Franklin Street Properties Corp. (FSP) Q3 2012 Earnings Report, Transcript and Summary

Good morning, and welcome to the Franklin Street Properties Corp. Q3 '12 Results Conference Call and Webcast. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Mr. Scott Carter, General Counsel. Mr. Carter, please go ahead.

Thanks, and good morning, and welcome to Franklin Street Properties' Third Quarter 2012 Earnings Call. With me this morning are George Carter, our Chief Executive Officer; John Demeritt, our Chief Financial Officer; Janet Notopoulos, the President of FSP Property Management; and Jeffrey Carter, our Chief Investment 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 Factors section of our Annual Report on Form 10-K for the year ended December 31, 2011, which is on file with the SEC. In addition, these forward-looking statements represent the company's expectations only as of today, October 31, 2012. 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 is contained in yesterday's press release, which is available in the Investor Relations section of our website at www.franklinstreetproperties.com. Now I'll turn the call over to John Demeritt. John?

Thanks, Scott. Welcome to our earnings call. We're going to be talking with you about our third quarter results and we'll start with a short overview. Afterward, George Carter, our CEO, will further discuss the quarter and FSP. I'm going to be brief and will be referring to our earnings release, the supplemental package in the 10-Q that we filed yesterday. I'm going to start with our new bank facility. We have a terrific bank group consisting of 10 banks, and I believe they can help us in many ways. During Q3, we closed on a new credit facility with this group that added liquidity for us, plus the benefit of better pricing and longer term. As of September 30, we had cash of about $24 million on the balance sheet and $418 million in availability on this new credit facility, giving us about $442 million in liquidity. We closed the new facility on September 27, and it provided us with an increase in liquidity as the line we replaced was capped at $600 million. The new line -- of our new facility is $900 million including a floating rate line of credit and a fixed portion of the term loan. Pricing on the line of credit, which has a $500 million availability, is currently at 145 basis points over 30-day LIBOR. So we're at a rate of about 1.7% now on our line. The line is for a 4-year term plus an option to extend for 1 year is available to us for a fee. The new facility also has a term loan component of $400 million, which is currently fixed at a rate of about 2.2% for a 5-year term. We can also increase the facility up another $250 million, should we and the bank group want to…

Thank you, John. Welcome to Franklin Street's Third Quarter 2012 Earnings Call. As usual, I will follow my written comments in our press release of yesterday and then open the call to questions. But before I begin, let me say on behalf of everyone at FSP, how much our thoughts and encouragement are with anyone listening to this call who might have been adversely affected by Hurricane Sandy. Having been through several devastating hurricanes with family, personal property, homes and commercial real estate investments, I know how overwhelming, frustrating and hopeless it all can seem at times like this. Events like Sandy do tend to add perspective to many things. For the third quarter of 2012, FSP's profits as represented by FFO totaled approximately $19.9 million or $0.24 per share, an increase of approximately $900,000 or $0.01 per share compared to the second quarter of 2012. For those of you who have followed FSP over the last few years, you know that we did anticipate 2010 being our low operating profit year, and so it proved to be. We anticipated 2011 to be our first year of FFO recovery, and it was. We were optimistic about 2012 and for the first 3 quarters, we have achieved continued FFO growth. We are very optimistic about the balance of 2012 for continued operating profit growth -- FFO growth. And we are very positive about continued growth above that for 2013. Our directly-owned real estate portfolio of 37 properties, totaling approximately 7.4 million square feet, was 89.9% leased as of September 30, down from 90% leased as of June 30. The drop in percentage of leased space of approximately 0.1% in the third quarter was due solely to the acquisition during the quarter of the 386,000 rentable square foot value-add suburban office building…

[Operator Instructions] Our first question is from Dave Rodgers with R.W. Baird.

Just wanted to follow-up your comments about the acquisition market, George. Perhaps give us a little bit more color on the types of sellers you're seeing out there. Is the backlog growing? Or are you just having more recent success that suggest the closings or the potential closings you mentioned over the next couple of months? And I guess just to tie out the thought on acquisitions, you had used the term months instead of quarters, so should we expect a fairly decent amount of activity heading into the year end?

Dave, it's George. Let me turn this over to Jeff, who is our Chief Acquisitions person, CIO. He can give some perspective on the market for sure. I think we are very active on a number of potentials. But if you were going to say between now and year end or after year end, we'll probably lean more to first quarter of 2013 than between now and year end. But Jeff, why don't you give some perspective on the market.

Absolutely. We are seeing pretty strong activity in most of our markets with potential dispositions and a lot of different profiles that are out there. There's a pretty good spread between core assets that are for sale in our markets, as well as deals that have a bit of a value-add bend to them. In most of our markets I'm seeing more competition on the value-add assets. There seems to be more money that's aggressively pursuing those deals. The underlying condition, though, in all cases is people are focused. Investors are focused on assets that are extremely well located and that can be bought at a reasonable price or discount, if possible. Markets where they see some potential upside or that have at least bottomed. Atlanta is a great example, especially in some of the inner markets of Atlanta, Buckhead, Midtown, Central Perimeter, where investors seem to be focusing again on buying some deals, if they can, that have a good trajectory upward, a good track record in the past, are really infill properties. And I'm seeing more interest on deals that have that last mile to lease from my competitors, whether they're 80% or 85% leased or something thereabouts versus just pure core deals that are 100% stabilized. But in all the deals that we've been working on and that we've discussed, including Westchase and including Ravinia, particularly, they were marketed broadly and plenty of competition in terms of bidders on both of those deals, as well as other deals I'm seeing in the market.

