Q3 2022 Easterly Government Properties Inc Earnings Call
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Greetings and welcome to the easterly government properties third quarter 2022 earnings conference call. At this time, all participants are in a listen only mode.
You didn't answer session will follow the formal presentation.
If anyone should require operator assistance during the conference. Please press star zero on your telephone keypad. Please note. This conference is being recorded.
Now I'll turn the conference over to your host Lindsay.
Winterhalter you may begin.
Good morning before the call begins please note that certain statements made during this conference call May include statements that are not historical facts and are considered forward looking statements within the meaning of the private Securities Litigation Reform Act of 1995.
Although the company believes that its expectations as reflected in any forward looking statements are reasonable it can give no assurance that these expectations will be a change or a cheap. Furthermore, actual results may differ materially from those described in the forward looking statements and will be affected by a variety of risks and factors that are beyond the company's control.
Including without limitation those contained in the company's most recent Form 10-K and Form 10-Q filed with the SEC and then its other SEC filings. The company assumes no obligation to update publicly any forward looking statements.
Additionally, on this conference call the company may refer to certain non-GAAP financial measures such as funds from operations funds from operations as adjusted and cash available for distribution you can find a tabular reconciliation of these non-GAAP financial measures to the most comparable GAAP numbers in the company's earnings release and separate.
The amount of information package on the Investor Relations Pat page the company's website at IR easterly REIT dotcom.
I'd now like to turn the conference call over to Darrell Crate Chairman of easterly government properties great job. Thanks Lindsay.
Good morning, everyone and thank you for joining us for this third quarter conference call. Today. In addition to Lindsay I'm also joined by Bill Trimble, the company's CEO and Meghan busier, the company's CFO and COO.
During the quarter, we entered a new phase in the real estate market rates are rising quickly how fast is uncertain. The transaction market has slowed and there is a gap between buyer and seller expectations cap rates are readjusting.
Of course, none of this will adversely impact our tenant credit quality or occupancy or our dividend having rent that is backed by the full facing credit of the U S government, coupled with managing the portfolio for consistency and stability should reduce uncertainty for investors, particularly during uncertain times.
So that leads me to the front for the question how can we use this period to enhance our portfolio and add value for our shareholders.
First we are enhancing the institutional quality of our portfolio by disposing of a set of assets that are either in remote locations or with agencies, where we do not see an ability to build the defined edge in serving our agency client. These are fine agencies, but at this time, we believe concentrating on.
What we know best will enhance our ability to add value.
Second we're using the proceeds from the disposition to pay down most of our outstanding floating rate debt, we have been disciplined about terming out our liabilities to match our assets and that favors us in these times of interest rate uncertainty.
Third we're maintaining meaningful liquidity in order to purchase assets that may be owned by landlords experiencing some financial distress.
We have found ourselves at a disadvantage relative to developers over the last several years they have been projects, assuming an exit with ever lower cap rates that works for them longer than we imagined that is over liquidity will start to dry up some will need a partner to complete their projects not mentioned spa.
<unk>, but we will be ready should this opportunity presented itself.
And lastly, we're actively bidding on transactions in a way that reflects the new cap rate environment I don't imagine it will get much done in the next quarter or two but I do imagine the market will reprice and you'll find ourselves with our liquidity ready to acquire additional accretive quality assets.
So we're pleased with how our portfolio is positioned as we look forward and we will continue to execute our business strategy with the intent to deliver safety and stability to our investors. The goal is to deliver an attractive risk adjusted return to our shareholders. It's backed by tenants that represent the full facing credit of the United States government and with that.
I'll turn the call over to Bill to give you insights into the third quarter activities.
Thanks, Darryl and good morning, Thank you for joining us for our third quarter earnings call starting with acquisitions during the third quarter easily acquired a 28900 square foot U S District courthouse located in Council bluffs, Iowa, This courthouse or build to suit facilities are delivered in 2021 is 100% leased the GSA on behalf.
The judiciary for 'twenty year, noncash will turn does not expire until 'twenty 41, as part of the H Judicial circuit. This property serves the Western division of the Southern District of Iowa, a district that we created over 140 years ago. This facility located just across the river from our National Park service.
