Easterly Government Properties, Inc. (DEA) Earnings Call Transcript & Summary

Good afternoon, everyone, and welcome to Citi's 2021 Virtual Global Property CEO conference. I'm Manny Korchman of Citi Research. And we're pleased to have with us Easterly Government Properties' CEO, Bill Trimble. This session is for Citi clients only. And if media or other individuals are on the line, please disconnect now. Disclosures are available on the webcast. For anyone joining, there's a big ask-a-question box in front of you on your screens, throw in questions. They will come to me anonymously, and then I can ask them of the management team. Bill, with that, I will turn it over to you to introduce everyone with us here from your team. If you want to give a quick overview of Easterly, and then we can go to Q&A.

Yes. Thank you very much, Manny. I'm joined today by our Chairman, Darrell Crate, our CFO and COO, Meghan Baivier; and our Head of IR, Lindsay Winterhalter, and it's a real pleasure to be here today. And I think that I can't believe it's been an entire year since we're all enjoying ourselves in Florida, trying to avoid handshakes, stealing Purell and hoping that this wouldn't end up in a recession. But for Easterly Government Properties, it turned out to be an amazing year. We exceeded our guidance. We exceeded our acquisition volume. I think Meghan did a terrific job in our balance sheet deleveraging. And serve the government during a very important time. And I think a lot of people got a real appreciation for some of the acronyms that you make jokes about, sometimes, Manny, but I think the FDA certainly should get a big round of applause what they've accomplished in the federal government, in general. So we're really pleased to be their partner and really excited to have delivered that FDA laboratory in early October. But it's been a great year, and this year looks like it's shaping up to be even better.

Great. So as we begin here, just coming out of the pandemic, if an investor were to choose only one real estate stock to own, what are 3 reasons that should be Easterly?

Well, if you have to hold me to only 3, I have many more, but I'll try to cut it down. I think the Easterly portfolio today is stronger today than it was pre-pandemic, and I think that's fairly obvious. We've accretively grown the portfolio by 13% in 2020. We've delevered the balance sheet, as I mentioned. We've raised equity using our 4 capabilities on the ATM at highly attractive levels. And we have delivered a brand new state-of-the-art laboratory for the FDA. We've re-leased several important assets for long-term durations, and we're growing the weighted average remaining lease term of our portfolio to an unprecedented year-end high. Two, I'd say, with various federal agencies, primarily for the GSA as our primary tenant. 99% of our lease income is backed by the full faith and credit of the U.S. government. At a time where tenant credit quality may be compromised. And I think we've seen that because of the prolonged impacts from the pandemic. Now is a great opportunity to appreciate the stability that comes with the U.S. government credit. And three, if I -- just 3. We've worked hard on our balance sheet, and Meghan has done a terrific job. And today, we are a predominantly fixed rate structure and an attractive interest rate with long-term maturities. We're currently towards the lower end of our target range of 6% to 7% -- times leverage.

Great. Well, I think we should start with acquisitions. And just remind us how you come up with sort of your stated acquisition range. And as you look at it this year, I think you said this year is going to be better than it was last year. When you say better, that's in terms of what? Is that in terms of acquisitions? Is that in terms of fundamentals? What is better about this year?

Absolutely. Well, I think last year was a standout year. We were -- we said $200 million, and we delivered, I think, about $252 million in acquisitions. And the reason we is, Manny, we use that $200 million level. That's a number that we know that we can do with our amazing team through off-market transactions and a smattering of marketed transactions as well. And that's a level where we know that we're not going to step in and really move the market too much and change pricing. And as I said before, we're able to probably buy many times that in 1 year, but then we'd be paying for it over the long term. And I think our shareholders appreciate us for that steady growth. Last year, all in, it was close to 9%. And so it was a wonderful year. And I think why are we saying that this year is going to be better? Well, first of all, I think $201 million would be a real disappointment this year. So I think we're going to do a lot better than that. And why? I think there's a number of factors. We're seeing a lot of opportunities, certainly in newer buildings that are being offered via outpatient clinics that are out there. We're seeing our existing sellers, people that we've had wonderful relationships for the last decade, are maturing in age and also maybe sensibility and have realized that selling to us is a wonderful way to do a transaction, potentially looking at a next year or a year after where they could be facing a very different tech structure than they're currently facing from the federal level. So I think that's important. And then I think, in general, with -- I don't know where interest -- you're going to ask me where interest rates are going. We can only guess. We were wrong last year. But I think we've seen a turn, many of these owners that we deal with directly are considering this an opportunity to sell at a great price. And still, for us, it's very accretive with our cost of capital.

