PS Business Parks, Inc.
Q3 2013 Earnings Call Transcript

Published: 29 Oct 2013

[Operator:]

Good afternoon and welcome to the PS Business Parks’ Third Quarter Investor Conference Call. My name is Tiffany and I will be facilitating the audio portion of today’s interactive broadcast. This event also features streaming audio, which will allow you to listen to the show to your PC speakers. All lines have been placed on mute to prevent any background noise. For those of you on the stream please take note of the options available in the event console. At this time, I would like to turn to the show over to Ed Stokx.

[Ed Stokx:]

Thank you. Good morning and thank you for joining us for the third quarter 2013 PS Business Parks’ investor conference call. I’m 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 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 Joe.

[Joe Russell:]

Thank you, Ed. Good morning and thank you for joining us. Today I will briefly review PSB’s third quarter leasing and financial results and then discuss recent acquisition activity. JP will go in some more detail on the quarterly operational metrics and Ed will conclude with the financial results. In the third quarter PSB’s Same Park NOI improved by 2.2% compared to 0.7% last quarter. This uptick reaffirms the positive progression we are seeing in NOI results as this is the strongest single quarter improvement since the fourth quarter of 2008. Same Park occupancy moved up 10 basis points sequentially while the non-Same Park pool saw better traction hosting a 230 basis point improvement. Combined total portfolio occupancy was 90.2%, without question the biggest factor in occupancy growth has been the continued lease up of the Northern California portfolio acquisitions which today stands at 91%. JP will go into more detail on full portfolio performance in a moment. This quarter, we saw flat rent growth with deals over 5,000 square feet down slightly by 0.2% and smaller transactions below 5,000 square feet positive by 0.3%. This is the second consecutive quarter was flat to slightly positive rent growth or rent change compared to the prior 19 consecutive quarters of negative rent growth. With improving market condition, the focus is to drive leasing volumes by firmly up or increasing pricing to our advantage. This quarter, PSB’s leasing teams completed just over 2 million square feet in about 530 separate transactions. Through the first three quarters of 2013, that takes PSB’s leasing volume to 6.4 million square feet. Leasing traction has been boosted by an overall uptick and economic conditions coupled with the strong positive reaction to repositioning efforts on the 7.2 million square feet of non-Same Park assets acquired subsequent to 2011. At the end of the quarter, we had a 610 basis points spread between Same Park and non-Same Park occupancies, and with anticipated occupancy growth, these properties will continue to fuel overall company performance. The consistent and positive trend in occupancy levels within these assets is the testament of PSB’s investment focus, repositioning efforts, and leasing strategy. Now to recent acquisition activity. PSB has acquired 559,000 square feet of flex properties along with a four-acre parcel of land in Dallas for a purchase price of $27.9 million. The assets are primarily single-story Flex Park located in two sub markets. Four buildings totaling approximately 256,000 square feet, which are currently 67% leased are additive to PSB's largest Dallas flex park known as Royal Tech in the Freeport Las Colinas sub market. With the addition of these assets, PSB now owns 1.3 million square feet in this Dallas sub market where we enjoy a commanding ownership position and a track record of keeping occupancy north of 90%. These assets are a good addition to our Las Colinas parks and will be equally assimilated giving us even more ability to serve both current and new customers. The second component of the acquisition, which is approximately 303,000 square feet provides PSB with a strong presence in the sub market known as Valwood in Northeast Dallas. In place occupancy was 77% at time of acquisition. Typical for PSB, this is a value add opportunity, and we will improve occupancy through proven leasing and property management strategy. With these assets, PSB becomes the largest owner of flex products in this submarket. In 2013, with this most current acquisition, PSB has magnified its Dallas portfolio by 948,000 square feet adding five concentrated Business Parks in three submarkets. We now own 2.7 million square feet in 14 parks in Dallas, where we see strong business activity and have been pleased that little or no competitive spec construction is taking place. In total, with a combined purchase price of $45 per square foot on these 2013 Dallas acquisitions, we have purchased assets well below replacement cost and should see stabilized returns in a 9% plus range once we achieve predicted occupancy of 90% or better. On a final note, I would like to welcome Bob Rollo to PS Business Parks’ Board of Directors. Bob recently retired from a long and distinguished career in the executive search industry and brings a broad-based set of experiences to our company’s Board. I look forward to his advice and to his contributions. Now, I’ll hand the call over to JP.

