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Northstar Realty Europe Corp.  (NYSE:NRE)
Q4 2018 Earnings Conference Call
March 13, 2019, 9:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

See all our earnings call transcripts.

Prepared Remarks:

Operator

Hello and welcome to NorthStar Realty Europe Fourth Quarter Earnings Call. My name is Sean and I will be your coordinator for today's event. Please note that this call is being recorded. (Operator Instructions)

I will now hand you over to Trevor Ross, General Counsel, to begin today's conference. Thank you.

Trevor K. Ross -- General Counsel

Good morning and welcome to NorthStar Realty Europe's Fourth Quarter 2018 Earnings Conference Call. Before the call begins, I would like to remind everyone that certain statements made during the course of this call are not based on historical information and may constitute forward-looking statements. These statements are based on management's current expectations and beliefs and are subject to a number of trends and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. I refer you to the Company's filings made with the SEC for a more detailed discussion of the risks and factors that could cause actual results to differ materially from those expressed or implied in any forward-looking statements made today.

The Company undertakes no duty to update any forward-looking statements that may be made in the course of this call. Furthermore, certain non-GAAP financial measures will be discussed on this conference call. Our presentation of this information is not intended to be considered in isolation or as a substitute for the financial information presented in accordance with GAAP. Reconciliations of these non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP can be accessed through our filings with the SEC at www.sec.gov.

I will now turn the call over to our CEO, Mahbod Nia.

Mahbod Nia -- Chief Executive Officer

Thank you, Trevor, and thank you everyone for joining us today. In addition to Trevor, I'm joined by Keith Feldman, our CFO. NorthStar Realty Europe or NRE is a New York Stock Exchange listed REIT focused on prime European office properties. In line with our stated strategy of focusing on high quality assets in gateway cities across Germany, UK, and France; we now own 15 properties located in London, Paris, and key German cities including Hamburg, Berlin, and Cologne. Since inception, NRE has consistently generated compelling risk-adjusted investment returns and I'm pleased to say that this strong performance continued throughout 2018. In another active year, we successfully leased or released over 60,000 square meters of space, which contributed to a 4% uplift in our portfolio value based on the year-end independent valuation by Cushman & Wakefield.

During the year we completed $1 billion of strategic asset sales exiting the Netherlands and Portugal, releasing over $450 million of net equity, and crystallizing an approximate 17% IRR for stockholders. We also continued to rationalize our cost structure realizing over $3 million of savings in our corporate expenses ahead of our stated 2018 target and equating to $5 million of annual savings on a run rate basis. We further reduced our leverage to 40% and our weighted average cost of debt to 1.41%. These achievements are reflected in our strong earnings and real estate operating results for the full year and fourth quarter of 2018, which we'll discuss in further detail. However, firstly, I would like to make a few remarks regarding the macroeconomic environment and the European commercial real estate market.

Economic growth in Europe moderated during 2018 with gross domestic product or GDP growing by 1.8% and 1.9% in the Eurozone and the European Union respectively, down from 2.4% in 2017 primarily due to a weaker global trade environment. However, the foundations of the European economy remained stable with favorable financing conditions and labor market dynamics set to continue to provide underlying support to economic growth. Unemployment in the Eurozone reached 7.8% in January 2019, down from 8.6% a year earlier and the lowest level recorded since October 2008. The ECB recently reduced its 2019 GDP forecast for the Eurozone down from 1.7% to 1.1%. Eurozone inflation dropped to 1.4% in January 2019 from a peak of 2.3% in October 2018, but the ECB's expecting it to remain below 1.5% through 2020.

In response to weakening economic indicators in the region, the ECB announced its intention to maintain interest rates at 0% at least until the end of 2019 and beyond if deemed necessary to ensure the continued and sustained convergence of inflation to levels close to 2% in the medium term. Prior to this announcement, the expectation was that the ECB would begin hiking rates during the summer of 2019. The ECB also introduced a new monetary stimulus package aimed at encouraging banks to provide credit to consumers and businesses. Looking at the UK, Brexit remains a key focus with continued uncertainty negatively impacting sentiment. The UK economy recorded a mere 0.2% growth during the fourth quarter or 1.4% for the full-year 2018. European Commission forecasts the UK economy to grow by 1.3% in both 2019 and 2020.

