PS Business Parks, Inc.
Q1 2015 Earnings Call Transcript

Published: 30 Apr 2015

[Operator:]

Good morning and welcome to the PS Business Parks First Quarter Investor Conference Call. My name is Steve and I will be facilitating the audio portion of today’s interactive broadcast. 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] At this time, I’d like to turn the call over to Ed Stokx. You may begin Mr. Stokx.

[Ed Stokx:]

Thank you, Steve. Good morning and thank you for joining us for the first quarter 2015 PS Business Parks investor conference call. I am Ed Stokx, CFO of the company. And with me today 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 Web site at psbusinessparks.com. I will now turn the call over to Joe.

[Joe Russell:]

Thanks, Ed. Thank you for joining our call this morning. I will briefly touch on Q1 results, discuss our view of the acquisition arena and targeted asset sales. Maria is travelling today and is not on the call, but as typical JP will go into more detail on the operational metrics, Ed will take you through the financials and then we will take your questions. We got off to a decent start in Q1 with slightly higher leasing volume than Q4 which totaled over 2 million square feet. I was pleased that cash rent change hit a seven-year high at 4.9% with all market positive, except Washington D.C. and Dallas. Of note, our Southern California portfolio close to positive rent change in San Diego, Orange County and LA, the first time all three have been above the line since 2007. We did take an occupancy dip sequentially due to natural expirations, but are encourage that the bulk of these move-outs in Florida and Texas, two of our stronger market. Same Park NOI improved 2.6% and we added another $10 million to our cash position which now totals $190 million. On that note, sensible acquisition opportunities remain limited. Bidding is aggressive for all asset types and portfolio sizes. We remain focused on uncovering underperforming in value add properties with an investment philosophy that is tied to acquiring quality assets that are ultimately accretive. Capital flows and competitive buying behavior seems to be close to an all-time peak in several markets. So we are being particularly careful about the variety of strategic and economic factors that lead us to any particular investment opportunity. As noted last quarter, we re-launched the sales process tied to the two business parts we own in Sacramento and expect bids later this quarter. In Redmond, Washington, excuse me, we also received condemnation proceeds for a taking of five flex buildings at our Overlake Business Park, for proceeds of 13.9 million or $170 per square foot. The remaining park is an excellent location, adjacent to Microsoft headquarters, where we now have a reduced but prime business park that totals 411,000 square feet, comprised of 22 buildings with current occupancy at 94.8%. Finally, Maria has been busy with our multi-family development in Tysons. We are on track to begin construction in late 2015 or early 2016, as we finalize building permits and select the contractor. Now to JP's comments.

[John Petersen:]

