iStar Inc.
Q2 2013 Earnings Call Transcript

Published: 25 Jul 2013

[Operator:]

Good day, everyone. And welcome iStar Financial’s Second Quarter 2013 Earnings Conference Call. (Operator Instructions) As a reminder, today’s conference is being recorded. At this time for opening remarks and introductions, I would like to turn the conference over to Mr. Jason Fooks, Vice President of Investor Relations and Marketing. Please go ahead, sir.

[Jason Fooks:]

Thank you, John, and good morning, everyone. Thank you for joining us today to review iStar Financial’s second quarter 2013 earnings report. With me today are Jay Sugarman, Chairman and Chief Executive Officer; and David DiStaso, our Chief Financial Officer. This morning’s call is being webcast on our website at istarfinancial.com in the Investor Relations section. There will be a replay of the call beginning at 12

[Jay Sugarman:]

Thanks, Jason. Thanks to all of you for joining us this morning. We worked hard in the second quarter to begin ramping on investment activity and to set the table to resolve several of the existing NPL assets, both will be important to continue the earnings momentum we have begun to develop and to bridge us until our land portfolio can become a meaningful contributor to earnings in 2015. Our result will likely show up until the second half of the year, we are pleased with the progress we were able to make on both fronts in the quarter. Our pipeline of investments is beginning to grow and several NPL’s are getting closer to resolution that will free up both unproductive capital and significant management resources. More to report on that as the year progresses. On the land front, we are moving as quickly as possible to bring several assets, to a point where our value creation effort should become more tangible. Single-family sector continues to improve. We remain committed to deploying resources to find ways to enhance our returns in all of our project. I’ll talk about some early success material later in the call but first let’s go quick review of the business lines. Our real estate finance book saw continued payoffs but also the closing over the first large investment in our pipeline, $140 million plus preferred investments in Landmark Apartment Trust. Segment profit was $8.2 million, with further new investment closings and more NPL resolution needed to build that number. The net lease book remains relatively stable, and the cap rate in the sector continuing to fall for large scale portfolios, our strong yields and long lease terms look quiet good. Segment profit was $11.3 million for the quarter. We’ve been pretty selective so far in new investments but our net lease team is focused on finding situations where we can add real value. Much like last quarter the operating portfolio continue to benefit from very strong performance from the condominium assets in the portfolio. Strong sales in Miami at Ocean House, 1 Rector Park in New York, The Martin in Las Vegas and the 10 Rittenhouse Square in Philadelphia, led the way to a strong quarter. Segment profit was $31.1 million, while this number will be hard to sustain as the condo portfolio sales off, we are starting to see a pick up in leasing at several of our transitional assets. Moving to land portfolio, our growing team is making progress despite the continued drag on earnings, with segment profit of negative $14.3 million. We are in dialog with builders on a growing number of lots and continue to seek ways to participate in the firming market for homes in our core development place. More on this segment in a minute, but first let me turn it over to Dave to review the numbers for the quarter in more detail. Dave?

[David DiStaso:]

