Highwoods Properties, Inc. — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018. Highwoods is an office REIT operating primarily in nine southeastern and mid-Atlantic markets through Highwoods Realty Limited Partnership. At quarter-end, it owned or held interests in 30.7 million square feet of in-service properties, 1.8 million square feet under development and approximately 350 acres of development land.
Financial and operating performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Rental and other revenues | $179.4 million | $180.2 million | $538.6 million | $526.9 million |
| Net income | $35.0 million | $59.5 million | $122.3 million | $132.6 million |
| Net income available to common stockholders | $33.2 million | $57.0 million | $116.3 million | $126.3 million |
| Diluted earnings per share | $0.32 | $0.55 | $1.12 | $1.23 |
| FFO available to common stockholders per share | $0.86 | $0.86 | $2.58 | $2.55 |
| Net operating income (NOI) | $118.3 million | $119.0 million | $358.4 million | $349.4 million |
| Same-property NOI | $108.8 million | $107.9 million | $327.6 million | $323.7 million |
For Q3, same-property NOI increased 0.8%, while total NOI decreased 0.6%, mainly because of NOI lost from property sales. Office occupancy declined from 92.9% at December 31, 2017 to 90.9% at September 30, 2018. New and renewal leases signed in Q3 had weighted-average GAAP rents of $27.27 per square foot, 18.5% above prior leases for the same spaces. FFO is a non-GAAP measure; it was nearly unchanged per share in Q3 and increased for the nine-month period.
Cash flows: Nine-month operating cash flow was $293.0 million, up from $270.2 million. Investing activities used $290.9 million, including $130.2 million for development, $89.9 million for tenant improvements and leasing costs, $52.2 million for building improvements and $50.6 million for acquired Nashville development parcels. Financing activities used $78.1 million. Cash and restricted cash together fell $76.1 million to $12.3 million; cash and cash equivalents alone were $5.3 million.
Debt and liquidity: Mortgages and notes payable, net, were $2.087 billion at September 30, up from $2.014 billion at year-end 2017. Debt comprised $97.6 million secured and $1.999 billion unsecured; weighted-average rates were 4.0% and 3.48%, respectively. Debt and preferred stock equaled 35.5% of undepreciated asset book value and 29.6% of total capitalization. The company reported $534 million of debt not fixed-rate or protected by hedges. Its $600 million revolving facility had $415.6 million unused capacity at quarter-end ($426.6 million on October 16); management reported compliance with debt covenants and expected available funding sources to meet short-term needs.
Material changes and notable items
- Q3 net income fell substantially year over year, primarily reflecting much smaller gains on property dispositions and lower equity earnings from unconsolidated affiliates than in Q3 2017. Q3 2017 included $19.8 million of property disposition gains; Q3 2018 recorded nominal gains. Nine-month 2018 property gains were $17.0 million versus $25.2 million in 2017.
- Nine-month revenue rose 2.2%, supported by developments placed in service, same-property revenue growth and a $3.8 million restoration fee, partly offset by revenue lost from dispositions. Nine-month interest expense increased 4.9%, reflecting higher average debt and lower capitalized interest, partly offset by lower average rates.
- In Q1, the Operating Partnership issued $350 million of 4.125% notes due 2028. In Q2, it repaid $200 million of 7.5% notes at maturity. A further $150 million of forward-starting swaps locked the underlying 10-year Treasury rate at 2.91% for planned debt issuance expected before June 11, 2019.
- Four development projects totaled 1.106 million square feet, with anticipated investment of $480 million; $169.2 million had been invested and the projects were 99.2% pre-leased at September 30. Expected capital expenditures for started or committed developments were approximately $330 million.
- The company acquired two Nashville development parcels for $50.6 million in Q1 and sold a building and land parcels for $34.0 million in Q2, recognizing $17.0 million of gains. It also sold land parcels for $2.1 million in Q3.
Outlook, risks and contingencies
No specific earnings or FFO guidance was provided in the supplied filing text. Management expects cash, operating cash flow and financing sources to cover short-term liquidity needs. It expected to sell an additional $49 million to $89 million of non-core properties during the remainder of 2018, while cautioning that sales, timing and terms were uncertain. The next quarterly common dividend of $0.4625 per share was declared on October 18, payable December 4, 2018.
Risks discussed include tenant credit deterioration; difficulty leasing vacant, second-generation or newly developed space; slower economic or office-employment growth and excess development supply in core markets; higher interest rates and operating costs; and inability to obtain capital or refinance debt on favorable terms. Management noted that covenant compliance could change with operating performance, transactions or economic conditions. The company also has customary debt cross-default and acceleration provisions. It was primarily self-insured for employee health claims beginning in 2018 and recorded a $0.6 million reserve, with stop-loss coverage. No real estate impairment was recorded in 2018, compared with $1.4 million in 2017.
The company adopted the new revenue recognition standard in 2018 with no cumulative adjustment. It planned to adopt the new lease standard on January 1, 2019; management expected limited impact on lessor revenue accounting, but anticipated recognizing right-of-use assets and lease liabilities for ground leases and expensing certain leasing costs previously capitalized.
Investor verification priorities
- Review occupancy trends, lease expirations, leasing spreads and whether signed lease economics translate into occupancy and cash rent growth.
- Assess development delivery, remaining funding needs, tenant commitments and the timing of stabilization, particularly for the large Asurion project.
- Verify debt maturities, floating-rate exposure, hedge effects, revolver availability and covenant headroom as interest rates and financing needs change.
- Reconcile recurring property and same-property performance with GAAP earnings, which were materially affected by property-sale and affiliate gains in the comparable period.
- Track execution of planned non-core asset sales, capital spending, liquidity and the sustainability of dividends relative to operating cash flow.