Thanks, Joe. First I’ll discuss market conditions, view progress in the Same Park portfolio and then update progress on non-Same Park assets, which now totaled 2.2 million square feet. Market fundamentals remain positive in Northern and Southern California, Texas, Seattle and Florida. In the first quarter these markets combined for net absorption of over 4 million square feet. Washington Metro did not improve much over the last three months, but it is becoming more stable. In Q1 Washington Metro had negative net absorption of approximately 500,000 square feet. Across our portfolio market level occupancy is tightening and to same job growth is giving a boost of confidence to our targeted small business users. In Q1 for the portfolio we release nearly 2.1 million square feet in 562 transactions, an average of just over 3,700 square feet. Retention in Q1 was 56% and rate growth was 4.9% and Same Park occupancy slipped 80 basis points to 92.5% as a result of this few large and move outs in Florida and Dallas. I will now take you through a breakdown by market of this activity. Northern California had another strong quarter and executed 454,000 square. Our team took advantage of land lord favorable market conditions and posted compliantly in cash rent growth of 12.5%. Same Park occupancy was 95.3% in Q1. In Florida we signed 425,000 square feet with rent growth of 8.3%. Same Park occupancy dropped 280 basis points to 90.9%. This drop in occupancy was due in part due to relocation and expansion of a 120,000 square foot customer into the 148,000 square foot MITC acquisitions we closed last summer which I discussed on our third quarter conference call. To date we have really 62% of the billings with goods activity on the remaining of vacant units. Our MITC products coupled with strong South Florida industrial market will give us the ability to take MITC occupancy back to its traditional mid-90s. In Texas we signed 377,000 square feet in 77 deals. Same Park occupancy dropped 250 basis points from Q4 to 92.4% primarily resulting from tow move outs over 30,000 square feet. Additionally, subsequent to quarter end we lost 100,000 square feet user as they consolidated several locations into one facility. We are actively marketing these buildings and have good activity. Rent in Texas increased 3.1% in Q1. In Southern California we completed 347,000 square feet in 161 deals with positive rent growth of 4.3% in the quarter. In Orange county rent increased 5.1%, LA grew rent 4.4% and San Diego rents were up 2.8%. Occupancy in Southern California dipped by 10 basis points to 92.8%. Our team in Washington metro also completed 347,000 square feet in 108 separate transactions. The Same Park occupancy in Washington metro increased 20 basis points to 89.9%. Deals are still subject to pricing pressure in Washington metro as cash rents fell 4% during the quarter. Management update on our 2.2 million square feet of non-Same Park assets. We grew occupancy in these properties by 630 basis points to 79% during Q1, of this 2.2 million square feet 1.6 million square feet is in Texas. We took advantage of marked momentum and increased the occupancy 180 basis point to 76.1%. [Indiscernible] corporate commons, a 340,000 square foot park in San Montero occupancy still hovers around 80% as we push rate in the midst of completing park repositioning later this quarter. And I'm confident in our team, the sub market drivers and our ability to grow occupancy through the same 95% level as a rest of PSBs Northern California portfolio. Overall looking forward to our 2015 explorations I remain incurred by strong market fundamentals little competitive new construction and a healthy and growing customer base. With 5.2 million square feet or 19% of our portfolio expiring for the balance of 2015 I'm encouraged that our approximately 80% of this explorations are current strong markets where we achieved positive rent growth in Q1. I plan on taking the advantages of these favorable market conditions as we progress through 2015. Now I'll turn the call back to Ed.

[Ed Stokx:]

Thank you, JP. FFO for the first quarter of 2015 was $1.13 per share compared to $1.20 per share for the first quarter of 2014, the decrease resulting from the company's exit of certain non-strategic markets. Partially offsetting the decrease resulting from asset sales was an overall increase in NOI from owned assets of 4.4%. Same Park NOI increased 2.6% over the first quarter of 2014. The increase was driven by a 1.3% increase in revenue combined with a 1.2% decrease in operating expenses. The comparative decrease in operating expenses was primarily due to lower utility cost similar to the first quarter of 2014 the first quarter of this year was impacted by highest snow removable cost. During the first quarter we incurred 1.8 million of snow removal expense. Approximately 50% of which is expected to be recovered through operating expense recoveries resulting in a net NOI impact of approximately $900,000 in the quarter. Recurring capital expenditures for the first quarter of 2015 were 9.5 million, compared to 9 million in the same period of 2014. The company’s dividend payout ratio was 57.5% in Q1 of this year, compared to 56% for the first quarter of 2014. Total retained cash after capital expenditures, debt service and distribution was 10.7 million and 12.5 million for the first quarter of 2015 and 2014 respectively. We will now open the call for question.

[Operator:]

[Operator Instructions] Thank you. Our first question comes from the line of Eric Frankel with GreenStreet Advisor. Your line is open.

[Eric Frankel:]

Obviously not a lot of new news on the capital allocation front, but I was hoping if you can get a little bit more color on -- obviously your cash pile really increase, just want to get a little more color on, are there any markets where there might be some opportunities in the future or if you're looking at potentially new market to see opportunities here after opportunities are pretty dry in the market if you're actively searching. So some extra color will be appreciated? Thank you.

