Franklin Street Properties Corp. (FSP) Q3 2012 Earnings Report, Transcript and Summary

Good morning, and welcome to the Franklin Street Properties Corp. Q3 '12 Results Conference Call and Webcast. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Mr. Scott Carter, General Counsel. Mr. Carter, please go ahead.

Thanks, and good morning, and welcome to Franklin Street Properties' Third Quarter 2012 Earnings Call. With me this morning are George Carter, our Chief Executive Officer; John Demeritt, our Chief Financial Officer; Janet Notopoulos, the President of FSP Property Management; and Jeffrey Carter, our Chief Investment Officer. Before I turn the call over to John, I must read the following statement. Please note that various remarks that we 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, which is on file with the SEC. In addition, these forward-looking statements represent the company's expectations only as of today, October 31, 2012. While the company may elect to update these forward-looking statements, it specifically disclaims 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. Now I'll turn the call over to John Demeritt. John?

Thanks, Scott. Welcome to our earnings call. We're going to be talking with you about our third quarter results and we'll start with a short overview. Afterward, George Carter, our CEO, will further discuss the quarter and FSP. I'm going to be brief and will be referring to our earnings release, the supplemental package in the 10-Q that we filed yesterday. I'm going to start with our new bank facility. We have a terrific bank group consisting of 10 banks, and I believe they can help us in many ways. During Q3, we closed on a new credit facility with this group that added liquidity for us, plus the benefit of better pricing and longer term. As of September 30, we had cash of about $24 million on the balance sheet and $418 million in availability on this new credit facility, giving us about $442 million in liquidity. We closed the new facility on September 27, and it provided us with an increase in liquidity as the line we replaced was capped at $600 million. The new line -- of our new facility is $900 million including a floating rate line of credit and a fixed portion of the term loan. Pricing on the line of credit, which has a $500 million availability, is currently at 145 basis points over 30-day LIBOR. So we're at a rate of about 1.7% now on our line. The line is for a 4-year term plus an option to extend for 1 year is available to us for a fee. The new facility also has a term loan component of $400 million, which is currently fixed at a rate of about 2.2% for a 5-year term. We can also increase the facility up another $250 million, should we and the bank group want to do that. George is going to have some comments about the new facility as well in his remarks. So at September 30, we had $482 million drawn on this new line, which is unsecured; $82 million was drawn on the line and $400 million was drawn on the term loan. Our total market cap was about $1.4 billion, making our debt to total market cap ratio about 34.4% at the end of September. This unsecured debt structure and level continues to provide a good loan to value for our lenders and gives us flexibility to use our balance sheet for growth. FFO for the third quarter of 2012 was up $3.6 million or $0.04 per share, compared to our third quarter last year. The increase in FFO was primarily because of 3 acquisitions we made in the last 12 months or so, and interest income earned on secured real estate loans that we've made. Same-store NOI was up 5.9% comparing Q3 of '12 to '11, and on a year-to-date basis is up 4.7%. And this is primarily from the benefit of new leases we've signed over the last year, over the leases that have expired. Our occupancy has increased to 89.9%, which is where we were at the end of September. So that's a brief overview of our financial performance. The earnings release supplemental and 10-Q filing go into further detail about them, and we can take more questions at the end if you'd like to discuss anything further. This concludes the financial highlights. And at this point our CEO, George Carter, will tell you more about FSP, the results and where we are. Thanks for listening. George?

