Q4 2019 Earnings Call

We're looking statements that we made in the course of this call. I'll review our financial results after.

Jaime Ferrar our chief executive officer discusses some of the quarters operational highlights. I'll now turn the call over to Jamie. Good morning. I'd like to start off by reviewing our 2019 results relatives to the expectations. We set for ourselves at the beginning of the year 2019 was a tremendous year for city office. We exceeded the top end of our initial guidelines for noi net property Acquisitions and same-store cash and Grill in doing so we added Seattle as a new market in our portfolio took grew our footprint in both, Portland and Denver.

The 4.3% same-store cash noi growth in 2019 was driven by executing on strategic leasing initiatives contractual rent step up and strong conditions across our markets.

We also achieve the midpoint of our core ffo Target and improved in place occupancy by 1.5%

We accomplish these goals while efficiently raising capital and growing the market capitalization of our common Equity by 82% over the course of the year.

This strong execution resulted in a 42.6% total return for common shareholders in 2019 continuing the trend of double-digit average annual total returns since our IPO.

Our Focus continues to be on several main themes improving property level cash flow driving nav growth and targeting high-quality acquisition to further build out our portfolio.

Our Denver Tech property is a good case study of these themes Denver Tech is comprised of two adjacent buildings one that we acquired in 2015 and the other that we reject we acquired in September of 2019.

We acquired the first building in 2015 at a price reflecting that the largest tenant would be significantly reducing at square footage creating a major at leasing opportunity wage since completed a substantial renovation creating a fitness center upgraded conference facilities improved vacant space and a modernized Lobby.

2019 we acquired the second sister building and set in motion plans to combine the two into a campus with a shared landscape Courtyard and mutual access to complimentary amenities.

These efforts have translated into solid leasing results at the end of 2019. The combined Denver Tech buildings were 62.7% occupied with 105,000 square feet of vacancy.

In January two previously disclosed new leases took occupancy totaling fifty eight thousand square feet. We previously targeted the have these two tenants occupy in the late 2019. But completion of their build oats will occur just after year end this increased the current occupancy of Denver Tech to 78%

Even more impactful is the new leasing that also occurred after year in we executed a ten year lease in January with a new credit tenant to take seventy thousand square feet of space. I'm bringing overall occupancy to 93.7% when the tenant moves in during the third quarter of 2020 the costs associated with this ten year lease will be incurred during the first and second quarters temporarily lowering a f f o however, this is a great long-term result and we now have a stabilized asset that is well positioned for the long-term in addition to these activities. We completed three hundred and thirty one thousand square feet of new and renewal leases across our portfolio during the quarter. We look to create a successful renovation and leasing outcomes at several other properties.

We have in process.

Or recently completed major Renovations at our mission City Sorrento Mesa Center and Camelback Square properties.

Of note at our Sorrento Mesa property in San Diego the very strong Life Sciences Market is driving potential for significant leasing opportunities both in our vacancies and by marking existing rents too much higher market levels executing on these opportunities is one of Management's highest priorities in 2020, which has the potential to be a major drawback of cash flow growth and value creation.

Try and do another key priority our acquisition pipeline remains robust. Although we have witnessed higher valuations in recent months.

Low interest rates and availability of both debt and Equity Capital has resulted in the compression of cap rates across our markets. This is made securing transactions more challenging and we're having to work hard to find the right properties with the characteristics. We like at reasonable valuations.

the effects

The lower cap rates are partially offset by our lower borrowing costs and the Acquisitions. We're pursuing still generate healthy Returns on invested equity.

We continue to have a strong Pipeline with over seven hundred fifty million of transactions. We are actively working on we're targeting a mid-point of 360 million of Acquisitions in 2020 that we expected deployed by the end of the third quarter if we're successful with that timing we're projecting core ffo between 32 and 34 cents in the fourth quarter, which would be the first quarter of that. We are fully deployed. Tony will provide details on our 2020 guidance and will update our timing expectations on future calls as we deploy this capital.

It is worth noting that while the acquisition environment is more challenging do to increase competition. These conditions have also led to an increase in the value of our own portfolio. We're in the envious position of having bought one and half billion of well-located properties in great cities that are situated for continued cash flow growth.

Yep.

Certainly over the next few years. We remain open to opportunities to harvest value at specific properties where we think we can a creatively redeploy proceeds.