Turning to the real estate market, the European commercial real estate investment volume stood at EUR94 billion in the fourth quarter and EUR312 billion for the full-year 2018, in line with 2017 levels. Office remained the most sought-after asset class representing approximately 41% of total transaction volume. Prime property yields in most asset classes and markets were stable during the fourth quarter and continued to remain at a significant premium to European sovereign yields. European office vacancy decreased by 10 basis points to 6.3% during the fourth quarter, the lowest level since 2002. European office take-up decreased by 2% compared to 2017, which was the strongest annual result since 2007 although the decline was more reflective of limited available stock due to record low vacancy rates as opposed to the lack of demand.

Strong demand, active pre-letting, and low levels of speculative completions continued to place upward pressure on rents during 2018, which grew by 5.5% year-over-year. German real estate investment volume reached EUR77 billion last year, 6% above 2017 and the second highest level recorded in over a decade. The office vacancy rate continued to decline reaching 3.7%, 20 basis points lower than the previous quarter and a level last seen in 2000. Limited availability of space and strong demand led to 4.2% and 6.8% increases in prime and average rents across the Top 6 German cities respectively. Total UK investment volume reached GBP16 billion in the fourth quarter and GBP65 billion for the full-year 2018, a 6% decrease compared to 2017. Central London office investment volume totaled GBP20 billion last year, slightly below the 2017 level. Take-up in Central London during the year exceeded levels achieved in both 2016 and 2017.

Flexible workplace providers continue to account for a significant portion of take-up equating to 31% of Central London leasing volume during the year. Driven by a number of large prime transactions completed during the year, French investment volume was EUR31 billion in 2018, 6% above 2017. Paris accounted for approximately 40% of total investment. With a robust occupational market, the vacancy rate continued to fall to 1.4% in Paris CBD creating positive pressure on rents, which on average increased by 3.3%. Turning the discussion back to NRE, I'm pleased to report another positive year in which we made significant progress with our stated initiatives and further enhanced the operational performance of our portfolio. As of December 31st, 2018, our 206,000 square meter portfolio comprised of 18 properties leased with blue-chip and other high quality tenants in key cities across Europe.

The portfolio was 97% occupied and had a remaining weighted average lease term of approximately 6.2 years, including signed leases commencing in the beginning of 2019. Our office portfolio comprised of 13 properties and generated approximately 90% of our net operating income, was 96% occupied on a pro forma basis and had a remaining weighted average lease term of approximately 6.1 years. The overall portfolio is valued at $1.3 billion based on the year-end 2018 independent valuation by Cushman & Wakefield representing $3 million or $0.86 per share compared to the 2018 mid-year valuation driven by leasing and asset sales at significant premiums to their June valuation. In total we sold seven properties last year with three additional sales completed earlier this year. Our ability to materially enhance the value of these assets prior to the sale is reflective of our continued commitment to active asset management as we seek to generate value for our stockholders.

These sales released approximately $450 million of net equity to NRE after the repayment of financing and transaction costs. During the first quarter of 2019 we completed the sale of Uhlandstrasse in Frankfurt for $41 million, 65% above our allocated purchase price including CapEx. During our ownership, we've extended lease agreements for 70% of the lettable area and increased the weighted average lease term by around four years enhancing the value of the property. We also recently completed the disposal of two retail assets in Germany, Werl and Kirchheide. Since entering the European market in 2014 we've sold 37 properties, exited six countries, and significantly reduced our exposure to the non-office properties demonstrating our clear commitment to simplifying the business and generating value for our stockholders. With that, I'm pleased to announce that NRE delivered another quarter and full year of solid operating results.

I will now hand over to Keith Feldman, our CFO, to further discuss the financial results.