When you're looking at your bull's-eye, how much does the age of the asset matter? You said you're seeing a lot of new assets coming your way now at IPO, I don't think we're talking about very many newer assets. I think that was probably older assets at the time, what's changed?

Yes. What's changed is there's been -- certainly with the VA developments, which was really occurred during our time, just at the end of our time as a private equity concern. With the Obama administration working bipartisan with the Republican party to introduce that $4 billion upgrade -- actually, it was a $60-some billion core, but $4 billion worth of new outpatient clinics that we'll be serving our 22 million servicemen and women throughout the country at these amazing new facilities that can divert people to either the public or private sector, depending on what the needs may be. But -- so that's one reason. We've also just purchased some newer buildings. And I think it's quite incredible that with 80 buildings or so right now, that we actually -- have actually made our buildings younger. It's hard to do. We can't do this much longer, but we've been, I think, very fortunate to be buying some really great new buildings at this time.

I think at prior meetings, maybe just as long ago as NAREIT November, we're talking about the potential for other developers or developers of other products that have some distress and that be a potential funding or acquisition source. Is that still the case now?

We took advantage of that, Manny. There were a few cases. I'm not going to point them at because I'm sure they wouldn't like to get that they were distressed, but in this sort of format. But I think we saw several buildings and are glad to have him today, one of them being very new. And they're part of it. I don't really see that as much going forward. I think people have cleared the decks. And from that standpoint, we're seeing more opportunities in other areas.

Switching to development. Do you think that this is a year where you really ramp up your development pipeline?

Meghan?

Yes. So we've nicely delivered a property every year. We're in the process now of working on an asset that's closer to $100 million and $225 million estimated total scale, and we're in the thick of it with the FDA, and we expect that, that pipeline will continue to present opportunities for us. So we're ramping into Atlanta throughout the year, Manny.

When you talk about a deal like that and especially with the confidence of allowing us into the 10 size-wise and whatever else? What's sort of the back and forth at this point? Is it a matter of the details? Is it a matter of the timing? Is it literally just getting everything signed? Like where are you in that process?

Yes. We're in, I would say, back half of the design phase. And the FDA is really honing what they want to put into this building. Changes are always positive for us. And it's remaining on track to be sort of a mid-'23 assets.

And then other things that are potentially in that development pipeline? Or is it going to be one at a time and don't ask for more?

No. Look, we -- we're optimistic that post-COVID and when Atlanta really gets ramped and running on the construction side of the house and they're out of design. But that will bring to you other opportunities to market. And we obviously have competed well historically, and we expect to compete well in the future.

What does competition in that space look like? Is it relationship? Is it proof of ability? Is it price? Is it -- where is that?

Yes. And generally, each competition can be a little bit different in terms of what the parameters are, but it's always a combination of skill set, history building these assets as well as price.

Sorry, just looking here at where I want to go with it. In terms of the competitive landscape for both development and acquisitions, has anything changed meaningfully there?

No, it really hasn't. I think that we have 2 primary competitors that are in the acquisition that are private equity, and they continue to do the same thing they've done. We tend to have a more focused look at things than they do. I think we have a better cost of capital. And so we are able to execute on the buildings that we want to, which would be a very small subset of what they probably are interested in doing. There continues to be no one else in the public markets that we butt heads against. We love Steve Derk and OFC, and we have never come into competition with them on a single building. We're in different zones. When you get very large, you do, of course, get the large insurance companies, I think that you'll see the Koreans come in from the South Korean insurance companies, and you'll also see sovereign wealth funds sniffing around for some of the largest buildings, but it's been very much consistent the entire time.

And I guess those other groups being involved, how much does that impact the yields in those larger more fully marketed deals versus where you're doing deals?