Thanks, Jay, and good morning, everyone. Let me begin by discussing our financial results for the second quarter of 2013, as well as recent capital markets activities before moving on to discuss our business segments. For the quarter, our adjusted income was $4 million, compared to a loss of $1 million for the same quarter last year. Results in the current quarter included $12 million of loss on early extinguishment of debt associated with the early refinancing of debt. While results in the 2012 quarter included $25 million of gains associated with the bulk sale of 12 net lease properties. Excluding these items, our adjusted income for the quarter would have been $16 million compared to a loss of $25 million in the same quarter last year. Contributing to the year-over-year improvement to adjusted income was $25 million decrease in interest expanse as result of the progress we’ve made over the past year to reduce our cost of capital and overall indebtedness. In additional, we recorded increase income from continued strong residential sales. This was partially offset by lower earnings from equity method investments, following the sale of LNR. Our net loss allocable to common shareholders for the quarter was $26 million or $0.31 per diluted common share, compared to a loss of $59 million or $0.70 per diluted common share for the same period last year. Excluding the aforementioned items, our net loss allocable to common shareholders for the quarter was $15 million versus a loss of $83 million in the same quarter last year. During the second quarter, we issued at par $265 million of 3.875% senior unsecured notes due July 2016 and $300 million of 4.875% senior unsecured notes due July 2018. We used the proceeds from these transactions to repay the remaining $97 million aggregate principal amount outstanding on our 8.625% senior notes due June 2013 and the remaining $448 million aggregate principal amount outstanding on our 5.95% senior notes due October 2013. We have satisfied all debt maturities for the remainder of the year. During the second quarter, we also repaid $76 million of our February 2013 secured credit facility, bringing the remaining balance to $1.6 billion at June 30, 2013. Additionally, we repaid $52 million on the A-1 tranche of our 2012 A-1, A-2 secured credit facility, bringing the remaining outstanding balance of the A-1 tranche to $8 million. The balance of the A-2 tranche at the end of the quarter remains $470 million. As we discussed before, we spent the past several quarters working in earnest to extend our debt maturity profile and reduce our cost of capital, result of those efforts is that we have significantly improved our debt maturity profile through the end of 2015 with less than 7% of our debt rolling $300 million maturing during the next 2.5 years. In addition, we have brought our weighted average cost of debt down to 6% at the end of the quarter versus 6.5% at September 30, 2012. Our leverage for the second quarter was two times, a decrease from 2.1 times at the end of the prior quarter and at the low end of our targeted range of 2 times to 2.5 times. Subsequent to quarter end we were pleased with the continued positive ratings momentum as Moody's Investor Services revised its rating outlook on us from stable to positive. We work closely with the agencies to highlight the meaningful progress we've achieved and we are committed to demonstrating continued progress towards stated goals of creating value across each of our four business segments. Okay, let me turn to investment activity in our real estate and loan portfolios. During the second quarter we closed on an investment origination in Landmark Apartment Trust of America. We agreed to provide up to $146 million of preferred equity financing of which we've already funded $66 million. We expect to fund the balance of our commitment as Landmark acquires additional multifamily communities. Separately, we invested $43 million of additional capital during the quarter across our business segments. At the end of the quarter, we had over $700 million of cash, which provides us plenty of dry powder to pursue attractive investment opportunities. Our pipeline for new investment is continued to grow, giving us the ability to evaluate a fairly wide set of opportunities and we hope to put a sizable amount of this capital to work over the next 12 months. Over the next year we expect to make an additional $200 million of investments in existing projects in our net leasing, operating and land segments. Also in the second quarter, we generated $538 million of proceeds from our portfolio, which included $155 million from repayments and sales of loans in our real estate finance portfolio, $117 million from sales of operating properties and $16 million from sales of net lease assets, $25 million from sales of land and $225 million of other investments, which consist primarily of proceeds from the previously announced sale of LNR Property. At June 30, 2013, our total portfolio had a carrying value of $5.4 billion, gross of $422 million of accumulated depreciation and $32 million of general loan loss reserves. Let me discuss each of our four business segments. Our real estate finance portfolio totaled $1.5 billion at the end of the quarter. This includes $1.2 billion of performing loans that had a weighted average LTV of 73% and a weighted average maturity of just under three years. They were comprised of $684 million of first mortgages or senior loans and $492 million of mezzanine or subordinated debt. The performing loans generated a weighted average effective yield for the quarter of 7%. Included in the performing loans, we had $42 million of loans on watch list. At the end of the quarter, we had $370 million of nonperforming loans or NPLs, which are carried net of $426 million of specific reserves. Our NPLs were mainly comprised of 34% land, 23% hotel, 20% entertainment and 14% retail. For the quarter, we recorded a $5 million provision for loan loss bringing our total reserves for loan losses to $480 million, consisting of $448 million of asset specific reserves and $32 million of general reserves. While we saw the levels of provisions decreased this quarter, the rate which they may continue to do so is uncertain and we could see quarterly fluctuations. Next, I’ll discuss our net lease portfolio, at the end of the quarter, we had $1.7 billion of net lease assets, gross of $326 million of accumulated depreciation. Our net lease portfolio totaled 20 million square feet across 34 states. During the quarter, we invested $15 million in our net lease portfolio. These fundings include the development of 185,000 square foot build-to-suit campus just outside of Chicago, which is leased to Universal Technical Institute for 18 years. Additionally, we generated $16 million of proceeds, recognizing a $3 million gain. Our net lease portfolio was 94% leased at the end of the quarter, with a weighted average remaining lease term of 12 years. For the quarter, our occupied net lease assets generated an unleveraged weighted average effective yield of 7.8% while our total net lease portfolio generated an unleveraged weighted average effective yield of 7.2%. Let me now turn to our operating properties portfolio. Our operating properties totaled $1.1 billion, gross of $93 million of accumulated depreciation. The portfolio was comprised of $825 million of commercial and $302 million of residential real estate properties. We invested $10 billion in these operating properties during the quarter. The commercial properties represent a diverse pool of real estate assets across a broad range of geographies and collateral types, such as office, retail and hotel properties. They generated $29 million of revenue offset by $20 million of expenses during the quarter. Our strategy within this portfolio is to reposition or redevelop these assets with the objective of maximizing their values through the infusion of capital or intensive asset management efforts. At the end of the quarter, we had $182 million of stabilized commercial operating properties. The stabilized properties were 88% leased, resulting in a 9.5% unleveraged weighted average effective yield for the quarter. During the quarter, we sold $24 million of operating properties which resulted in a $5 million gain. The remaining $643 million of commercial operating properties are transitional real estate properties that were 56% leased and generated 2.9% unleveraged weighted average effective yield for the quarter. We are actively seeking to release these properties to maximize their value. During the quarter, we executed approximately 50 commercial operating leases covering 300,000 square feet. The residential operating properties were comprised of 805 condominium units remaining in inventory at the end of the quarter. These units are generally located in products characterized by luxury buildings in major cities throughout the United States. During the quarter, we sold 118 condos for $92 million in proceeds, resulting in $36 million of income, offset by $5 million of expenses. This brings me to our land portfolio. At the end of the quarter, our land portfolio totaled $962 million and included 11 master planned communities, seven infill land parcels and six waterfront land parcels. Master planned communities generally represent large-scale residential projects that we plan to entitle, plan and develop. We currently have entitlements of these projects for more than 25,000 lots. Our infill and waterfront parcels are currently entitled for 6,000 residential lots and select projects which include commercial, retail and office. The projects in the portfolio are well diversified with our largest exposures in California the New York Metro area, Florida and several markets in the mid-Atlantic and Southwest regions. During the quarter, we invested $8 million into our land portfolio through capital expenditures. During the quarter, we contribute a land parcel into a joint venture in exchange for $21 million in proceeds for which we recorded a $3 million gain and received both a preferred partnership interest and a 47.5% equity interest in the development joint venture. The joint venture will develop the project called Marina palms in Miami, Florida, which will be of 468 unit luxury condominium with 112 slip full-service Marina. After the first few months of presales, 85% of the first tower is under contract or reservation. At the end of the quarter, five of these land projects were in production with sales activity having begun, nine were in development and actively seeking entitlements and 10 were in the predevelopment phase. With that, let me turn it back to Jay. Jay?

