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#Good morning, everyone, and thank you for joining us for the First Quarter 2018 PS Business Parks Investor Conference Call.
This is <UNK> <UNK>, Chief Operating Officer.
Here with me are <UNK> <UNK>, CEO and acting CFO; and <UNK> <UNK>, Vice President and Controller.
Before we begin, let me remind everyone that all statements other than statements of historical fact included in this conference call are forward-looking statements.
These forward-looking statements are subject to a number of risks and uncertainties, many of which are beyond PS Business Parks' control, which could cause actual results to differ materially from those set forth herein or implied by such forward-looking statements.
All forward-looking statements speak only as of the date of this conference call.
PS Business Parks undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
For additional information about risks and uncertainties that could adversely affect PS Business Parks' forward-looking statements, please refer to the reports filed by the company with the Securities and Exchange Commission, including our annual report on Form 10-K and subsequent reports on Form 10-Q and Form 8-K.
We will also provide certain non-GAAP financial measures.
Reconciliation of these non-GAAP financial measures to GAAP is included in our press release, which can be found on our website at psbusinessparks.com.
I will now turn the call over to <UNK>.
Thank you, JP, and good morning, everyone.
First, I will give a quick overview of company results for the quarter, then JP will provide specifics on operations and markets, while <UNK> will finish with the financial update.
We started the year well.
If you remember, there were 2 events that drove first quarter 2017 Same Park NOI unusually high.
These events were triple net billings and a very mild winter for snow.
If you strip out these 2 items, we would have seen 3.9% Same Park NOI growth in the first quarter of this year.
We continue to see strong results in the majority of our portfolio, including 4.3% rent growth or nearly 1.6 million square feet of leasing and 70% retention.
We did see occupancy dip sequentially due to natural expirations, but are encouraged that the bulk of these move-outs were in the strong West Coast and Florida markets where we will be able to re-lease these suites with higher rents.
All of our markets are experiencing job growth and confidence remains high within our customer base.
Now that the development of Highgate at The Mile is complete, we revised the JV agreement with our partner, and commencing on January 1, we took control of the partnership.
Doing this allows us to consolidate Highgate in our financials.
We continue to see success with lease-up and occupancy increased to 91 ---+ excuse me, 61.5% in the quarter.
Now that winter is over, we are seeing the lease-up pace accelerate to last year's levels as we enter the busy spring and summer months.
At the beginning of the year, we reclassified 7.6 million square feet of flex properties to industrials based on a critical review of our properties' office-to-warehouse ratio.
We revised our definition of industrial to include properties with both truck-loading access and less than 40% office build-out.
We believe the reclassification will assist investors to better understand our business operation.
On the acquisition front, bidding is aggressive for flex and industrial products, no matter the size of the portfolio.
We remain focused on identifying underperforming and value-add properties with an investment strategy that is tied to acquiring quality assets that are ultimately accretive.
Capital flows and competitive buying behavior are at all-time highs in the markets we operate.
In fourth quarter, I announced that we were marketing our 3 office parks in Orange County.
The assets totaled 705,000 square feet and generated approximately 3% of the company's NOI.
So far, this year, we've sold the 2 larger assets totaling 598,000 square feet for net proceeds of $115 million, or $192 per square foot.
That leaves 2 other previously announced assets, which are being held for disposition, these are the remaining small office parks in Orange County and the large tenant flex park in Dallas.
We are confident that both will close this year.
We are working to identify acquisition assets, which we can exchange in order to protect the gains on the sale.
However, for the reasons stated above, the investment arena remains a challenge.
Regarding our CFO search, we continue to assess internal and external candidates.
Now I will turn the call over to JP.
Thanks, <UNK>.
As far as our markets are concerned, our industrial and flex portfolios continue to operate under landlord favorable conditions in the first quarter.
California, Texas, Florida and Seattle all delivered positive net absorption, rent growth and healthy user demand, along with minimal, new competitive constructions.
I will now discuss first quarter specifics by market.
In terms of market fundamentals, nothing much has changed in Washington Metro, as landlords deal with GSA and government contractor consolidation headwinds.
Owners remain very aggressive when competing for deals over 10,000 square feet, especially with TI and amusement packages.
Our team in Washington Metro continues to outperform the market by focusing on small businesses and we signed 335,000 square feet in 116 transactions and average deal size of 2,900 square feet.
Same Park occupancy dipped 140 basis points to 90.4% due to the move-out and downsizing of a handful of users over 15,000 square feet.
Rents declined 8.8% and retention was 69%.
Moving down to South Florida, we had another strong quarter, signing 390,000 square, with retention of 79% and cash rent growth of 3.7%.
Occupancy dipped by 130 basis points to 96.2% as one 44,000 square foot user vacated at the end of 2017.
We have good activity and I expect that space to be re-leased soon.
As a reminder, we're losing a 100,000 square foot user this quarter as they outgrew their space.
Our marketing efforts are bearing results and I expect to re-lease that space in the next several months to a couple different users.
In Texas, we signed 74 leases for 272,000 square feet, an average of 3,600 square feet.
