NorthStar Realty Europe Corp. (NYSE:NRE) Q3 2018 Results Earnings Conference Call November 6, 2018 9:00 AM ET
Trevor Ross - General Counsel
Mahbod Nia - CEO
Keith Feldman - CFO
Matt Boone - FBR
Hello, and welcome to the NorthStar Realty Europe Third Quarter Earnings Call. My name is Molly, and I'll be your coordinator for today's event. [Operator Instructions] Please note that this call is being recorded. [Operator Instructions]
I will now hand over to Trevor Ross, General Counsel to begin today's call.
Good morning, and welcome to NorthStar Realty Europe's Third Quarter 2018 Earnings Conference Call. Before the call begins, I would like to remind everyone that certain statements made during the course of this call are not based on historical information and may constitute forward-looking statements. These statements are based on management's current expectations and beliefs and are subject to a number of trends and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. I refer you to the company's filings made with the SEC for a more detailed discussion of the risks and factors that could cause actual results to differ materially from those expressed or implied in any forward-looking statements made today.
The company undertakes no duty to update any forward-looking statements that may be made in the course of this call. Furthermore, certain non-GAAP financial measures will be discussed on this conference call. Our presentation of this information is not intended to be considered in isolation or as a substitute for the financial information presented in accordance with GAAP. Reconciliations of these non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP can be accessed through our filings with the SEC at www.sec.gov. I will now turn the call over to our CEO, Mahbod Nia.
Thank you, Trevor, and I thank everyone for joining us today. In addition to Trevor, I'm joined by Keith Feldman, our CFO. NorthStar Realty Europe or NRE is a New York Stock Exchange listed REIT focused on prime European office property, with 23 properties located in key cities across Germany, the United Kingdom and France. With [indiscernible] of the productive quarter during which we increased same-store quarter-over-quarter net operating income by almost 4%, benefiting from significant leasing activity during the year, while continuing to make progress with our cost-saving initiatives and today, signing a binding sale and purchase agreement to sell the Trianon Tower in Frankfut for approximately $760 million, delivering return of about 20% IRR for NRE's stockholders.
Before discussing NRE's third quarter performance in more detail, I'd like to make a few remarks regarding the macroeconomic environment and the European commercial real estate market. During the third quarter, GDP in the EU and eurozone grew by 0.3% and 0.2%, respectively. Weakened economic sentiment indicators, driven by the decline in confidence among consumers and manufacturing firms, coupled with slower GDP growth in the third quarter, suggest some softening of economic conditions may lie ahead.
This is reflected in the IMF's recent revision of its 2018 GDP forecast for the eurozone down by 0.2% to 2%. Other key risks include the Italian economy, which stagnated during the third quarter and the ongoing dispute regarding Italy's 2019 budget and seemingly inadequate tranche to reduce its national debt, which stands at 132% of GDP, the second highest in the eurozone behind Greece.
Unemployment in the EU reached 6.7% in September, the lowest ever recorded since January 2000, down from 7.5% a year earlier. Eurozone inflation was up to 2.2% in October compared to 1.5% a year earlier and above the central bank's medium-term target of 2%. Core Inflation has also begun to pick up, rising to around 1.1%. The ECB recently reaffirmed its intention to maintain interest rates at 0% at least through the summer of 2019, while confirming its asset purchase program is likely to conclude this year. The U.K. economy appears to have rebounded during the third quarter following a slowdown in the first half of 2018. The Office for National Statistics recently reported a 0.7% GDP growth in this 3 months to August, driven primarily by household spending. However, the outlook for the U.K. economy remains unclear as uncertainty regarding U.K.'s departure from the EU continues to present a potential downside risk to the economy. In fact, early indications suggest that growth may have already slowed during the fourth quarter.
In line with 2017, European commercial real estate investment volume totaled €216 billion in the first 9 months of 2018, with investment in the U.K., France and Germany accounting for 60% of total investment volume. Prime property yields in most asset classes and markets remained broadly stable and continue to reflect a significant premium to sovereign yields, with the exception of Italy. The yields on the Italian 10-year government bond has risen by 24% since June 30 to around 330 basis points. We've seen little to no impact noted on property yields.
The European office take-up increased by 4% year-over-year in the third quarter, demonstrating the continued strength across European occupied markets. Driven by a combination of robust leasing activity and a subdued new supply pipeline, European office vacancy decreased by 30 basis points to 6.5% in the third quarter, the lowest level since 2002. And office rents grew by 6% year-over-year, well above the 10-year average rental growth rates.
