Forest City Enterprises Exec Insights: Barclay’s Arena, Cap Rates and Ownership

On Friday, Forest City Enterprises Inc Class A (NYSE:FCE-A) reported its first quarter earnings and discussed the following topics in its earnings conference call. Here’s what executives shared with analysts and investors.

Barclay’s Arena:

Sheila McGrath – KBW: We’re getting so much closer to Barclays opening, I’m wondering if you could give us a sense on how you view progress versus your original expectations and if there was any derivative impact on your neighboring retail like Atlantic Center?

David J. LaRue – President and CEO: Sheila, thank you for question. The progress as we noted in our comments is very positive. I think on our prior call we mentioned that we have fallen behind a bit in our pro forma progress because of the dispute in the MBA regarding the labor contract, but we have seen and as you can see from the numbers, progress has reaccelerated. The interest around the project in the neighborhood as a result of Barclays Center opening in September has definitely increased. We have adjacent retail assets which have been well leased and continue to be well leased, but the opportunity to have quality assets and that additional traffic in the area has sparked additional interest, so it’s a spillover benefit that we look forward to.

Sheila McGrath – KBW: From a modeling standpoint on Barclays Arena, do we have to expense all of the interest upon opening or is that phased in some. How should we view that part of it?

Robert G. O’Brien – EVP and CFO: We will have to. As soon as the Arena opens we will have to begin expensing interest on the loans there. In addition, included and we disclosed this in our MD&A, we are already expensing obviously a bunch of the premarketing expenses there as well, which is obviously a bit of drag, anticipated within the overall scope of the budget, but a drag against current earnings because you can’t capitalize those costs.

Sheila McGrath – KBW: Is there a rule of thumb in terms of stabilization? So, in terms of the arena on the NOI standpoint, it opens in September, is it a 12 month stabilization or how do you think?

Robert G. O’Brien – EVP and CFO: Yeah, I guess I’d ask Matt to comment as well. Our sense, Sheila, is that certainly ’12 or late ’12 and all of ’13, we’re going to be working to take it out, honestly. We’ve got a lot of events planned and the revenue side looks very good, but it’s going to take at least a year. So, we think 2014 probably represents the first year of fully stabilized operations. Matt, do you have comments?

Matthew L. Messinger – EVP, Investment Management: Yeah, I agree. We’re obviously, we’re really excited and pleased with where we are in our contractually obligated income components and the limited events that have gone on sale, have been great. But like any operating business, like a hotel or any operating real estate asset, it takes time to stabilize, it’s I think two years plus or minus is how we look at it. We may do better in certain areas, we’re likely to do better, but I think that’s a good way to look at it about two years, plus or minus.

Sheila McGrath – KBW: Since you are on that, could you give us a little bit insight on the higher price units at 8 Spruce, how are they leasing versus kind of your expectation on pace and price?

Matthew L. Messinger – EVP, Investment Management: Right, they are leasing well, but it’s early in the process. The top of the building is even today not completely delivered, and in inventory, we just delivered a (indiscernible) for about the final 100 or so units in the last month or so. But there is still a couple of floors of units including those penthouses that are not completed. But there are a number of three bedrooms that have gone online so far as the top of the building and they’ve leased pretty well, but again, part of our caution that our initial, which is proving to be somewhat conservative, but our initial two-year lease of that we talked about being in our internal projections, sort of took into account that the upper four units and the more expensive unit take more time to lease, to deliver, the bigger financial decisions for individual renters, and there was a seasonality as well of course which we now have leased through a full year, but we saw strongest the leasing has been that were subject to the same trends that faced that – that everybody faces leasing apartments and it’s – there are better months and worse months. So overall, with the limited supply that has hit the market, we’re pretty pleased and meeting or exceeding expectations thus far, but we’ve got a ways to go still.

Sheila McGrath – KBW: Last question, Bob, on FFO versus EBDT, can you just run through the deferred tax impacts? So in other words, FFO, you’re not really paying cash taxes but it seems like it’s negatively impacted because you’re not adding those back. Just talk about that nuance there, because if we compare you to REITs on FFO, I think your AFFO will be adjusted higher on that number.