Keith Feldman -- Chief Financial Officer, Treasurer

Thank you, Mahbod. Good morning, everyone, and welcome to our fourth quarter 2018 earnings call. During 2018 we made significant progress with various initiatives, including value-enhancing active asset management and strategic asset monetizations, that generated $450 million of equity capital and realized an IRR of 17% while driving positive same-store NOI results and realizing over $3 million of G&A and expense savings. As Mahbod mentioned, during 2018 we have executed leases or lease extensions for over 60,000 square meters. We continue to demonstrate our long-term relationship with our existing tenants, which is reflected in the 85% tenant retention rate across -- achieved across our portfolio since 2015. Our leasing activity during 2018 included a nine-year lease for over 11,000 square meters at Boulevard MacDonald in Paris with one of our largest tenants BNP and a new 33,000 square meter lease at Marly, our logistics asset.

In addition, we recently signed leases for approximately 9,000 square meters at Valentinskamp in Hamburg, which increased contractual occupancy to 82% and included a 10-year value-enhancing lease extension with the asset's largest office tenant, Baker Tilly. During the fourth quarter 2018, NRE reported net operating income or NOI of $24 million. Looking at our same-store sequential year-over-year operating performance on an FX adjusted basis, rental income increased by 1.7% reflecting indexation uplifts realized during 2018 and the commencement of new leases in the second half of the year. Same-store year-over-year NOI increased by $2.2 million or 16% partially due to the prior year including a $900,000 write-off of straight line rent related to the expansion of Invesco at Portman Square.

Excluding this one-off operating expense in the prior year, same-store NOI increased by 9.3%, which was driven by the increased rental income, higher recoverability due to the leasing, lower non-recoverable operating expenses, and other one-time income related to lease terminations. For the fourth quarter 2018, NRE reported cash available for distribution or CAD of $11.5 million or $0.22 per share, $0.01 per share below the third quarter 2018 due to slightly lower income from Trianon which was sold in mid-December 2018. The full-year 2018 CAD was $0.90 per share, $0.01 above the full-year 2017 due to an increase in same-store NOI, lower corporate expenses, and the benefit of NRE stock repurchases completed during the year largely offset by income loss from asset sales. Over the past year, we have made significant progress in internalizing various services, including asset management, accounting, and tax services.

I'm pleased to say that we have realized approximately $3.2 million of savings in other expenses and G&A expenses in 2018, ahead of the previously stated $2 million to $3 million target and remain on track to achieve $5 million of annual savings on a run rate basis. After deducting mortgage debt and adjusting for cash and other balance sheet working capital items, EPRA NAV based on the 2018 independent valuation by Cushman & Wakefield adjusted for currency movements was $20.67 per share as of December 31st, which was reduced by approximately $0.30 per share of transaction costs associated with the strategic review process as well as the 2018 incentive fee payable to our manager. As of December 31st, 2018, NRE's overall leverage was 40%, down from 52% a year earlier and our weighted average debt maturity was approximately five years.

We have refinanced over $140 million of debt during the year reducing the weighted average cost of debt down to 141 basis points over EURIBOR and GBP LIBOR 16 basis points below year-end 2017. During the year we repurchased $83 million or 6.1 million shares of NRE stock at an average price of $13.73 per share, an approximate 25% discount to our current trading price. As of March 8th, we had $500 million of corporate liquidity including $70 million of availability under our credit facility and $430 million of unrestricted cash, of which approximately 200 million was held in US dollars, which was converted from euros at a rate of approximately 1.145. In addition, in February NRE joined the S&P SmallCap 600 index, which appears to have resulted in increased liquidity in our stock. On March 7th, we declared a cash dividend of $0.15 per share of common stock. This dividend is expected to be paid on March 29th to stockholders of record as of the close of business on March 25th. Overall, we are pleased with the Company's financial and operational performance in 2018 and look forward to updating you further during the quarters ahead.

Operator, please open up the call for questions.

Questions and Answers:

Operator

(Operator Instructions) We have a question from the line of Bryan. Please go ahead with your question.

Bryan Maher -- B. Riley FBR, Inc. -- Analyst

Good morning, gentlemen. Real quick questions. Mahbod, you talked a little bit about the moderate -- moderating economic conditions in the Eurozone. Is that having any impact that you're seeing on asset pricing?

