Equity Commonwealth

NYSE:EQC

Earnings Call Transcript 2020-Q4

[Operator]

Greetings, and welcome to Equity Commonwealth's Fourth Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.

It is now my pleasure to turn the conference over to your host, Sarah Byrnes, Senior Vice President of Investor Relations. Thank you. You may begin.

[Sarah Byrnes, IR]

Thank you, Rob. Good morning and thank you for joining us to discuss Equity Commonwealth's results for the quarter and year ending December 31, 2020. On the call today are David Helfand, President and CEO; David Weinberg, COO; and Adam Markman, CFO.

Please be advised that certain matters discussed during this conference call may constitute forward-looking statements within the meaning of federal securities laws. We refer you to the section titled forward-looking statements in yesterday's press release as well as the section titled risk factors in our annual report on Form 10-K for a discussion of factors that could cause actual results to materially differ from any forward-looking statement, including any statements regarding the overall impact of COVID-19.

The company assumes no obligation to update or supplement any forward-looking statements made today. We also post important information on our website at eqcre.com, including information that may be material.

Today's remarks also include certain non-GAAP financial measures. Please refer to yesterday's press release and supplemental containing our results for reconciliation of these non-GAAP measures to our GAAP financial results.

With that, I will turn the call over to David Helfand.

[David Helfand, CEO]

Thanks, Sarah. Senior Vice President, that has a nice ring to it, and we congratulate you, Sarah, on your well-deserved promotion.

Good morning, everyone. Appreciate you joining us. I'll begin with brief comments on market conditions and provide an update on the company's current activities. Story of 2020 was, of course, the pandemic and its impact on everyone and everything. While vaccines give hope for better days ahead, consequences for the economy are still uncertain. The stock market has attracted a lot of attention of late. And at its low last March, the S&P was down 31% versus the start of the year. Since that time, the markets rallied 75%, driven by expansion of the Fed's balance sheet and stimulative fiscal policy.

Despite these market gains, there is real stress across the country, particularly amongst lower wage workers who have borne a disproportionate share of job losses. In some ways, the real estate industry mirrors this divide with the [perhaps 5:23] data infrastructure, industrial and life sciences, among others, significantly outperforming out-of-favor sectors, including retail, lodging and office.

For 2020, the Morgan Stanley REIT Index declined 7.6%, its worst performance since 2008. At EQC, with the portfolio down to 4 assets, we are focused on evaluating opportunities to deploy our capital. As we've discussed with many of you, we're targeting a variety of asset classes, particularly but not exclusively those that have been hit hard by investor sentiment relating to post-COVID demand expectations.

We've been consistent in our investment approach, targeting portfolios, platforms and companies rather than individual assets. Given the optionality we've earned through the successful execution of our $7.6 billion of dispositions, we believe it's prudent to focus on transactions that will help define our future rather than one-off deals that would create friction if we were to determine later that selling our remaining assets and returning capital to our shareholders is the right path.

In the past, we've avoided discussing, even in general terms, the type of transactions we've been reviewing. Given the importance of potential new investments to EQR story, makes sense now to try and share more about our approach to capital allocation. As we work to evaluate opportunities, we're mindful of the Equity group formula, be patient, disciplined and rigorous

about risk management. First question we ask about every deal and the last is, are we being paid for the risk we're taking?

Moreover, we try to be contrarian in our thinking as going with the herd generally doesn't yield superior results. That has led us to evaluate out-of-favor sectors such as lodging, retail and office, as I mentioned before. We prefer operationally-intensive challenges and complex situations, all other things equal, as we believe our experience and demonstrated execution capability give us an edge in those types of transactions.

In addition to looking for the right platform and the right asset class, we're looking to identify other levers for value creation beyond asset management and operational enhancements. In the case of the original Commonwealth transaction, we underwrote not just a collection of assets trading at a discount but also a unique tax position that has allowed us to sell assets and retain capital to pursue new opportunities.

As we go about the day-to-day process of underwriting deals, you should know that we have an outstanding investments team with experience across a wide range of real estate sectors, diligently looking for the right opportunity. We work collaboratively and strive to bring to bear everyone's perspective and experience to better vet opportunities and assess risk. As we sit today, we have 28 employees down from almost 75 years ago. We've endeavored to reduce costs as appropriate across the company without impairing our ability to effectively pursue investments.

