Columbia Property Trust, Inc.
Q2 2018 Earnings Call Transcript

Published: 27 Jul 2018

[Operator:]

Good day, and welcome to the Columbia Property Trust Second Quarter 2018 Conference Call. [Operator Instructions]. Please note, this event is being recorded. I would now like to turn the conference over to Matt Stover. Please go ahead.

[Matt Stover:]

Thank you, and good afternoon, everyone. Welcome to the second quarter 2018 Columbia Property Trust investor conference call. On the call with me today are Nelson Mills, President and Chief Executive Officer; Jim Fleming, Executive Vice President and Chief Financial Officer; and other members of our senior management team. Our results were released this afternoon in our quarterly supplemental package, which can be found on the Investor Relations section of our website and on file with the SEC on Form 8-K. We also filed our 10-Q with the SEC this afternoon. Additionally, we'll be providing a copy of today's prepared remarks on our website shortly after the call and an audio replay will also be available by this time tomorrow. Statements made on today's call regarding expected operating results and other future events are forward-looking statements that involve risks and uncertainties. A number of factors could cause actual results to differ materially from those anticipated, including those discussed in the Risk Factors section of our 2017 Form 10-K. Forward-looking statements are made based on current expectations, assumptions and beliefs as well as information available to us at this time. Columbia undertakes no obligation to update any information discussed on this conference call. During this call, we'll also discuss certain non-GAAP financial measures. Reconciliations to comparable GAAP financial measures can be found in our supplemental financial data. With that, I'll turn the call over to Nelson Mills.

[Nelson Mills:]

Thank you, Matt, and thank you everyone for joining us today. It's an exciting time here at Columbia Property Trust as the success of our portfolio transformation and leasing efforts continue to yield solid financial results. Best of all, we're in a strong position to capitalize on future opportunities ahead to create additional and shareholder value. The real estate we've assembled over the last several years is now one of the best positioned portfolios in the entire office sector. Approximately, 80% of our assets are located in the three high barrier coastal Gateway markets of New York City, San Francisco and Washington, D.C. We're focused specifically on attractive submarkets within the cities, such as Midtown South in Manhattan and the SoMa and financial districts in San Francisco. As tenant demand for these exciting neighborhoods continues to grow, we have a targeted approach to offer tenants exactly what they want. That is well located and newly renovated boutique space with efficient floor space. We've built a competitive position by meeting the market's demand for flexible, creative space, couple with attractive amenities and attendant services. This has translated to a strong leasing pace at attractive rates and terms across our portfolio. The competitiveness of our portfolio is evident in our quarterly performance. As Jim will share in a moment, we are again raising our full year guidance. The lease rate for our portfolio has now reached 97%, up from 95% a year ago. We generated normalized FFO of $0.39 per share, up sharply from $0.26 a year earlier. Our same-store NOI growth accelerated to 11.7%, up from 5.5% in the first quarter. We also leased 150,000 square feet in the second quarter, including Inspire Brands' headquarters at Glenlake, replacing the majority of Newell Rubbermaid's commitment, which expires in 2020. We have very few expirations in the next couple of years, but we're highly focused on proactively addressing long-term expirations across the portfolio. We're making great progress on that front and look forward to reporting our success in the coming quarters. We continue to reshape our portfolio during the quarter with the sale of 222 East 41st Street in Midtown Manhattan. This is a building acquired in 2007, which was occupied primarily by a single tenant. When we learned that the tenant would not renew, we launched a proactive leasing campaign that resulted in innovative full building 30-year lease to NYU Langone Medical center with almost no downtime in occupancy. This enabled us to achieve an exit cap rate in the low 4s with a gross sales price of $332.5 million. The proceeds from this sale further strengthen our capacity to capture opportunities ahead. Our strong balance sheet remains a hallmark of Columbia and we finished the quarter with leverage below 30%. On top of that, we have strong NOI growth with very little in the way of near-term lease expirations and a significant number of signed leases starting to commence. The gap between our economic occupancy and our leased percentage will further narrow driving even more growth in earnings. We do have some current leasing opportunities with 220,000 square feet of vacancy and 225,000 square feet scheduled to expire this year and next. We expect to achieve substantial rent increases for the vast majority of that space. In fact, we estimate that our in-place net rents today are on average 10% below current market rental rates. This embedded growth will be evident in our industry-leading same-store NOI and FFO growth this year. But as I indicated earlier, we never stop seeking ways to create value. And 222 East 41st Street in Manhattan is just one example. 650 California Street in San Francisco's Financial District is another. We purchased this iconic office tower in 2014 and quickly revitalized it. Enhancing is of appeal to a broad range of tenants. We have released the majority of the building to high-quality small- to mid-sized tenants, all with good credit at triple digit rent roll outs. The building is now 96% leased with an average remaining term of over six years. Another example is 315 Park Avenue South in Manhattan's Midtown South district. A building we've repositioned to drive leasing success. This quarter, we signed another full quarter lease, leaving just one floor available. When we acquired the building in 2015, we knew we would get 17 of the 20 floors back through lease expirations in the first three years. We have now leased 16 of those 17 floors, a substantial rolls up in rent. Looking ahead, our track record and balance sheet will enable us to continue our momentum and success. We are focused on identifying and capturing compelling acquisition targets, enhancing our properties to attract demand, and proactive and innovative leasing. All geared toward continuing to grow cash flows. I want to thank our team for their ongoing commitment, hard work and creativity in delivering these results. We have a terrific team and we're committed to improving it even further. To that end, I'm very pleased to welcome the newest member of our senior leadership, Dave Cheikin. As Senior Vice President of Strategic Real Estate Initiatives, he will bring further leadership and innovation to the operation of our real estate. Dave spent the past 16 years with Brookfield Properties, most recently as head of the New York and Boston regions where he oversaw the company's $25 million square-foot commercial office portfolio. Dave will be based out of our New York office and will provide operational leadership for our portfolio nationwide. He'll also provide direct oversight for our properties in New York, Washington, D.C. and Boston alongside our proven teams in those markets. We're very excited to have Dave on board. As you can tell, we're excited about what we've accomplished. The results we're now generating and the many opportunities ahead. We'll keep working hard to create value and to establish Columbia as the best operator in our markets. And with that, I'll turn the call over to Jim.