In the fourth quarter of 2019. We successfully completed the sale of our Logan Tower Property in Denver though. It was the smallest asset in our portfolio. The sale generated a 2.9 Million combined with our other five prior asset sales. We produced an aggregate, irr of 17% and 72 million of games in the last five years while also better focusing our corporate full.

If we're successful in executing a number of the key leasing initiatives more of these opportunities may present themselves in conclusion. We are optimistic about the company's prospects for 2020 underpinned by the continued leading performance of our targeted cities. We believe the steps we're taking at the property level to improve cash flow as well as the corporate actions to enhance our balance sheet and Grill, the company should drive net asset value for investors over the long term. And with that. I'll turn the call over to Tony to provide further details on our financial results. Thanks, Jamie off on a gaap basis our net operating income in the fourth quarter was 24.5 million. This represents a zero point 1 million dollar decrease relative to the amount reported in the third quarter. The small decrease was primarily attributable to the sale of Logan Tower in the quarter overall reported core ffo of 13.4 million or 25 off.

as per share which was

1.1 million higher than a third quarter interest expense was lower in the fourth quarter as we benefited from the lower interest rates from the loan modifications that we completed in the third quarter as well as from the full repayment of our line of credit balance with proceeds from our common stock offerings are fourth-quarter a f f o was 7.9 million or 14 cents per share of our fourth-quarter info was affected by the cost of tenant improvements and leasing commissions incurred during the quarter their largest of which related to the tenants who took occupancy in Denver Tech off after your end that Jamie mentioned and a significant renewal at our mission city property from Q3 2019 where we extended a 31,000 square foot tenant for an additional 10 years.

We also have some Capital expenditures related to projects that Sorrento Mesa Michigan City and 190 Office Center that impacted Us in the quarter due to the relative size of our portfolio and the impact of suck at leasing it any 1/4 r a f f o numbers will continue to move around some from quarter-to-quarter or at least the activity and capital expenditures are provided on page of 16 and 18 of the supplemental package consistent with our definition of Ethel. We have excluded some first-generation leasing costs the largest of which relate to our recently acquired Canyon Park property further details or disclosed on page eighteen underneath recurring Capital expenditures.

We have enhanced our leasing activity disclosure at this quarter by providing additional details on our Leasing.

Threats and reformatting the information with leasing spreads of 9.3% on a cash basis for the quarter rolling up existing leases to Market is proving to be a driver off of same-store and a white growth.

Our fourth quarter same-store cash nly grew 3.9% versus the fourth quarter last year. It also increased by 4.3% for the full 2019 calendar year as compared to 2018 Orlando Portland and San Diego where our best-performing markets in the fourth quarter each with double digit same-store College Grove, 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.

Moving on to our balance sheet are total debt of deferred financing costs at December 31st with $607 million our net debt to Enterprise Value ratio was reported as 36.7%

It's

September 2019, we entered into a $50 five-year swap Arrangement. The term loan is priced off of Libor. So the swap fixes the 30-day Libor a component of the birth rate at 1.27% for the five-year term on the term loan given the positive differential and rates the unrealized gain from this hitch is reflected in our 10-K and comprehensive income at quarter-end 100% of our debt was effectively fixed and had a weighted average maturity of 5.6 years.

Last we have provided full year 2020 guidance in our press release. Our guidance does not include any Capital raise assumptions and provides a range for Acquisitions, which will mature early impact our results. We refer you to the material assumptions and considerations set forth in our earnings release.

Based on these assumptions. We are estimating core ffo between a dollar and a dollar for the full year ending December thirty first twenty twenty four pack should increase beginning in Q2 through the end of the year as a full impact of the future Acquisitions take effect. Once we are fully deployed. We are projecting a quarter long run rate for ffo of 32 to 34 cents per share our projections assume this will occur in the fourth quarter.

based on our

24 deployed corfo expectations average dividend coverage on an afo basis will be close to 100% depending on significant leasing transactions and capital projects in any one quarter off this incorporates a reduction in our overall leverage as compared to leverage levels prior to our common stock offerings in the second half of 2019. We are comfortable with this in terms of coverage Dynamic given numerous plan increases in cash flow the high-growth nature of our recent acquisitions and the lower targeted Leverage.