I think when you get to the pristine deals, I mean, you're going to be looking, obviously, below 6 cap in those areas and could probably float down to 5.5 or so or maybe even further if it's a large enough facility. But thanks to Megan's hard work, and our shareholders -- we're still able to get accretion at most levels there.

We just wrack your brain on sort of how the government thinks about things going forward. In conversations with office landlords, we're talking about the space of the future. And the answers have basically been -- we don't know, but we're not seeing any change yet. Is that the right way to frame how the government is thinking about bringing their people back into physical facilities?

Well, I think -- I'm not -- we don't know part. I think I can do a little better than most of the other folks with that answer. In that -- in these build-to-suit facilities, they cannot conduct their mission. For the most part, outside of the facilities. It's just -- it's too secure. There's too many needs skip rooms, communications, obviously, very sensitive files. I mean there's -- if you went into one of our DEA facilities, you could run into $20 million for the cash stack on a desk. I just don't think that's going to be a big hit in one of their workers home apartments.

So that will be a big hit.

Yes, it will be a big bet. But the laboratory space, they're doing a lot of work there. And so I can tell you that for the majority of our facilities and certainly the wonderful agencies we work for, the future is probably going to look for at least the next 30 to 40 years, what it looks like now. In those facilities that are not, we call plain vanilla. They have important missions, but maybe they're more regular office space. The great news is we've already renewed them. For the most part. And so that's really not going to be an issue for another 15 years.

I guess, taking that a step further, do they need more space? Can they bring out one day?

Yes. I mean, I think that's -- Manny, you hit the nail on the head for us, which is our biggest concern and why we will usually sell a facility is that we are worried about expansion. 10 years from now, not just 5 years now. We look at 10, 15 years from now. And so I think that certainly, the field offices, the FBI and so forth luckily, when they were planned after 9/11 in many cases or just before, they're expansion joints, they're on 10-acre properties. There's plenty of room for us to build the features and functionality for the mission-critical jobs that those agencies perform.

Megan, can you give us an update on where you stand on lease renewals for the year? At the last print, I think you had 11% expiring in '21?

Yes, that's right. So I reiterate briefly the comments I made on the fourth quarter call. So we've got a handful of leases that were 2020 or even 2021 renewals that we have sort of fared the deck on. And I spoke on the call that currently, that subset of leases where we have renewed and are going through the TI work now. We do expect those leases to be up in the 17% to 20% ZIP code. And then as we look out to the remaining that we're on the stuff at the end of the year, our March is 2020 and 2021. Also extreme optimism about dose, getting renewed, very confident. They're all in some stage of the procurement process. Asset management team is working really hard to get those over the line. Looking forward to having updates as early as next quarter.

And then while the cameras on you, forward equity has been sort of your preferred way of funding a lot of growth, especially over the last year to 18 months, I guess. Is that still the right formula or right recipe?

Yes. With the pipeline sort of in that ZIP code of $200 million, $200 million just plus, it is a nice way. It's efficient. They're onesies and twosies these deals. And so we can lightly step into the markets and raise some really accretive capital. But not get in the way, if you will, of investors. And it's highly appropriate for what we're doing with that strategy, with the onesies and twosies. Yes.

Darrell, you look bored just watching. So let's go to you for a little bit. When you and Bill sat down a decade, has it been a decade for the company?

Yes, it has been a decade.

Yes, decade.

When you sat back a decade ago and you took an napkin and a pan and you drew out your plan, does it look like what it ended up being? Or sort of where have things veered off from that?

Yes. No, it does. I mean, we continue to use that same bull's eye diagram that Bill drew on that napkin 10 years ago and that you saw in our IPO presentation, and that's in our investor deck today. We assembled the most pristine portfolio of government buildings. And investors should know that they're backed by the full faith and credit of the United States government, and that was the theorist, which is buy the real estate, sell the credit. So we're very well positioned. And as we look forward, we'll just keep doing that steady growth and buying some of the best mission-critical buildings and the agencies that are right for us.

I guess, connecting that comment with one you made a little while ago, the VA pipeline wasn't there when you guys sort of launched. So what would have that back felt that? I guess the question being, if you're at 250 now, including the new VA stuff, shouldn't it be sort of 350 including what you would have done pre-VA?

