Easterly Government Properties Inc

NYSE:DEA

Earnings Call Analysis

Easterly Government Properties Q2 2024: Strong Growth Outlook and Strategic Acquisitions

Easterly Government Properties reported Q2 2024 financial results with net income per share at $0.04 and core FFO per share at $0.29. The company highlighted closing $1.5-$2 billion in pipeline opportunities and new strategic acquisitions. They issued $200 million in fixed-rate notes and secured a $400 million revolving credit facility. Full-year guidance remains strong at $1.15-$1.17 core FFO per share. Future growth looks promising with a projected 2-3% core FFO per share increase annually. A focus on mission-critical assets leased to U.S. government tenants continues to drive stability and investor returns【4:0†source】【4:6†source】【4:7†source】.

Company Overview and Growth Opportunities

Easterly Government Properties is positioning itself uniquely in the real estate investment trust (REIT) sector by focusing on mission-critical properties leased primarily to U.S. government agencies. The need for specialized facilities continues to rise, and Easterly is keen to capitalize on this by actively seeking and integrating properties that enhance operational efficiencies. The CEO highlighted a growing pipeline of roughly $1.5 billion to $2 billion in acquisition opportunities, indicating a robust potential for expansion.

Financial Performance and Guidance

In the second quarter of 2024, Easterly reported a net income per share of $0.04 and core funds from operations (FFO) per share of $0.29, with available cash for distribution amounting to $24.8 million. They maintained their full-year FFO guidance for 2024 within the range of $1.15 to $1.17 per share. This expectation factors in the completion of several key acquisitions and development investments, reflecting the company’s confidence in its growth trajectory.

Strategic Acquisition Plans

The company successfully executed three accretive deals in 2024, highlighting its resilient sourcing abilities despite lower market transaction volumes. With a blend of strong access to capital and an enhanced cost of equity, management aims to strategically broaden its asset base through well-integrated acquisitions that complement existing operations.

Investment Strengths Amid Market Volatility

Easterly operates with a stable tenant base, primarily U.S. government agencies, which provides a buffer against market fluctuations. The focus on developing specialized and purpose-built facilities for agencies like the FBI and DEA ensures a consistent demand for its properties, offering lower cash flow volatility. Moreover, the company emphasizes that the completion of their development pipeline and existing tenant relationships are vital for sustained revenue growth.

Capital Markets Activity

Recently, Easterly raised $200 million through fixed-rate senior unsecured notes, showcasing strong demand among investors. This, along with a new $400 million revolving credit facility, positions the firm to tap into further capital for future acquisitions. The ability to access favorable capital markets reinforces Easterly’s competitive advantage as it continues to seek growth in its mission-critical property focus area.

Leasing Strategy and Future Expectations

Easterly is navigating the leasing landscape with a solid strategy to renew existing leases, particularly with major tenants such as the FBI. For 2024, the company highlighted the significance of closing existing lease deals and is optimistic about positive outcomes for leases expiring in 2025, especially in high-demand sectors.

Concluding Perspective

Despite challenges in the broader real estate sector, Easterly’s strategic focus on government-related properties provides a distinct edge, ensuring stability and potential for robust growth. With clear guidance and a strong acquisition pipeline, the company paints a promising picture for sustained shareholder value enhancement in the coming years.

Earnings Call Transcript 2024-Q2

[Operator]

Greetings. Welcome to the Easterly Government Properties Second Quarter 2024 Earnings Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded.

I would now like to hand the conference over to your speaker today, Lindsay Winterhalter, Head of Investor Relations. You may begin.

[Lindsay Winterhalter, executive]

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 attained or achieved. 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 filed with the SEC and in 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, core funds from operations and cash available for distribution. You can find a tabular reconciliation of these non-GAAP financial measures to the most comparable current GAAP numbers in the company's earnings release and a separate supplemental information package on the Investor Relations page of the company's website at ir.easterlyreit.com.

I would now like to turn the conference call over to Darrell Crate, CEO of Easterly Government Properties.

