Trustreet Properties, Inc.
Moderator: Curtis McWilliams
08/09/2005 - 10:00 AM ET
Confirmation # 739400
Trustreet Properties, Inc. - 2nd Quarter 2005 Earnings Call
Moderator: Curtis McWilliams
August 9, 2005
10:00 AM ET
Operator: Good day ladies and gentlemen. And welcome to the Trustreet
Properties Second Quarter 2005 Earnings conference call. At
this time, all participants are in a listen-only mode.
Later, we will conduct a question and answer session and
instructions will follow at that time. If anyone should
require assistance during the conference, please press *
then zero on your touchtone telephone. As a reminder, this
conference call is being recorded.
Statements in this call which are not strictly historical
are forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995.
Forward-looking statements involve known and unknown risks
which may cause the company's actual future results to
differ materially from expected results. These risks
include, among others, general economic conditions, local
real estate conditions, changes in interest rates, increases
in operating costs, the availability of capital and the
profitability of the company's taxable subsidiary.
Additional information concerning these and other factors
that could cause actual results to differ materially from
these forward-looking statements is contained from time to
time in the company's SEC filings. Consequently, such
forward-looking statements should be regarded solely as
reflections of the company's current operating plans and
estimates. Actual operating results may differ materially
from what is expressed or forecast in this call. The company
undertakes no obligation to publicly release the results of
any revisions to these forward-looking statements that may
be made to reflect events or circumstances after the date
these statements were made.
I will now turn the call over to Curtis McWilliams, the
company's President and Chief Executive Officer.
Curtis McWilliams: Thank you Omar. And thank you everyone for taking the time
to join us today in now our second quarterly earnings call
since the merger of U.S. Restaurants and CNL Restaurant
Properties, to form Trustreet Properties. With me today in
Orlando are Steve Shackelford, Trustreet's Chief Financial
Officer and Chief Operating Officer. And I'd also like to
introduce Michael Shepardson, the Executive Vice President
responsible for our specialty finance segment. In our call
today, I will provide a general overview of the company's
business this past quarter and then Steve Shackelford will
give a more expansive view of Trustreet's second quarter
financial performance. We will then open up the call for any
questions that you may have.
As you begin to evaluate Trustreet, note that the combined
company has been serving the restaurant marketplace for 20
years. On the other hand, we are a relatively new company
that continues to work through the full integration of the
U.S. Restaurants business and the CNL Income Funds into our
platform. I'm glad to report that our market share within
the restaurant sector remains strong and the integration of
the business and the portfolios continues to proceed. Yet,
there still remains much work to be done, especially in
fully realizing the operating synergies that should result
from the combination of the two business platforms.
Let's start by reviewing the core net lease portfolio. As of
June 30, 2005, we had approximately 1,768 stores in the core
net lease portfolio, having a book value of $1.7 billion.
Since the time of the merger, the net lease portfolio has
responded very well. The average lease rate in the portfolio
is 9.8%, based on carrying value and the overall portfolio
has a remaining lease term of 10.7 years. With more than 170
different concepts and 450 tenants spread across 49 states,
we still haven't found that Alaskan property as of yet, the
portfolio remains one of the most diversified real estate
portfolios in REIT world.
In addition, we have a large upside opportunity for the REIT
portfolio, given our current count of 104 vacant properties
with no lease. While our portfolios have historically had a
vacancy rate in the 2 to 4% range, a 10% vacancy rate
associated with the U.S. Restaurant's portfolio has clearly
impacted the productivity of the investment we have made in
net lease properties. With 65 million in net investment we
have redoubled our efforts to bring this vacancy rate down
either through re-leasing the properties to new restaurant
operators or through selling the properties and reinvesting
the net proceeds into new sale/leaseback investments.
Currently, we have 11 stores under letters of intent to be
re-leased and another 26 stores that have signed sales
contracts or contracts out for signature with prospective
buyers. Making the portfolio as productive as possible
remains a major priority today.
On the acquisition front, Michael Shepardson and his
marketing/originations team had a good quarter. Most
importantly, we closed the Perkins Family Restaurant
transaction, which was announced previously. On June 29, we
acquired 67 stores for approximately $140 million,
subjecting them to triple net leases. The provisions of the
leases were 20-year initial lease term and a straight-line
rental rate of approximately 9.36%. Consistent with our
portfolio concentration guidelines, we've elected to hold 23
stores in the core portfolio, having investment value of $61
million and have allocated 44 properties to the Trustreet
1031 investment property sales platform to be sold primarily
to tax motivated retail investors.
For the six months ended June 30, 2005, we acquired $190.3
million of restaurant real estate. As of today, we signed
commitment letters with operators to acquire another $174.4
million, of which the vast majority is expected to close
before year end. Consequently, we remain very confident in
our ability to acquire between $300 and $325 million of
property this year, as per our previous guidance.
Our investment property sales platform experienced another
strong quarter. During the three months ended June 30, we
sold 33 restaurant properties for a net gain aggregating
$11.4 million in our specially financed segment. The net
gain percentage over acquisition costs was 19.2% during the
quarter. In addition, we sold 19 properties out of the core
REIT portfolio, registering a net gain over our carrying
value of approximately $800,000. The average selling CAP
rate for our properties in the second quarter was 7.1%.
