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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good morning and welcome to the Lexington Realty Trust First Quarter 2020 Earnings Conference Call and Webcast. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded.
I would now like to turn the call over to Heather Gentry, Investor Relations. Please go ahead.
Thank you, operator. Welcome to Lexington Realty Trust first quarter 2020 conference call and webcast. The earnings release was distributed this morning and both the release and quarterly supplemental are available on our website at www.lxp.com in the Investors section, and will be furnished to the SEC on a Form 8-K.
Certain statements made during this conference call regarding future events and expected results may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Lexington believes that these statements are based on reasonable assumptions. However, certain factors and risks, including those included in today’s earnings press release and those described in reports that Lexington filed with the SEC from time to time, could cause Lexington’s actual results to differ materially from those expressed or implied by such statements.
Except as required by law, Lexington does not undertake a duty to update any forward-looking statements. In the earnings press release and quarterly supplemental disclosure package, Lexington has reconciled all non-GAAP financial measures to the most directly comparable GAAP measure.
Any references in these documents to adjusted company FFO refer to adjusted company funds from operations available to all equity holders and unit holders on a fully diluted basis. Operating performance measures of an individual investment are not intended to be viewed as presenting a numerical measure of Lexington’s historical or future financial performance, financial position or cash flows.
On today’s call, Wil Eglin, Chairman and CEO; and Beth Boulerice, CFO will provide a recent business update and commentary on first quarter results. Executive Vice Presidents, Brendan Mullinix; Lara Johnson; and James Dudley will be available during the question-and-answer portion of our call.
I will now turn the call over to Wil.
Thanks, Heather. Good morning, everyone. First and foremost, we hope you and your families are staying safe and healthy during this unprecedented and challenging time. There are considerable uncertainties facing the global economy and some parts of the REIT industry, and we are working diligently in this environment to mitigate any potential impact on our business and take full advantage of new opportunities that we believe our company is so well positioned to act upon.
The COVID-19 pandemic has created a few challenges, but our company is operating well, and our portfolio performance has been extremely resilient. We acted early in March to ensure the safety and health of our employees by transitioning to a complete work from home arrangement. All in all, it is proven quite effective.
In addition to smoothly moving to a virtual work environment, our employees have donated over $100,000 to charities and provided considerable financial assistance to help the family of one of our employees who lost both her father and husband in successive weeks. To me, there are no finer corporate citizens than ours, and I could not be prouder.
A significant asset of our company is our long standing relationships with our tenants and our communications remain open and active. To-date, we have fared extremely well with our consolidated cash base rent collections with 99.8% of April rents collected, and May rent collections are higher than at the same date in April.
As expected, we have received rent relief requests from some of our tenants, and we are amenable to deferring rent in the context of negotiating lease modifications that we believe may preserve or enhance value. Every situation is different, with some tenants needing financial assistance, and most others in our view, being opportunistic in their requests.
At quarter end, our overall portfolio was 97.2% leased, up slightly when compared to last quarter and our weighted average lease term of 8.3 years is working in our favor in a defensive climate. We have minimal lease expirations for the remainder of 2020, with only 2.4% of our overall revenue subject to renewal, and our outlook on leasing outcomes in 2021 remained largely unchanged at this time. We will provide updates accordingly as the year progresses.
We continue to focus on our core business objectives, and we are pleased to have completed the bulk of our transition to in industrial REIT. While we cannot estimate the full impact that COVID-19 will have on our overall business, we believe our risk is mitigated as a result of this transition, and our emphasis on warehouse and distribution facilities has generated strong shareholder returns relative to other sectors.
In January and February, we purchased $195 million of high quality industrial assets with a robust weighted average lease term of 9 years in strong submarkets of Chicago, Phoenix and Dallas. Subsequent to quarter end, we acquired an industrial property in Savannah for approximately $35 million, which was matched funded through a small equity raise off of our ATM.
Fortunately, we did not have substantial investment commitments in place at pre-pandemic valuations and we have capital to invest at higher yields as a result. We believe we are in a more advantageous investment environment than we have been in recent years, with cap rates having moved 5% to 10% in our favor. Accordingly, we are actively engaged in underwriting new investments, and we’re working to add high quality, well located acquisitions and build-to-suits to our pipeline, with most opportunities at going in cap rates in the 5.25% to 6% range.