[John Petersen:]

Thanks Joe. We (inaudible) current market conditions and follow with specific results of PSB’s portfolio. First, I’d characterize general market dynamics in most of the country is solid. In the third quarter, net absorption was positive in 9 of our 13 markets. Store volume, especially with small users has been active and consistent over the last several quarters. Our ability to control lease negotiations is a submarket-by-submarket and part-by-part decision. To the extent our parks are in the 90% plus occupancy, we likely have a better chance to dictate landlord-favourable terms. As it relates to the Washington DC market, as evidenced by the recent government shutdown and budget impact, the marketplace remains unpredictable. The drag in the overall DC market is seen primarily in GSA and government contractors who are hesitant to make decisions on their real estate needs. However, non-government related users and small businesses are active as we see in any market, but our DC leasing team is seeing normal tour volume from these user groups. Even though the government has reopened and once again made short-term decisions around budget and debt levels, it will still likely be difficult for many large users to make meaningful long-term decisions. But that said, we like our position in DC and are confident we can maneuver it through these most recent events. I will now take you through PSB leasing results for the quarter. We completed just over 2 million square feet of lease transactions at an average of 3,700 square feet with a blended term of 3.3 years in the third quarter. Year-to-date, our production is over 5% ahead of 2012, but we are seeing activity that should allow us to continue to maintain this pace for the balance of the year. Northern California again saw healthy volume primarily with small users as we signed 452,000 square feet in 87 deals. Southern California and Washington Metro each contributed approximately 370,000 square feet of lease transactions. The Washington Metro team targeted small users and signed 88 deals for an average size of 4,200 square feet. Of note included in these numbers was a 70,000 square feet 10-year renewal with the GSA in Virginia. Without this GSA renewal, the average deal size in Washington Metro was 3,400 square feet. Southern California signed 187 transactions for an average deal size of 1,900 square feet and Texas provided 318,000 square feet with an average deal size of 8,600 square feet, while Florida closed 303,000 square feet for an average deal size of 5,000 square feet. Now to occupancy; Same Park occupancy increased 10 basis points from the second quarter to 92%. Let me touch on three notable changes. Orange County has moved up and is now at 90.9% occupancy, a 300 basis point improvement from Q2 and a 470 basis point gain from Q1. Austin lost 550 basis points with occupancy adjusting to 91.6% as four users over 10,000 square feet left the portfolio. I expect we will be able to release these quickly as often as a strong market and activity is good on these spaces. Portland dropped 50 basis points to 90.3% as we had one customer over 25,000 square feet vacate and we currently have good activities on this vacancy. As Joe discussed earlier, cash rental rates were flat over expiring rents in the second quarter. We realized positive rent change in seven of our markets and flat to negative rent in six markets. In Portland rents were 9.1% primarily to a decreased rental rate on a space over 10,000 square feet. Orange County rents were up 6.6% and Washington Metro rents slipped 4.9% as a result of several longer term leases expiring and being released at market. Positive rent changes were seen in Austin at 7.8%, Dallas up 6.4%, Miami gained 4.4%, San Diego up 2.5% and Northern California gained 1.6%. Retention in the third quarter was 60% bringing year-to-date average to 62%. Retention was healthy within 8 of our 13 markets at 60% or better with Florida at 74%, Northern California