On the operational side, we expect same-store cash on a white growth to be between one and 3% We expect to post strong same-store cash on our growth in the first choice and fourth quarters, but the middle part of the year, we expect will be flat as we have a combination of known vacates and some free rent periods. The two most significant are at 58 and Phoenix and 190 Office Center in Dallas at 5090. We are downsizing and relocating a 19,000 square foot tenant at the end of May to accommodate a larger tenant desired expansion space. This will temporarily bring occupancy down as we prepare the expansion space at 190 Office Center United Healthcare is downsizing and giving me back twenty five thousand square feet in March by year-end. We expect cash flow and occupancy will return to q1 levels.

Continued positive Trends and overall portfolio occupancy and we have provided a guidance range of 92 to 94% at year-end implying a healthy increase over current occupancy at the midpoint of the range.

That concludes our prepared remarks and we open up the line for questions operator.

We will now begin the question-and-answer session to ask a question. You may press * then 1 on your touchtone phone. If you are using a speaker phone, please pick up your handset off pressing the keys that anytime your question has been addressed and you would like to withdraw your question, please press star then to this time. We will pause momentarily to assemble our roster.

The first question will come from Michael Carroll of RBC Capital markets.

Yeah, thanks. This is Jason on from like just wondering it looks like you guys were able to fill up some of the vacant space at Camelback square and a party. I was wondering if you could touch on kind of the leasing success at those and what other large blocks of space you have available right now sure so, it's Jamie. Thanks for the question. Camelback square is one where we're about to launch our repositioning. So we did have some move ins we had some move-outs Network higher than than where we were previously but we really expect to get the major impact their post renovation plans Los Angeles. We're excited about it. We expect to have it done by the end of the year and given how hot that little pocket is we think that's going to be really transformational for the asset in terms of overall kind of blocks of vacancy. When you look at kind of the major ones across the company. We we talked about on the call at our Denver Tech property where we're going to bring that one to 93.9.

By the end of the year, we are in discussions with some tenants to take some additional.

That'll probably be early next year. But we think we can get that one even higher in our Sorrento Mesa properties in San Diego with a life science portfolio Thursday. We have one full they can building roughly sixty thousand square feet. That's great space. It's a hot submarket. We're waiting for the right tenant there and that's going to be very impactful when a lease that one up. We do have a significant mark-to-market opportunity later this year in that same portfolio. Those are the big ones. Ugh Pima Center. We do have some space Thursday. We're we're doing some work and renovating as well as at 190. We have a little bit of space as well as Tony mentioned with getting back that floor from United Healthcare later this year. Okay, great. And secondly, I think you guys have two larger expirations coming up in about a year with Ally Financial and Kaplan. Just wondering if you guys could give any insight on to what your expectations down.

With those sure so Ally Financial roles in the end of twenty 2160.

3000 feet to full building. Um Ally we are in early discussions a renewal. They're exploring their options as well in the market. They have a need for a potentially some expansion space and we've looked at potentially adding on to our building to accommodate that so we think we'll have better visibility on that property in the second half of the Year. Jeff Kaplan is 124000 feet rolls, December 31st of 21. We already done a renewal with a subtenant that's in there for seventy-nine thousand feet and push that out five years. So we we've basically taken care of 63% of that building and we're looking at either a potential renewal with Kaplan discussions with the existing sublease to tenant or looking to Market that last block of space, but we don't get it back for you know a year and three quarters at this point, so it's still a little bit early.

Got it. Thank you.

The next question comes from Rob Stevenson with Jenny.

Good morning, guys, Tony. What are you expecting in terms of the sort of capex and TI leasing commission spend in 2020 given the comments around, you know, some of this leasing that you're going to do and some of these tenant moves Etc. Yeah, good morning, Rob. So, you know particularly the first half of the year. We are expecting the impact from from the name is Jamie spoke about the the the the tenants movement at Denver Tech. And so I would expect that the first part of the year is going to be on the entire end of the of the of the the, you know, if you look historically we have a range of as high as eleven cents per share Delta between Corfu and ffo, I would expect it to be near that higher end of the range for the first three quarters as we deal with the move out of these tenants. So the first part of the year will be impacted by some of this move out, but that will normalize by Q4 and it'll be back to more normal.

levels, you know effectively we're projecting that once we're fully deployed for Successful by Q4 be able to hit that Corp fo

For 32 or 34 cents, which effectively would put us right back on top of dividend coverage. Okay. So the $0.11 Delta is in the second quarter though. I'm expecting it in in the it'll be spread between the second and third quarter and so both quarters will be impacted. Okay, and then the the the acquisition guidance of 342 380 seem very specific amount. Can you talk about what's you know, I think you said that there was like 750 that you're working on. I mean, what's this? Is there anything that's under contract or l o at this point at this point Rob just to give you a high level send so pipeline the top of the pipelines over 750. It's it's you know more substantial than that wide variety of deals smallest is about thirty million. The largest is around two hundred million bucks for a multi-building portfolio. So pretty wide range. We've really targeted exactly dead.

