Earnings Call Transcript - FSP Q1 2020

Operator, Operator

Good morning and welcome to the Franklin Street Properties Corp. First Quarter 2020 Results Conference Call. All participants will be in a listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Scott Carter, General Counsel. Please go ahead.

Scott Carter, General Counsel

Good morning and welcome to the Franklin Street Properties first quarter 2020 earnings call. Joining me this morning are George Carter, our Chief Executive Officer; John Demeritt, our Chief Financial Officer; Jeff Carter, our President and Chief Investment Officer; John Donahue, President of FSP Property Management; and Eriel Anchondo, our Chief Operating Officer. Also joining me this morning are Toby Daley, Executive Vice President of FSP Property Management; and Will Friend, also Executive Vice President of FSP Property Management. Please note that various remarks that we may make about future expectations, plans and prospects for the company may constitute forward-looking statements for purposes of the Safe Harbor provision under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those discussed in the Risk Factors section of our Annual Report on Form 10-K for the year ended December 31, 2019, as updated with the COVID-19 pandemic in the Risk Factors section of our Quarterly Report on Form 10-Q for the quarter ended March 31, 2020, both of which are on file with the SEC. In addition, these forward-looking statements represent the company's expectations only as of today, May 1, 2020. While the company may elect to update these forward-looking statements, it specifically disclaims any obligation to do so. Any forward-looking statements should not be relied upon as representing the company's estimates or views as of any date subsequent to today. At times during this call, we may refer to funds from operations or FFO. Reconciliations of FFO and other non-GAAP financial measures to GAAP net income are contained in yesterday's press release, which is available on the Investor Relations section of our website at www.fspreit.com. Now I will turn the call over to George Carter. George?

George Carter, CEO

Thank you, Scott. Good morning everyone and welcome to Franklin Street Properties first quarter 2020 earnings call. We will do this call a little differently from past calls as our home office in the State of Massachusetts has extended the closure of non-essential businesses until May 18. FSP home office personnel are currently working remotely. With that reality presenting itself, we tried to give more color on our first quarter by written word in our earnings release last night, and I encourage you to read it. I will give a few prepared remarks and John Donahue will talk about our property portfolio operations. After that, we will open up the call for questions. All of our executive team are on the call and will be available to answer questions. First, I would like to thank, on behalf of all of us at FSP, all the people on the frontlines of this COVID-19 pandemic. This obviously includes first responders such as healthcare workers, but also all the other essential business workers who, without hesitation, stand post every day in the face of increased personal risk to maintain the support systems of our country. Our people on-site operating FSP properties include property managers, maintenance engineers, security personnel, cleaning crews, and many others. Our tenants have been engaged, communicative, and supportive of operations in our buildings. If there is any bright spot in the darkness of this tough time for America and the world, it is the brave and unselfish way so many have stood up and pulled together for a common cause. That provides us important perspective for the future. Franklin Street Properties started 2020 with the objective to add meaningful net new tenant absorption at our properties, which means more net rent-paying occupancy. This opportunity existed for many reasons, primarily due to strong prospective tenant interest that carried over from our leasing activity in 2019 into January and February of 2020. Secondly, we have experienced a lower lease roll for 2020 and 2021 for the first time in several years. Additionally, we have been communicating with larger tenants that have lease roll in 2021 and beyond and are making good progress on that. The first quarter of 2020, particularly January and February, started strong and we were on track to achieve our full-year leasing objectives. However, in March, the COVID-19 virus and the country's economic shutdown obviously changed the landscape for us and most office owners. So where are we right now? Leasing prospects from Q1 are still progressing; these are potential tenants that have already toured our properties and are in some form of lease negotiation. We believe we will execute a number of new leases with these prospects between now and year-end. Brand new leasing prospects, however, those coming with their tenant representatives, leasing brokers, or business representatives require traveling to look at our space and conduct new space planning efforts, have definitely hit the pause button. It's impossible to know how long this COVID-19 economic shutdown will impact our business or the effects on our existing tenants' ability to pay rent. Consequently, we're temporarily suspending FFO guidance. We remain optimistic and view it as a timing issue, not an 'if' issue, but a 'when' issue. With those comments, I will turn the call over to John Donahue, President of our Property Management. John?

