PS Business Parks, Inc.
Q1 2017 Earnings Call Transcript

Published: 26 Apr 2017

[Operator:]

Good afternoon, my name is Adam and I'll be your conference operator today. At this time, I'd like to welcome everyone to the PS Business Parks' First Quarter Investor Conference Call. All lines have been placed on mute to prevent any background noise. And after the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. Ed Stokx, you may begin your conference.

[Ed Stokx:]

Thank you. Good morning and thank you for joining us for the first quarter 2017 PS Business Parks' investor conference call. I'm Ed Stokx, CFO of the Company, and with me today are Maria Hawthorne, President and Chief Executive Officer; and John Petersen, Chief Operating Officer. Before we begin, let me remind everyone that all statements other than statements of historical fact included in this conference call are forward-looking statements. These forward-looking statements are subject to a number of risks and uncertainties, many of which are beyond PS Business Parks' control which could cause actual results to differ materially from those set forth in or implied by such forward-looking statements. All forward-looking statements speak only as of the date of this conference call. PS Business Parks undertakes no obligation to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. For additional information about risks and uncertainties that could adversely affect PS Business Parks' forward-looking statements, please refer to the reports filed by the Company with the Securities and Exchange Commission, including our annual report on form 10-K and subsequent reports on form 10-Q and form 8-K. We also report certain non-GAAP financial measures. Reconciliations to gap of these non-GAAP financial measures, is included on our press release which can be found on our website at psbusinessparks.com. I will now turn the call over to Maria.

[Maria Hawthorne:]

Thank you, Ed. And thank you all for joining us this morning. First, I will give a quick overview of company results for the quarter. Then JP will provide specifics on operations and markets while Ed will finish with financial update. I'm starting off by saying that we had an outstanding quarter under the all metrics. Our strategy is on the part concentration in top tier markets combined with strong market fundamentals along with superb execution by our operations team but at Same Park NOI growth of 8.9%. Other highlights included strong Same Park occupancy of 94.6% with 3.5% rent growth and production of 1.8 million square feet. In addition, as occupancy stabilizes at record level in the West Coast in Florida future growth in Same Park NOI will continue through the annual rent increases in the leases. The benefit as the economy continues with flows of steady growth and lower employment in the markets, we operate. In 2017, PSB remains well positioned as we see healthy customer demand in the majority of our market. From the West Coast to Texas and Florida we continue to capture brands that have trended beyond past peak level and there is no softening of activities with smaller, well located flex, industrial or office spaces in our business park. We are driving down concessions in these markets as well and capturing rent growth up to 20% while maintaining low transaction cost of $3.15 per square foot on leases executed during the quarter. I have no new news on the acquisition front, as we believe that too many office [ph] are overpriced and we will maintain our discipline in evaluating prices at record low cap rate for stabilized assets with in place market rent. We continue to hunt for undermanaged value add opportunity. In first quarter, our capital allocation on towards funding the development of our 395 unit Multi-Family project in Tysons, Virginia known as Highgate which is opening next week, the construction will continue to first quarter 2018. We also completed the sale of development rights we held for medical office buildings in North Silver Spring, Maryland for $6.5 million. We had acquired the development rights as part of 2006 acquisition of Westech Business Park. The rights were on [indiscernible] to our part where a hospital is currently under construction. Now I will turn the call over to JP.

[John Petersen:]

