PS Business Parks, Inc.
Q2 2015 Earnings Call Transcript

Published: 29 Jul 2015

[Operator:]

Good morning. My name is Tanya, 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.

[Edward Stokx:]

Thank you. Good morning and thank you for joining us for the second 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; John Petersen, Chief Operating Officer; and Maria Hawthorne, Chief Administrative Officer. Before we begin, let me remind everyone that all statements other than statements of historical fact 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 now turn the call over to Joe.

[Joseph Russell:]

Thank you, Ed. Good morning, everyone. I will begin with the summary of Q2 results in sales activity; then J.P., Maria and Ed will give you more specific color on the quarter and our position going into the second-half of the year. We are seeing good levels of tenant demand as market vacancy decrease, landlord concessions are easing and rents are more favorable; all good consequences of an improving economy with little to no inventory being built of our product type. With conditions like these, we are exerting more command as customers come to us to renew or lease new space. This quarter Same Park NOI increased by 4.2%, the strongest level since the fourth quarter of 2007. Leasing volume in Q2 gained momentum on top of good Q1 and we executed over 2.7 million square feet in approximately 675 transactions. The vibrancy within our markets continues to improve. And for PSB, this was an all-time-high volume of leasing for a single quarter. Sequentially, Same Park occupancy improved 40 basis points to 93.1%, and Non-Same Park improved 380 basis points to 82.8%. Rent change was 3.1% versus 4.9% last quarter. To dispositions, we have closed one of two owned parks in Sacramento. Last week, North Pointe 213,000 square foot park was sold to a local investor for $17.7 million, or $83 per square foot. The buyer selected for the 154,000 square foot Northgate Park is now nonrefundable, and we expect that to close in the coming days. With these sales, we have completed targeted dispositions in Portland, Phoenix, except for one small building and now Sacramento. Overall, I’m pleased by the valuations we’ve received on the sales and commend Coby Holley, our Vice President of Acquisition and Dispositions on his efforts. PSB’s cash balance now stands at approximately $228 million. But we continue to be disciplined and not place this capital into the low-yielding overbid acquisition offerings that dominate today’s sales environment. Our view is that, market valuations are too high to typically justify investments in many assets and our markets at this – and/or markets at this point of the cycle. We are underwriting a fair amount of product being offered for sale, but again have been judicious in deploying capital thus far in 2015. However, we do have accretive uses for our cash in the not-too-distant future, as we find the Tysons multi-family development, the likely redemption of an upcoming $75 million preferred issuance, and the payoff of the $250 million CMBS loan on the Northern California portfolio on June 1 of next year. All these events take place within the next 12 months. Now to J.P.’s comments.

[John Petersen:]

Thanks, Joe. First, I’ll give my view on market conditions, then discuss trends in our divisions, and finally, provide a quick look at what I see for the second-half of 2015. In Northern California, Southern California, Texas, South Florida, and Seattle, where 64% of our revenue is derived and market fundamentals are trending favorably with healthy tour volume, lower concessions, improving occupancies, positive net absorption, and growing rents. Washington Metro, which accounts for the remaining 36% of our revenue, trails these other markets in the recovery. The Bay Area stands out as a top performer with a strong economy and robust demand, supporting our ability to maintain high occupancy and aggressively push rents, which were up 18.5% in the second quarter. The pro-business climate in Texas continues to be a catalyst for tenant demand and we completed over 570,000 square feet of deals and improve total park occupancy 320 basis points at the end of the quarter with rents up over 9%. Of note, in Dallas, while weighted occupancy was 85.1% for the quarter, we were able to re-lease a large expiration that occurred in Q2, and ended the quarter in Dallas at 90.3%. Fundamentals in Seattle are solid, and we drove rents higher by nearly 7%, and puts occupancy into the 96% range. In Southern California, the economy is solid and while rents were basically flat in Q2, deal volume was over 460,000 square feet and occupancy in San Diego and Los Angeles are both around 96%. Finally, in Florida, we did almost 450,000 square feet of leasing and occupancy at MICC is back to 94%, with good activity on our remaining vacant suites. In Washington Metro, we are now seeing improving statistics with small and midsized companies, specifically technology, nonprofits, and creative companies with the year-to-date positive net absorption in Northern Virginia for the first time in several years. In the quarter, PSB occupancy in Washington Metro improved almost 80 basis points to 90.6%. Government contracted and large tenant consolidations are still a drag on the market, but our focus on small users lines up nicely with the improving fundamental in Washington Metro. Looking ahead to the second-half of 2015, I expect the same set of positive dynamics to help drive solid results in the majority of our portfolio. We have 3.4 million square feet of expirations over the remainder of 2015. 22% of these expirations are occurring in Northern California, 20% in Southern California in Washington Metro, and 18% in Texas. These expirations coupled with a more confident small business customer base, lower market vacancy, and no new construction will foster our efforts to push rents and grow occupancy in all of our markets. Now, I’ll turn the call to Maria.