[Darrell Crate, executive]

Thank you, Lindsay. Good morning, everyone, and thanks for joining us for the second quarter conference call. We had a busy quarter cultivating and closing transactions, driving results at our development sites, and serving as a strategic partner to our U.S. government agencies. We've also spent considerable time bringing our investors into our buildings to help them appreciate the difference between our purpose-built, mission-critical portfolio versus the more traditional office sector.

As listeners on this call may have observed, we updated our website to help viewers better understand the mission-driven specifications of the buildings in our portfolio, and just recently, certain events underscored the importance of fulfilling mission through real estate. Here are some examples.

First, the investigation following the assassination attempt at President Trump's rally in Pennsylvania has been spearheaded by FBI - Pittsburgh, whose field office is one of our facilities. FBI field offices are very specialized buildings and must be constructed with anti-ballistic glass, SCIF rooms equipped to national intelligence security standards, including radio frequency shielding and ductwork to prevent infiltration. We have to account for things like blast protection, security screening and other structural requirements that are essential to agencies like the FBI being able to operate effectively at times like these.

The FBI employs approximately 35,000 people, including special agents, intelligence analysts, linguists, scientists and information technology specialists. Whenever there is an event and our U.S. government agencies are in proximity, they absolutely must be ready to go 24 hours a day, 7 days a week, 365 days a year.

Next, in last week's news about the apprehension of the arrest of alleged cartel leaders, including Joaquin Guzman Lopez, also known as El Chapo Jr., was carried out by agents in our FBI / DEA - El Paso facility. The FBI and DEA in our joint El Paso facility worked together with HSI to apprehend cartel leaders that boarded a plane in Mexico and then crossed the border into the U.S., allowing law enforcement to arrest them. The 3 agencies, all Easterly tenants, worked in tandem over the course of the next several months in order to execute this high-stakes plan. This is a clear example of what you have heard me previously say about how our specialized facilities enable these agencies to thwart and stop cartel activities and reduce drug trafficking.

Our DEA facilities must be equipped for highly specialized and complicated testing of synthetic drugs, some of which we have never been seen or examined before, through drug signature programs that analyze samples to determine processing methods, geographic origins, and manufacturers for heroin, cocaine and methamphetamine. We have machines in our facilities that can take an organic drug and identify its origin down to a specific parcel of land where the organic substance was sourced. This isn't conceptual. It's not a sci-fi movie. Just last Thursday, in connection with the arrest of the alleged cartel leaders, Attorney General, Merrick Garland, said, Fentanyl is the deadliest drug threat our country has ever faced, and the Justice Department will not rest until every single cartel leader, member and associate responsible for poisoning our communities is held accountable. This is what the FBI and DEA agents depend on us for each day in order for them to do their mission-critical work. So much of this work can't be done outside of our specialized facilities. They are the definition of mission-critical assets.

Finally, I'll give you one more example. Let's talk about the Veterans Administration, which is our top tenant. Over half of all veterans used at least 1 VA benefit or service in 2021. And of those 9.8 million users, approximately 51% use multiple benefits, up from 36% in 2010. Our VA properties include community-based outpatient clinics that are designed to be a one-stop shop for veteran care. These regionally focused centers can have a specialized mix of departments, from radiology, dental and optometry to mental health, physical therapy, prosthetics and phlebotomy. And each department has its own set of physical requirements. For example, radiology has its own baseline for humidity and temperature control, while pharmaceutical requires specialized security systems. In VA - Phoenix, we have a customized kitchen, and these models are built directly into the walls of certain rooms so that care providers can assist veterans with various disabilities with self-sufficiency and re-acclimating to their homes.

This is our definable edge. If we take one thing -- if you take one thing away from this call today, I hope it's that you understand how essential the infrastructure we provide is to these U.S. government agencies. We are meaningfully differentiated from an office portfolio, and this provides our shareholders with greater stability and lower volatility of cash flow.

Real estate markets have suffered, but our portfolio continues to perform well. And during this time, we've taken the opportunity to expand on our strengths and broaden our strategy to provide attractive returns to our shareholders. Rather than remaining idle, we are focused on cultivating opportunity.

