Q3 2019 Earnings Call

Good day and welcome to the City office, three Inc. third quarter 2019 earnings call and webcast.

At this time all participants are in a listen only mode.

Great question and answer session will follow the formal.

In addition.

To ask a question you May press Star then one on your touched on Fad.

If you're using a speakerphone please pick up your handset before passing the keys.

To withdraw your question. Please press Star then too.

As a reminder, this conference call Spain.

Recorded.

If you require operator assistance. Please press Star then see route.

It is now my pleasure to introduce to your Mr. Anthony Maretic, The company's Chief Financial Officer, Treasurer, and corporate Secretary. Thank you Mr. Maretic you may begin sir.

Good morning, before we begin I'd like to direct you to our web site at city office read Dot Com Rican download our third quarter earnings press release.

Supplemental information package the earnings release and supplemental package. Both include a reconciliation of non-GAAP measures that we discussed today to their most directly.

Comparable GAAP financial measures.

Certain statements made today that discuss the company's beliefs or expectations or that are not based on historical fact may constitute forward looking statements within the meaning of the federal securities laws or the company believes that these expectations reflected in such forward looking statements are based upon.

Reasonable assumptions, we can give no assurance these expectations will be achieved.

Please see the forward looking statements disclaimer in our third quarter earnings press release, and the company's filings with the FCC for factors that could cause material differences between forward looking statements and actual results.

The company undertakes no obligation to update any.

Forward looking statements that may be made and of course this call I will review our financial results after Jamie for our Chief Executive Officer, Scott. So some of the quarter's operational highlights I'll now turn the call over to Jamie Good morning, since our last earnings call in August we've been actively taking steps to position city office for.

Long term success.

During the quarter, we capitalized on strong equity and debt capital market conditions significantly improve our balance sheet.

We've also continued to source attractive acquisition opportunities, which will drive long term performance. In addition, leasing momentum and healthy same.

Stores results have continued across our portfolio.

With my comments today I'd like to speak to each of these major components of our results this quarter.

Starting with our recent capital raising activity the combination of strong equity market conditions and outperformance of our common stock year to date.

Allowed us to access equity capital at our highest pricing today.

Between shares issued through our ATM programs during the third quarter and a follow on offering in early October we raised just over 200 million at an average gross issuance price $13.56.

Per share.

This was an important step is it allowed us to secure capital for portfolio broken diversification, but it also will reduce our fully deployed leverage levels.

Separately, we took advantage of the drop in interest rates over the summer to renegotiate loan terms on approximately.

$88 million of property level debt.

Tony will provide more detail shortly but these steps will generate meaningful savings overtime.

Moving to our recent acquisitions and pipeline, we closed a 49 billion dollar acquisition in Denver during the quarter called 76, So one tech.

This six storey building is located in the Denver Tech Center Submarket of southeast Denver adjacent to our existing property 70, 595 Tech, which we previously called DPC Crossroads.

We've combined the two properties into a 380000 square foot.

Hi, its cabinets.

Features a full suite of attractive and recently built out amenities.

This enhances the profile of both buildings and provides us leasing flexibility as tenants grow or contract within the two buildings.

In addition.

We will be further amenitized into properties and of course.

Solid aided the leasing execution with one of the best leasing teams in Denver.

76, So one tech was 95% leased at the time of acquisition with a weighted average lease term remaining of 7.5 years, when including committed leases.

The building has had.

Recent leasing success and the tendency is anchored by Jackson National Life Insurance company, and a well capitalize public company.

Our third quarter occupancy for 76, so one tech shows it's 80% as one of the tenants sign a lease to expand into new space and they are expected to.

We occupy the space late in the fourth quarter 2019 or early 2020 .

We acquired the property at a 7.1% cap rate and expect it will produce solid long term results.

Hi, 76, so one tech we continue to evaluate a broad pipeline in excess of 700.

Hundred 50 million.

Given the typical timeline of a closing process, we don't expect to have any further acquisitions in 2019.

We're focused on executing on the pipeline and are targeting between 320 and $360 million of new acquisitions.

On a related note we.

Two smaller dispositions in process in Denver, one of which is a land parcel adjacent to our circle point property and the others are Logan tower property.

The buyers deposit on the circle point land parcel is nonrefundable.

We will provide further details on our next earnings call.

Turning to our.

Adding performance during the quarter. We continued the trend of robust same store cash NOI growth with 5.8% growth for the quarter year over year.

