May 8, 2013
Executives
Christina Cha – Director of Investor Relations William J. McMorrow – Chairman and Chief Executive Officer Matt Windisch – Executive Vice President Justin Enbody – Chief Financial Officer
Analysts
Jason M. Ursaner – CJS Securities, Inc.
Kelly M. Metzler – Bank of America Merrill Lynch Will C.
Marks – JMP Securities LLC David J. Gold – Sidoti & Co.
LLC
Operator
Good morning and welcome to the Q1 2013 Kennedy-Wilson Earnings Conference Call. My name is John, and I will be your operator on today’s call.
At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session.
Please note that this conference is being recorded. I will now turn the call over to Christina Cha, Vice President of Corporate Communications.
Christina Cha
Good morning, everyone. Joining us on today’s call are Bill McMorrow, Chairman and CEO of Kennedy-Wilson; Matt Windisch, Executive Vice President of Kennedy-Wilson; and Justin Enbody, Chief Financial Officer of Kennedy-Wilson.
Today’s call is being webcast live and will be archived for replay. The replay will be available by phone for one week and by webcast for one year.
Please see the Investor Relations section of Kennedy-Wilson’s website for more information. Statements made during this conference call may be forward-looking statements.
Actual results may materially differ from forward-looking information discussed on this call due to a number of risks, uncertainties, and other factors indicated in reports and filings with the Securities and Exchange Commission. I will now turn the call over to Bill McMorrow.
William J. McMorrow
Good morning everybody. I’m going to take you through the earnings release here.
Both Matt Windisch, Executive Vice President of Kennedy-Wilson and Justin Enbody, our Chief Financial Officer are with me. I’ll take you through the earnings release and then we’ll open the call up for any questions that you have.
But as a starting point, we had a very good first quarter with our EBITDA being reported at $31.9 million which was a 66% increase over the $19.2 million for the same period of 2012, and just as a point of reference for some perspective our EBITDA for the entire year of 2009 was $37 million. If you go down to our investment account, our investment account, net of depreciation and amortization at the end of the quarter was $843 million versus $837.6 million.
This change was comprised of $46.6 million of cash contributed to investments and $41.1 million of cash distributed from investments. The other concept which is a bit of a new concept that we are reporting is, we wanted to show you what our gross investment account is before depreciation, because as you all know the majority of our investment account is carried on our books at a depreciated cost.
So on a gross basis, our investment account was $929.6 million at the end of March 2013 versus $911.3 million. The accumulated depreciation as of March 31, 2013 was $86.5 million versus $73.7 million as of December 31, 2012, which obviously shows you that we ran almost $13 million worth of depreciation through our income statement in the first quarter.
And as a side note, our depreciation on an annual base is now both at the joint venture level and the KW level, our share of it is running approximately $50 million on an annualized basis. In terms of what we own now, we’ve got 17.1 million square feet of real estate comprised of 14,764 apartment units and 54 commercial properties.
Additionally, as of March 31, the Company and its equity partners own an excess of $1 billion in unpaid principal balance of the loans secured by real estate. And as you may have seen in our press releases in April, we closed another apartment building in Salt Lake City called Foothill which brought our total apartments that we own now to 15,400.
We also have under firm contracts non-refundable contracts another 900 units, which will take our apartment business to almost 16,500 units. The other way to look at both our apartment and our commercial businesses are what we call our same-store metrics and these are properties that we’ve owned at the same period of time, March 31, 2013 versus the prior year.
On a same-store basis our multifamily units, rental revenue, net operating income, and occupancy at the property level increased by 4.8%, 5.7%, and 0.4% respectively over the same period of 2012. In addition, based on our investments in our commercial office buildings of 3.2 million square feet and net operating income and occupancy at the property level, in the rental revenue increased 10.3%, 19.3%, and 4.6% respectively.
From January 2010 through March 31, 2013, the Company and its equity partners have acquired approximately $8.2 billion of real estate investments including the unpaid principal balance of loans purchased. During the three months ended March 31, 2013, the Company and its equity partners acquired $233.4 million of real estate related investments.
