Equity Commonwealth (NYSE:EQC) Q2 2019 Earnings Conference Call August 1, 2019 10:00 AM ET
Sarah Byrnes - VP, IR
David Helfand - President and CEO
David Weinberg - COO
Adam Markman - CFO
Conference Call Participants
Manny Korchman - Citigroup
Alexander Pernokas - Bank of America
Greetings. Welcome to the Equity Commonwealth Second Quarter 2019 Earnings Conference Call. At this time all participants are in a listen-only mode. A question-and-answer session will follow a formal presentation [Operator Instructions] Please note, this conference is being recorded.
I would now like to turn the conference over to your host, Sarah Byrnes, Vice President, Investor Relations. Thank you. You may begin.
Good morning, and thank you for joining us to discuss Equity Commonwealth’s results for the quarter ended June 30, 2019. Our speakers today are David Helfand, President and CEO; David Weinberg, COO; and Adam Markman, CFO.
Please be advised that certain matters discussed during this conference call may constitute forward-looking statements within the meaning of federal securities laws. We refer you to the section titled Forward-Looking Statements in yesterday’s press release as well as the section titled Risk Factors in our most recent annual report on Form 10-K for a discussion of factors that could cause actual results to materially differ from any forward-looking statements. The company assumes no obligation to update or supplement any forward-looking statements made today. We also post important information on our website at www.eqcre.com, including information that may be material.
Today’s remarks also include certain non-GAAP financial measures. Please refer to yesterday’s press release and supplemental containing our second quarter 2019 results for a reconciliation of these non-GAAP performance measures to our GAAP financial results.
With that, I will turn the call over to David Helfand.
Thanks, Sarah. Good morning, and thank you for joining us. I’ll begin with brief comments on market conditions, review our second quarter results and provide an update on the company’s current activities.
U.S. economy continues its growth in the second quarter with GDP up 2.1%, a slowdown from 3.1% in the prior quarter as trade tensions, geopolitical risk and slowing growth in Europe and China likely dampened growth. 224,000 new jobs were added in June, the 105th consecutive month of U.S. job growth. New job creation has averaged 172,000 per month year-to-date compared to an average of 235,000 in the first six months of 2018, and the unemployment rate remains below 4%.
Stock market has been on a tear year-to-date with the S&P 500 up 20%, the NASDAQ up 23% and the RMS Index up 20% despite weakening U.S. corporate profits. The yield on the 10-year Treasury is 2%, down more than 100 basis points from its peak in November of last year and roughly 90 basis points lower than a year ago. On the short end of the curve, 1-month LIBOR is roughly 2.25%, up almost 15 basis points from a year ago.
Turning to office fundamentals. New supply continues to run ahead of historical averages and new start numbers do not indicate any significant reduction in future supply over the next couple of years. Demand remains decent, resulting in a national vacancy rate holding basically steady at approximately 12%. Real estate debt capital markets remain robust with credit available from a range of lenders at historically low all in rates. Spreads are generally flat to tighter versus last quarter and the CMBS market is particularly active.
Office sales volume totaled roughly $52 billion in the first half of 2019, a modest decline from a year ago. Cap rates were generally stable across the country. Flat transaction volume is understandable as owners at the margin decide to refinance rather than sell given the availability of inexpensive debt capital.
At EQC, we had a solid second quarter as same property cash NOI was up 11%, and we completed the sale of two properties with gross sale price of $361 million. As previously mentioned, we sold Bellevue Corporate Plaza in Bellevue, Washington, a 255,000 square foot office building with additional development rights for a gross sale price of $195 million. In late June, we sold Research Park in Austin, Texas, a 1.1 million square foot industrial property on 188 acres of land for $165.5 million. Pricing for Research Park on in place income was in the high 5% cap rate range.
For the first time in five years, we do not have any assets in the market for sale at this time. Since taking responsibility for EQC, we have sold 161 assets for $6.9 billion and 67 transactions. Through the conversion of a disparate portfolio of undermanaged assets into cash, we have created value and optionality.
Today, we are fundamentally a different company with a small portfolio of high quality assets, a strong balance sheet and a track record of consistent execution. Our strategy will continue to be informed by market conditions, and we will be patient and disciplined in our evaluation of a broad range of investment opportunities including non office asset classes. With $3.2 billion of cash, we’re well positioned to create long-term value for shareholders.
