PS Business Parks, Inc.
Q3 2014 Earnings Call Transcript

Published: 28 Oct 2014

[Operator:]

Good afternoon. My name is Sean and I will be your conference operator today. At this time I would like to welcome everyone to the PS Business Parks’ Third 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. Thank you/ Mr. Ed Stokx, you may begin your conference.

[Ed Stokx:]

Thank you. Good morning and thank you for joining us for the third 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. I will now turn the call over to Joe.

[Joe Russell:]

Thank you, Ed. My comments today will be focused on third quarter company performance, acquisition updates and disposition status. JP will go deeper into property operations and performance by markets and Ed will give you his financial update. The third quarter was driven by decent leasing volume of 2.4 million square feet sequential occupancy improvement of 10 basis points within the Same Park portfolio, while total portfolio occupancy was unchanged at 91.2% which now includes three assets comprising 313,000 square feet acquired during the third quarter with significant occupancy upside. Same Park NOI improved by 1%, while total portfolio NOI was up 5.1%. On a per market basis, we saw negative cash rent comps in Washington DC and Orange County. All other markets had positive rent growth; JP will go into that in a moment. Now to acquisition and disposition initiatives. Acquisition opportunities remain limited and expensive, particularly compared to our efforts over the last several years. We continue to seek out underperforming below replacement cost assets, but frankly, we are currently seeing pure sensible deals and bidding for all assets is ruminative of peak market level. Today’s incredibly cheap debt and more buyers entering the market are obvious reasons. This quarter we closed on one small portfolio in Dallas, a six building, 145,000 square foot Flex Park adjacent to the two buildings Spring Lake Business Park acquired in 2013 located in the Valwood submarket. This expanded park is now eight buildings and totals 206,000 square feet taking PSB’s presence in Valwood to approximately 700,000 square feet where we are the largest owner of Flex product. Turning to disposition, we previously announced the sale of PSB assets in Portland totaling 1.2 million square feet for net proceeds of $160 million. One asset remains in Portland, a 102,000 square foot flex park that is under contract and may close this quarter. PSB’s Phoenix assets are under contract and are also scheduled to close late this quarter. Finally, a buyer for the 367,000 square foot portfolio in Sacramento has been selected with a close likely to occur in Q1 of 2015. The significant gains tied to the closing coupled with limited near-term sensible trade options led to our decision to declare a special dividend which I will walk you through. The company now has in excess of $225 million of cash on the balance sheet and an untapped credit facility giving us plenty of capacity to strike when the right acquisition opportunities arise. Now to JP’s comments.

[John Petersen:]