I don't know. I mean, our job is to -- we think -- and as you remember, when we went public and our observation during that time was if we go steadily deliver investors 7% year in and year out for 5 years, 10 years, as I think we've said, that puts us -- should put us on the cover of REIT magazine. And we're doing a terrific job, and that creates top quartile like performance. And we've done that. And even during a year of COVID, our growth rate is higher. And if we can compound at that rate for investors over 10 and 20 years, they're going to do very well relative to any market that they could otherwise be invested in.

And then in terms of dividend strategy along with that, I think we've been talking about cash flow growth for a number of years now? And is it finally getting to a point where that's going to come into the dividend?

It should. As the portfolio grows, PTO was a little bit of a speed bump as we look back. And that was where CAD didn't continue to grow, but we're in a place as we look forward. And as these renewals are done and the opportunity to buy more buildings as COVID is gone, should give us every opportunity to grow the dividend.

Is there some element of -- you guys were very active during COVID. I know Visa -- I spoke to you guys from all kinds of airports and airplanes and wherever you were checking things out. Did that preclude others from going out there or did at least mute some of those or muffle some of those conversations that people would have had? And now as things wake up again, does it actually make it harder for you?

Go ahead, Darrell.

No, I think we're very well positioned. Bill did a fabulous job getting out in front of people. And as we -- as times get lifted, there's opportunity to visit these buildings with all the constituents that we need to as we buy them, there is some pent-up demand.

Bill, you've been itching to get on this ESG question. So what are your top 3 priorities to improve your ESG score next year?

Well, I'd tell you, I think it's an important area, and we're really seeing there's a lot of -- as you know, a lot of money moving into the EPC area. And I think one of the great things when we set this whole company up was at the front end of that at the beginning, in a lot of ways with the United States federal government certainly in their priorities. I think we made great strides. We're publishing at our inaugural environmental of social responsibility policy in late 2020, so that's out there. And we believe that the top 3 priorities to proceed to boost that ESG score. I mean, I think are quite doable. And certainly, from the environmental perspective, we're creating and monitoring and improving energy store profiles, which are extremely important to the government. That's what they're really looking at. Easterly and our primary tenant. Again, the government both care about the environmental profile of our portfolio through that. Just one single lens. We've been gathering portfolio metrics, which takes a lot of work, but he hands-off to our portfolio managers. I think we probably burned a little less in our Texas facilities over the last 4 weeks. But we've been gathering portfolio metrics all along. And we're programming basically LED retrofits on our own anywhere we can do within the portfolio and our parking garages because most of these facilities are easily gotten to by focus cars, which is one reason we've been able to continue operating. And this has been an ongoing program, and I think you're going to see us pushing that in the future. On the social side of things, we value diversity, and I think we always have. And I think Darrell certainly brought that to us when we started off and figured out how we were going to put this company together. And certainly, our first major hire. After we went public, our CFO and COO, Meghan Baivier, has been pushing that and an example of that as well. 38% of our employees are female, 20% of our employees are nonwhite and 40% of our named executive officers are women, 2 of our 3 standing committees of our Board of Directors are chaired by women. We strongly believe the diversity of views, experience, skill sets, gender and ethnicity throughout our organization, promotes a more inclusive culture that attracts top talent, innovation and diversity. It's our goal to remain a leader in this important initiative, and you can be assured there'll be more good news ahead in that front. And finally, in governance, and I'd like to start, but I think we'll let Darrell speak to it a little bit. Basically, we have a wonderful Corporate Governance Committee. And we're continually evaluating what we can do. We made some major strides last year at the end of the year by dropping a majority voting standard and uncontested elections of policies requiring directors who fail to receive a majority vote in an uncontested election to submit their resignations, and we have a robust stock ownership policy that applies to all of our named executive officers as well as our independent directors. And we have an incentive clawback policy, which I do not plan on having tested. And we intend to continue our commitment to regularly assessing our corporate governance structure. But Darrell, you were really part of this at the beginning. And as the Chairman of the Board, I think it's more appropriate that maybe you make some observations on it.