Occupancy in Texas dipped 80 basis points due to one large user moving out at the end of 2017.
Retention in Q1 was 74% and rents increased 4.8%.
At the end of the first quarter, a 100,000 square foot government contractor vacated, and we are in the process of marketing this space with good interest geared towards subdividing the building.
Our team in Northern California continued their run of outstanding performance, increasing occupancy to 97.6% on 250,000 square feet of leasing.
Rents were up almost 19% in the quarter as we are able to capitalize on strong demand and limited supply.
Retention was 50%, primarily because we pushed out customers who are not willing to pay market rent and upgraded the credit quality within our portfolio.
In Southern California, our team signed 131 leases totaling 305,000 square feet, right in line with our sweet spot of a 2,300 square foot average deal size.
Blended Southern California occupancy increased 10 basis points to 97.4%, with Los Angeles leading the way at 97.9%, Orange County at 97.1% and San Diego at 96.7%.
These numbers exclude our Orange County office properties that we sold or held for sale.
Demand is still robust and rents in Southern California increased by 3.9%, with retention of 80%.
In Seattle, we are benefiting from consistent demand, a strong job market and limited new supply that kept occupancy at 98.2%, while increasing rents by 16.4%.
Our retention of 22% in Seattle was a result of a lack of expansion opportunities for our customers within our parks.
Moving by economic tailwinds, healthy job growth and a strong small business climate, I am focused on the opportunity we have with the 4.3 million square feet of expirations remaining in 2018.
Of this 4.3 million square feet, approximately 35% or 1.5 million square feet expire in California and 37.2% roll in Texas and Florida giving the teams plenty of opportunity to extract favorable lease terms.
I will now turn the call over to <UNK>.
Thank you, JP.
We reported FFO of $1.59 per share for the first quarter, a 4.6% increase from $1.52 in the first quarter of 2017.
The growth was driven by higher NOI combined with lower amortization of long-term equity compensation and preferred distributions.
First quarter Same Park NOI growth of 0.7% was driven by a 2.4% increase in revenue, due mostly to higher rates.
First quarter Same Park property expenses were up 6.5%, due to the higher snow removal cost and utilities.
Excluding the impact of triple net expense going in the first quarter of 2017, the Same Park revenue growth was up 4.2%.
Based on an amendment to the joint venture agreement, we consolidated our multi-family asset Highgate as of January 1, 2018, and as a result, delivered 427,000 of NOI for the first quarter of 2018.
During the 3 months ended March 31, 2018, we incurred $7 million in total capital expenditures compared to $8.7 million in the same period in 2017.
$1.3 million of the increase ---+ decrease relates to costs incurred on the 2016 acquisition in Rockville, Maryland, as we were repositioning asset in the previous space for occupancy last year.
262,000 of the decrease was a result of a reduction of capital incurred on our assets sold or held for sale.
Our dividend payout ratio was 67.6% compared to 71.1% for the 3 months ended March 31, 2018 and 2017 respectively.
We generated free cash of $14.2 million during the quarter of ---+ first quarter of 2018 compared to $12 million in the first quarter of 2017.
The increase in free cash was primarily due to the decrease in capital expenditures and lower preferred distributions.
On January 3, we redeemed the remaining 139 balance on our 6% Series T preferred stock, which brought our average coupon rate to 5.4%.
Now we will open the call for questions.
Yes, <UNK>.
We can say, for the cap rates, we were in the mid-5s.
And the timing for Texas is coming up very shortly.
And then, our final offset ---+ office outset, we're just doing a little bit more still in our marketing, so that will be a little bit later in the year.
At this point, we don't have anything else planned.
Just one comment, I'm sorry for interrupting, but the large flex asset in Texas, we had announced that about a year ago.
And so ---+ and now, it's closing fairly shortly.
Yes.
From quarter-to-quarter, we'll have leases that may or may not roll off higher rents for specific situation, but it's not indicative of the market at all.
As I mentioned in my comments, Dallas is a good market, and we do have ---+ we had a large user, as I mentioned, vacate at the end of 2017, and we'll have to re-lease that.
But otherwise, we like the market and expect rents to continue to move forward in Dallas.
<UNK>, on the classification of the flex to industrial, just had a couple of questions, firstly, how do your new or newer definitions compare to how the potential appraiser or buyer or somebody else looking at those properties will look.
Manny, I'm sorry, but you're completely staticky.
I can't understand your question.
Is that better.
There you go.
Thank you.
So <UNK>, the question was on the reclassification of the properties from flex to industrial, how would a potential buyer or appraiser or some other third-party look at those.
Would the definition closer to what you were looking at previously or what you're looking at now.
No.
Absolutely, it would be considered industrial.
And as you know, we look at every ---+ we see every industrial package come out and what we recognize is that a lot of our products, which we call flex, is really defined in the market as industrial.
And then, also in investor meetings, Manny, JP and I spend a lot of time defining flex.
So what we wanted to do was create a consistent definition that is consistent not just for us, but also consistent among our industrial peers on how we look at industrial.
