Greetings. Welcome to the Equity Commonwealth Second Quarter 2021 Earnings Conference Call. [Operator Instructions] Please note this conference is being recorded. I will now turn the conference over to your host, Sarah Byrnes. You may begin..

Thank you, Alex. Good morning and thanks for joining us to discuss Equity Commonwealth’s results for the quarter ending June 30, 2021 and an update on the merger between Equity Commonwealth and Monmouth Real Estate Investment Corporation. On the call today are David Helfand, President and CEO; David Weinberg, COO; and Bill Griffiths, CFO.

Please be advised that certain matters discussed during this conference call, including relating to the pending merger, may constitute forward-looking statements within the meaning of federal securities laws.

We refer you to the section titled Forward-Looking Statements in the press release issued yesterday as well as the section titled Risk Factors in our annual report on Form 10-K and quarterly reports on Form 10-Q for subsequent quarters, for a discussion of factors that could cause actual results to materially differ from any forward-looking statement.

The company assumes no obligation to update or supplement any forward-looking statements made today. We have made important filings with the SEC in connection with the pending merger. Today’s call is not intended to be and is not a substitute for those filings.

We urge you to read those materials carefully before making any voting or investment decisions. We also post important information on our website at www.eqcre.com, including information that maybe material. The portion of today’s remarks on our quarterly earnings also includes certain non-GAAP financial measures.

Please refer to yesterday’s press release and supplemental containing our results for a reconciliation of these non-GAAP measures to our GAAP financial results. With that, I will turn the call over to David Helfand..

Thanks, Sarah. Good morning. We appreciate you joining us. I will begin with an update on today on the company’s current activities as we prepare to complete the merger with Monmouth. Since we announced the deal with Monmouth in May, we have been focused on the successful completion of the transaction and integration of the Monmouth assets and team.

As we spent more time with the Monmouth team and toured more of the real estate, our conviction and excitement for the deal has grown. We continue to view the merger as a compelling opportunity for both Equity Commonwealth and Monmouth’s shareholders to participate in the opportunity to build a leading business in the industrial sector.

We believe the tailwinds propelling the business will continue with strong demand driven by e-commerce expansion, as well as reshoring by U.S. manufacturers and retailers, increasing inventory levels to mitigate supply chain challenges.

Combination of Monmouth’s portfolio of high-quality assets with cash flows from creditworthy customers, coupled with approximately $5 billion of balance sheet capacity, provides the combined entity with the ability to grow without the need to raise equity.

As the market for industrial product remains highly competitive, cap rates continue to compress. We’re looking at a broad range of opportunities, including M&A, large portfolios and working closely with merchant builders to source investment opportunities.

Our investment philosophy is less focused on targeting specific markets and instead is guided by identifying opportunities to achieve attractive risk-adjusted returns.

With respect to the shareholder meeting to vote on the transaction, this morning, we filed an amendment to the proxy, changing the date of the shareholder meeting to August 24 to comply with notice requirements. As we approach the vote, we look forward to engaging with investors on this transformational opportunity.

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

Thank you, David and good morning everyone. I am going to cover where we’re spending our time and then I’ll give an update on our office portfolio. First and foremost, we are digging into Monmouth’s real estate. Our investments team is traveling every week, touring the properties and markets and meeting with tenants and local brokers.

Most of the portfolio’s value is in well-located, newer, state-of-the-art buildings. For example, the average property age is 10 years, and 80% of the revenue is from properties that were built the last 15 years. 90% of the revenue is from properties with clear heights of 24 feet or higher.

And with an overall coverage ratio of just 21%, many properties have land to accommodate today’s higher parking requirements and provide future expansion opportunities. The properties are well maintained. Brokers are giving us positive feedback, and the tenants are fully utilizing their buildings.

In many cases, tenants have made substantial investments in their spaces that should increase their stickiness. The investments team is also underwriting new acquisitions, and with the help of Mike Landy, meeting with merchant builders. We are introducing ourselves and letting them know that we are looking at a broader range of investments.

Rather than buy only single-tenant net leased assets, we are willing to take on leasing and development risk. While this is a single-tenant net lease portfolio, there is still work to be done. There are 6 acquisitions totaling 1.8 million square feet under contract for $238 million.

These properties have a weighted average lease term of 13.5 years and are expected to generate $13.7 million in annual rent. There are also several parking lot expansions in progress and more under discussion. These expansions are expected to cost around $30 million and have historically been structured at un-leveraged yields around 10%.

And with any portfolio of this size, there are leases rolling that need to be addressed. In all cases, our team is working side by side with the Monmouth team to identify ways to maximize value.

Turning to our office portfolio, in the quarter, we signed 29,000 square feet of leases, consisting of 8,000 square feet of new leases and 21,000 square feet of renewals. Rental rates for renewals increased 20% on a GAAP basis and 13% on a cash basis.

Our 4-property 1.5 million square foot portfolio ended the quarter 83.1% leased, down 250 basis points from the first quarter. For the remainder of the year, we have 51,000 square feet rolling, almost all of which we expect to get back. Inquiries and tours have picked up, and we are hopeful this will lead to more signed leases later this year.

We continue to work our office properties while we focus on closing the Monmouth transaction and are excited for the next chapter of EQC. With that, I will turn the call over to Bill..

Thanks, David. Good morning, everyone. I will briefly review our financial results for the quarter and then address our progress to date on accounting and tax integration on the Monmouth transaction. Funds from operations were $0.4 million this quarter compared to $3.1 million in the second quarter of 2020.

