PS Business Parks, Inc.
Q2 2014 Earnings Call Transcript

Published: 31 Jul 2014

[Operator:]

Good morning, good afternoon. My name is Brianna and I will be your conference operator today. At this time I would 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 2014 PS Business Parks investor conference call. I am Ed Stokx, CFO of the company and with me are Joe Russell, 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 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 Joe.

[Joe Russell:]

Thank you, Ed. I will begin with a brief overview of full company results and then touch on acquisition activity and conclude with an update on our disposition efforts. This quarter PSB reached a broad level of positive performance as we achieved Same Park NOI growth of 2.9%, the highest since the fourth quarter of 2007 and FFO improved by 3.3%. Same Park weighted occupancy ticked up by 20 basis points sequentially. While non- Same Park assets posted sequential occupancy growth of 250 basis points. All told total company occupancy compared to a year ago has improved by 150 basis points with quarterly cash rents improving by 1.1%, the highest level since the second quarter of 2008. The trend line we are seeing has been from a gradual improvement in overall market conditions coupled with continued momentum from repositioning efforts on recently acquired parts. Year-to-date, we are now lease approximately 4.5 million square feet and are encouraged that second half leasing could be equally vibrant based on the health of the economy and the level of conversations we are having with our existing customer base of 5,000 plus users. Turning to acquisition activity, we recently closed on two single buildings in Miami and Dallas, each property is adjacent to and within existing owned parks. In Miami, we acquired a 149,000 square foot industrial building at MICC which is currently vacant for $85 per square foot. It will be a strong addition to the 3.3 million square foot 48 building park and a market that has produced company high occupancy of 98%. The building maybe reconfigured to multi tenancy but will likely accommodate larger than average users and potentially offer our own customers growth option. In Dallas, we acquired a 19,000 square foot building for $60 per square foot located within Arapaho Business Park which was purchased last year where we now own 19 buildings totally just over 400,000 square feet. The building was 100% leased at closing. While there is good size inventory of assets for sell in many of our markets, we are seeing high pricing and active competitive buying behavior that has thus far tempered our appetite for larger scale purchases. We continue to focus on value add opportunity instead of well occupied and low yielding assets, just as you have seen us do with the 1 billion plus dollars of investments over the last four years. In regard to dispositions, we are encouraged by the activity and engagement tied to the marketing processes in Portland and Phoenix. In Portland, buyers have been selected and the assets are in various stages of due diligence. At this point, we anticipate closing sometime in the fourth quarter, but until completed, we will not be discussing additional details on the sales. In Phoenix, we are through first rounds of initial bidding and have also been pleased by the level of attention the portfolio has received. The marketing and sales process has just begun in Sacramento. Now to JP’s comments.

[John Petersen:]

