quarter to say, hey Adam you got 50 assets you were trying to sell, there is only two that you sold in the quarter or should I expect to see 8 or 10 and possibly in the supplemental let’s say I have sold 8 or 10, is this really going to progress at this rate where we can monitor it quarter-by-quarter.

Adam Portnoy

Short answer is yes; that’s where we are currently engaged and trying to do. I can’t guarantee but it’s going to be the much more robust rate, then the one you’ve seen in the last first nine months of this year.

Operator

(Operator Instructions) We will now go to the line of Mitch Germain. Please go ahead.

Mitch Germain - JMP Securities

Adam what’s the criteria for determining what’s for sale versus what do you want to invest and try to lease. What are the criteria or the items that is it location, is it age of the asset, what specifically is differentiating one versus the other?

Adam Portnoy

It’s a whole bunch of stuff Mitch. Generally there are some portfolios that we have looked within the group that we have thought about as a group or sub-portfolio because of their geographic location and I won’t disclose it on this call because I don’t think it’s appropriate, but there are certain groups that fit into certain geographies that may be make sense for us to get out of. There are others that are property type, meaning of this 275, there could be a group of 15 that's a whole business park and what I call second tier market.

Well maybe it make sense to get out and maybe not all 15 of the properties are really struggling, maybe its 9 and 6 are well leased. So maybe it makes sense to sell all 15 properties into that business park, that's how we think about it. That gives you a flavor, but of course it depends on market conditions, it depends on how well leased, it depends on how the age of the building all of things you mentioned, you go into the calculus.

Mitch Germain - JMP Securities

And it just describes, I mean you talked about investing in some of this properties leasing them, and clearly some of those leases are going to possibly be under water on a net effective basis. Why even go to that measure and why not just try to sell these properties as it is and take an impairment to that?

Adam Portnoy

Yeah, it’s a good question Mitch. The answer is that just being in market everyday there is vastly different market for - buyers are just - the valuation you get for a vacant building are very high vacant building with lower occupancy, its far different then you get for a building that’s get occupancy. So if I could do maybe, the gain we are talking about is the gain that a lot of the developers do. They enter in to a lease, (inaudible) upside down leases are negative net effectives because it gets them two years into the lease a pretty healthy cash flow which they can then cap and then they get some almost out or maybe even better then their investment. So its certainly the game of okay, you show a building today that’s vacant and maybe you get, just for example to say $0.20 to a $1 versus if I do a very aggressive lease and we get it leased up, it’s a 100% leased in two-three years into it, its going to be cash volume you know X and you put a cap rate on that X someway I can get $0.90 to $0.95 on the dollar.

That's the game we are playing, I mean it’s just, it doesn't make sense in our minds to just sell to all these properties today because the value we get in marketplace would be so much lower than if we try to lease some of them up. But at the same time, it’s sort of a balanced approach. I'm saying to everybody, we are going to do that with some of these properties. There are some properties not all but there's definitely some properties that we are going to take, we are just going to bite the bullet and take the position that you are advocating Mitch which is look let's just get rid of these.

They are vacant, it’s going to be too hard to lease them up, it’s going to be too costly, it’s too much of a drag on occupancy and NOI. So let's just sell those. We are going to do that with a portion of it. And we want to try and do that over the short-term, a little longer-term one years to two years, when I try to turnaround some of, get some of those buildings leased up and then try to sell them but we think would be much better value. We think it’s much better for stakeholders in the company to sell properties 18 months from now let's say $0.90 on a dollar, a $1 to $1.10 on a dollar than sell it today for $0.20 to a dollar. That's what we are trying to do.

Mitch Germain - JMP Securities

They are also easily financeable I'm assuming with occupancy. Last question Adam, it seems like obviously this is a bit of a strategic shift, right, I mean shifting away from growth in CBD to more now, pairing down the suburban if that's a good way to put it, you skirted around specifically what you are looking to do with some of the proceeds from these sales right, maybe if you can get a bit more specific, is it going to be shifting back to CBD reallocating that capital or is it going to be addressing leverage which clearly remains a huge concern with investors?

Adam Portnoy

Yeah, I think well, I'm not sure if we got, if we sell something below book value, it would take down leverage. I'm not sure we helped our leverage ratios much or so I think we are going to end up, I think where we are biased towards is try to take the proceeds and in a majority of instances reinvest it into CBD properties. That's what we are going be doing. I'm not sure of taking the proceeds; we are just going to be shrinking the company at the same time. So we will take down debt, we are taking down the asset at the same time. So shrinking the company and taking down the assets I mean if I could sell something for $2.00 on a dollar and we pay debt well then yeah, but I'm not sure that's where we are, that's not what we are talking about doing here.

Mitch Germain - JMP Securities

And just to confirm when you kind of talk about this bucket of properties, you are excluding any assets that you are currently warehousing or that currently SAR has right to first [refusal] or is that or those properties are also included in that 275 that are looking to be sold down the road?

Adam Portnoy

No, if any properties that, no they are not included in the 275 because they are not challenged anything that could (inaudible) we will be challenged. Yeah, if anything could be sold that could fit in the criteria is obviously 100% net leased so that's why.

Operator

And speakers there are no more questions in queue. Mr. Portnoy, please go ahead with your closing remarks.

Adam Portnoy

Okay, thank you all for joining us on the third quarter conference call. We look forward to seeing many of you at the NAREIT Conference in San Diego next week. Thank you.

Operator

Ladies and gentlemen that does conclude our conference for today. Thank you for your participation and using the AT&T Executive Teleconference. You may now disconnect.

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