Easterly Government Properties, Inc. Q1 FY2020 Earnings Call

Greetings, and welcome to the Easterly Government Properties First Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. I will now turn the call over to Lindsay Winterhalter, Vice President, Investor Relations. Please go ahead.

Good morning. Before the call begins, please note the use of forward-looking statements by the company on this conference call. Statements made on this call may include statements that are not historical facts and are considered forward-looking. The company intends these forward-looking statements to be covered by the Safe Harbor provisions for forward-looking statements contained in the Private Securities Litigation Act Reform of 1995, and is making this statement for the purpose of complying with those Safe Harbor provisions.

Thank you, Lindsay. Good morning, everyone, and thank you for joining us for this first quarter conference call. Today, in addition to Lindsay, I’m also joined by Bill Trimble, the company’s CEO; and Meghan Baivier, the company’s CFO and COO. Before we begin, I want to extend my well wishes for the health and safety of everyone on this call. These are unprecedented times, and we all eagerly await the day when we can meet face-to-face once again. What a quarter it has been? We’ve witnessed the strength of the company’s defensive and differentiated strategy; the virtues of a revenue stream backed by the full faith and credit of the U.S. government are serving investors well. We’ve spent the last five years as a public company, carefully assembling the necessary tools to perform in any business environment. And we’ve achieved scale in our operations, meaningfully diversified, and maintained the average length of our leases.

Thanks, Darrell, and good morning. Thank you for joining us for our first quarter earnings call. Given this unique backdrop, I’ll begin with our operations at Easterly in light of the COVID-19 pandemic, and then continue with my more traditional discussion of our quarterly activities. We commenced our work-from-home protocol for our employees on Friday, March 13th, and thanks to our superb operations and IT staff. We enjoyed a near seamless transition from in-office operations, with efficiency remaining high and morale strong. With just 40 employees company-wide, our leadership team is able to maintain our close structure with time to ensure that the Easterly team is doing well, their families are staying safe, and they have the support they need during these challenging times. I’m proud of how Easterly has adapted to this change, and I applaud our staff for being ahead of the curve in terms of planning and preparedness. We continue to monitor the effects of social distancing across the region and the country and look forward to returning to our offices soon, but only when it is safe to do so. Our proactive approach extends to our strong commitment toward and partnership with our primary tenant, the U.S. Federal Government. The operations with many of our tenant agencies are deemed essential. Our asset management team has been exceptional in deploying the structured COVID-19 response plan across the portfolio while also meeting the unique needs of certain properties as they combat suspected and confirmed COVID-19 cases. Today, there have been 17 suspected cases and three confirmed cases of COVID-19 throughout our entire portfolio. Our team has worked quickly with the government to address these situations as they arise, and we’ll continue to review our response plan to ensure the health and safety of our tenants and our employees. The praise we have received from the GSA and the underlying agencies with respect to our level of service in an expeditious manner is just another example of our differentiated approach towards the U.S. government. These are trying times, and Easterly has and will continue to deliver.

Thank you, Bill. Good morning, everyone. Easterly’s unique portfolio of government-leased real estate has once again allowed us to predictably post strong expectations meeting earnings. Like Bill, allow me a moment to discuss Easterly’s operations from a financial standpoint. We are pleased to report the financial impact from COVID-19 on the Easterly rent roll has been de minimis. In the first quarter, uncollected rental income was approximately $1,300, and we do not expect any material rent collection issues for the second quarter and beyond. Turning to our quarterly results. As you saw in our earnings release, for the first quarter, net income per share on a fully diluted basis was $0.02. FFO per share on a fully diluted basis was $0.30, FFO as adjusted per share on a fully diluted basis was $0.29, and our cash available for distribution was $21.8 million. As of March 31, we owned 72 operating properties, comprising approximately 6.8 million square feet of commercial real estate, with two additional projects totaling approximately 222,000 square feet under development or in design. The weighted average age of our portfolio was 13.1 years. Turning to the balance sheet, at quarter-end, the company had total indebtedness of approximately $943 million, with $414 million available on our line of credit for future acquisitions and development-related expenses.

