Whitestone REIT (WSR) Q1 2013 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to Whitestone REIT First Quarter 2013 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. David Holeman, Chief Financial Officer of Whitestone. You may begin, sir.

Thank you, operator. Good afternoon, and thank all of you for joining the Whitestone REIT First Quarter 2013 Earnings Conference. Joining me on today's call will be Jim Mastandrea, our Chairman and Chief Executive Officer. Kindly please note that some statements made during this call are not historical and may deemed -- be deemed forward-looking statements. Actual results may differ materially from those indicated by the forward-looking statements due to a variety of risks and uncertainties. Please refer to the company's filings with the Securities and Exchange Commission, including the company's Form 10-K and Form 10-Qs for a detailed discussion of these risks. Acknowledging the fact that this call may be webcast for a period of time, it's also important to note that today's call includes time-sensitive information that may be accurate only as of today's date, May 6, 2013. The company's earnings press release and first quarter supplemental operating and financial data package have been filed with the SEC, and the Form 10-Q is expected to be filed tomorrow. All are or will be available on our website, whitestonereit.com, in the Investor Relations section. Also included in the supplemental data package are the reconciliations from GAAP financial measures. And with that, let me pass the call to Jim Mastandrea.

Thank you, Dave, and thank you, all, for joining us on our call today. Today, we're going to review our first quarter results and update you on the recent progress of our initiatives. Dave's portion of our call will focus on our financial results and the overall strong financial condition of Whitestone. As we have stated in our previous calls and in our annual shareholder letter, our 2013 goals are to drive FFO per share to exceed our current dividend. We do that by extracting the intrinsic value from our assets we own, acquiring accretive assets in high-growth target markets and lowering our overall cost of capital through debt refinancing; to initiate our first development project on land we own; and third, to align our management team for continued growth. Now let me review our progress so far for 2013 and highlight some of our accomplishments. We strengthened our balance sheet and capital base in the first quarter by improving and increasing the size of our unsecured credit facility. The facility was increased to $225 million, including a $50 million accordion option, and the overall pricing was reduced by approximately 100 basis points. We strive to maintain our financial flexibility to protect against unforeseen economic climate changes. Having survived numerous retail -- real estate downturns, I've learned that leading through these cycles provides a reward of upside opportunities to capitalize upon when others may find themselves financially constrained and gives us a competitive advantage when making acquisitions and attracting new tenants. We grew our base to over $430 million in the first quarter, adding $25.7 million in acquisitions in the quarter and have another $21 million under contract, which we expect to close in the second quarter. We now own 52 Community Centered Properties located in Texas, Dallas, San Antonio,…

Thank you, Jim. I will start by reviewing our balance sheet or financial position, then turn to a review of our key operating results and conclude with a few comments regarding our outlook. During the quarter, we continued to strengthen our balance sheet by growing our real estate assets by 7% or $27 million from year-end and by 48% or $141 million from a 1 year ago. We lowered our overall weighted average interest cost as of the end of the quarter to 4.4% as compared to 5.9% a year ago. We continued to grow our total market capitalization to $481 million as of quarter end, up $188 million or 64% from a year ago. We increased our pool of unencumbered properties, that is properties without secured mortgages, to 25. The cost bases of our pool of unencumbered assets now exceeds $230 million, which represent over half of the cost bases of our total assets. During the first quarter, we improved our unsecured credit facility. We amended the current unsecured credit facility, increasing the borrowing capacity by $50 million to $175 million. We added an accordion feature that will allow the facility to further increase to $225 million. We reduced the interest rate by approximately 1%, which translates to $950,000 or $0.05 per share on the balance currently drawn. We extended the term of the facility to 2 years to 2017, and we eased the overall financial covenants, including the lowering of the capitalization rate to value our assets. Our new credit agreement provides us with the ability to execute contracts and close quickly on value-add acquisitions as we continue to accelerate our growth. We believe the increased facility, reduced pricing and expanded access to capital exemplifies the progress we have made over the past 6 years to create shareholder…

