Highwoods Properties, Inc. — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 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 30.5 million rentable square feet of in-service properties, 2.0 million square feet under development, and approximately 400 acres of development land. Financial amounts below are in millions unless otherwise noted.
Financial performance and position
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Rental and other revenue | $178.8 | $177.3 | $359.2 | $346.7 |
| Net income | $53.0 | $39.6 | $87.2 | $73.0 |
| Net income available to common stockholders | $50.7 | $37.6 | $83.1 | $69.3 |
| Diluted earnings per common share | $0.49 | $0.37 | $0.80 | $0.68 |
| FFO available to common stockholders per share (non-GAAP) | $0.87 | $0.90 | $1.72 | $1.69 |
| Net operating income (NOI) | $119.1 | $118.4 | $240.1 | $230.4 |
Q2 NOI margin was approximately 66.6% of revenue, versus 66.8% a year earlier. Q2 same-property NOI was $108.5 million, essentially unchanged from $108.5 million; same-property cash NOI was $103.5 million versus $104.7 million. The declared common dividend was $0.4625 per share for Q2, up from $0.44 a year earlier.
For the first six months, operating cash flow was $184.0 million, versus $172.1 million. Investing activities used $201.8 million and financing activities used $60.5 million; cash and restricted cash declined by $78.4 million to $9.9 million. Capital expenditures included $85.7 million for development, $62.0 million for tenant improvements and leasing costs, and $34.7 million for building improvements.
At June 30, total assets were $4.65 billion and net mortgages and notes payable were $2.06 billion, compared with $2.01 billion at December 31, 2017. Debt consisted of $98.1 million secured and $1.97 billion unsecured indebtedness, before unamortized debt costs. Cash and cash equivalents were $4.2 million, with $5.7 million restricted cash. Revolver availability was $457.6 million at quarter-end and $463.6 million on July 17. The reported leverage ratio (debt plus preferred stock to undepreciated asset book value) was 35.3%; management reported covenant compliance.
Material changes and notable items
- Q2 revenue increased 0.9%; first-half revenue increased 3.6%. Development properties placed in service and higher same-property rents and cost recoveries contributed, partly offset by lower occupancy and revenue lost on dispositions.
- Q2 net income included $17.0 million of property-disposition gains; the company sold a building and land parcels for $34.0 million. Excluding disposition gains and affiliate activity, income was $35.5 million, down from $38.8 million. Thus, reported earnings growth was substantially affected by the sale gain.
- Q2 interest expense rose 10.7% to $17.9 million, mainly due to lower capitalized interest, higher average debt balances, and higher average rates. First-half interest expense increased 6.6% to $36.3 million.
- 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. The company also entered $150 million of forward-starting swaps locking the underlying 10-year Treasury rate at 2.91% for a planned debt issuance before June 11, 2019.
- The company acquired two Nashville development parcels for $50.6 million. It had 1.279 million square feet of office developments in progress, 93.2% pre-leased, with $179.8 million invested and anticipated total investment of $531.0 million.
Outlook, commentary, and risks
Management expected office portfolio occupancy to be approximately 91% for the remainder of 2018, versus 91.5% at June 30 and 92.9% at December 31, 2017. It expected same-property NOI to improve in the second half as higher rents and parking income more than offset lower expected occupancy and higher operating expenses; total NOI was expected to remain relatively consistent with the prior-year period. Management also expected higher revenue and operating cash flow for the rest of 2018, while interest expense was expected to be higher than in 2017.
Second-quarter new and renewal office leases covered 1.117 million square feet at weighted average GAAP rent of $26.96 per square foot, 18.2% above prior leases in the same spaces. Expected future capital expenditures for started or committed development projects were approximately $368 million. Management anticipated selling a further $30 million to $105 million of non-core properties during the rest of 2018, but gave no assurance that sales would occur on those terms or schedule. The filing provides no numerical full-year earnings or FFO guidance.
Key risks include tenant credit deterioration, difficulty leasing vacant or newly developed space, excess office supply or weaker economic and employment growth in its markets, rising interest rates and operating costs, and access to capital or refinancing at debt maturities. At June 30, $502.0 million of debt was variable-rate or not protected by hedges; a 100-basis-point increase would raise annual interest expense by an estimated $5.0 million. Approximately $368 million of development funding needs and reliance on capital markets, revolver borrowings, and asset sales are additional liquidity considerations. A $0.7 million reserve was recorded for self-insured health claims.
Most important facts for investors to verify
- Whether occupancy stabilizes near management’s approximately 91% expectation and whether leasing gains translate into sustained same-property NOI and cash NOI growth.
- Development project costs, completion and stabilization dates, pre-leasing, and funding needs—particularly the large Asurion project and the approximately $368 million remaining committed development spend.
- Debt maturities, refinancing terms, variable-rate exposure, swap performance, and continued compliance with debt covenants.
- Whether forecast non-core asset sales occur and how proceeds are used, given the low unrestricted cash balance and substantial investment program.
- The quality and recurrence of earnings: Q2 net income benefited from a $17.0 million disposition gain, while FFO per share declined year over year; assess GAAP results alongside the company’s non-GAAP FFO and NOI measures.