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Whitestone REIT (WSR) Q2 2019 Earnings Call Transcript

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Whitestone REIT  (NYSE: WSR)
Q2 2019 Earnings Call
Aug. 01, 2019, 11:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, and welcome to the Whitestone REIT Second Quarter 2019 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Kevin Reed, Director of Investor Relations. Please go ahead, sir.

Kevin Reed -- Director of Investor Relations

Thank you, Eduardo.

Good morning, and thank you for joining Whitestone REIT's second quarter 2019 earnings conference call. Joining me today -- on today's call are Jim Mastandrea, our Chairman and Chief Executive Officer; and Dave Holeman, our Chief Financial Officer.

Please note, some statements made during this call are not historical and may be deemed forward-looking statements. Actual results may differ materially from those forward-looking statements due to a number of risks, uncertainties and other factors. Please refer to the Company's earnings press release and filings with the SEC, including Whitestone's most recent Form 10-Q, for a detailed discussion of these factors.

Acknowledging the fact that this call may be webcast for a period of time, it is also important to note that this call includes time-sensitive information that may be accurate only as of today's date, August 1, 2019. The Company undertakes no obligation to update this information.

Whitestone's second quarter earnings press release and supplemental operating and financial data package have been filed with the SEC and are available on our website, www.whitestonereit.com in the Investor Relations section.

During this presentation, we may reference certain non-GAAP financial measures, which we believe allow investors to better understand the financial position and performance of the Company. Included in the earnings press release and supplemental data package are the reconciliations of non-GAAP measures to GAAP financial measures.

With that, let me pass the call to Jim.

James C. Mastandrea -- Chairman and Chief Executive Officer

Thank you, Kevin, and thank you, all, for joining us on our second quarter 2019 earnings conference call.

I would like to highlight four areas in my remarks today. First, our continued strong leasing activity related to our value-add properties. Second, our development pad opportunities that we continue to capitalize on. Third, our predictable and sustainable cash flows. And fourth, our progress toward achieving our long-term goals.

My first point is our strong leasing. We continue to focus and execute on our proven and resilient commercial, retail, real estate e-commerce-resistant business model and have posted strong leasing activity in the second quarter. Once again, we continue to build on our solid and predictable cash flow. Our leasing is the result of mixing a well-crafted tenant base developed through our extensive research and analysis, including the demographics and psychographics of the potential consumers in the surrounding neighborhoods of our properties; controlling our real estate through disciplined and leased underwriting that avoids restrictive co-tenancy clauses and employing triple-net structures, percentage rent clauses, shorter-term lease durations and annual base rent increases of 2% to 3% in our leases. This provides us an inflation hedge and participation [Phonetic] in the success of our tenants' businesses.

Our approach avoids the retail disruption that the Internet continues to cause. We focus on the consumer and the entrepreneurial service oriented tenant to drive high volume traffic to our centers. Our proactive leasing allows us to transfer properties market by market to create value. We lease to tenants that are financially sound and primarily entrepreneurial. Ultimately, their success is our success. We have redefined the retail real estate industry by the way we've repositioned our real estate portfolio.

Our approach of leasing to tenants focused on the new e-commerce resistant, service based economy produces consistent leasing results. Our end goal is to create value for all of our Whitestone REIT stakeholders.

Let me now take a moment to highlight some additional detail in our leasing results. During the quarter, we executed 57 leases and 35 -- 57 renewal leases and 35 new leases for a total of 284,000 square feet, representing $26.1 million of lease value. That's incredible. Looking deeper into our leasing results, our same-store occupancy rate was down 190 basis points from a year ago and 67 basis points from the first quarter of 2019. These percentages represent a decrease of leased square footage of approximately 90,000 square feet from a year ago and 30,000 square feet from the first quarter. However, this change in occupancy year-over-year is largely the result of the move-out of only five of our 1,350 tenants.