I would like to note that this exceptionally strong 1031
market has led to a more challenging acquisition environment
in general for freestanding retail properties. As I
previously noted, our robust acquisition pipeline aside, we
continue to see new market entrants playing in the
restaurant space. However, without the numerous advantages
that we enjoy in addressing this marketplace, our
longstanding broad and deep relationship with restaurant
operators, our ability to do very large transactions, our
investment banking products and services, as well as our
alliance with Bank of America, many of these new competitors
can only compete on purchase price and lease terms. With an
intent to sell all of these properties as quickly as
possible into the 1031 market, these competitors are less
sensitive to the fundamental value of the property or the
underlying terms of the lease.
The good news is we believe restaurant operators are
recognizing more and more the importance of working with a
trusted landlord who will be their real estate partner as
they contemplate their strategic alternatives. This approach
clearly will favor Trustreet going forward.
Before turning the call over to Steve, I also want to note
that we successfully sold a very significant portion of our
mortgage portfolio to a third party institutional investor
shortly after the end of the second quarter. As Steve will
further expand upon, this transaction generated a slight
gain over the book value of our investment in the mortgage
pool. More importantly, it allows us to focus our efforts
and our resources into our core business, the sale and
leaseback of high quality commercial real estate. And with
that, I will turn the call over to Steve.
Steve Shackelford: Thank you Curtis. Good morning everyone. Before I get into
the financial details, I want to expand briefly on what
Curtis alluded to when he discussed our competitive
advantages as we address the restaurant net lease sector. He
touched on the Perkins Restaurant deal. $140 million
financing that I believe illustrates in one transaction, the
depth of Trustreet's platform. It was a transaction in which
Michael and the Trustreet investment banking team became
aware that the owners of Perkins were looking to sell the
company. We were one of only four M&A advisors who were
asked to bid on the original assignment, which was simply to
provide sell-side advisory services. While we didn't win
this assignment, because our investment banking teams
reconnaissance had identified this possible transaction, our
originations team was well down the road in analyzing the
balance sheet of Perkins in determining that by bifurcating
the real estate from the business, the owners could realize
more proceeds than a straight sale of the combined company.
Within only a few days, we were back in their offices in
Memphis presenting a pre-emptive real estate purchase
proposal. And 48 hours later, we had secured the deal. Once
we agreed on a transaction, our real estate and investment
property sales teams analyzed the overall exposure we wanted
to hold in the portfolio and what we wanted to sell through
our 1031 sales platform. Each of the site's real estate
attributes were examined. And as Curtis noted, we ended up
holding 23 sites and we're in the process of selling the
remaining 44 sites.
Our investment property sales business has held its 44
properties about 5 weeks now and already have secured 13
signed contracts and 16 others are under letters of intent.
The ability to finance large transactions holding a portion
and distributing a portion to our IPS platform where we can
profitably recycle the capital, is an incredibly potent
combination.
Regarding financial results during the second quarter, FFO
was $18.6 million or $0.32 per share. We also introduced in
our release our adjusted funds from operations (AFFO) metric
that attempts to address the shortcomings of using
traditional FFO when analyzing our business. We explain this
metric in greater detail in our release and for the second
quarter, AFFO was $21.7 million.
After the first quarter, I discussed with you what
management believes to be the key drivers of the Trustreet
business model in an effort to provide a road map to
understand the financial performance. The second quarter
represents the first standalone quarter financial results
subsequent to the February 25th merger. Prior year results
reflect CNL Restaurant property standalone results and are a
poor comparison to the merged company.
The Perkins transaction comprised the bulk of the
originations in the second quarter and did not close until
the end of June, so rental revenues were not impacted in the
second quarter. Rental income for our operating and capital
leases in our restaurant portfolio was $43.1 million.
Included in that amount is approximately $2.2 million in
straight line revenues.
As we noted in the press release, the portfolio continues to
be well diversified by concept, tenant and geography. We
have placed approximately $87 million in the first half of
the year into our core real estate portfolio and expect that
the total volume for the year will approximate $100 to $110
million.
Interest income on our loan portfolio was $6.6 million in
the second quarter. Curtis referenced the July sale of
approximately $194 million of our $292 million in loans. We
originated most of these loans in the late 1990s and the
loans were not held for sale. We received an unsolicited
expression of interest on the mortgage loans and the
ultimate purchase price on the loans allowed us to sell them
and absorb an approximate $8.6 million swap loss that offset
the appreciation in loan value and record a net gain, that
along with the recognition of previously deferred loan fees
should approximate $2.4 million in the Third Quarter. With
the loan sale executed, I expect that interest income will
be reduced to a run rate of about $2.3 million per quarter.
The approximate $158 million in debt against the loan
portfolio that was sold had an attractive rate. However, it
was clear that the lender did not anticipate renewing the
facility, as they were moving away from the segment. The
2007 maturity, and this consideration was certainly a key
consideration in our determination to sell the loan
portfolio.
Regarding G&A, more work needs to be done to bring these
expenses in line with our expectations. The time and effort
expended on the integration, as well as resources allocated
to the distraction in Hawaii where the FTC is contesting our
agreement to spin off the immaterial convenience and gas
business operation, has contributed to a higher level of
expense than anticipated. We believe we will be out of this
business before the end of the year. We have identified
expenses of approximately $1 million in the second quarter
that we believe as we move into 2006 will be eliminated and
move us more closely to a $9 million quarterly run rate.
