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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Greetings and welcome to the Equity Commonwealth Second Quarter 2018 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded.
I'd now like to turn the conference over to your host, Sarah Byrnes. Thank you. You may begin.
Thank you, Matt. Good morning and thank you for joining us to discuss Equity Commonwealth's results for the quarter ended June 30, 2018. Our speakers today are David Helfand, President and CEO; David Weinberg, COO; and Adam Markman, CFO.
Please be advised that certain matters discussed during this conference call may constitute forward-looking statements within the meaning of federal securities laws. We refer you to the section titled Forward-Looking Statements in the yesterday’s press release, as well as to the section titled Risk Factors in our most recent Annual Report on Form 10-K for a discussion of factors that could cause actual results to materially differ from any forward-looking statement. The company assumes no obligation to update or supplement any forward-looking statements made today. We also post important information on our website at www.eqcre.com, including information that may be deemed to be material.
Today's remarks also include certain non-GAAP financial measures. Please refer to yesterday’s press release and supplemental containing our second quarter 2018 results for a reconciliation of these non-GAAP performance measures to our GAAP financial results.
With that, I will turn the call over to David Helfand.
Thanks Sarah. Good morning and thank you for joining us.
I’ll begin with brief comments on market conditions, review our second quarter results and provide an update on the company’s progress so far in 2018.
In the second quarter, the U.S. economy grew 4.1%, continued adding jobs at a healthy pace with roughly 200,000 new jobs created each month. The unemployment remained steady through June at 4%.
With respect to interest rates, the 10-year Treasury yield has held fairly steady in a range just below 3% and is currently at 2.97%. On the short-end of the yield curve, one-month LIBOR is 2.08%, an increase of roughly 50 basis points since the beginning of the year.
The equity markets remain volatile. The S&P is up 6% for the year and the NASDAQ is up almost 11%. Morgan Stanley REIT Index is flat for the year after being down 8% in the first quarter.
Turning to office fundamentals, in the second quarter national net absorption was positive 20 million square feet, 11 million square feet of new supply was added to new inventory. National vacancy at 13% remained flat.
Looking forward, the new supply pipeline remains elevated with over a 100 million square feet under construction nationally, creating headwinds for further occupancy gains and rent growth. Generally speaking, supply is concentrated in markets that are also characterized by strong demand.
With respect to real estate capital markets, office transaction volume declined again in the second quarter, a continuation of a slowdown in transaction volume we've noted for the past two years. We continue to successfully execute on a repositioning strategy to selectively sell assets when we can achieve attractive pricing. Despite volatility and interest rates, the real estate debt capital markets remain healthy with active fixed and floating rate lending programs from diverse sources including banks, life companies, debt funds and CMDS
Debt capital is readily available at attractive pricing and on flexible terms and for the most part lenders are accepting lower margins blunting the impact of higher base rates.
Turning to EQC, we continue to make progress executing on our business plan. We remain focused on creating value to aggressive leasing, creative asset management and selective dispositions. Our leasing volume and pipeline is healthy and we're focused on addressing our largest vacancies.
Our team continues to execute exceptionally well as evidenced by our strong leasing results again this quarter. As a result leased occupancy is up 230 basis points versus a year ago.
Turning to dispositions in the second quarter we closed on the sale of 1601 Dry Creek Drive a 100% leased property in Longmont Colorado totaling 553,000 square feet for a gross sale price of $69 million, pricing was in the mid-6% cap rate range. Year-to-date we’ve completed $854 million of dispositions.
We currently have three properties totaling 1.2 million square feet in various stages of the sale process. Our strategy will continue to be informed by market conditions. While the real estate investment sales market has softened somewhat in the last couple of years, pricing remains elevated by historical standards, cap rates and expected IRs are low and prices propounder high relative to replacement cost. Pricing environment today for high-quality assets is not in our view, lend itself to achieving superior returns and as a result we'll continue to be patient.
With that I'll turn the call over to David.
Thank you, David and good morning everyone.
I will begin by reviewing our second quarter leasing activity and giving an overview of our largest markets. And then I’ll cover our lease roll through year-end and in 2019.