at 67%, Seattle 65% and Southern California at 60%. Now I would like to take you through progress on some of our assets acquired since 2010. Our teams have made significant progress on these assets and we have taken occupancy on the combined 9.5 million square feet from 71.4% at purchase to 86.6% in Q3. In Washington Metro occupancy on a 1.6 million square feet acquired in Tysons, Virginia and Rockville, Maryland has thus far improved from 68.5% of acquisitions to 92.2% as of September 30th. Of note, 611,000 square foot West Park Business Campus in Tysons where we had the heaviest repositioning burden is now 95.1% occupied, up from 74.5% at the time of acquisition. PSB is effectively executing on the strategy of providing generic made-ready suites targeted to small users. Regarding the Northern California Industrial & Flex acquisition, occupancy is approximately 91% today, up from 87% in Q2 and 82.2% at the time of acquisition. Leasing volume in the Bay Area in general and in our asset specifically has been healthy and we expect to put occupancy in this portfolio higher into the 90s. More recently, the July 2012 acquisition in Seattle known as 212th Business Park, a 958,000 square feet industrial park is moving forward. With the repositioning basically complete, our team in Seattle has taken occupancies on 52% of acquisition to 69% today. In fact, year-to-date we have signed 193,000 square feet of new leases. Activity is solid and our outlook remains optimistic with demand coming from smaller 12,000 to 25,000 square foot industrial users. For the remainder of 2013, we have approximately 1.7 million square feet expiring with an average customer size of approximately 2,700 square feet, precisely where we are seeing most of our activity. Of the remaining expirations, Flex represents 66%, Industrial 18% and Office 16%. The majority of our parks are close to or above 90% and without question small users drive the bulk of our leasing volume. With an inventory of vacant units averaging 4,300 square feet in size, PSB portfolio is well positioned to benefit from the activity of smaller companies in each of our markets. Now I'll turn the call over to Ed. Ed Stokx Thank you, JP. Adjusted FFO as outlined in our press release for the third quarter of 2013 was $1.21 per share compared to $1.19 per share for the third quarter of 2012, up 1.7%. For the nine months ended September 30, 2013, adjusted FFO per share was $3.60 compared to $3.53 in the first nine months of 2012, an increase of 2%. These increases in FFO were driven by growth in total portfolio NOI. In the third quarter, Same Park NOI increased 2.2% over the same period in 2012 driven by a 1.7% comparable increase in Same Park revenue partially offset by a modest 0.6% uptick in expenses. During the same period, Non-Same Park NOI increased 12.1% as occupancy in this portfolio continues to improve. Year-to-date, Same Park NOI is up 1.2% with revenues up 1.4% and expenses higher by 1.7%. The increase in revenue was driven by 40 basis point improvement in year-to-date occupancy. Non-Same Park NOI is up 15.4% on a year-to-date basis driven by occupancy improvements as well as the $67 million of acquisitions completed in the latter half of 2012 and 2013. During the third quarter, we had recurring capital expenditures of $15 million compared to $15.4 million in the third quarter of 2012. Year-to-date recurring capital expenditures have been $36.1 million compared to $39.6 million in the same period of 2012. On a year-to-date basis, we have incurred $6.7 million of non-recurring capital improvements related to repositioning of recently acquired assets. In the first nine months of 2013, the company has retained $31.6 million of free cash and has had a dividend payout ratio of 52.2%. The company’s free cash combined with the $250 million available on the credit facility position PSB to continue to pursue opportunities that will grow shareholder value. With that, we will open the call for your questions.

