Equity Commonwealth (NYSE: EQC) continued to shrink its portfolio last quarter, selling three more properties while pushing several more assets through the sales pipeline. That smaller collection of properties caused earnings to decline, once again. Meanwhile, the company completed several strategic initiatives during the quarter, including paying down debt, repurchasing shares, and converting to a new REIT structure that could open the door for acquisitions.
Equity Commonwealth results: The raw numbers
|Metric||Q4 2016||Q4 2015||Year-Over-Year Change|
|Normalized FFO||$29.6 million||$34.4 million||-14%|
|Normalized FFO per share||$0.23||$0.27||-14.8%|
Data source: Equity Commonwealth. FFO = Funds from operations.
What happened with Equity Commonwealth this quarter?
Asset sales drove down earnings:
- Equity Commonwealth sold 30 properties over the course of 2016, including three in the fourth quarter, which resulted in an $0.18 per-share decline in income versus the prior year. While the company offset some of that lost income by using a portion of the cash proceeds to pay down debt and buy back preferred stock to reduce related cash outflows, earnings still declined sharply.
- Those sales left the company with just 33 properties during the quarter, which had an average occupancy of 91.1%. That's up from a 90.8% occupancy rate in those same properties during the third quarter, but down from 91.8% in the year-ago quarter. The company also signed 1.4 million square feet of new and renewal leases during the quarter for rental rates that were 20.2% higher compared to the prior rates on the same space.
- Equity Commonwealth completed several strategic transactions during the quarter, including selling three properties for $117.5 million, repaying a $167.8 million mortgage loan, paying off $250 million of senior notes six months early, and buying back $43.4 million in common stock. Even with these transactions, the company ended the year with $2.1 billion of cash (roughly $18 per share) against just $1.1 billion of debt.
- During the quarter, the company converted into an umbrella partnership real estate investment trust, or UPREIT, which lets property owners contribute real estate in exchange for operating units that can convert into real estate investment trust (REIT) shares. This structure allows property owners to avoid capital gains taxes because it acts like a 1031 exchange.
What management had to say
On the conference call, management noted that the recently robust sales market for office assets seems to be running out of steam. There were fewer buyers for these properties, and they had to pay higher borrowing costs due to rising interest rates.
Because of that, Equity Commonwealth was starting to shift gears away from asset sales and focusing more of its attention on creating value from the assets that remain. That includes organic leasing of its few remaining properties, as well as evaluating the best ways to allocate the massive cash war chest it built up as a result of jettisoning assets over the past few years. This pivot back toward growth mode was one of the drivers behind its decision to convert to an UPREIT, which gives it more flexibility for acquisitions.
While Equity Commonwealth is beginning to transition away from asset sales, the company still has several property sales in various stages of completion. Shortly after the quarter ended, the company completed one property sale and had eight more in the pipeline. If it completes all those sales, its portfolio will be down to just two dozen properties, which is a stunning transformation for a company that held 156 properties at the end of 2014.
Meanwhile, with a net cash position, the company needs to decide the best way to deploy that capital in the most shareholder friendly manner, which is why it continues to evaluate a variety of options including acquisitions, share repurchases, debt repayment, and distributions.
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