In view of our retained cash flow, financial flexibility, anticipated sale proceeds and access to capital markets, we’re quite comfortable with our financial approach to our forward pipeline, although ongoing market conditions may change our view in the future. We believe the longer-term industrial opportunity also appears promising, as we expect to see a continued shift to e-commerce, more resilient supply chain that accommodate additional inventory, and the potential for more goods to be produced domestically, which bodes well for our business.
We disposed $43 million of office properties during and subsequent to quarter end. These assets generated a combined annualized net operating income of $3.2 million. Although subject to change given the current environment, our 2020 disposition plan still contemplates disposing of or marketing for sale up to $500 million of primarily office properties.
While we remain active and engaged, we have witnessed and expect to continue to see a slowdown on the dispositions front at least for the remainder of the first half of the year, with a potential pickup in the transaction market in the second half of the year. Our focus continues to be on our transition to becoming a 100% industrial REIT by year end 2022, although our progress this year may be slower than we anticipated when the year began.
We have been active in both issuing and repurchasing common shares in a volatile market. Year-to-date, we have issued approximately 4 million common shares net at an average price of $11.06 per share under ATM program. Depending on our share price, we will continue to access capital markets to fund acquisitions, supplementing our investment needs with retained cash flow, disposition proceeds and utilizing our credit line as needed.
With a strong balance sheet, favorable liquidity position, healthy weighted average lease term and a conservative payout ratio, we believe we are well positioned for the current environment. At this time, we are maintaining 2020 adjusted company FFO guidance in the range of $0.74 to $0.77 per common share, although this is subject to change depending on portfolio performance over the balance of the year. Our business strategy remains largely unchanged, and we will continue to capitalize on favorable market opportunities to grow our industrial portfolio.
With that, I’ll turn the call over to Beth, who’ll provide the financial update.
Thanks, Wil. Starting with first quarter financial results, our adjusted company FFO was approximately $0.19 per diluted common share, which was in line with our expectation. Our adjusted company FFO payout ratio of 55.3% at quarter end remains extremely conservative, which is particularly important in this current environment.
Property operating expenses of $10 million are down when compared to last quarter, of which, 80% was attributable to tenant reimbursement. D&A expenses were under $8 million in the quarter, a decrease of $700,000 compared to the first quarter of 2019. Our estimated 2020 G&A is still forecasted to fall within a range of $31 million to $33 million.
During the quarter, the tenant at our Chillicothe, Ohio property dissolved this tenant entity and is no longer paying rent. We were able to backfill the majority of the space and sustain the rent with the subtenants in place. However, we recorded a non-cash deferred rent receivable write-off of about $600,000 relating to the prior tenant.
Additionally, we recorded a $1.2 million deferred rent receivable reserve on one of our properties due to tenant credit concern. Year-over-year, same-store occupancy was down a little over 1%, although same-store NOI was down just 0.2% and up 0.5% when excluding single tenant vacancies.
Moving on to rental collection, as Wil mentioned, we have done well with our consolidated cash base rent collection with all of March a 99.8% of April paid. We have also collected 84% of May rent that were due at the beginning of the month, which is a slightly better collection rate as compared to April for the same time period. Although promising to-date, the information regarding historical rent collection should not be considered an indication of expected future rent collection.
As mentioned, we have received rent relief requests from some of our tenants. The amount of rent relief requests we have received represented 5.5% of our 2019 annual cash base rent. The majority of these requests were in the form of rent deferral requests over varying periods of time. The amount of rent relief requests from tenants whose operations we believe have been impacted by the current pandemic to the point of needing financial assistance represented less than 1% of our 2019 annual cash base rent.
Our team continues to work diligently with our tenants as we manage through these unprecedented economic conditions, and while we are in discussions, to-date, we have not yet granted any rent relief. We evaluate all requests to determine what is the best course of action moving forward. In all these instances, we are requesting specific financial information, including any government assistance requested to deem if rental relief is warranted.
Some tenants have chosen not to provide such information and have continued to pay rent. We do not expect any material impact to our GAAP rental revenues resulting from rent relief requests at this time, absent any material tenant default. However, we can give no assurances on the outcome of any rent relief request.