[Maria Hawthorne:]

Thank you, J.P. I’m happy to give an update regarding our multi-family development in Tysons, Virginia. Last time we spoke, I announced that we had completed the rezoning process and we’re proceeding with next steps. We will soon begin site-work including demolition of the vacant office buildings. The new Class A 394 unit apartment building will be known as Highgate [ph] at Metropolitan Mile [ph]. It sits across the street from the headquarters of Hilton, Gannett and Freddie Mac. Our site is specifically revived in McLean, Virginia; one of the highest income communities in Washington DC with an excellent school system. More fuel for our ability to succeed at this excellent location. We are encouraged about our position with Highgate due to several improvements to the Tysons market. Tysons has recently seen the delivery of approximately 1,000 units in high-rise buildings and absorption has been strong. This absorption is driven by positive job growth, coupled with excellent reception of the $7 billion of transportation infrastructure improvements now complete, headlined by the Metro. The shift in live-work [ph] balance will continue to favor our project as Tysons becomes more desirable to both commercial tenants and residents. PSB owns 45 prime acres in the heart of Tysons and the five-acre Highgate site is a perfect and flat rectangle that will be cost effective and simple to develop. The product we are developing sits in underserved part of the market. We are offering a mid-rise building with modern and upscale amenities that will attract multiple generations of occupants. The site includes two parks, including a sizeable dog park, and all of this is unique in Tysons. Construction on the 450,000 square foot Class A building will likely begin in late fourth quarter or early 2015 pending full-loading [ph] permit. Our JV partner, Kettler, will be managing the process and overseeing full site development and construction activities. PSB’s total cash commitment will range between $75 million and $85 million over the next two years and we expect completion of the project in calendar year 2017. Now, I will turn the call over to Ed.

[Edward Stokx:]

Thank you, Maria. FFO for the second quarter of 2015 was $1.20 per share compared to $1.19 per share for the second quarter of 2014, the increase driven by a higher total portfolio NOI. FFO for the first six months of 2015 was $2.33 per share, compared to $2.39 for the same period of 2014, the decrease resulting from the company’s exit of certain non-strategic markets, partially offsetting the decrease from the asset sales was an overall increase in NOI from owned assets of 6.1%. Same Park NOI increased 4.2% over the second quarter of 2014 as comparative revenues increased 3.6% and expenses increased 2.1%. The revenue increase was driven by Same Park occupancy growth combined with modest, but steadily improving rental rates. For the six months ended June 30 Same Park NOI increased 3.6% over the same period of 2014, the increase driven by a 2.5% increase in revenue and essentially flat operating expenses. Recurring capital expenditures in the first six months of 2015 were $21.1 million compared to $18.4 million in the same period of 2014. While transaction costs on a square foot basis executed are down, the increase was driven by the record volume of leasing during the quarter. Total retained cash after capital expenditures, debt service and distributions was $21.1 million and $25.1 million for the six months ended June 30, 2015 and 2014, respectively. Finally, as we reported yesterday, our Board of Directors approved a 20% increase in our quarterly dividend, taking it from $0.50 to $0.60 per share per quarter. We will now open the call for questions.

[Operator:]

[Operator Instructions] Your first question comes from the line of Blaine Heck with Wells Fargo. Your line is open.

[Blaine Heck:]

Thanks, everyone. It looks as though rent spreads are pretty healthy at this point everywhere, but the Maryland and Northern Virginia markets, and J.P., I appreciate your prepared comments. But can you just give a little more color on those markets, as there’s quite a bit of role there in 2016. Do you think we can see some improvement in rent spreads there going forward?

[John Petersen:]

Yes, specifically, Blaine, Washington Metro?

[Blaine Heck:]

Right.

[John Petersen:]

Yes. So, as you probably know, we continue to improve the rent spreads, quarter by quarter. Over the last several quarters, we may have a spike here and there depending on what leases come back. I expect that it will be of several quarters probably before we get into the positive range, knowing what expirations we have ahead of us. And – but what we are seeing, as I mentioned in my remarks is good activity with small users, that is the one area, where we have the ability to push rents. But, again, we do have some expirations coming at us next year, where we may have to compete larger expirations where we may have to compete for that business, and that may require aggressive pricing.

[Blaine Heck:]

So do you think just as a follow-up, do you think it’s feasible kind of on average throughout the year, you can get to maybe a flatter or positive number?

[John Petersen:]

You know, Blaine, it’s too early to tell, we’re going to fight real hard to get there. But we’ll just have to see where the market goes and what competitive behaviors like to compete for those deals.

