PS Business Parks, Inc.
Q2 2017 Earnings Call Transcript

Published: 26 Jul 2017

[Operator:]

Good morning. My name is Sania and I will be your conference operator today. At this time, I'd like to welcome everyone to the PS Business Parks Second Quarter Investor Conference Call. All lines have been placed on mute to prevent any background noise. 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 second quarter 2017 PS Business Parks investor 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 facts 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 will also provide certain non-GAAP financial measures. Reconciliation to GAAP of these non-GAAP financial measures is included in our press release which can be found on our website at psbusinessparks.com. Now I will turn the call over to Maria.

[Maria Hawthorne:]

Thank you, Ed, and thank you all for joining us this morning. First, I will discuss the company's results for the quarter along with updates on investments and JP will provide details on operations and markets and Ed will finish by giving financial specifics. We had another outstanding quarter on nearly all metrics. We continue to see robust market fundamentals and great execution by our operations team. The company's total NOI growth was 5.3% and despite the move out of 200,000 square foot industrial tenant in Northern California, same-store occupancy is been solid 93.7%. Demand remained strong throughout the West Coast, Texas, and Florida, as we benefit from the infill locations of our card concentration. Our employment improved in all of our markets leading to healthy customer demand and expansions within our own customer base. Landlord depending markets also maintained low transaction costs which were $3.22 per square foot on leases executed during the quarter. There were no acquisitions during the second quarter, as cap rates for industrial and flex products remain compressed and assets were being sold with in debate market rents and high occupancy. We continue to search for value-add opportunity. We had one small asset sales in our Dallas market totaling $2.1 million with a $1.2 million gain. It was a non-core single storey office building in our flex and industrial portfolio. I'm happy to announce that Highgate at The Mile officially opened on June 1st. As you know I've been giving you updates on this project for three years. It is a 395 unit luxury mid family located in Tysons, Virginia. Leasing began in May and our leasing success has exceeded expectations. In the first 10 weeks of operations, we have executed deals on 75 apartments or 19% of our units. Our rate for this infill [indiscernible] and I could not be happier with the initial success of this $117 million asset and our operating and development partner, Kepler. In summary, we had a great quarter and first half of the year and we expect this momentum to continue for the balance of the year due to our portfolio team and strategy. Now I will turn the call over to JP.

[John Petersen:]

Thanks, Maria. Led by an expanding U.S. economy, solid job growth, low unemployment, and healthy demand from small businesses, our teams completed 2 million square feet of leasing in the second quarter with rent growth of 3.2%. I will take you through second quarter statistics by markets beginning in Washington Metro. Nothing much has changed in DC in the last six months. The private sector economy is still active but GSA and government contractor are not, leasing economics are not favorable to landlords and the overall market occupancy in Suburban DC hovers at approximately 85%. Having said that, our DC team is busy and signed 130 leases totaling 465,000 square feet. Sequentially, Same Park's occupancy in Q2 increased 20 basis points to 89.4% aided by strong retention of 76%. In order to secure some of this renewal business, we had to reduce incoming rent to current markets and thus rents declined 9.6%. Finally, in Washington Metro, I mentioned on the last call that a large GSA user wants schedule to move out during the second quarter. At this point, it appears it will be staying through September. This tenant generates approximate $300,000 per quarter. In terms of production, the Southern California team is focused and signed 179 leases totaling 403,000 square feet. Blended total occupancy dropped 110 basis points to 94.9% as we lost one 30,000 square foot industrial customer in Los Angeles. Subsequent to quarter end, we released that space with 14% rent growth. Strong demand from our core users helped us grow rents overall in Southern California by 5.1%. Moving to another strong market, in South Florida we capitalized on strong user activity increased occupancy 40 basis points to 98% and compared to 350,000 square feet of leases and 89 transactions with current growth of 3%. Retention was 75% and thanks to clocking down some key renewals. In Miami, we are seeing a lot of tenant demands for spaces below 20,000 square feet but less activity and more user options above 20,000 square feet including some new developments further west of MICC. In Texas, we signed 346,000 square feet in 65 transactions. Federal economic conditions helped us grow rents in Austin over 14% and 6.3% in Dallas. In Austin, where demand and tour volume is strong, occupancy was 94.2% and retention of 59%. Dallas occupancy was 90.3% during the quarter. In Northern California, we capitalized on strong market fundamentals; leasing volume was 332,000 square feet comprising 104 deals. Northern California was 94.9% occupied with 14.4% rent growth. Regarding the 200,000 square foot industrial space in San Jose, we took back in April, we have completed our market improvements and are actively marketing the space with good activity. Market conditions in Seattle remained very solid aided by limited new construction and healthy demand that operators already say that 98.2% occupancy in Q2 and 94,000 square feet and grew rents 15.7% continuing to reach new fees especially in Kent Valley. Looking into the second half of 2017, we remain focused on improving occupancy in DC and Dallas, expanding our growing existing customer base and extracting favorable lease terms in our other markets. We have 2.7 million square feet approximately 10% of our portfolio expiring in 2017 and I can't wait to attack these opportunities. Now I will turn the call over to Ed.