Total interest expense was approximately $26 million,
resulting in an average rate of 5.66% during the quarter.
The amortization of non-cash deferred financing costs
comprised $2.5 million of interest expense. During the
second quarter, we entered into a five-year swap fixing our
term loan at 4.2%. And at June 30, 83% of our outstanding
debt was fixed rate debt or variable rate debt subject to a
swap or cap.
We did not experience any significant loan reserves or real
estate impairments during the quarter. Our investment
property sales program continues to execute as we
communicated in the first quarter. This activity is
highlighted in the table entitled "Discontinued Operations
by Segment." We generated $11.4 million in net gains before
minority interest, selling 33 properties for $70.8 million.
Our margin averaged 19.2% of original costs during the
quarter, in line with the 20.7% in the first quarter.
As I emphasized in the first quarter, I think it's important
to recognize that our acquisitions come in a lumpy manner.
On the other hand, the dispositions resulting from the
investment property sales business is not relatively
concentrated, as it includes a large number of small dollar
value transactions.
Between 2002 and June 30, 2005, we've sold on average a
property every other business day. Since 2001, we've sold
$989 million in restaurant properties, generating net gains
of $114.7 million. At June 30, 2005, we had $161 million in
restaurant real estate inventory held for sale in the
specialty finance segment. We continue to expect total gains
in 2005 to achieve a run rate that averages approximately $8
to $10 million per quarter. We do expect to direct $200 to
$225 million of our total new originations in 2005 to the
investment property sales platform.
With respect to capital capacity, after the loan sale, we
have approximately $82 million outstanding on our revolving
credit facility. And we have $168 million of capacity on our
warehouse credit facilities. We have achieved 80% of our
acquisitions target for the core real estate portfolio as of
June 30. Also, we're pleased to be effective on a $700
million shelf registration that we expect will be used as we
examine the best routes of refinancing the impending
mortgage debt maturities coming due in 2006. Underlying
those maturities of $246.6 million in debt, is approximately
$421 million in real estate. While we do not expect to raise
a large amount of equity and do not have an immediate need,
we will continue to monitor the markets as to the timing of
an equity raise, which should enhance our ability to broaden
research coverage, which I think is a good thing for
investors and will strengthen our balance sheet by
decreasing debt.
Management expects to continue to recommend a dividend rate
of $1.32 per annum and fully expect our adjusted funds from
operations will be more than sufficient to cover that
dividend. I expect by November that the merger integration
will be sufficiently complete and my intent is that the
operations in Hawaii will be sold. And at that time, we'll
be prepared to outline our 2006 business model and guidance.
Curtis.
Curtis McWilliams: Thank you Steve. And with that, we'll open up the phones for
any questions that you may have.
Operator: If you have a question at this time, please press the 1 key
on your touchtone telephone. If your question has been
answered and you wish to remove yourself from the queue,
please press the # key. Again, if you have a question,
please press the 1 key. Our first question comes from Nap
Overton of Morgan Kegan. Your question please.
Nap Overton: Good morning.
Curtis McWilliams: Morning Nap.
Steven Shackelford: Morning.
Nap Overton: Do you have an additional buyer in mind for the Hawaii
assets given the FTC's challenge of the transaction you've
proposed?
Curtis McWilliams: Nap, there was another buyer that U.S. Restaurants was
negotiating with quite closely when they made the decision
to enter into an agreement with Aloha. So, it is very likely
that we will go to that buyer. There are a couple other
buyers who have been identified that are prospective
candidates, as well. So, we do know of other buyers out
there. Yes.
Nap Overton: Okay. All right. And then, on your availability of capital
right now, Steve, I believe you said you had $82 million
available on your revolver?
Steven Shackelford: Right. Yes.
Nap Overton: And that is after reflecting the portion of the assets
purchased to date that were -- have been earmarked for
long-term investment, right?
Steven Shackelford: Yes. That's correct.
Nap Overton: Okay. All right. And then where are you -- I know you had
originally thrown out a number of $6.3 million in savings
expected to be realized from the mergers. What portion of
that would you say the second quarter reflected? And do I
understand your comment about November -- by November having
the merger complete, that you expect to have those cost
savings implemented by that time?
Steven Shackelford: What I anticipate -- As we move into 2006, is that we'll
have achieved a run rate of about $9 million. That $36
million run rate would be in comparison to, I believe, a $42
million run rate premerger. So you would have most of those
savings at that point. So as we move into next year, I
expect that we'll have achieved 90 or 95% of that ultimately
with a goal to get our G&A down about $8.75 million, is
where our goal is.
Curtis McWilliams: On a quarterly basis.
Steven Shackelford: On a quarterly basis.
Nap Overton: Okay. All right. And so with the investment property sales
business, the gain in the quarter was $11.4 million? That
was a kind of better than expected quarter and a little
probably better than you would anticipate going forward on
average quarter for the investment property sales business,
right?
Steven Shackelford: That's correct, Nap.
Nap Overton: Okay. And though you're not providing any guidance, you
previously said that you expected FFO for the remainder, the
last three quarters of 2005 to exceed the quarterly or the
dividend distributions for that period of time, which would
be $0.99 which I can read into that FFO per share would need
to at least modestly increase during the next couple of
quarters. Is that a correct or reasonable assumption to
expect that FFO might inch up over the next couple of
quarters?