Despite not being able -- despite not being together for the past year, the EQC team has risen to the challenge, the work-from-home. And we continue to work collaboratively to identify the right opportunity to create long-term value.

With that, I'll turn the call over to David.

[David Weinberg, COO]

Thank you, David, and good morning, everyone. As David discussed, we are spending a considerable amount of time sourcing and underwriting investments. While we have yet to sign a deal, we remain persistent. This is an extremely competitive environment where the demand for real estate investments exceed supply.

On the demand side, there's a global search for yield. By some estimates, there's a record amount of dry powder, around $300 billion of equity looking for real estate. Interest rates are near historical lows and attractive financing is available for better assets and businesses. In other words, while our $3 billion of cash is a competitive advantage, in today's world, it does not guarantee success.

With respect to supply, in 2020, deal volumes were down 35% across the board. Just $60 billion of office traded hands compared to the $100 billion to $110 billion of deals each of the prior four years. While industrial volumes were flat, apartment sales were down 27%, retail volumes were down 60% and hospitality was down 70%. Risk-off deals, which check all the boxes, are getting done.

When the resulted for buyers and sellers to disagree on, pricing is easier. The same, however, cannot be said for deals with risk. Lease-up and repositionings are difficult to underwrite when there's limited leasing activity and demand is challenging to forecast. With buyers cautiously looking forward and sellers optimistically looking backward, pricing gaps are large and rarely overcome. In most cases, there is no catalyst forcing an owner to sell.

Where there is distress, such as in hospitality and retail, there are some one-off trades but fewer larger deals. For the most part, owners and lenders have been working together and there has yet to be a day of reckoning. In the stronger growth sectors, such as single-family residential and industrial, demand continues to be robust and pricing is held or might even be higher today.

Against this backdrop, we continue to focus on two themes: we believe one group of investments such as retail, hospitality and office is susceptible to pricing resets. Keep in mind, we are not limiting ourselves to substantially distressed investments where assets may trade for pennies on the dollar. Instead, we are hopeful that we will find ways to access these deals where we are getting paid for the risk that we are taking. We do not need perfect visibility into the future. We believe a deal this type can make sense with the right basis and story.

The other group of investments such as single-family residential, life sciences and industrial are appealing due to their growth profiles. While these deals are unlikely to display elements of distress, we continue to seek them out. We believe the right deal, which includes a story and the appropriate scale, can generate attractive risk-adjusted returns.

In all cases, we are open to and have explored a variety of means of execution. We have looked at buying portfolios, businesses and entities, including whole and partial purchases. We have proposed a variety of structures with the different operators, including folding them into EQC or providing them growth capital with a path to an EQC-owned business. We have examined rescue and recapitalization opportunities including different structures and investing in different parts of the capital stack.

We have explored the use of our balance sheet, stock and OP units to solve problems such as leverage, investor liquidity or tax issues. And we've approached larger private real estate businesses with the concept of them utilizing the EQC entity to access the public markets.

To date, we have looked at a variety of opportunities. Many times, we have chosen to pass. Sometimes, the other side elected to not transact or had access to alternative capital. Nonetheless, we remain hopeful and continue to devote our time and resources to finding that first deal.

With that, I will turn it over to Adam to give an update on our financial results.

[Adam Markman, CFO]

Thank you, David. I'll briefly cover financial and operating results for the quarter and year-end. Detailed FFO, NFFO and NOI walks are in the press release. I won't reiterate that information, but rather, we'll highlight a few key points which emphasize the unique position that we've created by monetizing the undervalued portfolio that we took control of over six years ago.

Following $7.6 billion of dispositions, the largest asset on our balance sheet is cash, and the most important factor that contributed to the decrease in earnings in 2020 was lower interest income earned on our cash deposits. In 2019, we had an average cash balance of $3 billion earning 2.4%. Despite our average balance being more than $200 million higher in 2020, we earned nearly $50 million less in interest income due to the average interest rate earned on these deposits falling to below 70 basis points. The trend has continued with our current average rate below 30 basis points.