Thanks Joe. First, I will review progress on our Non-Same Park assets which now total 2.7 million square feet; I will then discuss market dynamics and Same Park performance. So typically, Non-Same Park assets have blended occupancy today of 80.4%, an improvement of 420 basis points from Q1 and 200 basis points since the end of the second quarter and that’s nearly 1300 basis points from acquisitions. First, starting with Seattle, we saw strong momentum at 212th Business Park in the quarter, taking occupancy at 910 basis points from the end of the first quarter to 84% today. We have seven vacant units left with good market demand. In the 1.2 million square feet Dallas flex acquisition we have increased blended occupancy 440 basis points from acquisition to 77% today, primarily due to reconfiguring large vacancies to smaller units. And finally, at Bayshore Commons in San Mateo, occupancy is slightly lower at 80%, as we filter out those customers unwilling to step up to current market rents. With both new and renewing customers, we are able to grow expiring rents 15% as we reset leases to market rate. Favorable market traction and our proven repositioning tactics including the amazing suites in the smaller spaces that allows us to continued progress across these assets over the next several quarters. Now to overall market conditions. Net absorption is positive in all PSP markets except Washington Metro. User demand is active and there is a very little new competitive construction. I was pleased with recent volume in Q2, which totaled 2.2 million square feet and 634 transactions. Washington DC remains burdened by less activity tied to direct government leasing and the related impact on government contractors. Unemployment however is still below 5% in both Fairfax and Montgomery counties where our parks are located, getting strength to our core small user environment. This relatively healthy job market has enabled us to target small users and grow occupancy 60 basis points from Q1 to Q2. In order to achieve this occupancy improvement, our teams have had to be more aggressive with rental rates. Maryland rents are up 4.7% and Northern Virginia rents were up 10.2% for the quarter. Leasing volume good in the second quarter, as we've signed 103 leases for average size of 4,200 square feet. As we head into the second half of 2014 our team in DC is focused on these active small customers as we continue to maneuver the challenging DC market. Nearly every other PSP market is experiencing positive momentum, especially Northern California where we executed 560,000 square feet in Q2 with solid rent growth of 9%. Southern California also had an active quarter completing 411,000 square feet of deals with positive rent growth of 2.1%. In Los Angeles, occupancy slipped 150 basis points to 93.6% primarily due to one large industrial customer outgrowing our park. We have strong interest in that vacancy. In Orange County, occupancy increased 80 basis points to 91.5% and rents were up 2.9% with smaller users leading the way. In Dallas, Same Park occupancy dipped slightly to 90% as we have added two 10,000 square feet customers in the portfolio. However, we were able to grow rents in Dallas 5.8% in Q2 and 164,000 square feet of leasing. Finally, in Austin we signed over 100,000 square feet. Occupancy improved 180 basis points from Q1 to 93.8% and rents increased 10.2%. Looking to the second half of 2014, we have 3.5 million square feet or 12% of the portfolio expiring. Of the 3.5 million square feet, 22% expires in Southern California, 20% in Florida, 17% in Northern California, 14% in Northern Virginia and 10% in Dallas. Our teams view most of these expirations as an opportunity to capitalize on improving fundamentals, continue to tap into active small business users and push occupancy and cash to rent growth wherever we can. Now I’ll turn the call over to Ed.

[Ed Stokx:]

Thank you JP. Adjusted FFO, as defined in our press release, for the second quarter of 2014 was $1.26 per share compared to $1.22 per share in the second quarter of 2013, an increase of 3.3%. When taking into account the effect of the November 2013 issuance of common stock comparative FFO per share increased 11.5%. The increase in FFO for the three months ended June 30th was driven by total portfolio NOI growth of 6.5% with Same Park NOI up 2.9%. The 2.9% increase in Same Park NOI was driven by 2.3% increase in revenues as weighted occupancy improved 160 basis points to 92.5%. Sequentially, the decrease in revenue is tied to recovery income resulting from the $2 million of snow expense incurred in the first quarter. Operating expenses during the quarter increased 315,000 or 1.1% over the prior year driven by a modest increased in utility costs. For the first six months of 2014, the company’s dividend payout ratio was 55.3% compared to 49.6% for the six months ended June 30, 2013. Total retain cash after capital expenditures debt service and distributions for the six months ended June 30, 2014 and 2013 was 25.1 million and 24.6 million, respectively. This retain cash combined with our untapped $250 million credit facility and solid coverage ratios position the company with significant capacity to continue to grow and deliver shareholder value. With that we will now open the call for questions.

[Operator:]

(Operator Instructions). Your first question comes from the line of Michael Bilerman with Citi. Your line is open.

[Unidentified Analyst:]

Hi this is Kevin (inaudible) for Michael. The first question I just wanted to drill down on the rent spreads. The cost to deposit territory this quarter I am just trying to get a sense of how much of that is from the overall market rent growth kind of surpassing the embedded rent bumps versus the rollup of the non-Same Park portfolio?

[Ed Stokx:]

Kevin the majority of it’s just due to market conditions continuing to improve versus the impact of acquired assets.

[Unidentified Analyst:]

Okay. And then can you just break it down based on trends versus smaller tenants versus large tenants or is there any traction either/or more than any other?