This brings our year to date same store cash NOI growth to an impressive 4.5%.

Our occupancy decreased.

From 93.4% to 91.2% during the quarter, which is a little bit misleading as far as our actual performance.

I mentioned earlier that our new acquisition 76, So one tech is 95% leased but one significant tenant does not technically occupy the space yet.

This.

Down the reported occupancy at this property to 80% and lowered the combined portfolio occupancy by about half a percent at quarter end. Despite 76, so one tech being leased long term.

Further we had approximately 119000 square feet of Vacates during the quarter.

These were known Vacates.

We mentioned on previous earnings calls well were necessary as part of our Camelbak square repositioning at higher market rents.

These move outs in Q3 will be offset by the 114000 square feet of new leases that are signed and committed but not yet an occupancy.

Vast majority of these committed leases.

Expected to commence in Q4, although the timing of the construction of tenant suites could straddle your it.

Notably during the quarter, we signed a 30000 square foot lease at EUR 70, 595 Tech property, which is a significant step at least in the attractive blocks of vacancy at that property.

We therefore.

Expect portfolio occupancy to pick back up in Q4, and we've provided updated guidance of over 92% at your it.

In conclusion, the net effect of the transactions that I discussed and the impactful balance sheet enhancements that Tony will detail have position city office to take advantage of opportunities in a thriving.

Markets.

Management's focus continues to be on intelligently investing our capital.

Enhancing our balance sheet, and driving and Hawaii growth.

We believe these steps will increase net asset value for our investors and increase our share price over the long term.

With that I'll turn the call over to Tony to provide further details on our financial results.

Thanks, Jamie on a GAAP basis, our net operating income in the third quarter was 24.6 million.

This represents a 2 million dollar decrease relative to the 26.6 million reported in the second quarter.

The decrease was primarily attributable to a 2.6 million onetime assignment fee income.

Reported in the previous quarter without the onetime fee in the previous quarter and Hawaii would've increased by approximately 600000, which was driven by the acquisition of 76. So one tech late in the third quarter and I know why growth from our same store portfolio.

The gross assignment fee income received.

Saved up 2.6 million was recorded within rental and other revenue in the second quarter for accounting purposes, the outlays and expenses were classified in Germany as onetime costs.

Those costs were approximately 1.1 million, resulting in a net 1.5 million benefit in the previous quarter.

Overall, we reported core AFFO of 12.4 million or 29 cents per share, which was 1.3 million lower than the second quarter.

As I mentioned the second quarter included a 1.5 million benefit from an assignment fee income with an offsetting increase attributable to the year to date acquisitions.

DNA was also.

We hired in the quarter, partly due to higher costs related to our first year being subject to auditor attestation under Sarbanes Oxley.

Our third quarter, AFFO was 9.3 million or 22 cents per share.

Excluding the impact of the higher share count from our capital raising activity.

Our AFFO would have been right on top of our 23 and a half cent dividend.

Our third quarter AFFO was affected by the tenant improvements on leasing commissions associated with our leasing activity in the quarter do relative size were portfolio and the impact of significant leasing in any one quarter. Our AFFO numbers will continue to move around some firm.

Quarter to quarter.

Our leasing activity in capital expenditures are provided on pages 17 to 19 of the supplemental package consistent with our definition of AFFO. We have excluded some first generation leasing costs, the largest of which relate to our recently acquired Kenyan part property further details or disclose on page 19 under Nonreoccurring capital.

Managers.

Our third quarter same store cash NOI grew 5.8% year over year or 4.5% for the first nine months of the year as compared to the same period in the prior year.

Orlando, Portland, and San Diego, where our best performing markets in the third quarter, each with double digit same store cash and <unk>.

Why growth, which was primarily driven by combination of occupancy gains in those markets free rent burn off and mark to market or step up in rents.

With a slight decrease in occupancy we experienced the end of Q3, we expect same store growth to remain positive, but moderate in the fourth quarter.

Moving onto our balance sheet, our total debt net of deferred financing costs at September Thirtyth was 652 million.

Our net debt to enterprise value ratio was reported at 43.5%, but that's figure does not include the additional 6.9 million shares issued in early October .

Including the <unk>.

So seats from that offering net of underwriting discounts, our net debt to enterprise value is closer to 37% today.

During the quarter. We also took advantage of a drop in interest rates to renegotiate loan agreements on four of our properties. The annual savings from those renegotiations resulted in.