Thanks Maria. During the first quarter, our teams once again harness the overall strength in the economy and achieved solid results. To volume of healthy our existing customers continue to look at expansion opportunities and net absorption was positive in our market. I will now take you through first quarter statistics by market beginning in Washington Metro. The good news in Washington Metro is that the overall market is stabilizing but the Trump Thump has not yet manifested itself with the GSA or government contractors. The GSA continues to consolidate when we can and contractors not yet willing to take down new or additional space. However the private sector economies active and unemployment in Northern Virginia and Montgomery County is below 4%. The [indiscernible] execute on the 40,000 square feet of the existing customer experiences in Q1. Overall market occupancy in [indiscernible] 85% and competition for deals is still intense. To find [ph] 110 leases totaling 357,000 square feet in the quarter. Sequentially Same Park occupancy in Q1 dropped to 89.2% from 94.5% as a result of through expiration of 20,000 square feet. Rents declined 8.5% in Washington as we battle to secure some wanted lease renewal. Now for a quick update on our Shady Grove acquisition in Rockville. Reposition is in full swing. They've already completed handful of leases above pro forma rents and will start delivering inventory this quarter. Lease [indiscernible] will be completed by the end of the year and I'm encouraged by our progress today. Moving to Florida, we capitalized on the strong South Florida economy and increased occupancy by 300 basis points to 97.6%. MICC is over 98% lease with limited availabilities and a healthy customer base. We completed 315,000 square feet of leases and 74 transactions with rent growth of 3.6%, retention was 69%. Heading West Texas, we fund 306,000 square feet and 76 transactions. Favorable economic conditions helped us grow rent and optimal of 15% and almost 3% in balance. Occupancy dropped by 340 basis points in office and 94.3% as three customers over 10,000 square feet were at the portfolio. We had solid activity in all three spaces and anticipate favorable re-leasing dynamics on these units fairly quickly. In Dallas, occupancy was flat at 90.5%. However tour activity is active and we achieved 75% retention in Q1. In Southern California economy is fairly well in all three markets and 153 leases were signed totaling 346,000 square feet. Retention was 57% resulting from a handful small customers moving ahead in the quarter. In Southern California blended occupancy is 96%, to both Santiago and LA north of 98% and Orange County at 92.7%. Rent growth was again healthy at 6.4%, with Los Angeles leading the way at 8.5%. Heading up to North California, once again we capitalized on strong market in both occupancy and rent growth. Northern California was 97.8% occupied coupled with 20.4% in rent growth. Eight straight quarter of rent growth over 15%. Leasing volume is relatively light, due to our limited availability with 245,000 square feet. As of April 1, we took back 200,000 square foot industrial space in San Jose with rents good 30% below market. We're impacting occupancy in the short-term, we will back phase, this space with improved economics. Seattle continues to outperform at 98.7% occupancy driven by 225,000 square feet of leasing. Retention of 96% was driven primarily by a large industrial renewal at our 212 Business Park in Kent Valley. Rent growth was 10.2%. As we move to Q2 and beyond the majority of our portfolio is extracting favorable leasing economics driven by job growth, active small business dynamics and strong interest in our well located infill business parks. We still have opportunity and are focused on improving occupancy at leasing out, in addition to pushing rent growth in Florida, Texas and California. The 4.4 million square feet expiring in 2017 and company will capture this upside and have another product year. Now I'll turn the call over to Ed.

[Ed Stokx:]

Thank you JP. FFO for the first quarter of 2017 was $1.52 per share compared to $1.26 per share in the first quarter of 2016, an increase of 20.6%. The growth in FFO is driven by strong operating results as Same Park NOI increased to 8.9% over the first quarter of 2016 as well as savings in both interest expense and preferred equity distributions resulting from the mortgage repayment and issuance of lower rate preferred equity. The Same Park NOI compared to growth of 8.9% was driven by a 5% increase in revenue and a 3% decrease in expenses. The revenue increase was driven by improving occupancy higher effective rents as well as higher income from first quarter Triple-Net expense billings. The comparative decrease in operating expenses was tied to mild winter conditions in Washington DC as we incurred $1.4 million less in snow removal cost in the first quarter of 2017 than the same period of 2016. Excluding the impact of Triple-Net expense billings and the snow savings Same Park NOI was up a strong 4.8%. The Same Park portfolio now comprises all of the companies operating assets with the exception of 226,000 square foot acquisition completed in the third quarter of last year. During the three months ended March 31, 2017. The company incurred $8.7 million in recurring capital expenditures compared to $6.3 million in the same period of 2016. The increase was due to the nature and timing of leasing activity and the completion of certain tenant improvement projects. While the common dividend increased 13.3% during the first quarter of 2017 the company's FAD payout ratio was consistent at 71.1% and 71.2% for the three months ended March 31, 2017 and 2016 respectively. Through the end of April, we have funded $53.5 million of the $75 million construction loan on our Highgate Multi-Family Development and we anticipate fundings of remaining $21.5 million through completion which is anticipated in early 2018. In addition to the funding of the construction loan, during the quarter we completed the previously announced redemption of Series S preferred equity. As result of each transactions we ended the quarter with $017 million outstanding on our credit facility. In the first quarter of 2017, we generated $12 million of free cash after capital expenditures and distributions compared to $10.3 million in the first quarter of 2016, an increase of 16.4%. We will now open the call for questions.

