Franklin Street Properties Corp. (FSP) Q3 2009 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Third Quarter 2009 Franklin Street Properties Earnings Conference Call. My name is Latrice; I will be your coordinator for today’s call. At this time, all participants will be in a listen-only mode. We will conduct a question-and-answer session towards the end of this conference. (Operator Instructions). At this time, I would like to turn the call over to your host for today’s conference Mr. Scott Carter, General Counsel. Please proceed.

Thank you and good morning, everyone, and thanks for participating in this call. With me this morning are George Carter, our Chief Executive Officer, and John Demeritt, our Chief Financial 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 factor section of our annual report on Form 10-K for the year ended December 31, 2008, which is on file with the SEC. In addition, these forward-looking statements represent the Company’s expectations only as of today, November 4, 2009. 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 as contained in yesterday’s press release, which is available in the Investor Relations section of our website at www.franklinstreetproperties.com. Now, I will turn the call over to John Demeritt. John?

Thank you Scott. Welcome to our earnings call. We’re going to be talking with you about our third quarter and nine-month results and we’ll start with a short overview. Afterwards George Carter, our CEO, will further discuss the quarter on FSP. I’m going to be brief and we will be referring to our earnings release, the supplemental package and the 10-Q that were filed last night. I’d like to start with the balance sheet, which continues to serve us well and will enable us as we move ahead. As of September 30, we had cash of $26.4 million and $159 million in availability on our line. This totals about $185 million in liquidity to help operate FSP and fuel future growth. Our property portfolio is well diversified geographically and has no secured debt. Properties with secured debt can have property-specific issues that could cause a sale when the market is not right for it, sort of like where we are right now. Since our debt is unsecured, it’s viewed more like one property and connects to mitigate the risk of the potential sale. Geographic diversification within our portfolio spreads outlook economic risk across the portfolio which we think benefit shareholders over the long haul as well. At the same time, our low leverage ratio provides a terrific loan-to-value for our bank group on our unsecured loans. Our interest rate coverage ratio is also very high compared to our peers at about 11 times through nine months. Our debt maturities on these loans are about two years away but we’re laying the groundwork for expansion with them in the future. The sense we have right now is the credit markets are still difficult, particularly given the level of bank closures recently but we are a desirable credit. Over the past month…

Thank you John, and thank all of you for taking the time to listen to our third-quarter 2009 earnings call. As John has said, our FFO for the third quarter of $0.25 per share was sequentially flat compared to our second quarter. More specifically, there were no property sales in the quarter, we don’t have any properties listed for sale and we don’t anticipate listing any at this time. As I’ve said in past calls it isn’t just about the absolute price and cap rate that properties are trading at, but it is as much about liquidity and competitive bid pricing which is still substantially lower than our normal active commercial real estate market. I will say this though, and you may have heard this on other calls. For the quarter, we have seen some improvement in the amount of transactions done, the amount of properties offered, the amount of properties bid on, the number of bidders, just more activity, and I hope I know everybody does, this portents some liquidity coming back into the sales market, there definitely has been some improvement going forward. Rental revenue rose to over $31.7 million for the third quarter from about $29.3 million last quarter, but our occupancy dropped to about 90% for the third quarter from 92% in the second quarter as our lease roll into a weak leasing market had its consequence. I will say that on the ground when you look across the country, and we have a diversified portfolio primarily of suburban office, depending on what statistics you read from what source, vacancies are somewhere between 15% to 20% and it’s still very tough out there. The one thing I would say though that is quite different from really the start of the year is that we are seeing…

(Operator Instructions). Your first question comes from Dave Aubuchon - Robert W. Baird.

George, you’ve mentioned the acquisitions that you’re looking at, and I believe you said it looks like it’s going to close on more before this year, and can you provide a little bit more detail on what the pipeline looks like and perhaps bracket where you’re seeing those opportunities and assuming in your core markets, but maybe little bit more specific by region, and then the cap rates? And yields that you’re seeing right now whether or not the increased activity you’re seeing is moving the cap rates at all?