The other major factor impacting earnings was dispositions with $1.57 billion of assets sold over the past two years. A portion of the proceeds from these asset sales were used to pay down our remaining debt, generating an interest expense savings of over $8 million for the year. The order of magnitude of these changes stand in contrast to lower parking revenue and occupancy declines in the same-store portfolio, which contributed to a same-store cash NOI decline of $2 million, of which parking is the real driver.

Our four property portfolio totaling 1.5 million square feet was 85.7% leased at the end of the fourth quarter down 200 basis points from last quarter. The decline was largely the result of a 24,000-square-foot tenant who defaulted on their lease at Capital Tower in Austin. We're currently litigating this dispute. Note that given the very small size of our remaining portfolio, there will be more volatility around occupancy and other operating metrics.

Leasing activity continues to be slow, although we saw a modest pickup from the third quarter. We signed 39,000 square feet of new leases in Q4, including 10,000 square feet of new leases. In the fourth quarter, we collected 97% of contractual rents, and in January, we collected 96%. February collections are consistent with our recent experience.

In terms of balance sheet activity in July, we prepaid the last debt that we had outstanding. The only debt-like component in our capital stack is $123 million of convertible preferred. The disposition of three properties in the first half of 2020 generated $757 million of gross proceeds and significant taxable income. As a result, we declared a $3.50 per share special common distribution that was paid in October. We do not have any properties in the market for sale at this time and do not expect to be required to pay a special distribution this year.

In March, prior to the $3.50 per share special distribution, we repurchased 711,000 common shares at a weighted average price of $29.31 for a total of $20.8 million. Since taking responsibility for EQC six years ago, we have sold 164 assets for $7.6 billion. We have repaid $3.3 billion of debt and preferred, paid $1.2 billion of common distributions to our shareholders, repurchased $266 million of common stock and have a current cash balance of $3 billion or $24 per share.

Thank you, and we will now open the call to your questions.

[Operator]

[Operator Instructions]

Our first question comes from Emmanuel Korchman with Citi. Please proceed with your question.

[Emmanuel Korchman, Citi]

Thank you for that deeper look into sort of your opportunity set. As you sit there underwriting deals, I feel like you're probably more aligned with the investors on this call than other landlords when thinking about the future of office. So was just hoping to get your views on where the office space goes, especially on topics like working from home and that impact on ultimate office usage and how you think about that when you're underwriting office deals.

[David Helfand, CEO]

Yes. Thanks, Manny. Obviously, a lot of opinions and thought. Obviously, Salesforce's announcement is an interesting one. We've done a lot of business with them on the leasing side over the years. I think clearly, work from home is going to be a part of the landscape looking forward. And I think for the next few years, companies are going to experiment with how to manage their team and their people.

I think Sam has been pretty outspoken, and I tend to agree with them that longer term, when it's safe to do so, people will still want to be at the office, to inculcate culture and to make sure people understand what the company is about and what it's trying to achieve. So I would probably number us, and we have said this in the past, among the more relatively bullish about high-quality office in high-quality markets. And having said that, it may be a few years before the fundamentals reflect an upward trend, even the dislocation that's gone on so far.

[Emmanuel Korchman, Citi]

And then I don't remember which David said this but I think you reiterated that you're not looking at single deals and you really want a platform or a portfolio. Does that mean you're not looking at single deals and not underwriting those deals? Or is your desire just to act in a bigger way once you do act?

[David Helfand, CEO]

David, do you want to take that?

[David Weinberg, COO]

Well, actually, Manny, you're right on both points. Well, we are looking at single deals but not with really a focus on execution or the actual acquisition of those one-offs, more just to understand pricing and what's going on real-time in the markets. But as David said in his prepared remarks, rather than create friction by buying a couple of one-off assets, we are looking for larger transformative type investments to set the future.

[Operator]

[Operator Instructions] There are no further questions. At this time, I'd like to turn the call back over to David Helfand for closing comments.

[David Helfand, CEO]

Thanks for joining us today. We appreciate your interest. Be well. Thanks.

[Operator]

This concludes today's conference. You may disconnect your lines at this time, and we thank you for your participation.