John Donahue, President of Property Management

Thank you, George. Good morning, everyone. FSP started the year off with a strong first quarter of new leases. As George mentioned, the 144,000 square feet of new leases set our first quarter record for FSP. The vast majority of those leases are scheduled to commence in the second half of 2020. Regarding our active pipeline of prospective tenants, we're currently tracking approximately 300,000 square feet of new prospects that have shortlisted FSP buildings and continue to communicate their needs to commit and execute within three to six months. The prospects with planned occupancy needs in 2021 and beyond have largely paused, but we believe they will likely reengage over the summer months. Despite the pause, we continue to communicate with all prospects, and the majority still have not adjusted their space needs downward. Many of them are seeking to re-plan with architects to rethink density and future space usage. Existing tenants in discussions to expand or renew have also paused for the most part, as they want to reassess how they use space and review growth pace. Rent collections for April totaled approximately 98% so far. Tenants began to inquire about rent relief in mid-March, prompting FSP to proactively work closely with our tenants to assess their financial conditions and differentiate between those truly in need and others seeking opportunistic relief. While it is too early to predict May collections and beyond, we are working with tenants who have requested rent relief. Discussions to date have revolved around amended lease terms for rent deferrals encompassing roughly 1% to 2% of annualized rents. Importantly, we have not executed any amendments yet. As we navigate unique situations regarding each tenant's financial condition, we are still determining the full impact of the pandemic on annualized rents or near-term cash flow. Our Asset Management and Property Management teams have performed exceptionally well in maintaining dialogue with tenants and fostering transparency, as evidenced by our strong April rent collections. Re-entry plans are underway with varying timelines and circumstances for each building. FSP operates in 12 broad markets or MSAs and multiple submarkets within these MSAs. While shelter-in-place orders will persist in some submarkets, re-entry will begin cautiously for a few select buildings. Some tenants prefer a slow and conservative approach to re-entry, with the largest tenants generally looking to wait until June or July. FSP is communicating with our tenants to understand their needs and assure them that we will be prepared when they are ready. The new normal for the upcoming months will necessitate teamwork, flexibility, and safety, including revised employee traffic patterns, reconfigured spaces, and enhanced cleaning protocols. Patience, understanding, and clear communication will be critical. Thank you. Operator, please begin the Q&A portion of our call.

Operator, Operator

Thank you. We will now start the question-and-answer session. The first question will come from Dave Rodgers with Baird. Please go ahead.

Dave Rodgers, Analyst

Yes, good morning everyone. Hope you're all doing well. John Donahue, I will start with you. I think in the press release you said 356,000 square feet of remaining expiration, 388,000 square feet of executed leases. I assume all 388,000 are anticipated at this point to start this year and can you give us some color on the 356,000 of expirations, how much of that has been renewed, how much leaves, and how much has been backfilled, do you have a sense of where that's coming from?

John Donahue, President of Property Management

Hi Dave, it's John. Thank you. Yes, the majority of the 388,000 square feet are still expected to commence this year. In regards to the 356,000 square feet on our expirations for calendar 2020, we believe an amendment will be signed by the IRS shortly any day now, reducing that below 300,000 square feet of remaining expirations for this year. As for the remainder, we cannot precisely determine how many will renew; however, there will be some renewals. I did mention in my prepared remarks that some of that has slowed down or paused. At the end of the first quarter, we executed one amendment, so there will be some renewals. We simply don't know how many yet.

Dave Rodgers, Analyst

And in the IRS, it sounds like it's not done. Is that just a short-term push out? Or does that kind of push it out beyond 2021 and give you some more time there?

John Donahue, President of Property Management

Yes. I had previously commented that their staging at Broadway 1999 Broadway has been slower than anticipated. Their downsizing, which we expected to come into effect this year in the first half, has been pushed out until early 2021. So that's a little over 60,000 square feet or so that will not come back to us this year and will now be extended into next year.

Dave Rodgers, Analyst

Okay. And then I guess regarding next year, any thoughts on Jones Day? I know that's still a ways out there from a construction standpoint, but they need somewhat a move-in. So are those discussions continuing or have they slowed down?

