PSB
#Thank you.
Good morning, and thank you for joining us for the Second Quarter 2017 PS Business Parks Investor Call.
I'm Ed <UNK>, CFO of the company, and with me today are <UNK> <UNK>, President and Chief Executive Officer; and <UNK> <UNK>, Chief Operating Officer.
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 in or implied by such forward-looking statements.
All forward-looking statements speak only as of the date of this conference call.
PS Business Parks undertakes 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 to GAAP of these non-GAAP financial measures is included in our press release, which can be found on our website at psbusinessparks.com.
Now I will turn the call over to <UNK>.
Thank you, Ed, and thank you all for joining us this morning.
First, I will discuss the company's results for the quarter, along with updates on investments, then JP will provide details on operations and markets and Ed will finish by giving financial specifics.
We have another outstanding quarter on nearly all metrics.
We continue to see robust market fundamentals and great execution by our operations team.
The company's total NOI growth was 5.3%.
And despite the move-out of the 200,000 square foot industrial tenant in Northern California, Same Park occupancy is a solid 93.7%.
Demand remained strong throughout the West Coast, Texas and Florida as we benefit from the infill locations of our park concentration.
Unemployment improved in all of our markets, leading to healthy customer demand and expansions within our own customer base.
Landlord-friendly markets help us maintain low transaction costs, which were $3.22 per square foot on leases executed during the quarter.
There were no acquisitions during the second quarter as cap rates for industrial and flex product remain compressed, and assets are being sold with in-place market rents and high occupancy.
We continued to search for value-add opportunity.
We had one small asset sale in our Dallas market totaling $2.1 million with a $1.2 million gain.
It was a non-core single-story office building in our flex and industrial portfolio.
I'm happy to announce that Highgate at The Mile officially opened on June 1.
As you know, I've been giving you updates on this project for 2 years.
It is a 395-unit luxury mid-rise family building located in Tysons, Virginia.
Leasing began in May, and our leasing success has exceeded expectations.
In the first 10 weeks of operation, we've executed deals on 75 apartments or 19% of our units.
Our rates are within pro forma, and I could not be happier with the initial success of this $117 million asset and our operating and development partner, Kettler.
In summary, we had a great quarter and first half of the year, and we expect this momentum to continue for the balance of the year due to our portfolio, team and strategy.
Now I will turn the call over to JP.
Thanks, <UNK>.
Led by an expanding U.S. economy, solid job growth, low unemployment and healthy demand from small businesses, our teams completed 2 million square feet of leasing in the second quarter with rent growth of 3.2%.
I will take you through second quarter statistics by market, beginning in Washington Metro.
Nothing much has changed in D.
C.
in the last 6 months.
The private sector economy is still active but GSA and government contractors are not.
Leasing economics are not favorable to landlords and the overall market occupancy in suburban D.
hovers at approximately 85%.
Having said that, our D.
team was busy and signed 130 leases, totaling 465,000 square feet.
Sequentially, Same Park occupancy in Q2 increased 20 basis points to 89.4%, aided by strong retention of 76%.
In order to secure some of this renewal business, we had to reduce incoming rents to current market, and thus rents declined 9.6%.
Finally, in Washington Metro, I mentioned on the last call that a large GSA user was scheduled to move out during the second quarter.
At this point, it appears it will be staying through September.
This tenant generates approximately $300,000 per quarter.
In terms of production, the Southern California team was focused and signed 179 leases, totaling 403,000 square feet.
Blended SoCal occupancy dropped 110 basis points to 94.9% as we lost one 30,000 square foot industrial customer in Los Angeles.
Subsequent to quarter end, we re-leased that space with 14% rent growth.
Strong demand from our core users helped us grow rents overall in Southern California by 5.1%.
Moving to another strong market.
In South Florida, we capitalized on strong user activity to increase occupancy 40 basis points to 98%.
We completed 350,000 square feet of leases in 89 transactions with rent growth of 3%.
Retention was 75%, thanks to us locking down some key renewals.