[John Peterson:]

Yes sure. As always we have a better ability to push rents with smaller customers more often or not they want to be in the space quicker more often they are not represented by brokers and frankly there is less competition for some with of smaller customers we target. As you probably know we make an effort to have our spaces ready to move and we are able to push pricing on smaller customers versus the customer there over 10,000 square feet which were more heavily negotiated, more often now their broker reps and so that’s been our focus all along, we continue to being a better success there.

[Unidentified Analyst:]

Okay and then just final question. Joe you mentioned in your opening remarks that you had a tempered appetite for larger -- at this point to competition on the transaction market so I was just wondering how we should think about the eventual deployment of the assets sale proceeds,, will you hold the cash on hand for opportunistic acquisitions as they pop up or do you have opportunities on the balance sheet side as well?

[Joe Russell:]

So, we're plus or minus just a little bit past the midpoint of the year. If you look at our history, first of all, we typically end up seeing more acquisition opportunities, second half of typical calendar years, not sure if that will play through or not, but that's certainly has been the history over the last several years. There is no question that as I noted the competitive environment is particularly extreme right now due to interest rate and a fair amount of easing on capital availability. So, again it's a little bit more competitive out there. So we're just going to have to wait and see, now the fact that we still have a fair amount of running room relative to those times and execution opportunities both with deployment of the capital and/or any balance sheet implications, but we'll have to wait and see. As I noted we anticipate, but again we'll see the proceeds and the timing of the asset sales will likely happen in the fourth quarter. But again we'll have to continue to see how that plays through. And as those things do happen, we will from there talk more specifically about the options that we have at our disposal.

[Unidentified Analyst:]

Okay. Thank you.

[Joe Russell:]

Sure.

[Operator:]

Your next question comes from the line of Craig Mailman with KeyBanc Capital Markets. Your line is open.

[Craig Mailman:]

Hey guys, just wanted a follow up on the dispositions. Joe where you guys stand now, do you think it's more back half 4Q that these kind of close or is it there earlier in the quarter?

[Joe Russell:]

(Inaudible) itself right. I mean I just think that based on again the way the processes have played through so far, it appears the likely in the fourth quarter but to nail it down to a specific month or exact date at this point is going to be prudent.

[Craig Mailman:]

Okay. And then I know you guys don’t want to get into pricing, but just curious acquisitions can be lumpy, the two that you guys did this quarter were on the smaller side. Are there going to be any gains that need to be sheltered here; are there any guys who are pretty tied to cash flows, is there a special dividend then need to happen, kind of what's your thinking on sheltering the proceeds and any tax liabilities?

[Ed Stokx:]

Craig, this is Ed. There will be some gains associated with some of these assets. And as Joe said, we're looking at and we'll consider all of our options. So at this point, again, it's too early to tell what the ultimate resolution will be?

[Craig Mailman:]

Okay. Just want to drill down into the acquisitions you guys did in MICC, what do you think you guys you need to spend to get that leased up and convert to multi-tenant?

[Joe Russell:]

Well, first of all Craig, as I mentioned, it’s about 140,000, 950,000 square foot building. And it’s historically been leased to a single tenant. It will be able to be divided. And the real question is whether or not that's going to be necessary, both because of overall market trends there and lack of availability of that type building, especially as well located it is, not only within MICC but to the airport. The building itself is in great shape. It’s Class A, A minus, fully functional relatively new especially compared to our existing holding industrial building. So we feel it’s going to have a good amount of appeal out in the overall market. If we do go into more of a multi-tenancy set of options, it’s likely to be just two or maybe three spaces because again of the way, not only the way the building is configured but just again it’s adaptive of some larger users. The other thing that we can do very differently with this building than the prior owner was able to because we own three adjacent parcels where we obviously have building, we can open up ingress and egress to the property very differently than the prior owner had ever been able to do. So, again that might facilitate some additional multi-tenancy. But those costs honestly are going to be quite nominal. The building is in great shape, as I mentioned, got a new roof, new mechanical, it’s in pristine condition. So it’s not the same flavor that we encountered when we originally bought MICC years ago where we really had to recapitalize a lot of those buildings.

