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Edited Transcript of NRE earnings conference call or presentation 13-Mar-19 1:00pm GMT

Q4 2018 Northstar Realty Europe Corp Earnings Call

NEW YORK Apr 1, 2019 (Thomson StreetEvents) -- Edited Transcript of Northstar Realty Europe Corp earnings conference call or presentation Wednesday, March 13, 2019 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Keith A. Feldman

Northstar Realty Europe Corp. - CFO & Treasurer

* Mahbod Nia

Northstar Realty Europe Corp. - CEO, President & Director

* Trevor Kincaid Ross

Northstar Realty Europe Corp. - General Counsel & Secretary

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Conference Call Participants

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* Bryan Anthony Maher

B. Riley FBR, Inc., Research Division - Analyst

* Mitchell Bradley Germain

JMP Securities LLC, Research Division - MD and Senior Research Analyst

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Presentation

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Operator [1]

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Hello, and welcome to NorthStar Realty Europe Fourth Quarter Earnings Call. My name is Shawn, 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.

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Trevor Kincaid Ross, Northstar Realty Europe Corp. - General Counsel & Secretary [2]

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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'll now turn the call over to our CEO, Mahbod Nia.

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Mahbod Nia, Northstar Realty Europe Corp. - CEO, President & Director [3]

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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, the U.K. 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 re-leased 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'd 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 remain stable, with favorable financing conditions and labor market dynamics set to continue to provide underlying support for 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, with the ECB 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 the new monetary stimulus package aimed at encouraging banks to provide credit to consumers and businesses.

Looking at the U.K., Brexit remains a key focus with continued uncertainty negatively impacting sentiment. The U.K. economy recorded a mere 0.2% growth during the fourth quarter or 1.4% for the full year 2018. European Commission forecasts the U.K. economy to grow by 1.3% in both 2019 and 2020.

Over to the real estate market. Total European commercial real estate investment volume stood at EUR 94 billion in the fourth quarter and EUR 312 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 continue 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 a lack of demand. Strong demand at the 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 EUR 77 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, that's a 4.2% and 6.8% increases in prime and average rents across the top 6 German cities, respectively.

Total U.K. investment volume reached GBP 16 billion in the fourth quarter and GBP 65 billion for the full year 2018, a 6% decrease compared to 2017. Central London office investment volume totaled GBP 20 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 EUR 31 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 31, 2018, our 206,000 square meter portfolio comprised of 18 properties with the 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 an uplift of $43 million or $0.86 per share compared to the 2018 midyear valuation, driven by leasing and asset sales at a significant premium to their June valuation.

In total, we sold 7 properties last year with 3 additional sales completed earlier this year. Our ability to materially enhance the value of these assets prior to sale is reflective of our continued commitment through active asset management as we seek to generate value for our stockholders. These sales released approximately $450 million of net equity to NRE after repayment of financing and transaction costs.

During the first quarter of 2019, we completed the sale of Uhlandstrasse in Frankfurt for $41 million, 65% of our allocated purchase price, including CapEx. During our ownership, we have extended lease agreements for 70% of the lettable area and increased the weighted average lease term by around 4 years, enhancing the value of the property.

We also recently completed the disposal of our 2 retail assets in Germany, Werl and Kirchheide. Since entering the European market in 2014, we've sold 37 properties, exited 6 countries and significantly reduced our exposure to the non-office properties, demonstrating a 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.

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Keith A. Feldman, Northstar Realty Europe Corp. - CFO & Treasurer [4]

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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 a realized 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 an 85% tenant retention rate across -- achieved across our portfolios since 2015.

Our leasing activity during 2018 included a 9-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 of 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 nonrecoverable operating expenses and other onetime 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've 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 31, 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 31, 2018, NRE's overall leverage was 40%, down from 52% a year earlier, and our weighted average debt maturity was approximately 5 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, and approximate 25% discounts were at current trading price. As of March 8, we have $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 U.S. dollars, which was converted from euros at a rate of approximately $1.145.

In addition, in February, NRE joined the S&P Small Cap 600 index, which appears to have resulted in increased liquidity in our stock. On March 7, we declared a cash dividend of $0.15 per share of common stock. This dividend is expected to be paid on March 29 to stockholders of record as of the close of business on March 25.

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.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We have a call -- a question from the line of Bryan.

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Bryan Anthony Maher, B. Riley FBR, Inc., Research Division - Analyst [2]

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

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Mahbod Nia, Northstar Realty Europe Corp. - CEO, President & Director [3]

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Bryan, yes, I think the moderation, I think it's important to put that into context. The eurozone is still growing well above -- or in line or actually slightly above its long-term average growth rate. And certainly, I would say the weighted capital we see in 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 [happened here], 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 regards to our assets, I think we're in a fortunate position to own great assets with a 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.