Mishel annualized interest expense savings of approximately 800000.

And this was achieved without incurring any prepayment penalties.

We also expanded our unsecured credit facility to 300 million by entering into a 50 million five year term loan.

Simultaneously.

We are interested into a 50 million five year swap arrangement.

The term loan is priced off of LIBOR. So the swap fixes the 30 day LIBOR component of the borrowing rate at 1.27% for the five year term of the terminal.

At quarter end LIBOR swap effectively fixed our.

Loan interest rate at 2.67%.

Given the positive differential in rates the unrealized gain from this hedge is reflected in our 10-Q and comprehensive income.

As a result of those balance sheet transactions, we lowered our overall weighted average interest rate on our total debt portfolio.

To 3.99% at quarter end versus 4.22% at the end of the prior quarter.

At quarter end and including the swap agreement I discussed 93.4% of our debt was effectively fixed and had a weighted average maturity of 5.6 years.

Finally in our third quarter.

Earnings release, we provided updates to our previously issued 2019 guidance.

The updated full year guidance, primarily reflects the higher share count from our share issuances and interest savings through to the entity or.

Based on these assumptions, we are anticipating core AFFO between a dollar.

17, and $1.19 per share for the full year ending December 31 2019.

Excluding the impact of sure Ocean says the updated range would have been between $1.24 and $1.26, which is at the higher end of our previous guidance.

Further we continue to expect.

Same store cash NOI growth between four and 5%.

A full set of revise guidance estimates and underlying assumptions is provided in our third quarter press release that concludes our prepared remarks, and we will open up the line for questions operator.

Thank you we will now begin the question and answer session to ask a question.

Can you May Press Star then one on your Touchpads huh.

We are using a speakerphone please pick up your handset before pressing the keys.

At any time your question, it's been addressed and you would like to withdraw your question. Please press Star then too.

This time, we will pause for a moment somewhere a roster.

Sure.

My first question today will come from Michael Carroll of RBC capital markets. Please go ahead.

Hey, guys good morning judgment on for Mike.

I'm wondering about 76, a one time acquisition I'm, just curious what other type of capital one's chasing.

And also if that was the mark the deal.

Thanks for the question, yes. It wasn't marketed deal it was fairly competitive I think we had a good advantage given that we own next door and clearly new the market well and it was a.

Pretty large private right.

That sold it but there was a very competitive process.

Gotcha, and then are you expecting any leasing synergies now that you guys have kind of built out a little closer there.

As part of what we're doing it really was helpful to put together and Amenitized capital. So we're taking a few steps there one.

The building we.

It had a great food offering we have recently built out in our other building a fitness shared amenities conference. So combining them all provides a much better package and so as part of that we've we've re awarded the leasing on that to the team that was.

Leasing 76, one who did a fabulous job. So we do think there's going to be some synergies and advantages there, particularly as some of the tenants in that building our rapidly growing it might be a a good candidate to grow into our buildings.

Okay, Great and then moving away from DTC could you provide an update on leasing.

RP in Sorrento Mesa.

And then any trends that you're seeing in those markets.

Sure. So this is Tony here, so our peak collection no we effectively a back filled the space that was a vacated by matters.

Sometime ago sometime ago, and tens are moving into occupancy at a.

Right around that our peak collection.

I was was a effectively you know 89% Oh, we have another 10 moving into Q4.

In terms of Sorrento Mesa, we are we still do have one building a life sciences that is they can be.

Prospects looking at that we've completed the majority of our cosmetic work, we built that kind of a centralized amenity campus. So we're in good shape. There the market is extremely strong there as well as far as rents.

So the value of the vacancy is very significant to us.

Got it thank you guys.

Thank you.

Next question today will come from Rob Stevenson of Janney. Please go ahead.

Good morning, guys, Jamie how are you thinking about market concentration. These days when you're evaluating you know this $750 million of deals Phoenix in Denver now over 20%.

Brent if you get camels back in Denver Tech lease and Tampa isn't far behind is that about where are you sort of want to keep things in those markets and maybe your trade in and out of assets.

Are you comfortable going to 20, 530% exposure in the market. These days.

That's a good question Rob So if you look a few of our markets Weve.

Got a lower waiting towards Seattle, and Portland, but.

Generally we're very comfortable with what we have we're just slightly over 20.