This includes $226 million of real estate and $7.4 million of unpaid principal balance of loans secured by real estate, in which we invested $38 million and $5.7 million respectively. Subsequent to the end of the quarter, we actually had a big month in April.
Matt Windisch
And we closed $900 million of real estate related investments in April and that took $75 million of our equity to do.
William J. McMorrow
And you will also notice in the subsequent events to the end of the quarter that out of the BOI REIM loan portfolio we got $33 million of distributions in April. So if you add that plus a few other things to what we got back in the first quarter, we got back out of our investment account almost $80 million of cash through distributions and through the end of April we put out, including the number that Matt just mentioned, we put out $125 million of cash.
In March 2013, the Company acquired the interests of some of our existing partners in the 615-unit apartment building in Northern California, increasing our ownership from 15% to 94%. The original 15% that KW own was carried on our books at zero due to prior distributions, and so the resulting consolidation in this investment as a result of that consolidation, the Company realized the $9.5 million acquisition related gain.
In terms of property level financings, during the three months ended March 31, 2013 the Company and its equity partners completed $207.6 million of property refinancings at an average interest rate of 2.31% and an average maturity of 7.4 years. These refinancings include $122 million of financings that we did in Japan at a fixed rate of 1.35% and as we’ve mentioned on prior calls, what we’re doing with both our multifamily and office portfolio is going out as longer term as we can at fixed rates.
And to give you a little frame of reference, during the first quarter of 2012, the Company and its equity partners completed refinancings of $80 million in Japan at a fixed rate of 1.61% with a maturity of five years. In the United Kingdom, on our BOI REIM loan portfolio, our book equity in this investment now is $58.3 million and we own 12.5% interest in the BOI REIM portfolio.
In December 2011, we and our equity partners acquired the BOI REIM loan portfolio that had an unpaid principal balance of $2.1 billion. As of March 31, 2013, the unpaid principal balance was $417 million due to loan resolutions of approximately $1.7 billion, representing 80% of the loan pool.
You might also recall that at the JV level, meaning the JV level between our partner Fairfax and KW, we each had a 12.5% interest, so 25% of the total pool, we borrowed $323.4 million and between the two of us we put in approximately $125 million of equity. That $323.4 million loan had a maturity date of October 2014, but as a result of the resolutions over the last year and a half and particularly in March, we were able to pay off that entire loan of $323.4 million on March 21, 2013.
I’m going to ask Matt now who has the responsibility for Japan to report on our Japan multifamily assets.
Matt Windisch
Thanks, Bill. Our Japan multifamily assets continue to perform very well.
We’ve maintained 97% occupancy in those 50 buildings as of March 31, 2013. To give you a sense of the investment we had in Japan, our book equity at the end of the first quarter was roughly $84 million and that is a 41% interest in the assets before our carried interest.
Our maximum investment in Japan was $120 million. Since that time on the KW side, we’ve distributed $40 million from our Japanese subsidiary back to KW.
None of that $40 million has run through our income statement, because we’ve run $13 million of depreciation during that same time period and actually picked up a loss of $1 million from a GAAP perspective. But the $40 million of distributions, roughly half of those are from property operations, and the other half were a combination of refinances and also this bullet here, the third bullet.
We had $11 million of cash that came out of our currency hedge, related to a gain on that hedge. None of that ran through our income statement, but all went to reduce our basis.
And so, in little over 2.5 years we’ve now distributed, as I mentioned, $40 million out of Japan back to the Company, reducing our book basis down to $84 million.
William J. McMorrow
Right, Matt. Thanks.
And so, I think this is another very good example of what happens in our investment account where we still own all the buildings. We’ve been able to finance these now out on a longer term basis at a lower interest rate, but our carried value of the Japan investment has actually gone from roughly $120 million down to $84 million on our books.
As it relates to the service business, the management on leasing fees and commissions increased by 31% in the quarter to $13.6 million. During the quarter our service business achieved an EBITDA of $5.2 million, which was an 86% increase over the same period of 2012.
In terms of corporate financings, in March 2013 we issued 9 million shares of common and also as you see in the subsequent event on top of that the [issue] was exercised in April. So in total, that was 10.4 million shares that generated proceeds of approximately $162 million, of which $35 million was used to pay off our line of credit.