[Craig Mailman:]

Is it a user that sold this to you guys or is landlord that can compete with you guys…

[Joe Russell:]

It’s been in and out of couple of ownership structure but one time it was a user owned building and then they did a sale leaseback with institution and then that’s who we acquired the asset from.

[Craig Mailman:]

What are asking rents you guys are taking once you guys are typically getting in MICC this?

[Joe Russell:]

They can range by product size on a net basis anywhere from $6, $7, $8 or maybe into the $9 range right now. So there is a variety of price points depending on the size and condition of a particular space or adaptability based on size and functionality. But that’s the range and I would say this one would be in the higher quadrant of those price ranges.

[Craig Mailman:]

Okay. If you guys have to build a building in MICC, what do you it would cost you?

[Joe Russell:]

I would say you're certainly into a 100 plus dollar range on a per square foot basis. Again, if you do a like-by-like comparison to the level of build out and quality of this particular asset which also includes fully airconditioned warehouse space et cetera. So we feel like we definitely bought it well below replacement cost. And again, we’re pleased to add it into the portfolio there.

[Craig Mailman:]

Okay. And then just one last quick one for JP. The (inaudible) you guys had in Maryland and Northern Virginia. So just curious, were those tenants any expansions in the market or was it mostly just chair shuffle and you guys were will to be aggressive on pricing?

[John Petersen:]

Yes. As I mentioned earlier that market had negative net absorption. And so we're driving our team to keep the buildings leased and in fact in this quarter we actually grow occupancy. From time-to-time if you're renewing and customer bringing in your new customer, you're going to be a little more aggressive especially the bigger those tenants are to capture that business. And so we've made the decision whether it’s a certain space or certain customer to drop rents to get a deal. And so we're going to see that still from time-to-time as we push trying to get our occupancy into the mid-90s.

[Craig Mailman:]

On those deals, do you guys win a term or TIs or is it just a normal PSP deal with rental?

[John Petersen:]

We do our best to, if we're really having a dive on rate, to keep shorter terms and to minimize the capital of course. And most of our space, not all but most of it and we see it what we call make ready. So we have made the initial investment in the TIs. There may be something to add on to that when we track the new customers but not much. But that is a component in that market too is you got to get the space ready. So we try and preempt that and it’s working right now.

[Craig Mailman:]

Great, thanks guys.

[Joe Russell:]

Thanks Craig.

[Operator:]

Your next question comes from the line of Eric Frankel with Green Street Advisors. Your line is open.

[Eric Frankel:]

Thank you. Were there any specific assts within the Maryland, Northern Virginia portfolios that experienced rent roll downs?

[John Petersen:]

No, not really Eric, just Maryland -- at little bit here and there Maryland. The one consistency was the spaces were a little bit larger than our trying to 4,000 square feet; they were 8 to 12 to 14 in that size range, but at not really the specific park.

[Eric Frankel:]

Okay, great. Thanks. I respect the gag order on the Portland sale but I was curious maybe you could just comment on the buyer composition pool maybe?

[Joe Russell:]

As I noted Eric, we had good activity, both there and I will tell you as I noted good activity in the Phoenix portfolio. The thing that’s analogist and similar to both sets of buyer type are again not a group of public entities but we’ve seen both institutional level and then even more locally based but well healed investors that like the product type and specific to each market saw good overall market dynamics and reasons why the comments on each of those markets. And in fact some of them are actually even on the ground there as we speak, I mean they own existing assets. So, it's a real collection in both markets, we've been pleasantly surprised, if that's the right word or encouraged by the fact that again at a lot of interest, a lot of both in and out of town types of buyers. And by all account, buyers that have enough capital to again take down the assets with good capital at their disposal. Again, as I noted and as it relates to the environment what we're competing with in, there is just at the moment a fair amount of that kind of capital in the market. So, it certainly plays through the taken those assets into these processes.

[Eric Frankel:]

Alright. I'm just curious speaking about the acquisition pipeline, would you say that you have the pipeline of assets you are looking at obviously a little bit more under lease is, would you say it larger, say when you guys to put your equity rate last year or smaller?