[James Fleming:]

Thank you, Nelson. We had another strong quarter, and we're raising our guidance ranges today for our year-end lease percentage, our same-store NOI growth and our FFO. These measures reflect the strength of our portfolio and the capabilities of our local leasing teams and position us as one of the leaders in the office sector from a growth perspective. We're now 97% leased across our portfolio, up another 30 basis points during the quarter with limited rollover in the next few years. And as Nelson mentioned, we've reloaded our balance sheet. These two factors provide an excellent foundation for further growth ahead. We have a shrinking but still meaningful gap between our economic occupancy and our lease percentage. Currently, at an 8-percentage point spread, this is down from 13 percentage points a quarter earlier. Our year-end forecast for economic occupancy is 92% to 93%, and this should drive another $17 million of annual revenue over today's level. At 97% leased, most of the heavy lifting with our current portfolio has been accomplished. But we have another 220,000 square feet of available space to lease, much of which is in our most attractive and desirable buildings. We also have 225,000 square feet of leases expiring the second half of this year and in 2019, which creates more opportunity for our leasing teams to capitalize on lease roll ups. Our balance sheet has continued to improve with most of the proceeds from the sale of 222 East 41st Street used to pay down debt. We ended the quarter with more than $4 billion of unencumbered properties. And our net debt is now less than 30% of gross assets. We recently gained notice to prepay our Glenlake mortgage in October, which will leave us with only one mortgage loan in our entire portfolio. Our debt-to-EBITDA ratio is down to 6.2x. And as we've previously said we expect it to be around 6x for the full year 2018. Now that we've reloaded the balance sheet, we will continue to seek attractive opportunities through invest in growth assets so we can build on our recent success. Based on the strong second quarter results and our outlook for the rest of the year, we are again raising our normalized FFO guidance to a new range of $1.46 to $1.51. This range reflects very robust growth of 28% to 32% over 2017 levels. And we see AFFO rising even more. We're also raising our outlook for full year same-store NOI growth to a range of 11% to 13%. And we now expect a year-end lease percentage of 95% to 97%. With this quarter's share repurchases, we've now repurchased $42 million of stock year-to-date, reducing our share count to 118 million shares. That level could fall further as we remain opportunistic buyers of our stock given our strong balance sheet, with a $153 million still available under our current share repurchase authorization. After a lot of hard work and good execution over the past several years, we're now in a very good position. We have strong growth in earnings and cash flows and very little near-term leasing risk, a solid balance sheet and a high-quality portfolio. We believe our stock also provides great value today. We look forward to updating you again on our progress at the end of October. And with that, Nelson and I will be happy to take your questions. Operator, if you could please open the lines.

[Operator:]

[Operator Instructions]. And our first question comes from Sheila McGrath of Evercore.