German real estate investment volume totaled €56 billion in the first 9 months of the year, 12% above the same period last year, strong investment appetite and limited supply of core assets continue to put pressure on prime office yield, which compressed by 17 basis points compared to the same period last year. The vacancy rates in the top 6 cities was 4.6%, 20 basis points below the second quarter. While average office rents grew by 1.3% during the quarter. French investment volume totaled €19 billion in the first 9 months of the year, 18% above the same period last year as investors continue to focus on large transactions.
Following the strong start to 2018, our office take-up slowed during the third quarter but remained above the 2017 level. The constraint new supply pipeline continues to pave pressure on rent, which grew at 4% year-over-year or 9% in the case of prime rents. Total U.K. investment volume reached €49 billion in the first 9 months of the year, 5% below the same period last year. Take-up across central London stands 9% above the long-term average, reflecting a resilience of the occupied market, despite the wider macroeconomic outlook.
Turning the discussion back to NRE, I'm pleased to report another positive quarter, during which we continued to strengthen the operational performance of our portfolio. Our 280,000 square meter portfolio comprises of 23 properties located -- leased to blue-chip and other high-quality tenants and is valued at $3.1 billion based on the midyear 2018 independent valuation by Cushman & Wakefield, adjusted for currency movements as of September 30, 2018.
Overall portfolio occupancy increased from 86% as of December 31, 2017 to 97% as of September 30, 2018, reflecting leases signed during the year, and the portfolio had a remaining weighted average lease term of approximately 6.1 years.
Our office portfolio comprise of 18 properties and has a combined rentable area, 204,000 square meters, is 96% occupied with the remaining weighted average lease term of approximately 6.1 years as of September 30 and generates around 97% of our net operating income.
In September, we completed the disposals of Office 123 in Lisbon for $15 million, 6% above the midyear valuation by Cushman and Wakefield. I'm pleased to say that having exited Portugal, we have now fully executed our stated strategy of refocusing the portfolio on our core markets of Germany, the U.K. and France, reducing overall leverage in the process, while enhancing the quality of portfolio's income profile and maintaining our dividend.
Earlier today, we signed a definitive sale and purchase agreement to sell the Trianon Tower in Frankfurt for approximately $760 million, in line with the midyear valuation by Cushman & Wakefield but $86 million above the midyear 2017 valuation, which preceded the completion of certain value-enhancing asset management initiatives. Trianon is our largest asset, and since its acquisition in July 2015, we've leased 7 vacant floors and secured lease extensions with Deutsche Bundesbank, the second-largest tenant, and Franklin Templeton, the third-largest tenant. We've also completed an extensive reestablishment program, bringing the property back in line with modern, technical and esthetic standards, securing its competitiveness in the market. As part of the transaction, NRE will retain a $6 million minority investment in the assets in the form of preferred equity with a 7% yield. We expect to complete the transaction prior to the year-end 2018, releasing approximately $360 million of equity and achieving a return of about 20% IRR for NRE shareholders. With that, I'm pleased to report that NRE delivered another quarter of solid operating results.
I will now hand over to Keith Feldman, our CFO to further discuss the financial results.
Thank you, Mahbod. Good morning, everyone, and welcome to our Third Quarter 2018 Earnings Call. We're pleased to report positive financial results for the third quarter 2018, including strong growth in same-store net operating income or NOI as a direct result of the value-enhancing leasing completed over the last year. During the first 9 months of 2018, we signed new leases, a lease extension relating to 49,000 square meters. This included a 9-year lease for over 11,000 square meters at Boulevard Macdonald in Paris, with one of our largest tenants, BNP, a new 33,000 square meter lease at Marly, our logistics asset located in Paris, which increased this asset's occupancy from 45% to 100% as well as a number of new leases across certain U.K. and German assets.
For the third quarter of 2018, we reported NOI of $24 million, and looking at our same-store year-over-year operating performance, rental income increased by $1.2 million or 5%, reflecting the above-mentioned leasing activity and certain significant leases that commenced in the fourth quarter 2017 and early 2018. Same-store year-over-year NOI increased by $2 million or 9%, reflecting improved recoverability of operating expenses as a result of higher occupancy across the portfolio. Our same-store quarter-over-quarter rental income and NOI increased by $900,000 or 4%, reflecting the commencement of some of the previously mentioned new leases. NRE reported cash available for distribution or CAD of $11.5 million or $0.23 per share, which was $0.01 per share above the second quarter of 2018, reflecting the growth in same-store NOI.