John Donahue, President of Property Management

Yes, Toby Daley, our Regional Director for Atlanta is on the call. I'll ask Toby to provide some insights on Jones Day. Toby?

Toby Daley, Executive Vice President of FSP Property Management

Hi, Dave. The Jones Day lease is scheduled to expire at the end of May next year and construction in Atlanta, despite the pandemic, has continued. Reports from Jones Day’s broker indicate their construction is actually ahead of schedule. Therefore, we continue to count on Jones Day surrendering the space in May and that's how we've been marketing the space to prospective tenants. We are pleased with the initial interest and tours, although the last few weeks have seen a slowdown in tour activity. We are still remotely working with prospects over the phone. There is always a chance that Jones Day could require more time for their new building's completion, but by all accounts, that could be a 30 to 90-day holdover and not an extended period.

Dave Rodgers, Analyst

Great, thanks for the color, Toby. John, another question for you on the 300,000 square feet of new prospects. You stated that this has interest in executing in the next three to six months. How much of that is a 2020 move-in? I would assume very small, but is it more of a 2021 impact? I assume pre-COVID, how would you have seen that playing out?

John Donahue, President of Property Management

I think you're right, Dave, as a general rule. However, there is a sense of urgency among many of those prospects; there will be some commencements in the second half of the year, likely late in Q4. For larger prospects, which comprise about half of that square footage or slightly more, they are looking at Q1 of 2021 or beyond, but it appears they have a sense of urgency.

Dave Rodgers, Analyst

And last question for you, John, how much of that pipeline, the 300,000 square feet is redevelopment-oriented in the three projects you previously detailed versus just the core portfolio?

John Donahue, President of Property Management

It's spread across the country. We have one notable prospect in particular—two really good prospects for Minneapolis—one would straddle both of the buildings there, Marquette and the 121 South Eighth. We also have a prospect for Miami and another for Charlotte. Activity in Northern Virginia and Richmond is promising as well. So overall, I would say it's spread across the portfolio.

Operator, Operator

The next question will come from Rob Stevenson with Janney. Please go ahead.

Rob Stevenson, Analyst

Good morning, guys. What percentage of your tenants are on electronic pay versus traditional mailing a check to you? And when do you generally know what your collections will wind up being?

John Demeritt, CFO

Rob, this is John Demeritt. I don't have an exact percentage breakdown for you there. We do receive collections via wire ACH, we have a lockbox, and we also accept standard mail. Generally, we receive a significant portion of the rent in the first few weeks—specifically the first two weeks. Some tenants, particularly government ones, do pay in arrears, so it can be later in the month.

Rob Stevenson, Analyst

Okay. Do you expect to communicate monthly collections going forward until things normalize, or is that just a one-off thing ahead of earnings?

John Demeritt, CFO

I think we will likely speak about it in our next quarter. I do not plan on putting out press releases on cash collections for April and May.

Rob Stevenson, Analyst

Okay. At this point, is the expectation that May collections will be significantly lower than April's, or is that just anybody's guess?

John Demeritt, CFO

We really have no idea at this point. We've got a lot of tenant discussions ongoing, as mentioned in our disclosures, so depending on how that plays out, I expect it will be quite busy in May.

Rob Stevenson, Analyst

What were you seeing demand wise in Houston and, to a lesser extent, Denver pre-COVID in January and February, especially after oil started dropping below $60 a barrel? Were any of your existing oil and gas tenants looking to sublet at that point, or did that only start after the major decline during COVID?

John Donahue, President of Property Management

Rob, it's John Donahue. I'm going to turn it over to both Will Friend and Toby for insights on Denver and Houston, respectively. Generally, we haven't seen much communication regarding rent relief from the oil and gas markets. We're monitoring that closely, but so far, we've been fortunate. I'll start with Will Friend, our Regional Director in Denver. Will?

Will Friend, Regional Director in Denver

Hey Rob, this is Will. I think John's comments for Denver are relevant. We haven't seen substantial space on the market for subletting, and very few oil and gas tenants have reached out for rent relief so far. This doesn’t mean we haven't had any requests, but they have not come from our major oil and gas tenants; mostly, they've been from smaller service types. However, we do have a couple of oil and gas companies that we've been talking to during COVID about their space needs. Their pace has slowed, but they are continuing to respond.

