Franklin Street Properties Corp. (FSP) Q2 2012 Earnings Report, Transcript and Summary

Good morning, and welcome to the Franklin Street Properties Corp. Q2 2012 Results Conference Call and Webcast. [Operator Instructions] Please note that this event is being recorded. I would now like to turn the conference over to John Demeritt, Chief Financial Officer. Mr. Demeritt, please go ahead.

Thank you. Good morning, everyone and thank you for participating in this call. Just to start things off, we gathered a couple of people today for Q&A. Jeff Carter, our Chief Investment Officer, is with us; and Janet Notopoulos, the President of our Property Management company is also with us; as is George Carter, our Chief Executive Officer. Before we make our comments, I must read the following statement. Please note that various remarks that we make, may make about future expectations, plans and prospects for the Company may constitute forward-looking statements for purposes of the Safe Harbor Provisions under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward-looking statements, as a result of various important factors, including those discussed in the Risk Factors section of our Annual Report on Form 10-K for the year ended December 31, 2011, and as updated on the 10-Q we filed all of which are on file with the SEC. In addition, these forward-looking statements represent the Company's expectations only as of today, August 2, 2012. While the company may elect to update these forward-looking statements, it may specifically disclaim any obligation to do so. Any forward-looking statements should not be relied upon as representing the Company's estimates or views as of any date subsequent to today. At times during this call, we may refer to funds from operations or FFO. A reconciliation of FFO to GAAP net income is contained in yesterday's press release, which is available in the Investor Relations section of our website, at www.franklinstreetproperties.com. Having read that, I will begin with some comments about the second quarter and will start with a short overview. Afterwards, George Carter, our CEO, will further discuss the quarter in FSP. I'm going to be very brief and we'll be referring to our earnings release, the supplemental package and the 10-Q that were filed last night. As of June 30, 2012, we had cash of about $22.6 million and $106 million in availability on our line of credit, giving us about $128.6 million in liquidity. Also at June 30, we had $494 million in unsecured debt and our total market cap was about $1.4 billion. We only have unsecured debt on our balance sheet and our debt-to-total market cap ratio was 36% at June 30. This debt structure and level continues to provide an attractive loan to value for our lenders and investment bankers. We are exploring a number of additional financing possibilities with them currently to position us for more growth. FFO for the second quarter of 2012 was down about $1.1 million or $0.02 a share compared to the second quarter last year. The decrease in FFO was primarily because we had $3.3 million in contribution from our investment bank in the second quarter of 2011 that we did not have in the second quarter of 2012. We have previously announced we're not doing any new specification of real estate. This decrease in FFO was partially offset by the benefits of real estate investments that we've made over the last 12 months. These include 2 acquisitions we made in the fall of 2011 and interest income from $106.2 million secured loan that we had for the full second quarter of 2012 and neither of these investments did we have in the second quarter of 2011. We also had the benefit of new leases signed over the last year of the leases that had expired, which raised our occupancy to 90% compared to 86.9% at June 30, 2011. I'd also like to point out that on our last call, 1 of our research analysts suggested that we include same-store comparisons. We thought about that and have included in our 10-Q and supplemental report, that information. And same-store results for the first 6 months of 2012 were up 4.7% compared to the first half of 2011. This makes a lot of sense given the leasing that was accomplished in the last year. To make the same-store results more comparable, we exclude bankruptcy proceedings we received this year from our NOI and that analysis, which you'll see noted in the filings, if you take a look at them. So that's a brief overview of our financial performance. The earnings release, supplemental and 10-Q filing go into further detail about our results. We can take more questions at the end if you wish to discuss them further. So let's conclude the financial highlights. And at this point our CEO, George Carter, will tell you more about FSP results and where we are. Thank you for listening. George?