[Blaine Heck:]

Okay. Fair enough. And, Joe, I appreciate your comments on the acquisition environment being tough at this point in time. Can you just give a little more color on any markets you guys may be targeting and what sort of cap rates or price per ton you are seeing on deals that you may have bid on?

[Joseph Russell:]

Yes, the amount of product in the market, Blaine, as I noted is pretty good, meaning, there is a fair amount of inventory that’s coming into the market, across most of our markets from West Coast, the East Coast, and then, obviously, in Texas as well. We continue to underwrite a number of assets. And at this point, we continue to see, as I noted, pretty extreme aggressive bidding. Cap rates can range on a going in yield basis anywhere between a below six or below five, and then we’ve even seen a few deals due to certain conditions even go lower than that. So it – as I noted, it’s a pretty tough environment for us to make sense of putting capital in those low-yielding types of assets. So it appears at this point to be that way in almost every market that we’re in, we’re continuing to look for different angles, value-add opportunities, stressed assets, those kinds of things. But, again, as I noted the buyer behavior is very, very aggressive.

[Blaine Heck:]

Okay. That’s helpful. And then last one and it looks like operating margins were higher sequentially. Was there anything one-time in nature either in revenues or expenses that may have drove that – driven that, or do you think we can expect solid margins going forward?

[John Petersen:]

So, Blaine, the numbers were pretty clean. There was no – there were no one-time or non-recurring hits this quarter. So, I think, it’s a pretty good reflection of where we are.

[Blaine Heck:]

Okay, great. Thanks.

[John Petersen:]

Thank you.

[Operator:]

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

[Craig Mailman:]

Hey, guys. J.P., maybe a follow-up on DC, you noted a couple of larger expirations in that market. I know large is kind of a relative term for you guys, relative to some other peers. Could you just walk through kind of some of the chunkier expirations you guys have had of you there [ph]?

[Edward Stokx:]

Sure, Craig, we – I will go through deal-by-deal, of course. But we do have – you mean, large in that market is kind of anything over 20,000 square feet, which is where competitive landlord behavior gets a little goofy. And we do have some of those as we always do that are coming up longer-term leases. And we’re going to have to compete for that business. For those deals over 20,000, 20,000 and above, we just have to compete on concession packages, and as I mentioned earlier, on rental rates. So below 10,000, that’s our sweet-spot as you know. And that allows us to compete more and more in more favorable conditions. But right now sitting here in July of 2015, I feel a lot better about that market than I did last year at this time.

[Craig Mailman:]

Got you, and if you had to quantify like the percent of the role that’s over 20,000 square feet, kind of where were that taken? Do you have any that are like 50,000 to 100,000 square feet?

[John Petersen:]

We have some in that range, but not a lot. And on a percentage basis most of our customer base is smaller as you know, I mean, that’s the lion’s share. But as you also know, bigger deal can have an impact on our quarter-to-quarter numbers. But, again, market conditions for our product type there are much improved over a year ago.

[Craig Mailman:]

Right, and I guess, more broadly, we all know that there is vacancy in Northern Virginia, Maryland is little bit better, but for your sweet-spot the 10,000 and below, what’s the vacancy is competitive set there currently? And I’m just trying to gauge your ability to push rents.

[John Petersen:]

Yes, I’m happy to say we’re outperforming in terms of that, even that competitive pure-set for, say, 10,000 and under, where vacancy is high-teens still, where our product line is up along the Metro lines and Tysons, even Prosperity our multi-tenant parks there. That’s done very well and those parks are in the mid-90s. And so that’s where we’re able to compete and that’s where frankly customers are moving. I’m sure, Craig, you’ve read the stats from third-party firms and that’s where the traction is going. Where the traction isn’t getting, as I mentioned in my remarks, is government contractors, larger of these contractors are still consolidating, M&A is going on there as you know. So that’s helping the big tenant, but our smaller guys that market still in Northern Virginia and Maryland, is in the mid to high teens in terms of vacancy.

[Craig Mailman:]

Okay. That’s helpful. Then, Maria, the commentary on Highgate was helpful. Just curious what the yield expectation is on that development. And I know you said, your kind of capital commitment is $75 million to $85 million, but what’s the scope of the total project?

[Edward Stokx:]

Craig, this is Ed. Regarding the comment on the yield, at this point we’re not prepared to get into the yield numbers yet. But it’s certainly a project that we’re very comfortable with going forward and with the investment that we’re making. Total magnitude of the project including the land value is approximately $115 million.