Rob Stevenson, Analyst

Okay.

John Donahue, President of Property Management

Toby, can you share insights for Houston?

Toby Daley, Executive Vice President of FSP Property Management

Yes, Rob, Toby here. In Houston, we were approaching 99% collections for April, with only two tenants making no payment, totaling $4,400. Our tenant base remains strong. We did lose Petrobras, which was suffering toward the end of last year, resulting in a loss of 144,000 square feet in Westchase; we're currently marketing that. However, the rest of our tenant base has shown unexpected resilience, with very few requests for relief. Most of those that have asked are small businesses like doctor's offices and retailers, not our major oil and gas firms. We're optimistic this trend will continue.

Rob Stevenson, Analyst

What was the demand pre-COVID for space in Houston? Which industry groups were looking for incremental space back in January and early February?

Toby Daley, Executive Vice President of FSP Property Management

I would say a mix of financial services firms and oil and gas engineering companies were looking during that time. While most have temporarily paused, we still have a few prospects. I think there is a 120,000 square foot tour scheduled next week for Westchase.

Rob Stevenson, Analyst

Okay. Lastly, John Demeritt, what debt covenants or other covenants would be problematic if you had to start deferring a greater amount of rent? Have you started conversations with lenders about temporary waivers just in case?

John Demeritt, CFO

Well, the accounting rules dictate that if you have reason to believe a lease is collectible, and if there are agreements on deferring rents to be repaid later, there would not be any write-offs associated with that. However, if we believe a tenant is uncollectible, there would be receivable write-offs, and we would transition to a cash basis with that tenant. Significant write-offs in a quarter could trigger a covenant issue, but at this point, we have no reason to ask for covenant relief. I have discussed the risks with most banks in the Bank Group and emphasized that this is a potential risk, but we will need to work through tenant issues first.

Operator, Operator

Our next question will be from Joab Dempsey with Stifel. Please go ahead.

Joab Dempsey, Analyst

Hi, good morning everyone and thanks for taking my questions. I wanted to start with a question about the dividend. In this post-COVID world, many peers are evaluating dividends, and by our calculations, Franklin REIT is not covering the dividend currently and might not for the next three years. Do you have thoughts about possibly cutting it again?

George Carter, CEO

Hi Joab, this is George Carter. I will give you the same answer I provide every time I’m asked this question: We make that decision as a board every quarter, taking into account various factors.

Joab Dempsey, Analyst

Okay, great. And regarding the supplement, it looks like you have $30 million outstanding in a note payable. How do you see that money being used, and are there plans to tap the fixed income market to cover CapEx spend or dividend payouts in the near future?

John Demeritt, CFO

Joab, it's John Demeritt. We had $30 million drawn on our $600 million line of credit at the end of March, leaving us with $570 million available. I drew down some cash in early April due to rising uncertainties, ensuring we have extra cash on hand. Our current cash balances are around $43 million, which we believe will suffice for a while. Therefore, we have plenty of availability and do not plan to raise new debt at this time.

Joab Dempsey, Analyst

Okay, great. Lastly, I know the office sales market is challenging right now. Are there planned asset sales in the company's future?

Jeff Carter, President and Chief Investment Officer

Hi Joab, this is Jeff Carter. The investment sales market is largely stagnant at the moment. However, as I've stated in past quarters, Franklin Street believes our portfolio has a strong mix of value opportunities. We intend to realize that value, and once it is realized, every asset could potentially be available for sale at that time. Currently, however, we do not have any assets under consideration for disposition.

Joab Dempsey, Analyst

Okay, thanks for taking my questions. Stay safe, everyone.

Jeff Carter, President and Chief Investment Officer

Thanks.

George Carter, CEO

Thank you, Joab.

Operator, Operator

Our next question will be from John Kim with BMO Capital Markets. Please go ahead.

John Kim, Analyst

Thanks. Good morning. George, you mentioned that new leasing activity has really slowed down. I'm curious if you're getting any visibility from the brokerage community or tenants regarding the increase in physical tours once certain shelter-in-place regulations are lifted.

George Carter, CEO

Hi, John. Let me pass that question to John Donahue, as he has some insights on that. John?

