Easterly Government Properties, Inc. (NYSE:DEA) Q4 2023 Earnings Call Transcript February 27, 2024
Easterly Government Properties, Inc. misses on earnings expectations. Reported EPS is $0.04 EPS, expectations were $0.29. DEA isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Greetings. Welcome to the Easterly Government Properties Fourth Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session between the company’s research analysts and Easterly’s management team. [Operator Instructions] Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Lindsay Winterhalter, Head of Investor Relations. Please go ahead.
Lindsay Winterhalter: Good morning. Before the call begins, please note that certain statements made during this conference call may include statements that are not historical facts and are considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Although the company believes that its expectations as reflected in any forward-looking statements are reasonable, it can give no assurance that these expectations will be obtained or achieved. Furthermore, actual results may differ materially from those described in the forward-looking statements and will be affected by a variety of risks and factors that are beyond the company’s control, including without limitation, those contained in the company’s most recent Form 10-K filed with the SEC and in its other SEC filings.
The company assumes no obligation to update publicly any forward-looking statements. Additionally, on this conference call, the company may refer to certain non-GAAP financial measures such as funds from operations, core funds from operations and cash available for distribution. You can find a tabular reconciliation of these non-GAAP financial measures to the most comparable current GAAP numbers in the company’s earnings release and separate supplemental information package on the Investor Relations page of the company’s website at ir.easterlyreit.com. I’d now like to turn the conference call over to Darrell Crate, CEO of Easterly Government Properties.
Darrell Crate: Good morning, everyone, and thank you for joining us for this fourth quarter conference call. Today, in addition to Lindsay, I’m also joined by Meghan Baivier, the company’s President and COO and Allison Marino, the company’s CFO and CAO. We’re pleased with the earnings results for 2023, and we look forward to continuing to deliver predictable earnings to our shareholders supported by our foundation of leases backed by the full facing credit of the United States government. As you saw in our guidance, we are executing on a path for strong core FFO growth in 2024. Allison will speak to that in more detail. Needless to say, we’re excited to share our outlook with you. For over a decade, we have been honing a definable edge in the mission critical facilities that serve our government.
Our goal is to use that edge to provide our shareholders with a stable, predictable cash flow stream. By specializing in these mission critical properties, Easterly can play an important role in supporting essential functions for the United States government and its adjacent partners. While office REITs contend with remote work threatening their occupancy outlook and portfolio growth, Easterly’s facilities remain critical to the safety and security of our government agency partners. Accordingly, this provides that stability we seek for our investors. While we are discussing predictability, let me address our dividend. We fully acknowledge our higher than average payout ratio and we are confident in our ability to maintain and grow our dividend.
Our disciplined approach to prudently managing our balance sheet, our unique long-term visibility of cash flows and the creditworthiness of our U.S. government tendencies continue to serve as sources of stability and growth. The CapEx in our buildings is predictable and the demands for capital expenditures by our tenants are not excessive. Our view is to return as much cash flow to investors as is reasonable as a strong steward of their capital. The leases we have today provide $2.9 billion of rental income backed by the full facing credit of the U.S. government. With only one renewal of all of our assets to only a 10 year term at a 10% spread, these aggregate cash flows will be just under $6 billion in rent. And as Meghan will share when she discusses our renewals to date, you will see those assumptions are quite modest.
Given the strength of this cash flow, we are confident in our ability to provide healthy dividends to our investors for the years to come. What also sets us apart from typical office REITs is our commitment to customization. Our buildings are equipped and fortified with infrastructure and security protocols to ensure uninterrupted operations for key government agencies, such as the Drug Enforcement Administration and the Federal Bureau of Investigation. To reiterate, these assets have one important trait in common. They all help fulfill important government missions that cannot be accomplished from home. For example, drug enforcement agents require secure labs to analyze and store confiscated contraband. FBI agents must investigate crimes in person and if facilities designated for their use.
Our facilities continue to support the work that ensures the safety of the country and as a result 97% of our properties remain leased. It’s clear to us that as we explore how to best collaborate with other state and local agencies we find additional facilities with similar longevity with the added benefit of lease escalations. We see potential to grow our holdings of government and government adjacent assets with lease escalations to approximately 15% of our portfolio. We can further apply our definable edge in development of properties for both government tenants and government adjacent tenants that have similar facility needs to our most tenant improvement intensive buildings. We’re keenly aware of investor seeking the opportune moment as assets in liabilities reprice with accelerated interest rates and liquidity drying up in the bank market, this development segment is taking the lead on repricing.