Thank you, Joe. First I will discuss market conditions, operating performance and then review progress in our non-Same Park assets, specifically the assets acquired by early Q3 which totaled 2.7 million square feet. Market dynamics are positive in Northern California, South Florida, Texas and Seattle, but Orange County and Washington Metro are not seeing the same level of robust activity. In the quarter, net absorption was positive in all PSB markets except Washington Metro. Overall, there remains very little new competitive construction. In Q3, really 2.4 million square feet and 613 transactions, an average of just under 4000 square feet. Retention in Q3 was 66%. I will now take you through a breakdown by market with this activity. Northern California executed 589,000 square feet with solid rent growth of 10.7% and Same Park occupancy increased 190 basis points to 95.5%. In Florida, we signed 266,000 square feet with rent growth of 4.3%. Same Park occupancy dropped 260 basis points to 94.9% as a 100,000 square feet user left the portfolio. We are currently demolishing the space and have good activity. In Austin, we signed 200,000 square feet and Same Park occupancy improved 40 basis points from Q2 to 94.2% with rents growing 3.8%. In Dallas, we did 207,000 square feet, Same Park occupancy up slightly 28.7% as we have two users of 15,000 square feet in the portfolio. Rents increased 2.4%. Washington DC remains burdened by a little government new leasing or expansions and the impact to government contractors based on reduced budget. While our core small user environment remained active in our DCSS, there still exists pressure, particularly on spaces over 100,000 square feet deal-to-deal as market dynamics are compounded for qualified tenants. Still our team in Washington Metro completed nearly 490,000 square feet in 115 separate transactions. Same Park occupancy in Washington Metro increased to 90%, up 80 basis points from Q2. Due to market pricing pressure, our cash rents fell 12% in Maryland, and 10.4% in Northern Virginia. Southern California also had an active quarter completing 442,000 square feet of deal with rent declines of 1.4% due to lingering pressure in Orange County. Occupancy in Southern California slipped to 110 basis points to 91.4% in the quarter as we lost two users totaling 80,000 square feet. Now I will discuss performance in our non-Same Park assets. As Joe mentioned, excluding the Q3 acquisitions, weighted occupancy for Q3 was 81.6%, up 380 basis points from Q2. Today, occupancy is 85% which represents a total improvement of 17.3% from acquisition. First, starting with Seattle. We continue to progress at 212th Business Park. In Q3, we increased occupancy 1250 points from the second quarter to 89.2% today. We have four vacant units left with good market demand. In the 1.2 million square feet of Dallas flex acquisition we have increased blended occupancy of 730 basis points from acquisition to 80% today, primarily due to the active flex market in Dallas. At Bayshore Commons in San Mateo, our repositioning is in full swing and while occupancy remains at slightly 81%, we are growing expiring rents 15% as we reset leases to market rates. Finally, the 149,000 square foot building we acquired at MICC in July is now 100% leased. Subsequent to the end of Q3, we were able to lease the entire building and accommodate these expansion needs of an existing customer. This lead begins late in Q4. The tenant will vacate a 120,000 square foot building within MICC early in 2015, giving us good rent upside as we turn the building to smaller size bases. Now, I’ll turn the call over to Ed.

[Ed Stokx:]

Thank you JP. Reported FFO for the third quarter of 2014 was $1.20 per share, unchanged from the $1.20 per share reported in the third quarter of 2013. When taking into account the effect of the November 2013 issuance of common stock comparative FFO per share increased 7.1%. The increase in FFO was driven by an increase of 5.1% in total portfolio NOI including Same Park NOI of 1%. Same Park revenues increased 1.8% during the quarter over the same period of 2013 as a result of improving occupancy while Same Park expenses increased 3.3%. Driving the expense increase were higher property taxes and repairs and maintenance. Sequentially, Same Park operating cost increased 5% as we typically incur higher utility cost during the summer months. For the nine months ended September 30th 2014, the company’s dividend payout ratio was 57.8% compared to 52.2% for the nine months ended September 30, 2013. Total retained cash after capital expenditures, debt service and distributions for the nine months ended September 30, 2014 and 2013 was $33.3 million and $31.4 million, respectively. As we noted in our press release, as a result of the sale of two business parks in Portland as well as the pending sale of other assets, the company declared a special dividend of $2.75 per common share. This distribution which will aggregate approximately $94.3 million is driven by the net taxable gain resulting from the asset sales after taking into account gains protected through 10/31 exchanges. While we intend to remain disciplined in our capital allocation, the retained proceeds from the sale combined with recurring retained cash positioned the company with significant capacity to continue to grow and deliver shareholder value as we identify opportunities that meet our strategic objectives. We will now open the call for questions.

[Operator:]

(Operator Instructions) Your first question comes from the line Craig Mailman from KeyBanc Capital. Your line is open.

[Craig Mailman:]

Hey guys, maybe just heading straight to acquisitions here Joe, it seems like conditions are very much back to peak and maybe a little bit frothy your view. I mean, from what you are seeing are we well above replacement costs on a lot of asking here and people just really paying up for vacancy, kind of what are you seeing in the different property types that you guys play in and maybe which regions are you seeing the most frothy pricing?

