TIER REIT, Inc. (NASDAQ:TIER) Q2 2016 Earnings Conference Call August 9, 2016 11:00 AM ET
Telisa Schelin - Chief Legal Officer
Scott Fordham - CEO
Dallas Lucas - CFO
Rob Stevenson - Janney
Anthony Paolon - JPMorgan
Welcome to the TIER REIT Second Quarter 2016 Earnings Conference Call. [Operator Instructions]. It is now my pleasure to introduce your host Ms. Telisa Schelin. Thank you Ms. Schelin, you may begin.
Welcome to the TIER REIT Second Quarter 2016 Earnings Call. I'm Telisa Schelin, Chief Legal Officer for the Company. Before we begin, please note that statements made during this call that are not historical may be deemed forward-looking statements. Future events and actual results, financial or otherwise, may differ materially from events and results discussed in the forward-looking statements due to a variety of risks and uncertainties, many of which cannot be predicted with accuracy and some of which might not even be anticipated.
Please refer to our filings with the Securities and Exchange Commission, specifically the annual report on form 10-K for the year ended December 31, 2015 for a detailed discussion of these risks and uncertainties. It is also important to note that today's call may include time sensitive information that may be accurate only as of the relevant date to which it relates. We assume no obligation to update or revise any forward-looking statement, whether as a result of new information, future events or otherwise.
I will now turn the call over to Scott Fordham, Chief Executive Officer of TIER REIT.
Good morning everyone and thank you for joining us today for our second quarter 2016 earnings conference call. In addition to Telisa, in the room with us today are Dallas Lucas, our Chief Financial Officer and other members of our Management team.
On today's call, I will update you on our second quarter accomplishments and progress against our long term strategy. And then I will turn the call over to Dallas, who will review our quarterly financial and operational results, our updated 2016 guidance, certain of our key markets and our balance sheet. Following our prepared remarks, we will open up the call to questions from sell-side analyst. We're pleased with our second quarter results as we made strong progress on each of our strategic goals for the year.
Our quarterly results were slightly ahead of expectations and show the benefits we're realizing from our leasing efforts over the past several quarters, as well as the benefits of our internalization of property management and lower borrowing cost. With the sale FOUR40, a 39 story, 1 million square foot office tower, located in Chicago Central loop for a $191 million. We continued the execution of our plan to exit non-strategic markets and enhance our portfolio's focus within our targeted growth markets. Year-to-date, we have sold approximately $260 million of assets and we're pleased with our pricing achieved so far. We anticipate completing the sale of additional non-strategic properties prior to year end. During the quarter, we completed 193,000 square feet of new, renewal and expansion leases and ended the quarter at 90.4% leased.
We continue to make progress on our 2017 lease expirations in Houston executing a 50,000 square feet lease with Lubrizol, a sub tenant at One BriarLake Plaza and subsequent to quarter end, we completed an additional 9500 square feet early renewal with Farmers Insurance at our One Eldridge Place property in the Energy corridor of Huston. We're making steady progress on our development and redevelopment activities. Construction at Domain 8 in Austin is proceeding as planned and we expect to deliver the space in early 2017 into a market that continues to show very healthy demand and strong rental rate growth. Additionally, we're over 25% complete with our $25 million redevelopment project at Bank of America Plaza in Charlotte.
Due to the excitement around this project and continued momentum in the market, rent growth continues to be strong and we look forward to delivering this new space in the spring of 2017, further energizing the corner of Trade and Tryon in Uptown Charlotte. We continue to strengthen our balance sheet utilizing a portion of the proceeds from the sale of FOUR40 to repay borrowings outstanding under our revolving credit facility. And subsequent to quarter end, we repaid $63 million of higher coupon secured debt, allowing us to further reduce our borrowing costs and create additional balance sheet flexibility. As we progressed through the second half of 2016, we intend to create additional balance sheet flexibility through the sale of other non-strategic assets. We're progressing toward the sale of our Wanamaker property in Philadelphia in certain of our properties located in Louisville, Kentucky.
We believe we're selling these assets at a point in the cycle when it is prudent to do so and we intend to announce full details as each transaction is completed. Provided the successful execution of these property sales. We will have substantially completed the strengthening phase of our strategic plan, focus on solidifying our balance sheet. This will position us to recycle proceeds generated from further sales into future targeted acquisitions and development opportunities. However, we remain patient and will only pursue opportunities that align with our focused strategy and demonstrate a clear path to long term value creation for our stockholders.