These tenants are unique in that they occupy large spaces in our portfolio. And they are more representative of the older, traditional retail tenants. Specifically, four of the tenant moveouts were in our Houston market, creating approximately 50,000 square feet of vacancy and one was 47,000 square foot grocery store closed in our Phoenix market. We have previously spoken of this grocery closure at a property in our Phoenix market, which does represent about half of the occupancy decline. In 2018, we received a 47,000 square feet building as part of a lease settlement termination. Interestingly enough, our original interest in the property was only a leasehold interest, so we received the building back and we received a cash settlement. Now it's our opportunity to break this down into smaller spaces, which we've already planned and put it into our production model.

Given our favorable cost basis in this asset, we will continue to work to maximize the long-term value of this asset. Of the balance approximately 90,000 square feet of vacancies as of the end of the quarter, approximately 14,000 square feet are currently under lease and expected to be included in occupancy over the balance of the year. The remaining vacancies are being actively marketed potential replacement tenants.

As we always do, we are evaluating breaking these larger vacant spaces into smaller spaces that demand higher rental rates per square foot and are more attractive with e-commerce-resistant tenant mix that Whitestone properties attract. We believe we have great opportunities to reposition these properties and add value to each as we move ahead.

The second point is related to our development pad opportunities. This value-add component of our strategy includes the development of residual land that we acquire with many of the initial acquisitions at little or no cost when we purchase a property. We are now feeding these parcels of land into our production pipeline to expand leasable square footage and cash flows.

This quarter we completed a multi-tenant 7,000 square foot pad at our Anthem Marketplace property in Arizona at a [Indecipherable] ROI yield of 10.5% at lease terms that are averaging 7.5 years. This successful pad development exemplifies the opportunities we continue to extract from our portfolio to add value to our properties and for our shareholders.

My third point is that our strategy continues to produce predictable, reliable and sustainable cash flows. Our unique value proposition is owning prime community center properties and capturing tenants who provide for the needs of the consumers in the surrounding neighborhoods where they live, work and play. [Indecipherable] in our properties. Our communities are our anchors, not any of the specific tenants. Consumers visit our properties 18 hours a day, seven days a week. Whitestone's strategy focuses on highly attractive growth markets of Dallas, Fort Worth, Austin, San Antonio, Phoenix, Mesa, Gilbert, Chandler and Scottsdale which all sit at top of most every list of the fastest-growing cities in the country.

With such a diverse stream of cash flows where no one tenant accounts for more than 3% of our ABR and locations in such desirable markets, we have built a portfolio over the past nine years to produce cash flows that are predictable, sustainable and continue to increase. As further evidence, Whitestone has produced solid fundamentals that continue to increase such as average base rent that has grown from 4% a year ago to $19.53 primarily as a result of rental rate growth of 7.5% on new and renewed leases signed.

Our balance sheet and capital structure support our business model and growth strategy and provide us stability, flexibility and by, all means, simplicity. We have only one class of stock which is common stock, no joint ventures, no partnerships. What you buy is what you own.

Let me now discuss our continued progress toward our long-term goals. We continue to work to reduce overhead and to scale our overhead by creating efficiencies in our operations to drive increasing, sustainable cash flow. Our long-term goals include reducing leverage, improving general and administrative expense to revenue ratio, making accretive acquisitions and dispositions and redeveloping and developing our out-parcels and land parcels. Our accomplishments at Whitestone are the result of an exceptional leadership team and extraordinary people. We have a strong belief that employee development is fundamental to our business. We hire talented people and remain dedicated to further developing our employees to become our future leaders through our real estate executive development program which we've titled REED, and our first scholar program in conjunction with the Jones Graduate School of Business at Rice University.

From time to time, people will leave Whitestone, and when they do, we want you, our investors, to know that we have a deep bench and others in training to replace it. This helps us in many ways including when we expand our business. But it also helps us to create a workforce who's talented with diverse backgrounds and perspectives and a culture that is performance based and dedicated to achieving our goals.

And with that, I would like to turn the call over to Dave Holeman. David?

