Franklin Street Properties Corp. (FSP) Q2 2012 Earnings Report, Transcript and Summary

Good morning, and welcome to the Franklin Street Properties Corp. Q2 2012 Results Conference Call and Webcast. [Operator Instructions] Please note that this event is being recorded. I would now like to turn the conference over to John Demeritt, Chief Financial Officer. Mr. Demeritt, please go ahead.

Thank you. Good morning, everyone and thank you for participating in this call. Just to start things off, we gathered a couple of people today for Q&A. Jeff Carter, our Chief Investment Officer, is with us; and Janet Notopoulos, the President of our Property Management company is also with us; as is George Carter, our Chief Executive Officer. Before we make our comments, I must read the following statement. Please note that various remarks that we make, 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, and as updated on the 10-Q we filed all of which are on file with the SEC. In addition, these forward-looking statements represent the Company's expectations only as of today, August 2, 2012. While the company may elect to update these forward-looking statements, it may specifically disclaim 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. Having read that, I will begin with some comments about the second quarter and will start with a short overview. Afterwards, George Carter, our CEO, will further discuss the quarter in FSP. I'm going to be…

Thank you, John. Welcome, everybody to our Second Quarter 2012 Earnings Call. As is custom, I will discuss this call, on this call my written comments and last night's earnings release and then open it up for questions. So for the second quarter of 2012, FSP's profits as represented by FFO, funds from operations, totaled approximately $19 million or $0.23 per share, a decrease of approximately $529,000 or $0.01 per share compared to the first quarter of 2012. From an operational revenue point of view, our operational profit of view, our revenues and profits were pretty much flat between the first quarter and the second quarter, John mentioned these bankruptcy proceedings that -- proceeds that we got in the first quarter. This was from a former tenant of our Innsbrook Richmond Virginia property, LandAmerica. We're an accreditor there, and as those bankruptcy proceedings continue, we get checks sometimes. You never know exactly how much they'll be and when you'll get them. That property, Innsbrook in Richmond, Virginia has been fully leased for some time now and so this thing with LandAmerica just proceeds with us as accreditor. But again, from an operational point of view, our operating revenues and our operating profits were about flat between the first quarter and second quarter. Some of the new leasing has got to get through 3 rounds before they start to kick in on the FFO line. Our directly-owned real estate portfolio of 36 properties, totaling about 7.1 million square feet was approximately 90% leased as of June 30, and that's up from approximately 89% leased as of March 31. Most of the rental/leasing markets where our properties are located, remained stable during the second quarter, both in terms of occupancy and rental rate levels. We continue to make slow but steady progress…

[Operator Instructions] And the first question comes from Josh Patinkin from BMO Capital Markets.

I'm here with Rich, too. And I'd like to ask you guys about rent per square foot. I saw in the supplemental, if I'm reading it right, it looks like we're quoting 2011 rent per square foot. So going forward in 2Q, what's the spread been looking like and do you think you're achieving pricing power there?

I think we had a couple of sentences in the MD&A on page 17 that covers the leasing for the 6-month year-to-date, Josh. I don't have it right in front of me now, one second. So our leasing for the first 6 months of 2012, we leased 383,000 square feet of office space, about 295,000 of that was with existing tenants. A weighted average of about 4.5 years. The leasing I think was about 1.4% higher than average rents that we had in the 2011 schedule, that you were referring to there. Do you want -- I mean, Janet or...

Those number we're using for the first time are the averages of averages. And I think they're reasonably meaningful depending upon what kind of leasing activity we're doing. I think what we've decided is that this is a good way to present it and we'll footnote or disclose this quarter where we have mostly renewals that, that's part of what's driving it. If next quarter, we have a big new lease, it may be different, we'll flush that out, but I think it shows the trend.

And we thought that this would be a good benchmark for comparison to look at the sort of 2011 GAAP rents from each billion of portfolio and then compare our new leasing activity against that. We thought that might be a good way to do it.

Are there specific markets where you think perhaps it's turning in your favor and you're starting to see this mix in commodity like product here, the gain traction in pricing?

I think as George said, obviously, some markets are harder than others like Houston. But whether it's going to have an impact is going to depend upon whether we have vacancy in those markets. Sometimes we've already benefited to be able to see much on a portfolio basis spring into our properties.

But I think broadly speaking, Josh -- I think broadly speaking, our big rent roll downs are over. And broadly speaking, in the vast majority of our markets, rents are firming and moving up. So we -- again, there are a lot of factors here and without continued broad-based employment gains in our economy, I think you've got a lid on all of this stuff to some extent, particularly in suburban office. But again, broadly speaking, we're off the bottom in rent levels and I would say, broadly speaking, our rents are moving up, not down and in virtually every market. And in some of the energy markets, certainly more than others.

And then on the Atlanta acquisition, can you guys just give us some color on what the cap rate was and once you stabilize the property with the leasing activity you've been talking about where you think these yields might go?

This is Jeff. Josh, the One Ravinia property was acquired at approximately 82% leased and at that in place 82%, we were approximately a 7 cap rate. We have some leasing activity that started to spur during due diligence. And if those leases are finalized, we'll be in the neighborhood of 85% to 86% leased. We think that the Central Perimeter, as George mentioned, is positioned well for an Atlanta recovery that appears to have begun, particularly in Buckhead, but there is good leasing activity in the Central Perimeter. We like this property from a locational standpoint and we believe that there is good embedded growth not only in the existing rent roll with rental rate increases, but also with additional leasing. And so I'm optimistic that we're going to see some nice, nice growth in that property.