According to NAIOP, flex is a subset of industrial.
So ---+ and industrial does include manufacturing, warehouse, flex and R&D.
So that all falls under the industrial umbrella, but we just wanted to have a more consistent definition, both within our definition as well as consistent with our peers.
And then, if I look at your supplemental disclosure, it looks like some places have been re-classed between those 2 buckets, and then others like the lease expiration schedule haven't.
Am I looking at something incorrectly, or is that to come.
It should have all been re-classed, Manny.
But you know what, we're going to check that.
And if something was off, we'll definitely send a note out and repost.
But we think we caught all of that.
Okay.
And then, my final question is going back to the CFO search that's been on for a while.
I was under the impression that you had identified somebody a couple of months ago or a month ago.
What has changed there.
Is it a different type of candidate that you're searching for.
Or something else that's precluding you from closing that process.
Actually, we have very good internal support, both within our own team as well as Public Storage.
So as we've been identifying external candidates, we're also evaluating internal candidates.
And we just want to make sure we hire the right person.
Sure, <UNK>.
So we think it will help the defense sector, and that's primarily Northern Virginia.
Unfortunately, we don't think that really is going to kick in for a year or 2 until the GSA can really understand what their new requisitions are for that space and contractor requirements, et cetera.
But we do think, in a year or 2, we'll start to see the benefit of that, primarily in Northern Virginia.
Does that help.
Well, those are still current tenants, customers of ours, in suburban Maryland.
You're right.
And we're talking with both right now in terms of renewing their space.
But the reality in suburban Maryland is vacancy rates are in the high-teens in suburban Maryland, as you well know.
And I don't anticipate that changing at all.
And thus, there's no pricing power as we renew tenants, especially the big deals like that, as you know.
There have only been a handful to 2 handfuls of deals over 20,000 square feet in suburban Maryland over the last 4 years.
So where our focus is, as I've discussed before, is on occupancy and maintaining our customer base.
So unfortunately, there's no pricing power yet in suburban Maryland because vacancy rates are in the high-teens.
Good question, <UNK>.
And we should be stabilized before the end of the year.
And that's assuming we have as strong leasing this spring and summer and fall as we did last year.
It's a little bit difficult to predict, both because Tysons is a new market and ---+ for a lot of the owners, if you think about all the new high-rises in our project.
And so it's hard to really trend.
But just based on what we saw last year, we should be stabilized by the end of the year.
Oh yes.
I mean, we're ---+ when you're entitling 40 additional acres, right now, I believe that's the largest retitlement occurring in Fairfax County, and that we submitted last year and that's about an 18-month to 2-year process.
But as soon as we can get through that, we're preparing ourselves to launch phase 2.
Sure, Tony.
And this is the reason why if you look at the analyst package, starting last year, we've started breaking out by quarter, and we literally call out snow because last year was incredibly light.
And what happens when you have a very mild winter, you also have low utility.
This year, we saw a more normalized snowfall, but it was a cold winter, and so utilities were a little bit higher.
If you think about expense control, our teams are doing a really good job of holding most of their controllable expenses at a 1% or 2% increase year-over-year.
But utilities ---+ well, snow winter, then utility can fluctuate first quarter, and then summer and fall, which really hits us in third quarter.
And then, the only other expense that we really see kind of high operations-wise that will continue through the year will be the property taxes.
Does that help.
Absolutely.
This quarter, you shouldn't ---+ in Q2, you shouldn't see a big variance from that.
We do have to match our expense reimbursements with the level of expense.
So expense reimbursements recorded in the second quarter will be lower than the first quarter.
But sequentially, from an NOI perspective, we will definitely see some benefit from the lack of snow removal and utility costs.
Yes, Tony.
We love our all the markets that we're in right now.
We consider them all core for PSB.
The West Coast, South Florida, those markets that we're in, everyone considers core, gateway.
And so we are looking to acquire in any of our markets.
And on the investment sales front, activity was very low, especially compared to some of the activity last year because there haven't really been, in the gateway markets, any major industrial sales to date.
But what we're seeing is that there ---+ you do get into a bidding war.
And sales are hot right now for industrial and flex.
And very often, the bidding just kind of spirals out of control with as many as 5 and 6 qualified buyers in our market.
So it's ---+ where you're seeing the sales happen that are in place, 4 caps.
And even upon stabilization, they're not getting above a 4.5 unleveraged cap rate.
Yes, good question, <UNK>.
No, there's nothing to read into that.
We're negotiating the ground lease with the current customer on extending both the ground lease and the customer.
So I wouldn't read anything unusual there.
Does that help.
For some reason, we can't hear you, <UNK>.
<UNK>, if you can hear us, the ground lease is with the airport authority and so it's just taking a little bit longer just because we are negotiating with the airport authority.
They don't have these leases turn very often.
So we are in the negotiations, as JP said, for both extending the ground lease and our customer.
Okay.
Thank you, everyone, for your interest in the company and we'll talk to you next quarter.
Have a good day.
Thanks, Stephanie.