[Joe Russell:]

Yes, Craig, yes, it’s a combination of a number of things you just alluded to. So, there is pretty frothy behavior that’s going on in the bulk of our markets that again, certainly limits our aggressiveness when it comes through with the fully or near full occupied assets. Lot of buyers at the table, the amount of capital, at their disposal is heavy. So, we are seeing timing to getting for looking at those kinds of assets. The competitive paper that I talked to and again, what is our continued focus is to acquire assets well below replacement cost, so that we are able to go through a repositioning process or re-leasing process to capture that upside. There is a degree of that type of product out in the market. A few newer, I would say, buyers have come into that space. We’ve seen a strange or little bit more aggressive behavior there too, but the biggest issue is there. At the moment, there is not as much of that out there and instead again of us reverting to just looking at stabilized highly competitive and in our view overpriced asset we help a prudent thing to do in the near term was to again do the special and still to leave us with plenty of capacity to go on capture things as they arise in the coming quarter, so.

[Craig Mailman:]

So, you guys have $225 million in cash now, the special is about $94 million and then you are going to have obviously the proceeds coming in from the other assets. I mean, do you guys expecting 175 million-ish of cash at the end of 1Q 2015?

[Joe Russell:]

Craig, I don’t want to get into speculating what our cash balance will be just because the pending sales aren’t final but, we will have sizable watches that are availability to seek up opportunity for sure.

[Craig Mailman:]

Okay, and what is the – do you guys have an acquisition pipeline now and it sounds like you are going to be able to 10/31 is that just a reversal to what you’ve recently bought or do you guys have stuff that you are expecting to close in the next two quarters?

[Joe Russell:]

Yes, in Ed’s commentary, we allocated the known either closing that has happened. There is not a lot of product in the mix that we would talk to it in the moment, we will, again, see how that plays through in the next couple of quarters. And it all typically revolves around these tighter windows as we close on assets, you got a pretty short period of time to both identify and then few months after that actually close the asset. So, there are a few things that we continue to look at. But it’s not the range and the size that I’ll tell you that we were saying one to two years ago. And, what we’ll see again, is other opportunities arise as the – again, other sellers bring products to the market. So, tough to say exactly how that is going to play out at the moment, Craig, but, bottom-line we feel like we are still very well positioned to deploy capital when the right opportunities arise.

[Craig Mailman:]

Okay, and then just separately, JP, can you go through what the differential in spreads is for your new and renewal leases during the quarter? Does, DC Metro look any better on renewal leases than new leases or is it pretty similar?

[John Petersen:]

Typically, we are going to have better spreads on renewal. For obvious reasons, what we phased out is – as I mentioned in my comments for larger – the larger renewals that we still have to compete with the marketplace. So, we have – let’s call it 5000 below, we are seeing more positive momentum more from new and specific renewals, but if we have a larger transaction, we have to compete, we face the market because that will be represented by a broker and a choppy deal around and we have to compete which is reflected in some of our discounting we have to be able to keep these units at our portfolio.

[Craig Mailman:]

So, did that, I don’t know if you are going to see in your case, but that is down 30 basis points. What has that broken out blended between new and renewal?

[John Petersen:]

Actually, I am just looking at it right now. For the company, renewals are basically flat and newer just down 0.5 for the company.

[Craig Mailman:]

Okay and then just one last… go ahead.

[John Petersen:]

Go ahead.

[Craig Mailman:]

No, go ahead.

[John Petersen:]

No, I have finished, I finished.

[Craig Mailman:]

Okay, and then just one last one on the MICC lease, so you guys are going to have a little bit of dampen time. What do you guys are thinking for that that space lease at timeframes to – tenant to the other building?

[John Petersen:]

Well, I think, as we – this was really an execution to get this building leased with an existing customer which – one of the challenges we face in that park as you know is, when a customer grows with us in the Park like environment, at sometimes they outgrow it and leave the portfolio. We are able to capture the growth from the existing customer and that space as I mentioned, is already kind of right-sized for organic growth with the existing customers in the marketplace. So, I can’t give you a specific timeframe, but I am confident of our ability to track that that building pretty quickly.

[Craig Mailman:]

Great, thank you guys.

[Ed Stokx:]

Thanks, Craig.

[Operator:]

Your next question comes from the line of Kevin Verin from Citi. Your line is open.