[Joe Russell:]

With the exit that we took in latter part of last year leaving both Portland and Phoenix, intentionally we regroup our efforts and feel good about the debt and the level of activity that we see in our remaining markets. So as a, kind of first Tier or primary focus we feel that we got good running room in the variety of markets we continue to own assets and even with stronger platform that we’ve got in all of those markets, we're seeing a fair amount of activity coming into the market. It's, as I noted continuing question, where we are at this particular point in a cycle where asset values have gotten to such levels that we’re really being particularly careful relative to our outlook and the level of investment that we’re making into certain for sale properties or bidding activities, et cetera. There continue to be more products coming in the market. And we feel like we’re busy seeing a lot of deals, the real question as I noted is just again the quality and the return that anyone those might should play forth for our investment purposes. So it's not really a question of us leading needing to go to a new market. It's really continuing to deal with the competitive pressure and in our view more often than not in the current environment, assets are trading at much higher values than we think are sensible. So, we’re looking at a lot of product and I think we have good running room in the markets that we're in. Like the dynamic of the fundamentals in those markets. And we'll take entity and we focus on them.

[Eric Frankel:]

And just a quick thought on that, if assets are so high and I get that, it's implied that assets are trading above replacement costs everyone to find it; we should look to be developer in certain circumstances?

[Joe Russell:]

Well again where that can make sense in pockets, we’ve done that before and to a degree I would kind of morph that question into another reason why we’re in motion on a multi-family development which by all accounts is not a small transaction, that development property alone with [land] will be in excess of $100 million. So as I noted we’re full steam ahead on the mechanics and the variety of things that we need to do on get that development into motion. But where it could make sense and where it's additive to our core holding, yes, I mean we would definitely consider development opportunities as well.

[Operator:]

Thank you. And your next question comes from the line of Blaine Heck with Wells Fargo. Your line is open.

[Blaine Heck:]

So rents for us increase during the quarter and it was like pretty healthy at this point everywhere, but the Maryland, Northern Virginia markets. JP, I appreciate your prepared comments, but can you just give a little more color on those markets and maybe whether you think we could see improvement in rents there going forward this year? And what types of users or industry do you think maybe could drive that?

[John Petersen:]

Your question maybe was about Washington Metro specifically, those markets?

[Blaine Heck:]

Right.

[John Petersen:]

So, you're well aware of the challenging market conditions there. Having said that, we continue to lease space there and are able to from time-to-time take our -- on deal-to-deal improves market rents. You may be aware over the last several quarters we’ve taken around rents from negative 10% range, now we’re getting to the lower single digits, my goal is to knock that into positive throughout the course of the year but as we turn space to market there is going to be -- from time to time a deal that we have to be aggressive on it and we’ll do that. And the reason we’ll do that because the supply demand curve there isn’t where it needs to be. So we are making progress on certain assets and we will push where we can and where other we have to go drive on price we’re going to drive on that price to.

[Blaine Heck:]

Okay and that's helpful color and then the other region that's on negative market trends, this quarter was Dallas. I think that's the first time negative there in a couple of years, was there anything specific that drove that rolled down?

[John Petersen:]

No Blaine, nothing specific. Just a circumstances with few deals but -- and a small decrease in that's still remains good market and we continue to drive occupancy on our acquisitions there as you know and so we’re -- I'm confident Dallas is going forward.

[Blaine Heck:]

Okay and then can you just comment a little bit more on this potential sales with Phoenix and Sacramento, how those dispositions are progressing and any color on pricing you can give?

[John Petersen:]

Yes, as noted we expect call for offers on two properties in Sacramento later this quarter. Interest has been good, I would say it's been better than it was compared to what we saw a few months ago when we put those same assets after market. We’ll see how the bidding comes through I think I talked before about the fact that we got two separate business parts in that market each of them are relatively small but they seem to potentially cater to different types of buyers so unlike like what we did on the last go around where we had a single buyer looking on both sets of assets we may end up with separate buyers for the two parts. So too soon to tell you or talk to any specific pricing guidance and we’ll see how the process plays out we’ve got a small 23,000 square foot building in Phoenix, again we've got recent activity on that and that's because of its size, highly focused, I mean our efforts have been highly focused on private buyer and that's what’s going through our math, so again a little bit of a same timing on [indiscernible].