Our same property portfolio was 89.8% leased at the end of the second quarter, up 120 basis points from the first quarter and up 230 basis points year-over-year. For the quarter, rental rates increased 23.6% on a GAAP basis and 10.4% on a cash basis. The primary contributors to this rollup were leases we signed in Austin and Denver. Please keep in mind that as our portfolio has gotten smaller, there likely will be greater fluctuations in our operating results.
In the quarter, we signed 292,000 square feet of leases consisting of 189,000 square feet of new leases and 103,000 square feet of renewals, the largest lease we signed in the quarter was a Bridgepoint Parkway in Austin. We renewed Equinor Energy Services formerly known as Statoil in 80,000 square feet. Also as we discussed on our last call at 8750 Bryn Mawr in Chicago, we signed a new 79,000 square foot 20-year lease with Komatsu for its U.S. headquarters.
Turning to our markets, Austin and Bellevue continue to be strong. The vacancy rate in Austin is 10.7%. This is 100 basis points higher than last quarter due to the delivery of 580,000 square feet of new supply. Leasing continues to be strong and we expect the vacancy rate to decline later this year.
During the quarter in addition to renewing Equinor we signed a new lease of Bridgepoint and we also signed a new full flow lease a capital tower in downtown Austin. The vacancy rate in Bellevue CBD is 6.3% and heading lower. As we had previously said, given the strength of this market and the quality of Tower 333 we believe this property is well-positioned for quality of Tower 333, we believe this property is well-positioned for Expedia’s lease expiration in December 2019. We continue to actively pursue new tenants in anticipation of this upcoming move-out.
In the Philadelphia CBD, the vacancy rate is 12.9%. Our property, 1735 Market Street is one of the premier office buildings in the city and the vacancy rate for trophy properties is under 9%. We continue to see good activity for the lower floor space that is currently available.
In the Denver CBD, the vacancy rate is 16.8%. As we discussed on our last call, the vacancy rate is temporarily elevated due to the first quarter delivery of 950,000 square feet of new supply. We expect this vacancy rate to trend lower as tenants start to take occupancy later this year. In the quarter, we signed 23,000 square feet of new leases at this property.
Finally, I would like to comment on our lease rolls through year end and in 2019. For the remainder of 2018, we have 99,000 square feet rolling or 1.7% of our leased square footage. We expect to get about half of this space back. In 2019, we have 564,000 square feet rolling with 9.9% of our lease square footage.
Only three expiring leases are greater than 50,000 square feet. The largest lease rolling next year is with Georgetown University, which occupies 129,000 square feet at the Green and Harris Buildings in Washington DC. This lease expires in September 2019 and we are in discussions. Next is our 59,000 square foot lease with BTA Americas at 109 Brookline. We expect to get this space back next summer.
Lastly, we have a 57,000 square foot lease at 1735 Market Street that expires in September 2019. This tenant is evaluating its options. The space is on the upper floors, will be very desirable should we get it back.
Given the limited amount of lease roll, remainder of 2018, we believe we are well-positioned to continue to increase the leased occupancy over the course of this year and we’re working on the leases rolling in 2019.
With that, I'll turn the call over to Adam.
Thanks David. Good morning.
I'll provide a review of our financial results for the quarter as well as an update on where we stand regarding GAAP repayments, distributions and share buybacks. Funds from operations were $0.17 per share compared to $0.25 per share in the first quarter of 2017. The decrease is the result of asset sales.
For the quarter, dispositions caused a decline of approximately $0.21 per share which was partially offset by $0.07 per share, lower interest expense and $0.05 per share higher interest and other income.
Other notable items include a $0.01 per share benefit from lower G&A and $0.01 per share due to a lower share count following the first quarter's buyback of 3 million shares. Normalized FFO was also $0.17 per share, compared to $0.22 a year ago.
As with FFO, the decrease in normalized FFO was due to dispositions completed over the past year, partially offset by increased same property cash NOI and interest expense savings from debt repayments, as well as increased interest income due to the combination of higher rates with higher cash balances.
Our same property portfolio at the end of the quarter comprised 13 properties, totaling 6.3 million square feet. The portfolio was 89.8% leased and 87.7% had commenced occupancy at quarter end.