Thank you, John. Welcome, everybody to our Second Quarter 2012 Earnings Call. As is custom, I will discuss this call, on this call my written comments and last night's earnings release and then open it up for questions. So for the second quarter of 2012, FSP's profits as represented by FFO, funds from operations, totaled approximately $19 million or $0.23 per share, a decrease of approximately $529,000 or $0.01 per share compared to the first quarter of 2012. From an operational revenue point of view, our operational profit of view, our revenues and profits were pretty much flat between the first quarter and the second quarter, John mentioned these bankruptcy proceedings that -- proceeds that we got in the first quarter. This was from a former tenant of our Innsbrook Richmond Virginia property, LandAmerica. We're an accreditor there, and as those bankruptcy proceedings continue, we get checks sometimes. You never know exactly how much they'll be and when you'll get them. That property, Innsbrook in Richmond, Virginia has been fully leased for some time now and so this thing with LandAmerica just proceeds with us as accreditor. But again, from an operational point of view, our operating revenues and our operating profits were about flat between the first quarter and second quarter. Some of the new leasing has got to get through 3 rounds before they start to kick in on the FFO line. Our directly-owned real estate portfolio of 36 properties, totaling about 7.1 million square feet was approximately 90% leased as of June 30, and that's up from approximately 89% leased as of March 31. Most of the rental/leasing markets where our properties are located, remained stable during the second quarter, both in terms of occupancy and rental rate levels. We continue to make slow but steady progress on our leasing efforts. Our property portfolio has relatively modest lease expirations over the next 2.5 years. And along our improving occupancy levels, that should allow overall tenant improvement, expenditures and leasing cost to moderate in relation to the level of rental revenues being achieved. And we are seeing the early signs of that trend and our projection in the coming quarters is for that trend continue. One of the things about occupancy that should be taken note of is that we did recently acquire a property in Atlanta which I'll talk about in a minute. It's a value-add play that has -- they can see in it. And so as that square footage comes in to next quarter, there may be some hiccup relative to occupancy as you include that value-add play into the whole mix. However, I would tell you that at some of the properties in our portfolio that had some vacancy right now, we have continuing good leasing activity on the value-add property we just purchased in Atlanta. We actually have currently some very good leasing activity. We are very optimistic that our leasing percentage, our occupancy levels will continue to rise in 2012 and 2013. Again, we're having, I think, slow but very steady success in getting back into that hopeful sort of mid-90s range, which is for suburban office, about practical full occupancy. There were no additional real estate investments completed in the second quarter of 2012. However on July 5, FSP made a $33 million 2-year bridge loan on a suburban office property located on the I-10 Energy Corridor of Houston, Texas. Property is a 14-story multi-tenant Class A office building, containing approximately 326,000 rentable square feet. This property is owned by FSP Energy Tower I Corp., a single asset REIT affiliate of FSP, and is approximately 100% leased. Our loan is secured by a first mortgage on the property. For those of you that sort of understood our recent loan, which has actually just been repaid on 50 South 10th Street, our Minneapolis, Minnesota property, this loan is very, very similar to that in concept. Energy Tower Corp. purchased this property in Houston some 6 years ago. We have been managing it since. And there was 1 large tenant in it at purchase and we did assume a loan on that property when Energy Tower Corp. purchased it. That loan was maturing. The large tenant in the property has only 2 years remaining on its existing lease and the lender on that property did not want to extend the loan. Energy Tower Corp. commissioned a survey of lenders, and when looking at what might be able to be done to refinance the property, Franklin Street Properties thought it would be attractive and so stepped in to that position. Energy Tower Corp. FSP, we are very optimistic that this will be another great loan, as the loan to Minneapolis was, and we are working with the existing large tenant on an extension. We hope to be able to accomplish that, but there's no guarantee, of course, and that submarket that this property is in, in the Energy Corridor in Houston is a good strong market. And we feel that even if we can't extend the tenant, we can lease the space. So we view this as a very good loan. The metrics of this loan are much like the metrics of the Minneapolis