Conference Transcript - DEA 2026-06-02

Operator

Well, it appears the clock is running, so we're presenting. How about that?

Darrell Crate, CEO

Hey, I'm Daryl Krayth, and we're here for Easterly Government Properties. Alice Marino is with me, who's the CFO of the company, and Cole Bardiwell, who runs Investor Relations and many more things. And to my left is our fabulous moderator, John Kim, from BMO, and I will turn the presentation over to him.

John Kim, Analyst — BMO

Great, thank you so much.

Darrell Crate, CEO

You should moderate as well. i just think maybe we should start off with an update on your company and for people and investors in here why should people look at your stock today yeah no i mean look i think um yeah you know all ceos are in love with their own puppies right we know that's true but i'll truly say that i think it's an exciting time to enter the stock allison and i started running the company day to day just a couple of years ago since then every year we've delivered two to three percent ffo growth we're committed to staying on that track you know to the medium to long term the midpoint of our guidance for next year is also getting us to that two to three percent spot we've turned over you know significant number of folks in senior management we've built out our executive leadership team we've expanded the pipeline of the business and to be candid you know we have a very incredibly stable business and what we changed a couple years ago is we were a hundred percent federal government today we're 90 percent we're going to get that to be about 70 percent why is that because there is in in what we call government adjacent and state and local leases they're more commercial and what folks are familiar with that allows us to have 60 basis points more growth than we would have otherwise this company's history is we've done a fabulous job since being private equity funds and then ultimately public because we managed this portfolio very well we have a platform that has real insights you know into working with the government supporting governments but but what we did not do very well during kovid as a company was manage cash flows for equity investors in real estate so accordingly that's our focus when allison and i assumed responsibility we ended up putting some portfolio management stuff in place ended up cutting the dividend and really putting ourselves on a growth strategy where we've got a much wider funnel of opportunity than we ever had before we're managing that well in the context of our cost of capital and we're delivering accretion and growing the business and so when you look at those things you look at you look the full faith and credit to the US government that backs our our tenant leases you'll find yourself with really strong cash flows as an incredible premium to treasuries and and we're very excited about what that what that provides in the growth that it'll deliver to investors over time.

John Kim, Analyst — BMO

Can you talk about the non-GSA leases going from 10% to 30%, GSA going from 90% to 70%. How long do you think that will take? And can you talk about some of these other non-GSA tenants that you're looking at, what's attractive to you?

Darrell Crate, CEO

Yeah, no, sure. I mean, this last year, we added, again, about 10% of the portfolio. It became, you know, what is a state and local, you know, as well as what we call government adjacent. state and local we have a triple a tenant down in wade county in north carolina that houses their school system it's one of the fastest growing counties in the country and what that leads to is a building that is permanent it's a great fixture for what they do and it's a and they're not going anywhere and it's terrific tenant credit government adjacent are buildings that look just like the ones that we that we manage you know which are fundamentally mission critical facilities You know, with SCIF space, which is special rooms that you cannot, you know, penetrate with listening devices, and they have no windows, and they're very secure facilities. Doing that for generally defense manufacturers and defense contractors, anybody with a contract with the U.S. government falls into that space. I think if we make progress over the next two to three years, getting to that 30% threshold, I think we'll be doing a great job. And I'll give you an example of, in Florida, the law enforcement. Law enforcement buildings, they have these facilities that they're building. We're building them from the ground up. We just did one in Fort Myers. It'll deliver probably September to December. It'll be on budget. It'll be early, crazy as that sounds. The state of Florida is really happy with that building. We are building it to a very attractive cap rate relative to our cost of capital. They have three or four more to build and I think we're well positioned to do exactly that. And it's a great way to have leases that are 35 years with a wonderful state that's growing. GSA is a large entity, but you have a very focused, I guess bullseye approach within the GSA tenants that you look at and assets but in your mind and can you maybe refresh us what makes a building truly mission critical from your perspective yeah i mean we we don't own any federal buildings in washington uh principally because that's where bureaucracy is happening um our our facilities are close to the mission close to the people so think of that as law enforcement that's the fbi almost a quarter of our business is the veterans administration caring for veterans you know in in their cities and neighborhoods. It's rule of law, which is courthouses. They've only left two courthouses since the Civil War. So again, very sticky assets. We're talking about border control. Again, our borders aren't changing, and that continues to forget about the politics. We will always have border work to do. So these, and then the Drug Enforcement Administration. We have a drug problem in the country. As long as we're making babies, we're going to make a couple more addicts. And so the DEA and drug enforcement is something that will continue to be important. Each of these facilities have special spaces that facilitate those missions, and we're excited to maintain those buildings well, and the government's excited to satisfy its mission.