The Company is in a very liquid position today. We have currently approximately $200 million of cash-on-hand.
Our line of credit is at zero. And in addition to that, in one of our domestic U.S.
funds, we have about $150 million of discretionary cash available for investment. As I referenced earlier, subsequent to March end, we acquired almost $1 billion of assets in which we invested $75 million and we have under contract, under non-refundable contracts now approximately $260 million of additional investments, the majority of which will close here in the second quarter.
So, with that overview, I’d like to open it up to any questions that anybody might have.
Operator
Thank you. And I’ll begin the question-and-answer session.
(Operator Instructions) And our first question is from Jason Ursaner from CJS Securities.
Jason M. Ursaner – CJS Securities, Inc.
Good morning, Bill.
William J. McMorrow
Hi, Jason.
Jason M. Ursaner – CJS Securities, Inc.
Congrats on a good start to the year.
William J. McMorrow
Thanks.
Jason M. Ursaner – CJS Securities, Inc.
Just first, I’d like to ask about the portfolio of commercial properties you build up. Almost 5.5 million square feet at this point and on a square foot basis relative to comps, looks significantly below market.
So just wondering how you think about the potential embedded gain in that part of the investment account and what the timeline might look like to fully lease those properties up and move it towards a more stabilized NOI where it might reasonably trade in line with comps?
William J. McMorrow
Yeah, thanks, Jason. On the office buildings, in general, you have to remember that part of what we do is we buy buildings that are either in some cases when bought a building in Marina del Rey, it’s 100% empty and there’s nothing wrong with the building.
It’s in a very, very good location. But the tenant that was in the building, roughly 60,000 square feet, outgrew the building.
They needed the 120,000 square feet. So they moved to another building.
So we were able to buy that building in Marina del Rey, which is a very hot market here in Los Angeles right now at a very attractive per square foot price. And so, we’ve had very, very good success over the years of taking buildings like that and then getting them to 100% occupancy.
And a good example, one that we actually did is the Stadium Gateway building down in Orange County that we bought just last summer and it had an occupancy of 60% at the time we bought it and as we sit here today the occupancy in that building is 100%.
So I think that’s really hit on the office buildings. You have to look at the office buildings in a little bit longer period of time to stabilize.
And then, I think the other thing to remember with the office buildings is unlike the apartment buildings, your capital costs of putting tenants into the buildings are higher than the apartment buildings. You’re typically in the office buildings doing five year to seven year, in some cases 10 year leases, but when you start with lower occupancy, you’ve got to include in your acquisition price, the cost of what you think it’s going to take you get at least up.
Over the years, as I said, we’ve really made very, very good money by buying these buildings that have lower occupancy we can grow to a higher occupancy while at the same time, what I think will happen here in Southern California, is rental rates will increase over the next 24 to 36 months.
Jason M. Ursaner – CJS Securities, Inc.
Okay. And just second in the multifamily not to get too specific on the details of the Summer House transaction, but just at a higher level, how much do you see this kind of validating the embedded gains on the investment account, and what's the best way for investors to be evaluating the potential size of the carried interest at this point?
William J. McMorrow
I mean it clearly goes to show you what can happen in our investment account and we're over time with the distribution, what happened on Summer House is that the NOI increased significantly since we bought it. We had owned this and one-time sold it, bought it back in 2010.
The people that bought it from us got into debt maturity issues and we bought it back from them, but during that period of time from 2010, you saw significant increases in the NOI on the property because of what was happening in Northern California and through the distributions and the refinance we were able to basically cash everybody’s money out of the properties. So that we were call carrying this sort of zero basis.
And so the multiple along this was four times on the KW investment account, when you look at really actually what happened here. And I am not for a minute saying that that’s what you should do with the rest of the investment account.
But it goes to show you that we have some, I would say significant embedded gains in the investment account and what we try to do in the supplemental income is give you, if you look at just the multifamily portfolio now, which by the end of the second quarter were almost 16,500 units. And you use the NOIs on that portfolio, and you can pick whatever cap rate, you’re comfortable with there, what I said for several years of the big portion of our investment account and half the depreciated cost is covered by the values of our multifamily assets.