[Operator:]

(Operator Instructions). Your first question comes from the line Josh Attie with Citi. Your line is open.

[Kevin Varin:]

This is Kevin Varin with Josh. On the Dallas acquisition, how long do you expect it will take to stabilize the asset, and then also do you have any near-term plans, development plans for the land parcel?

[Joe Russell:]

Okay. So yeah, two parts to the question. From a stabilization timeframe, I noticed that your initial goal to at least match the 90% hurdle, we are confident we can achieve based on not only the history that we’ve had in that Dallas market, but what we’ve seen in many of the other acquisitions that we talked about on today’s call. So I would anticipate it’s – as it has been with the range of other assets that we’ve acquired a several-quarter process. The good news there as I also noted in Dallas, we see very strong business activity. We have seen some -- again good initial activity on the Arapaho acquisition that we talked about last quarter, and with these recently acquired assets, we expect to get those off to pretty good start as well. So, that again gives a little bit more perspective on timing, and then the land parcel at this point, we don’t have any plans for that. It’s over time to be additive certainly if another building came into play relative to again either existing tenant demand or again just good market activity that we see in general. So in the near term, it will actually facilitate some of the parking advantages that we might want to make available to the surrounding buildings as well. So we haven’t added any additional metrics tied to specifically developing that land parcel, but at a certain point in time I would imagine we will do that.

[Kevin Varin:]

Okay, thanks. Just one last question just on how we should think about the permanent financing on the acquisitions, and then also could you talk about the refinancing of the remaining term loan balance that matures in December of next year?

[Joe Russell:]

Sure Kevin. The term loan which we’ve reduced to $90 million matures in December of next year. We do have one option here available to us to extend that into December of 2015, but with our retained cash and that retained cash continues to grow as the portfolio continues to grow. And with the flexibility that we have with our line, [258] fully available to us today, we think we’ve got plenty of options to take that out with retained cash, and we will continue to look at all options. The preferred market has been quiet, but we will continue to evaluate all options available to us.

[Kevin Varin:]

Okay, thanks a lot.

[Operator:]

Your next question comes from the line of Jordan Sadler with KeyBanc Capital Markets. Your line is open.

[Jordan Sadler:]

Good morning, guys. Just wanted to stay on the topic of acquisitions a little bit, obviously you are able to find another opportunistic one this quarter, I am curious what the, sort of, pipeline and potential looks like, is it sort of value-add oriented and what’s the flow been like most recently?

[Joe Russell:]

Yeah, Jordan, you are right, and the strategy that we have been deploying with almost 10 million square feet acquired over the last three years, it’s been adequately very similar. We continue to seek out and like the metrics tied to the value add assets that we brought in the portfolio, and again putting our own repositioning and marketing and operational strategies in those assets, we’re playing through and seeing really strong results from them. So that's kind of a top line focus for us. Again as we're looking across all our markets, there is a bit more product out in the market today. So that's a bit more encouraging. We're continuing to underwrite a fair amount of deals, and if I wouldn't say any major shift, but it's not untypical that a few more properties might come into the market with potential year-end parameters tied to them, and we see again what can play through there, but the focus again to your question is going to continue to be primarily value add. So again, we have life and continue to see the broader benefits of buying those kinds of assets and bringing them into the portfolio.

[Jordan Sadler:]

I guess that makes sense given sort of the direction of the occupancy you have seen, success you've had. So, along those lines, can you maybe talk a little bit about what the occupancy potential is for the portfolio? I know, I go back if memory serves me over the last several years, I remember occupancy is up in the mid-90s, maybe 94% or so. Is that possible in the sights for this portfolio, could it go higher, how should we think about it?

[Joe Russell:]

Yeah. I mean, obviously there is two parts of the portfolio today that if you can now compartmentalize it by Same Park and then our non-Same Park portfolio. And if you even look statistically on Same Park alone over the last three years, we’ve kind of stepped from 89% range for a few quarters, say four or so quarters, and then we made a shift forward to 91% range a couple of years ago, over the last year or so, last four quarters just as JP noted to we've been hovering around 92%. And again with the market themselves trending positive and economic conditions trending positive, we certainly think that we've got some more room to go and a few more steps if you want to think about that logically. It’s obviously difficult to predict at what level you had kind of theoretical feeling, but for us again at 92% levels today, we feel like we've got additional running room to push that stronger. And then again on the non-Same Park, I mean the acceleration there has been much faster and on the non-same park, excuse me and we're going to again I think we’ve even added momentum there, coupled with the fact the lot of the assets that we've bought are even in our most strongest markets Northern California, Dallas. I’ve already talked about it a fair amount on the call today. And again we're I think pretty, say even optimistic level we can do with those assets as well.