John Donahue, President of Property Management

Hey, John. Yes, we’ve certainly experienced a pause and slowdown in new prospects over the last 30 to 45 days; this trend is prevalent across portfolios. Virtual tours demand has increased significantly, and we’ve been conducting more of them. There’s a distinction between those with urgent needs and long-term planning. For major large prospects, we often see them engage with the market a year or more in advance. We are seeing some of those progress and move towards lease execution. However, those without urgent needs are taking a longer time to assess their growth potential and what their space requirements might be. While we anticipate re-entry to happen soon in areas we operate, we aren't certain how fast the engagement will ramp up.

John Kim, Analyst

How impactful do you think virtual tours are right now? Can new tenants finalize decisions without seeing the space physically? Are they at that point?

John Donahue, President of Property Management

For the most part, the majority rely on their representatives who are familiar with the buildings. They are not traveling across the country for physical tours, but regional or local prospects are still touring. We’ve conducted two major tours exceeding 100,000 square feet in the last 10 days, indicating activity. While virtual tours are very effective, they cannot entirely replace the physical experience of being in the space. It’s a temporary solution that helps facilitate progress, but in the end, they’ll need to see the real estate.

John Kim, Analyst

Regarding the leasing prospects in the Q that are still progressing, have there been discussions about changes in economic terms or any pandemic-related clauses being added?

John Donahue, President of Property Management

Yes, we have seen inquiries about including pandemic-related clauses. Most of our active prospects, especially those further down the line with leases or finalizing LOIs, have not re-traded yet. Meanwhile, those who can afford to pause are considering whether to secure better deals in the future. A lot will depend on the evolving situation around density and work-from-home dynamics. Prospects aren't adjusting their space needs downward; in fact, they might lean towards larger spaces given the current circumstances. Regarding pandemic-related clauses, attorneys are indeed addressing that across renewals.

John Kim, Analyst

Just one more question. For the tenants who have asked for rent relief or are concerned about doing so in the future, can you generalize which sectors they come from? Is there a spread right across different sectors?

John Donahue, President of Property Management

Yes, I'd categorize it this way: The tenants unable to pay rent in April and those likely to need relief in the near future are primarily what you'd expect. Small retailers, including delis and cafes, represent the largest number of tenants who didn’t pay rent. Thankfully, this represents a very small portion of FSP’s square footage and annualized rents, evident in our April collections. Next would be the flexible office industry, which includes co-working and executive suites—another category reaching out for rent relief. This too represents a very small percentage of our portfolio. Finally, the entertainment industry, which includes resorts, timeshares, etc., is also discussing potential deferred rent with us. This segment encompasses a larger portion of our square footage and annualized rents, and we are actively engaged with them.

John Kim, Analyst

What is your exposure to co-working?

John Donahue, President of Property Management

Our exposure to co-working is between 1% and 2% of our portfolio, which is quite small.

Operator, Operator

Our next question is a follow-up from Dave Rodgers with Baird. Please go ahead.

Dave Rodgers, Analyst

Yes, hey, George, a question for you. I think John Donahue was asked about energy exposure and risks on the leases, which Toby and Will both addressed as well. As you think about the exposure in Houston, Denver, and Minneapolis, given that you may have one of the highest exposures to what might be viewed as energy risk markets, how confident are you in that particular exposure versus how you should be positioned moving forward? Any thoughts would be helpful.

George Carter, CEO

Yes, Dave. We started this company over 25 years ago. Our exposure to Houston has been substantial, and I've been involved in real estate there for the last 50 years. These cycles in energy are well-known to our team. While the recent decline in the energy markets is quite extraordinary due to COVID-19 demand destruction, traditional market dynamics still apply. As the pandemic subsides and demand normalizes, we believe the energy markets offer great opportunities. We remain committed to maintaining our portfolio in those energy markets. That said, we aren't planning any expansions in Houston until we have a clearer vision of the future.

Operator, Operator

Ladies and gentlemen, this concludes our question-and-answer session. I would like to turn the conference back to George Carter for any closing remarks.

George Carter, CEO

Thank you for tuning in. I want everyone to stay safe. We will get through this and look forward to brighter days ahead. Thank you very much. Talk to you next quarter.

Operator, Operator

Thank you, sir. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.