Same-property net operating income was up 2.6% in the second quarter compared to a year ago. The increase was largely due to higher commenced occupancy with the largest contribution coming from over 160,000 square feet of newly commenced leases and 1735 Market Street in Philadelphia as well as contributions from leasing at 8750 Bryn Mawr in Chicago and 17th Street Plaza in Denver.
Partially offsetting higher GAAP revenues were continued increases in real estate taxes in Chicago and Philadelphia. Same-property cash NOI was 12.3% higher than in the second quarter of last year, driven by higher rental income as several tenants are now through their free rent periods. These gains were partially offset by tenant move-outs and the previously mentioned increases in real estate taxes.
Cash NOI for the quarter does not include $2.3 million of revenue from leases and free rent. Growth will also benefit from a 129,000 square feet of leases signed but not commenced on spaces that are currently vacant and therefore are not in cash or GAAP NOI. These leases will eventually generate $5.3 million in annual rent, but it will take time before this flows through our results. In addition to future dispositions, we will be impacted by tenant move outs but we continue to anticipate solid cash NOI growth.
Moving to dispositions, we sold one property for $68.5 million in the quarter. Year-to-date sales totaled $854 million. These sales generated a taxable gain which exceeds our operating loss carry forward by approximately $190 million. As we discussed last quarter, we expect to make a distribution for the year.
Turning to the balance sheet, we repaid the entire $400 million balance on our term loans. These floating rate loans had an interest rate of 3.23% at the time of their repayment. Total liabilities repaid are now $3 billion, including our Series E preferred.
The liability side of our balance sheet now includes just one $250 million bond due in 2020 and two small mortgages. Our balance sheet remains strong with approximately $22.50 per share a $2.8 billion of cash and marketable securities. We have built significant capacity and are actively looking to put it to work to create long-term value.
Since 2015, we've invested $245 million buying back approximately 9 million shares at an average price of $27.61. We did not buyback any stock during the quarter and we have over $130 million of share buyback authorization remaining. As we add value to our portfolio by strategically investing capital and addressing vacancy, we continue to look for growth opportunities where our team liquidity and balance sheet flexibility will be a competitive advantage.
Thank you. And with that, we will open it up to Q&A.
[Operator Instructions] Our first question is from Manny Korchman from Citigroup. Please go ahead.
Maybe a question for David, as you think about value-add or other types of opportunities out there, what kind of timeframe are you thinking about on, be it a lease-up or redevelopment or some other sort of larger projects versus just buying a property that less priced?
Manny, I think I heard this question. It was how to think about the timing for evaluating opportunities?
Well, or especially value-add opportunities where it's going to be a larger probably longer term project. Is there a limit or are you looking at projects that will add value in the next year, is it two years, is it five years given sort of people thoughts that how they timeframe this company is going to exist within, just how do we marry those two thoughts?
Manny, it’s Adam. We obviously spend a lot of time thinking about timing and I think you heard us say in prior meetings and on prior calls that commodity type deals paying market pricing doesn't get us excited. So I think by definition that means that we're going to find a special circumstance or we're going to seek out value-added opportunities.
And in terms of timing from our perspective, it's all about risk adjusted returns. We're fine if it takes time as long as we're getting paid for the risk that is wrapped up in the waiting. So I hope that's helpful.
And then just recently in a news report on Triangle Plaza being close to some of the contracts in Chicago, can you comment on that as of specifically?
Yes. So we don’t comment on rumors, but I think as we disclosed previously Triangle Plaza otherwise known as 8750 Bryn Mawr, is one of the three properties that are in various stages of the sales process, the other two being 777 East Eisenhower and 97 Newberry.
Our next question is from Jamie Feldman from Bank of America/Merrill Lynch. Please go ahead. I'm sorry, Jamie, your line is live, I guess that you’re mute by accident.
We'll move onto the next question from John Guinee from Stifel. Please go ahead.
Building on - I think it was Manny's question, David as you well know anything you really want to own these days whether it's office or industrial or multi-family trade at a sub 5 cap rate. And then you go out the quality curve and you get up around 7, 8, 9, 10 pretty quickly.
As evidenced by what you've done over the last few years, your skill set is clearly in the latter. If you look it out there and you look at all the private equity, is it amassed a lot of this 7 to 10 cap real estate, how many opportunities are there out there of large pools or large portfolios where they'd like to exit be a one stop shopping or one stop exit?