Great. And John, on G&A expense, I notice it moved upward this quarter. Is that recurring or do you think that will normalize next quarter and into the future?

I think with the G&A, you need to look at not only the G&A on the current income statement, but also what's embedded in discontinued operations. We've taken the step and allocated between the investment bank and the real estate segments in the past. And as part of that transition, more G&A was allocated to the REIT obviously this year, since we're not operating the investment banks in a similar fashion. You just kind of look at the both of those combined. I think combined, they're relatively flat, if I'm not mistaken.

I think Rich has a question as well for you.

On the loan payoff in Minneapolis, to what degree are you able to kind of manage the timing, because you've been quick to start the redeployment process already at $106 million? Is there -- is that just that you've been preemptive in terms of anticipating the refinancing? Or were you able to be -- govern the process, govern the timing a little bit so that you were ready to redeploy?

We certainly -- once we completed the 18-year lease with Target for all of the office space, we clearly anticipated a refinancing. And so we were active looking for other investments early on. If you want to do just again everything is fungible. But just a basic math, if you're getting back $106 million, between the Energy Tower loan of $33 million and the One Ravinia purchase of $53 million, we've already redeployed $86 million of the $106 million. Again, $33 million of it actually almost a month early. And again, we have our eye on other acquisitions right now. I think we will get all of that money redeployed in a reasonable amount of time, everything being equal. And as John mentioned in his opening remarks, we are exploring some additional financing opportunities for continued growth.

So in other words, if it was a 6.5% return, maybe over 7% with the fees you generated, you can actually turn an accretive -- it leads to an accretive transaction, assuming you're buying at about 6.5%?

Yes. You can on the ongoing rate. I mean, one of the things that these interim or bridge loans have associated with them in the market is commitment fees and exit fees. When you put all those in, you can come up with a higher number on some of these in our loans depending on the timeframe the loan is outstanding. Obviously, this loan got paid off very, very quickly. But from a ongoing recurring point of view, we're absolutely accretive going from the loan to the, Jeff, on One Ravinia purchase.

It's John. Q3 will be a little bit choppy to look at because we have the $33 million loan, as George mentioned, coming in the beginning part of prior July. We were losing the Target loan for -- we only had that for part of July. And obviously just bought Atlanta a couple of days ago. So moving -- the parts moving in and out might make Q3 a little bit odd, but it'll level out more in Q4 as we move along.

And the next question comes from Jeff Lau from Sidoti & Company.

I just had a quick question. Can you comment on the traction you're getting on Phoenix Tower, and again how much interest you have in it?

Yes, we actually had the property under a purchase and sell agreement, Jeff. Our feeling is it just fell out for general market conditions as I mentioned earlier. We have other buyers going through the property, potential buyers going through the property, doing their chores, doing their initial due diligence. So I think we've got pretty good traction on it. Again, we have some price expectations on the property that I think in a momentum market like the energy markets have been, like Houston has been, where you did have some cap rate compression, those price expectations can be met. We are so bullish about the property's long-term prospects that we aren't willing to just sell the property at any price or just let it go at sort of what may be coming over the transit right now. So we're -- the property's occupancy keeps rising. We have a equity ownership interest in the property as well as a loan on the property. So we're very bullish about ultimately selling it. I think at the end of the day, it's going to be a momentum play relative to energy and where energy goes. And there's so many factors that are swelling around there right now. We'll just have to wait and see. If my anticipation is that if it's going to sell at a price that we think makes sense for us, that's going to happen within the next quarter or 2. Otherwise, we probably take that property off market for a while, and continue leasing. We've got -- there are leases on that property that are substantially below the market now, and as those leases roll we definitely can move up that NOI and adjust that cap rate accordingly to a new buyer. So I think that's the game plan in the market for another quarter or 2 at max if we can get our price fine, if we can't, it comes out and we'll continue to own it for a while and let some of these leases hopefully blow up to market and do some more leasing with the property and consider putting it back on the market at that point.

Great. And I guess you said you're talking a little bit about some acquisitions you have an eye on right now. Any specific markets that you could tell us about?

We're looking basically in the markets that we're already in. We're not considering at this point opening up any new markets. We're acquirers, we're cyclical acquirers. By that, I mean, we work in generally big non-land constrained markets. And one of the disciplines of acquiring particularly suburban office and those kinds of markets, but even the CBD in those markets, is understanding the cycle of buying and selling. So when we look to acquire, we're always looking at markets that are down and hopefully close to a turn-up and vice versa on selling. So for example, this acquisition on Atlanta is a prime example of that. You might not see us acquiring in the energy markets anytime soon because they're a little bit hot. We have acquired and sold a number of properties in, for example, Northern Virginia, the Washington D.C. area. And that's a market that we're looking in right now because that market is starting to fall on hard times a little bit. So we'll just keep looking at markets that still have some value in them or have got some sort of cyclical opportunity in them. Atlanta will continue to be a market, Northern Virginia would be a market, probably not the energy markets. Some of them did west markets, still look pretty attractive from that cyclical acquisition sale point of view.

And as there are no more questions at the present time, I'd like to turn the call back over to management for any closing remarks.

I just want to thank everybody for turning in to the call. We look forward to speaking with you next quarter. Have a great day.

Thank you. This concludes today's teleconference. You may now disconnect your phone lines. Thank you for participating and have a nice day.