Jason M. Ursaner – CJS Securities, Inc.
Okay. That was it from me.
Appreciate it, thanks.
Operator
Next question is from David Ridley-Lane from Bank of America Merrill Lynch. Please go ahead.
Kelly M. Metzler – Bank of America Merrill Lynch
Hi, good morning, this is Kelly Metzler for David Ridley-Lane. We’ve heard from some of the commercial brokers that there is investor interests beginning to start in Spain, not necessarily deals, but interest.
I was wondering, if we could get an update on your operations in Spain and what your current view of the market is?
William J. McMorrow
Yeah, thanks Kelly. I would tell you first of all that our main focus continues to be in Europe and the United Kingdom and Ireland.
And, as you can see from the results of the BOI REIM portfolio, and I can tell you from the operations of our apartment buildings were basically, we have a 100% occupancy in the two apartment buildings that we own in Dublin, and in our office building that we bought there, the State Street office building where in that particular part of Dublin, you’ve got declining vacancy rates. That the main focus of what we’ll be doing in Europe this year, still continues to be in the United Kingdom and Ireland.
Having said that as I’ve mentioned before in our calls, we are continuing to do auction business in both Spain and Portugal, and the auction business gives us a way into these markets, I would say from a information perspective without us risking capital and we're not yet at a point in either of those markets, but particularly Spain where we’re prepared to commit capital. Now we’ve got a lot of things and we’re talking to people about.
We are looking at and so on and so forth, but right now really I think for the balance of this year unless some unusual opportunity comes along probably 100% of our capital will be in the two markets that I’ve mentioned before.
Kelly M. Metzler – Bank of America Merrill Lynch
Great, thanks for that color. And then did the acquisition of 615-unit apartment building in Northern California occur early in the quarter?
I am just wondering if the $6.4 million in rental revenue is a good run rate for the rest of the year or if the acquisition that would boost that up a bit?
Justin Enbody
The end of March and so, the majority of the rental income from that, nothing any of that really to speak of in the first quarter, so…
Kelly M. Metzler – Bank of America Merrill Lynch
Got it.
William J. McMorrow
But the NOI on that property is running at a higher level than that number that you mentioned.
Matt Windisch
That’s what our rental was for the quarter. So it will go up in the fix.
William J. McMorrow
I see.
Kelly M. Metzler – Bank of America Merrill Lynch
Okay. And lastly, could you provide a bit of color on the loan purchase in early Q2?
It was $0.8 billion of unpaid principal balance. What was the purchase price, and what is Kennedy Wilson’s equity ownership in that deal?
Thank you.
Justin Enbody
So we can’t get into the exact specifics on that, but I can tell you that we paid a purchase price of a substantial discount to par on that pool. It was a bigger discount than we paid on most of our pools to-date.
I can give you a range, which is, it was between $0.40 and $0.60 on the purchase price. And our ownership in that pool, it’s actually broken up into two pieces.
The first piece, we have a 50% interest in and in the second piece, we have a 5% interest in. For the blended ownership, it’s about 25%.
Kelly M. Metzler – Bank of America Merrill Lynch
Thank you.
Operator
Our next question is from Will Marks from JMP Securities.
Will C. Marks – JMP Securities LLC
Thank you. Good morning, Bill.
Good morning, Matt.
William J. McMorrow
Hey, Will.
Will C. Marks – JMP Securities LLC
I guess first, Matt, you were discussing the Japan portfolio. I am looking at the supplemental on page 19, and why was the NOI down for the quarter?
You may have mentioned this, but I might have missed it. I can see that revenues were up 2.5% that maybe wasn’t enough to boost NOI, or was there…?
Matt Windisch
There is actually a supplement which has been updated on our website. The NOI was $25.3 million on a run-rate basis for the year and that compares, it’s slightly down from last year and that’s because of the currency, but on a yen-to-yen basis, the NOI is flat year-over-year.
Will C. Marks – JMP Securities LLC
Okay. I guess I was trying to tie that with, and probably unrelated, but with the strong performances of comparable companies in Japan, is it not due to NOI growth, rental growth?