[Jay Sugarman:]

Thanks Dave. I mentioned last quarter we tried to offer few markers of value throughout the year as their early stages of certain land assets begin to crystallize value. Obviously, we cautioned that land is never a good business to try to generalize around and certainly are not yet in a position to project larger outcomes. We have seen some success in a few projects and are possibly worth noting. In Miami, we took several steps to unlock value and a parcel land we took back several years ago. Beginning last year, our in-house team and the third-party developer began the process of designing a sales center and preparing the site for construction of 234 unit towers in Ohio and Marina. As Dave mentioned, during the second quarter, we completed the contribution of this land into a joint venture in return for cash and interest in the JV. And once units were released for sale, we see contracts and reservations quickly written on almost the whole tower, first tower. The strong demand should enable construction of the first tower to begin later this year and if this strong demand continues, we’ll generate sizable returns on our basis upon completion of the second tower. One other project with growing moment is our Waterfront Redevelopment along a mile-long stretch of beach in Asbury Park. With a growing and increasingly successful downtown core restaurants, art house, cinemas and local shops, our Asbury Park Waterfront Redevelopment is kicking in the high gear. We’ve been investing continuously over the past several years to upgrade and prepare the Waterfront to follow on the success of the downtown and we recently brought our first project, a 28-unit townhome community called VIVE to market. By only representing 28 units out of likely 2,000 plus total Waterfront units. The sale out of the second phase of units in less than a day has confirmed the strong demand we see developing in the market and should enable us to accelerate our conversations with other home builders going forward. The project team on this one has put their heart and soul into it, and we look forward to being able to build something really special in a market that seems poised to finally live up to its potential. With that, let’s go ahead and open it up for questions. Operator?

[Operator:]

Thank you. (Operator Instructions) And first in the line of Michael Kim with CRT Capital Group. Please go ahead.