For institutional investors, revisiting this space with an eye towards easing interest rates, it's important to remember that these 3 key truths: we're focused on growth; we believe we have the resources to execute; and we anticipate our core strategy will have additional tailwinds in a declining rate environment. Given the strategy we laid out and the growth opportunities we have in front of us, we see a path to achieving a payout ratio in the next 24 months that is consistent with our historical levels.

We have a development pipeline that's significant, and we are working not only with U.S. government agencies, but also with high credit government-adjacent companies like those in the defense industry, which have government contracts and need customized facilities similar to the ones that we have owned and developed to support their own missions alongside their U.S. government partners. We're focused on being a chosen partner to the organizations we work with by building and developing properties that help them meet and facilitate their critical missions.

Thank you again for taking the time to join us this morning. And now, I'll hand things over to Meghan Baivier, our President and Chief Operating Officer.

[Meghan Baivier, executive]

Thanks, Darrell, and good morning. We are excited to have you join us this morning, and I echo Darrell's enthusiasm for the opportunities on the horizon. While the REIT sector has faced outflows over the past several years, Easterly has been working hard to harvest an incredible pipeline of long-term growth opportunities.

The missions of our tenant agencies continue to grow, both in terms of scale and criticality, and they have an ongoing need for specialized facilities. The same is true for the government-adjacent tenants on which we focus. We are seeing large-scale net lease projects with contractual escalators that fulfill our strict definition of mission-critical real estate. We believe Easterly has the platform, balance sheet and access to capital to uniquely pursue these types of opportunities and further enhance shareholder returns.

An increasingly favorable cost of equity aligns with our growth strategy and allows us to target strategic assets that not only complement our existing business lines, but also have the potential to drive long-term earnings growth. Our goal is not just to acquire assets, but to integrate them seamlessly into our operations, thereby maximizing synergies and operational efficiencies. By leveraging this opportunity, we aim to strengthen our market position and deliver sustainable value to our shareholders.

Since the time of our last call, we have capitalized on our growth strategy and acquired 2 additional assets, both in Orlando, Florida, and both critical to the safety, security and infrastructure of our country. We have successfully transacted on 3 accretive deals in 2024 despite a backdrop of lower market volume, highlighting our ability to source and execute in challenging environments.

In addition to acquisitions, we continue investing in our assets to further bolster our strong partnership with our important tenants. This is part of our competitive edge relative to other owners of mission-critical government-leased real estate and is an important component of our ability to consistently deliver stable cash flows to shareholders.

Looking forward, we see an outsized pipeline of opportunities that we believe will further our ability to meet our stated goal of delivering 2% to 3% core FFO per share growth year-over-year for years to come. We are making progress with an opportunity to serve as lender and then buyer of mission-critical assets that, we believe, will further change the growth trajectory of this organization. We look forward to keeping you apprised as this develops.

With that, thank you for your time this morning. I encourage attendees on this call to spend some time digging into the Easterly model to understand our opportunity for getting on a path for outsized growth over the next several years.

I will now hand the call over to Allison.

[Allison Marino, executive]

Thanks, Meghan. Good morning, everyone. I'm pleased to report the financial results for the second quarter. Both on a fully diluted basis, net income per share was $0.04 and core FFO per share was $0.29. Our cash available for distribution was $24.8 million.

We maintain our focus on growing the enterprise through the acquisition, development and renewal of mission-critical assets leased primarily to the U.S. government, as well as its adjacent partners. While calm on the surface, behind the scenes, our team is working at a rapid pace to execute on the roughly $1.5 billion to $2 billion worth of pipeline opportunities we see today. As a company with a $1.4 billion market cap, this outsized growth opportunity is extremely exciting for the company and hopefully our prospective shareholders. The Easterly team has done a great job of getting the balance sheet poised and ready to absorb the anticipated capital needs to fund this unique opportunity.