F P. I Omaha facilities provides strong geographic efficiencies for our asset management team and with the enduring mission of the U S judiciary, adding another courthouse to our portfolio undoubtedly strengthens the overall caliber of east choice assets.
In addition to the wholly owned acquisition activity easterly through our joint venture purchased our seven brand New VA facility located in Columbus, Georgia, which is part of our previously announced 10 building VA portfolio from this roughly 68000 square foot facility. The var is able to provide an enhanced.
Range of services to the approximately 30000 surrounding veterans the reside close the Georgia, Alabama State law like.
Like nearly all of the properties in this VA portfolio V. A Columbus sits on a brand new 20 year lease does not expire until 2042, we continue to expect the remainder of the assets the VA portfolio to deliver as planned and we expect the JV to close on a total of approximately $145 million of this portfolio.
In 2022.
We are maintaining an active presence in the acquisition market, but with careful consideration for the changing backdrop and rising cost of capital. We acknowledge this is a moment where the markets are undergoing a transformation interest rates are rising this year at a pace. This country is not seen in nearly two decades, there are inflationary pressures.
And we feel it's prudent to stay acutely aware of opportunities, but not chase deals for the sake of portfolio growth that said there are competitive advantages in this niche GSA market as previously mentioned the GSA lease structure protects us as landlords from inflation induced operating cost increases and further.
As Daryl mentioned, we believe in maintaining liquidity on the balance sheet as we estimate there may soon be a unique opportunity to help regional developers who have found themselves over extended and need of an exit strategy. This is very similar to what we did with FEMA Tracy development several years ago.
By pursuing only the most selective acquisition opportunities in this environment, we are strengthening the balance sheet for future development prospects, which has always been the most accretive use of our capital.
Finally, turning to this morning's announcement at a time when the transaction market is nearly paused easterly is pleased to report we executed our first portfolio disposition with an experienced private buyer of GSA leased real estate.
The disposition portfolio is comprised of 10 buildings, approximately 668000 leased square feet with a weighted average age of 14 years as a core rent making.
<unk> will go into further detail on use of proceeds and how this disposition was the right course of action for easterly at this time, but the sale only makes the remaining 85 properties in the easterly portfolio, even more reflective of our bullseye ownership strategy.
This sale our weighted average remaining lease term our annualized lease income per square foot and visibility of cash flows are all improved which ultimately enhances the NLP as a portfolio.
This sale in turn supports our stable dividend currently at a highly attractive yield.
Easterly is left with a more bullseye oriented portfolio a bit tighter geographical footprint and larger average property size.
Turning to leasing updates our asset management team continues to secure renewals that lengthen the duration of our government back cash flows and enhance the portfolio is any of it in the third quarter, we renewed the DEA drug laboratory located in Dallas, Texas for a new 17 year lease term.
We also renewed the FBI field office located in little rock, Arkansas for another 20 year lease term with a combined weighted average renewal term of 19 years. The importance of these two facilities for the U S government as a parent I congratulate the asset management team on continued strong renewal executions, and we look forward to providing updates.
In future quarters for 2023 renewals and beyond.
Turning to operations the third quarter of 2022 was a notable quarter for an ESG perspective as easterly released its inaugural ESG report. This report, which can be found on our corporate responsibility page is a notable step in our company's ESG trajectory for the first time easterly has committed itself to <unk>.
Certain environmental and social goals, including a 10% reduction in energy and a 5% reduction in water use by 2030.
It meant to increase the hiring and training practices across the company, 90% participation in charitable giving or volunteering by 2025, and finally implementation of an employee engagement survey with at least 90% participation for easterly employees. We felt good about establishing these important goals for our <unk>.
Company and continuing to be strong corporate citizens for our employees shareholders and the communities. We serve you can expect this report will be updated and progress towards these goals will be tracked on an annual basis. Many thanks to our director of sustainability for leading this effort and delivering a report which captures the company's increasing.
ESG initiatives so well.