[Craig Mailman:]

It’s helpful. Then just one last quick one for you, Ed, I know the dividend has gone up 20% here and you guys are always really good about keeping it at taxable. Just given kind of same-store growth here and the lack of acquisitions, is this a similar kind of trajectory we should expect over maybe the next one or two years?

[Edward Stokx:]

Craig, that’s a fair question, but it’s not one I’m prepared to answer at this point. I think our dividend philosophy is unchanged in terms of kind of focused on retaining as much cash as we can to put back into the business, but as our taxable income increases we’re forced to increase the dividend.

[Craig Mailman:]

Okay. Thanks, guys.

[Joseph Russell:]

Thanks, Craig.

[Edward Stokx:]

Okay.

[Operator:]

Your next question comes from the line of Manny Korchman with Citigroup. Your line is open.

[Emmanuel Korchman:]

Hey, good morning, guys.

[Joseph Russell:]

Good morning Manny.

[Edward Stokx:]

Hi, Manny.

[Emmanuel Korchman:]

If we look at the Sacramento sale, whether it would be the one that – the closure the one that’s about to close. I think you had a deal closed to tied-up at the beginning of the year, how did the final sort of valuation terms come out versus where that sale was pending out?

[Joseph Russell:]

Yes, Manny, we did have both parks under contract with single buyer a few months ago. Then we re-launched our marketing and sales efforts differently, where we segmented the two parks and that was the more successful endeavor for us, not only with the amount of activity that we saw from a bidding standpoint. But compared to where we were on the prior sale to this one, we did a bit better, meaning that we are able to extract higher valuation decoupling the two assets. So, again, we are pleased by that. And, again, we’re looking forward to getting the second of the two closures shortly. But, again, I think, as a good execution on our park, and with that we’ll be exiting obviously the Sacramento market.

[Emmanuel Korchman:]

Thanks. And just maybe, given your comments on how and these are repetitive comments from previous calls on how competitive the transaction markets are. How much thought have you given to putting more core product on the market and sort of just tapping the environment right now?

[Joseph Russell:]

Yes, I mean, again, when and if, any of that activity plays for us, we would communicate to those events. And what we did a number of quarters ago when we launched our efforts in Portland, Phoenix, and now Sacramento, we telegraphed that and we purposely conveyed the strategic merits of making those decisions. So at this point there’s nothing that we would talk to and/or convey as far as additional sales. But when and if the time comes for that, we would do it in the same way that we just did.

[Emmanuel Korchman:]

Great. Thanks.

[Joseph Russell:]

You bet.

[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 very much. I was hoping you could touch on just given your growing cash pile and where were share prices in the last several months and then the really tough acquisitions market your thoughts on share buyback at some point?

[Joseph Russell:]

Yes, hey, Eric. Again, as you’ve seen us do in certain periods of time, that’s in the wheelhouse of considerations, we haven’t done anything in that regard. The cash balance that we’re sitting on today as significant as it is, we do have meaningful commitments to that cash. And like always, we’re just going to evaluate the variety alternatives that we see, including stock buybacks, but again, nothing to talk to at this point.

[Eric Frankel:]

Okay. And trying to understand the really tough acquisitions environment, maybe you can provide a little bit of additional detail on the buyers debt financing ability of Sacramento?

[Joseph Russell:]

Yes. Oh, you mean, just on Sacramento itself?

[Eric Frankel:]

Yes, just in general, that would be – that’s a good real right example right?

[Joseph Russell:]

Yes. So maybe in boarder terms, I’ll talk about the variety of different buyers that came to the table, most of whom did have a combination of equity and debt. There were some buyers, but we’re looking at, again, equity partners, JV structures that kind of thing. The buyers that we selected have pretty clean approaches; that was another benefit of surety relative to close et cetera. So – but the debt markets are quite favorable even to individual buyers that are looking at the asset sizes in this range. And, again, that’s another reason why we’re continuing to see very aggressive buying behavior out in a lot of different markets right now.

[Eric Frankel:]

Okay. A final question, I noticed in your top 10 customer list that Raytheon dropped off, so J.P., is that a DC lease that rolled over during the quarter?

[John Petersen:]

Yes, Eric, I think that’s more a function of kind of other activity within the top with that – within the top 10 customers. I don’t think it wasn’t the matter of Raytheon moving out. It was other movement within the portfolio and a deal that we had done kind of in the – as J.P. mentioned, we re-leased the big space in Dallas, that impacted that as well.

[Eric Frankel:]

Okay, sounds good. Thank you very much. Appreciate it.

[Joseph Russell:]

Thank you, Eric.

[Edward Stokx:]

Okay.

[Operator:]

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

[Edward Stokx:]

Thank you. Thank you, Tanya. And thank you, everyone, for joining us this morning, and have a great day. And we’ll talk to you soon. Bye now.

[Operator:]

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