Thank you, Dave. As I look to the future, our core strength is our people. We select and retain only those who have demonstrated a passion and a desire to continue to hone their skills for the real estate business within the Whitestone culture. We train, educate and provide the necessary tools for our associates to be successful. Specifically, our in-house training and development of our people allows us to meet our growing needs and effectively service our tenants. On April 2, we announced the addition of Kyle Miller as Vice President of Operations. Kyle was previously the Senior Vice President, Development & Investment, for Trammell Crow Company, a national real estate investment company. Kyle will oversee the company's corporate operation activities nationally, including new construction and implementation of Whitestone's Community Centered Property business model. Kyle has a proven management leadership capabilities, and we welcome him as a member of our senior management team. Our accomplishments and progress this quarter are a result of our working together for the common goal of increasing shareholder value. We remain committed to advancing our strategic plan and unique business model and capturing the embedded cash flow or intrinsic value in our portfolio. In closing, I would like to thank you for your continued confidence and support and for the privilege to lead Whitestone. With that, I would like to conclude the review of our results. And operator, I will turn the call back over to you.

[Operator Instructions] We'll take our first question from Mitch Germain with JMP Securities.

So I know that you had said you were going to pursue some dispositions. Just curious where that stands, how many properties possibly being queued up for sale, their location. Any color, I'd really appreciate it.

Great. Dave, do you want to address that?

Sure. Thanks, Mitch. I think we had indicated on previous calls that we have 11 properties we've identified that are in our Texas region that we will look to recycle -- to sell and recycle the capital. We currently have 4 of those properties listed with a broker for sale and are soliciting offers. Obviously, we will consider the offer before we determine whether we sell it or not. But we have 4 of the 11 that are relatively small properties that just don't fit the Community Centered business model, probably in total, not more than -- with those 4 properties, not more than $8 million to $10 million in value. So we do have 4 properties listed and are hopeful to recycle that capital shortly.

Great. And then I know that you talked about some refinancing that you're doing. Where is the need -- that coming from? Is it insurance company debt, bank debt? Can you provide some color there?

Sure. All of those areas, Mitch, I mean we're seeing a lot of activity on the CMBS side again. The insurance companies are active. We're currently in the process of refinancing one of our properties that has secured mortgage financing on it, that's Pinnacle of Scottsdale. And we are seeing interest from life insurance companies, a lot of interest on the CMBS side and then some smaller banks as well.

And then, you going to be shifting the dynamic of that debt? I mean, are we changing the LTVs at all or pretty much just a straight refi?

Well, we're going to look at our capital structure in total, obviously. And individual assets, we may do different things on an LTV standpoint, but we're very comfortable with our overall debt leverage being 50% or so. So we'll look to use that debt in the best way when we have assets. Maybe certain assets may have ability to leverage a little more than others, but we're comfortable with an overall debt level of approximately 50% across the portfolio.

And I know the last time, Jim, I think that you and I spoke, you were feeling pretty good about the deal pipeline, a couple of things under LOI. I know you've closed one, you've got another one in your contract. Should we see a flurry of deal activity begin as we get closer to the summer months? Or is it just going to be kind of 1 or 2 a quarter, the way that we should see it for the rest of the year?

Yes, thanks, Mitch. We have about $500 million in our pipeline still. One property we have, it's a CMBS assumption. So it's queued up to close next month -- this month or possibly next month. We just signed an LOI on approximately 225,000 square foot property that if we keep the pace up. That'll probably go to contract in the next probably week or so, and then we have 3 more deals right behind it. What we're looking at is doing single rifle-type of transactions throughout the rest of the year, and we haven't really gotten into the portfolio-type transactions yet, but we would like to. Our target is to do $50 million a quarter for this year. So if we do $200 million at the end of the year, we'll feel that we've met our goal and even stretch it a little bit to get there. And we're doing that kind of lock and reloading, lock and reloading, as you know. But what we've concentrated on is absolutely the best-quality assets we could buy that has the best cash-on-cash return going in with some upside. And so far, we haven't had to compromise that strategy.