Thank you. We will now be conducting a question-and-answer session. The first question is from Manny Coachmen of Citi. Please go ahead.

Good morning. This is Katy McConnell on for Manny. I was wondering if you could just provide some color on the pricing of deals completed to date and where you stand versus the $200 million guidance for the year? And then maybe talk about how the competitive landscape has changed as you look for additional opportunities?

Absolutely. Good morning to you. So basically, DHA – Aurora, our first purchase is $14 million. Our FBI/DEA/El Paso joint facility was $38.7 million. Our VA - Mobile was $39.5 million, and the VA - Chico was $33.1 million, which totals to $124.7 million. So on our way to the $200 million mark, I’d say, we’re in an awfully good start since last time I checked, we still have a couple of months to go. We continue to see plenty of opportunities. I think the landscape in our market, in many ways, remains the same. I think there’s an additional opportunity now as some of the sellers we're familiar with are stepping forward. Hats off to our acquisitions team who are really working hard, talking to the owners of these buildings. There are a number of owners that also have properties outside the government space, including hotel developments. I think we’re going to see opportunities as some developers take advantage of the chance to sell those properties quickly and build cash reserves for future projects. From that standpoint, I think we have a bright pipeline this year and will continue to execute on it.

Okay, great. Thanks.

The next question is from Michael Carroll of RBC Capital Markets. Please go ahead.

Yes, thanks. Bill, just kind of off of those last comments, and I know it seems like there are some opportunities for some more single asset-type transactions. I mean, what about the portfolios? I know those are harder to predict, but are those owners more willing to sell some of their properties and de-risk during this type of environment? Or are they still holding tight?

Hey, Michael, good morning. I think it’s the same there really, but you can be assured we’re calling the owners of the smaller portfolios and the larger portfolios. From an M&A standpoint, we think we’re in a terrific position with our cost of capital. Naturally, things are not moving as quickly today and people are still prioritizing their own situations. So I would say, all in all, it’s pretty much steady state there, but my message would be that I have a positive outlook on what we’ll be able to accomplish in the pipeline this year.

Okay. And then on the single assets, how much bigger is the pipeline today, given these increased opportunities? Is there a way to quantify that?

No, I mean, I’d tell you, we’ve stuck to about $700 million out there that we think is a good number to be familiar with. The $200 million is based on what we’re pretty confident we can execute. I will just say that we are busy trying to exceed that number, and we have in many years; we can’t guarantee that sort of thing. But that’s certainly our preference, to keep pushing forward while we’re looking to find the best deals.

Okay. And then on the near-term lease expirations that are coming due, is there any delay in those? Is there a risk that some of those leases go into holdover? Or is the government still, I guess, working as typically we would expect, and is the activity kind of in line with where it has been historically?

Hey, Michael, this is Meghan. The GSA has proven to be very efficient while working from home. We are in touch with lease contracting officers, and leasing activity, in general, is progressing and moving forward.

Okay, great. And then I guess, the last question for me is, how should we think about the settlement of those forward equity commitments? I know you typically have 12 months to close those. Should we kind of straight-line that? Are you going to assume that you close those as more deals kind of come through?

Yes. Michael, that’s going to be used for, if you will, just-in-time funding around deals being closed.

The next question is from Peter Abramowitz of Jefferies. Please go ahead.

Hi, thank you. Just wanted to get your thoughts on kind of long-term in a recessionary environment. Obviously, for kind of more traditional real estate assets, you would typically expect some cap rate expansion. Now, being in the niche market that you guys are in, what are your thoughts on kind of how cap rates could potentially move, just given everything that the economy is facing?