In closing this has been an important quarter for easterly we have renewed our largest 'twenty two 2022 lease explorations for a weighted average duration of $19 three years, providing the company with increased certainty and duration of cash flow for future dividends, we added bullseye assets, both wholly owned and through the JV.
Increasing the overall quality of our portfolio.
We made significant strides in our environmental sustainability and corporate responsibility efforts through the publication of our inaugural ESG report and subsequent to quarter end, we executed on the company's first portfolio disposition, which simultaneously strengthens the company's balance sheet and portfolio profile.
We look forward to keeping everyone apprised of future endeavors, as we close out the year and with that I. Thank you for your time. This morning, and we will turn the call over to Megan to discuss the quarterly financial results.
Thank you Bill and good morning, everyone at a time when the market is bringing companies balance sheets into greater focus due in part to rising interest rates I am pleased with the strength of our portfolio and the actions, we've taken to recycle capital and enhance our leverage profile and position ourselves for opportunities to come.
As of September 30th we own 95 operating properties, comprising approximately $9 1 million square feet, either fully owned or through our joint venture with a weighted average age of 14 years and a weighted average remaining lease term of 10 one years.
The format for this morning's disposition announcement portfolio metrics look even stronger with a revised portfolio. The fact that 85 operating properties and $8 4 million square feet, either wholly owned or through our joint venture our new weighted average remaining lease term is enhanced to 10 three years and reflects the company's bullseye investment basis.
At quarter end the company had total indebtedness of approximately $1 4 billion, representing a net debt to annualized quarterly pro forma EBITDA ratio of seven four times with approximately $177 8 million outstanding on our line of credit.
In total this represents just over 14% variable rate debt for the company with the completed sale of a 10 property disposition portfolio subsequent to quarter end. We expect net proceeds will be used to pay down outstanding debt obligations, taking Easter lease adjusted net debt to annualized quarterly pro forma EBITDA ratio down.
Six nine times as of September 30th.
Furthermore, we will have extinguished a mortgage with a rate well above the company's weighted average and that current Jacksonville we.
We will have reduced the company's floating rate exposure from 14, 1% to one 3% of all outstanding debt obligations.
Improved the company's weighted average interest rate by eight basis points.
Lengthened the weighted average maturity of outstanding debt obligations to six one years and out.
Added capacity for future acquisitions and development related expenses by recycling non bull's eye assets.
When combined with the approximately $92 5 million of unsettled forward equity these actions translate into a well positioned balance sheet for the company in a time of rising rates.
Turning to our third quarter results on a fully diluted basis net income per share was <unk> <unk>.
<unk> per share was 32 cents and <unk> as adjusted per share was offset 32 cents or.
Our cash available for distribution was $28 $5 million.
And finally, turning to our earnings guidance in connection with the announced disposition and the changing reality in the capital markets. We are revising our <unk> guidance per share on a fully diluted basis to a range of $1 26 to $1 28.
This guidance is predicated upon a number of factors, including no additional wholly owned acquisition activity beyond the approximately $107 7 million already completed year to date the.
The closing of properties in the Z a portfolio totaling approximately $145 million at the company's pro rata share.
The completed sale of all 10 properties in the disposition portfolio and no additional material development related investment in 2022.
Like the majority of our REIT Brethren, we plan on issuing our 2023 guidance in connection with our Q4 and year end 2022 earnings results given the slowing transaction market the increased cost of capital and general uncertainty in the capital markets. We feel it is prudent to withhold guidance until we have greater clarity of the market and our ability to drive earnings.
Growth for our shareholders in a rapidly evolving environment.
With that we thank you for your commitment to our thesis and appreciate your partnership.
I will now turn the call back to shortly.
Thank you at this time, we will be conducting a question and answer session. If you'd like to ask a question. Please press star one on your telephone keypad.
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One of them. Please while we poll for questions.
Our first question comes from the line of Michael Griffin with Citi.
Proceed with your question.