Along these lines, we continue to see high quality tenant demand for new office development at our premier land sites within Austin. And while remaining disciplined, we continue to pursue opportunities to create additional stockholder value through development, provided our risk is appropriately managed. In the meantime, we will continue our efforts to create additional value within our high quality strategic portfolio and execute on the sale of our marketed assets.
I will now turn the call over to Dallas, who will provide more detail in his remarks. Dallas?
Thanks, Scott and good morning everyone. For the quarter our financial results were slightly ahead of expectations as a result of stronger portfolio operational performance as well as timing of certain non-recoverable expenses. FFO attributable to common stockholders excluding certain items for the second quarter of 2016 was $20.7 million or $0.43 per diluted share as compared to $17.2 million or $0.34 per diluted share for the comparable quarter of 2015. Second quarter same-store NOI was essentially [indiscernible] on a GAAP basis decreasing slightly by 2/10 percent, while increasing by 6.5% on a cash basis compared to the same period in 2015.
Moving on to our guidance, we're increasing our 2016 guidance for FFO excluding certain items to $1.56 to $1.60 per diluted share. The $0.04 increase at the midpoint is attributable to the timing and composition of dispositions for the full year; stronger operating performance as well as the mitigation of potential downside leasing during the first half of the year. We're also updating our 2016 guidance for NARIET defined FFO to $1.52 to $1.56 per diluted share. The difference between NARIET redefined FFO and FFO excluding certain items is primarily a result of the $1.9 million interest charge related to hedge ineffectiveness we recorded this quarter on our interest rate swaps.
This valuation accounting charge, resulting from the increased probability for LIBOR rates to become negative, thereby creating the potential to incur higher cash interest expense due to the LIBOR floors built into our credit facility. This accounting charge could be adjusted in future periods subject to changing forward LIBOR rate probabilities offset by the decrease in hedging period. Lastly, we're increasing our guidance for disposition to $300 million to $500 million based on the successful disposition activity to date and the additional properties that we're currently marketing. We anticipate the majority of the remaining dispositions will occur in the latter part of the year. All of the assumptions supporting our revised outlook are provided in our earnings release.
Now turning to our operational results and leasing activity, at June 30, 2016, our total portfolio was 90.4% occupied, an increase of 150 basis points from the prior quarter. This increase was driven mostly by our sale of FOUR40, partially offset by an expected 20 basis point decrease in our overall portfolio occupancy resulting from known tenant move-outs. Overall, fundamentals in our strategic markets outside of Houston remains strong, supported by continued employment growth. I would like to provide some additional color on several individual markets, often continues to be one of the strongest markets in our portfolio with a growing diverse economy that is supportive of continued office absorption. The Class A vacancy rate in Austin was 10% at the end of the second quarter. Rents were up 5.7% over the prior year.
Development remains in check and demand is such that new construction is currently 82% pre-leased. Further, all existing office space at the domain is 100% leased and we're seeing tremendous tenant interest in our Domain 8 development property which is scheduled for delivery in the spring of 2017. Similarly, in Charlotte, where we're also into our way with our retail development at Bank of America Plaza, the Class A vacancy rate was 9% at the end of the second quarter which was a 10-basis point decrease over the prior quarter. Class A rental rate increased by 5.6% over the prior year, while 48% of the current development activity is pre-leased. Overall, we're still seeing solid demand for office space in the Charlotte market. In fact, although we currently have limited available space, we have achieved rental rates on recent leases at our Bank of America Plaza properties that are 20% higher than a year ago.
In the Dallas-Fort Worth market, we saw a 20 basis point increase in the Class-A office vacancy rate to 16.4% in the second quarter, while rents increased by 7.5% over the prior year. Looking ahead Dallas-Fort Worth has 10 million square feet of office development currently under construction, of which 66% is pre-leased. Finally Houston remains a challenge leasing market, though we continue to successfully reduce our future expirations. Class-A, subleased space continues to grow totaling 8.6 million square feet available as of quarter end, along with 4.2 million square feet of space currently remain under development for delivery in the next 18 months. Total Class-A office availability reached 19.6% as of the end of the second quarter and is expected to increase further through the end of 2016.
While asking rental rates remained generally flat during the second quarter higher tenant concessions have reduced effective rents. Leasing velocity is currently low and is expected to remain so for the near term. However, we have been successful in completing early renewal accounted for over one-third of the 2017 lease explorations we faced at the beginning of the year. And we're seeing increased leasing activity at our Loop Central property. After 2017, we will have limited lease expiration exposure until 2019. In this market environment, we will continue to focus on managing the remaining near term lease expirations prudently investing in our properties to remain competitive and seeking opportunities to capture potential occupancy gains as tenants become more active in the leasing market.
