Q4 2012 Earnings Call Transcript
Transcript Call Date 02/25/2013

Operator: Welcome to the CommonWealth REIT Fourth Quarter and Year-End Results Conference Call. This call is being recorded.

At this time, for opening remarks and introductions, I would like to turn the call over to the Vice President of Investor Relations, Mr. Tim Bonang. Please go ahead, sir.

Timothy A. Bonang - VP, IR: Thank you, and good morning, everyone. Joining me on today's call are Adam Portnoy, President and Managing Trustee and John Popeo, Treasurer and Chief Financial Officer.

Before we begin today's call, I would like to read our Safe Harbor statement. Today's conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and other securities laws. These forward-looking statements are based on CommonWealth REIT's present beliefs and expectations as of today, February 25, 2013.

Forward-looking statements are not guaranteed to occur. Actual results may differ materially from those projected or implied in any forward-looking statements. Information concerning factors that could cause differences is contained in our Form 10-K, which we filed with the Securities and Exchange Commission or SEC earlier today and in our Q4 supplemental operating and financial data package found on our website at

Forward-looking statements are not guaranteed to occur. The Company undertakes no obligation to revise or publicly release the results of any revision to the forward-looking statements made in today's conference call as a result of new information, future events or otherwise. Investors are cautioned not to place undue reliance upon any forward-looking statements.

In addition, this call may contain non-GAAP numbers, including funds from operations or FFO, normalized FFO, and cash available for distribution or CAD, earnings before interest, taxes, depreciation and amortization or EBITDA and property net operating income or NOI. A definition of each of these non-GAAP measures and a reconciliation of each of them to net income and reconciliation of normalized FFO to FFO are available on our Q4 supplemental operating and financial data package found in the Investor Relations section of the Company's website.

I also note that the transcription, recording and retransmission of today's conference call are strictly prohibited with the prior written consent of Commonwealth REIT. Finally, we will not be conducting a question-and-answer session during this call and after the presentation by management.

Now I would like to turn the call over to Adam Portnoy.

Adam D. Portnoy - Managing Trustee and President: For the fourth quarter of 2012 we are reporting fully diluted normalized FFO of $0.82 per share compared to $0.76 per share during the same period last year.

During the quarter, on a consolidated basis, we signed 181 individual leases for 3 million square feet, with 74% of the square feet representing renewals and 26% representing new leases. During the year ended December 31, 2012, on a consolidated basis, we signed 554 individual leases for 7.4 million square feet, with 65% of the square feet representing renewals and 35% representing new leases. The average term for the leases entered into or renewed during the quarter was seven years and the weighted average GAAP rental rates were 5% above prior rents for the same space.

Capital cost commitments associated with leasing activity this quarter were $13.59 per square foot or about $1.94 per square foot per lease year. Of the 3 million consolidated square feet of leasing activity during the fourth quarter, 13% of the square feet involve CBD office properties, which added 8% rollup in GAAP rents and 59% involved industrial and other properties, which had a 22% rollup in GAAP rents. The remaining 28% of our consolidated square feet leased during the quarter involved our suburban office properties which had an 8% roll down in GAAP rents.

Some of the leasing highlights during the quarter include 1.1 million square feet of industrial leases executed during the quarter in Austin, Texas, which had a 22% rollup in GAAP rents. Also, we had about 434,000 square feet of leasing activity at our industrial properties located in Oahu, Hawaii during the quarter, which had a 35% rollup in rents.

As of December 31, 2012, our consolidated occupancy from continuing operations was 90%, compared to 89.6%, as of December 31, 2011, and 89.5% as of September 30, 2012. Our occupancy from continuing operations for our wholly owned properties which excludes results from our majority owned consolidated subsidiary, Select Income REIT, was 87.2%, as of December 31, 2012. On a consolidated same-store basis, excluding properties held for sale, our occupancy declined by a modest 10 basis points to 89.5%, and NOI declined by 1.4%. The primary reason for these declines was a decrease in occupancy and an increase in operating expenses at our CBD office properties located in our Chicago market.

More specifically, real estate tax expenses increased by $3.5 million or about $0.04 share during the fourth quarter, at our CBD office buildings located in Chicago. This real estate tax increase will be largely reimbursed by tenants in later periods because real estate taxes are typically paid and collected from tenants on a cash basis in Downtown Chicago, but we are required to record the GAAP expense as soon as the tax increases are known. Largely because of this increase in real estate taxes in Chicago, our same-store NOI for our CBD office properties declined by 6.8% during the fourth quarter. This decline was partially offset by same-store NOI increases of 4.2% in our suburban office properties and 1% in our industrial and other properties. Generally our CBD office properties, which represent 56% of our wholly-owned portfolio NOI, continued to perform better than our suburban office properties.