Curtis McWilliams: That's a very reasonable expectation, Nap.
Nap Overton: Okay. Can you make any comments about progress on the
investment property sales business halfway through the third
quarter?
Curtis McWilliams: Well, I think you can already tell by the fact that the --
we've already announced the numbers on the Perkins that
within five weeks we've got literally all but a handful of
the Perkins stores either sold or under contract to sell or
under letters of intent that it remains -- continues to be
very robust.
Nap Overton: Okay. And that was -- Let's see. 44 of them were allocated
to the investment property sales business and you said you
had contracts for sale on 13, is that right?
Curtis McWilliams: 13 and LOIs on 16. So 39 are basically are -- or 29 rather
are basically off the market.
Nap Overton: Okay. 29 out of 44. Okay. All right. And of -- well, and the
gains on those are not out of line with previous experience?
Curtis McWilliams: Correct.
Nap Overton: Okay. Is the 83% of debt that is fixed rate, Steve, does
that reflect the post-end of quarter adjustment for the sale
of the mortgage portfolio?
Steven Shackelford: No, it does not. I believe that was as of June 30th.
Nap Overton: Okay. And just for modeling purpose to get that kind of
straight, you sold the -- you gave us some guidance on the
interest income going forward from that portfolio and the
adjustment and the end pro forma quarterly adjustment to
interest expense from that sale would have been --
Steven Shackelford: Well, the adjustment to income was moving forward, your
$6-1/2 million sort of run rate will be in the $2.3 to $2.4
million run rate. And on the interest expense you took out
about $158 million in debt that was averaging about 6.3% in
interest cost.
Nap Overton: Okay.
Steven Shackelford: So the gain in the second half of the year, I referenced at
$2.4 million, $2.4 million number --
Nap Overton: Right.
Steven Shackelford: -- as part of that overall transaction, will offset the
accretion -- that we would have experienced in the second
half of the year from that. And we expect in 2006 that this
portfolio not being part of the transaction will be
somewhere between $0.035 and $0.055 in accretion. That we
will lose.
Curtis McWilliams: But the plan is, of course, that we'll take the capital that
we have freed up as a result of that transaction and
redeploy it back into the core net lease portfolio to
mitigate the loss of that interest income converted in
essence into rental income, which is where we want it to be.
Nap Overton: And would the net capital infusion from that sale have been
194 minus 158?
Steven Shackelford: It's essentially that. It freed up, I believe, $37 or $38
million that was used to pay down the revolver. You'll
notice on June 30, the revolver was $134 million. We
subsequently since June 30 brought that down through the
sale in addition to some other proceeds down to about $82
million.
Nap Overton: Okay. All right. Let's see. And then the average
capitalization rate on your sales of 7.1%, is that for the
investment property sales program or total real estate
segment and specialty finance segment?
Curtis McWilliams: That actually I believe is both, I think. Both -- Because we
sell all of our properties that are even in the core
portfolio that are sold, are sold through the investment
property sales platform. And so I think that 7.1 reflects
both. It would not reflect dispositions of any vacant or
non-performing properties that we might have -- that might
have occurred in the second quarter.
Nap Overton: Okay. And you shared with us the capitals of the -- the GAAP
capitalization rate on the Perkins transactions was 9.3%,
9.36%?
Steven Shackelford: Yes.
Nap Overton: And what were the escalators there? And what do they average
over the 20 year initial term and on an annual basis? And
what was the cash rate on that transaction?
Curtis McWilliams: Nap, the Perkins deal is actually a proprietary structure
that we use, especially in conjunction with companies that
are being sold. We don't release the sort of -- that
structure because it's actually a fairly unique structure.
It does have a low initial rate and then it has fairly high
sort of increases thereafter for a period of time. But, I
just assume, because of -- Actually Perkins signed a
non-disclosure on that. A confidentiality agreement. We
would prefer not to get into the structure of it.
Nap Overton: Okay. Thanks. That's all I've got.
Operator: Our next question comes from Melissa Ford from Banc of
America Securities. Miss Ford, your question please.
Melissa Ford: Hi. I just have two quick things this morning. Can you
provide the depreciation and amortization and interest
expense included in the income from discontinued operations?
Steven Shackelford: Yeah. The interest expense that's in the discontinued
operations is about $1.2 million. And you'll be able to see
this in the 10Q that we file this afternoon. And the overall
depreciation was relatively nominal because you don't
depreciate held for sale properties. So that you -- It's a
pretty nominal number.
Melissa Ford: Okay. And you align the property expenses and state and
other taxes. Can you tell me how much of that is -- Is that
mostly all taxes or are there some -- can we exclude some
property expenses from that?
Steven Shackelford: In terms of the property expense line on the P&L itself?
Melissa Ford: Yes.
Steven Shackelford: No. Those are primarily all related to property expenses,
direct property expenses and taxes on properties. The
$2,083,000 --
Melissa Ford: Yes.
Steven Shackelford: -- is what you're referencing? No. Those are all property
expenses in state and other taxes themselves.
Unidentified Participant: She's asking if they --
Steven Shackelford: In terms of add back --
Unidentified Participant: -- allocation between property taxes and property
expenses.
