Business context and reporting period
Highwoods Properties, Inc. and its operating partnership filed this unaudited Form 10-Q for the quarter ended March 31, 2019. Highwoods is an office REIT operating primarily in nine U.S. markets. At quarter-end, it owned or had interests in 30.7 million square feet of in-service properties, 1.6 million square feet under development and approximately 350 acres of development land.
Financial performance and liquidity
Unless otherwise stated, amounts are in U.S. dollars. Financial statement figures below are in millions.
- Revenue: $172.4 million, down 4.5% from $180.4 million in Q1 2018.
- Profit: Net income was $8.4 million versus $34.2 million; net income available to common stockholders was $7.3 million versus $32.4 million. Diluted EPS was $0.07 versus $0.31. FFO per share, a non-GAAP measure, was $0.72 versus $0.85.
- Property operating performance: NOI was $111.8 million, down 7.6%. Same-property NOI fell 7.2% to $106.3 million; same-property cash NOI was essentially flat at $108.3 million versus $108.2 million. NOI as a percentage of revenue was approximately 64.9%, versus 67.1% a year earlier.
- Cash flow: Operating cash flow was $62.7 million versus $78.5 million. Investing used $81.5 million versus $145.6 million; financing provided $21.1 million versus $46.6 million. Cash and restricted cash totaled $12.5 million at quarter-end, including $4.8 million of unrestricted cash.
- Debt and liquidity: Mortgages and notes payable, net, were $2.16 billion, up from $2.09 billion at year-end 2018. The company reported $464.8 million of unused revolver capacity at March 31 and $502.9 million at April 16. Its leverage measure—debt and preferred stock relative to undepreciated asset book value—was 36.1%; debt and preferred stock represented 30.5% of total capitalization. The company said it was in compliance with debt covenants.
- Margins and occupancy: Office occupancy declined from 91.6% at year-end to 91.0% at quarter-end. New and renewal leases signed during the quarter had combined GAAP rents 17.5% above prior leases for the same spaces.
Material changes versus the prior comparable period
The sharp decline in earnings principally reflected the unexpected closure of Laser Spine Institute, which leased a 176,000-square-foot Tampa building. Highwoods recorded $5.6 million of lease-receivable credit losses, $2.3 million of lease-incentive write-offs, $4.1 million of notes-receivable write-offs and $11.6 million of accelerated depreciation and amortization on tenant improvements and leasing costs. The event also contributed to an approximately $8.0 million reduction in same-property revenue.
Depreciation and amortization rose 20.2% to $69.2 million, in part because of the Laser Spine Institute write-offs and development properties placed in service. Other income/loss was a $3.8 million loss versus $0.5 million of income, primarily due to the notes-receivable write-off. Interest expense increased 1.9% to $18.7 million.
During the quarter, the operating partnership issued $350 million of 4.20% notes due April 2029 and prepaid a $225 million unsecured term loan due in 2020, recording a $0.4 million extinguishment loss. Investment cash outflow was lower than a year earlier, when acquisitions and development spending were higher.
Outlook, commentary and risks
- Management expected occupancy to remain approximately 91% for the rest of 2019. It anticipated higher same-property NOI in the remainder of the year, as rent and parking revenue gains were expected to exceed lower occupancy and higher operating expenses. It also expected total NOI and rental revenue to improve, partly reflecting development properties placed in service; these are expectations, not guarantees.
- Approximately $293 million remained to fund started or committed development projects. Three reported projects totaled approximately 902,000 square feet, were 89% preleased and had estimated total investment of $422.2 million.
- Highwoods expected to sell $68 million to $118 million of non-core properties during the remainder of 2019, without assurance that sales would occur on the expected timetable or terms. It sold two buildings and land on April 12 for $32.5 million and expected a $6.7 million gain.
- The board declared a $0.475-per-share dividend for payment June 4, 2019. The filing notes that distributions reduce cash available for debt repayment, capital expenditures and growth.
- Key risks include customer credit deterioration, leasing and occupancy weakness, development and market-supply risks, higher interest rates and operating costs, access to capital, and the ability to refinance debt. At quarter-end, $485 million of debt was variable-rate and not protected by hedges; a 100-basis-point rate increase was estimated to raise annual interest expense by $4.9 million.
- The company adopted the new lease accounting standard on January 1, 2019 with no net cumulative retained-earnings adjustment. It recognized a $35.3 million ground-lease liability and a $29.7 million related right-of-use asset. Disclosure controls were reported effective.
Important facts for investors to verify
- How much of the Q1 earnings and same-property NOI decline is attributable to the Laser Spine Institute event, and what are the expected leasing, recovery and re-leasing costs for that space?
- Whether management’s occupancy, NOI and revenue expectations for the remainder of 2019 were achieved.
- Progress, leasing and remaining funding needs for the development pipeline, including the approximately $293 million of expected capital requirements.
- Actual timing and proceeds from planned non-core property sales, including the April 2019 sale and the expected $68 million to $118 million of further dispositions.
- Debt maturities, refinancing terms, revolver availability and exposure to variable interest rates, as well as continued covenant compliance.