loan that again was just recently repaid. Also on July 31, FSP purchased a Class A suburban office property in Atlanta, Georgia known as One Ravinia Drive for about $52.8 million. This property is 17 stories, contains approximately 387,000 rentable square feet and is approximately 82% leased to numerous tenants, and is located in the Central Perimeter submarket of Atlanta. FSP and its affiliates have been investing in the suburban Atlanta office markets since 2003 and we currently own 3 properties there totaling approximately 907,000 square feet. As I mentioned earlier, this is really a value-add property. We've been keeping our eye on Atlanta in the last few years. It's a traditional big cyclical market, it has big ups and downs. We feel Atlanta has started a recovery. We started to see it in a couple of the submarkets, most notably Buckhead, at this point. We believe the Central Perimeter market is a market that will be sort of next to benefit in the continuing Atlanta recovery. This is an iconic property bought at a very good price. We're very excited about it and have leasing activity at it right now. There were no property sales in the second quarter of 2012. Although, we always review and evaluate our directly-owned portfolio for potential advantageous disposition opportunities. In addition, certain properties owned by some of our single-asset REIT affiliates in which FSP may have a financial interest, could become possible candidates for sale as they stabilize their occupancies and the markets in which they are located become more attractive to potential acquirers. FSP Phoenix Tower Corp. a single-asset REIT affiliate of FSP owns a 34-story multi-tenant Class A office building, containing approximately 629,000 square feet located in Houston, Texas, and that property is currently being offered for sale. FSP has both an equity and first mortgage loan investment in FSP Phoenix Tower Corp. We -- the energy markets had gotten a lot of momentum in them at the start of this year, sort of the second half of last year. Houston being one of the, obviously, key markets in that area. And there was quite a bit of cap rate compression, and again a lot of potential buyer momentum in those energy markets, so Phoenix Tower was put into the market and has generated a lot of interest. I would say however though, that since that property has been put in the market and we're seeing this through all of our energy markets that we're in, in Denver, Dallas even, as well as Houston, that some of the blooms come off the rose relative to energy, so there's certainly some concern. I mean, we started the marketing of Phoenix Tower Corp., oil was about $100 a barrel. It's significantly less than that now and there's a lot of talk about global slowdown and price per barrel of oil and so on in the future. So some of the buyers have paused a bit in the energy markets, but we still have activity at Phoenix Tower Corp. and hope to complete a sale there. The one thing that hasn't win yet in the energy markets and in Houston is leasing. The tenant's certainly looking at the energy markets longer term and leasing activity is still strong in the energy markets. This Phoenix Tower property has multi-tenant property and is 90-plus percent leased and we have continuing good leasing activity at the property. As I mentioned earlier as well, on July 27, FSP's $106.2 million 2-year bridge loan to its single-asset REIT affiliate, FSP 50 South 10th Street Corp., was repaid in full from the proceeds of an institutional third-party first mortgage loan secured by the Minneapolis, Minnesota CBD property. This loan was a 5-year interest-only loan which was actually just like the original loan that was put on the property at acquisition. That loan matured at the end of last year which is why we were able to take advantage of stepping in and providing a bridge. This new loan that replaces it, as I said, it's 5-years interest only and actually got a sub-3% interest rate, which is really extraordinary. I think it says a lot about not only the property and the Credit Target Corp. which is the major tenant there, but also just what's happening in the shorter-term rate markets these days. It's really, really extraordinary. We do anticipate additional potential real estate investment opportunities this year. We are actively working on some right now and are very excited about those opportunities. We're very optimistic about the balance of 2012 and looking into 2013. Again, we have good property acquisition opportunities. We're making good leasing progress on our portfolio. Again, cost of leasing is coming down because we have such few lease roll over the next 2.5 years against the amount of revenue we're receiving. So we're very optimistic, and like probably everybody else, cautious when you look at the broader and rest of the economy, and world economies and all of the things that potentially could go on, on the negative side there, but the trend is our friend at this point. With that, I would open it up for questions.