In Texas, we signed 346,000 square feet in 65 transactions.
Favorable economic conditions helped us grow rents in Austin over 14% and 6.3% in Dallas.
In Austin, where demand and tour volume is strong, occupancy was 94.2% and with retention at 59%.
Dallas occupancy was 90.3% during the quarter.
In Northern California, we capitalized on strong market fundamentals.
Leasing volume was 332,000 square feet, comprising 104 deals.
Northern California was 94.9% occupied with 14.4% rent growth.
Regarding the 200,000 square foot industrial space in San Jose we took back in April, we have completed our market-ready improvements and are actively marketing the space with good activity.
Market conditions in Seattle remain very solid.
And aided by limited new construction and healthy demand, we operated our real estate at 98.2% occupancy in Q2, signed 94,000 square feet and grew rents 15.7%, continuing to reach new peaks, especially in Kent Valley.
Looking into the second half of 2017, I remain focused on improving occupancy in D.
and Dallas, expanding our growing existing customer base and extracting favorable lease terms in our other markets.
We have 2.7 million square feet, approximately 10% of our portfolio, expiring in 2017, and I can't wait to attack these opportunities.
Now I'll turn the call over to Ed.
Thank you, JP.
FFO for the second quarter of 2017 was $1.55 per share compared to adjusted FFO of $1.36 per share in the second quarter of 2016, an increase of 14%.
The growth in FFO was driven by Same Park NOI, combined with lower interest expense and preferred equity distributions.
Same Park NOI growth of 5.2% was driven by a 4.5% increase in revenue, tied to higher effective rents as rent spreads on executed deals increased 3.4% in the first 6 months of 2017 and 5.3% for all of 2016.
Comparatively, Same Park occupancy increased modestly.
Same Park operating expenses were up 2.9% due to higher property taxes, utility costs and compensation expense.
For the 6 months ended June 30, 2017, the company incurred $23.4 million in total capital expenditures compared to $14.5 million in the same period of 2016.
$5.6 million of the increase relates to costs incurred on the company's recent acquisition in Rockville, Maryland as we complete the repositioning of the asset and prepare space for occupancy.
The balance of the increase incurred in our Same Park portfolio and was driven by transactions executed in 2017 as well as costs incurred on leases executed in late 2016.
Year-to-date, Same Park transaction costs per square foot are $3.06 on executed deals, consistent with the $3.05 per square foot incurred on all transactions executed in 2016.
For the 6 months ended June 30, 2017, the company's dividend payout ratio was a strong 71.9% compared to 67.2% for the same period of 2016.
The company generated free cash of $21.9 million for the first 6 months of the year compared to $24.9 million in the same period of 2016.
The decreases relate to the 13.3% first quarter increase in the common dividend.
As <UNK> noted, our multifamily development commenced operations during the second quarter and is nearing final completion.
Through July, the balance outstanding on the $75 million construction loan the company provided the joint venture is $61.9 million.
We anticipate funding the balance over the next few months as the project is completed.
With operation commencing, we reported an equity loss from the ---+ on the unconsolidated joint venture of $382,000 during the quarter.
The primary driver of the loss were operating expenses incurred in connection with the commencement of leasing and property management activity.
We will now open the call for questions.
Nothing unusual, <UNK>.
Our in-place contractual rent increases are just over 2.5% on average across the portfolio.
Nothing unusual.
Yes.
<UNK>, only on like maybe some of the new leasing and renewals that JP referenced and that are in the package by market.
<UNK>, no, we haven't seen anything specifically from a regulatory standpoint.
What we have seen is small businesses are confident right now.
They're growing.
They're expanding, maybe 2,000 or 3,000 square feet at a time, but I think they feel good about the business environment and maybe their prospects going forward.
So ---+ but from a regulatory standpoint or any governmental involvement, no, we haven't seen anything specifically.
Well, I think, <UNK>, we recognize that the balance sheet is in very good position right now.
We've got no debt outstanding other than a very ---+ relatively small balance on the line of credit.
