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Equity Commonwealth (NYSE:EQC)
Q3 2019 Earnings Call
Oct 30, 2019, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Greetings and welcome to the Equity Commonwealth Third Quarter 2019 Earnings Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions] As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Sarah Byrnes, please go ahead.

Sarah Byrnes -- Vice President, Investor Relations

Thank you, Stacey. Good morning and thank you for joining us to discuss Equity Commonwealth's results for the quarter ended September 30, 2019. Our speakers today are David Helfand, President and CEO; David Weinberg, COO and Adam Markman CFO. Please be advised that certain matters discussed during the conference 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 to the section titled Risk Factors in our most recent Annual Report on Form 10-K for a discussion of factors that could cause actual results to materially differ from any forward-looking statements. The Company assumes no obligation to update or supplement any forward-looking statements made today. We also posted important information on our website at www.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 third quarter 2019 results for a reconciliation of these non-GAAP performance measures to our GAAP financial results.

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

David Helfand -- President and Chief Executive Officer

Thanks, Sarah. Good morning. Thanks for joining us. I'll begin with brief comments on market conditions, review our third quarter results and provide an update on the Company's current activities. US economy showed continued growth in the third quarter with GDP, up 1.9% versus 2% in the prior quarter. 136,000 new jobs were added in September and the unemployment rate dropped to 3.5%. The last time the rate was the slow was December of 1969. New job creation has averaged 161,000 per month year-to-date compared to an average of 220,000 in the first nine months 2018.

Stock market has been strong year-to-date, with S&P 500 up 22%, NASDAQ, up 23%, and NASDAQ up 25%, the RMX Index up 28%. Yield on the 10-year treasury is 1.8% down 20 bps since our last call and more than 120 basis points from a year ago. The shortage of the curve one-month LIBOR is 1.8% as well, down almost 50 bps from a year ago.

Turning to office markets, new supply continues to run above historical averages, and new start numbers do not indicate any significant reduction in supply for the next few years. Demand remains decent resulting in a national vacancy rate holding basically steady at approximately 12%. Real estate debt capital markets remain robust with credit available from a range of lenders at historically low all-in rates. In the last quarter. lower base rates that tightened spreads of lower financing cost for virtually all borrowers.

While the sales volume totaled $91 billion in the first nine months of 2019, a modest increase from a year ago driven by higher transaction volumes in tech focused markets. Cap rates were generally stable across the country.

At EQC had a very good third quarter, with excellent progress in a number of leasing opportunities. Same property cash NOI was up 6.9%. There were no dispositions during the quarter, year-to-date we completed $812 million of dispositions and we're preparing the market for year-end, Tower 333 in Bellevue, 109 Brookline in Boston and the Green and Harris Buildings in Georgetown.

Since taking responsibility for EQC, we've consistently executed our leasing and asset management funds. In addition, we have sold 161 assets with $6.9 million, with 67 transactions. Proceeds have repaid $3.2 billion debt in preferred, we paid $734 million common distributions, repurchased $245 million of stock that leaves us with a cash balance of $2.8 billion. We've converted at this portfolio of under-managed assets to the cash, we've created value and optionality. Today, we're a fundamentally different company, with small portfolio for all the assets, strong balance sheet, good track record of execution.

Our strategy continued to be informed by market conditions, we will be patient and disciplined in our evaluation of a broad range of investment options. We need to spend time evaluating opportunities in the office markets, office adjacent businesses and other sectors as well where we can buy long-term growth.

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

David Weinberg -- Executive Vice President and Chief Operating Officer

Thank you, David and good morning. Let me begin by recognizing the strong efforts of the EQC team this quarter, especially with respect to leasing. For the quarter alone, a portfolio of 2.5 million square feet, we signed 298,000 square feet of leases, consisting of 116,000 square feet of new deals and 182,000 square feet of renewals. With these leases we addressed our greatest occupancy risks. The largest new deal was 71,000 square feet at 109 Brookline in Boston. This backfills recently vacated space and commences next March, 109 Brookline is a 99% leased. The largest renewal was a two-year extension of Georgetown University's, 129,000 square feet lease at the Harris Building in Washington, D.C., together with the previously signed 18-year, 112,000 square feet lease with the British school at the Green Building, this property is 100% leased.

At Capitol Tower in downtown Austin, we signed a new 21,000 square foot lease that covers a space we got back second quarter, this commences November 1. Capitol Tower is now 98% leased.