Turning to our estimated 2020 adjusted company FFO guidance, we are maintaining current guidance in the range of $0.74 to $0.77 per diluted common share. Factors driving this decision include our current outlook on investments in disposition, minimal 2020 remaining lease exploration and the potential sale of our Dow Chemical facility later in the second half of the year, among other things.
We also have built in approximately 150 basis points of bad debt expense into our guidance for the remainder of the year as we believe it is prudent given the current economic environment. Keep in mind, this guidance range is forward-looking and is always subject to change. We will continue to monitor our guidance closely in light of existing and future market conditions.
Looking at our balance sheet, we believe we entered the pandemic in a position of strong financial strength with ample liquidity and borrowing capacity. At quarter end, we had approximately $90 million of cash, including restricted cash was approximately $470 million available on our unsecured revolving credit facility.
We remain very comfortable with our leverage of 5.5 times net debt to adjusted EBITDA at quarter end, and note that our unsecured debt to unencumbered NOI is 5.1 times. Unencumbered NOI represented more than 85% of our portfolio at quarter end. Further, we have no significant debt maturities before 2023. At quarter end, our consolidated debt outstanding was approximately $1.4 billion with a weighted average interest rate of approximately 3.7% and a weighted average term of 7 years.
With that, I’ll turn the call back over to Wil.
Thanks, Beth. I will now turn the call over to the operator, who will conduct the question-and-answer portion of the call.
We will now begin the question-and-answer session. [Operator Instructions] Our first question today comes from Jamie Feldman with Bank of America.
Good morning. This is Elvis on for Jamie. I just had a quick question. So on your commentary and also in the release you mentioned that today’s market conditions are a little bit more favorable, and cap rates have widened a bit in your favor in that 5% to 10% range. Can you just elaborate on that? Is that because of COVID-19? And are you seeing any transactions out there that are given you sort of this perspective?
Yeah, I think that that’s what we’ve observed in the market so far. I think, you know, quite a bit of it is that debt capital hasn’t been readily available. So if anything, our view is that as debt markets recover over the balance of the year, cap rates may very well compress, again, and this opportunity may be, you know, somewhat limited, so we want to try to take full advantage of that.
And we do have transactions that we’re working on in our pipeline that prove the thesis that the cap rates widened out. So we think that’s a good opportunity for us. And the other thing is, you know, fewer buyers are you know, able to get through diligence in some transactions. So the buyer pool is a little bit limited from that standpoint.
And would you say these are distressed sellers or sellers that are looking to just exit markets? Like can you perhaps give us some indication of the makeup of those sellers that you see lower their pricing?
Yeah, I wouldn’t think that there will be any real distressed opportunities in our asset class. But, you know, generally we’re, you know, we’re often buying from merchant builders who’ve either completed build-to-suits or build spec real estate that’s been leased. And they have an interest in you know, getting liquidity from their projects to move on to whatever’s next. So, you know, in these sales, they may be making you know, a little bit less money than they thought a few months ago. But I think it’s just the desire for liquidity in the context of their overall strategy more than anything else.
Thank you. That’s helpful. And then maybe just one more on the office side, has tenant interest or invest interest increased in sort of the suburban second tier city office buildings, as you know, perhaps people start to think about leaving less than cities? I’m just curious on your thoughts there and any conversations you’re having.
I think it’s a little early to draw conclusions. But our view is that, in many cases, this will be good for suburban office as companies look to diversify how they’re office and their people. So
you know, in terms of the rent relief requests that we got, it was sort of disproportionately small in office, which you know suggest to me that that thesis may, you know, may prove that to be true, but it’s just a little bit early to have proof of that.
All right, thank you.
[Operator Instructions] Our next question comes from Todd Stender with Wells Fargo.
I hope you’re well, guys.
Thanks, Todd.
You’ve maintained guidance which is rare right now. We’ve seen most of the REITs withdraw guidance. What’s included in yours? You’ve got a handful leases still expiring, acquisitions that may close and then dispositions like you mentioned. Just want to see what’s in there?