[Michael Kim:]

Hi. Good morning. Nice quarter and then really appreciate the effort in disclosing more information on asset level detail for investors. Jay, my first question, I know you talked about the pipeline for new investments is growing, a lot of talk in the market, just the impact of the recent uptick in rates? How should we think about where you deploy capital into new investments, what sort of investment tightened asset classes would you favor in a higher interest rate environment?

[Jay Sugarman:]

Thanks Mike. I guess our focus certainly has been on some of the higher yielding opportunities that we think we have a well-positioned company for. So we’re not really in the commodity business. So I think small changes in rates have had a pretty meaningful impact. I think most of our borrowers are looking to make very significant returns on their capital and so small changes in rates probably don’t change their business plans too much and that has allowed us to continue to follow that area pretty successfully. I think longer term if you see rates move up, I think that opens the door frankly for more on the net leasing side of that business. I have seen lots of activity and lower rates have driven cap rates down pretty materially. So back up in rates there actually that would be a little bit good for us. But we’re still seeing plenty of economic activity on the underlying properties and I think 50, 75 basis points probably doesn’t unhinge that.

[Michael Kim:]

Got you. I appreciate that. And nice to see the monetization of some of the stabilized commercial properties during the quarter and just looking at the yield profile, would almost assume that the unleveraged weighted average effective yield for the assets that were sold during the quarter were closer to 10% for these assets. I'm just curious if you can provide some color on these transactions maybe in the type of assets, implied cap rates and the rationale for monetizing?

[Jay Sugarman:]

Yeah. I guess, it’s a mixed bag and again hard to generalize, those cap rates you mentioned sound a little high there is seasonality in the stabilized portfolio, so it’s a little bit difficult to go quarter-to-quarter.

[Michael Kim:]

Okay.

[Jay Sugarman:]

But I would say we sold a commercial property adjacent to one of our condominium of properties. I think that cap rate was more than 6.5 zone. We sold a piece of commercial property on the West Coast that didn’t really have a cap rate, but certainly was a minor piece of a larger portfolio out there just taking more time than we wanted to spend on it. So you’ll see us to continue to peel off stuff that either from the time management perspective or valuation perspective makes more sense for somebody else to own. But again, I think trying to unwind the cap rates we’ll try to do a better job of giving you a little more detail. The largest trade this time was again a commercial piece down in Philadelphia and I think that went off got it at 6.5 within the 6’s.

[Michael Kim:]

Okay. No. I appreciate that. And in the press release and in the prepared remarks you talked about executing about 50 commercial operating property leases for about 300,000 square feet. When you say executed, does this mean this is already reflected in the second quarter or is this more of a timing issue and then kind of when can we expect this to flow through the income statement and what does that do for the effective yield if anything?

[Jay Sugarman:]

As you know, Mike, specifically we’re signing the leases but either just through free rents or actually when the rent begins to kick in. It’s probably a little bit of a lag. So you probably didn’t see much, if any effect in the second quarter from those leases.

[Michael Kim:]

And most of those leases are those kicking in, in the third quarter or is it kind of more two or three quarters out where that might become the typical lag?

[Jay Sugarman:]

Yeah. I can't give you a weighted average, but most of those have a little bit of downtime before the rent starts to come in. So by year end, I would say they are all going to start, giving you an exact date between now and then, I am not sure.

[Michael Kim:]

I understand. Okay. Great. Nice quarter. Thank you.

[Operator:]

And next we go to Amanda Lynam with Goldman Sachs. Please go ahead.

[Amanda Lynam:]

Thanks so much for taking my questions. I know that your upcoming debt maturities over the next 2.5 years are very, very modest, but could you just update us on your plans for the capital structure longer term. How are you feeling about the mix of secured versus unsecured debt, to the extent you could talk about any opportunistic things you might be looking to do, would appreciate the color?

[David DiStaso:]

Yeah. I think, given the limited maturities coming up, we are focused, I think a little bit more at this point on trying to match from the asset profile of the pipeline that we think is coming down the pike. So that will probably drive its tenor and it will drive where we go fixed or floating. Longer term, obviously we have said we want to be a primarily an unsecured borrower with a rating in kind of the BB, BA2 range. So we’ve got some work to do there, but those two things are probably driving our vision right now, more than any specific transaction.

[Amanda Lynam:]

Great. Thank you.

[Jason Fooks:]

Operator, any more questions?

[Operator:]

One moment. And we will go to Jonathan Feldman with Nomura Securities. Please go ahead.

[Jonathan Feldman:]

Good morning. Just wondering, if you guys could provide an estimate in terms of your expectations around spend, both operating and CapEx on the land portfolio this year?