A pipeline of opportunities lies ahead where we believe we can engage in these products accretively at our current cost of capital. All of this leads to our commitment to grow Easterly core FFO on a trajectory of more than 2% for this foreseeable future. We believe we are positioned to deliver a consistently growing core FFO cash flow stream, which in turn would allow us to increase our dividend and continue to deliver strong results for our shareholders. This is an exciting time for Easterly. We’re seeing a pipeline of mission critical opportunities in 2024 and beyond, while also building a portfolio with a foundation of cash flows backed by the full facing credit of the U.S. government. Thanks for your time this morning. And I’ll now turn the call over to Megan to discuss opportunities for growth in 2024 and beyond.
Meghan Baivier: Thanks, Darrell, and good morning. Thank you for joining us for our fourth quarter earnings call. 2023 was a productive year for Easterly. The deal market returned, and we were able to transact on several accretive acquisitions during the second half of the year. In total, Easterly acquired either directly or through the joint venture four properties leased to tenants that include the United States Judiciary, the Department of Veterans Affairs, the Department of Homeland Security and the State of California for an aggregate pro-rata contractual purchase price of approximately $80.4 million. Easterly now owns directly or through the JV 90 properties totaling 8.8 million leased square feet. Our portfolio remains young with a weighted average age of 14.6 years and our duration of cash flows remains enduring with a weighted average remaining lease term of 10.5 years.
As mentioned on prior calls, we have always viewed Easterly as the mechanism to access high credit quality cash flows through the lens of real estate income derived from one of the world’s most stable economic entities, the United States government. The most recent example of that is found in today’s development landscape. Here, we are observing a stark contrast between the limitations faced by private developers and their resources available through a public REIT balance sheet. Private developers constrained by financial considerations are encountering challenges and accessing the substantial capital required for ambitious building projects. The complexities of securing financing coupled with market uncertainties appear to be impeding private developer’s ability to embark on large-scale projects.
In contrast, Easterly’s fortified balance sheet and enduring financing partner relationships emerge as a potential reservoir of capital. Easterly possesses the tools and capacity to leverage various debt and equity markets and tap into diverse revenue streams to finance projects. With that background, we are currently pursuing an attractive set of opportunities with private developers to serve as a partner and help finance and subsequently own a pipeline of mission critical assets primarily leased to the U.S. government. Turning to the company’s wholly-owned development activity, our FDA Atlanta project continues to progress nicely with an estimated 150 workers on-site daily. We expect that the project will cost approximately $229 million and deliver in the fourth quarter of 2025.
Approximately $150 million of the total cost will be tenant improvement reimbursed by the federal government via lump sum payments. We anticipate receiving an approximately $25 million reimbursement payment in the third quarter of 2024 and the remaining $125 million upon completion and acceptance of the space by the government. We look forward to providing you with meaningful updates in the coming quarters as we make progress on this 162,000 square foot state-of-the-art laboratory 100% pre-leased to the United States government for a non-cancelable term of 20 years. With such a substantial TI investment in this project, we anticipate this facility will serve the needs of the government for an excess of 50 years. Turning to cash flow predictability, during the fourth quarter, Easterly renewed GSA Clarksburg, a 70,000 square foot facility for a new 15 year term that commenced in January 2024.
For the entirety of 2023, we renewed 100% of our expiring leases for a combined 4.4% of annualized lease income at year-end, all for a weighted average term of 16.4 years. These results serve as a stark contrast to our Office 3 brethren. Further, as is customary on our fourth quarter earnings calls, we’d like to discuss our releasing successes as of year-end. Due to the unique nature of our leases, final renewal rents cannot be ascertained until the exact amount of TI dollars required by the government at renewal is known and the TI work is complete. As such, there can be a lag in providing releasing data relative to the point at which we have signed a renewal lease. As of December 31, 2023, we have renewed 32 leases since IPO. Of that 32, 18 are renewals for which TI work, if any, has been completed and accepted by the government.