Yeah, I mean the truth is, Todd, there really haven’t been, you know, many moving pieces that that would have changed our outlook, you know, from the beginning of the year. So I think and if disposition slowed down, there’s right less dilution from that this year that’s actually, you know, good for funds from operations.
So the parts of the model really haven’t changed, you know, in any way that would have caused us to revisit guidance. You know, we don’t have much lease rollover and our expected outcomes on all that stuff is still consistent with what we thought when the year began. You know, acquisition activity may be a little less than we thought, but LIBOR has come down. So you know, we’ll pick up some interest savings on that side of the equation.
And for any deals that you do lend, is it fair to say you’ll run up your line of credit at least over the near-term, just until maybe debt capital comes back your way?
Yeah, we view ourselves as having line capacity and the disposition market is not shut, it’s just slower. But you know, knock on wood, we’ll have a handful of office sales in second quarter. We think the transaction market probably functions better in the back half of the year as the debt markets recover.
And don’t forget that given how low our dividend payout ratio is, you know, we have a lot of retained cash flow as well. But I’m not – you know, we’re not looking at putting any long-term debt on the balance sheet at this time. We think that you know spread should tighten over the balance of the year before we think about longer-term debt.
So that’s helpful. How about tenants? Have you – I looked into your release in the supplemental, I don’t see any tenants mentioned for the acquisitions. Can you disclose who some of those are?
Yeah, Brendan maybe I’ll turn that over to you to give a little bit of a sense of who the tenants were in first quarter acquisitions.
Sure. Let’s see, it was Kellogg’s, BMW, Stanley Black & Decker. So those are all high investment grade ready credits. And the fourth building was leased to Ball Corporation, which is I want to say a – excuse me, BB plus credit, so high on investment grade credit.
Okay, that’s helpful. Thank you, Brendan. And then the Phoenix asset had 6 years left on the lease. What cap rate did that got? So there was a 4.8% I guess a blend cash cap rate. How about just that just because it was on the shorter lease term side?
That cap rate was just a little bit south of a 5% cap, it is a brand new class A 40-foot clear building. It’s about 160,000 square feet. It’s located across the street from a brand new manufacturing facility that Ball Corporation constructed. So we think that the likelihood of renewal is extremely high there. And it’s just a first-class building in a primary market.
Great. Thank you, Brendan.
Our next question is the follow-up from Jamie Feldman with Bank of America.
Hey guys. So just one more for me. Can you give us any sort of – or any color you can share on the reserve you took in the quarter? That would be helpful to us. Thank you.
Beth, I’ll let you jump in on that one.
Sure. Good morning. Yeah so, we took a $1.2 million reserve for one tenant that we had credit concerns about, you know, every quarter we go through all of our deferred rent receivables and any accounts receivable that we have. And we have to, you know, assess them for probability of collection.
So, given this, this tenant had been downgraded by S&P and was having some operational issues as well due to COVID-19. And their industry was impacted as well, for that reason. So, given all of these factors and other factors, we thought that it was not probable that we would be able to collect the full deferred rent receivable and we put them now on a cash basis.
Are you able to share what industry that tenant is part of? And then also, is it an office or industrial tenant?
It was in the consumer products industry.
And it is industrial.
Industrial. And then just one more big picture question for me. As I look at your sort of market concentration, Houston is number one on a consolidated basis, number one on office and number three on industrial. Can you just talk about sort of what you’re seeing on the ground there, you know, potential lease rolls coming this year and next and you know, sort of any risks to your assets in that market?
Sure. James, you want to offer your perspective?
Yeah, sure. So our Houston portfolio is comprised of 7 properties, you know, 1.6 million square feet. It’s got a weighted average lease term of 15.7 years. So with the exception of one small, you know, 79,000 square foot office building where we had vacancy we’re really not in the market.
And over the last few years, we’ve really gone back about five years so we’ve kind of disposed of our direct oil and gas exposure. We do have one tenant in two buildings that fabricates piping. But other than that the majority of it is really Dow. So, you know, with the long weighted average lease term and the types of tenants that are not direct oil and gas related, I think we’re well positioned in Houston.
That’s all for me. Thanks, guys.
Thanks.
[Operator Instructions] Our next question comes from Jon Petersen with Jefferies.