We continue to make progress with our initiatives to reduce direct corporate expenses, and I'm pleased to say that we have realized approximately $2.1 million of other expense and G&A savings in the first 9 months of 2018. In addition, we remain on track to be at the higher end of the previously stated $2 million to $3 million of savings for the full year of 2018 and $4 million to $5 million of savings for 2019.
In August, we refinanced $54 million of mortgage debt, secured by certain French assets, which extended the maturity by 2 years, increased the proceeds to $77 million and reduced the interest margin to 1.65% from 1.85%.
As of September 30, 2018, NRE's overall leverage was 51%, down from 57% as of September 30, 2017. NRE's weighted average cost of debt was 139 basis points over Euribor and GBP LIBOR compared to 164 basis points as of September 30, 2017. As of September 30, 2018, NRE had a weighted average debt maturity of approximately 5 years.
After deducting mortgage debt and adjusting for cash and other balance sheet working capital items, EPRA NAV based on the midyear 2018 independent valuation by Cushman and Wakefield, adjusted for currency movement, was $20.85 per share as of September 30, 2018, which was broadly in line with the previous quarter.
As of November 2, we had $135 million of corporate liquidity, including $65 million of unrestricted cash and $70 million of availability under our credit facility.
On November 2, 2018, we declared a cash dividend of $0.15 per share of common stock. This dividend is expected to be paid on November 16 to stockholders of record as of the close of business on November 12.
Overall, we are pleased with the company's financial and operational performance in 2018 and look forward to updating you further during the quarters ahead.
Operator, please open up the call for questions.
The first question comes from the line of Matt Boone calling from FBR. Please go ahead.
So starting off, looking at the sale of the Trianon Tower, was that opportunistic? Or had you been looking to divest that asset? Can you just, kind of, like walk us through how that transition came about?
Matt, it's Mahbod here. Look, this has been actually in the making for some time. So I'd say that transaction is really the product of several months' work. And it's really no different than what you've seen us do not consistently across the portfolio over the last three, four years with other assets, where we've wanted to acquire an asset that we felt has potential to -- for value enhancement. We realized that potential, and then we've chosen to monetize that potential in order to be able to repeat that. So other examples, recent examples that I can sight, Boulevard Macdonald [indiscernible] since we haven't sold the asset but the lease reggae we did there. The Maastoren asset in Rotterdam, where again that was stabilization of that tower and then a sale led a significant gain to our basis, combo house in the U.K. Portman Square, [indiscernible], Marley-la-Ville. So I think this is really just -- it was decided some time ago, upon conclusion of substantially most of the asset management initiatives that we've had envisioned and then implemented on this asset to explore a sale, and that's what you're all seeing today.
And then based on where your share price is currently trading against your NAV, how are you thinking about the redeployment of proceeds in terms of acquiring additional assets versus the share buyback program?
So with regard to the current share buyback program, we've executed on $83 million of the $100 million authorization. But I think that with regard to the use of proceeds from this particular sale, we just signed the SPA for this sale in the early hours of this morning. Its closing is some time this year. $360 million is a substantial return of equity, and frankly, for that it's just we have multiple options. So what we do with it, I'm not really in a position to give guidance on today, but it could be a combination of a number of different things, all designed to be for the benefit or for enhanced value for NRE's shareholders.
And then my last question is just looking at your continued progress, the expense saving initiatives, and sorry if I missed this, but where did you say where are you in that process? And when can we expect to see that fully realized, be it the beginning of 2019 or midway through 2019?
Matt, it's Keith. So we're on track to save about $3 million this year for the full year. And then by the first quarter of next year, we should be at the full run rate of about 4 million to 5 million, hopefully at the top end of that guidance. So you should see that full benefit really starting in the first quarter of next year.
[Operator Instructions] We have no further questions coming through. So, I'd like to hand the call back over to your host.
Okay. Thank you everyone for joining us today. We are pleased to present to you with our results and what has been yet another busy and productive quarter and look forward to updating you on our further progress in due course. Thank you.
Thank you for joining today's call. You may now disconnect your lines.