The other 14 are renewals with pending TI projects. This combined 2.18 million square feet across 32 renewals includes CTO Arlington, IRS Fresno and various smaller leases in Buffalo. When we exclude these assets, the average rent spread achieved on the remaining renewals is anticipated to be 18%, including an estimated $40 per square foot of TI utilized by the government. The weighted average total renewal term for these leases was 17.2 years. In closing, we believe the essential nature of our assets, observed building utilization trends and the demonstrated strength of our renewals speak volumes for the necessity of our portfolio and the dependability of our underlying cash flow. We are seeing prospects for attractive growth and we believe Easterly is well positioned to transact and pursue unique opportunities to enhance the enterprise.
With a solid NOI supporting our platform, we hope our listeners today appreciate the unique nature of our business. With that, I thank you for your time this morning, and I will turn the call over to Allison to discuss the quarterly and year-end financial results.
Allison Marino : Thank you, Megan. Good morning, everyone. It is my pleasure to be joining you this morning and report the company’s strong quarterly and year-end consensus meeting results. Given the predictability of cash flows and the certainty of our leading role in this market, we believe Easterly is poised for growth in 2024. I am pleased to report that at year-end, Easterly’s portfolio performed solidly. We have leveraged at the midpoint of our target range, less than $80 million drawn on our revolver and only 6% floating rate debt exposure. For the fourth quarter, all on a fully diluted basis, net income per share was $0.04 and core FFO per share was $0.28. Our cash available for distribution was $21.9 million. For the full year, net income per share was $0.20, core FFO per share met consensus at $1.14 and cash available for distribution was $94.8 million.
With an eye to the balance sheet, it is important for us to stagger debt maturities and manage our interest rate risk. We have thoughtfully managed our assets and liabilities ensuring that we’re well positioned to address 2024 maturities and capitalize on emerging opportunities. As you can see from our fourth quarter and full year results, our balance sheet reflects stability and strategic foresight. The strength of the company’s cash flows are backed by the full faith and credit of the United States government. This allows us to achieve a better cost of capital through a lower cost of debt. While we can be quickly lumped in with our office peers and broader sector weakness, the superior credit of our U.S. government tenant and forecastability of our cash flows separates Easterly from other office REITs. Our commitment to financial prudence is reflected in our recent announcement of our inaugural investment grade BBB credit rating from KBRA.
We finalized the rating in the fall of 2022 and have maintained it since that time. We believe this will serve us well as our capital needs expand. While growth is at the heart of our strategy, we view the momentum behind that growth as a key differentiator for Easterly. There is power in our working capital management, which is reflected in achieving ongoing property operating expense savings, managing G&A creep and releasing a positive spread. We have taken a disciplined approach to operational efficiencies and tenant engagement. With this backdrop, our focus remains on growing the portfolio at opportune moments. Particularly when compared to private developers and other real estate owners, the advantages of being a public company are central to our growth strategy.
As Meghan shared earlier, we have access to a diverse pool of debt and equity sources, which allows us to acquire accretively and maintain a cost of capital advantage even when others may be faced with constraints. Turning to 2024, we are introducing our full year core FFO per share guidance on a fully diluted basis in a range of $1.14 to $1.16. This guidance assumes the closing of VA-Jacksonville through the joint venture at its pro-rata acquisition price of $40.9 million and that we will have $100 million to $110 million of gross development related investment during 2024. At its midpoint, this sets the path for Easterly to deliver strong core FFO per share earnings growth to shareholders in 2024. We believe this represents a market leading risk adjusted return and charts the course for delivering long-standing growth opportunities for our shareholders.
With that, we thank you for your time this morning and appreciate your partnership. I will now turn the call over to Shannon for questions.
Operator: [Operator Instructions] Our first question comes from the line of Michael Griffin of Citi.
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Q&A Session
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Michael Griffin: Darrell, you said you remain committed to the dividend at least in the near- and medium-term. But if I look at, I guess, expectations for ’24 and then probably consensus on ’25, it seems like the dividend is not near kind of that coverage level. I guess, is it a function of executing on external growth to grow earnings? You talk about the 2% kind of expectations for the near-term. Is it throttling down CapEx? Just how do we get comfortable around a more normalized payout ratio going forward?