Normalized FFO was a negative $0.1 million compared to a positive $3.7 million a year ago. The changes to both FFO and normalized FFO were primarily due to lower interest income and a decrease in income from properties sold, partially offset by a decrease in G&A. Same-property net operating income was down 1.9% or $0.2 million for the quarter.

The decrease was largely due to occupancy decreases at 1250 H Street and capitol tower, lower parking revenue and modest increases in operating expenses. These decreases were partially offset by increases in straight-line rent, as well as an increase in commenced occupancy at 1225 Seventeenth Street.

Excluding straight-line rents, same-property cash NOI was $7.7 million, a decrease of 12.8% or $1.1 million compared to last year. General and administrative expense was $7.4 million for the quarter, an improvement of $0.9 million or 11% compared to last year.

Separately, $4.2 million of costs related to the Monmouth transaction have been incurred through June 30. We have significant balance sheet capacity with no debt and $3 billion of cash or over $24 per share, earning an average interest rate of roughly 22 basis points.

Finally, we have $150 million available on our share repurchase authorization, which expires in June 2022. Turning to the Monmouth transaction, our accounting and tax teams have been working in full transition mode for the last couple of months.

We are coming up to speed on Monmouth’s processes and procedures and have developed strong working relationships with our counterparts there. Our systems integration plan is in place and ready to execute at closing. Thank you. And with that, we will open it up to Q&A..

Thank you. [Operator Instructions] Our first question comes from Manny Korchman with Citi. Please proceed with your question..

Hey, good morning everyone. David, you spoke about meeting – going out to meeting with the merchant builders to sort of build out the pipeline or better understand the pipeline.

Are there relationships in place where sort of their contractual or otherwise set that these particular builders sell everything to Monmouth or something along those lines or if not, what’s sort of your competitive advantage, other than paying highest dollars, to get those deals? Thanks..

Well, to answer your first question, the only contractual relationships they have are the six acquisitions I referenced in my prepared remarks, nothing beyond that.

And then in terms of the competitive advantage, I’m not sure I can point to any specific one, but I would say we’ve got $5 billion of buying capacity, and these merchant builders have pipelines much larger than they have ever had in the past.

So they are looking to further these relationships with preferred buyers to make their lives easier, and we hope we’re one of the few that are selected..

And I would add that the introduction from Mike and his team has been a warm introduction. Monmouth has a history of performing with these merchant developers. They know what to expect and we have assured them that they can count on us when we commit that we’ll close like Monmouth has in the past..

And David, again, one – for one of the Davids, there is obviously the competing bid from Starwood out there, but Monmouth has still chosen your deal.

What is the likelihood or how much do you think about having to change your deal to get this closed when the vote comes around on the 24th?.

Well, I don’t know the answer to the question.

What I know is that there are a competing bid out there, but I don’t believe – we don’t believe that anyone offers the same combination that Monmouth and Equity Commonwealth shareholders can avail themselves of, which is the foundation of the Monmouth assets, a stock deal that is tax deferred and capacity to grow the business from where it is.

I think that’s what makes our deal unique..

And one last one for me, in terms of the office sales, you’ve put out a plan to sell down the remaining assets.

Do you need leasing to accelerate or are you willing to just exit those per the plan you’ve set out and make yourselves a pure-play industrial no matter where leasing or other kind of lens?.

Yes. I don’t – to answer your question, given two of the assets are in Austin and there is a lot of capital looking to find a home in Austin.

We’ve got a great asset in Denver, which is 92% leased with Salesforce logo at the top and a nice-sized asset in DC, but not too big, which is a highly liquid market, I wouldn’t say we need to stabilize any of those assets.

We are in an environment, especially given the Austin assets, where we may find buyers are so bullish on lease-up and market dynamics that we will look at a hold-sell analysis and conclude it’s better to sell it as is than hold it. But I wouldn’t interpret that to mean we’re going to cut and run.

We’re going to be thoughtful about it and see what’s the best way to maximize value given those dynamics?.

Okay, thank you all..

Thank you. Our next question comes from Daniel Ismail with Green Street. Please proceed with your question..

Great, thank you.

As we have gotten to know the Monmouth portfolio and the industrial sector a bit better, has there been any changes to the prospective strategy that you can envision this portfolio shaping up to be, assuming the deal closes?.

No. I think our strategy, at least what we’ve articulated to date, in terms of the existing portfolios, we recognize the concentration with respect to FedEx is too high. And we’re going to either have to grow our way out of it and/or sell down some of that position. As David referenced, the industrial market, cap rates continue to compress.

Rent growth is still accelerating, and it may be easier to sell some of those FedEx assets in nontraditional institutional markets given this environment. But that would be the only impact on the existing strategy today.

Then otherwise, as David said, in terms of acquisitions, we’re keeping our eyes open, looking at many different types of deals on the risk spectrum, and we’ll continue to do so..

Great, thanks..

Thank you. [Operator Instructions] Ladies and gentlemen, there are no further questions at this time. I would now like to turn the call over to David Helfand for closing remarks..

Thank you, guys, very much for joining us this morning. I just want to take a minute and acknowledge the Monmouth and EQC teams that have been working extremely hard to create a smooth transition and merger of the two companies. We are excited about the deal.

We are optimistic about the opportunity, and we believe that the combination is unique and an option for Monmouth’s shareholders to participate going forward with what we are going to all create together. So we look forward to talking with you as we move this deal towards closure. Thank you very much..

This concludes today’s conference, and you may disconnect your lines at this time. Thank you for your participation, and have a wonderful day..