Good morning, John. Not a lot of them. And I think we would agree that that we're looking for something is difficult to find, but the history of our shops is that we've been able to find opportunities that are either complicated or have some issues associated with them more tailored solution can be effective without competing in the market and an option and that’s what we are hoping for.
We continue to pursue our business plan, which we think makes sense despite a lack of opportunity out there. There are specific value-creation opportunities we have in the existing portfolio. We're going to continue to pursue them. And as we've said when we get to the end of the line, if there isn't an opportunity we can act on, then we’ll do what we think is in the interest of shareholders and potentially liquidate. But up to that point, we're going to continue to look for opportunity.
And what do you think of Expedia's worth vacant? Clearly as we’ve done that math?
Well, it's - I guess your starting point would be what is replacement cost. It's one of the nicer buildings in the market. It was built in 2008. It won't be brand new, but it would compete with new construction. So, I would circle that. But keep in mind you need that to be your all-in cost or maybe a notch below it given the age of the property.
I was hoping you would do that math for us.
I think replacement cost estimates are readily available, and although having said that they keep moving up.
Our next question is from Mitch Germain from JMP Securities. Please go ahead.
Just adding to John's question regarding I think David just said when you hit the end of the road, has anything changed with regards to your timing when that end of the road could be?
No. No change, Mitch.
I know you made some rightsizing on the staffing side. Is G&A reflective of a good run rate here or are there any one-timers that we should be aware of?
Yes, the G&A is down about 6.2% or $738,000 from last year, about half of that savings is from lower payroll expense, following the 9% or 10% actually reduction force during the first quarter of this year. You’re also starting to see the burn-off of the special grants that were issued when we first took control of the company back in 2014. The rest of that will run through by the end of the year, and that's when you'll get to a real run rate. We are getting closer, but you'll see the actual runway when we get to the end of the year.
Last one for me. Maybe strategically in terms of putting some of the dry power work, has anything changed with regards to geographically what markets you’re targeting? I mean some of them maybe price declines that you see in New York or may be brought that market into more focus for you or is this still really more of a bias toward the Midwest and West Coast?
What we’ve consistently said, we’re open-minded and we’re looking for opportunities that are attractive from a risk adjusted return perspective. So we would look wherever that opportunity is, whether there's long-term growth and opportunity.
Our next question is from of Jamie Feldman from Bank of America/Merrill Lynch. Please go ahead.
So your portfolio is just over 6 million square feet. You've got a little over a million square feet on the market for sale. I mean at what point is this portfolio just become too small to keep operating in this format?
I’m not sure what do you mean by too small to keep operating. If I take your general point at the portfolio is getting small, I agree with you on that and we think we've done the right thing in creating value by selling assets at a greater price than the market was according that real estate, we're going to continue to do that.
We have a set of assets we think makes sense long term if we’re going to stay in business and we have some assets as we've mentioned that we would continue to look to sell if we can get the right pricing. But I don't think there's any point at which the portfolio becomes too small to operate.
And then David just thinking about the role for next year that you outlined which is helpful. Can you just talk about maybe some of the leasing prospects for the ones you know are moving out?
Well, the only tenant that identified moving out next year is BT Americas 59,000 square feet at of 109 Brookline. It's a great building and a great market and we've got some tenants there that are in a growth mode. So we are speaking with them and we're trying to market that space to a variety of users, could in traditional office users, data center users and lab space users.
Beyond that, we really don't know much in terms of who is definitively vacating. We've got a 16,000 square foot tenant at Bridgepoint that will vacate the end of this year. So it will hit our first quarter numbers next year.
Boston another great market, we're marketing that space and the only other update is at 8750 Bryn Mawr, we have 37,000 square feet rolling in March of next year and we just renewed that tenant this past month.
And give a sense of the mark-to-market on leases for next year or, are they above the below market?
That’s something we look at more closely at the end of this year.
Thank you. This concludes the question-and-answer session. I'd like to turn the floor back over to Mr. Helfand for any closing comments.
We thank you for joining us today. We appreciate your interest in Equity Commonwealth. Have a good day.
This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.