Okay. Thanks, maybe going back to the guidance comment I'm, just seeing if you run rate for Q expectations through 2023, it would imply deceleration I guess relative to 'twenty 'twenty. Two we're not going I know you you just talked about how you didn't provide guidance for 'twenty three but I mean is this how we should be thinking about it with the framework kind of going into it and I mean.
Additional color or commentary you could buy here would be would be great.
Sure So with regard to this year's guidance really the the this shift is due in equal parts to two interests and deal volume as well as the run rate until the shares from the disposition or for a portion a large portion of the fourth quarter. So yes.
Scrap as we go into 2023, considering the run rate effect of disposition and the forward curve would be the primary drivers of how we how we start off looking at 'twenty wage rates.
Okay cool that's.
Oh I'm sorry.
Well, we will issue formal guidance in February .
Gotcha. That's that's helpful. Appreciate the color on that and then maybe maybe back to the dispositions you know it it didn't seem to me that you would necessarily needed to be a forced seller in a in a market like this and I understand proactively kind of assessing the you know the floating rate debt side of things but.
You know back in my math shows about a low sevens, just spoke cap rate kind of compared to where you're trading at an implied cap of call. It about a mid sixes. So I guess kind of piggybacking on that.
Maybe give some more clarity around why this transaction was kind of right. At this time and you know any anything else you could provide there would be helpful. Yeah. Good morning.
I think the first thing to realize is that while we love all of our buildings, we have a broad range of different missions different geographies different sizes and within our portfolio and I think it's shortened noted when you saw the buildings, we sold which we like many of them were located in remote regions that were difficult.
For our asset management team to really to really dig into secondarily, there mostly in the sort of a 30000 to 40000 square foot size, so really not of scale for our company, but most importantly, I think is that they werent part of our bullseye strategy.
And that's important I think that is very important and we concentrate on agencies we know.
The judiciary, we've talked about those homeland security agencies that have been a terrific parts of our portfolio and so we've really tried to construct a great portfolio to move on and there's a very educated buyer on the other side of this portfolio.
Also saying that there's another factor at play right now as we saw cap rates compressing at a incredible rate from last November until basically March of last year basically from the Texas down to the low fives during that period of time and everything got compressed I mean, the good stuff the okay stuff and.
Even the bad stuff, which obviously, where we were not interested in or rolling moving down as you saw a lot of appetite in this particular sector.
Now what we're seeing is more of a return to what we've enjoyed for the last 10 years, which is there's different pricing as a broader spectrum, whether you have most of our buildings really laboratories F. B is St.
Federal Courthouse is theyre going to trade at a lower cap rate, but the plain vanilla sorts of buildings, which I think the government is always going to need are beginning to gap out on that and that's why I think this would be not these buildings are reflective of good buildings, but theyre not reflective of our core portfolio Megan.
You bet.
I guess I would just also say if you look at these times of uncertainty, we want to position ourselves to have liquidity and while.
We think that.
The price for a building that was a good transaction, having that liquidity for the opportunities that are coming as we look to 2023 of course, we're uncertain on the timing of those opportunities, but those opportunities are ahead of us and we just want to be very well positioned to see it.
And then there's a low sevens just both cap rate is that right around in the right ballpark you'd give or take that is yes. Okay.
Great. Thanks, so much guys I appreciate it yeah, that's it for me.
Our next question comes from the line of John Kim with BMO Capital markets. Please proceed with your question.
Thank you it seems like you've had more of a refined strategy on what your bullseye.
Target is.
There's been some cap rate compression on that in two weeks or months until recently, but just given your cost of capital and interest rate environment is not really conducive for acquisition.
What is your strategy on achieving earnings growth. It was not really on the backburner for now.
Yeah, I think we would not.
Not necessarily agree with the premise that there isn't an opportunity for this market to normalize and in our cost of capital to be in line with where that market is normalizing and our ability to go to go back and do what we've done for for eight years and acquire Accretively to drive external growth John .
I think I'm sorry.
Affirmatively, you know, which is the best bet is what was going to happen is it going to take a quarter or two quarters three quarters. We don't know, but that is that we are it's very clear what the what the future holds and that's why we're positioning ourselves in a way that we can take advantage of it.