Great. And last one for me. Dave, that G&A number for the quarter, I know you referenced some performance-based incentives in there. Is that nonrecur or is that something that's going to recur? And I guess kind of what I'm alluding to, is this quarter a good run rate or do we back that out to come up with a more appropriate run rate?

It's, as I mentioned, a couple of items. Just as a smaller growing company, its -- individual items sometimes make a bigger impact than they do when you're a little larger. So we have in our G&A this quarter an amount relating to the vesting of restricted shares that were granted back in 2009. That amount will continue for the -- through the balance of this year. That's really just recognizing the amount that's been earned. It's just noncash, it's approximately $350,000 a quarter. And then we have -- did have acquisition expenses of $170,000 in the quarter, which those acquisition expenses won't repeat, but obviously we'll have other acquisition expenses on different properties.

[Operator Instructions] We'll take our next question from Carol Kemple with Hilliard Lyons.

On the G&A, you talked about earlier in the call, as a percentage of property revenue, you expect it to decline. Can you give us any number of where you expect it to be by year-end percentage-wise or how quick you think it will move?

Well, I think we've set a target to be down in the 10% to 12% range. That's going to take a little more time than by year-end because obviously, the acquisitions won't contribute. We've set a target to get to 10% to 12% SG&A costs as a percent of revenue. And like, as I mentioned, there are some unusual things in there like the vesting of the shares and acquisition expenses that need to be pulled out, but our internal target is 10% to 12%.

And that's -- is that a total property revenue and not just rental revenue?

Correct. Total revenues.

And will the share charges, will those be ongoing in 2014 or they going to end fourth quarter of this year?

So we have a -- there was a long-term equity incentive program that was adopted by our shareholders and rolled out in early 2009. And those shares vest according to hitting financial targets. Right now, based on our expectation, we -- the expense would end at the end of 2013. Should we continue to grow and hit additional targets, then we potentially would be -- have additional expense that we'd be recording. But currently, we are recording the expense to get us to the expected vesting of the shares that were granted in '09.

Okay. And has there been any change in the board's attitude or tone on the dividend at recent meetings?

That's a good question. In fact, what we do, Carol, is we present to them the financial information and where we believe that the company's going. And we set as a target to reach FFO that exceeds the dividend, and our goal to do that is before the end of the third quarter. We walked them through all the potential opportunities we have within the portfolio and what we think the intrinsic value is. And with that -- when I say that, let me let you know what I'm referring to, and that is the inventory or space that we purchased when we made most of our acquisitions that we have on our shelves that we can lease. And that's in 3 different categories, it's in brown boxes that's -- which means it doesn't have their HVAC in as yet; it's in white boxes, which means drive-own HVAC is in; and then it's in space where a tenant occupied, moved out or might just need some paint and decorating. So on a net-net basis, we walk them through that particular area to show how we can reach our target. The second area we look at is just ordinary lease-up, bringing our occupancy up on a net basis, net of the cost it takes to get us there. And then the third area is a restructuring of our debt. We got some significant opportunities to capture a fairly good portion of our interest savings to reduce our interest expense. And then the last area is accretive acquisitions. And so we've been very successful in making progress towards each of those goals. The only thing is the time frame of this, the gestation period on a piece of real estate is usually anywhere from 12 to 24 months. And we're now starting to get out towards the latter part of that with a lot of our assets, meaning closer to the 18, 24 month range, with some of these you'll start seeing come to fruition.

So from all that, that you've presented to the board, have you noticed -- I guess, basically, have they been any more concerned with the dividend than they have in the past? Or are they feeling more comfortable than they have?

Well, they feel just as comfortable. Yes, very comfortable, yes. And yes, if you look at it overall, look in the business size of the company, the spread on the dividend right now is actually very minimal. To catch up is not -- it should not be overwhelming to us. And we've been -- we've fully disclosed that each time we've done an offering, and we've exceeded it in the past, then we do another offering depending on what kind of assets we buy, there's a little catch-up period. So they're very comfortable with it.

[Operator Instructions] We'll take our next question from John Power with Redwood Fund.