Now regarding our balance sheet, we have made meaningful progress during the quarter to further enhance our balance sheet flexibility while deleveraging and reducing our cost to capital. We repaid the $108 million outstanding balance on our revolving line of credit with proceeds from the sale of FOUR40. Additionally in April, we repaid without penalty the $23.2 million loan secured by Plaza at MetroCenter. Subsequent to quarter end, we prepaid without penalty the $62.8 million mortgage loan on our Three Parkway property that was scheduled to mature in November of this year. The only remaining 2016 debt maturity consists of our $49 million loan secured by our Fifth Third Columbus property which was transferred to a receiver in early 2016. We anticipate that we will dispose this property in full satisfaction of the loan by year in 2016.
With that, I will turn the call back to Scott for closing comments.
Thanks, Dallas. We're pleased with our second quarter and year-to-date results which showed meaningful progress on our 2016 objectives. We believe the continued execution of our strategic plan throughout 2016 will provide us the opportunity to unlock embedded stockholder value. Moving beyond 2016, we remain focused on our strategy of owning and operating best in class office properties in our 7 targeted growth markets of Austin, Dallas, Houston, Atlanta, Charlotte, Nashville and Denver.
And we look forward to not only creating additional value within our existing portfolio, but also identifying opportunities to recycle capital into new investments that demonstrate a clear path to long term value creation. With our focus strategy, disciplined approach and high quality portfolio, we believe we're well positioned to deliver on our objective of providing stable dividend income and outsized stockholder return over the long term.
This concludes our prepared remarks. I'll now turn the call over to the operator for questions from sell-side analysts.
[Operator Instructions]. Our first question comes from Rob Stevenson with Janney. Please proceed with your question.
Scott, you talked about Louisville disposition, is that likely to be a portfolio sale or you looking to sell that sort of piecemeal.
That is what likely to be a piecemeal sale, we would sell several properties and in different portfolios, in total, we've got a million square feet in Louisville and we believe selling in bite-size pieces is the way to go in this particular market. So, but we're seeing good activity on the properties that are in the market today. We feel like we'll see good execution on that.
And then Dallas, how much additional debt could you pay off this year without incurring substantial prepayment penalties. And what that sort of level looking like in 2017 as well?
Rob, we have a total of $125 million of property debt left to repay between now and February of 2017. We have a [indiscernible] million loan that we can pre-pay in October this year and then a $59 million loan in February of 2017.
What about for the rest of 2017? As you continue to pursue the disposition plan, I mean if you're going to reduce debt materially more than that, you're going to have to pay some prepayment penalties or is the back half of 2017 more debt starts to open up that you can pay without penalty?
No, we really don't have any pre-payable debt after February of 2017.
And then, Scott, how much -- at this point when you're setting there today, how much additional known move-outs or guys that are unlikely to renew or you sitting here looking at the day, when you're looking at the expirations over the next couple of years versus guys that are likely renew and/or get back some space?
When we look out particularly into 2017, really Houston becomes the focus for us. As you know we started the year with about 360,000 square feet that was expiring in Houston during 2017. We've taken care of a lot of that today, over a third of it. We still have a little over 200,000 square feet that expires in Houston in 2017. In the vast majority of that we know will be move-outs.
We've talked about how BP represents about 110,000 square feet to 115,000 square feet of what's remaining to expire in Houston. We anticipate that to be a move out. So certainly, we're going to have some downward pressure in Houston in 2017. But with the activity that we're seeing across the rest of our markets, we believe we have some ability to offset that as well because the rest of the market the fundamentals remain very, very strong.
Okay. And then given the disposition proceeds over the next -- call it 9 to 12 months or so. Are you guys looking at adding anything interesting from an acquisition standpoint from across your desk that you've been doing decent work on?
Yes, so the dispositions that we've got lined out for the rest of the year, the capital, the equity that we will get out of those, will basically go towards paying down the debt that Dallas walked you through, so the call for $125 million to $130 million over the next 6 to 9 months. Beyond that if we get out in the market with additional assets to sell, we will be looking to recycle those proceeds or put them to work in other opportunities. And obviously, looking at our own stock is something that we'll keep on the radar.