[Jordan Sadler:]

Last one will just be along the same lines I am looking at the ‘14 role and there is some -- you've been able to push (inaudible) to a point particularly in the seven markets we have the gains this quarter. I am thinking about sort of 25%, 26% of rents rolling next year and I see I know Southern Cal and Northern Virginia these are couple other bigger exposures. Can you maybe talk about sort of what your expectations vis-à-vis rents might be there?

[Joe Russell:]

Well, I think maybe I will let JP go ahead and chime in. JP talked about Southern California, again although many quarters we've talked about that being a tougher part of the overall portfolio and we’re finally getting very close to it not now, beyond negative rents spread there. Orange County is still lingering a bit, but LA and San Diego Counties are posting noble positive, rent change and again the economic conditions that we see in Southern California large are healthy, much healthier than they were certainly one, two or three years ago. JP?

[John Petersen:]

Well and Ken as you mentioned or I mentioned we've grown occupancy in Orange County specially. And now that we were into the 90s there we can probably start to have the ability to drive rents, whereas we’re getting up there it’s more difficult to do that. But now I think heading into next year, our focus is going to be pushing out a little bit more as Joe mentioned and then also turning on the rents, that's our goal there. And in DC it would be the same kind of formula, get occupancy a little bit higher. I can mention in our West Park campus, we’re in 95% there, it’s the strong number and that should give a stability in that park to try to push rents into next year and as of parks get to that level our goals to move rents.

[Joe Russell:]

And overall not that it’s big difference, our role nature is slightly lighter than it was in full year 2013. So at the end assuming continued improvement in marketing conditions which no doubt we are seeing I think we have got better ability with many more of our parks trending passed 90% occupancy that’s due better rent costs when we go into 2014.

[Jordan Sadler:]

Okay, that’s helpful color. Thanks guys.

[Joe Russell:]

Thanks, [George].

[Operator:]

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

[Eric Frankel:]

Thank you. I was wondering if you just maybe give an update on what was going on with the Tysons Corner land parcel in West Park?

[Joe Russell:]

Sure Eric. We announced obviously last quarter that we could have done a reentitlement process. So it’s going to take us a few quarters to get to the point where we have got, much clear timing and actual size and all the components that are going to come into the multifamily community. The efforts that’s been going on since our last call has really been again all of the -- behind the teams assemble to design and metals and all those kinds of things. So the team’s working hard on that. I really don’t have much of an update for you yet, but we are in motion there but there is just nothing to report back.

[Eric Frankel:]

Okay, thanks. Maybe just talking about your leasing spreads maybe just talk about the average vintage of leases that are turning over now, are they 2009 leases or the 2008 leases? Just trying to get a sense of what’s the mark-to-market?

[Ed Stokx:]

Yeah. I think they are in a couple of lesser rates, but 9 and 10 range?

[Eric Frankel:]

Yeah. Approximately 80% post 2008, 20% pre 2008 in your numbers, what was turned over this quarter?

[Ed Stokx:]

This quarter?

[Eric Frankel:]

Yeah.

[Ed Stokx:]

No, I don’t have a ball park off top my head that I can talk to you right now.

[Eric Frankel:]

Okay. I guess my final question just on operating expenses your growth is pretty low this quarter. Is there some way we can model that going into next year whether we’re expecting some type of normalization or what is that when occurred?

[John Petersen:]

Nothing unusual, Eric this quarter, we have had some continued successes on reducing our property tax expenses in terms of the assess value throughout the portfolio. Other than that there is really nothing that’s been unusual in the quarter.

[Eric Frankel:]

Thank you.

[John Petersen:]

Thanks, Eric. Okay.

[Operator:]

There are no further questions in queue. I now turn the conference back over to Ed Stokx.

[Ed Stokx:]

Okay. Thank you everyone for joining us and your interest in the company. And we’ll look forward to talking to you in the near future. Take care.

[Operator:]

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