Steven Shackelford: I don't have that Melissa. But I can get that for you.
Melissa Ford: That would be great.
Steven Shackelford: Okay.
Melissa Ford: Okay. That's it. Thank you.
Steven Shackelford: Thank you.
Operator: Our next question is from Sam Kidston of Blackrock.
Sam Kidston: Hi guys. I just -- Just a handful of questions here. One is
on the mortgage portfolio going forward. Is my understanding
that you're going to get out of that business or just scale
it back?
Curtis McWilliams: We actually have been out of originating mortgages for our
own balance sheet since late 2000, early 2001. So we've not
originated any mortgages since that time. U.S. Restaurants
had some mortgages and that's actually some of what's left
in our portfolio right now. But, we have no intent at this
time to be originating mortgage loans into the restaurant
sector. When we identify mortgage opportunity, we refer it
to Bank of America, who is our alliance partner in that
marketplace.
Sam Kidston: And so the remainder of the portfolio, are you looking to
sell that or let it run off? What's the idea?
Curtis McWilliams: Those assets are not held for sale. So, the intent at this
point is to just continue to hold them and earn the interest
spread we have on them. Obviously, just as we had with the
large portfolio we ended up selling, if someone comes across
the transom with an offer, we're obligated to consider it.
But we're not actively marketing those properties -- those
loans.
Sam Kidston: Okay. And then just a couple questions on the capital
structure. Did you guys mention that you're going to do a
small equity raise? Did you say that?
Steven Shackelford: We haven't made a determination. What we've done is we filed
the shelf. What we have available in capital, which are now
the revolver and the warehouse credit facilities that we
talked about, is adequate to fund what we have, that Curtis
outlined, in terms of commitments. If there was a one-off
deal where something came along like that, that certainly
would serve as an impetus to perhaps do that. But we're not
in any immediate mode to raise equity.
Sam Kidston: Okay. And then you also mentioned that in 2006, you have
mortgage debt coming due. What was the amount and the
underlying real estate?
Steven Shackelford: The underlying amount, the real estate is about $421
million. And I think the overall amount I said was $272
million coming due. So it's about a 58% advance rate on
that. That net lease securitization that we executed in
February as part of the transaction, had a 70% advance rate.
And while we haven't made a specific determination to do
another secured deal, if we did that deal and could achieve
that kind of execution, it would obviously free up some
assets as well, which is interesting to us. So we'll
continue to sort of evaluate the secured versus unsecured
route as we move forward. And actually it was $246.6 million
in debt and $421 million in real estate underlying that
debt.
Sam Kidston: What's the rate on that?
Steven Shackelford: The overall rate on that together is -- with all end cost is
about 5-1/2%.
Sam Kidston: And if you did that deal today, what are you looking at?
Steven Shackelford: Well, we executed in that marketplace -- We've done over a
billion in that net lease to securitization marketplace. And
we executed in February at right around that rate, 5-1/2%.
Our expectation is we're anticipating that it could be a
little bit north of that in 2006, but our hope is that we
could execute similarly to what we did in February.
Sam Kidston: Okay. And then just a couple of questions on the vacancies.
You guys are obviously aggressively remediating the 100 plus
properties that you have. But, just could you give me some
sense for what the process is by which vacancies come into
the portfolio? How much lead time you guys have and things
like that?
Curtis McWilliams: Sure. And we've got a slightly different process than what
U.S. Restaurants had, which I think allows us to sort of
keep our vacancy rate a little lower. We're actually very
proactive as we evaluate properties. Well before a property
actually becomes vacant or hopefully well before a tenant
even approaches us and says that they may be having problems
or the tenant is approaching us saying there is a lease
expiration date coming up and we're not renewing.
First we get sales numbers on about three-quarters of the
portfolio today. And all the new stuff that comes in, we get
sales numbers -- monthly sales numbers on it. So we
calculate the rent to sales number on a monthly basis for
all our properties that we get that information. And so we
can pretty well judge very quickly how that store is
performing and whether it is actually performing well enough
for a restaurant operator who wants to continue to operate
that store. If the rent sales number gets too high, we
immediately send -- sort of a red flag goes up from our
credit and servicing department and it moves over into our
people who look at these assets and in property management
and make a phone call to the tenant to find out what is the
issue. If the issue is simply there's construction going on
in front of the store which will be done in two months'
time, there's no problem and it continues on. However, if we
do find that fundamentally the store is having problems
either because the concept is having problems or the
demographic area that they're operating in is having
problems, we begin to then assess the real estate more
specifically, begin to make contingency plans for if there
is continued serious degradation in the store performance
where the tenant may be coming back to us seeking relief,
we'll have a good understanding at that time of what are our
alternatives with respect to the real estate.
So all that happens before we actually end up with a vacant.
Once we have a vacancy if it's due to a credit problem, we
immediately go into action in terms of knowing what those
alternatives might be, who the alternative uses might be. Is
the highest and best use for that real estate actually a
restaurant or might it be something other than that? We've
converted Burger Kings to bank branches. We've converted
Chevy's to drug stores. And so we look at sort of all the
various options as we consider those.