However, in terms of looking at acquisitions today. It's pretty tough to find something that we think makes sense, but with that being said, we're looking at opportunities that we think could be strategic to the portfolio and we'll just have to play those through to see if there are real opportunities out there. But as of today, we don't have anything pinned down to put the money to work in terms of acquisition. We do think from the development perspective because of the activity that we're seeing at our key land parcels in Austin whether be Third and Shoal, Downtown or in the domain. The leasing activity that Dallas mentioned in the domain on our Domain 8 is tremendous.
And we anticipate that that could lead to additional opportunities to put money to work and create additional value. So, we're pretty excited about the opportunities that we're seeing there. But again, with that being said, we're certainly going to make sure that we manage that risk appropriately.
Okay. Then just last question a similar one. Anything in, as that you are finding on the land parcel standpoint for future development, anything interesting there?
So first of all, the land parcels that we have are what we're comfortable with. It represents about 3% of our total real estate assets which we think is manageable. We're not looking for to acquire any future land, but again we're seeing great activity at the Third and Shoal Downtown as well as Domain.
So, I wouldn't be surprised to have an opportunity to move forward with the development on one of those two parcels and we're starting see activity up in Legacy area of Dallas as well. So, we're definitely seeing the activity, so hopefully that translates and us being able to move forward. But again, we're going to do that in a very disciplined way and not jump out there without managing the risk.
Thank you. Our next question comes from Anthony Paolon with JPMorgan. Please proceed with your question.
First question, just make sure on the $250 million of sales for the balance of the year, what assets are in that mix?
First of all, we're looking at Wanamaker. We've been working on that sale for a while and it's progressing nicely. So, we feel like that could be completed by the end of the year. There's also several of the Louisville assets that we think could be completed by the end of the year. And then also the Fifth Third center asset would be disposed as well, hopefully by the end of the year.
Can you comment on just liquidity into sales market and what's changed there as you brought this things out, particularly bringing out Louisville I guess is the way this to come out and just what the receptivity has been.
The Louisville market is going to be a little different. You're going to see more local type buyers in that particular market. We have seen good activity on the buildings, because if you're going to be in Louisville, those are very quality properties to be in, so we've definitely seen the activity. With that being said, it's a different type market than our target growth markets. It's not quite as dynamic, but we're seeing good activities.
And then in Austin, you talked about the activity levels there, what would you need to see actually start a new project which need actual pre-leasing or just a better comfort level? What's the boogie?
I think in general what you're going to want is a good commitment towards the building before you get going on anything. We'd like to see Domain 8 essentially put to bed, but with the activity that we're seeing we think that those commitments could come and allow us to do the future development. But we definitely have to manage that risk appropriately. We feel like relating the cycle, so we definitely need to see the strong commitment before moving forward.
Do you think you have capacity to do another domain asset end potentially like Third and Shoal at the same time?
Tony, we do. I think what we would look at is how much at risk development we've got going at any one point in time. And I think that we would have the ability to do those two particularly as we move through the dispositions that we're working on today. We think we're going to be in good position to do that. However, those -- it may be that both of those projects aren't an opportunity in this cycle. We feel very comfortable holding into the next cycle and that's what we need to do to move forward that development.
And then on page 17 of the supplemental, just a question on those leasing stats, I think you'd mentioned, you've done some expansions in Nashville and then you had the Houston, I just want [indiscernible] the sub-tenant there, were those not on that page or just were they not done in the second quarter, just trying to understand --?
Tony there can be a timing mismatch from time-to-time. So for example, the Lubrizol deal that we did in Houston, that was essentially a 38,000 square foot lease that was going direct and that will go direct in 2017. And there was a 12,000 square foot component of that which was expanded in the new space which actually shows up in the numbers here. So there could definitely be a mismatch in timing, but that's how that Lubrizol deal shakes out in terms of page 17.
And Nashville, I think -- was there an extension there or--?
Yes, essentially what's going on in Nashville is the big tenant out there, is the State of Tennessee. We've worked through the details of a lease extension with the State of Tennessee. In fact, we have a signed lease. They have continued to look at their space needs and the hope is that, that they are going to stay in all of their space where as originally we thought we were going to get about 25,000 square feet back. So, there is a little noise as a result of that in working through that, but we think that, that all will be worked out by the end of the year.
Thank you. At this time, I'd like to turn the call back over to Mr. Scott Fordham for closing comments.
Great, thank you. And thanks again for joining us this morning and we look forward to speaking to you again in November. If you are a financial adviser or an individual investor with questions, please contact our investor services department at 972-483-2438. Thank you.
Thank you. This does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time and have a great day.
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