David K. Holeman -- Chief Financial Officer

Thanks, Jim.

I am happy to provide a few more details on our second quarter and year-to-date operating and financial results. At the start of 2019, we adopted the new lease accounting standard and as such all income related to tenant leases is reflected in a single rental line on the operating statement. The impact of bad debt is now a component of the single rental line item and is no longer a component of operating and maintenance expenses. And real estate taxes paid by certain major tenants directly to the taxing authorities are no longer reflected in rental income and real estate tax expense. These bad debt and tax changes are reflected in the 2019 reporting periods but have not been made to the Company's 2018 historical results. The Company's net income, net operating income and funds from operations were not impacted by these presentation changes.

We continued to build on our positive start to the year in the second quarter of 2019. We further enhanced the overall quality of our assets and our tenant mix continues to improve as evidenced by increases in our composite average annual base rent per leased square foot.

Net income attributable to Whitestone REIT for the second quarter was $3.3 million or $0.08 per share compared to $2 million or $0.05 per share in 2018. Net income attributable to Whitestone REIT for the six months was $6.1 million or $0.15 per share compared to $5.1 million or $0.12 per share for the six months period in 2018.

NAREIT funds from operations for the quarter was $10 million or $0.24 per share compared to $9 million or $0.21 per share in 2018. For the six months, NAREIT funds from operations was $19.8 million or $0.47 per share compared to $19.1 million or $0.46 per share in 2018. Funds from operations core, which we adjust NAREIT FFO for non-cash, stock compensation and proxy cost professional fees, for the quarter was $11.1 million or $0.27 per share. This compares to $12.4 million or $0.30 per share in 2018. For the six months, our funds from operations core was $22.9 million or $0.55 per share compared to $25.1 million or $0.60 per share in 2018. The decrease in funds from operations core was primarily the result of wholly owned and equity investment property dispositions of $26 million, higher interest cost driven by fixing the interest on a greater percentage of our debt and extending maturities and higher professional fees in 2019.

Our property net operating income was $22 million for the second quarter of '19 as compared to $22.5 million for the same period in 2018. This change was the result of property dispositions in both our wholly owned portfolio and in our equity investments in real estate partnerships. Our same store net operating income for the quarter was flat with the prior year, largely as a result of the 190 basis point year-over-year reduction in occupancy. For the six months, our net operating income was $45 million compared to $45.4 million a year ago. This decrease is primarily due to lower same store occupancy and property dispositions, offset by positive same store rental rate growth producing a year-to-date $460,000 increase in same store NOIs for a 1.1% same store NOI growth on a six month basis.

Adjusting for $1.9 million of proxy content professional fees incurred in 2018, general and administrative expenses for the 2019 second quarter were flat with the prior year quarter. As a percentage of revenue, including our pro rata share of revenue from our real estate partnerships, general and administrative expenses excluding 2018 proxy contest professional fees, were 16.7% for the 2019 six month period, an improvement of 20 basis points from 16.9% in the 2018 six month period. Included in our second quarter 2019 general and administrative expense was $1.1 million for the amortization of stock-based compensation.

We expect the amortization of stock compensation to be approximately $3.5 million for the balance of 2019. Interest expense was $6.5 million for the quarter or $200,000 higher than the prior year as a result of higher interest cost from fixing interest rate and extending maturities. As of the end of the quarter, 87% of our debt is subject to fixed rates. This is up from 64% a year ago. Our weighted average interest rate is 4.1%, which is up from 3.9% a year ago, and our average remaining term on our debt is approximately 5.5 years which is an improvement from 3.5 years a year ago.

Now turning to our balance sheet. At the end of the quarter, our ratio of net debt to undepreciated total real estate assets was 57.9%, which is an improvement of 40 basis points from a year ago. As I mentioned last quarter, we significantly improved our underlying debt structure through the amendment, extension and expansion of our credit facility and the inaugural issuance of corporate bonds. The result of these actions was a greater percent of our debt is subject to fixed rates, we now have a well-laddered debt maturity schedule with minimal near-term debt maturities and extension of the average debt tenure and a largely unsecured debt structure.