Robert G. O’Brien – EVP and CFO: That’s exactly right, Sheila. So, there is a comparison, I think it’s on Page 26 of our supplemental, that compares EBDT and FFO, and you see a fairly sizeable adjustment to EBDT and add back that deferred tax, and that does – you don’t see that same add back in FFO. We’re filing the redefinition of FFO to the letter so that we’re in compliance. Certainly deferred taxes is exactly what it says. It hit their income statement, but they are not cash so it’s not a cash charge. So things like that like capital expenditures or like straight line rents will all obviously be or can be added back for AFFO So I think that addresses your issue.

Cap Rates and Ownership:

Paul Adornato – BMO Capital Markets: We appreciate all the added disclosure surrounding FFO. I was wondering if you were planning to issue FFO guidance at any point in the future or at least talk about specific assumptions underlying FFO?

Robert G. O’Brien – EVP and CFO: Paul this is Bob. As you know we’ve not provided guidance in the past we’ve tried to talk about where our portfolio is headed hat being said in my prepared remarks today I tried to give at least some indication of the impact to interest because of our capitalized interest expense and how that’s going to impact our results as well as taxes where we had a decent tax benefit last year in large part driven by NOLs also driven by asset sales. In our current projection we’re not projecting huge amount of gains in our performance although we continue to market some of the nice core assets that will have the swing on current deferred taxes and therefore with those impact.

Paul Adornato – BMO Capital Markets: Fair enough. With respect to 8 Spruce Street David I was wondering if you could give us some sense of where you see cap rates for similar trophy multi-family out there?

David J. LaRue – President and CEO: Well again I think Paul as you look across the spectrum core assets in core markets and very strong markets like New York have been very aggressive, and I think that’s just a reflection of quality, both from a standpoint that the existing asset and the future growth opportunities, but it’s also a reflection of capital available in the marketplace to invest as opposed to where 10-year treasuries are and other investment alternatives. I don’t want to ponder what cap rates could be on our projects. I think that the interest that we’ve seen to-date through the signing of the confidentiality agreements in the property tours has been very strong, and we will see how that plays out. As I mentioned during my comments, we are excited to own this asset. We’re going to remain in this asset. We’re looking for a minority investor in order to again capitalize on the value that I think has been demonstrated and continues to be demonstrated by this quality of product.

Paul Adornato – BMO Capital Markets: Just to clarify, ultimately what type of ownership or equity interest you expect to maintain in that asset, and what kind of a fee streams would come to Forest City?

David J. LaRue – President and CEO: The existing ownership, us and our current partner, will continue to own at least 51% of that building, and from that, we will get our normal – from a fee basis, which is an important part of any real estate company’s operation. We’ll get our normal fees that we would get and negotiating with the new partner, we will again look at market driven factors and have that discussion with them if we get to that point.

Paul Adornato – BMO Capital Markets: With respect to the lease turnovers at 8 Spruce, now that you have been open over a year, what kind of increases are you putting through?

David J. LaRue – President and CEO: What we’ve had is – that’s a very good question, as we’ve talked about we are now into that lease-up and lease-rollover period that we had great acceptance during last summer and spring. We are generating in our lease-rollovers between 3% and 4% increases and again have continued to have good interest on the tenant from the units that have vacated the building. The interesting thing is, again it’s early in the cycle, I mean less than 10% of the available units have rolled over, that will obviously accelerate. As you recall, last year we had a very successful lease-up during the summer month, but right now less than 10% of those units have rolled over and we are pleased with the tenants that are renewing, but we are also pleased with how quickly some of the campus spaces that have vacated have been spoken for.

Paul Adornato – BMO Capital Markets: Finally, at Barclays Center, are you planning any investor outings to see either Barbra Streisand or Justin Bieber?

David J. LaRue – President and CEO: If you go on web, you could probably buy a ticket for one, but what I think was referring to was maybe after the opening having at that one we’ve worked out some of those things in the operation et cetera, so not specifically to Barbra Streisand or Justin Bieber, but I am sure, you’re big Justin Bieber’s fan and maybe we could work something out.