[Ed Stokx:]

Thank you, JP. FFO for the second quarter of 2017 was $1.55 per share compared to adjusted FFO of $1.36 per share in the second quarter of 2016, an increase of 14%. The growth in FFO was driven by Same Park NOI combined with lower interest expense and preferred equity distributions. Same Park NOI growth of 5.2% was driven by a 4.5% increase in revenue tied to higher effective rents as rent spreads on executed deals increased 3.4% in the first six months of 2017, and 5.3% for all of 2016. Comparatively, Same Park occupancy increased modestly. Same Park operating expenses were up 2.9% due to higher property taxes, utility costs, and compensation expense. For the six months ended June 30, 2017, the company incurred $23.4 million in total capital expenditures compared to $14.5 million in the same period of 2016. $5.6 million of the increase relates to costs incurred on the company's recent acquisition in Rockville, Maryland, as we complete the repositioning of the asset and prepare states for occupancy. The balance of the increase incurred in our Same Park portfolio and was driven by transactions executed in 2017 as well as costs incurred on execute in late 2016. Year-to-date the Same Park transaction costs per square foot are $3.06 on executed deals consistent with the $3.05 per square foot incurred on all transactions executed in 2016. For the six months ended June 30, 2017 the company's dividend payout ratio was a strong 71.9% compared to 67.2% for the same period of 2016. The company generated free cash of $21.9 million for the first six months of the year compared to $24.9 million in the same period of 2016. The decrease is related to the 13.3% first quarter increase in the common dividend. As Maria noted our multifamily development commenced operations during the second quarter and is nearing final completion. Through July, the balance outstanding on $75 million construction loan the company provided the joint venture is $61.9 million. We anticipate funding the balance over the next few months as the project is completed. With operations commencing we reported an equity loss on the unconsolidated joint venture of 382,000 during the quarter. The primary drivers over the loss were operating expenses incurred in connection with the commencement of leasing and property management activity. We will now open the call for questions.

[Operator:]

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

[Eric Frankel:]

Could you embeddiness is within the operating portfolio was there any embedded rent bumps that were set especially pronounced this quarter it seems like your sequential NOI growth was particularly good.

[Ed Stokx:]

Nothing unusual Eric our in place contractual rent increases are just over 2.5% on average across the portfolio.

[Eric Frankel:]

Okay. So there were no big bumps in DC or anything in the Bay area like a random 5% or 10% bump for a larger lease.

[Ed Stokx:]

But nothing unusual.

[Eric Frankel:]

Okay.

[Maria Hawthorne:]

Yes, Eric only on like maybe some of the releasing and renewals that JP referenced that are in the package by markets.

[Eric Frankel:]

Okay, that's helpful. And my second question may be a thought from the past couple of quarters have you seen any regulatory action from the state or the federal government that would benefit small businesses going forward or any change in mood among your tenancy.

[John Petersen:]

Eric, no, we haven't seen anything specifically at least from a regulatory standpoint. We have seen is you small businesses are confident right now they're growing, they're expanding maybe 2,000 or 3,000 square feet at a time but I think they feel good about the business environment and maybe their prospects going forward. So, but from a regulatory standpoint or any governmental involvement no we haven't seen anything specifically.

[Operator:]

[Operator Instructions]. Your next question comes from the line of Craig Mailman from KeyBanc. Your line is open.

[Laura Dickson:]

Hi everyone this is Laura Dickson here for Craig.

[Ed Stokx:]

Hi, Laura.

[Laura Dickson:]

Thanks. So I guess first I just want to -- I was wondering because you guys always look for, look at opportunities, look for opportunities at a discount to replacement cost so, I was wondering with the start trading at a premium what are your thoughts on issuing equity to fund acquisitions.

[John Petersen:]

Well I think Laura, we recognize that the balance sheet has been in very good position right now we've got -- we've got no debt outstanding other than a very relatively small balance on the line of credit. So, there's significant capacity within the balance sheet right now. That being said for a significant action we would, we would certainly consider of issuing equity but we also recognize the capacity that is in embedded in the balance sheet today.

[Laura Dickson:]

Okay that makes sense and also for Ed what’s driving the variability in G&A and how should we think of it as a run rate.

[Ed Stokx:]

Laura I think the modest decline from Q1 to Q2 was tied to some first quarter payroll burden cost and then a little bit higher cost in the first quarter on the Eltiv just the way the accounting for that plan works but again relatively modest change from Q1 to Q2. I would say that the Q2 number that's roughly all in about $2.4 million is a good run rate going forward.