Darrell Crate: And as we — one of the things I was trying to emphasize in my prepared remarks is the predictability of our cash flow well with a very, very horizon far in the future. And so, as we look forward, we see with our existing portfolio, we can of course grow into our dividend as we have lease renewals. But you’re exactly right, we confirm a little CapEx to manage CAD and we’re also working hard on avoiding the G&A creep and continue to cut expenses in order to make that so. And as I said, we’re looking at and as we sort of discussed on our Analyst Day, we’re seeing some real opportunities in the development market and sort of individual assets in the wholly owned asset area, where we can buy some things accretively.
So, we feel very good about our earnings this year. And then if you continue to take the trajectory that we’re giving — we’re guiding to and push it out sort of one or two more years, I think you’ll see that we are in a nice place with our dividend and we feel it’s our business given the predictability and the stability of the cash flows and the long enduring nature of our lease obligations that getting as much cash to shareholders is the right way to continue to deliver return for folks who invest in DEA.
Michael Griffin : And then maybe turning to guidance, I noticed you hadn’t incorporated expected acquisitions into the full year guide. You had historically done it, I think in ’22 and ’21, maybe not so last year. But you’ve talked about this pipeline that you’re seeing. Can you maybe quantify how many acquisitions you’re looking to do this year? I imagine that would help move the needle on earnings and maybe where you’re seeing cap rates or return hurdles, kind of on those acquisition targets?
Meghan Baivier: So we’re prudently not including it in our guidance just for everybody to be able to understand sort of the growth potential embedded in the assets we own going into the year. We will close on our remaining VA in the joint venture. And what I would say looking at the acquisition market today there is robust levels of potential deal flow in the market and we are engaged with numerous sellers both on the — in particular on the wholly owned acquisition side of the house, in addition to sort of the development — the developers who are facing needs that would be more sort of longer term over the next couple of years. So we see value in that market kind of in the mid-7% type cap rate range, which is a level that we look to be able to transact at accretively and continue to contribute to the growth of for shareholders.
But I think going into this year, as that market continues to build, I would say, over the course of the spring and summer, we’re really excited about the ability to add that on to what is already a platform of growth.
Darrell Crate: And I’ll just say — I’d like to just say it again, because I think it’s such an important point. Our guidance this year does not include us having to buy anything. And the market that we’re seeing to provide a little bit more color is that the bid ask spread on cap rates is wide, but there’s opportunities to pick off buildings. The timing of that is uncertain. But as Meghan said, we’re transacting at accretive levels in those mid-7%, and we will look forward to increasing our guidance as we find those opportunities. But we just given where the market is, given the positioning and given that we want investors to just understand the track that we’re on, We’re being conservative in how we are bringing things forward and only talking about guidance about things that we feel are certain and don’t require things outside of the four walls of this office in order to make those — make that guidance a reality.
Operator: Our next question is from John Kim of BMO Capital Markets.
John Kim: I just wanted to clarify on your guidance of $100 million to $110 million of development related investments that’s the financing that you’re providing to private developers? And I’m wondering what’s the yield you’re expecting on it?
Allison Marino: So for that guidance that is purely FDA Atlanta, which is our previously announced development, and we’re targeting yields in the mid-7%s on that as we discussed last quarter.
John Kim: So the development financing is not in your guidance?
Allison Marino: Correct.
Meghan Baivier: No. The opportunity set for these sort of private developers looking for capital that would also to Darrell’s prior point be additive, as we look to engage with those folks.
John Kim: And just to clarify, I think Darrell mentioned that the financing you’re providing is our projects you plan to own once they’re complete?
Meghan Baivier: You broke up a little bit, but yes, we would — these are assets that we would be looking to own at completion as well.
John Kim: What leverage level can you get to maintain your investment grade rating from KBRA?
Meghan Baivier: They’re very comfortable with our 6.5x to 7.5x range that we’d be looking to do this. So I think opportunistically we could — certainly set at the higher end of that if not a little bit in excess, but that’s a range that they’re abundantly comfortable with.
Darrell Crate: Again, that excess leverage would come from developing these buildings and would again be repaid with lump sums or these are — or long-term leases.