Our property in suburban Austin Bridgepoint Square is 87% leased. We are seeing good activity. Austin continues to do well, with a vacancy rate of 9.9%. At 17th Street Plaza in Denver, we expanded one tenant and signed two new leases for a combined 14,000 square feet. This property is 89% leased. While this market remains competitive, with a vacancy rate of 14.5%. We continue to see interest from prospective tenants.

With these deals, our portfolio was 93.5% leased at the end of the quarter. This is up 300 basis points from second quarter and up 40 basis points year-over-year. Rental rates increased 9.1% on a GAAP basis and were flat on a cash basis.

Looking ahead for the remainder of 2019, there are just thousand square feet of leases expiring, half of which we expect to get back. In 2020, there are 192,000 square feet of leases rolling, we expect to get most of this space back. As I previously said, we are seeing strong leasing activity across our properties and are working aggressively to address this alone.

With that I will turn the call over to Adam.

Adam Markman -- Executive Vice President and Chief Financial Officer

Thanks, David. Good morning. I'll review our financial results for the quarter and briefly discuss our recent special distribution. Funds from operations were $0.21 per share of $0.04 per share from the third quarter of 2018, despite a $0.09 per share decrease in FFO caused by $990 million in asset sales over the comparative period.

Setting the effect of the dispositions was $0.05 per share of higher interest and other income, $0.04 per share of lower interest expense, $0.02 per share from lower overhead and $0.01 per share of increased NOI from the same property portfolio. Normalized FFO was $0.21 per share compared to $0.18 a year ago. The growth in normalized FFO was the result of $0.04 per share of increased interest income, $0.04 per share of interest expense savings resulting from debt repayments, $0.02 per share from lower overhead and $0.01 per share of increase in same property cash NOI and termination income. This growth in normalized FFO was achieved despite a decrease of approximately $0.07 per share from property dispositions. Net operating income in the seven asset same property portfolio was up 5.2% or $800,000 in the third quarter compared to a year ago.

Most of the growth was driven by increased rental income from leasing activity in Denver and downtown Austin, including the related increases and escalations and reimbursements. Same property cash NOI was $17.1 million, 6% higher than in the third quarter of last year, driven largely by higher rental income and escalations resulting from leases commencing and the burn-off of free rent in Austin and Denver.

Cash NOI for the quarter does not include $382,000 of revenue from leases in free rent. Additionally, there are116,000 square feet of leases signed, but not commenced on spaces that are currently vacant and therefore not in cash or GAAP NOI. These leases will eventually generate $6.5 million in annual rents. As we've discussed in the past, tenant move-outs will temper growth, in particular Expedia's move out at the end of 2019 will significantly impact the first half of 2020. Amazon have leased this space and will take occupancy and begin paying rent during the third quarter of next year.

General and administrative expense for the quarter totaled $8.5 million. This compares to $10.9 million a year ago, with savings driven by lower share-based compensation and a decrease in payroll expense as a result of staffing reductions earlier in the year. Year-to-date asset sales totaled $812 million. These sales generated a taxable gain that was roughly $340 million in excess of the net operating loss that was carried forward from the beginning of the year. As a result of this taxable gain as well as income generated in the ordinary course of operating our business, we paid a $3.50 per share special distribution last week.

Briefly, turning to the balance sheet, our only remaining loan is a $26 million mortgage, following our recent distribution we have $2.8 billion or $22 per share in cash. Looking ahead to 2020 given the small size of our real estate portfolio and our significant cash balance, we are monitoring the test that requires 75% of the REIT's income to come from qualified investments.

Interest income from bank deposits is not qualified. So we may need to find alternative sources of qualified income. There are multiple ways to generate good REIT income including asset sales and earnings from qualified investments such as mortgage-backed securities and REIT equities and preferreds.

We continue to look for opportunities where our team, liquidity and financial strength, will provide a competitive advantage. Thank you.

And we'll open it up for Q&A.

Questions and Answers:

Operator

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first question comes from Alexander Pernokas with Bank of America Merrill Lynch. Please go ahead.

Alexander Pernokas -- Bank of America -- Analyst

Hi. Good morning, guys. Just following up on your recent comment about the qualified income. Are there any particular instances where you would look to source this income? Is there anything specific that you can point to as a potential source or are you just kind of in the early stages of exploring options?

David Helfand -- President and Chief Executive Officer

Yeah. Well, we have begun the exploration and it's most likely to be agency debt. The liquidity of that market is second only to the treasury market and therefore, it is I think the best way for us to preserve our capital, generate some return on that cash until it's invested.