So there's significant capacity within the balance sheet right now.
That being said, for a significant transaction we would certainly consider issuing equity, but we also recognize the capacity that is in ---+ embedded in the balance sheet today.
<UNK>, I think the modest decline from Q1 to Q2 was tied to some first quarter payroll burden cost and then a little bit higher cost in the first quarter on the LTEIP, just the way the accounting for that plan works.
But again, a relatively modest change from Q1 to Q2.
I would say that the Q2 number, it's roughly, all-in, about $2.4 million, is a good run rate going forward.
Nothing more than kind of consist ---+ consistent with what's in the second quarter.
Yes.
I think if you look at kind of where our secondaries are trading, the deal that we did in the fourth quarter of 2016 at 5.2% is trading today pretty much on ---+ at par on a strip basis.
So if you look at that as an indication of where we could potentially issue preferred today at 5.20%, I would still tell you that it certainly brings into play the opportunity to redeem the 6% that were redeemable in May of this year.
So certainly, I would say that, that is something that we're looking at very closely.
Yes, we are actively marketing it, and the space looks great.
There's very little supply available.
And we have activity, but nothing that I'm ready to talk about right now.
But I'm real confident in our ability to lease that space.
And when we do, we'll see a nice rent pop from the outgoing customer there.
So feel good about that piece of opportunity right now.
Yes, it's going to be solid.
I mean, to be honest, it's going to be very solid, so we'll see.
I mean, we're being very selective on the credit.
We're being very selective on the type of use.
So we have an incredible piece of real estate that we're being very selective with.
So we may be more patient and wait for the right user.
As you know, the demand in the economy in Northern California is very strong.
So ---+ and we anticipate our ability to push rent significantly.
But all that comes into play with factors like credit and term and everything else.
So we'll just have to wait and see, but I'm confident about the rent increase there.
Yes, sure.
In terms of looking forward a little bit, I don't see material change in that mark-to-market.
With an occupancy rate in the general suburban market of 15 ---+ or sorry, 80% to 85%, there's not a lot of pricing power for landlords to be able to drive rents.
And until we see that pricing power drive rent, that's when I think that mark-to-market will start to deteriorate a little bit.
But we do have, as I mention consistently, the smaller spaces, especially below 5,000 square feet, there's more activity.
The challenge is when you do a 30,000 square foot renewal that's coming off a 5- or 10-year lease, I mean, you have to meet the market, right.
And so that's what we're having to do.
And unless there's some dynamics that push the occupancy up to 90% in those suburban markets, so us and our competitors can sort of get some pricing power.
We still are faced with some rent write-downs to keep that occupancy.
Yes.
I think we are positive on '17 and '18.
And as I mentioned earlier, especially Northern California and Seattle, very robust demand, limited supply, very low vacancy.
Can we keep growing rents in the high teens, low 20s in those markets.
No.
Each quarter-over-quarter, no, I don't think that's sustainable forever.
And it may fluctuate quarter-to-quarter depending on a big deal we do or a renewal or something.
But yes, I like the dynamics in those markets, and because of that, I like our ability to push rents.
Having said that, we've pushed rents.
As I think I mentioned in the last call, Northern California rent growth has been over 15% or around 15% for the last 9 quarters.
So we are definitely capturing that rent growth and I expect it to continue.
But again, it may fluctuate from quarter-to-quarter in both Seattle and Northern California.
Yes, Gene, as I mentioned in my prepared comments, that really is tied to some of the costs that we are incurring in repositioning our asset in D.
C.
in Shady Grove ---+ at Shady Grove.
So we spent roughly, year-to-date, about $5 million on that.
We've indicated in the past that we'll spend about $10 million in repositioning and leasing that up.
So I would expect that we'd incur the balance of that probably over the remainder of this year and maybe a little bit into next year.
Yes.
We wouldn't expect, on a blended basis, for that number to vary widely.
Thank you, everyone, for joining us this morning, and we look forward to talking to you in the future.
Take care.