I thought Bill mentioned earlier that you know the the plain vanilla assets, that's where you're going to see some cap rate expansion, that's where you could get some accretive acquisitions. If you pursue that route but it doesn't seem like we call them that way and that's why.
No we are not quite hard, but I think.
No I think we are not going that direction and I think most of the acquisitions that you see in that area for us has been part of our portfolio.
And so we've always been Johnson Bullseye Bullseye Bullseye I think I don't know how many times. It appears in my speech every time, but we really like to drive to that and you know there's been questions have asked I think one note came out asking about.
About occupancy or when does that when does the government get back the government has been in our buildings the entire time, which I'd like to point out to folks and they are important missions, but I think the world is changing at some point I can't forecast, what's going to happen in 15 years from now or 10 years from now with that but we do know that the F. B I the laboratories the courthouses.
Are going to continue to be occupied and extremely valuable and into more important very expensive and difficult to replace so that's the area that we're going to spend our time in and it just seemed a natural moment to also Oh, some liquidity is in the us for the balance sheet.
On the rising operating expense this quarter I realize some of that's probably why they are related but.
I was wondering if you had that figure on a same store basis.
And how you feel about managing those costs into 2023.
Can you repeat the first half of the question, Jon well, what about on same store basis quarter over quarter. Yeah. I mean, the Opex you have on the total portfolio basis, but I'm I was wondering if you had been on a same property basis.
Yeah, so in the quarter and same store NOI quarter over quarter due due to that spike in utilities in August , which we by the way have seen moderate.
In September I'm really.
Yeah.
Fully offset the contribution of the deals we have done in the second quarter and the utilization. So when $1 3 million offsetting $1 3 million and then obviously the rising rising interest rates netted netted to about a penny a quarter over quarter Episodically.
And do you expect.
There are pressures next year and keeping that expense number elevated.
I mean, I think we all appreciate the inflationary environment, we're in but over you know over time are our leases. So we want to reiterate do provide for that inflation protection. They may not be able to insulate for one month spike such as we are we had happened in August , but but over the arc.
First time, our base is well matched to our expenses and we.
We are effectively.
Keeping opex growth inside of current inflation levels.
Okay.
That's great. Thank you.
And our next question comes from the line of Michael Carroll with RBC. Please proceed with your question.
Yeah. Thanks, maybe just staying on the the Opex I guess question that John was asking about it looks like Opex was up about $2 6 million sequentially, but your recoveries were up only about 700000, I mean was that difference just really driven by the seasonal nature of August or is that going to continue going forward.
So Mike remember the tenant reimbursements line item that you see in our financials is not the Opex base reimbursement that is embedded in rental income that's related to those interim tenant improvement projects that we perform on behalf of the government. So nevertheless to you know to get at.
Your question right we are.
With me.
Same store Opex growth. This year as you know sub 8% and we do expect to be able to as I said in my prior comment continue to effectively hedge that with our base.
Yeah.
So I mean, it looks like with total revenues were up about 1.4 million. So theres still a pretty big gap between what was the increase in Opex I'm, assuming that is just driven by the seasonal nature of it and.
And as we move forward into <unk>, you're going to be able to kind of that the opex increase is not going to be as significant and so you should see some benefits of that going into fourth quarters is that correct.
Yeah. So again just to keep the detail take care of our same store NOI quarter over quarter did decline $1 3 million due.
Nearly entirely by the utility Spike right, we do expect that to revert them as.
As we move into the fourth quarter.
Okay.
And then just related to the asset sales I guess did you change your definition of Bullseye properties I was surprised that you had so many non bullseye properties within your portfolio I mean, I guess outside of the sales. How many do you have left that you would consider selling and did you say you don't want in your portfolio or it doesn't fit your criteria.
Well I think we feel good where we are now obviously, we had our renewals of our largest plain vanilla assets are very sensitive terms in the last few years, and then 15 year terms.
So this really would cover most of those assets that we would put into that category.