[Laura Dickson:]

Okay, sure there. Sure if that any other Eltiv expenses in 3Q or 4Q.

[Ed Stokx:]

Nothing for the kind of consistent with consistent with what's in the second quarter.

[Laura Dickson:]

Okay. And also regarding an update on the preferred pricing and how that's trended the last couple months was just wondering if that's any closure to the 75 days to Wingsspread that you guys wouldn’t look at -- to redeem.

[Ed Stokx:]

I think if you're look at kind of where our secondary sort of trading the deal that we did in the in the fourth quarter of 2016 at 5.2% is trading today pretty much on a at par on this trip basis. So, if you look at that as an indication of where we could potentially issue preferred today 520 I would tell you that it certainly brings into play the opportunity to redeem the 6% that were redeemable in May of this year. So certainly I would say that is something that we're looking at very closely.

[Laura Dickson:]

Okay, great and then just one last one for me. And are there I know you're active in marketing the 200,000 square foot space in Northern California just was wondering are there any significant prospects on the space.

[John Petersen:]

Yes, we are actually marketing space looks great. There's a very little supply available and we have activity but nothing that I'm really talk about right now but I'm really confident our ability to release that space and when we do we'll see nice rent pop from the outgoing customer. So we feel good about that that piece of opportunity right now.

[Laura Dickson:]

Any idea like the kind of mark-to-market you could achieve.

[John Petersen:]

Yes, it can be solid I mean to be honest it's going to be very solid so we'll see and we're being very selective on the credit we've being very selective on the type of use so, we have -- we have an incredible future real estate that we're being very selective with. So we may be more patience and wait for the right user as demand and then economy in Northern California is very strong so and we anticipate their ability to push rents significantly but all that comes into play with factors like credit and term and everything else so we have wait and see, but I'm confident about the rents increase there.

[Operator:]

Your next question comes from line of Gene Nusinzon. Your line is from --

[Gene Nusinzon:]

Hi this is Gene Nusinzon. Thank you, this is Gene Nusinzon. Hey guys, couple of questions on markets for you in DC for the rent roles you've got coming up in 2018 what's your expectation for mark-to-market there and just when do you anticipate if ever the DC market stabilizing.

[John Petersen:]

Yes sure, in terms of looking forward little bit I don’t see material change in that mark-to-market with an occupancy rate in the general suburban market of 15% or I'm sorry 80% to 85%, there is a lot of pricing power from landlord to be able to drive rents and until we see that pricing to drive rent, that's when I think that mark-to-market start to deteriorate little bit. But we do have as I mentioned consistently the smaller spaces such as 5,000 square feet there is more activity and challenges you do 30,000 square foot renewals coming off of five or 10-year lease, then you have to leave the market right and so that’s we’re having to do and unless there is some dynamics of push to the occupancy up to 90% throughout the market, so competitors can certainly get some pricing power. We still face with some rent right down to keep that occupancy.

[Gene Nusinzon:]

Got it. And how about just Seattle, San Francisco I think lastly spoke at NAREIT, you guys were very positive on just the March market profile in 2018 and you surprised call that’s going to be similar to 2017 or better?

[John Petersen:]

Yes, I think we are positive on 2017 and 2018 as we mentioned earlier especially on the California and Seattle, very robust demand, limited supplies, vacancy and repeat growing rents in the high teens, low 20s in those markets, each quarter-over-quarter no I don’t think that's sustainable forever and it may fluctuate quarter-to-quarter depending on a big deal we do a renewal or something but yes I like the dynamics in those markets and because like our ability to push rents. Having said that, we pushed rents as I think I mentioned last call during the California rent it's been over 15% or around 15% for the last nine quarters. So we’re definitely capturing that rent growth and expected to continue but again it may fluctuate quarter-to-quarter in both Seattle and Northern California.

[Gene Nusinzon:]

Okay. Final question on I guess [indiscernible] with the GIs and LCs that flow through the cash line items. Can you just comment on the fluctuation there and what should we anticipate for the balance of the year?

[Ed Stokx:]

Yes, as I mentioned in my prepared comments that really is tied to some of the costs that we are incurring and repositioning our assets in DC and TD Grove. So we spent roughly year-to-date about $5 million on that, we have indicated in the past that we will spend about $10 million in repositioning and leasing that up. So I would expect that we would incur the balance of that probably over the remainder of this year and may be a little bit into next year.

[Gene Nusinzon:]

So did you think the – after this asset stabilizes you will expense I guess whatever $3 in change per square foot for the activity -- leasing activity that is on going forward?

[Ed Stokx:]

Yes we wouldn’t expect on a blended basis for that number to vary widely.

[Operator:]

There are no further questions at this time. I would turn the call back over to the presenters.

[Ed Stokx:]

Thank you everyone for joining us this morning and we look forward to talking to you in the future. Take care.

[Operator:]

This concludes today's conference call. You may now disconnect.