John Kim, Analyst — BMO

Just moving on to the acquisitions and acquisition pipeline. Your pipeline today is $1.5 billion. and it's been like at that level for a while but can you just talk about how much of that you actually move to the next phase in terms of due diligence and making a bid for and just compare that versus your acquisition guidance which is much lower than that yeah so as you can imagine we have to manage an enormously wide funnel to be able to acquire and develop with our cost of capital today.

Allison Marino, CFO

And what that looks like in terms of overall composition is about a third federal, a third state and local, and a third what we call government adjacent, as Daryl mentioned. And then between that, you'll see another roughly third to half is development versus pure play acquisition. So when we talk about the spectrum of things that we can do and what is actionable we have a very deep network with a lot of fragmented ownership groups throughout this country most gsa owners outside of the institutional players like ourselves are regional family office sort of ownership groups so for us we're in constant dialogue with a very large network of those owners and some of them are just waiting on us right so it's we can agree to a price that makes both people happy and then there are others that we are in more advanced stages of discussion to acquire or bring into the portfolio or to develop and win that procurement we intentionally keep our acquisition guidance to a place where we have an executed loi i think that helps us put forth what we know versus what potential can look like and if you've noticed in our guidance this year, particularly while our acquisition number is low, our stated growth rate is still the two to three percent that we've always talked about. And that is driven by a combination of factors, including same store growth, internal operating metrics and efficiencies, as well as continuing to deliver on the things that we've already executed. So particularly to Daryl's point, we have a Florida Department of Law Enforcement lab that delivers in Q4. that is a piece of that growth for this year as we look to next year and we start to talk about what does growth look like in future years we have two courthouses that are in our development pipeline that will deliver so we are actively managing that billion and a half dollars things come in things come out but I would share that we're we're fairly far along on a number of pokers in the fire it's just about execution as we move forward and when you look at acquisitions What kind of spread are you looking to versus your cost of capital? Yeah, so I would say typically it's about 50 to 100 basis points. 100 basis points is obviously the goal. And then if we can create more for the right value generating building, we have to be cognizant of where our cost of capital is, obviously. But at the same point, we're looking to leverage the expertise we have created over the last decade to find places where there's price dislocation in the market and value creation opportunities in the market. So over the last year, we've bought assets that have slightly lower walt, but that we have a lot of certainty around what renewal looks like and the value that building is to that particular tenant and mission. Mission's a very funny word when you think about the government because it sounds like very spy and like Department of Defense-y, but most of the government thinks about their work as what they call mission. So in our most recently developed FDA lab in Atlanta, Georgia, development is an area where we seek to get about 150 basis points plus spread to our cost of capital. That building is responsible for a few things. So if you ever open the canned good in the United States, the testing of the sanctity of that can so that you don't get botulism and die when you eat green beans runs through a lab like that. They also test much of the infant formula in the country to make sure it is safe for your children to use. So it sounds very obtuse when you hear mission and what that means for development yields and acquisition yields, but the work actually being done is what drives the value for us when we look to acquire or develop.

John Kim, Analyst — BMO

They even have a smoking lab, so you just get the carcinogens that you pay for. no more no less this past quarter you made a Mez investment which was I think the first time for your company a much higher yield and spread to your cost of capital is this something that you want to grow how big do you want it to be and just tell us about you know making this leap into Mez investments sure so Mez is a super interesting place for us to think about programmatically it's not a one-time ability to deploy into a high yield exercise it is a structural opportunity to

Allison Marino, CFO

create yield but also have an opportunity to acquire and rights to potentially own that building in the future when it's developed so in this particular first case we are lending roughly eight million dollars on a small veterans administration building in i believe it's washington state and that will deliver in the next three-ish years when that delivers we'll have a right to buy the building for us that's obviously going to be a combination of cost of capital among other things but it's exactly the type of building we would like to own should we be able to come to terms at the time mez as a platform we would look to continue to deploy capital i would say roughly between 30 and 40 million dollars total at any given point under active investment so we're going to build that pipeline up over the next one to two years but there are in the VA space alone there are 20 plus buildings that are in procurement and about to be developed so that pipeline of being able to keep a MES program over the next five to ten years is is very likely and in fact we think it's a really great value driving opportunity it's the first opportunity for us to create a different part of the funnel and the pipeline of things that we're actively involved in now to create the future opportunity and that pipeline you know getting larger or staying the same as as opportunities cycle in and out i think generally what you'll see is that we bring the underwriting expertise we would to any acquisition or development to that pipeline as well we really want to understand the risk associated with the building while it's small dollars you know to most individuals or most companies i think for us we think about value creation with a long-term lens, but 600 basis points of spread is a great way to create value. So for us, there are definitely places where our cost of debt is very attractive, and in small increments, we can create some meaningful return on relatively small dollars.