With that, I’ll turn the call over to Dave.
Well, thank you, David, and good morning. I will begin by reviewing our second quarter leasing activity and giving an update on our properties, then I’ll cover the remaining lease roll this year and provide an overview of the roll in 2020. Our same property portfolio at the end of the quarter comprised seven properties totaling 2.5 million square feet. The portfolio was 90.5% leased, down 150 basis points from first quarter and year-over-year.
Commenced occupancy was 89.7%, down 140 basis points from first quarter and up 120 basis points year-over-year. In the quarter, we signed 58,000 square feet of leases, most of which were renewals. Rental rates increased 14.5% on a GAAP basis and 9.1% on a cash basis. The largest lease we signed this quarter was an extension of the GSA in 31,000 square feet through September 2020 in Denver at 17th Street Plaza. This property is 87% leased. While this market remains competitive with a vacancy rate of 15.2%, we continued to see steady interest from tenants.
Bridgepoint Square in Northwest Austin is 84% leased, and Capitol Tower in downtown Austin is 86% leased. The occupancy rates of both of these properties were negatively impacted this quarter when each of them had full-floor tenants vacate early. We are seeing good activity at both properties, and Austin continues to do well with a vacancy rate of 9%. With respect to our lease expirations, for the remainder of 2019, there is 215,000 square feet rolling.
Most of this roll is Georgetown University’s 129,000 square foot lease at the Harris Building in Washington, D.C., which expires September 30. We are working on a short-term extension with Georgetown. This leaves 86,000 square feet roll in the balance of the year, almost all of which we expect to get back. This includes BT Americas vacating 59,000 square feet at 109 Brookline in Boston. This is a great property in a unique location near Fenway Park and the Longwood Medical District, and we are seeing good leasing activity here.
In 2020, there’s 131,000 square feet rolling. This does not include the 427,000 square feet that Expedia will vacate the end of this year that has been leased to Amazon. Of the 131,000 square feet rolling, just 40,000 square feet is scheduled to expire during the first half of 2020.
With that, I will turn the call over to Adam.
Thanks, David. Good morning. I’ll review our financial results for the quarter and provide an update on distributions following our recent asset sales. Funds from operations were $0.17 per share, unchanged from the second quarter of 2018 despite a decrease of $0.08 per share from $1.1 billion in asset sales over the comparative period.
Costs related to the early payoff of our last unsecured bond caused an additional decline of $0.04 per share. Offsetting the effects of the dispositions and costs related to debt repayments was $0.07 per share of higher interest and other income, $0.03 per share of increased NOI from the same-property portfolio of which $0.02 is attributable to lease termination income and another $0.02 per share of lower interest expense.
Normalized FFO was $0.22 per share compared to $0.17 a year ago. The growth in normalized FFO was the result of $0.07 per share of increased interest income, $0.03 per share of increase in same property cash NOI and termination income and $0.02 per share of interest expense savings resulting from debt repayments. This growth in normalized FFO occurred despite a decrease of approximately $0.08 per share from property dispositions.
Net operating income in the seven asset same property portfolio was up 22.5% or $3.6 million in the second quarter compared to a year ago. Much of the increase, $2.2 million, was generated by lease termination revenue from the two previously mentioned full floor tenants that vacated early in Austin. The remainder of the growth is largely due to the burn-off of free rent and leases commencing in Denver and downtown Austin.
Same-property cash NOI was $17.5 million, 11% higher than in the second quarter of last year, largely driven by higher rental income and escalations resulting from leases commencing and the burn-off of free rent in Austin and Denver. Cash NOI for the quarter does not include $700,000 of revenue from leases and free rent.
Additionally, there are 21,000 square feet of leases signed but not commenced on spaces that are currently vacant and therefore not in cash or GAAP NOI. These leases will eventually generate $1 million in annual rents. As we’ve discussed in the past, tenant move-outs will temper growth. In particular, Expedia’s move-out at the end of 2019 will significantly impact the first half of 2020. Amazon have leased this space with rent commencing in the second half of next year.