Alexander Pernokas -- Bank of America -- Analyst

Okay, great. And then could you just walk through the lease up timeline on the under leased spaces and what kind of markets -- mark-to-market on rents, would you expect there? Are you expecting more of the same in terms of flat cash rent growth or more positive? I'm just curious on your thoughts there.

David Weinberg -- Executive Vice President and Chief Operating Officer

Sure. So there is a lot there, so let me begin by just commenting that we reported cash rents were flat this quarter that was heavily influenced by the Georgetown as is short-term renewal, excluding that lease cash rents would have been up 10%. In terms of the leasing opportunities, they're really at three properties. One is 17th Street Plaza in Denver, we're seeing good activity there. The next one is Bridgepoint Square in Austin, seeing good activity there and we have some larger spaces available for the first time, so that should be helpful going forward and then 1250H smaller building some space there, but that is a competitive market, so all three we're seeing good activity. We're aggressively trying to lease space, but I would caution, we have 192,000 square feet rolling next year, most of that space is coming back, and almost all of that space is and one of those three properties. So the leasing we do also we need to take into account the space we expect to get back.

Alexander Pernokas -- Bank of America -- Analyst

Great, thanks. That's it for me.

Operator

[Operator Instructions] Our next question comes from Mitch Germain with JMP Securities. Please go ahead.

Mitch Germain -- JMP Securities -- Analyst

Thanks. Just curious about -- obviously, it looks like you're queuing up a couple of more assets for sale. Boston and Georgetown, obviously, you guys were waiting on some leasing activity which materialized. Curious about the timing on the Bellevue property that lease has been in place for quite some time now. Why sell it now and why not previously or why not wait?

David Weinberg -- Executive Vice President and Chief Operating Officer

Because now we are actually in a position where there is more clarity going into 2020 then there was previously Expedia has started to move out of the property, so them holding over is highly unlikely and we're almost done, completing all the landlord work that is necessary to allow Amazon to move in. So it just made sense to kind of wait until now before taking that to market.

Mitch Germain -- JMP Securities -- Analyst

Got you. And then, just curious the Georgetown asset you went direct with the sub tenant and then a short-term renewal directly with Georgetown is that the way to think about how that outcome?

David Weinberg -- Executive Vice President and Chief Operating Officer

That's correct. Georgetown previously master leased both buildings at subleased to one of them to the British school. We went direct with them on a new 18-year lease that just started and then we went direct and were previously direct with Georgetown on a two-year extension through the other building.

Mitch Germain -- JMP Securities -- Analyst

Got you. Last one from me, I'm curious about the acquisition environment, it seems like there is still a significant pool of capital that you're competing against, particularly for entity level trades -- are you seeing, I'm curious about just the pipeline, are you seeing a number of opportunities that you're excited about? Are you looking -- are you having to stretch to look to new asset classes? I'm just curious how that process is playing out on the deployment side?

David Helfand -- President and Chief Executive Officer

Yeah. Thanks, Mitch, it's David Helfand. We would agree, there still is tremendous capital out there, obviously, both debt capacity and lots of equity. As it relates to what that means for our pipeline, we still are reviewing a variety of things, I mentioned both office related and non-office related and we'll try and find this unique situation where our capital and our team can add value. Haven't found yet, but we're looking at a wide array of things and just got to keep at it until we find the right opportunity.

Mitch Germain -- JMP Securities -- Analyst

Can I follow up on that, when you about non-office related, could it potentially be an asset class that the Equity Group has investments in?

David Helfand -- President and Chief Executive Officer

No. What we've talked about in terms of trying to give some sense of where we're focused, we've said -- it won't be apartments or manufactured housing and it won't be international unless it's just a tail and it likely or almost certainly won't be retail. But other than that there are a dozen other sectors that we probably reviewed opportunities in all of them.

Mitch Germain -- JMP Securities -- Analyst

Thank you very much. Great job.

David Helfand -- President and Chief Executive Officer

Thanks, Mitch.

Operator

There are no further questions I would like to turn the floor over to David Helfand for closing comment.

We appreciate the time this morning and we'll see many of you maybe in Los Angeles. Thank you very much.

David Helfand -- President and Chief Executive Officer

We appreciate your time this morning and we'll see many of you (inaudible) Los Angeles.

Operator

[Operator Closing Remarks]

Duration: 20 minutes

Call participants:

Sarah Byrnes -- Vice President, Investor Relations

David Helfand -- President and Chief Executive Officer

David Weinberg -- Executive Vice President and Chief Operating Officer

Adam Markman -- Executive Vice President and Chief Financial Officer

Alexander Pernokas -- Bank of America -- Analyst

Mitch Germain -- JMP Securities -- Analyst

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