[Operator Instructions] And the first question comes from Josh Patinkin from BMO Capital Markets.

I'm here with Rich, too. And I'd like to ask you guys about rent per square foot. I saw in the supplemental, if I'm reading it right, it looks like we're quoting 2011 rent per square foot. So going forward in 2Q, what's the spread been looking like and do you think you're achieving pricing power there?

I think we had a couple of sentences in the MD&A on page 17 that covers the leasing for the 6-month year-to-date, Josh. I don't have it right in front of me now, one second. So our leasing for the first 6 months of 2012, we leased 383,000 square feet of office space, about 295,000 of that was with existing tenants. A weighted average of about 4.5 years. The leasing I think was about 1.4% higher than average rents that we had in the 2011 schedule, that you were referring to there. Do you want -- I mean, Janet or...

Those number we're using for the first time are the averages of averages. And I think they're reasonably meaningful depending upon what kind of leasing activity we're doing. I think what we've decided is that this is a good way to present it and we'll footnote or disclose this quarter where we have mostly renewals that, that's part of what's driving it. If next quarter, we have a big new lease, it may be different, we'll flush that out, but I think it shows the trend.

And we thought that this would be a good benchmark for comparison to look at the sort of 2011 GAAP rents from each billion of portfolio and then compare our new leasing activity against that. We thought that might be a good way to do it.

Are there specific markets where you think perhaps it's turning in your favor and you're starting to see this mix in commodity like product here, the gain traction in pricing?

I think as George said, obviously, some markets are harder than others like Houston. But whether it's going to have an impact is going to depend upon whether we have vacancy in those markets. Sometimes we've already benefited to be able to see much on a portfolio basis spring into our properties.

But I think broadly speaking, Josh -- I think broadly speaking, our big rent roll downs are over. And broadly speaking, in the vast majority of our markets, rents are firming and moving up. So we -- again, there are a lot of factors here and without continued broad-based employment gains in our economy, I think you've got a lid on all of this stuff to some extent, particularly in suburban office. But again, broadly speaking, we're off the bottom in rent levels and I would say, broadly speaking, our rents are moving up, not down and in virtually every market. And in some of the energy markets, certainly more than others.

And then on the Atlanta acquisition, can you guys just give us some color on what the cap rate was and once you stabilize the property with the leasing activity you've been talking about where you think these yields might go?

This is Jeff. Josh, the One Ravinia property was acquired at approximately 82% leased and at that in place 82%, we were approximately a 7 cap rate. We have some leasing activity that started to spur during due diligence. And if those leases are finalized, we'll be in the neighborhood of 85% to 86% leased. We think that the Central Perimeter, as George mentioned, is positioned well for an Atlanta recovery that appears to have begun, particularly in Buckhead, but there is good leasing activity in the Central Perimeter. We like this property from a locational standpoint and we believe that there is good embedded growth not only in the existing rent roll with rental rate increases, but also with additional leasing. And so I'm optimistic that we're going to see some nice, nice growth in that property.

Great. And John, on G&A expense, I notice it moved upward this quarter. Is that recurring or do you think that will normalize next quarter and into the future?

I think with the G&A, you need to look at not only the G&A on the current income statement, but also what's embedded in discontinued operations. We've taken the step and allocated between the investment bank and the real estate segments in the past. And as part of that transition, more G&A was allocated to the REIT obviously this year, since we're not operating the investment banks in a similar fashion. You just kind of look at the both of those combined. I think combined, they're relatively flat, if I'm not mistaken.

I think Rich has a question as well for you.

On the loan payoff in Minneapolis, to what degree are you able to kind of manage the timing, because you've been quick to start the redeployment process already at $106 million? Is there -- is that just that you've been preemptive in terms of anticipating the refinancing? Or were you able to be -- govern the process, govern the timing a little bit so that you were ready to redeploy?

We certainly -- once we completed the 18-year lease with Target for all of the office space, we clearly anticipated a refinancing. And so we were active looking for other investments early on. If you want to do just again everything is fungible. But just a basic math, if you're getting back $106 million, between the Energy Tower loan of $33 million and the One Ravinia purchase of $53 million, we've already redeployed $86 million of the $106 million. Again, $33 million of it actually almost a month early. And again, we have our eye on other acquisitions right now. I think we will get all of that money redeployed in a reasonable amount of time, everything being equal. And as John mentioned in his opening remarks, we are exploring some additional financing opportunities for continued growth.