[Sheila McGrath:]

Just a question on the guidance, on same-store NOI and year-end occupancy going higher. Is that from lease up in your Manhattan properties or what's doing better that's driving that revision up than your original expectations?

[James Fleming:]

Sheila, thanks, this is Jim. The -- we've had -- I guess with -- the leasing success is really sort of build on itself. And we've had -- we had a positive quarter in the second quarter in terms of revenues. In terms of the lease percentage, as I think you know we have gotten it up to a little over 97%. And although we could buy something that's a bit more value add, that could drop that a bit just because it would provide some opportunity. We don't think we'll drop below that range of 95% to 97%. So we've just moved up over time. And we thought it was time at mid-year to go ahead and raise that number. In terms of same-store NOI, again, it started a little bit slower this year. We were between 5% and 6% in the first quarter. We're up, close to 12% in the second quarter. We expect based on what we know about lease commencements in the second half for the year to be at the high end of what our previous range had been, maybe even a little better. And so we thought it was appropriate to go ahead and raise that range right now. So things are just trending in a positive direction.

[Sheila McGrath:]

Okay, great. And, Nelson, I was wondering if you could give us an update on -- your thoughts on both the Atlanta assets, if you're contemplating sales there at some point? And then an update on your plans for the Madison Avenue redevelopment?

[Nelson Mills:]

Sure. Thanks, Sheila. So for the Atlanta properties, if you recall we have two properties. One is a -- the Glenlake properties, One and Three Glenlake. It's twin building campus. Greenlake one is fully leased, multitenant. Some great shape. Good remain -- good average remaining lease term. The other building was a 100% leased to Newell Rubbermaid. We -- that expiration is in 2020. However, we have released about 65%, 70% of that property. And we have active prospects to lease the rest of it. So the Glenlake property is in great shape. We're confident we could dispose off that one for a great price at some point. The other property, AT&T -- Lindbergh is a single tenant property leased to AT&T. There are 2.5 years remaining on that property. It appears that AT&T is leaving. And we are considering -- we are already actively looking at marketing that for releasing. But there is also some proven demand for both of these properties. And we are going to explore the market to see what price they could attract. If we got the right price, we might consider an early sell. Right now, we don't expect that to happen this year. If it did, it'd be at the -- near the end of the year. But -- so we're exploring those options. And then the other one, 149 Madison, we took possession of that property back in early spring. And we have done some demolition. And this is a 100-year old empty building that we took over that we planned to rehab and release in the NoMad area of Midtown South. And we've got a couple of options there, we're considering a full building user, which could be an attractive outcome. If that doesn't work out, if we're not able to go down that path, we certainly -- we'd feel great about leasing it on a multitenant basis. But plenty of demand in that area, nice property and we should come out -- it should turn out well on either path. I think we'll decide, we'll make a determination in the next month or so exactly which path we'll take, and we'll certainly let you know.

[Operator:]

Our next question comes from Vikram Malhotra of Morgan Stanley.

[Vikram Malhotra:]

Maybe just turning to the capital deployment. I guess at NAREIT and in the prior conversations you've talked about value add as a potential path but also some -- providing capital for certain types of development projects. Can you maybe just update us where you are in that -- in the search for opportunities?

[Nelson Mills:]

Yes, Vikram. So it's a tight competitive market as always. And in our markets, we are -- our team is actively pursuing opportunities in all three markets. San Francisco is particularly challenging given the fundamentals of that market and how well it's doing. But as you can imagine that the demand for properties is also great. Very difficult to win a project there at a price that works for us. D.C., fundamentals are much softer there, it continues to be soft but it's also a very competitive environment in terms of acquisitions. I think probably the most opportunity is in Manhattan. Fundamentals -- and some parts of Manhattan are a bit softer in these last couple of years. But we sense that perhaps it's not quite as competitive on the capital front either. And we think there could be some opportunities there. Again, very active. We're looking at several opportunities in the market. We are going to focus primarily on core-plus to value add. As we've explained, we have a very well-leased portfolio. It's very stable with very little roll. And we feel we need to blend into that some growth opportunities. So we are focused on anything from core-plus to value add. There are also a couple of -- as you alluded, there a couple of interesting potential development place in the city. In those cases we would partner with a capable developer. It's to be determined if we pursue those but we're certainly exploring those. So we think we're going to have some options. We're -- as always, we're going to be disciplined and prudent and patient. But we do think we'll be able to pick up a couple of opportunities in the coming quarters.