First, we were once again met with great success in the private placement market with the execution of $200 million of fixed-rate senior unsecured notes with 9-year maturities. This is our fourth entry into this market, and we were pleased with the oversubscribed interest from new and existing investors alike. We believe that credit quality of our underlying U.S. government tenant is a significant draw in this market, and our BBB stable rating from Kroll provides third-party validation of that. As of today, we have closed the first $150 million tranche of Series A notes, and we remain on track to close the second $50 million tranche of Series B notes on August 14, subject to customary closing conditions.

Second, we were pleased to partner with our premier syndicate of banks and execute a new $400 million revolving credit facility with an accordion feature that allows for total borrowing capacity of up to $700 million. With an initial maturity date of June 2028 and 2 6-month as-of-right extension options, we are pleased to extend the term of lender commitments and secure the liquidity necessary to pursue accretive capital deployment opportunities.

I would like to thank our capital partners on the successful execution of both transactions and a special thanks to Citi, PNC, Truist and Wells Fargo for serving as joint lead arrangers on our revolver. In total, we believe this success highlights our unique strategy, superior credit quality and attractive platform relative to other REITs.

Turning to guidance, after recent raise subsequent to last quarter's call, I am happy to share that we are maintaining our full year core FFO per share guidance for 2024 in a range of $1.15 to $1.17 on a fully diluted basis. This guidance assumes the closing of VA - Jacksonville through the company's joint venture at a pro rata acquisition price of $41 million, approximately $50 million in wholly-owned acquisitions throughout 2024, and $100 million to $110 million of gross development-related investment during the year. At its midpoint, this sets a path for Easterly to deliver strong core FFO per share earnings growth to shareholders this year. And as we start to execute on the outsized pipeline of opportunities that we have identified, we expect an outsized growth opportunity for our shareholders will then follow.

With that, we thank you for your time this morning and appreciate your partnership. I will now turn the call back to [ Towanda ].

[Operator]

[Operator Instructions] Our first question comes from the line of Michael Griffin with Citi.

[Michael Griffin, analyst]

Appreciate the color in the opening remarks. Just wondering if you could expand a bit kind of on the acquisition opportunities you're seeing. I think we've seen the transaction market thaw somewhat, so maybe an expectation about when they could pick up. And then, if you could give us a sense on where investment spreads are relative to your current cost of capital?

[Darrell Crate, executive]

Yes. Maybe just to start at the top, we -- as we talked about last quarter, the bid-ask spread was wide, and we obviously see that shrinking. We are in a place today where -- especially buildings where folks have debt that's maturing, time is a little bit on our side as we move forward. And that's having a powerful impact on, again, taking that bid-ask spread and shrinking it a bit.

For us, our cost of capital today is just about 7.25%. And stepping back, when we talked about our growth strategy and sort of 2% to 3% growth going forward and how we were continuing to build out our growth strategy, the stock was at $12. So, as we've seen this stock appreciate almost 10%, a little bit more since then, that only means more accretion, better cost of capital, and all those things that make REITs go around. We have a robust pipeline. As I said, we're working not only on U.S. government agencies, as well as state and local, but also those high-credit government-adjacent tenants, and we feel very excited about the growth prospects as we go forward.

[Michael Griffin, analyst]

Appreciate that, Darrell. And then, maybe just kind of one broad comment around the upcoming election, and if there's any chance of potential change in administration could impact various aspects of your business?

[Darrell Crate, executive]

Our core strategy of U.S. government assets, we've always picked agencies that really aren't swayed by the political wins, so VA, FBI, DEA. I think both parties agree that each of those serve a very important critical mission. We're not a -- the Department of Education is not on our list. And so, most of the folks who you hear are vulnerable to one party's preference over the other are not our major tenants.

[Operator]

Our next question comes from the line of Michael Carroll with RBC.

[Michael Carroll, analyst]

I guess, Meghan, can you give us an update on your leasing activity? I know it looks like the lease expiration schedule hasn't really changed much. So I'm assuming nothing was really signed this quarter. And I know last quarter, you're pretty optimistic by some of those progresses. So maybe can you give us an idea of the timing of when you can satisfy the 2024 leases and what's the outlook for the 2025 expirations?