The Philadelphia market represents the Company's largest market area with 11.2% of our consolidated NOI followed by Oahu, Hawaii at 9.8% of our consolidated NOI and our Chicago market at 8.8% of consolidated NOI. In our Philadelphia and Chicago markets almost 90% of the NOI comes from downtown office properties. Within our other market segment, the stronger leasing areas continued to be Australia; Austin, Texas; Seattle, Washington; Pittsburgh, Pennsylvania; Boston, Massachusetts; and Northern California. About 19% of our consolidated NOI was generated from these six market areas in the fourth quarter.

Through year-end 2013 we have 5.5 million consolidated square feet scheduled to expire from continuing operations or about 9.2% of our annualized rental income as of December 31, 2012. Also as of December 31, 2012, we had about 7.2 million consolidated square feet of vacant space from continuing operations. We currently estimate that we will lease about 6.5 million to 7 million square feet in 2013 and we estimate that about 60% of this leasing activity will be renewals. About two-thirds of our 2013 consolidated expiring square feet from continuing operations is located in our CBD office portfolio for our industrial and other portfolio. We feel reasonably confident that we will be able to renew or lease the space in the CBD and industrial properties at rental rates that are equal to or higher than current in-place rents.

The most significant leased expiration in 2013, which is currently scheduled to become vacant, is the 607,000 square feet located at One Franklin Plaza in Philadelphia, which is currently leased to GlaxoSmithKline till March 31, 2013. As of today, we are negotiating with a new tenant to possibly lease the entire building that is being vacated, but these negotiations are ongoing and we may not be able to reach agreement on acceptable terms. If we do not lease this building to this full building tenant, we may multitenant the property or list it for sale.

With regards to 2013, our current expectation is that consolidated occupancy will remain largely unchanged between year-end 2012 and 2013 at about 90%. In order to achieve this, we expect a modest 2% to 4% decline in same-store NOI during the year, which is largely driven by expected continued rent roll downs in our suburban office portfolio partially offset by expected rent roll ups in our CBD and industrial properties.

As most of you know, for the last five years, we have been aggressively repositioning CommonWealth's portfolio into high-value CBD office properties, with a focus on top performing downtown assets in secondary markets and to a lesser extent in gateway city markets.

Since December 31, 2007, we have acquired $3.8 billion worth of property, and the majority of these acquisitions have been high quality CBD office properties. During this same period, we have sold $1.5 billion worth of properties largely consisting of suburban office properties. Since the announcement of our 2012 third quarter results on November 7, 2012 and excluding transactions at Select Income REIT, CommonWealth has not acquired or entered into any agreements to purchase properties. During 2012, CommonWealth sold three properties with 299,000 square feet for $11.7 million.

In addition, during the quarter ended December 31, 2012, 94 of our properties was a combined 6.7 million square feet located throughout the United States were either listed or in the process of being listed for sale with third party brokers. These 94 properties include 37 suburban office properties with 3.1 million square feet and 57 industrial properties with 3.6 million square feet.

Since December 31, 2012, we have sold 18 suburban offices in industrial properties, with over 1 million square feet for $10.3 million. These 18 properties consisted of our entire Dearborn, Michigan portfolio.

As of today, we also have a suburban office property and an industrial property with a combined 675,000 square feet under agreement to sell for a total of $5.1 million. We expect to complete the sale of these two properties and to sell the remaining 74 properties currently listed for sale during 2013. However, our ability to sell these properties is dependent upon our finding third-party buyers willing to purchase these properties and accept the prices and terms and no assurance can be given that any of the properties will be sold in that time period or at all.

During the quarter ended December 31, 2012, the 94 properties that were either listed or in the process of being listed for sale were reclassified to discontinued operations and CommonWealth recorded asset impairment charges totaling $168.6 million relating to these properties. As of December 31, 2012, these 94 properties were 26.5% leased for an average of 2.5 years and they generate negative $1.2 million of NOI during the year ended December 31, 2012. As of December 31, 2012, these 94 properties had a combined net book value of, approximately, $332.6 million before fourth quarter impairment charges and $164 million after the fourth quarter impairment charges.

Before turning the call over to John Popeo I want to add that we continue to have strong liquidity, including over $425 million of availability under our $750 million unsecured credit facility. In addition we own about $783 million worth of marketable securities in Government Properties Income Trust and Select Income REIT. This liquidity provides us with more than adequate financial flexibility to fund future capital requirements.

I will now turn the call over to John Popeo, our CFO.