I wanted to find out, this is a little bit off-track and I'm thinking for Arizona, is there an opportunity for developing solar power at your centers, both for long-term financial gain and possibly for green marketing purposes? I'm thinking more for your tenants, not necessarily for the center. So I just was curious if you had looked at that at all.

Obviously, John, average, we have about 320 days of sunshine out of 360 days a year. So we think that there is an opportunity there. We have been -- you're always being judicious about your capital outlays versus the common area cost that you have. And during this phase of a cycle, where some of the properties aren't mature yet, I would say that we haven't put that as a priority list. But I think as we get closer to our target on each property and we get to a point where we can't extract any more value, then I think it's a great idea, so we're looking towards it.

We'll take our final question today from Josh Patinkin with BMO Capital Markets.

I'm wondering if you would mind updating us on Dana Park and how the lease-up strategy has gone there and how does the tenants are doing sales-wise.

Dave?

Sure, I'll start out. Maybe Jim will jump in as well. So we acquired Dana Park in September of '12, as you're aware. The property was approximately 70% leased at that time and had, I believe, about 11 tenants that were on alternative rents because of the overall occupancy level. So we jumped in and become very focused on leasing up that center. I believe we have about 20,000 square feet of leases in progress on Dana Park. And I think as of the most recent report I saw, we were at about 72% leased up. So we do have a tremendous amount of interest on the center. I know that when I talked to the -- to Richard Rollnick who runs the region, he's very high on the amount of activity we've seen on Dana Park and the interest. So I think we still feel great about that center and the lease-up potential and the ability to really accelerate rents and NOI at that center. On a tenant sales basis, we do get sales on most of our tenants. And what we've seen across the board is really the last couple of years of increases in sales. So not fully back to the highest levels back in '07, but we have seen most of the tenants with increasing sales in '12 versus '11 and '11 versus '10.

Great. You guys have obviously been very successful in building up an asset base in Phoenix in Scottsdale. Any new markets you're looking at today?

We have been very successful in Phoenix. We'll round that out with a few more properties. We want to come back to Houston and start recycling some of our assets here and then begin to increase our base in Houston where we've just -- we've added 2 properties in the last 12 to 18 months in Dallas. So we're now at 4 properties there. We plan to increase Dallas, and then we have one more market we're targeting, San Antonio. We have one property there. We're having discussions more recently about how do we staff that and start making acquisitions there. We tend to do more of a concentrated approach where we take and we target an area and we get to know the area exceptionally well, develop relationships with the sellers and the brokers and also reputation. That's important to us where we do not have a reputation for re-trading a deal. We don't get into bidding wars. If there's -- if it's a property for auction, we walk away from it. So we -- it takes a few months to build that kind of rapport with people in the marketplace so they know they can trust you. And we're about ready to transition to 1 or 2 other markets now.

And are there San Antonio and other Texas markets?

Yes, San Antonio is a great market with some great opportunities. Dallas is more competitive, but there's still some great opportunities in our space. We haven't looked at Austin. We tried to use our commercial airline services, one of the drivers, and it's very easy to get back and forth to Phoenix. I mean you can take a flight out of Houston to Phoenix and get a rental car, see all the property, just 6 hours, get a plane back. You can do that a little less convenient going to Austin. It gets a little easier going to San Antonio. Dallas, you can get in and out of there. So we tried to set it up on that basis. Primary markets, it's smaller properties as opposed to secondary markets, with the tertiary markets with large properties.

Ladies and gentlemen, this concludes today's question-and-answer session. At this time, I would like to turn the conference back to management for any additional or closing remarks.

Well, thank you very much. And I would just like to take a minute to thank all of you for participating in this call. You're all very important to us and we just want you to know that we do love the business, we approach it with a passion and we welcome any of you to call and meet us here, either in our headquarters office here in Houston or our satellite office in Phoenix and even tour some properties if you like. We have an Annual Shareholders Meeting coming up a week from Monday. And then if you could be there, we'd love to meet you and let you meet our Board of Trustees. With that, I'll say thanks again, and I will close, and I appreciate your participation.

Ladies and gentlemen, this does conclude today's conference. We appreciate your participation.