Thank you, John. Welcome to Franklin Street's Third Quarter 2012 Earnings Call. As usual, I will follow my written comments in our press release of yesterday and then open the call to questions. But before I begin, let me say on behalf of everyone at FSP, how much our thoughts and encouragement are with anyone listening to this call who might have been adversely affected by Hurricane Sandy. Having been through several devastating hurricanes with family, personal property, homes and commercial real estate investments, I know how overwhelming, frustrating and hopeless it all can seem at times like this. Events like Sandy do tend to add perspective to many things. For the third quarter of 2012, FSP's profits as represented by FFO totaled approximately $19.9 million or $0.24 per share, an increase of approximately $900,000 or $0.01 per share compared to the second quarter of 2012. For those of you who have followed FSP over the last few years, you know that we did anticipate 2010 being our low operating profit year, and so it proved to be. We anticipated 2011 to be our first year of FFO recovery, and it was. We were optimistic about 2012 and for the first 3 quarters, we have achieved continued FFO growth. We are very optimistic about the balance of 2012 for continued operating profit growth -- FFO growth. And we are very positive about continued growth above that for 2013. Our directly-owned real estate portfolio of 37 properties, totaling approximately 7.4 million square feet, was 89.9% leased as of September 30, down from 90% leased as of June 30. The drop in percentage of leased space of approximately 0.1% in the third quarter was due solely to the acquisition during the quarter of the 386,000 rentable square foot value-add suburban office building in Atlanta, Georgia known as One Ravinia Drive. The property portfolio excluding One Ravinia Drive increased occupancy during the quarter. The occupancy at One Ravinia Drive also increased from 82% at the time of acquisition to 84.5% as of the close of the quarter. We do anticipate by year-end our occupancy will be back up into the 90s. We have already done some leasing at East Baltimore -- our property in the CBD of Baltimore. And we are very active with a -- working on a lease at Greenwood Plaza in Denver, for the whole of our second building and -- again are very optimistic about continued occupancy gains for the balance of the year and into 2013. Our property portfolio is primarily suburban office assets. And most of the rental-leasing markets where our properties are located remained stable during the third quarter, both in terms of occupancy and rental rates. Our property portfolio has relatively modest lease expirations over the next 2 years. And along with our improving occupancy levels, we continue to see lower tenant improvement expenditures and leasing costs relative to the level of rental revenues being achieved. We think that trend continues in the future. There were 2 real estate investments completed in the third quarter. On July 5, FSP made a $33 million 2-year bridge loan on a suburban office property located in the I-10 energy corridor of Houston, Texas. The loan is secured by first mortgage on the property. We actually talked about this investment last quarter, as it was a subsequent event after the second quarter prior to our release of the earnings release. So I won't go into it further here. On July 31, FSP purchased a Class A suburban office property in Atlanta, Georgia, known as One Ravinia Drive, for $52.8 million. And again we talked about that last quarter, as it was a subsequent event to the quarter before we report it. So I will not talk further about One Ravinia. In addition, however, we do expect to close on the acquisition of a Class A suburban office property in Houston, Texas, known as Westchase I & II for $154.8 million, hopefully tomorrow. There have been some issues relative to the markets closing and bond markets closing, and wires and so on going because of the hurricane. But we're optimistic about closing tomorrow or very shortly thereafter. The property is a 2-building office complex totaling approximately 629,000 rentable square feet. It's located in Houston's Westchase District. Each building is 14 stories and the entire property is approximately 95% leased to numerous tenants. FSP, its affiliates and predecessor have been investing in suburban Houston since 1993 and with the addition of this asset we will own 6 properties totaling approximately 2.1 million square feet in Houston. Additional potential real estate investment opportunities are actively being explored, and we would anticipate further real estate investments in the coming months. There were no property sales in the third quarter of 2012, although we continuously review and evaluate our directly-owned portfolio of 37 properties for potentially advantageous disposition opportunities. However, we do plan to sell our 214,000 square foot Southfield, Michigan, that's a greater Detroit, property within the next year. In recent years, we have tried different strategies to improve that property's performance but have been unsuccessful in those efforts. Consequently, we have taken a provision for a loss on its sale this quarter. We do not anticipate reentering the greater Detroit market. It was our only property there, has been so, and we do not anticipate reentering. This property has been operating at a loss for the last few years. So once sold, it will actually be additive to our operating profits, removing that loss and FFO, obviously. 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 624,000 square feet located in Houston, Texas. It is currently being offered for sale. FSP has both an equity and a first mortgage investment in FSP Phoenix Tower Corp. This property actually was under contract, it fell out of contract. We are currently working with a new interested purchaser and hope to get it under PMS again shortly. Again, as reported in last quarter's earnings call, because it was a subsequent event before the earnings release, on July 27, FSP's $106.2 million 2-year bridge loan to its single asset REIT affiliate, FSP 50 South Tenth Street Corp., was repaid in full from the proceeds of an institutional third-party first mortgage loan, secured by the Minneapolis CBD property. Proceeds from that repayment of that loan, actually and then some, have effectively been used for the One Ravinia purchase in Atlanta, the Energy Tower first mortgage investment, and hopefully the purchase tomorrow of Westchase I & II in Houston. As John talked about, on September 27, the company did complete its new $900 million credit facility with a group of banks. And I think John gave you a good summary of it. But it expanded the size of our previous credit facility. It fixed the interest rate cost on a large portion of that credit facility, at a cost that really was about the same as our former 30-day variable revolver rate. So we took no, sort of, dilution on spread by fixing a portion, which was great. We did lower our current interest rate cost on the revolver portion and, obviously, extended the maturity significantly. And I would refer any shareholder who wants more detail on that to our 8-K report dated September 27 about that facility. We expect to use this new facility to assist our continuing growth plans and look forward to the balance of 2012 and beyond. That concludes my prepared remarks. I'd be happy to open it up for questions.