With respect to vacancies that arise out of lease
expirations, we enter into discussions with a tenant at
least two to three years in advance of the lease actually
expiring and begin to sort of understand what the tenant's
intent is with respect to that property. And, again, begin
that dialogue. And if it's to the extent that they know that
they're not going to renew, we begin a process working with
them to find an alternative use for that property, such at
the time that the expiration occurs, we hopefully have
either a new tenant or a buyer relatively well in hand.
The problem we have right now is the fact that we got about
60 odd stores from U.S. Restaurants where we didn't have
those advantages going into the vacancy and so we're sort of
playing a little catch up on those stores which, once we get
through that though, we expect to be sort of more in line
with our historic vacancy rates. Long answer. I apologize.
Sam Kidston: No. No. Thank you. The more color the better. And just on
the -- How many stores is it today that you own that are
vacant?
Curtis McWilliams: About 100 that are vacant with no lease.
Sam Kidston: A hundred with no lease. And are there -- What is your
visibility into the vacancy rate going forward? Have you
seen metrics deteriorating, improving across your portfolio?
Curtis McWilliams: From a credit standpoint, the metrics generally are
improving. The restaurant industry is in general doing very
well right now. We don't have new tenants going on the what
we call the watch list. In fact, more often tenants are
coming off the watch list as improvements, especially in the
Burger King system have certainly helped take some of the
financial stress out of those franchisees. In terms of the
lease expiration vacancies that may occur, we are monitoring
that. I think you all know and you've seen it before that we
only have about 1.8% of the portfolio based on rent with
leases expiring in 2005 and 2% in 2006. And we're in active
discussions with them right now on what we believe the
expectation of those are for renewing their leases, which
we, again, generally believe is going to be relatively high.
Sam Kidston: Okay. And then just to finish up here, the hundred stores
today vacant with no lease, and you said 11 of those are
under letters of intent and 26 under sale agreement, is that
correct?
Curtis McWilliams: 11 of them are under LOIs to re-lease. And 26 stores we have
either sales contracts or contracts out for signature on
those. It's about half and half. About half are actually
signed contracts; half are negotiated contracts or just
awaiting the signature of the buyer.
Sam Kidston: Okay. And so on the remaining 60 plus properties, what do
you think the timeframe for disposal is?
Curtis McWilliams: Well, I think that, again, with a portfolio of roughly 2,000
properties, I do expect that we'll continue to sort of have
a steady state in that sort of 40 plus store range which
would be about 2% of the portfolio, which is what we've
historically seen over the umpty-ump years we've been in
business. So, I would say that you get back down to those
levels, we expect by some time in the latter part of 2006.
Sam Kidston: Okay. Thank you very much guys.
Steven Shackelford: Thank you.
Operator: Our next question comes from Kenneth Campbell of ING. Your
question please.
Kenneth Campbell: Yeah. And I apologize if this is old history. U.S.
Restaurant used to have an investment in a New England
chain. And I remember it as Ground Round, but I'm not sure
if it is quite right. And I'm wondering whatever happened to
that in the merger transactions?
Unidentified Participant: Are you referring to a what was a proposed equity
interest or in the business?
Kenneth Campbell: It was an equity interest in a company that was in
bankruptcy or I think it was in bankruptcy at the time.
Curtis McWilliams: They made a proposal but that proposal was not accepted. And
they ended up not taking that equity interest in the
bankrupt company which was the Ground Round.
Kenneth Campbell: Okay. Okay. Okay. So that died then.
Curtis McWilliams: That deal never happened. We did actually, we, CNL
Restaurant Properties did have a number of leases with the
Ground Round which we never took any impairment on because
those are all in -- or if we took impairments they were very
modest. Those were all -- We were good in the dirt and most
of them got taken up by the franchisees.
Kenneth Campbell: Okay. Okay. Thank you.
Operator: Our next question comes from Brian Novelline of DRW
Investments.
Brian Novelline: Hi guys.
Curtis McWilliams: Hey Brian.
Steven Shackelford: Good morning.
Brian Novelline: Are you interested in giving any kind of an asset sales
forecast for the second half or is there any kind of range
that you can provide?
Curtis McWilliams: In our portfolio right now, we actually have -- We have
about 40 properties that we've identified for disposition in
the core portfolio, which is not reported in that number
that we gave to you of 1,768 properties. So we do have -- We
have put forth about 40 that we have identified for sale and
are actually appearing in discontinued ops within the
portfolio.
Brian Novelline: Okay. And as far as that -- The number for assets held for
sale, can you kind of break down just what sort of
investment property, what's core? What sort of the size of
the Hawaii?
Steven Shackelford: Yeah. I -- I'll -- Hi Brian. This is Steve.
Brian Novelline: Hi.
Steven Shackelford: I can try to break that down for you in a little more detail
because there's a couple of different pockets that that
amount relates to. But kind of globally, as we kind of look
at it with respect to the real estate segment, which of the
properties held for investment. You've got about $20 million
of that amount is considered real estate and held for sale.
You've got about -- the Hawaii business operations which we
discussed earlier and I referenced as an immaterial part of
this business, which is hung up with this FTC matter is
about $6-1/2 million. And you have on your real estate in
the specialty finance segment, broken down between a couple
different pockets. But in general, the rest of that is made
up of the Perkins transaction and other real estate we
acquired in the merger that we put on the investment
property sales platform to sell, as well as some properties
that is in our property improvement and redevelopment that
we're working on and are held for sale. So $20 million on
the real estate segment, $6 to $7 million in the Hawaii and
then the remainder is made up of the specialty finance
segment.