Mahbod Nia -- Chief Executive Officer

Hi, Bryan. Yes, I think the moderation, I think it's important to put that into context. The Eurozone is still growing well above the -- actually slightly above its long-term average growth rate and certainly I would say the weighted capital assumed real estate hasn't in any way dropped off. So no, we're not really seeing that. I think anything that's larger, more complex, or (inaudible), there's a little bit less interest than there has been historically. But on the whole, I think the economic performance is still quite strong albeit not as strong as it was. With regard to our assets, I think we're in a fortunate position to own great assets with long-term income profile and very strong creditworthy tenants in great locations in gateway cities. And so if anything, those are extremely rare still and sought-after so not seeing any impact on those other than the positive impact.

Bryan Maher -- B. Riley FBR, Inc. -- Analyst

Okay. And you guys made some really good progress last year with the cost savings. Is there any more low-hanging fruit as you kind of move through '19 here to take more costs out of the system?

Keith Feldman -- Chief Financial Officer, Treasurer

Hey Bryan, it's Keith. I think you should focus on the $5 million that we talked about. So, another $2 million in excess of what we achieved in '18 and then we'll continue to update the market as we find any additional savings moving into '19.

Bryan Maher -- B. Riley FBR, Inc. -- Analyst

And are the current Brexit discussions and issues surrounding that market having any impact on either asset sales opportunities or potential opportunities?

Mahbod Nia -- Chief Executive Officer

Yes. So I'd say at the moment no, not really. There are a contingent of investors that will unsurprisingly pause and wait for some clarity before investing, but I think that's very strongly capital looking for opportunities and that is still keeping prices propped up here for the time being. Could it be an interesting place for investment? Absolutely. I mean I think it's difficult to know which direction the Brexit discussions take going forward given this is although been happening very real time and is volatile. But I think one thing that's clear is that the uncertainty is unlikely to recede in the short term and that could bring about some interesting opportunities.

Bryan Maher -- B. Riley FBR, Inc. -- Analyst

And then just lastly from me, the strategic review process that you started last fall, do you have any thoughts as to how long that process is going to take to play out? Is it another quarter, is it two quarters, or what are your thoughts there?

Mahbod Nia -- Chief Executive Officer

So, I think not really in a position to comment. The strategic review committee and their advisors are in the process of conducting a strategic review to explore all of that -- all available options for unlocking value for shareholders and they'll provide an update in due course. So at the time of the announcement, the date of April 30th was referenced. We don't have any other date beyond that.

Bryan Maher -- B. Riley FBR, Inc. -- Analyst

Okay. Thank you. That's all from me.

Mahbod Nia -- Chief Executive Officer

Thank you, Bryan.

Operator

(Operator Instructions) We have a question from Mitch of JMP Securities. Mitch, please go ahead with your question.

Mitchell Bradley -- JMP Securities -- Analyst

Good morning, guys. Maybe just provide me some perspective of the profile of the buyers of the properties that you've been selling assets to?

Mahbod Nia -- Chief Executive Officer

Hey, Mitch. It's Mahbod here.

Mitchell Bradley -- JMP Securities -- Analyst

How are you?

Mahbod Nia -- Chief Executive Officer

It's quite varied to be honest with you. So if you look at the $1 billion, obviously the two big assets within that was the Trianon and the Maastoren and both different groups of capital. The Trianon, as you probably heard, went to an Asian investor to a consortium. But then some of the assets, some of the smaller ones; Uhlandstrasse, Werl, Kirchheide, the UK assets; that's a very different contingent, very different type. So I'd say anything from -- for the smaller ones, local high net worth to institutional to the Trianon, which ultimately was an Asian asset management company. So, really varied and that's driven by the size of the assets and the profile of the assets that we sold.

Mitchell Bradley -- JMP Securities -- Analyst

Got you. Are there any other assets that kind of non-core that you own that are being marketed for sale as we speak?

Mahbod Nia -- Chief Executive Officer

Well, the obvious ones that are non-core or non-office; Marly la-Ville, the logistics asset, and those two hotel deals and your expectation should be that it's likely that those will be divested.