[Operator:]

[Operator Instructions] and your first question comes from the line of Eric Frankel from Green Street Advisors. Eric your line is open.

[Eric Frankel:]

Ed, maybe I can ask about the company's strong operating performance in a different way. If I look at top line rental revenues for the company in 1Q '17 versus the prior quarter it looks like it increased by roughly a little over $3.2 million, what proportion of that $3.2 million is attributable to the higher Triple-Net expense billings?

[Ed Stokx:]

Eric, it's about $1.2 million tied to that and that represents in January, February we go through the process of truing up our expense billings from the prior year and that was the amount in excess of what we had accrued in 2016, is about $1.2 million.

[Eric Frankel:]

Okay that's helpful and I'm assuming that's, I mean obviously it's a catch up but it's non-recurring in nature that $1.2 million reimbursement if you will.

[Ed Stokx:]

Essentially yes.

[Eric Frankel:]

Okay and then on the expense side, what would same store expense increase have been, if the removable cost were flat relative to the prior yet?

[Ed Stokx:]

Give me your question, again. Eric.

[Eric Frankel:]

What would the same store increase - what would have that have been if store removable cost were essentially flat relative to last year? What were the impacts on the percentage basis on expense growth of the same of the snow removal?

[Ed Stokx:]

So expenses were down 3%, if you say expenses would have been flat, our snow was flat.

[Eric Frankel:]

Yes.

[Ed Stokx:]

Expenses would have been up about 1.5%.

[Eric Frankel:]

Okay, that's super helpful. I appreciate that and then I guess related to that, in terms of revenue growth for the company what's the average contractual escalator in place for, on an annual basis it's certainly I presume that you're baking that into lot of your leases as a way to get better economics.

[Ed Stokx:]

Absolutely and the average overall is about 2.5% to 3%.

[Eric Frankel:]

Okay, average about 2.7% to 2.8%.

[Ed Stokx:]

Yes that's a fair average.

[Eric Frankel:]

Okay, I'll jump back in the queue. Thank you.

[Ed Stokx:]

No, problem. Thanks Eric.

[Operator:]

And your next question comes from the line of Craig Mailman from KeyBanc Capital Markets. Craig your line is open.

[Craig Mailman:]

JP, maybe just talk little bit more about that 200,000 square foot take back in San Jose what prompted that and what do you think downtime on that's going to be and how much rent was that throwing off?

[John Petersen:]

Sure Craig. We were in negotiation with the user for a long time as you can imagine, leading up to the and frankly what market rents have gotten so elevated that they chose not to do this, not to pay those rents with us and they downsized into much smaller space, inferior location. We kind of knew this was coming and it's a great building I've known the building for 20 years and in terms of downtime, it's a big market we'll get back and release. I'm hopeful, in the next few quarters. It's a big space to be clear I mean 20,000 feet is.

[Craig Mailman:]

Yes. Are you going [indiscernible] tenants back you think?

[John Petersen:]

No.

[Craig Mailman:]

And then what was the NOI that or how much in rent per quarters have thrown off?

[John Petersen:]

Yes, outgoing rent was borrowed on a net basis below $0.50 and the market is well above that and how well above we'll find out right. We're thinking in terms of Northern California and talked about before is locking in term in credit right now in terms of length of leases, so we're juggling that with extracting highest rent and this is base where put all those factors into the equation to see what, see the long-term credit high rent, that's our goal.