Is it due to chasing some sort of yield or what would you attribute those public companies doing so well?
Matt Windisch
What’s happening in Japan is rental growth is starting to come back, particularly in Tokyo, on the apartment buildings. What’s happened though in terms of the pricing is that the cap rates have gone down in Japan, given a lot of the action that’s happening with the DOJ.
And so the public market companies are now trading at a 50% premium to their net asset value, which is close to all-time high. And so cap rates certainly, and yields have come down.
Rents are starting to move up, but the yields are certainly moving down, at this point, faster than the rents are moving up.
Will C. Marks – JMP Securities LLC
Okay. Thanks.
William J. McMorrow
As everybody knows, we’ve had a tremendous increase in the Nikkei and all the real estate stocks in Japan. So, the outlook for the real estate market in Japan is certainly much improved over what it was a year ago at this time.
Will C. Marks – JMP Securities LLC
Okay. Thank you.
On the broader multifamily, I think, it’s the 5.7% growth in NOI. How would you think about that going forward, is it accelerating, what would you expect for the year?
Matt Windisch
I mean, we’re seeing similar trends, Will, here in the second quarter than what we saw in the first. And so, rents continue to go up overall in the portfolio, Northern California in particular.
We’ve seen a lot of growth in the rents, a little less in Southern California at this point, but everything still is kind of going along the same pace.
William J. McMorrow
And then, I think too, Will, the other thing that’s happening in a good way in the apartment portfolio is that as you know, we historically have brought older buildings, not necessarily brand new buildings, and so two or three years ago, we were not generally doing extensive rehabs of the units because we didn’t think we could get as much of a rental pop as we wanted. But I would say across-the-board in all of our properties now, we have meaningful unit turns that we’re doing at around somewhere between $8,000 to $10,000 a unit and we are typically now on the ones that I was recently looking at.
We’re getting somewhere between 15% and 20% returns on that investment in the monthly rent. So we’re back to a market now where by reinvesting in these properties, we’re actually getting terrific rent increases.
Will C. Marks – JMP Securities LLC
Okay. Thanks.
And on that, just to be clear, when you gave your same property analysis, those figures include any kind of promotes, right?
Matt Windisch
No, the same property analysis is at the property level.
Will C. Marks – JMP Securities LLC
Okay. And I figured that.
William J. McMorrow
When you look at our ownership interest in those assets, it’s 40%, but that does not include the promote.
Will C. Marks – JMP Securities LLC
I know there is some ongoing, are you above certain hurdles at these properties, does it vary by property? I imagine you’re getting some ongoing promote that is not just at sale.
Matt Windisch
Yeah, I mean, generally our promotes vary in terms of the preferred return, but a lot of these apartment buildings were distributing over 10% current return to tax free and generally speaking that is above our preferred return rate. And so, as we all know, we’re paying the preferred return current in those cases.
Will C. Marks – JMP Securities LLC
And where does that show up if I look at your income statement on the revenue line? Where would the promote show up?
Matt Windisch
Generally, on these apartment buildings, you are not going to see the promote actually triggered until the sale.
Will C. Marks – JMP Securities LLC
Okay.
Matt Windisch
And so we’re paying the preferred return current, which means when we sell the property at that point in time, all the profit is split with the promoted interest as we’ve already paid the preferred return current.
William J. McMorrow
But I think it’s important, Matt, to reemphasize that generally speaking on all of these distributions that we’re getting, they are not going into our income statement. They are just simply being used to reduce the book carried value of that investment, which is why at the beginning we wanted to show you that really since 2009, if you look at it, we’ve run almost $86.5 million of depreciation against our investment account through our earnings and the same thing is true this year.
As I mentioned, we have $13 million worth of depreciation this first quarter. And so on an annual run rate basis, now we’re running at almost $50 million a year.
That’s our share of depreciation. It’s a non-cash charge and it obviously has the benefit of many other things too, because it provides shelter even though it’s a non-cash charge.
Will C. Marks – JMP Securities LLC
Okay. Now that make sense, it further highlights that the investment account never understates the true value of the portfolio.