[Operator Instructions] Our first question is from Dave Rodgers with R.W. Baird.

Just wanted to follow-up your comments about the acquisition market, George. Perhaps give us a little bit more color on the types of sellers you're seeing out there. Is the backlog growing? Or are you just having more recent success that suggest the closings or the potential closings you mentioned over the next couple of months? And I guess just to tie out the thought on acquisitions, you had used the term months instead of quarters, so should we expect a fairly decent amount of activity heading into the year end?

Dave, it's George. Let me turn this over to Jeff, who is our Chief Acquisitions person, CIO. He can give some perspective on the market for sure. I think we are very active on a number of potentials. But if you were going to say between now and year end or after year end, we'll probably lean more to first quarter of 2013 than between now and year end. But Jeff, why don't you give some perspective on the market.

Absolutely. We are seeing pretty strong activity in most of our markets with potential dispositions and a lot of different profiles that are out there. There's a pretty good spread between core assets that are for sale in our markets, as well as deals that have a bit of a value-add bend to them. In most of our markets I'm seeing more competition on the value-add assets. There seems to be more money that's aggressively pursuing those deals. The underlying condition, though, in all cases is people are focused. Investors are focused on assets that are extremely well located and that can be bought at a reasonable price or discount, if possible. Markets where they see some potential upside or that have at least bottomed. Atlanta is a great example, especially in some of the inner markets of Atlanta, Buckhead, Midtown, Central Perimeter, where investors seem to be focusing again on buying some deals, if they can, that have a good trajectory upward, a good track record in the past, are really infill properties. And I'm seeing more interest on deals that have that last mile to lease from my competitors, whether they're 80% or 85% leased or something thereabouts versus just pure core deals that are 100% stabilized. But in all the deals that we've been working on and that we've discussed, including Westchase and including Ravinia, particularly, they were marketed broadly and plenty of competition in terms of bidders on both of those deals, as well as other deals I'm seeing in the market.

And on the Houston asset, can you give us a little color on why that fell out of contract? Was that a buyer issuer? Or something more about the property?

I can't, really. I'd be breaking some confidences. But I think, Dave, in general, there was a feeling in the energy markets -- Houston primarily, but Denver and Dallas as well, to some extent. As the year began, the energy -- 2012 began, the energy markets were very, very hot and cap rates have compressed fairly substantially. There was a lot of anticipation on growth in rents and occupancies in the energy markets, particularly Houston. It was one of the reasons that it seemed like a good time to put Phoenix Tower on the market. Since then -- fairly shortly after the beginning of the year, as the market started to grab the potential of this global slowdown, not only Europe, but China slowing, U.S. potentially with the fiscal cliff, and all of that sort of thing, and the price of oil started to reflect that future slowdown with lower oil prices, some of the multiple came out of the energy markets. A lot of buyers were looking at low cap rates, high multiples with a lot of lender interest, as well, looking for very high loan-to-value sort of purchases, and several deals that were put up earlier in the year and had potential purchasers that were looking for high loan-to-values, low cap rates, high multiples fell out of bed. I think Phoenix Tower was broadly in that category.