[Vikram Malhotra:]

Okay. And then maybe one for Jim. Just in the -- given the leasing sort of success and the uptick to some of the numbers. I'm just kind of getting -- want to get an early sense of -- maybe early sense of same-store NOI growth into '19. Seems like the pace could potentially be at a very similar pace price to '18. Is that maybe too aggressive, on my part?

[James Fleming:]

That's an early question, Vikram. But I'll try to answer as best as I can. It's a good question. We would've had even higher NOI, same-store NOI growth this year, if we'd included the NYU lease -- the NYU building at 222. But we excluded that from our guidance at the beginning of the year because we expected to sell it. And of course, we did sell it. But even so we are -- we've got a 11% to 13% range this year. I'm not going to pin it down that precisely next year. But I do expect it'll be somewhere maybe slightly less than that but up to that level. So it could be high single-digits to low double-digits next year. That's at least what the numbers are looking like at this point. So again, very good, very solid growth in our core markets. That's really leading a lot of growth this year and next year.

[Vikram Malhotra:]

Okay. Great. And just one clarification on a comment you made. Potentially selling some of the Atlanta assets, would you need to 1031 those?

[James Fleming:]

Vikram, it's possible we might with one of those assets. We've been very fortunate through the years that we've been able to reposition this portfolio without having to do that. It's possible, if you look at -- you can see our GAAP basis in our 10-K, and the tax base is not too far off. So there could be some gains there and we might do it for one of those properties. I don't think it would be a big issue for us but that's a possibility.

[Operator:]

Our next question comes from John Kim of BMO Capital Markets.

[John Kim:]

At 222 East 41st, looks like you had an impairment on the asset this quarter. Your 10-Q quoted a net sales price of $285 million. I'm just trying to compare that to the $333 million that was quoted in the press?

[James Fleming:]

Yes. Thanks, John. There was some capital you may recall. There was over $90 million of capital that we had committed to this project when we signed the lease with NYU. And we booked that in the fourth quarter of 2016. And then when we got to the sale point, we've been dispersing capital along the way. You haven't seen the financials because it was already booked. But there was about $19 million or $20 million that had not yet been funded. So that had to be credited back in connection with the sale. There were transfer tax and some other things and a number of other transaction costs. I don't know if you want to comment any on it, Nelson. But that's the capital may be the one piece that you haven't factored. We have said low 300s net, but then you have to subtract that unfunded capital.

[Nelson Mills:]

That's right.

[John Kim:]

Okay. So there's a $50 million roughly difference between the two numbers. And you're saying $19 million is unfunded capital commitments and the rest is taxes?

[Nelson Mills:]

Transfer taxes, cost.

[John Kim:]

Okay.

[Nelson Mills:]

Yes.

[John Kim:]

Your cash rent spreads were slightly negative this quarter. I know it's been very positive in recent quarters. What specifically as far as assets contributed to the leasing spread?

[James Fleming:]

Exactly. And John, the biggest lease we signed this quarter was the Arby's lease, it's Inspire Brands, the Arby's parent company at Glenlake. That was a big chunk of it. And I think we've been telegraphing for a while. We thought would be about, we thought we would replace Newell with a similar rent, and we did. So that one was, I think, positive single-digits on a GAAP basis, and maybe negative 1% or so on a cash basis. It was -- that one was pretty flat and that was the biggest driver this quarter. So again, that was -- that's not a core market, that's about what we're expecting. But that's why we had pretty flat same-store NOI -- excuse me, flat leasing spreads this quarter. We do still think across the portfolio are -- on average we're about 10% below market with the in-place net rents. But of course, it varies from property to property.

[John Kim:]

Okay. Nelson, I think in -- few quarters ago it might be more than a year ago now, you were discussing pricing potentially cooling off in some of your markets. Do you still think this is going to happen? And is that one of the reasons that you haven't bought much recently?

[Nelson Mills:]

I think that's right, John. Certainly in San Francisco, we see no cooling in sight. The market is strong as ever for office product. D.C., we would expect some cooling in pricing. We haven't -- just based on the fundamental's, there's a lot of supply to be absorbed. It continues to be a challenging market but prices have held up pretty well there so far. I think we could see some softening, some movement there. But I think in Manhattan, we've seen some evidence in certain submarkets. I don't know how it translates exactly to lower pricing. But there's been some [indiscernible] spreads that have moved in favor of the purchaser, in the last year or so. Certainly, Midtown South we are focused, that has not been the case. It continues to be very strong, but we're hoping, we're thinking there could be some opportunities over the next few quarters to pick up some things at slightly better pricing. So always competitive markets for sure.