Brian Novelline: Okay and with the discontinued operations, you mentioned
some of the core portfolio is actually in the specialty
finance segment on the sale of real estate. Could you just
remind me what sort of divides the real estate and the
specialty finance?
Curtis McWilliams: I don't think there -- There isn't any core real estate in
specialty finance segment.
Brian Novelline: Okay.
Curtis McWilliams: We do identify -- Just as we continue to sort of look at
concentration risk and rebalancing the portfolio, we
continually identify assets within the core portfolio to
sell for one reason or another. And those are those 40
properties. They're still held within the REIT. When they
sell, they will not be sold through and the numbers will not
report through the specially finance segment.
Brian Novelline: Okay.
Curtis McWilliams: Although they are listed as discontinued operations.
Brian Novelline: Got it. Got it. And is there any sort of range for -- I know
19% is obviously a great return on sale. Is there any sort
of range of return for maybe second half sales just to sort
of help model -- ?
Steven Shackelford: Well, what we said I think is that the -- We achieved about
15% in the prior year. We did 20 in the first quarter and 19
in the second quarter and our expectation is is that at the
end of the year it would be somewhere between where we ended
last year and kind of what we've experienced over the first
two quarters this year.
Brian Novelline: Okay. Great. And as far as additions to the core portfolio
in the first half for acquisitions, did you say it was $87
million?
Steven Shackelford: That's correct.
Brian Novelline: And you're targeting sort of $100 to $110, so obviously
that's stepping down in the second quarter. Is that just a
function of the returns that you're getting on some of these
new assets? Or is it --
Curtis McWilliams: No. Actually, I was --
Brian Novelline: Why is that sloping down?
Curtis McWilliams: I would actually tell you that to the extent that we have --
we achieved sort of what we want to achieve in the
investment property sales side, specialty finance segment.
If we start originating more net lease assets than sort of
that original 300, 325, my expectation is a high percentage
of those will actually go back into the core portfolio which
is where we continue to sort of focus our efforts. There's
not a material difference between the sort of average
straight-line CAP rate of the pipeline going forward and
what we've achieved in the first half of the year. We're
sort of in the 9 plus percent range for both what we've
already originated and what we expect to originate in the
second half of the year. So, it's not due to a decline in
CAP rates. Just sort of how we originally anticipated we
would split that $300 to $325 million. To the extent that we
originate more than $325, I think a higher proportion of
that increase over that amount will probably go into the
held for investment portfolio.
Brian Novelline: Okay. Great. Thanks a lot.
Steven Shackelford: Thank you.
Operator: Again, ladies and gentlemen, if you have a question at this
time, please press the 1 key. We have a follow-up question
from Nap Overton of Morgan Kegan.
Nap Overton: Yes. -- In your adjusted FFO calculation, the principal
portion of capital leases item of $1.4 million, is that --
Does that relate to what shows up on the balance sheet as
net investment and direct financing leases?
Steven Shackelford: Yes, it does.
Nap Overton: Okay. And then what is -- What would you say a reasonable
expectation over a couple of year period for your net loss
or the cost of those properties that do go dark, going dark?
How much does that impair their value?
Steven Shackelford: Nap it's all --
Nap Overton: I know that's a broad question and an unspecific one. But
how should investors think about that?
Curtis McWilliams: Nap, it literally is all over the map. There are certain
properties that go dark where we are able to realize value
well in excess of our net carrying value. There are other
properties that go dark where we end up candidly at 35-40%
of our net carrying value. That would be the worst. But
we've hit those on a couple. So, I'd say in general, right
now, I just looked at the statistics for this year, we're
disposing of properties of at sort of in the 90s percent of
net carrying value that are dark. But I can't tell you that
that will continue.
Nap Overton: Okay.
Steven Shackelford: And Nap, one thing to think about is that in purchase
accounting, we've carefully tried to examine what we believe
the real estate value of the properties and the Income Funds
and U.S. Restaurant properties portfolios are so we -- if we
felt like a property is worth less, we've written that down
versus where it was in the book value. And other ones,
you've written up. So with respect to that portfolio, we've
tried to bring that in line with what our views are as to
that. So, the expectation in the near term on that
portfolio, because you have adjusted it to fair value under
purchase accounting would be that -- It wouldn't suggest
that you should experience those levels of impairment on
those portfolios.
Nap Overton: Okay. But if I understand anything about the business model
over a ten year period, or something, just a long term
business model, you would think that with your portfolio of
roughly 2,000 owned properties that maybe 40 of them would
be dark at any time, that would be a reasonable number to
carry as a dark inventory and that on those 40 properties,
you might lose somewhere between probably on average 60 or
you might recover somewhere between 65 and 75 or 80%?
Curtis McWilliams: I would say 2 to 3% to be at 40 to 60 on general and you'd
be probably looking at recovery somewhere from 65 to 85%.
Nap Overton: Fair. Thank you very much. And then could you elaborate just
a little bit on your comment about you are seeing increased
competition for investors in restaurant properties for
acquisitions? Could you just elaborate a little bit on that?