Okay, that was great color, George. Last question for me and I'll yield [Audio Gap] expectations over the next quarter to make additional loans into the single-asset REITs. I guess, in another way, are there any specific situations you see that we should be expecting some more of that activity?

We have nothing right now that's in the queue. All of that activity that may happen in the future would only happen, number one, if there was an opportunity with our own single-asset REITs that made sense at the market for, obviously, the FSP shareholders and for the shareholders of those single-asset REITs. Right now there is nothing in queue.

Our next question is from Josh Patinkin with BMO Capital Markets.

Looking at this asset that you guys bought in Houston, can you talk a little bit about how that transaction came about? The cap rate there and any other details worth sharing?

Josh, it's Jeff Carter. We are set to close on that, hopefully tomorrow.

Josh, did you say Atlanta or Houston?

I thought I heard Houston, but am I wrong there?

No, no. Okay. I'm sorry. I misheard you, I thought you were asking about Atlanta. I'm sorry.

We're scheduled to close on that asset tomorrow and I can give you just some general commentary about it. It was a broadly marketed deal, received considerable interest and was a property we were interested in from the start of its marketing. The property -- I can't give you specific cap rate, we haven't released any specific cap rates. But I can tell you on infill assets like this one, of this quality, we're seeing cap rate ranges of between 6.5 and 7.5 and this property will fall within that range. It is, as George mentioned, approximately 95% leased. Two buildings, one was completed in 2008 and one was completed in 1982. They are both approximately the same square footage and both 14 stories. They are very diverse in their rent rules and diverse in their expiration schedules. The submarket in Houston that this is in, in Westchase, is extremely competitive. The Class A tier 1 third quarter numbers for that market are about 1.7% taken. For Class A tier 2 properties, it's about 9.6%. And so it is a very robust market. And Houston, as you know, is a market where there's a lot of competition.

Okay, great. And kind of in context with George's comment on the global picture and what that's done to Houston property. Have you seen a deceleration in rent growth there? And what are the cash rent spreads right now in your other Houston assets?

I don't think that -- we have not seen a deceleration in rent at this point, whether that comes in the future or not. But as you know, leases take a long time to do, so there's a pipeline. The deals that we're signing now were probably started 1 month or a couple of months before. So what we have been seeing is steady increases because of the statistics that Jeff was citing on vacancy. I think we give our cash rents by 2011 in one of the schedules that we provided that will show you what they were for 2011. Our properties -- well, all Class A are in different submarkets and I don't think it's a meaningful number to average those. But they -- you should be able to find those in the supplementals. So the Park Ten is the smaller -- our smaller buildings out in one direction, and then we've got the stand-alone properties.

But I think broadly speaking, Josh, if you talk to the people on the ground in Houston at our properties, the rental market is still strong and not responding to the sales market slowdown that is reflective of the drop in oil prices and the uncertainty of the global economy and the future of oil prices. On the ground, the rental market is not that way. Vacancy is very, very low. We have strong demand at all of our properties. Rents have not gone down or moderated, so we're getting great activity and spread there on the ground, from a rental perspective. But the sales market, I mean, that -- again the cap rates compressed so much because of anticipation of much, much higher energy prices. And that, some of that bloom has come off the rose. Which by the way, was one of the things that allowed us to step in on Westchase at a price that we thought was attractive. We're very bullish for the long-term view of global energy demand, very bullish on Houston and its industry and technology for all kinds of energy, particularly hydrocarbons. And positioning capital for the longer term in the right light Class A assets and the right submarkets in Houston, we think is a real good long-term bet. The short term swings in the price of oil and buyers and lenders that move in and out can potentially give us opportunities. So you see on Westchase the opportunity to buy, you see on Phoenix Tower it falling out a bit and then coming back. Hopefully we'll put that under contract at every bit as good a price as we anticipated shortly. So it's an active market and a lot of speculation on the future on buys and sells. But in terms of the energy companies particularly, and all of the surrounding people and companies that service that business, it's a powerful market right now, one of the best markets in the country with no slowdown.

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. George Carter for any closing remarks.

Thank you, everyone, for listening into the call. I hope you have a good end of the year, and we look forward to talking to you at the end of the year about our fourth quarter and full year results. Thank you.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.