[Kevin Verin:]

Hey, good morning guys. Just to start to think about 2015, there is about a quarter of the portfolio set to expire, so, can you just comment on the geographic mix next year and also kind of walk us through where you are seeing the best opportunities to kind of roll up rents?

[Joe Russell:]

Sure, Kevin, we and typically, we have in mid-20s expiration and it’s pretty evenly divided by markets. We do have kind of in the mid to mid-teens, 15% to 18% kind of evenly divided between Texas, DC, Southern California and Florida, that’s kind of the range. And slightly less Northern California, but I view Texas is an opportunity for us. I view Northern California as an opportunity, Florida, opportunity for us, DC; we are in dialogue with those expirations already. And our retention year-to-date has been good there, so I am hopeful that we’ll have good success in a tough market retaining those customers. But most of the renewals or the expirations are in our markets where that I feel confident about.

[Kevin Verin:]

Okay, and is there any sense on what the mark-to-market is for the overall lease till next year?

[Joe Russell:]

No, not something that we have our fingertips right now that to discuss.

[Kevin Verin:]

Okay, thanks.

[Operator:]

(Operator Instructions) Your next question comes from the line of Eric Frankel from Green Street Advisors. Your line is open.

[Eric Frankel:]

Thank you. I was wondering can you talk about the Orange County office market, it doesn’t feel that that here.

[Joe Russell:]

Yes, honestly, it’s tied for us for a couple of basis Eric. Really that’s the challenge. We’ve got a couple spaces in the mid-20s that we can’t sub-divide and we are just not finding any traction there. That’s really the issue with Orange County and you are seeing our park. So, there is activity but, it’s really tied to one or two spaces and if you take out those spaces, we are in well into the mid-90s. So, it’s just one or two key bases that I got to tackle here, but as on that, we are in the mid-90s in Orange County.

[Eric Frankel:]

Okay, great, thanks. Could you perhaps comment on the West Park redevelopment? I know there is some news that came out of the last couple months, obviously you and your KV partner proposed some – what you are going to need process on the Park redevelopment. That it looks like the plan is much more extensive, it can last a number of years, and I am just wondering what you can share at this point?

[Joe Russell:]

Yes, Eric the process is tracking well and what I mean by that is, we are coming close to the end of our formal entitlement approvals. I would expect that to happen within the next quarter or two and by all accounts, the property continues to get both good reaction and is – I think complementary to the amount of demand that’s coming into the Tyson’s markets with all the infrastructure upgrades and new company integration or migration into that markets. So, we are tracking that continually as we get to the end of our process here on a re-entitlement process, but we are feeling positive about that and I would expect us to be in a much more definitive phase in the next couple of quarters relative to specific timing and the right elements are come with – that are going to come with the development, but we are feeling at this point pretty optimistic about it.

[Eric Frankel:]

Okay, thanks. Final question for now, Ed, you just commented on why are property taxes have increasing the most and just a great concern going forward?

[Ed Stokx:]

Yes, Eric, we are seeing the most property tax increases has been clearly in our Texas portfolio both in Dallas and in Austin. It – we have seen pretty consistent increases there that we will be able to recover as much of that as we can to our triple net leases. But we still want to manage that very aggressively because it ultimately affects how much rent we’ll be able to get from our customers. So, that’s something that we are very focused on and we pursue appeals of property taxes aggressively, but the taxing authorities throughout the State of Texas have been pretty aggressive.

[Eric Frankel:]

Ed, a just a confirmative stake on they are accepting the market value and that’s potentially is or is it just tax filled?

[Ed Stokx:]

Rates have been less of an issue, although rates have gone up, these values have been a bigger driver.

[Eric Frankel:]

Okay, thanks. I’ll jump back in the queue.

[Ed Stokx:]

Thank you, Eric.

[Operator:]

There are no further questions at this time. Mr. Stokx, I turn the call back to you.

[Ed Stokx:]

Okay. Thank you everyone for joining us and we look forward to talking to you in the future. Thank you.

[Operator:]

This concludes today's broadcast. You may now disconnect.