Let me now discuss in greater detail our leasing. The second quarter leasing activity represents a 42% increase in leased square footage and a 65% increase in total lease value compared to the first quarter of 2019 and a 58% increase in leased square footage and a 57% increase in total lease value compared to the second quarter of 2018. Consistent with our focused tenant mix strategy, our leases signed for the year have an average lease size of 2,800 square feet and an average lease term of approximately four years. Our GAAP leasing spreads on a trailing 12 month basis are 8% increase for renewals and a positive 5% for new leases.

Lastly, turning to our outlook for 2019. We are reaffirming our previously issued guidance.

And Jim and I would now be happy to take your questions.

Questions and Answers:

Operator

[Operator Instructions] We'll now take our first question from Mitch Germain from JMP Securities. Please go ahead.

Mitchell Germain -- JMP Securities -- Analyst

Thank you. On your renewal leases, on the renewals, I saw term came down a bit. I think term -- lease term overall for the quarter was a little bit lower than the last couple [Indecipherable]. Is that by design? Or is this a trend that is in the market right now?

David K. Holeman -- Chief Financial Officer

I could start out and Jim will probably add. Hey, Mitch, thanks for the question. I think as we've communicated we really do enjoy the shorter-term leases because it gives us the ability to be more proactive in our ownership of real estate to move the rates. As we've always said, obviously one quarter is not a trend. We continue to focus on leases kind of in that three to five year range with 2% to 3% annual bumps, and we're very comfortable with that as it gives us the ability as we improve the quality of real estate to move the rental rates.

James C. Mastandrea -- Chairman and Chief Executive Officer

Yeah. Mitchell, I'd like to add that tenants who are the entrepreneurial smaller type tenants, they're not thinking in terms of what's the square foot rent. They're thinking in terms of absolute numbers. So they're paying $2,500 a month and you say that -- and you say their increase is an absolute number, which is may be $300 a month. They don't think in terms of what's the percentage of that and we are able to charge them appropriately. Also, we're able to adjust the rents to avoid the NAV increases that we might find in some of the [Indecipherable] operations. But finally, when you have really great properties in strong neighborhoods, and you've seen many of them, their businesses do so well because we attract a lot of people that they don't want to lose that advantage they have in the marketplace. And so they're usually willing to go along. We just want to be careful that we're always fair in terms of what we charge -- what we charge and what the market will bear. And there's -- it's about a two to three year period, sometimes four years, when you buy a value-add property to adjust it to get it up to market rents. And then often, if you have the shorter-term leases you can quickly -- you can get it more quickly up to what the market rents are in the surrounding five-mile radius.

Mitchell Germain -- JMP Securities -- Analyst

Great. The Anthem land -- I know it's about 60% occupied. Maybe, one, what's the plan to stabilize that parcel or that development? And then two, what other projects are under way in the portfolio similar to that one?

David K. Holeman -- Chief Financial Officer

Yeah. Hey, Mitch, it's Dave. I'll start out and -- we'll go back and forth. So we did complete Anthem, 7,000 square feet pad in Arizona. It's going to have three tenants. One of those tenants is currently occupying 58% of the space. The balance of the space is split between two tenants. Half of that space is currently leased and expected to move in probably in the balance of the year. And then the other tenant we are marketing. So we're very confident with about plus 70% leased and just one space to fill up. And I think we communicated the returns on that are very good with a kind of plus 10% cash of return on our investments. In the portfolio, we have a number of pad sites and I'm going to kick it over to Jim to talk about that.