But you know we've always as I said here into the same same discipline and we always have said that we want to concentrate on those build to suit mission critical bullseye properties and Thats, what youre going to see us buy and that's what you're going to you know I think if if if if you see sales in the future for any reasons, they will probably be in the in the plain vanilla CAG.
Sure.
Would you consider these assets plain vanilla or would you consider then just non bullseye properties.
So non bullseye football I think we I think we I think we really consider this.
Same thing.
Yeah, I mean, you know bullseye isn't like isn't a binary thing. So you know there are some that are closer to the edge than others and.
This was an opportunity to kind of trim, along the edge of bullseye properties and as we said concentrated on our core.
Couple agencies, where we really can have a defined edge competitive advantage in serving the client.
Yeah again in times of adversity.
Time to kind of trim and then a little bit make sure. We're focused on you know what we do our very best create liquidity for the opportunities that are coming and it's in the context of all of that that are that the actions of the less you didn't really three months and six months have been taking place.
Okay. So then the non bullseye properties or plainville of properties that you still have in the portfolio. So I'd, probably with the IRS building and Fresno, Some other social security building, because they're happy with it and you're happy with those because the the lease term.
Yeah, we're very happy with both the lease term and I think he probably knows the IRS just got a $80 billion check right.
Friday.
And it's by the way I'll remind everybody on the call is the last place you ever want to get a call for them because they are in charge of national compliance, but yes that would be an example of a plain vanilla sort of property.
Okay, great. Thank you.
Thanks.
And as a reminder, if anyone has any questions you May press star one on your telephone keypad to join the question and answer queue.
Our next question comes from the line of Michael Lewis with Lewis. Please proceed with your question.
Thanks. This is good timing because I wanted to follow up on Mike Carol's question I had I had some of the same thought when I looked at the portfolio of 10 properties.
One of these is an S. T. A 81000 square feet in College Park, Maryland, one of them is a V. A 30000 square feet in Baton Rouge, one of them is leased to ice 25000 square feet in Pittsburgh and so.
I think those are probably bullseye agency and I'm just wondering like how this portfolio came together was did you market. This and found a buyer or did you negotiate with the buyer what properties were in the portfolio and which ones were out I was just kind of curious how it came together.
Yeah, Mike It was a well consider well compiled portfolio and it was competitively.
<unk> put into the market, we had a lot of interest.
Hmm.
Okay.
Yeah, Nathan competitors, we speak of regularly and I'm feeling very good that that we found a very efficient.
Our value perspective on the portfolio.
I see you didn't swap in and out.
Alright.
No we didn't.
Okay, and then on the guidance does it assume that all of the sales proceeds were used to repay debt and you know as part of that I'm wondering you know what that can you get at what cost because you don't have any maturity.
For the next 12 months and there was only $6 million of debt on the portfolio.
Yeah, that's right Mike.
It is our plan to pay down our line with proceeds then we obviously had 177 million outstanding at the end of the quarter.
And when you look through to the end of the year and the closing of the 10th property also with the consideration of completing our VA portfolio acquisition targets.
That does not change of $15 million on the revolver. So you know.
Adequate capacity there.
And you know should we need it should we need it a lot of continued continued following of us in Chicago I guess.
Okay that makes sense and then just lastly for me again I guess another guidance question right. So you lowered the guidance for this year by a sense and I think you mentioned you know half of that related to the you know the lower acquisitions and capital markets in Manhattan on the dispositions.
When I look at the dispositions right only two months in past and you're going to be and that's before you even redeploy the proceeds it's probably about five days before you yeah, sorry, if you misheard that but it's roughly four cents due to the generates three cents on.
On wholly owned transactions that you know are not no longer in our guidance and just about a penny for the disposition impact okay. Okay.
I Miss that that yeah that answers my question perfect Alright. Thank you.
No problem. Thank you.
And we have reached the end of the question and answer session I'll now turn the call back over to Daryl that'd be great.
Great. Thank you everyone and thanks for joining the easterly government properties third quarter 2022 conference call. We hope this call has been helpful and we look forward to speaking to you all again soon.
And this concludes today's conference and you may disconnect. Your lines at this time. Thank you for your participation.
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