General and administrative expenses for the quarter totaled $9.5 million, of which $900,000 are onetime costs from our recent reduction in force. Moving to dispositions. We have sold $812 million of properties year-to-date. These sales have generated a taxable gain that is roughly $340 million in excess of the net operating loss that was carried forward from the beginning of the year. This taxable gain as well as gains generated in the ordinary course of operating our business necessitated common distribution this year.
Briefly turning to the balance sheet, during the quarter, we redeemed our last remaining unsecured debt, a $250 million 5.875% unsecured bond. As a result, we no longer carry a credit rating. Our remaining loan is a $26 million mortgage, and we have $3.2 billion or $26 per share in cash. We continue to look for opportunities where our team, liquidity and financial strength will provide a competitive advantage.
Thank you. And with that, we will open it up to Q&A.
Thank you. At this time we will be conducting a question-and-answer session. [Operator Instructions] Our first question is from Manny Korchman with Citigroup.
Hi, good morning everyone. David, I think you said in your prepared remarks that this is the first time in sort of your history with the company that you don’t have any assets in the market. Was wondering if that's just a factor of timing and mix or maybe it’s a lease up that you guys talked about and you’re going to be sort of on hold for a while.
Good morning, Emmy. More of the former. I think we’ve previously identified there are a couple of assets, the Amazon leased building in Bellevue and the Georgetown asset that we will consider for sale. We just want to get the timing right, get the lease done and be in a situation where we can maximize value.
And then if we look at sort of the mix of assets you have left, you have a couple in Washington, D.C., you have a couple in Austin. If you were to exit, do you think you’d do the same you have, which is a little bit agnostic to sort of other holdings? Or do you think those would go in sets?
Well, I think the market would dictate that. We’ve got seven properties. The two that David Helfand referenced, I would say, are the two outliers, one being the long-term net lease to Amazon and one being the Georgetown property that would have one long-term lease with one tenant, a British school and the other one to be determined. We’re working on that Georgetown extension. What leaves us are five nice multi-tenant office buildings in very good markets: D.C., Boston, Austin and Denver. And then if we were choosing to sell those, we would have to determine what the best execution is at that time, be it a total portfolio, a sub-portfolio or as a one-off.
Our next question is from Alexander Pernokas with Bank of America.
Hi, guys. Good morning. I was just wondering if you could give us an update on some of the properties that saw a drop in occupancy. And do you have any prospects lined up for these tenants that moved out? And then maybe what kind of tenants are you trying to get in there? What kind of tenants do you think are most likely to take up that space?
Sure. It’s David Weinberg. Again, with seven properties, we can actually go one at a time. Tower 333, obviously, no drop in occupancy there. But as we spoke about, Expedia’s lease expires, and that's been backfilled with Amazon. Denver, the occupancy has been holding, I’d say, the last few quarters. We’ve been seeing good activity from small tenants and starting to see from bigger tenants as well. We’ve been kind of running in place, but it feels like there’s some more momentum there. It’s a combination of financial service firms and even some tech companies that are starting to look at that space.
In Austin, as I referenced in my prepared remarks, at both our assets, there was a drop in occupancy because we at each of them, we lost two a tenant. But I’ll tell you, having vacant space in downtown Austin is a great thing. There isn’t much of it available on the market. We’re seeing very strong interest, I’d say, primarily from tech tenants and other types of tenants, not necessarily financial service firms. And our asset in Bridgepoint has always attracted a variety of tenants. That's in Northwest Austin. We’ve continued to see good interest there.
Boston, BT Americas vacated yesterday actually, so that space is now available, not reflected in our quarter end numbers. Good activity there. Boston is a very tight market. That is a special asset built in the early 1900s. It was a cheap manufacturing plant, big open floor plates, great windows, et cetera, very good interest there. And then in D.C., as I said, we’re working to extend Georgetown. And we’ve got 1250 H in downtown Washington, D.C. That is a more competitive market. I’d say there, when we get a prospect, they’re looking at multiple buildings at the same time. And those tend to be more smaller law firms, associations in terms of the tenants we’re seeing.
[Operator Instructions] We’re receiving no more questions at this time, and I’ll turn the call back to David Helfand for closing remarks.
We thank you for your time and your interest in EQC, and we’ll see most of you in September. Thank you.
Thank you. This concludes today’s conference. Please disconnect your lines at this time. And have a wonderful day.