John C. Popeo - Treasurer and CFO: Thank you, Adam. Net loss available for CommonWealth REIT common shareholders for the fourth quarter of 2012 was $164 million compared to net income of $1.1 million for the fourth quarter of 2011. The decline primarily reflects impairment charges on assets held for sale. Rental income increased during the fourth quarter by 13.3%, reflecting rental income from properties acquired since September 2011. Operating expenses increased by 14.2% primarily due to property acquisitions.

Also, as Adam mentioned operating expenses at our downtown Chicago properties increased by about $3.5 million as a result of real estate tax increases, which are accrued but cannot be billed to tenants until they are paid on a cash basis in the future.

Current quarter adjusted EBITDA increased by 11.1% compared to the prior year. Interest expense increased by 7.6%, primarily reflecting acquisitions that took place over the past year, including interest on assumed mortgage debt. Our share of government properties income trust or GOV net income and normalized FFO for the third quarter totaled $2.6 million and $5.2 million respectively. We received over $4 million in dividends from GOV during the fourth quarter of 2012. We recognized gains on issuance of shares by GOV totaling approximately $7 million during the fourth quarter, representing our proportionate share of the difference between GOV, equity issuance price and the carrying value of our GOV shares.

Loss from discontinued operations for the fourth quarter includes net operating income, plus depreciation and G&A expense from 94 properties either listed for sale or in the process of being listed for sale with third party brokers as of December 31, 2012. Loss from impairments from discontinued operations of $168.6 million reflects the write-down of these 94 properties to their estimated fair market values during the fourth quarter.

Net income and normalized FFO attributable to the non-controlling interest in Select Income REIT or SIR totaled $5.5 million and $7.5 million respectively during the fourth quarter.

Today after SIR's December 2012 equity offering the Company continues to own $22 million or 56% of SIR common shares, while our retained interest in SIR continues to exceed 50%, we will continue to consolidate SIR's financial position and resolve into our consolidated financial statements. Normalized FFO available for CommonWealth REIT common shareholders was $0.82 per share for the fourth quarter of 2012, compared to $0.76 per share for the fourth quarter of 2011. Year-over-year per share results primarily reflect a decline in same-store occupancy, and the SIR IPO in March 2012 partially offset by property acquisitions during 2011 and 2012.

During the fourth quarter, we spent $48.7 million on recurring capital expenditures, which includes tenant improvements, leasing costs and recurring building improvements. We generated $15.5 million of cash available for distribution or CAD during the fourth quarter, resulting in a rolling fourth quarter CAD payout ratio of about 111.5% based on the former dividend rate of $0.50 per share per quarter, paid in the third quarter of 2012, and our new dividend rate of $0.25 per share per quarter, paid in the fourth quarter of 2012. After giving effect to our recent dividend reduction, our pro forma CAD payout ratio would have been about 64% for the year ended December 31, 2012.

During the year ended December 31, 2012, we spent about $132.7 million on recurring capital expenditures. In order to achieve our future leasing plans, it is our current estimate that recurring capital expenditures, including tenant inducements and leasing commissions will remain elevated until the office market recovers further.

Turning to the balance sheet, on December 31, 2012, we held $102 million of unrestricted cash. Rents receivable includes approximately $225.7 million of accumulated straight-line rent accruals as of December 31, 2012. Other assets include approximately $155.3 million of capitalized leasing and financing costs. The $171.8 million worth of properties held for sale represents the net book value of 94 properties held for sale, net of the $168.6 million of impairment charges during the fourth quarter plus related property level rents receivable and prepaid operating expenses and other assets.

On December 31, 2012 we had $1.2 billion of floating rate debt, including the $350 million SIR term loan and $95 million outstanding on SIR's revolving credit facility. At the end of the fourth quarter, we had $952 million of mortgage debt and $2.1 billion of fixed-rate senior unsecured notes outstanding. The weighted average contractual interest rate on all of our debt was around 5% at the end of the quarter and the weighted average maturity was around five years. The undepreciated book value of our unencumbered properties totaled about $7.8 billion at the end of the quarter. At the end of the fourth quarter, our ratio of debt to book capitalization was 55.4%. Our adjusted EBITDA to interest and our fixed charge coverage ratios were 2.7 times and 2.2 times, respectively. Also our debt to adjusted EBITDA ratio was 7.6 times. As of the end of the fourth quarter, we were comfortably within the requirements of all of our public debt and bank debt covenants.

In conclusion, we believe CWH will be well-positioned to benefit from any recovery in the office market during the next couple of years. We also believe that we continue to maintain strong liquidity with the undrawn capacity under our revolving credit facility and the current ownership of about $783 million worth of marketable securities in GOV and SIR.

That concludes our prepared remarks. Thank you everyone for joining us today.

Transcript Call Date 02/25/2013

Operator: The event is not accompanied by Q&A