[Operator:]

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

[Laura Dickson:]

Hi, guys. This is Laura Dickson here with Craig. I was curious about the five assets that were sold in Redmond that were part of the M&A domain process, just kind of wondering if you could explain how that came about and then just gives us some idea about pricing?

[Joe Russell:]

Sure. So, it was you know a condemnation process; it’s something that we have little control over relative to deflecting at the end of the day primarily because it was an issue that was tied to some road infrastructure and improvements that are tied to that general location on the markets. So we went through a protracted process through both evaluation types of the assets, appraisal, et cetera. Weren’t really sure of what the ultimate timing what's going to play through to be but the process got accelerated and then at the end of the day it was a condemnation process that we had to accommodate. The good news about it was we felt relatively good about the value that played through on the assets at 170 bucks a square foot and then physically it was what I would call a clean taking because 5 buildings of the 22 that we owned in that Park were taken but it was on the Northern end of our Park that at the end is really isn’t going to be problematic for the ongoing vitality of the rest of that park. This particular location is literally across the street from Microsoft’s World Headquarters, so there is fair amount of infrastructure demand that continues to take place in that area, along with freeway systems, et cetera. So that something that at the end of the day ideally need we would not have wanted to have lost those five buildings so we had no choice and for our own protection in value preservation we took it to an extended process and ultimately ended up at the evaluation I talk to.

[Laura Dickson:]

Great. And then so I guess is there any way to know like if there is any other assets in the portfolio that might be a subject to domain in the future?

[Joe Russell:]

No it's relatively rare that we end up going through processes like, it's can’t happen from time to time. Particularly when there are certain Parks and certain locations that are part of -- again these public processes that include enhanced road infrastructure, et cetera. There is not really any other activity like that in our entire portfolio at the moment. So that was an unusual case for us.

[Laura Dickson:]

And then for the non-Same Park portfolio just kind of wondering if you could talk about the larger opportunities, I know you discussed San Mateo, but if you could just kind of give some additional color on what is the bigger opportunities for occupancy in that pool? And then also just curious like when the -- but also just curious like when does the bulk on that actually like move into the same-store pool? I don’t know if that’s coming this year or next year?

[Joe Russell:]

I’ll let Ed address that in a second, but the areas of opportunity that JP talked to include Bay Shore, we’re very encourage about that particular asset, again it’s in San Mateo, phenomenal location. The only hindrance we’ve had on this from an occupancy standpoint is retooling spaces that have come back to us so that we’re actually vacant where we acquire the property along with common area upgrades that we’ve made to the park, we’re within a few weeks of getting that completely done and all our indications are -- market pressure continues to come direction through all of this even in the last four or five quarters we’ve raised rents anywhere from 15% to 25% on any particular leasing transaction even with the turmoil that’s going on in the park. So we’re very courage by that asset and just like JP said the rest of our Northern California portfolio which is an excess of 7 million square feet, over 95% occupied, there is no reason why that asset won’t be there relatively soon as well. And then we got little bit more of an occupancy gap in Texas and in one building in Austin, again good market activity on those assets. So we feel like those are good opportunities for us as well. Ed you want to talk about transition?

[Ed Stokx:]

Just from a transition standpoint of the 2.2 million square feet, 1.5 million of that are asset that were acquired in 2013. So those would fall into the Same Park portfolio at the beginning of 2016.

[Laura Dickson:]

I mean and then just one last quick follow-up, so with the one tenant relocated to like 120,000 square foot customer into the MICC, just curious about like the occupancy in that park now that -- following that relocation?