And on the Houston asset, can you give us a little color on why that fell out of contract? Was that a buyer issuer? Or something more about the property?

I can't, really. I'd be breaking some confidences. But I think, Dave, in general, there was a feeling in the energy markets -- Houston primarily, but Denver and Dallas as well, to some extent. As the year began, the energy -- 2012 began, the energy markets were very, very hot and cap rates have compressed fairly substantially. There was a lot of anticipation on growth in rents and occupancies in the energy markets, particularly Houston. It was one of the reasons that it seemed like a good time to put Phoenix Tower on the market. Since then -- fairly shortly after the beginning of the year, as the market started to grab the potential of this global slowdown, not only Europe, but China slowing, U.S. potentially with the fiscal cliff, and all of that sort of thing, and the price of oil started to reflect that future slowdown with lower oil prices, some of the multiple came out of the energy markets. A lot of buyers were looking at low cap rates, high multiples with a lot of lender interest, as well, looking for very high loan-to-value sort of purchases, and several deals that were put up earlier in the year and had potential purchasers that were looking for high loan-to-values, low cap rates, high multiples fell out of bed. I think Phoenix Tower was broadly in that category.

Okay, that was great color, George. Last question for me and I'll yield [Audio Gap] expectations over the next quarter to make additional loans into the single-asset REITs. I guess, in another way, are there any specific situations you see that we should be expecting some more of that activity?

We have nothing right now that's in the queue. All of that activity that may happen in the future would only happen, number one, if there was an opportunity with our own single-asset REITs that made sense at the market for, obviously, the FSP shareholders and for the shareholders of those single-asset REITs. Right now there is nothing in queue.

Our next question is from Josh Patinkin with BMO Capital Markets.

Looking at this asset that you guys bought in Houston, can you talk a little bit about how that transaction came about? The cap rate there and any other details worth sharing?

Josh, it's Jeff Carter. We are set to close on that, hopefully tomorrow.

Josh, did you say Atlanta or Houston?

I thought I heard Houston, but am I wrong there?

No, no. Okay. I'm sorry. I misheard you, I thought you were asking about Atlanta. I'm sorry.

We're scheduled to close on that asset tomorrow and I can give you just some general commentary about it. It was a broadly marketed deal, received considerable interest and was a property we were interested in from the start of its marketing. The property -- I can't give you specific cap rate, we haven't released any specific cap rates. But I can tell you on infill assets like this one, of this quality, we're seeing cap rate ranges of between 6.5 and 7.5 and this property will fall within that range. It is, as George mentioned, approximately 95% leased. Two buildings, one was completed in 2008 and one was completed in 1982. They are both approximately the same square footage and both 14 stories. They are very diverse in their rent rules and diverse in their expiration schedules. The submarket in Houston that this is in, in Westchase, is extremely competitive. The Class A tier 1 third quarter numbers for that market are about 1.7% taken. For Class A tier 2 properties, it's about 9.6%. And so it is a very robust market. And Houston, as you know, is a market where there's a lot of competition.

Okay, great. And kind of in context with George's comment on the global picture and what that's done to Houston property. Have you seen a deceleration in rent growth there? And what are the cash rent spreads right now in your other Houston assets?

I don't think that -- we have not seen a deceleration in rent at this point, whether that comes in the future or not. But as you know, leases take a long time to do, so there's a pipeline. The deals that we're signing now were probably started 1 month or a couple of months before. So what we have been seeing is steady increases because of the statistics that Jeff was citing on vacancy. I think we give our cash rents by 2011 in one of the schedules that we provided that will show you what they were for 2011. Our properties -- well, all Class A are in different submarkets and I don't think it's a meaningful number to average those. But they -- you should be able to find those in the supplementals. So the Park Ten is the smaller -- our smaller buildings out in one direction, and then we've got the stand-alone properties.

But I think broadly speaking, Josh, if you talk to the people on the ground in Houston at our properties, the rental market is still strong and not responding to the sales market slowdown that is reflective of the drop in oil prices and the uncertainty of the global economy and the future of oil prices. On the ground, the rental market is not that way. Vacancy is very, very low. We have strong demand at all of our properties. Rents have not gone down or moderated, so we're getting great activity and spread there on the ground, from a rental perspective. But the sales market, I mean, that -- again the cap rates compressed so much because of anticipation of much, much higher energy prices. And that, some of that bloom has come off the rose. Which by the way, was one of the things that allowed us to step in on Westchase at a price that we thought was attractive. We're very bullish for the long-term view of global energy demand, very bullish on Houston and its industry and technology for all kinds of energy, particularly hydrocarbons. And positioning capital for the longer term in the right light Class A assets and the right submarkets in Houston, we think is a real good long-term bet. The short term swings in the price of oil and buyers and lenders that move in and out can potentially give us opportunities. So you see on Westchase the opportunity to buy, you see on Phoenix Tower it falling out a bit and then coming back. Hopefully we'll put that under contract at every bit as good a price as we anticipated shortly. So it's an active market and a lot of speculation on the future on buys and sells. But in terms of the energy companies particularly, and all of the surrounding people and companies that service that business, it's a powerful market right now, one of the best markets in the country with no slowdown.

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. George Carter for any closing remarks.

Thank you, everyone, for listening into the call. I hope you have a good end of the year, and we look forward to talking to you at the end of the year about our fourth quarter and full year results. Thank you.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.