In both Denver in Phoenix, a would would be comfortable going a little higher based on getting some great quality assets, yes, but that's right around where we want to be long term on the upper end.

So you know our focus.

Is continuing to find great acquisitions, and some of our other markets. We continue to look at a couple of similar markets. We've discussed in the past as well.

And and build out a broader portfolio.

Okay, and any incremental known or likely move outs that ER that have come to light this quarter.

Yeah.

Hey, Rob it's Tony here. So in Q4, we do expect approximately another 50000 of known Vacates, though will take place during the quarter now some of that actually already been backfill, but there are 50000 square feet of I've known Vacates Q4.

Okay, but that but it is the.

As much as there is looking into 2020 is there anybody who's like given your notification in last 90 days or 100 days or so that of note.

Oh, Yeah, no real change in the last 90 days I'd actually say that you know on previous calls we've talked about we have seven times.

That are graph 3000 square feet that are rolling next year and on previous calls, we talked about having hi, competence and renewals on it at least for them and it would probably bump and number two five based on recent positive discussions.

And then we do have a couple of know our expected vacates.

In 2020, there both in the back half of the year and both of them may be a may may do short term extensions, so looking pretty good for 2020.

Okay, and then lastly, Tony any known a difference between Navy and core FFO in fourth quarter at this point.

So.

No no and they read so you're talking about our our I'll give you are only adjustment for AFFO is as you know we use corfo definition, which back what are the stock based compensation, which the noncash item.

They're not that's really the only adjustment we have then thanks.

Question, Robert Yeah, I, just wanted to make sure that there wasn't any any you know anything either from some of the debt refinancings or anything else. It's like a onetime thing that we need to be cognizant of that would be in core I thought there would be added back for core FFO that wouldn't be per day rate.

Her question, it's actually a good point worth mentioning I'm because.

I didn't talk about the refinancing we didnt managed to do all of those refinancings without actually incurring any prepayment penalties. So no prepayment penalties are expected.

Okay. Thanks, guys appreciate it thanks, Rob.

Our next question today will come from Bill Crow Raymond James. Please go ahead.

Thanks, and good morning.

Yes.

Updated thoughts towards co working exposure and maybe your thoughts going forward on that sector.

It's it's something we've been looking at a lot bill. So we have no exposure to we work.

We do have a few.

Just offices that are very well occupied there's nothing really significant across our portfolio than we have a couple smaller regional again when you look at the occupancy levels. They have a there are high and the space Buildouts great. So we have no concerns within our portfolio.

And then.

So how important.

Sure I saw that you're you're Tampa partner in a in the downtown building just acquired an office asset and Carol on what.

You also own N. and I'm, just wondering whether they reached out to you for potential partnership in that.

Building.

Oh that was on the table early on given the vacancy.

See in that particular building it was not something that we wanted to partner and within CIO. So that was not something we explore.

Okay, great. Thank you thanks Bill.

Our next question today will come from Craig Sarah B. Riley FBR. Please go ahead.

Hey, good morning, guys [noise].

Given that you still have a handful of loans that are price kind of in the mid 4% are there any other opportunities to to maybe work on those as well the bringing down too you know what's your change in the third quarter.

Yes, good question.

Craig I'm, you know just to get able to.

More color. So you know when interest rates kind of start to fall and there was that opportunity. We look at our entire portfolio. We focused on we had a couple of loans that have no prepayment penalty a and a couple of them. We're actually with the same bank that happened peaks and valleys, we managed to negotiate reductions and a wave or waiver.

Of those prepayment penalty.

The other loans within our portfolio that do have little bit higher rate.

I have substantial prepayment penalties, we made some inquiries, but were unsuccessful in sort of moving to the dial in that so.

That's a long way of saying I think we've taken advantage of the opportunity as best we can and the remaining.

Once the prepared palliative, there's probably two prohibitive for to make sense.

Got it.

Just going back to your commentary on sort of your acquisition pipeline and what you're looking to do with with the equity that was raised is it fair to say you guys going to shoot to do something on the order of 320 to 300.

The next year or is that sort of overtime, that's where you see I'm putting that money work.

Yeah. They based on where we are you know its beginning of November timing of transactions, we don't see anything meaningfully impacting Q4.

So our own internal plan at the start taking advantage and.

Closings early 2020 with full deployment on the back half of 2020.

Got it.

And just as we think about leverage in general going forward I I guess, just sort of the back of the envelope math is about 40% leverage on this round. The capital is that sort of how we should think about the company.