[John Kim:]

The recent hiring of David Cheikin to run strategic initiatives, is there anything specifically you'll be focusing on for the company to feed from his relationships and experience at Brookfield?

[Nelson Mills:]

Well, certainly, we're very excited to have Dave onboard. He is very capable, experienced, has a great reputation and particularly in the New York and Boston markets. So obviously he'll be running point there, direct oversight of all of our properties there, and our future opportunities there. But beyond that, he has really combined with Kevin and Dave Downey, Kevin Hoover and Dave Downey. We're really calling on him to really have an impact at the national level from an operations standpoint. He brings a lot of experience and creative and innovative sort of office management and leasing. He did a lot of interesting things at Brookfield. He's got a lot of great ideas for some things we could do around the portfolio. That's everything from some proactive leasing of future expirations and some creative ways to get to those to tenant services and various other aspects. So we're very excited to have him onboard. He's been with us for a couple of weeks. He's already jumped in, having an early impact, so very excited.

[John Kim:]

Okay. And just one follow up on 222 East 41st. Is it typical for this seller to be paying the transfer taxes? Or did you guys split that or how did you agree upon paying for that?

[James Fleming:]

It is, John, in most jurisdictions. It is -- it varies some from state to state, but that is the case in New York and in most jurisdictions.

[Operator:]

Our next question is a follow up from Sheila McGrath of Evercore.

[Sheila McGrath:]

Couple of quick more questions. On other income, were there lease termination fees or just what was in other income this quarter?

[James Fleming:]

Sheila, there were some lease termination fees this quarter. We do have those from time to time. We had -- in particular, we had one retail space at 315 Park Avenue South. We -- that lease was terminated. And we are excited about finding a better user for that space. But there were some lease termination fees.

[Sheila McGrath:]

Okay, great. And then the Boston asset, the NOI went down a little. Just what was going on there? And what are the long-term plans for that asset with just one asset in Boston?

[James Fleming:]

Yes, Sheila, I don't know. I can't comment on the NOI. I'd have to look back at that. I will tell you we've gotten some leasing done there. We've gotten leases done. We did everything but the top 2 floors so everything else is buttoned up. We are working hard on -- really figuring out what the right user is for the top floors and getting some activity. But I have to look at -- it probably is related to operating expenses, I have to look at why the NOI pulled back a little bit.

[Nelson Mills:]

And Sheila in terms of future plans, as Jim said, we've got a couple of more floors to lease. We've been talking about those floors for a while. But we have recently done some renovations there. Beautiful property. Great shape. We do get some good traffic through. There's been softer fundamentals in the Back Bay area, but a lot of that is being absorbed. And we've been patient in holding out for a good rate there. And I think we'll get that done in short order. As far as -- it's the only asset in Boston. We are not focused in Boston right now. It's a terrific market. We haven't ruled it out forever. But we do get some unsolicited interest in that property from time to time. So at the right price, we'd consider selling it but there are no plans to do so at this time.

[Sheila McGrath:]

Okay. And one last one on 315 Park Avenue South. That was a good success story. I'm just wondering now that you only have one floor left. How did the rents end up comparing to pro forma? And then if you could just give us, how the activity is on that last floor? And the last question is, was the tenant lease term there was at the staples? And what are your plans for the retail?

[Nelson Mills:]

Okay. So first of all on the rents, we did -- we have exceeded our expectations on our acquisition pro forma. Roughly, we had underwritten mid-70s on the lower floors to $90-ish, high-80s to $90 through the top. And as you know, we've gotten as high as $105 on the top floors and low-90s for the few floors below that, high 80s for the mid-floors. So we've done better on the rents for sure. And that's true. With -- concessions have been favorable as well. TIs and free rent have sort of been in line with expectations. So that's all going well. We have spent a little bit more money on the property than originally anticipated. For those of you who've been there recently, you'll see we're doing some precise work, and replacing some windows. And, I guess, we spent a little bit more than budgeted on that. But overall, in terms of return on cost, we're tracking to do a little better than our original pro forma. So it's been a hit. You're right, it's been a great success. And then in terms of the retail space, Staples has now moved out. And we do have a pretty solid prospect there. We think it will enhance good rates, good terms and will enhance the property. So more to come on that we hope in the next couple of months.

[Operator:]

This concludes our question-and-answer session. I would like to turn the conference back over to Nelson Mills for any closing remarks.

[Nelson Mills:]

Thank you all so much. We appreciate your time and your participation today, in particular your questions. And we look forward to seeing you all again soon. Thank you.

[Operator:]

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.