William J. McMorrow
Exactly, because on a monthly basis what we’re doing is we’re writing down the investment account either through depreciation or a combination of the distributions until it gets to, it could over period a time as you run this out. Depending on how long you hold the assets you could end up with your assets, some assets on your books at zero as happened in the case of Summer House.
Will C. Marks – JMP Securities LLC
Okay. That make sense.
That’s all for me. Thanks.
Operator
(Operator Instructions) Our next question is from David Gold from Sidoti. Please go ahead.
David J. Gold – Sidoti & Co. LLC
Hi, good morning. I was hoping that you could give a little bit more color on the investment pipeline from here.
First off, how active is it? And then two, I think you made a comment about $260 million of additional investment under contract.
I was curious if you can share with us how significant KW’s share of that would be?
William J. McMorrow
Yeah. In terms of one of the bigger assets that’s in that grouping of $260 million, David, it’s $225 million and in that particular deal where it’s actually going to be a small part of the equity we’re going to be 5% of the equity.
On the other remaining transaction, we’re going to be about half of the equity. At the beginning of the year, and obviously this is no forecast, we do a capital plan obviously for the year and if you look at what’s happened through kind of the first four months of the year, we’ve closed roughly $1.2 billion of acquisitions.
And it’s our feeling at this point that, again without being it forecast that our acquisition pipeline is going to be similar to what it was last year, which was around $3 billion. And I would say that we still feel comfortable with that number.
David J. Gold – Sidoti & Co. LLC
Got you. Okay.
And then, also curious, Bill, if you can, I know this is more one of those nitty-gritty questions. But from a distribution standpoint, are there any other large distributions that you are currently aware of that you would expect in the second quarter or basically currently have a sense of for timing this year?
William J. McMorrow
Yeah. I mean, too at the beginning of the year, obviously when we’re doing our capital plans, one of the things that we take into consideration is the cash that we have coming back to us.
And as I mentioned through April, we’ve got almost $18 million back out of our investment account. At the beginning of the year, I had mentioned that we thought we’re going to get about $100 million to $150 million of cash back out of our investment account.
So we’re through the first four months at $80 million. And I’m still real comfortable with that number.
The big part of what might happen really in the second half of the year depends on the BOI REIM loan portfolio resolutions. But I think the cash that we get back out of our investment account this year on top of the $80 million is going to be somewhere between another $30 million to $70 million.
David J. Gold – Sidoti & Co. LLC
Got you. Perfect.
Okay. And then one last, as we think about what has happened in Japan, I have to guess or imagine that you’ve given some thought to how KW capitalizes on that.
Anything there that you might be ready to share with us?
William J. McMorrow
Yeah, I mean, as I said that the markets clearly improved there and you’ve got more real estate companies in Japan now that have the capacity to access a better equity market. The obvious most current thing that we’re doing is taking advantage of the low interest rates there and extending our term on all of our loans, just like we’re doing here in the United States.
So, from a specific focus that’s what we’ve done there. These events have occurred so quickly in Japan.
There is always a time lag. But we’re obviously looking at all of our options in Japan.
And I think one of the things that we did in the first quarter that really turned out to be a good decision was really, I would say, cashing ourselves out of the hedge even though we’re re-hedged again in the same dollar amount. We took almost $24 million of cash out of the hedge in the first quarter.
So, from here on out now, we’re running at high occupancy levels in Japan. We’re running around 96%.
At one point we had 97%. And as Matt said earlier, I think you’re going to start seeing some, I would say, modest rental growth in Japan.
So kind of starting to push the envelop a little bit more in terms of the rental growth and we’re talking to a lot of folks and we’re just going to keep our options open in terms of the whole portfolio in Japan.
David J. Gold – Sidoti & Co. LLC
Got you. All right.
Perfect. Thank you.
Operator
That was our last question. I’ll now turn it back over to Bill McMorrow for any final remarks.
William J. McMorrow
All right. So, thank you all very much for coming on the call.
And as I will say, if there’s anything that comes up here post this call, Matt or Justin or I are here to answer any questions. So thanks very much for your time this morning.
Operator
Thank you, ladies and gentlemen. That concludes today’s call.
Thank you for participating. You may all disconnect at this time.