So in other words, if it was a 6.5% return, maybe over 7% with the fees you generated, you can actually turn an accretive -- it leads to an accretive transaction, assuming you're buying at about 6.5%?

Yes. You can on the ongoing rate. I mean, one of the things that these interim or bridge loans have associated with them in the market is commitment fees and exit fees. When you put all those in, you can come up with a higher number on some of these in our loans depending on the timeframe the loan is outstanding. Obviously, this loan got paid off very, very quickly. But from a ongoing recurring point of view, we're absolutely accretive going from the loan to the, Jeff, on One Ravinia purchase.

It's John. Q3 will be a little bit choppy to look at because we have the $33 million loan, as George mentioned, coming in the beginning part of prior July. We were losing the Target loan for -- we only had that for part of July. And obviously just bought Atlanta a couple of days ago. So moving -- the parts moving in and out might make Q3 a little bit odd, but it'll level out more in Q4 as we move along.

And the next question comes from Jeff Lau from Sidoti & Company.

I just had a quick question. Can you comment on the traction you're getting on Phoenix Tower, and again how much interest you have in it?

Yes, we actually had the property under a purchase and sell agreement, Jeff. Our feeling is it just fell out for general market conditions as I mentioned earlier. We have other buyers going through the property, potential buyers going through the property, doing their chores, doing their initial due diligence. So I think we've got pretty good traction on it. Again, we have some price expectations on the property that I think in a momentum market like the energy markets have been, like Houston has been, where you did have some cap rate compression, those price expectations can be met. We are so bullish about the property's long-term prospects that we aren't willing to just sell the property at any price or just let it go at sort of what may be coming over the transit right now. So we're -- the property's occupancy keeps rising. We have a equity ownership interest in the property as well as a loan on the property. So we're very bullish about ultimately selling it. I think at the end of the day, it's going to be a momentum play relative to energy and where energy goes. And there's so many factors that are swelling around there right now. We'll just have to wait and see. If my anticipation is that if it's going to sell at a price that we think makes sense for us, that's going to happen within the next quarter or 2. Otherwise, we probably take that property off market for a while, and continue leasing. We've got -- there are leases on that property that are substantially below the market now, and as those leases roll we definitely can move up that NOI and adjust that cap rate accordingly to a new buyer. So I think that's the game plan in the market for another quarter or 2 at max if we can get our price fine, if we can't, it comes out and we'll continue to own it for a while and let some of these leases hopefully blow up to market and do some more leasing with the property and consider putting it back on the market at that point.

Great. And I guess you said you're talking a little bit about some acquisitions you have an eye on right now. Any specific markets that you could tell us about?

We're looking basically in the markets that we're already in. We're not considering at this point opening up any new markets. We're acquirers, we're cyclical acquirers. By that, I mean, we work in generally big non-land constrained markets. And one of the disciplines of acquiring particularly suburban office and those kinds of markets, but even the CBD in those markets, is understanding the cycle of buying and selling. So when we look to acquire, we're always looking at markets that are down and hopefully close to a turn-up and vice versa on selling. So for example, this acquisition on Atlanta is a prime example of that. You might not see us acquiring in the energy markets anytime soon because they're a little bit hot. We have acquired and sold a number of properties in, for example, Northern Virginia, the Washington D.C. area. And that's a market that we're looking in right now because that market is starting to fall on hard times a little bit. So we'll just keep looking at markets that still have some value in them or have got some sort of cyclical opportunity in them. Atlanta will continue to be a market, Northern Virginia would be a market, probably not the energy markets. Some of them did west markets, still look pretty attractive from that cyclical acquisition sale point of view.

And as there are no more questions at the present time, I'd like to turn the call back over to management for any closing remarks.

I just want to thank everybody for turning in to the call. We look forward to speaking with you next quarter. Have a great day.

Thank you. This concludes today's teleconference. You may now disconnect your phone lines. Thank you for participating and have a nice day.