Darrell Crate, CEO

And is the investment purely a short-term investment, or do you plan to, in some cases, on the asset or would you like to yeah so it's it's it's modeled as traditional meds so it would have a termination date or a maturity date that being said um we would seek to embed rofer rofo rofo opportunities within these deals so that we have a right to acquire the asset um when it's delivered and we wouldn't lend against a project that we weren't interested in buying that isn't something that we want to do we're not a mes lender um i mean this program will continue to be modest so we never want to have it to the magnitude where there's some sort of earnings cliff in the future but it's a great way to get your foot in the door we're very good at developing Mike Ivey you know has over 35 years of experience developing these buildings who who runs that that area for the company and he's a great partner to younger folks who are you know who are developing these spaces and we end up with a higher quality product at the end that's either going be worth more that we may have some participation in or it'll be a much more attractive buy for us and we'll actually understand how to maintain it in the most efficient way going forward okay you talked about some developments that are completing that will add be added to earnings growth and you have a history of doing this but in today's environment with the cost of capital

John Kim, Analyst — BMO

being higher and cost overall being higher what's the hurdle rate you need to move forward with the development today?

Allison Marino, CFO

So typically we're hoping to achieve 150 basis points roughly spread to our cost of capital for the right asset it's not precise right it's never going to be 150.0 so when we think about continuum what we are trying to do is create a value opportunity where we have the best risk adjusted return so that's typically 100 to 150 basis point spread on a yield basis for delivered developments. Costs are certainly higher we have a number of cost protection mechanisms built into our development process we have a guaranteed maximum price contract so at the point we're bidding rents we know how much the building is going to cost to build for what we as an owner are required to deliver and then the second component which is very common in government development projects is this concept of a lump sum meaning the government has an above standard ti that they would like the landlord to execute when that design is finished we would have a guaranteed maximum price for that work as well and then we put a profit margin on top of that in terms of what we deliver and how we create return additional return on the development projects so I think for us it's still a place you're going to continue to see easterly bid on procurements look to continue to build sophistication there we have a specialty in labs and courthouses that's not to say we'll never do a non lab or courthouse but those are areas I think we see the most value creating opportunities for our internal skill set and then our wide network of other development partners is where we would look to potentially do a forward take out on development or MES or something else maybe just buy it out right when it's done so there's a lot of tools in the how do you get to the end goal of development toolkit but I think we we're really trying to put resources to the best places in each of those categories

Darrell Crate, CEO

can we move on to uh state level partnerships and investments you recently made one in enrichment but i wanted to ask what features of the state leases are attractive to you and are there certain states that you'd like to work with more than others yeah i mean we um we obviously like high credit states no offense for i love chicago we love doing business with people in chicago we just don't like the state of illinois to be our uh be our tenant uh we're looking for states you know that again are very credit worthy uh that you know continue to have population growth uh and you know in the state state and local projects they have a a different sticky criteria which is are they serving a critical function uh you know in that state government and you know what are governors in charge of governors are really just like mayors on steroids and their job is public safety it's to make sure the schools run properly it's fundamentally to make sure that the safety of the social safety net you know is in place and finding places that are properly located in order to serve that mission as important and when they're established they're known to be the place to get that state resource so we're very excited to align ourselves with those missions with the very high-credit-worthy organizations.

John Kim, Analyst — BMO

But are the leases structured flat, or they have...