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Bryan Anthony Maher, B. Riley FBR, Inc., Research Division - Analyst [4]

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

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Keith A. Feldman, Northstar Realty Europe Corp. - CFO & Treasurer [5]

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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.

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Bryan Anthony Maher, B. Riley FBR, Inc., Research Division - Analyst [6]

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

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Mahbod Nia, Northstar Realty Europe Corp. - CEO, President & Director [7]

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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 there's still a very strong weighted 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 all very -- 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.

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Bryan Anthony Maher, B. Riley FBR, Inc., Research Division - Analyst [8]

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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 2 quarters? What are your thoughts there?

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Mahbod Nia, Northstar Realty Europe Corp. - CEO, President & Director [9]

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So I am not really in a position to comment. The strategic review committee, and their advisers are in the process of conducting a strategic review to explore 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 30 was referenced. We don't have any other date beyond that.

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Operator [10]

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(Operator Instructions) We have a question from Mitch of JMP Securities.

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Mitchell Bradley Germain, JMP Securities LLC, Research Division - MD and Senior Research Analyst [11]

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

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Mahbod Nia, Northstar Realty Europe Corp. - CEO, President & Director [12]

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Mitch, it's Mahbod here. It's quite varied, to be honest with you. So if you look at the $1 billion, obviously, the 2 big assets within that were the Trianon and the Maastoren, both different groups of capital. The Trianon, as you probably heard, went to an Asian investor, through a consortium of. But then some of the assets, the smaller ones, the Uhlandstrasse, Werl, Kirchheide, the U.K. assets went to a very different contingent, very different type.

So I'd say it's anything from sort of small ones, local, high net worth to institutional to 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.

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Mitchell Bradley Germain, JMP Securities LLC, Research Division - MD and Senior Research Analyst [13]

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

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Mahbod Nia, Northstar Realty Europe Corp. - CEO, President & Director [14]

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Well, the obvious ones that are noncore or non-office, Marly-la-Ville, the logistics asset and there's 2 hotel deals. And your expectation should be that it's likely that those will be divested.

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Keith A. Feldman, Northstar Realty Europe Corp. - CFO & Treasurer [15]

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And Marly is held for sale.

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Mahbod Nia, Northstar Realty Europe Corp. - CEO, President & Director [16]

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And Marly is held for sale, yes.

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Mitchell Bradley Germain, JMP Securities LLC, Research Division - MD and Senior Research Analyst [17]

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Got you, got you. Last one from me. Is there any update on the BNP real estate lease? I know it's about a year of term remaining, and I know that 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?

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Mahbod Nia, Northstar Realty Europe Corp. - CEO, President & Director [18]

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Yes. I can certainly provide some insight. So BNP, you may know this, but BNP Real Estate, who are the tenant in that building, different from 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 their M.O. They find a site, they get planning, they build, they move in, they sign a lease they sell, they go 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 Paris 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 capabilities. And so we feel that they're pretty wedded to that asset or rather have no choice but to remain in the asset until their new building is developed, and that won't be until 2022. Whether that results...

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Mitchell Bradley Germain, JMP Securities LLC, Research Division - MD and Senior Research Analyst [19]

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So the like -- so, I was going to say, a likelihood a short-term extension, is that kind of what you're expecting?

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Mahbod Nia, Northstar Realty Europe Corp. - CEO, President & Director [20]

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Yes. So I mean, I think the 2 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.

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Mitchell Bradley Germain, JMP Securities LLC, Research Division - MD and Senior Research Analyst [21]

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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?

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Mahbod Nia, Northstar Realty Europe Corp. - CEO, President & Director [22]

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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 at current rent, as is also quite common in France and have the right to do that. So that -- there's multiple factors that play into that.

And if you sign a formal lease, then you may need to offer some contributions, current contributions, incentives, all that, and then we need to balance that with to be really economically beneficial in that effective rent basis. So I think the important thing to note that we don't see there being many options for them, if any, actually. And with this moment to -- or the delay to their existing building, I think that's like -- our expectation is they're likely to be in there until 2022.

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Mitchell Bradley Germain, JMP Securities LLC, Research Division - MD and Senior Research Analyst [23]

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Got you. Actually, one more from me, if you don't mind. Are there any -- I mean, obviously, 6 years plus of average lease 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?

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Mahbod Nia, Northstar Realty Europe Corp. - CEO, President & Director [24]

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Nothing out of the ordinary. I mean, like I said, with a portfolio like ours, there's always a few around the edges. More tenants whose leases may be coming up for expiry and will need extension or reletting. But I would really describe that all as ordinary course of business, but not being significant in size or anything or nothing that really concerns us in any way.

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Operator [25]

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

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Mahbod Nia, Northstar Realty Europe Corp. - CEO, President & Director [26]

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

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Operator [27]

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