[Meghan Baivier, executive]

Yes, happy to do that. As we look at the remainder of 2024, right, the 2 largest -- well, one is outsized. It's our FBI in Omaha. And then, we have an FBI tenancy in our Portland asset, as well as 2 other small tenancies. And I would say, certainly, the FBI - Omaha, I wish I could have had positive commentary for you today, but we feel very good about that, as we do about the others.

Looking to 2025, as those become more firmly in view, we've got a handful of FBIs and a courthouse in Aberdeen. I'd say the same sentiment applies there for positive news on the horizon, those procurements being at stages and in a position where we appreciate the progress and look to see a positive outcome.

[Michael Carroll, analyst]

Okay. And then, with these being the -- I guess, a lot of the expirations being kind of in the center of your bull's eye that you're typically targeting, can we assume cash lease spreads, are these in the 15% to 20% range? Or is there something unique that we should be thinking about?

[Meghan Baivier, executive]

Yes. FBI - Omaha is subject to a prospectus. We've known that. So, that renewal likely looks more like a flat renewal. But as we look to the 2 FBIs and the courthouse in 2025, yes, Mike, I would tell you those are -- our expectations are squarely in that high-teens range from a net effective spread.

[Michael Carroll, analyst]

Okay. Great. And then, just 2, I guess, kind of modeling-type questions. On the JV deal, like, what's the timing of completing that JV acquisition, the last acquisition from that transaction?

[Meghan Baivier, executive]

Yes. That last -- the Jacksonville VA, we -- it is our expectation that, that is teed up to close in the quarter, and that would be the last transaction.

[Michael Carroll, analyst]

Okay. And then, final one for me. I know there was a small -- I don't really want -- it's so small. So, I'm not sure it's worth talking about, but there is a loan provision for credit losses that was added back to FFO. Can you kind of explain what that is? And should we expect any additional credit loss provisions to be recorded over the next few quarters?

[Allison Marino, executive]

Sure. I can take that one. So, as we've shared, there's an opportunity in the market for us to partner with developers on projects and act in a lender position. We have a small pre-lease award loan out to a developer. And while that loan is not experiencing actual loss or default, accounting rules require us to estimate a credit loss probability for this asset for the term it's outstanding. So, that will continue to get tweaked through its maturity date.

[Operator]

[Operator Instructions] Our next question comes from the line of Christopher Sreckovich with Jefferies.

[Christopher Sreckovich, analyst]

[ Stepping in ] here for Peter. Just wanted to touch on maintenance CapEx. It was a little bit higher this quarter. Can you talk about expected run rate going forward and any items we should look out for, for the rest of the year from an AFFO perspective?

[Allison Marino, executive]

As you can probably expect, there's always timing as projects kick off and complete throughout the year. So I would say there's no changes to our run rate expectations on that line.

[Christopher Sreckovich, analyst]

Okay. Great. And then, I guess, we're generally on the acquisition front, we kind of touched on it a little bit, but as rates come down, generally, you get a different pool of buyers looking at these assets. Do you think you'll see more competition for the assets you're targeting and kind of how will that impact pricing?

[Meghan Baivier, executive]

I'll take that. I think we are excited for the cost -- our cost of capital to be normalizing and really presenting increased opportunities to acquire at a healthy 50 basis points to 100 basis point spread. That cost of capital is still leading in the industry, right? Our ability to access the private placement market in the way we did, the equity cost today of the stock, right, so our blended cost of capital is still a competitive advantage as we go into the marketplace. It's been -- it's really more about meeting sellers' expectations.

[Operator]

Thank you. I'm showing no further questions in the queue. I would now like to turn the call back to Darrell Crate, Chairman of Easterly Government Properties, for closing remarks.

[Darrell Crate, executive]

Thank you, everyone, and thanks for joining the Easterly Government Properties Second Quarter 2024 Conference Call. We look forward to keeping you posted on the coming quarters and as we make progress on our pipeline of growth opportunities.

[Operator]

This concludes today's conference call. Thank you for participating. You may now disconnect.