Good morning Dave. Sure. The pipeline it’s been interesting because we are definitely seeing a stabilization in cap rates and sort of, I would almost call it a stabilization in transactional business in the property type that we believe is best to acquire at this part of the cycle, and that property type has been primarily existing fully leased properties, credit tenants, long-term leases, cap rates, when I say long-term leases I‘m talking about anywhere between 7 and 15 years. Net leases, so you don’t have the operating expense risk going along with them. These are mostly newer properties so even though the leases maybe long coming off the back end you still have a very viable product type, this is particularly important in suburban, and definitely looking in regions that are areas that we already are in where we know people, where we know properties that are on the market etcetera. Cap rates, as I mentioned probably in the last call, we are looking at the cap rates for these kinds of properties of anywhere between 8.5 and 9.5 caps and those held pretty steady for the quarter. From our perspective there is a time in the cycle to buy these kinds of properties. The time to buy these kinds of properties is when you are unsure of how deep this canyon will be and how wide it will be. I think a lot of us in the real estate business right now think we are getting close to a bottom. We are still not sure how long it will take to turn up, how long employment lags that the GDP cycle, etcetera, and I think that for the balance of ‘09 and 2010, I think our pipeline, because we are connected to a few very good sources and a lot of these sources are primarily developer type sources who have construction loans that are maturing. We really anticipated selling or owning or financing properties that they developed at much different metrics a year or two ago when they started the development. I think our pipeline looks good and is of significant size in this product type.

Do you think that pipeline would match, the acquisitions would match what you have already acquired this year, if you look at the balance of next three or four quarters?

It certainly has the potential to and then so.

You mentioned that you do have quite a few in your square footage, and your portfolio is expiring over the next four to five quarters. Can you detail a little bit more distinctly what the potential downside is from those leases that are rolling whether or not you keep some of the bigger leases, I think we all know about the capital one leased this quarter, but if you look out into 2010 you do have a lease to side base and I understand that most of that space is subleased, but also the Tektronics deal in Texas in Q2 and Q3 of next year. Can you provide a little bit more detail where do you think you see your occupancy moving over the next four to five quarters?

Yes, I mean occupancy is going to go down. We are going to have increased vacancy over the next few quarters. There is really not much doubt about that. Again, I don’t know net how the profit FFO picture will be affected because that is being offset by the things. The biggest stain on the upcoming lease roll, there are four significant properties that have the role associating with them. One is in the Richmond Virginia area Innsbrook, this is the Latin America property, cap one property that we talked about so extensively. There was a bankruptcy there which virtually vacates that whole property. That property is about 298,000 square feet, we’ve actually leased about 21% of that property already with really no downtime from the exploration of the cap one lease, and we have real and significant interest looking at the balance of the space in that property. There are three different tenants that have leased 21% already and we have several other tenants looking at that space. Again, the good news is it’s a wonderful property and in one of the best locations in that market, and so we should be competitive in leasing that up. One of the things that we’re trying to do and I think most landlords are trying to do, is if we can sign tenants on shorter term leases with no or lower TIs, you try to do it rather than signing some big long lease at a much lower rent with a large TI and sort of encumbering the value of that property over the long haul. I mean if you believe in a recovery, you definitely want to try to stay short at this point. One of the things that gives me some encouragement is that we are getting tenants and…

On the banking side, you did mention that it looks like you are starting to feel a lot more optimistic about the outlook there. Do you feel like that’s a breakeven business in 2010 or you don’t reach that point yet. Obviously it’s pretty early in the turn?

I’d just qualify it, but I don’t know. I mean that is one market that can dramatically change from moment to moment with stock market or events in the world, but the way we are looking at it now is that business should be profitable in 2010 and far more than breakeven.

Again, the breakeven point in terms of capital raise and that is typically around the $15 million mark, is that correct George?

That’s a good number. Again, deals can vary a little bit in terms of how we structure them and lowed and profitability et cetera, but generally speaking sort of all in, yes that’s a good number.

My last question is related to the balance sheet. John, I assume that you have given your comments about mortgages that you want to stay away from the security side. Should we expect, obviously depending on the level of acquisition activity within the portfolio, should we expect that maybe a term out some of the line of credit debt into another unsecured term loan?