Curtis McWilliams: And I'll let Michael chime in after my comments here since
he's really at the forefront on the battlefield on this. We
do continue to see, especially people who are taking
advantage of the 1031 market today and view it as a very
attractive way to make a quick dollar investing in the
restaurant real estate and flipping it into the 1031 market.
We -- For example, there was a deal we were looking at last
month where -- And it was a good deal. It was one of the top
QSR concepts in the country and it was in some very
attractive locations. Although the franchisee in this case
was a relatively weak franchisee. Had not particularly
strong numbers. Actually were outside of our credit box. And
we thought we got very aggressive and bid about $40 million
for that real estate only to be topped by a competitor whose
plan is to immediately flip everything into the 1031 market,
who bid $48 million for that same real estate. We were given
last look, but when you're 20% disconnect on value and you
were a little concerned about the credit, you just -- Those
kind of deals just don't make sense. And so you just at that
point, you just sort of walk away and say that's just one
you're not going to do. And so we are seeing that,
especially where we end up being sort of in a bid situation.
So we're -- Our origination guys more and more are trying to
do the kind of deals where people value the various things
that we bring to the table. The relationships, the ability
to hold a significant number of the sites. The ability to
bring Bank of America's alliance products with our
sale/leaseback financing. Leverage on the relationships we
have because that's where we are able to get deals that make
sense for us, both from a CAP rate standpoint and sort of
what's our embedded cost in the dirt. Michael, do you want
to add anything to that?
Michael Shepardson: Sure. That's a pretty accurate summary, if you will Nap. We
have seen about a handful of institutional competitors and
by and large, to Curtis' point about the 1031 market being
pretty frothy, the bulk of our competition is coming from
brokers. And for many of our clients, that doesn't
necessarily fit their needs because they're looking for
funding today and brokers are by and large not able to
provide that to them. So, what we have seen competition come
from a couple of different areas. But it's not
extraordinarily different from what we've seen in the past.
It's just on certain transactions, it does get -- it does
heat up a fair amount.
Nap Overton: Okay. Now, one final question and this is a bigger picture
kind of question. But, clearly an investor evaluating the
value of your company is going to look at the investment
property sales business separately and differently from the
core real estate portfolio. How do you guys look at the
value of that business?
Curtis McWilliams: Strategically, I look at the value of that business avenue
and I've had long conversations on this is, that it is very
important to us that we have the ability to create value
from our investment in restaurant real estate through two
different mechanisms. One is obviously through the patient
holding of that real estate in our portfolio and making
determinations well out into the future when might be the
time to realize the value of that property through an
ultimate sale.
And secondarily, to sell those properties immediately and
realize the value today due to either if we're in a low CAP
rate environment, selling more through investment property
sales, holding less into the core portfolio for a high CAP
rate environment, being able to hold more in the core
portfolio, less through investment property sales.
The Perkins transaction, great example of where it's a good
deal, large deal, but is it a deal that I want to have where
I want to have Perkins be a top five tenant within the
portfolio? No. So we make sure that we sell down our
exposure accordingly, and it gives us all that flexibility.
It also gives us continuing understanding because we're in
that market. We know what pricing is in that market and it
allows us to make sure that we're making good decisions in
terms of pricing within the market at any given time.
So, there are lots of strategic reasons why we're in that
business. In terms of how you as an investor might look at
the multiple on that business, now I think that there are
whole hosts of sort of specialty finance companies that you
can look at that you can sort of come up with sort of a peer
group analysis on terms of the multiple, the [inaudible]
that that business generates. But strategically, which is
the more important thing to me, it is just fundamental to
our business, we do believe long term that it will be less
and less a contributor to the overall FFO of our business as
the core portfolio grows and we expect that the investment
property sales business will remain fairly static in terms
of its contribution.
Nap Overton: Okay. Thanks very much.
Steven Shackelford: Thank you.
Operator: Our next question comes from Sam Kidston of Blackrock.
Sam Kidston: Yes. Sorry guys. Just one final follow up. You mentioned
that the sale of the mortgage portfolio and the redeployment
of that capital would be I believe you said somewhat
accretive and could you just give me the amount and the
timeframe?
Steven Shackelford: Sam this is Steve. The transaction itself in the second half
of the year -- This transaction obviously is recorded in
July so it'll be in the third quarter. So the sale itself
will generate about $2.4 million in gains and would more
than offset any of the spread we would have received on that
in the second half of the year. And we will obviously
re-employ the approximately $38 million of capital that
we've freed up into net lease properties, which leaves you
somewhere in the $0.03 to $0.04 range, $0.035 to $0.04 range
of dilution that will have to be overcome next year in 2006.
Curtis McWilliams: Through the reinvestment of that capital in net lease
properties.
Sam Kidston: Okay. Thank you guys.
Steven Shackelford: Thank you.
Operator: It appears there are no more questions at this time.
Curtis McWilliams: Omar, thank you very much. And again, thank you to all of
you who participated in the call today. We continue to
appreciate your interest in Trustreet Properties as you
watch us continue to what we believe execute as we said
we're going to execute, within the restaurant marketplace.
We look forward to ongoing dialogues with each of you in the
months ahead. Have a great day.
Operator: Ladies and gentlemen, thanks for participating in today's
conference. This concludes the program. You may now
disconnect.