[Craig Mailman:]

But our annual basis is about $0.03 FFO drag, if you were to release it.

[John Petersen:]

Yes, about right.

[Craig Mailman:]

Okay and then, just Ed curious you guys usually kind of flag, things like the Triple-Net expense billings. Why not do that this quarter given the kind of sizable nature of that and kind of give a normalized FFO?

[Ed Stokx:]

Well it's, in terms of showing an adjusted FFO. Well because it is directly related to operations of the company it's a timing issue, in terms of when we bill it, when we collect it and we recognize the income but it's not again it's directly tied to operations versus the things that we typically carve out and adjusted FFO are unusually large buyout [ph] to payments that we received or other non-operating type recurring activity.

[Craig Mailman:]

Great, thanks guys.

[Operator:]

And your next question comes from the line of Manny Korchman from Citi. Manny your line is open.

[Manny Korchman:]

JP, maybe a follow-up on Craig's question. You talked about that on that 200,000 square foot space that you were in negotiations for a while or discussions for a while, is there anything else like that out there that we should be mindful of as we look at it, at tenants [indiscernible] right now?

[John Petersen:]

Specifically in Northern California or anywhere?

[Manny Korchman:]

Just anywhere that we can expect either large whether to call to take back or move out or however you want to define it.

[John Petersen:]

Yes, sure Manny. We - there are few we're always in negotiations with the larger users and until [indiscernible] but there is a deal in Washington Metro that's over 40,000 square feet that with the GSA later this year, is not going to renew. We're certain of that, aside from that I don't really think - can't think of anything that we firmly know about its vacating, any size. Good luck there, [indiscernible] we had a good opportunity to maintain that occupancy.

[Manny Korchman:]

Okay and then just looking through your occupancy stats, it looks like there is some maybe unexpected weakness in the Flex portfolio. Is there anything we should read into there, is that maybe seasonal just couple tenants moving out. I noticed some movement particular in Northern Virginia and Austin.

[John Petersen:]

Yes, no, I wouldn't hear anything about it. It's just kind of that happens from time-to-time especially in Austin, our Flex portfolio will be solid long-term didn't even our Flex portfolio there will be good. Sometimes telling [ph] some guys that happens.

[Manny Korchman:]

Great, thank you.

[Operator:]

[Operator Instructions] Your next question comes from the line of Gene Nusinzon from JP Morgan. Gene your line is open.

[Gene Nusinzon:]

Good quarter. What drove the tick up in TIs this quarter?

[Ed Stokx:]

What was the reason for the tick up in TIs?

[Gene Nusinzon:]

Yes.

[Ed Stokx:]

Really just a timing issue. If you look at our TIs on a per square foot basis, they're holding very, very consistent in the $3 range Maria said we were at $3.15 for the quarter, which you may notice actually a disclosure that we've added this quarter to our supplemental that you can see that by market. But they're pretty consistent, so that's just the timing of projects getting completed and make sure they're leasing.

[Maria Hawthorne:]

And we had a pretty big leasing quarter in fourth quarter. So we're completing tenant improvement related to that leasing too.

[Gene Nusinzon:]

Can you talk about any incremental yield you're getting on TIs, if you baked those into some of your renewals? What are the economics there if you have a tick up in TI, should we anticipate?

[Ed Stokx:]

Gene, that's not a big part of our leasing strategy to amortize TIs into leases. One of the things that we talk about consistently and we're very disciplined about is keeping our space very generic and that goes along with keeping our transaction cost low. So it's not our normal activity there amortized TIs into the rents.

[Gene Nusinzon:]

Got it. Thanks. And just looking at the large tenant portfolio and the small tenant portfolio. Can you provide a breakdown of the rent bumps you had in each on a renewal basis?

[Ed Stokx:]

You're asking for the rent spread between large and renewal or large and small?

[Gene Nusinzon:]

Yes.

[Ed Stokx:]

Yes, if you look at our large rent increase it was about 4% and the small was about 2.9% and as average as JP noted and Maria noted 3.5%.

[Gene Nusinzon:]

Great and any change from what you've seen historically between those two portfolios?