Yes, that’s a good thought. I’m just not sure of the timing of it. Right now the spreads are a little higher than we’d like. We’re enjoying a pretty good rate; we only have two years left. So, we would certainly be looking at that when that term loan comes to maturity either absorbing it into a line of credit or doing exactly that to stretch not a longer term loan.

Your next question comes from John Guinee - Stifel Nicolaus.

George, great job on summarizing your major roles in the next few months, can you add to that what you see happening on Technip, which I think is the end of next year as well as Ober Kaler, which is early 2011?

Technip really is a little bit of a moving target. It’s involved in a couple of properties of ours. In the Park Ten property Technip is effectively already gone, and we’re working on leasing that space. They are involved in a whole strip right along I-10 of Houston and in several buildings there they’ve had a new building built for them which is right next to another property that we have as a syndication where they are the major tenant and until this new building was built for them they back filled some space in our Park Ten property. So they are moving around and according around, they are a little hard to predict, but on the Park Ten property where we have the Technip vacancy, we are leasing that actively as we speak to other tenants, again a number of them energy tenants in that energy quarter or market of Houston. Ober Kaler, which is a 2011 expiration in Baltimore, a law firm, I don’t know in the final analysis where that goes and I don’t want to speak for Ober Kaler, I don’t know if any announcements have been made or anything else and so I don’t know the answer there, but we would assume at this point that the law firm would be leaving us.

Going back to Technip, is 86,000 square feet in Park Ten and then additional space in the syndication building?

Right.

Park Ten we ought to underwrite that as in lease up now, and then which asset is the syndication asset.

The name of that asset is Energy Tower.

How much space do they have there? Just roughly, I mean is it 10,000 or?

Yes, I can find it for you.

They have 326,000 square feet.

326,000 in Energy Tower.

Yes.

Do you have a position; is that a syndication where you have any position or do you sold that all off?

No, no. We don’t have any position there, that’s all on the outside investors.

Then I think you increased your loans outstanding, you probably you made a loan to one of your syndications, which one is that?

Well, probably the most significant one is 385 interlocking, which is a construction loan for a property spec developing in Colorado.

Any lease termination fees in the third quarter?

Yes, we had one lease termination fee for our property in Missouri that occurred, and that space has already been re-let to an existing tenant in the building.

How much was that?

The fee?

Yes, the lease term fee.

Lease term fee was 445.

Then the last question is, it looks like from your supplemental that you are running amortization of favorable leases, anywhere between $800,000 a year and $1.1 million a quarter, I’m assuming that that’s a amortization of above market leases, so it’s a deduct from a GAAP NOI to get to get to a cash NOI, is that the right way to look at that?

Yes, we had to back for purposes of calculating FFO, but I guess if you’re going with GAAP, yes, it sounds right.

Then just one last question, I’m sorry, can you talk a little bit about your new syndication that you’ve started, is that something that FSP has any loan on now or what exactly is your involvement besides the investment banking effort to syndicate the equity?

Typically we will acquire an asset when we do syndication; essentially we will lend money to entity that will hold that asset while we syndicate it that’s the technically correct term. On this one, we haven’t done that yet, we really aren’t able to according to reg D-rules and regs talk about syndications that are in process right now, otherwise we could fly in the phase of some of the rules that are established with that. So there is really not much else we can say about that one John.

Basically your teams working on it, it hasn’t been closed yet and therefore a loan has not yet and made on to it?

That’s correct.

Your final question comes from [Bob Sarason - Glen Oaks].

Can you give me a little update on Colorado property, because I’m just trying to understand the economics behind it, $42 million total loan commitments there and $50 million of it’s been funded. So is it fair to assume that you have $27 million of additional funding to do on that. So, what’s the timing of that and what’s the goal trying to get that money back on permanent financing?

Yes, this is George. That was a syndication effectively a spec development, which is right next to two light type properties developed by the same on the ground developer that are owned by FSP and those properties are virtually fully occupied. So, we raised the equity through outside investors for that property and provide the construction loan, we do have the balance of that construction loan committed to and it’s drawn down as needed on a month-to-month basis. When the property is completed at least that property will either be permanently financed which will allow our capital to come back or sold and allow our capital to come back.