James C. Mastandrea -- Chairman and Chief Executive Officer

Yeah, we do -- in fact some of those pad sites are very, very large. They're actively in the planning stage right now. For example [Indecipherable] we're in discussions with a major coffee company for a pad that was covered up with asphalt. So that's in progress. In Fulton Ranch down in there -- in the technology sector of Phoenix, we've got several pads that we're looking to develop down there. Market Street which is located in DC Ranch, we have a pad that can accommodate about 50,000 square feet more of buildings. And we're in the discussions -- in some design discussions. BLVD Place in Houston is really, really hot right now. And since we bought that property, where the Whole Foods is located as you know, there were two apartment buildings built behind it. One was 350 units, another one was 240 units. They're both up and operating now. Right across the street -- literally across the street is another 340 unit building and it happens to be to be main and main, which is the best location for some office space and some mixed space more. And so we have about 140,000 square feet of space we can build there.

We have -- Memphis is open. It's a Mexican restaurant. We've had meetings with the Rooftop theater operator, and they're now asking us if they can put a second screen on top of the roof. So we have some development plans there. And then, not finally but one of the ones I care to mention today is Dana Park which is down in Mesa. Mesa is now in the top 50 cities in the country. It's just growing very, very fast again. And we have plans laid out for about 200,000 square feet of additional retail. There is also multifamily plans there for 340 units and then plans for a hotel. So we've got a lot of things on the drawing board. It keeps a team of a few people very, very active.

Mitchell Germain -- JMP Securities -- Analyst

Great. Last one for me. Do you have any additional asset sales that you're planning in the back part of the year?

David K. Holeman -- Chief Financial Officer

We have -- we'll continue to look at our portfolio. There are -- in our equity investment in our real estate partnership, I think there are currently three assets that are for sale there that the proceeds would be -- some portion of it would come to Whitestone business to pay us down. So, nothing currently active in our wholly owned portfolio. In the equity investments, there are three properties, and we're going to continue to look at our capital sources which involve selling properties when we feel like we've added all the value we can.

James C. Mastandrea -- Chairman and Chief Executive Officer

Yeah, and Mitchell, I can say that just to follow on Dave's comment on the equity investment we have in the company called Pillarstone, which you're well aware of. In fact, when we were talking to you and others we've said we think that Whitestone should become a pure real estate retail play as when we develop that business model. We're now in the process of selling off. We have a LOI, not a contract, for three properties that once sold will pay off all the debt owed to Whitestone and the debt owed to one of the insurance company banks.

Mitchell Germain -- JMP Securities -- Analyst

Thank you.

David K. Holeman -- Chief Financial Officer

Thank you.

Mitchell Germain -- JMP Securities -- Analyst

[Indecipherable].

James C. Mastandrea -- Chairman and Chief Executive Officer

You're welcome.

Operator

[Operator Instructions] We'll now take the next question from Craig Kucera. Please go ahead.

Craig Kucera -- B. Riley FBR -- Analyst

Yeah. Thanks. Good morning. And I apologize if you addressed this earlier. But you had a pretty sizable decline in your SG&A expense both year-over-year and sequentially, both cash and non-cash. Was this a light order? Or how should we think about sort of a run rate for G&A on both a cash and a non-cash basis for the rest of the year?

David K. Holeman -- Chief Financial Officer

Yeah. Thanks, Craig. So let me just -- to your question. Included in our G&A, as you said, is both a cash portion and then the amortization of our stock compensation. In the second quarter of '19 that amortization of stock compensation was a little lower than some of the other quarters. It was $1.1 million. For the balance of the year, we expect that non-cash G&A portion to be about $3.5 million for the next two quarters in total. And then the cash portion of G&A was relatively flat with the first quarter. And I think the cash portion of the G&A for the second quarter is a pretty good run rate. And then the non-cash portion, which is just the amortization of stock compensation, should be about $3.5 million for the balance of '19.

Craig Kucera -- B. Riley FBR -- Analyst

Okay. Great. And just circling back to some of your leasing activity, I think the cash leasing spreads have been sort of trending down the last few quarters. Occupancy's, I think sort of peaked maybe in third quarter at 92% and has softened a bit. I think last quarter you mentioned that you thought you needed to shuffle some things internally, there was maybe a bottleneck. Do you think you've taken care of kind of those things internally? Or are we sort of still midstream in that activity?