[John Petersen:]

No, nothing. I mean that's pretty normal for us there. Gene.

[Gene Nusinzon:]

Great and it looks like your US Government exposure came down about $0.03 can you talk about what the move out was?

[Ed Stokx:]

There wasn't any significant move out in this quarter, just could be that the remaining lease terms that are left on the GSA leases, how that's annualized. But - the GSA has been contracting, we talked about that a lot in terms of their usage and their space utilization and that's why that percentage has come down from being in the mid six's plus percent couple years ago to where it is today.

[Gene Nusinzon:]

Great and final question on cap rate; any shift from last quarter?

[Maria Hawthorne:]

Cap rates is still strong, but one of the things that's come out in the first quarter report is that, first quarter investment sales are at the lowest level now that they've been since early 2013. So I think and what we're beginning to see and we're hopeful of is some cracks [ph] in that, sellers have very high expectation, that buyers are now beginning to have a little bit more conservative underwriting. So you're kind of seeing a place now where sales aren't as quick, there is not quite as many did. However if it's for good industrial assets in top tier or even second tier markets, there can still be a feeding frenzy.

[Gene Nusinzon:]

Great, thanks guys.

[Operator:]

And your next question comes from Eric Frankel from Green Street Advisors. Eric your line is open.

[Eric Frankel:]

Two quick follow-ups. One, Ed I think there is a pretty big slug of preferred that can come up for redemption in the middle of the year, any thoughts on redeeming that?

[Ed Stokx:]

Yes, it's a fair question Eric. That's at 6% redeemable in May. The preferred market has been fairly quiet but the outstandings have come back a little bit. Our most recent issuance is trading roughly at about 5-4 [ph] strip yield. So if you were to use that as a kind of indication of where we could issue today probably wouldn't make sense to swap out at 5.4 to 6% but if that trend continues and may continue to improve, certainly could be an option.

[Eric Frankel:]

What spread is attractive? Is it 75 bps for whatever is redeemable relative to what you can issue today?

[Ed Stokx:]

Well there is hard and fast spread, but it looks much more attractive and makes more economic sense when you get closer to that 75 basis point spread.

[Eric Frankel:]

Okay and then, I think this is in reference to the last call. I was asking about the optimism among senior tenant base and the effects of the change in the Presidential administration. Have you followed up with any tenants surveys about what they think is going to change in the economy and perhaps some regulatory and including regulatory changes?

[John Petersen:]

Yes, that's a good thought, a good question. Something we think about all the time, Eric and we do survey our customers regularly and what that allows us to adjust what we ask them, so we're going to - ask them some of these question and getting their take, but anecdotally and even statistically we're seeing our existing customer base doing very well even from just day-to-day standpoint not on expansions but paying rent on time, they're healthy, their businesses are growing and how much of that is due to Trump, all his plans. I don't know, we're going to ask those questions and sure way to find out, what they say. My guess is, - and we'll find out. As the margins are optimistic but I don't believe that are small tenant base is planning their business based on what Trump is doing, but we'll find out.

[Eric Frankel:]

Okay, that's all guys. Thank you very much.

[Operator:]

And your next question comes from Manny Korchman from Citi. Manny your line is open.

[Unidentified Analyst:]

It's Mike [indiscernible]. Just quick question Ed just on the, those expense true ups, is that rolling also into the annualized, realized rent per foot. So in the $15.16 number that affected you, that $1.2 million in there.

[Ed Stokx:]

That is in there, yes.

[Unidentified Analyst:]

So we would expect sequentially absent obviously the bumps that you have and releasing that you've done a positive spread that number probably be fixed down or stays relatively flat sequentially.

[Ed Stokx:]

Yes, fair point.

[Unidentified Analyst:]

Okay, perfect thanks.

[Operator:]

And there are no further questions in the queue. I'll turn the call back over to Mr. Stokx.

[Ed Stokx:]

Okay, thank you. Thank you everyone for joining us and we look forward to speaking to you next quarter. Have a good day. Bye now.

[Operator:]

And this concludes today's conference call. You may now disconnect.