Darrell Crate, CEO

No, they're generally structured to look like commercial leases, which is terrific. So in that business, think of us more as a net lease business. I mean, I'm fond of saying, and when we talk a little bit about valuation, we are more of a net lease company than an office company. I'd love to say we're a net lease company with a scoop of office on top because you know we do have to you know work on making sure our buildings are improved but that's really you know sort of something extra you know beyond you know the value that we create and just owning these fantastic properties okay and can we dig deeper into some of the government adjacent tenants that you look to do business with defense tech manufacturing is a growing part of the overall ecosystem how aggressive do you want to be with some of these pursuing some of these private tenants again I think it's looking for companies that are growing looking for high credit tenancy I mean you know single a triple B plus you know remember most of our cash flow is double a plus cash flow that comes into you know into the system so mixing a little you know single a triple B plus is you know it's like that's like infusing a little disco into our party but relative to most other real estate it's very credit worthy and so finding folks with that strong credit rating who are doing something that also is facilitating important missions under the in the government is is what we do well and those of course are commercial leases with escalators and you know are on you know very attractive terms and we actually know how to service those buildings and make sure that the capex and the other activities that are there are

John Kim, Analyst — BMO

efficient and and make the building relevant and fight obsolescence can you talk about how AI has impacted your business either directly or with your tenants I think you can make one can make the argument that some of your tenants require specialized infrastructure like skips that you mentioned earlier is this does this make your some of your tenants more sticky than a typical corporate tenant that other breeds may have?

Allison Marino, CFO

Yeah, so it's hard to imagine a world where it's completely AI immune, but if you can think of the government as a monolith that does not move fast, AI is not their very first mover, right? Whereas many organizations, ourselves included, are thinking about how every single day it can change the work that we do. It's not generally the orientation of most government departments to embed that level of technology into their work. Many of the things that are unique about our buildings is that the work has to be done there. So that is not just SCIF. That is also because it might serve as a distribution facility or it might be a healthcare facility. And as much as we would love to believe that AI is going to revolutionize healthcare delivery in this country, it's not happening in the next half a decade. Certainly not the next decade either, particularly when it comes to care like prosthetics so in our health care delivery system at our VA clinics one of the largest areas that we're seeing patients in are auditory and ambulatory care like prosthetics those two things they have to go to the VA clinic to be fitted they have to go in for the hearing test they have to be assessed by a health care professional that is not it's not AI immune by any stretch but it's just on the the lagging end of technology and innovation yeah but but we are um ai immune with regard to um our leases being terminated or changed because of ai

Darrell Crate, CEO

ai will get infused you know it's not that where it's non-existent it'll be infused into the work that's done but when we look at the certainty of rent payments we have we have very little uh sense that those are going to be changing over the next couple decades you know because of ai which i think is generally the fear in office i mean you you know we're we're booked in office because you know truth is you know we're not retail we're not multi-family we're not industrial and and so and we do have an office component and the folks who show up are a workforce and we actually you know do the work to maintain the buildings and so that's how we got categorized office, but in a whole set of ways, you know, we are, you know, all of the influences that you see in office and the risks are something that really aren't part of our portfolio day Any questions from the audience? So about a year ago, I moderated this panel with you, and we talked a lot about Doge and the impact that would have on your business and maybe the government cutting office locations, and that didn't really impact you but can you just give an update on yeah you know i mean and doge was a really you know as i i think we said at the time you know doge is a tailwind for what we do because fundamentally when you squint at doge it's about bringing private sector practices into government and it is about and that and that's where the united states government has always found its efficiency and the u.s government today realizes that what they are good at is when something's wrong with the building calling and complaining and having a landlord like us fix it quickly getting a light bulb changed in the government crazy as it sounds they're not really great at that they can go catch you know cartel leaders but they really can't maintain their buildings that's for a whole set of reasons but like the simplest one is that when Congress cuts a budget of an agency the first thing they do is they cut the capex on the buildings that they own. What this has led to is $85 billion of deferred maintenance is piled up. Nobody intended for that to happen, but it did. And so for the first time since the Truman administration, we have somebody running the GSA who's a commercial person. This person was the chief administrative officer at Goldman Sachs, Rand Cushman-Wakefield. His name's Ed Forst. Terrific guy, and he's very motivated to work on behalf of the American people. And he's infusing a culture of trying to find those private sector practices that can make government better for the taxpayers, while also not disrupting the bureaucracy that protects us all, you know, each and every day. So what Doge has done is it has opened the eyes of government to think about these private sector practices. We've had much more fertile ongoing conversations at every level within the GSA about what we're doing and what we do well. Allison is so fond of explaining that you know private enterprise you know went asset light a long time ago and two decades later we've got the u.s government now looking at saying well why do we own so many of these buildings a third of the u.s uh government's uh inventory is um is is leased we believe that will become about two-thirds uh you know over the next decade uh and that would be a very wise choice for them they'd have better buildings that serve their mission better uh and they would save a ton of dough for the taxpayers and so seeing them migrate in that direction is very helpful and doge and the concept of doge was the catalyst for that just

John Kim, Analyst — BMO

moving on to your share price it's performed well this year it's out performed REITs but overall still trades at a discount of multiple to the office and the net lease sectors how do you convince investors that DEA is more than just a bond proxy?