Good morning. I’d tell you, having done this since 2000, started looking at this in 2009, it’s been incredible how little cap rates have moved through various events we’ve seen over the last decade. The scarcity of the buildings, which is an advantage we have, is mostly the driving factor. We’ve been very careful not to, as we said, become the elephant in the swimming pool and start driving pricing up too much in front of us. You will continue to see a disciplined approach from us for long-term growth. In this market today, we’re seeing the same sorts of cap rates as last year, and into the first quarter, most of those have been in the low to mid-6 area. Obviously, when you’re looking at pristine properties, and let’s take a brand-new FBI with a 15 or 20-year lease or maybe even one of our new FDA laboratories, which we were fortunate enough to build ourselves and have over 7% yield on, those sorts of facilities are going to be below 6, maybe 5.9, 5.8. I think they’ve always been there. With our current cost of capital, even they could be attractive for our shareholders. We’ll maintain a disciplined approach, but you might also see us occasionally go for pristine properties that enhance our average lease term and improve the portfolio quality as long as it’s accretive.

Sure. Okay. Thank you. That’s helpful. And then just one more, given the shifting priorities for federal spending, does that impact the concentration of different agencies in the portfolio? Do you see that having an impact on just the mix of tenant exposure from government agencies moving forward?

No, I think the Federal Government remains the largest employer in the world and the largest office tenant in the United States. The Federal Government does not seem to be pulling back on their expenditures right now. In fact, I think we might see more opportunities as government appears to be growing substantially during this period of time. I think we can only be beneficiaries of that. Our portfolio has been targeted at about three dozen agencies that we believe will do just fine, whether we have Republican or Democrat in office. If you look at our FEMA facilities or the FDA laboratories we’re building, there’s still many more to go. I don’t see the Federal Government cutting back on the new FDA laboratories or the VA outpatient clinics providing an incredible amount of service to our veterans. The FBI has certainly got a lot going on. The Federal Government is a good place to be and will be for the foreseeable future, and they’re leaning into development projects.

All right. That’s it for me. Thank you.

The next question is from Bill Crow of Raymond James. Please go ahead.

Great. Good morning, everybody. Any change in the buyer pool out there that you’re competing against? I’m just curious whether this period is knocking folks out or pushing them into a more defensive mode, looking for long-term net lease structures?

Good morning, Bill. It’s hard to tell exactly what’s happened. I will tell you that we have won every single building we’ve wanted this year, including some off-market deals. From our standpoint, it’s been clear sailing. There were rumors at the beginning of March that others were thinking about entering the government space because it was such a safe area. That has not happened. The daunting task of dealing with the Federal Government is difficult if you don’t have trained personnel, verticals, and a government operations team. We’ve seen that quickly dissipate. So from our perspective, we have not seen a big change in the landscape.

I appreciate that. What are you seeing on re-leasing spreads?

Hey, Bill, this is Meghan. The dynamic around how we approach re-leasing and what drives our re-leasing spreads really has not been impacted by this pandemic. The fact that the replacement cost of the asset remains the high watermark for these conversations really hasn’t shifted. Our re-leasing processes stay on track in line with that expectation.

All right. Thanks, Meghan. One more for you…

Sure.

...given the cost of capital today, do you find yourself leaning more into equity on a relative basis? Or are you trying to maintain your debt equity balance as it has been historically? What are your thoughts there?

Yes. Obviously, we’re well-positioned today, but as we continue to build into the year and lean into the $200 million-plus type goals in terms of acquisitions, that presents an opportunity for us to continue using equity to deleverage the balance sheet, while still meeting earnings expectations; that’s a dynamic we plan to take advantage of as we move through the year.

Yep. Okay. Thank you. I appreciate it.

Thank you.

This concludes the question-and-answer session. I would like to turn the floor back over to Darrell Crate for closing comments.

Great. Well, thank you, everyone, for joining the Easterly Government first quarter 2020 conference call. While the company will not miss a beat because of COVID, we all look forward to the end of quarantine and being together with colleagues and investors soon, and we wish everybody good health.

This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.