[Joe Russell:]

It's in range I recall it. What we've certainly seen a little bit more of an we like to tackle quickly when we see them or what we would call bolt-on opportunities two of which we just we did this quarter, obviously relatively small. But again the opportunities to see those with you've got a 100 plus existing parts on variety of markets. So, we continue to look for those kinds of opportunities. And again, we're busy in that theme thing really at the end of the day the decision and issue tied to the types of returns and the pricing points that we are coming into assets are likely to trade out.

[Eric Frankel:]

Great, thanks. I'll jump back in the queue.

[Ed Stokx:]

Okay, thanks Erick.

[Operator:]

(Operator Instructions) Your next question comes from the line of Michael Mueller with JPMorgan. Your line is open.

[Michael Mueller:]

Oh thanks sticking with acquisitions for a second, I mean are there typically buildings in your parks a lot of them that you don’t know that you could see repeated this over time?

[Joe Russell:]

It might be they've repeated as you mean just --

[Michael Mueller:]

Probably MICC that you bought, that were impart --

[Joe Russell:]

Sure, it wouldn't be unusual. And yes, I mean we will see often times and maybe sometimes we're not widening our park but there might be again assets adjacent to and or close enough that the dynamic of having that better concentration is very additive to all of our efforts in a particular sub market. So that's one for the things that we continue to stay close to. And we hope that continue to find opportunities in that regard as well.

[Michael Mueller:]

Okay. And within MICC and out of curiosity how many - are there other buildings there that you don't know they're part of it?

[Joe Russell:]

There are a few but I wouldn't I mean in MICC I mean we own a very dominant position that whether I can tell exactly what the number is but historically 90% more.

[Michael Mueller:]

Okay. And then the last question I know you probably don’t want to dive into – or can’t dive into specifics but just think Portland and Phoenix just out of curiosity I mean house pricing looking like shaping up relative to what your thought gone into the process a couple of months ago – a few months ago.

[Joe Russell:]

Well, the only thing I’ll really characterize is that the fact that we had as much activity was also tell you the fact that it’s a competitive bidding environment. So, we haven’t been disappointed with the level of pricing and that’s encouraging us to continue the processes. So that’s all I’ll say at this point.

[Michael Mueller:]

Okay. Thanks.

[Joe Russell:]

Okay. Thanks Mike.

[Operator:]

The next question comes from the line of Eric Frankel with Green Street Advisors. Your line is open.

[Eric Frankel:]

Thanks again. I read an interesting article yesterday regarding the redevelopment of Tysons Corner with the new Metro line coming in. I did note that the apartment supply pipeline now be getting very large I am just kind of curious given your redevelopment efforts for the vacant office building, how that’s going and how do you feel about developing into that type of market in the next couple of years if the redevelopment gets approved?

[Joe Russell:]

Sure. Yes, Eric. We’re fingers crossed the Metro line is supposed to spoke as open as we speak so we’re very pleased by that finally taking place. But the thing that we’re getting good traction on is we’ve got our formal submittal into all the government agencies for the, zoning of the site that’s going well. We would hope to have more clarity on that I would say by the beginning of next year. The other part of this development that not only gives us, what we feel it’s a good lead but a good competitive position is it is simple to execute because it’s going to be a (inaudible) development so it’s not a highlight structure and is I think going to be priced well and based on our reconnaissance as we speak the pricing level that we're aiming the asset for share continue to be very competitive even with some additional deliveries downstream. The Tysons market as a whole continues to be very vibrant, JP was just reminding me that our West Park portfolio right there from an office standpoint, we're now just north of 95% occupancy. So we still see good traction relative to companies wanting to be there. And then on top of that it just adds other relative to the infrastructure that's now going to be a big step forward with the metro line opening up. So we still collect we've got a good competitive position and we're with our partner and particular working very hard to get us through the entitlement process.

[Eric Frankel:]

Thank you very much.

[Joe Russell:]

Yes.

[Operator:]

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

[Ed Stokx:]

Okay. Thank you everyone for your interest in the company. And we look forward to talking to you in the future. Have a great day.

[Operator:]

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