Keith Feldman -- Chief Financial Officer, Treasurer

And Marly is held for sale.

Mahbod Nia -- Chief Executive Officer

And Marly is held for sale, yes.

Mitchell Bradley -- JMP Securities -- Analyst

Got you. Last one for me. Is there any update on the BNP Real Estate lease? I know there's about a year of term remaining and I know one of the other BNP leases just extended and certainly the market is fairly strong, but do you have any sort of idea what's happening there yet?

Mahbod Nia -- Chief Executive Officer

Yes, I can certainly provide some insight. So BNP -- you may remember that BNP Real Estate who was a tenant in that building is different from BNP who -- BNP Bank who are in Boulevard MacDonald where we extended that leaseback up to 10 years, that new long-term lease. BNP Real Estate, we've always known that they will eventually move out because that's sort of they know they find a site, they get planning, they build, they move in, they suddenly lease or sell, they're going to do that again. But you may have seen that they recently publicly announced that their new building will not be ready for occupation until 2022. So, I think we're in a fortunate position where in a market where current CBD you've got 1.4% vacancy today, there really aren't any interim options we don't believe for BNP. They've also invested quite heavily in that building, it's their showcase for showing prospective clients their development capability. And so, we feel that they're pretty wedded to that asset or rather have no choice but to remain in the asset until that new building is developed and that won't be until 2022. Whether that results...

Mitchell Bradley -- JMP Securities -- Analyst

So you say likelihood a short-term extension, is that kind of what you're expecting?

Mahbod Nia -- Chief Executive Officer

Yes. So I mean, I think the two options are either there's a formal lease extension or they just remain in occupation on a rolling basis until they vacate and we don't see that being before 2022.

Mitchell Bradley -- JMP Securities -- Analyst

Got you. Any sort of lease extension though assuming there is uptick versus what the in-place rents are given the strength of the market, correct?

Mahbod Nia -- Chief Executive Officer

Yes. I think it's probably rented around at market now give or take. So, I think it's more a question of do you have a formal lease extension for a duration of time or do you just actually let the lease roll over that current rent as is also quite common in France and we like to do that. So that -- there's multiple factors that play into that and if you sign a formal lease, you may need to offer some contributions -- current contributions, incentives, all that. And then, we need to balance that with really that economically beneficial in that effective rent basis. So, I think we've got to say that we don't see there being many options for them, if any actually. And at this moment, the delay to their existing building I think that that's like -- expectations are they're likely to be in there until 2022.

Mitchell Bradley -- JMP Securities -- Analyst

Got you. Actually one more for me, if you don't mind. Are there any -- I mean obviously six years plus of average least term remaining, it seems like it's a fairly durable income stream. But is there anything that we should know about with regards to kind of smaller tenants or any kind of planned vacates or kind of capital that may be necessary over the course of the next 12 months?

Mahbod Nia -- Chief Executive Officer

Nothing out of the ordinary. I mean with a portfolio like ours, there's always few around the edges smaller tenants whose leases may be coming up for expiry or extension or reletting, but I would really describe that all as ordinary course business, but nothing significant in size or anything. Nothing that really concerns us in any way.

Mitchell Bradley -- JMP Securities -- Analyst

Thank you.

Mahbod Nia -- Chief Executive Officer

Thank you, Mitch.

Operator

We currently have no questions coming through. (Operator Instructions) I will now hand you over to Mahbod Nia for closing remarks. Thank you.

Mahbod Nia -- Chief Executive Officer

Thank you, everyone, for joining us again today and we look forward to updating you again next quarter.

Operator

Thank you for joining today's call. You may now disconnect your lines. Host, please stay on the line.

Duration: 28 minutes

Call participants:

Trevor K. Ross -- General Counsel

Mahbod Nia -- Chief Executive Officer

Keith Feldman -- Chief Financial Officer, Treasurer

Bryan Maher -- B. Riley FBR, Inc. -- Analyst

Mitchell Bradley -- JMP Securities -- Analyst

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