So $27 million, you basically have to come up with $27 million of cash, I’m assuming that thing will be done in the year within the next year to fund their construction, is that correct?

Right.

And then what debt is of lease on that building?

It’s just topped off. There are no leases in the building at all now.

So it’s completely a 100% on spec and you have no committed leases?

Correct.

Then going back to some of the vacancies that you have, have you looked at your exposure to impairments on these properties. I kind of look at these things and I see some that’s 80% vacant or properties. For example, if I look at the federal weight property that’s been basically 80% vacant for three years now. I don’t understand if lease properties keep generating negative NOI, how they support their carrying without you?

Well, this is John. There is a distinguishment between impairment, and I think you are talking about potential market value right now, and it has to do with your hold period. If you have secured debt on our property that’s coming due in two years you are more than likely going to have impairment because two years from now you need to do something to finance that property. We are not in that position, and so, when you look at FAS 144 which is what the rule is, the use for when you are evaluating impairments you evaluate whole period on undiscounted cash flows over a long period of time and use a variety of factors. As a result we tend not to have an impairment charge that would pop on these, that’s just the way the GAAP is written for this particular exercise, and market value is something very different.

But in that analysis, you are using it at some point; you are using a residual value in that discounted cash flow analysis. So, you are making assumptions that residual cash flow or that residual value is a number that’s at least equal to its current market value?

No, it’s equal to our greater than our carrying value over the long term hold. That’s the way GAAP is written on this. We are not in fair value accounting right now.

Right, I understand this.

Just to put a little color on it, from my perspective if people have an impairment usually people have to sell assets, we are not in that position right now. So it’s kind of in some ways when you look at cap rates and movements in them and sort of try to push those on to a balance sheet adjustment, it doesn’t make sense for a company like ours. You are talking about mark-to-market and that’s very different than impairments.

Then going back to the Land America Building, can you give me some idea of the rental rates you are getting on that? I know you said that on an average you are seeing lease roll down or lease reductions of 10% to 15%, is that about what you saw on the leases that you executed on Land America 10% to 15% below what you were receiving?

That’s correct, on the leases we’ve executed there, that would be accurate.

Then lastly on the equity offering, you made a comment that you would look at additional equity offering depending on how your shares were received, and I know as a shareholder I’d look at it and say well we are down 15%, almost 20% since the equity offering six week ago. Is there a threshold where you would see below $11, below a certain level that you just wouldn’t issue additional equity?

Well, of course there is a level at which you wouldn’t issue equity whether it would be received or not in the market place at some sort of pricing. I mean we’re issuing equity not to survive or to pay down debt per se, we are issuing equity to acquire property which we believe both on a current profit basis FFO accretion et cetera, and on a long term ROI basis, we will be accretive to our equity shareholders. There is a price in the market place that properties are selling at and there is a price in the market place that our stock would be selling at. Those would have to lineup to be accretive and positive to equity shareholders or we wouldn’t issue equity, but I think the answer to your question is that there are two metrics that would have to lineup the acquisition metric and obviously the price of your stock metric.

Right, I mean how the market has currently received your equity offering?

I don’t know exactly what you are asking?

This is John, I would just throw a comment that. If you follow the REIT index, which I’m sure you do, a lot of the REITs in the last few weeks or last month have seen their share prices declined significantly.

I follow the REIT, and I’m very focused, that anywhere near like FSP, I mean you are down from 14.50 to 10.50, 10.75 in eight weeks since the equity offering. So that’s a 30% drop I think the REIT index is best it’s off 5%. So it’s just a big concern when you talk about addition looking to do more equity offerings when you see that literally the stock is down 30% in eight week, that’s way beyond any other office REIT that I’ve seen or follow?

Bob your point is the right point. That is to say you are only doing equity offering when you can be accretive on the acquisition front. So you would only do it if we could be accretive on the acquisition front. If the stock has fallen and is not accretive, you wouldn’t do an equity offering.

There are no further questions in queue at this time. I would like to turn the call back over to Mr. George Carter, CEO for closing remarks.

I just thank everyone for turning into the call and we look forward to seeing some of you at the 2009 [Mayreed] Annual Convention in Phoenix-Scottsdale. Thank you.

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect and everyone have a wonderful day.