Moving forward as far as you know sort of a target leverage on a new acquisitions and sort of gradual bringing down leverage.

Hey, Craig I think you hear about right I've talked about that in the past I've used the term low fortys. So you guys are as we're kind of pulling it out our own math was kinda between 40 and 40.

Five on the on this acquisition capital and will depend a little bit on the Chunkiness of the acquisitions, you know a cat timing or size it perfectly.

And a little bit maybe to turn by the cap rates for the where we're ensuring where we're getting sufficient NOI. So you know low fortys certainly I would agree that that's the right.

Number two.

Got it and I think you mentioned this in your commentary, but but it sounds like there was a lease that's a they've got picked up at 70 595, what was that number.

However, the rents.

[noise], so 30000 feet. So it's a full floor.

Now there is a tenant that about half of the floor. There that's going to roll that Tony mentioned in the fourth quarter. So we backfill that and taking up the rest of this based on that Florida rate. We negotiated was 20 650, starting rental rate.

Okay.

And you know I know that market.

For quite a while it's been a little slow and I think you've even alluded to but that protect center being a little slow.

Are you seeing better activity there now and it was that sort of what led you to maybe double down on that's that's a market.

Yeah. It was something we looked a lot Greg so we think but having the campus it really positions are building.

As well so you know high quality food amenities fitness conference large outdoor integrated space.

If you look at who is winning a lot of the major leasing activity over the last little while it was this particular building that we bought and so they basically fully back filled it and they did that by having really built.

Though space that was move in ready so that's something we're probably going to explore going into next year is advancing the quality. The vacancy that we have building some specs lease bringing that same leasing team that had a lot of success moving them over onto our property and so we think there's a lot of synergies there but for sure that submarket has strengthened along.

Okay. Thanks.

Appreciate the question.

And again, if you would like to ask a question. Please press Star then one.

Our next question today will come from Mitch Germain of JMP Securities. Please go ahead.

Yeah, Hey, guys you know Portland.

6%, Seattle, 3% <unk> when you talked about a deal pipeline of of 750 million is there a concerted effort to possibly growth further in some of those markets, where you have less scale.

Oh, absolutely the challenge we have in some of those markets is the valuations are just at a point where.

You know that you're hitting a lower percentage, it's harder to buy well make the math work maybe look at our pipeline really is up there is a mixture of some smaller transactions a couple of larger and then a couple of portfolio that.

Our substantial size that would give us significant scale in some markets that we don't have exposure to.

Or were minimal exposure, so I think theres a way for us hopefully accelerate the growth in a few of those particular markets that we're feeling really good about.

And then Jamie just on that point when you talk about your pipeline and your underwriting I have you made any real shifts in the way that youre underwriting too maybe.

Maybe account for Hum later cycle or anything that you know or is it really market by market that your that you're kind of looking at these assets.

We've made a lot of ships over the last year or two I would say as far as how we underwrite assets. So generally you know where we've been seeing a lot of growth in.

Yes, and over a long term goals, we're not expecting that that's going to be there every year.

Has been but where pricing accordingly that there are gonna be set that youre later in the cycle, there's going to be some pullback in rents and we're making sure we're pricing assets. Accordingly, so that if that happens we're still hitting our business plan.

And if it doesn't happen for a long time, we're going to exceed our business plan, but we want to make sure we're comfortable in any market for the types of underwriting never done.

Great last one from me Tony just to understand the leverage I know you've talked about.

I guess, who is debt TV.

And what that is.

Post a equity raise is it you know just assuming kind of back and the envelope.

Post equity raise that your debt to net debt to EBITDA. They get shaved by about a full turn is that the way to think about it.

I think somewhere between half a turn full turn so even before we are kind.

Hi, Sevens I'm now kind of.

Guiding to low seven.

And terms are they the adjustment post post a deployment, but again a lot of that will depend on the on the acquisitions and what the initial cap rates going into those acquisitions are but it shouldn't it shouldn't moved down signal.

Secondly.

Thank you.

That's right.

Ladies and gentlemen, this will conclude our question and answer session. At this time I'd like to turn the conference back over to Mr., Jamie for our for any closing remarks.

Thanks for joining us today, we look forward to updating you further on our next call.

Goodbye.

Right.

The conference has now concluded we thank you for attending today's presentation and you may now disconnect your lines.