Great, thanks. I was curious if you think there will be a lot of distressed opportunities this time around, and you talked about how you expect maybe some better pricing opportunities. You know, but certainly in the last 10 years, it seems like the industrial market especially has become more institutionalized. So just curious how much money you think is on the sidelines looking for distressed opportunities and whether or not that kind of, I guess prohibits those opportunities coming to market just because there’s so much capital out there looking for properties?
Yeah I mean, you know, I just don’t think that our asset type that we’re – you know, we’re interested in investing and is going to see a whole lot of distress you know, so for us, I mean cap rates have widened out which is appealing on the investment side, but you know, we’re not going to keep capital on the sidelines waiting for distress you know, I just don’t see it. So it’s, you know, time will tell. But I don’t see a lot of distressed opportunity coming into our opportunity set.
Got it. And then I guess on the similar line, you guys are still trying to sell some properties. I think you said in your prepared remarks that you still think you can get Dow Chemical done in the second half of the year. I guess, you know, is the pricing on that you think similar to what you were thinking, you know, a few months ago? And then how do we think about maybe some properties that I guess had a little more risk on it in terms of near-term lease maturities like your office building in Downtown Philly. You know, how do – what’s kind of the market are those sorts of buildings right now?
Sure. You know, the situation with Dow is an interesting one. You know, early in the year when the 10-year treasury was sort of yielding 1.5%, there was a market of investors who could prepay the debt, pay the yield maintenance and refinance and make the math work at valuations that were very good for us.
The second buyer, that is, you know, someone who would want to keep the debt intact, that’s mainly a 1031 exchange in investor universe, you know, pre-pandemic, we felt like we had a transaction put together, but with an offshore investor who’s no longer travelling to the US.
You know, we’re in negotiations with another buyer, but we just can’t, you know, predict with certainty when you know, when that transaction might get done. And maybe Lara, I’ll ask you for your perspective on the balance of the office sale process.
Sure. Thanks, Wil. So you know, the sale markets have needless to say, been impacted by the disruption primarily in the debt markets and institutions that binding themselves to a large extent. That being said, there are a number of private buyers who are still very active and looking for opportunities, some 1031 motivated and some not. There have been among transactions, nationally with hard deposits, some price slippage, some deals that have been walked and certainly a slow down on the timing of transactions.
But that there are buyers out there, we’ve been able to access them on a number of assets we have in the market and we’re in active negotiations on a few transactions with private buyers and under contract on a few others. So you know, it’s a slimmer group of prospective buyers and transactions are certainly slowed down by the disruption in the debt markets and the logistical issues associated with the pandemic. But we’re hoping that will loosen up in the second half of the year as Wil said.
Great. All right, thank you. Appreciate the color.
Our next question comes from [Barry Gertner] [ph] with City Stables.
Hi, good morning. Thank you so much. Great quarter, given everything that’s going on. A quick question for you in terms of rental deferral request. Is there any specific, you know, process in place as you examine them or things you think about? And then on that same vein, obviously there are some of your tenants that will be a major beneficiary of the programs initiated by the Fed in the corporate bond market. And when you bifurcate the two going forward, is that something you’re taking into consideration from folks that asking for the rental deferral?
James, you want to jump in and answer that one?
Yeah, sure. So we’ve put together a list of underwriting criteria that we send out to the tenants that have requested relief. We’ve established a rent relief committee that reviews that criteria as it comes in. Some tenants have been forthcoming with that information and others have chosen not to provide that information and continue to pay rent.
And part of the process is definitely evaluating other avenues for which the tenants have relief that may be available to them. So that’s definitely part of the process. But we’re definitely asking lots of questions and making sure that anything that’s granted is a genuine request or advantageous to us from the perspective of getting a lease extension or better credit.
Got it. Thank you very much.
Thank you.
This concludes our question-and-answer session. I would like to turn the call back over to Wil Eglin for any closing remarks.
Thanks, operator. We appreciate everyone joining us this morning and we hope that you’ll visit our website or contact Heather Gentry, if you’d like to receive our quarterly materials. In addition, as always, you may contact me or the other members of senior management with any questions. Thanks again for joining us today and have a great day.
The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.