But I think -- and Manny, as you can see, we're going to be a leader in ESG. One of our early funds was a green fund. And we have a tenant that is committed to the environment. President Obama in 2008 set a standard for government buildings. And as you know, in our world, our tenant pays for improvements that our shareholders get to own. So it's a terrific time to take some of that $1.9 trillion and make sure that we are continuing to do a terrific job of upgrading our buildings and making them conform with the government standard. And when we think about the folks who are attracting to the Board, we have a diverse pool of candidates. We are very focused on being a leader in the REIT industry related to ESG. You'll see that in our proxy when it's published, and you'll see it in our actions throughout 2021.

Darrell, on the point of the government covering the costs and Bill talking about LED retrofits. Is that a push or pull? Do you go in there and do it and send them a bill and they reimburse you? Or is it a conversation that you need to do...

I mean, one of the ways that we're a strong partner to the government is to offer them opportunities to enhance the facility to execute mission.

And part of the comprehensive mission of government is being a strong global citizen. Maybe I'll let Darrell answer this, please do. What's one thing you wish the Street better understood about your company model and strategy?

I think it's the consistency and the stability of what we're delivering. I mean, year in and year out, we've delivered $200 million to $300 million of acquisitions. We've delivered consistent growth and it's all backed by the full faith and credit of the U.S. government. So one, over time, that spread between treasuries and the return that we deliver should get ever smaller. And when folks group us as a net lease or office, but we're truly different, and we're providing a stability of cash flow. We've got billions of dollars of leases that are to be paid over the next 20 years that are not going to experience any volatility of your confusion. You saw it at the beginning of the pandemic when our stock was a safe haven. Our portfolio is better today than it was pre-pandemic. And we should -- there's a lot of excitement for sort of the REITs that maybe were out of favor in hospitality and other areas as we reopen. But investors shouldn't lose sight of the stability, consistency of growth that we're continuing to deliver.

Do you think that if you were to double or triple acquisition volumes at the expense of yields or returns that, that would be perceived positively or is received positively or negatively by...

I mean the -- obviously pay attention. But Manny, as you know, that's just not our way. I mean we want to be disciplined investors, our ideas to gobble everything up. As Bill says, we don't want to be the elephant in the swimming pool in this sort of subset of the real estate market. So we're making very attractive acquisitions, and these are buildings that are very high quality. As you know, they're younger, they are on mission, they're important. And we're going to experience renewals for them for the next 40 years.

I mean, if you look at 2 things visuals, think about the 4th of July, and they shoot off as many fireworks in the last 30 seconds, as they do in '20 minutes. And it's great, then all of a sudden, it stops. And another one is think of a world-class hot dog eating contest. It's really sort of fund 8 watch for a while, but it really doesn't work out for the long term, and we're always trying to trying to be there for more build. Nobody shows up for the hotdog eating Marathon. Nobody does. Yes. They're eating tofu and running with you, Manny. I mean, they're in great shape.

We try to be low on sizzle and high on substance, Manny. That's what we're doing.

That's the next report title right there.

There you go.

You can play the song around.

I'll leave this song ready to my boss. We'll turn to the rapid-fire to close up the session. When we're sitting physically together in Florida a year from today, what will be the one thing that will have surprise people most about your business over the prior 12 months?

I think that there was no surprises. Over the last 12 months that we've succeeded and hit our numbers and probably raised stuff and bought more buildings than people expect at the beginning of the year to match the other 6 to 7 years that we've been public.

What do you think your corporate travel budget will be in 2022 as a rough percentage of what you spent in 2019?

We expect it to be 120%. So commensurate with the corporate growth.

What will -- I hate this question for you guys, but I'll ask it anyway. Darrell, are you net lease today or office today? Or what are you today?

We are net leased with a scoop of office, Manny.

Right. So what will the same-store NOI growth be for the rest of -- or for the overall net lease sector in 2022?

I don't know, but we're going to continue to deliver 2% to 3% growth as -- and that's consistent with what we've always said.

And what will the 10-year treasury yield be 1 year from today?

Bill, do you want to give me yours?

Yes. Because I'm sorry, Jerome Powell is online, too. 2.4%.

Meghan?

That's correct.

I'll go 2.25%.

It's higher than most people have said throughout the conference, if that's at all helpful.

Of course, that's what they thought last year.

You heard from us, Manny.

I'm just sharing, not appointing. Thank you, all.

Thank you, all. Thanks a lot.

Appreciate it. Thank you. Have a great day.

See you.