David K. Holeman -- Chief Financial Officer

Yeah. I think -- we'll both comment as well. I think obviously we feel like we got a really good team in place to drive occupancy. I think we talked about on the call that the decline in year-over-year occupancy is largely the result of kind of five larger-space tenant boxes in our portfolio. I think we're obviously working through those. But we got -- we have really good lease activity so far this year. The second quarter lease activity from a volume standpoint was very strong. On the spreads, you're right. The cash spreads over the last three quarters have been a little lower. Our GAAP spreads have been in that kind of 7.5% range. We're continuing to watch those. We're continuing to be focused on pushing our occupancy as well as pushing the rates.

James C. Mastandrea -- Chairman and Chief Executive Officer

Yeah. And Craig, one of the -- this is Jim. One of the things that changed it's -- to us, it's all about the people. And what we did is we switched around a process in terms of meeting and discussing leases where now we do it once a week for two hours at the beginning of the week, and it's really all the regions calling in on a conference call, going through their activity lease by -- believe it or not, lease by lease by lease, and we have someone who leads that process who's very, very good at it. The change was -- the difference is, we're doing it on a regional level and expecting a person to bring that all together for the senior management team. Now, what we've done is we've changed it to have all of the leasing people -- so the underwriting is the same. And we have a senior manager -- management person, namely me, at those meetings, so that when there's decisions made that deviate from a policy or a process that we might have, it's made right away. An example would be we don't subordinate leases. We don't subordinate our leases to any loans from banks, and answer that question right away. We don't permit any co-tenancy provisions, that's answered, it's off the table right away. We must have personal guarantees, answered right away. So the whole process of filtering is the same. And then on Saturdays, we pick a different person and they usually take us out and show us what they're doing in one of the marketplaces. Little boring to tell you that, but that's what we do.

David K. Holeman -- Chief Financial Officer

Craig, I might just add one thing as well to Jim. I touched on this, the leasing activity. I think one of the things that are -- that's really positive so far this year that potentially you don't see is, if you look for instance at our renewal volume, we've renewed almost 50% more square feet this year than we did in the six month period last year. Ultimately, what that results in is, some of those leases that are not coming in due for six months or something, but ultimately that results in a greater retention rate and higher occupancy levels. So that lease activity we think is a really good leading indicator of our future results.

Craig Kucera -- B. Riley FBR -- Analyst

All right, guys. Thanks for the color.

David K. Holeman -- Chief Financial Officer

Thanks, Craig.

Operator

It appears there are no further questions at this time. I'd like to turn the conference back to Mr. Mastandrea for any closing remarks. Thank you.

James C. Mastandrea -- Chairman and Chief Executive Officer

Yes. Thank you, all. Thank you very much. Just in closing, I'd like to say that from our perspective we continue to believe that our strategy is proving -- it's predictable, it's reliable and it's sustainable cash flows. I believe I commented the last call that we had that if you take from the time we did our IPO through the time that 12/31/18, we had paid out approximately $260 million in dividend. And I say that only because it's a stat that you don't really hear at any place or look at any place. But the meaningfulness behind that is the level of very close tolerances where we run our business, and we feel very confident that we can continue to run that and maybe even see it get better in the shorter term and even longer-term future. All the results can be seen in our leasing success. We have achieved year-to-date incredible results and we continue to ring true as our -- as we progress toward our long-term goals. So, I'd like to thank you all for joining us on our call today, and look forward to our call next quarter. Thank you, all.

Operator

[Operator Closing Remarks]

Duration: 37 minutes

Call participants:

Kevin Reed -- Director of Investor Relations

James C. Mastandrea -- Chairman and Chief Executive Officer

David K. Holeman -- Chief Financial Officer

Mitchell Germain -- JMP Securities -- Analyst

Craig Kucera -- B. Riley FBR -- Analyst

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