[Jay Sugarman:]

Yeah. I think, Jonathan, looking forward we talked about spending approximately $200 million over the next 12 months, on all of the different portfolios. I think on land, you are probably talking about that being approximately half -- we would be spending over the next 12 months in development.

[Jonathan Feldman:]

And on a going forward basis, do you expect that spend to moderate next year and in the out years or how should we think about that?

[Jay Sugarman:]

Yeah. I think as more projects come on line, I think you will probably see that increasing over a period of time and then as sales gain momentum you will see obviously cash come back into the company more so than going out.

[Jonathan Feldman:]

And then just lastly or even in past calls you have talked about expectations around profitability being centered, I think around 2015. Did you guys just -- there having been since there is a time since you guys have talked about that and the changes in your cost of capital. I just wondered if you had have any thought giving guidance, any current thoughts in terms of when you think you might get a report, net income positive quarter?

[David DiStaso:]

I guess, I’d say, Jonathan, well, two things, one given the very significant proportion of the assets we now own and depreciate on our own balance sheet. Here we think analyze probably not metric, we’re going to track too much. We think adjusted income is the right metric, adding back only depreciation and some of the other factors that we think would bleed off over time. But I do think we are looking at 2015 as a kind of jump step a year when some fairly large land projects go into production. And we should see some -- begin to see some meaningful sales. It doesn’t mean we’re not looking to make progress before that and it doesn’t mean certainly on an adjusted basis, we feel like we have already perhaps broken through. But I don’t think you’ll see us talking about net income very much. You will see us talking about the segment profits and overall adjusted income and yeah, lowering the cost of funds, pulling some of the NPLs into an earnings position, pulling some of the transitional assets in the higher lease state. Those are all good things that will continue to move earnings up. But we think the next, big step for us is to get the $700 million of cash sitting on the balance sheet to work. If we do that successfully, if we redeploy some of the capital, we will continue to come in; will set the stage nicely for the land portfolio to kind of turbo boost that.

[Jonathan Feldman:]

Totally understood. And just towards your comment on profitability not being about the best metric to track progress of the company, have you given any more thoughts to or do you have any suggestions for investors newer to the story in terms of value in the company and in particular, on an NAV basis? Is there any additional assistance you guys think you’ll be able to provide in terms of tackling that challenge?

[David DiStaso:]

I think we have done what we can on the finance and the net lease and the operating properties. I have given you the statistics I think. People can make their own judgment on what cap rates are and how fast leasing can occur. We see certainly markers of value in each of those being relatively transparent. I think land is the one place people are still trying to get a hand around it. As I said, we’re going to give things as they come through the system that we think are meaningful but it's hard to predict a large scale per shift that we know we were building towards. That will only kick in when some pretty meaningful projects come on line and we can provide sales statistics, structures in which we either ventured or in which we own a very significant economic interest. So I think that’s a little ways off. I think what we have consistently said is we think our book basis would be impossible to replicate on those assets today. So we feel quite good with that. But the upside potential and the optionality embedded in it is harder to put in down or has been to do that, so we have some real strong [indices] of value from the end users.

[Jason Fooks:]

Thanks Jonathan.

[Operator:]

And we will go to Ian Goltra with Forward Management. Please go ahead.

[Ian Goltra:]

Good morning, Jay. Just a quick question regarding Michael Kim's earlier question, surrounding seasonality, I just wanted to confirm which of the assets are seasonal and what's the source of that seasonality?

[Jay Sugarman:]

One of the biggest is hospitality in Waikiki, which does have a pretty pronounced seasonality. We also get on one of our large net lease projects the little bit of participation payments to come in. So there is a couple of things that are going to show up that will make those numbers move around a little bit.

[Ian Goltra:]

Okay. Good. Thank you.

[Jason Fooks:]

Thanks Ian.

[Operator:]

And Mr. Fooks, I will turn it back to you.

[Jason Fooks:]

Great. Thank you for joining us today. If you have any additional questions on today’s earnings release, please feel free to reach out to me directly. John, would you please give the conference call replay instructions once again.

[Operator:]

Certainly. And ladies and gentlemen, the replay starts today at 12.30 p.m. Eastern and will last until August 9th at midnight. You may access the replay at anytime by dialing 800-475-6701 or 320-365-3844. The access code is 298455. Those numbers again, 800-475-6701 or 320-365-3844, the access code 298455. That does conclude your conference for today. Thank you for your participation. You may now disconnect.