[Joe Russell:]

Yes, so we move -- we grew an existing customer from our Same Park MICC portfolio they took the whole building; that we acquire last summer. Great story for us there, we since backfilled 62% that building and like I mentioned, I have good activity on the rest of that building relatively and entire MICC we traditionally operate that in mid-90% range, we are in the low 90s now and we’re trying to get that back up to more mid-90. Subsequent quarter is a strong market, we proven we can operate that at that range and we will do that. So -- and we’re getting good rent growth as I mentioned in my prepared remarks of over 8%. So good opportunity for us there and it looks like it about we’re going to be there.

[Operator:]

And our next question comes from the line of Eric Frankel with GreenStreet Advisors. Your line is open.

[Eric Frankel:]

I just want to talk about something near to dear to my house, the Orange County office market. Occupancy is still, so it's lagging still little bit occupancy in the leasing spread, certainly turned positive we’ve seen this quarter some additional thoughts though on from the vacancies you still have to fill?

[Joe Russell:]

We very pleased with the rate growth there and our team has been working hard to push rents where we can. We still have one or two pockets of office space which for us larger vacancies call it over 10,000 to 15,000 square feet and that’s really with those leasing and we’re in the mid-90s so there is a couple of pockets we’re working on, we are seeing activity there that we haven’t seen and it's good legitimate business opportunities. Our flex staff and everything else in Orange County is in very good shape. So there is couple of isolated pockets that’s where we’re focused on and there is activity there too.

[Eric Frankel:]

And just final question maybe perhaps Maria can touch upon this next call. But and turning to the redevelopment process in [Tysons] Corner, what’s the future there, I mean how expansive can that be going forward?

[Joe Russell:]

The thing that’s been our advantage so far which we hope we could continue to leverage and unlock is we have a 45 acre contiguous lot basically, we’ve got several parcels, but it's literally right in the heart of Tysons, there is five acre site that’s tied to our current redevelopment project, is one piece of Eric. It's too soon to tell how much more specifically we might be able to do at this site, but we’re encourage by the fact that again we’ve got 45 flat acre, we have an incredible land mass there, It’s highly over parted as we speak; because basically outside of one building every one of the other buildings was surface parked anywhere from 5 to 7 per thousand ratio so there is some interesting opportunities that could play for us over overtime and we've been pleased by the receptivity that we got on the submission 400 unit development process so we're going to keep working it and again stay tuned and will talk to you as much as we can downstream but at this point nothing we can nothing we can talk to you specifically, but without question it is a prime site higher and better yield.

[Operator:]

Thank you. And our last question comes from the line of Michael Mueller with JPMorgan. Your line is open.

[Michael Mueller:]

Hi. I was wondering if you look at the non-Same Park Occupancy and think about it on a Same Park basis and thinks sequentially, what was the organically sub for occupancy change in that pull of assets.

[Joe Russell:]

I'm not sure I'm following your question exactly, sorry.

[Michael Mueller:]

Yes basically if you take you’re non same park occupancy, how does that change relative to an apples-to-apples basis without the mix changes of same store portfolio versus the non-same store, how that change 4Q?

[Ed Stokx:]

Numerically it was up like 630 basis points, so obviously that improve at a much higher clip on a relative basis to the Same Park portfolio and [ROS] per footage; you guys have those numbers here?

[John Petersen:]

We don't have [ROS] per footage here.

[Ed Stokx:]

It's pulled about what 2.2 million, so.

[Michael Mueller:]

Okay so what is 630 is that apples-to-apples? So keeping that pull constant if it would have been unchanged in the fourth quarter?

[Joe Russell:]

No Mike it’s not entirely apples-to-apples because they were some acquisitions that we made. In the fourth quarter we acquired an asset in San Jose and then we also acquired an asset in Austin in the fourth quarter. So those that would certainly impact the waiting change in occupancy if you exclude those the increase is probably somewhere around 2% to 2.5%.

[Michael Mueller:]

Okay that's what I was looking for that's great okay. Thank you.

[Operator:]

Thank you. There are no further questions at this time presenters, I’ll turn the call back over to you.

[Joe Russell:]

Okay. Thank you everyone for joining us and we appreciate your interest in the company and we’ll talk to you soon. Thank you.

[Operator:]

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