Darrell Crate, CEO

Yeah, I mean, I think it's just important to see our growth rate relative to office. And one of the missions that I, you know, that I referenced is that what Allison and I did a couple years ago is essentially, you know, readjusted the metrics of the performance of the company to match something that would be top quartile in our sector. That said, you know, we cut our dividend, we repositioned the cash flows so that we could be delivering more growth to investors, and it's crazy enough, when you have about a third of your earnings in retained earnings, it's a little easier to grow a company in a hard asset business. So we've positioned it that way. We get a free building a year from our retained earnings. We don't squander the capital. We really think about return on invested capital as an important part of growing the business. And accordingly, we've continued to grow what we're doing. And so it's really an exciting time and we're still at a multiple that's below office. I think if you compass out relative to office and look at the risks, they're far lower. So I'd argue that we should be certainly at a premium. That's another $3 to $4 a stock just to get to median. And I would argue that we're more like a net lease business. I mean, fundamentally, we have the stickiness and we have the growth that will ultimately mandate it. Allison's going to work really hard the next year to get us an investment grade rating from two agencies that you've heard of. I think that the chances of that are very good. If you think about it, there's some other real estate businesses that you look out there that have a very high credit tenant, sort of triple B plus, A minus kinds of money coming in the top of the business and they tend to be graded you know two levels below so you know single a triple b plus turns into a triple b company what's coming in the top of our business is you know double a plus there's no way that this organization is operating in a way that's eight notches lower than the money that comes in the top i cannot think about anything we do that's risky every day you know that would that would deserve that so we'll be making that argument to the to the agencies I think that'll be successful that would add another hundred basis points of growth to what we do which would turn us from a two to three percent grower into a three to four percent grower that's very competitive with net lease our credit tenant is better than most net lease the persistence of our leases is better than net lease and our growth rates going to be comparable so and our payout ratio is going to be in line and those companies traded a five to six times multiple which you know doing the math is another fifteen dollars on top of you know the stock you know the the stock price where we are today so even if we get half of that we're going to do a great job for investors and the idea of investing in full faith and credit government leases and getting a 12 to 13 percent compounded return for five to seven years you know it's a kind of a set it and forget it kind of strategy so i think that's a compelling argument but you'd be the one who would know how to make that more succinctly we do have a question from the audience yep so um we operate today an investment grade balance sheet what that looks like is we have a target leverage ratio currently stated on an adjusted basis of six and a half to seven and a half, we have a plan to de-leverage over the next 18 to 24 months to push that to something

Allison Marino, CFO

with a six handle on it on a cash basis, which as you can imagine with development would be lower on an adjusted basis. So that is our plan. We are making headway to that every quarter. Part of that pathway is driven by the delivery of our next three development projects. If we just stand still and they deliver, we will have three natural de-levering points over the next 18-ish, 24 months, in addition to looking to create leverage positive or leverage accretion scenarios throughout our portfolio. In terms of AFFO, we did reduce the dividend last year. That has right-sized our payout ratio to a very sustainable between 60 and 70 percent. On an AFFO basis, we feel like the dividend is in a great place to allow us to grow. and on a dividend yield basis we are still in the eights or nines depending on the day so it's a very attractive dividend yield for how safe that dividend is and then when we talk about cost of capital I think we're not immune as most of our peers are to the move in interest rates this year however this has been a really interesting year on a cost of debt basis bank markets are back open spreads are still at all time tights and while the foundational and underlying rates have moved all in cost of capital is still at a better place than it was even last year so that is helping us

Darrell Crate, CEO

maintain our cost of capital even if our equity cost of capital isn't the perfect place we'd like it to be so i would say we're roughly in the nines from a cost of capital perspective which allows us to execute and create yield north of that we are out of time unless you want to make a bold prediction for this year I think it's gonna be well I think it's gonna be for us it's gonna be an exceptionally exciting year where we're we really appreciate everyone taking a little time to listen to our presentation follow the stock we're here we're available we've got young Cole down here who we hired in December we used to have a lawyer in the position for investor relations we hired some of those on the sell side so he's pretty succinct fast talking and and very capable explaining what we're doing and his job every day is to get the story out and he's doing a great job doing exactly that so if you don't know him yet introduce yourselves and he'll help you learn a little bit more about easterly government properties. Thanks so much.

John Kim, Analyst — BMO

Thank you.