You know that level based on where we want to get you on our overall leverage, so it could be a little higher could be a little lower. Depending on where Cap rates are today. We do not have anything under contract. Okay, and in terms of the stuff you're looking at any new markets.

Yeah, we've we've really been proactive over the last six months spending time in a few new markets. So a lot of the pipeline is in our existing cities. We've spent a fair bit of time Salt Lake to talk about in the past Nashville's one. We spent a lot of time in lately that we like the fundamentals of a lot.

Okay. Thanks guys. Appreciate it. Thanks Rob.

The next question will be from Barry Oxford of d a Davidson.

Great. Thanks guys. When you guys were talking, you know about your Acquisitions and the cap rates, I guess nudging down slightly given where the 10-year is instead as you're spread on your cost of capital going to remain the same or is that going to come in in twenty-twenty when you're doing these Acquisitions? So I'll start on that wage. It's only can jump in very so basically if you look at where we've been getting quotes for really good quality life code debt. It's it's kind of treasuries plus or minus about a hundred and fifty so off today that you know a little under 3 on the debt side. We we certainly are modeling that for the course of the year, but probably around that range the cap rates are coming down that substantially lower than where we were before and so one of the things we've been cognizant are doing is really trying to as we deploy These funds find newer vintage really high club.

All the assets with rock-solid tendency, you know sleep well at night assets.

So that'll as well nudge the cap rate down a little bit. But when you take the, you know cost of borrowing we're still seeing cash-on-cash returns over very long periods of time 10, 15 plus years in the seven to eight plus percent range so still very healthy. And and that's basically what we're targeting today.

Okay, great. And then when you guys talk about no Capital guidance or not issuing Capital here in 20 20. Do you guys think you may not be having that in your guidance, but given your 360 midpoint pipeline of Acquisitions that you want to do. Can you do that without issuing?

Hey Barry, it's Tony here. So a couple of points there, you know, we raised right around $200 of equity between the end of the third quarter and the beginning of the fourth quarter. Yep, so dead 300 midpoint taking the midpoint of that range. Sixty million in that effectively represents a 45% leverage on that Equity. So the answer to your first question is yes, can we do it with their existing capacity and the answer is yes, in terms of future needs, you know, we we do intend to refresh RS3 and ATM program here shortly just to give us a flexibility so that way, you know, the pipeline activity increases and and it makes sense to do further activity we can do so and you know, could we do so in later in 20 20 20, I think it's a there's a possibility for sure if that's the case, but there isn't any short-term intention to to to draw any further capital and we have the capacity now to execute on this plan.

Great.

The color guys. Thank you.

Once again, if you have a question, please press * then 1 the next question will come from Greg. Kucera.

Hey, good morning guys. Just want to go back to your commentary on Acquisitions. Just giving that nothing's under contract. It's probably fair to assume that nothing will close here. And first course you're really going to see the bulk of the activity waited two more likely third quarter or how should we think about it? I think that's fair Craig q1. We don't anticipate having any closings. I think I talked to in Q3 is where we expect of an our own planning to be fully deployed. So start in Q4 fully deployed when you look at the transactions again, there's a number that are a later stage as far as our underwriting and whatnot. So it's really hard for us today to pinpoint exact dates, but we think that's a reasonable Target.

Got it, and I appreciate the color on the the large blue box here over the next couple of quarters, but I think he closed 2019 with about a hundred and sixty basis points of leasing office that hadn't commenced yet. Can you can you handicap when you anticipate those tennis beginning paying rent throughout 20/20? Is that is that going to be weighted towards, you know back half or front half or how do you think about that?

So for some of the known leases that we signed for instance some of the larger ones that Jamie described in the call. There are some free rent periods. And so therefore their cash rents will be back with the back end of 2020 and that really ties into the guidance we gave on same-store results where we talked about q1 and Q2 for being strong but Q2 and Q3 being flat because some of the new tenant month free rent.

Okay, got it and and give him the commentary on on cap rates and and you know looking at your cost of capital today. I know you mentioned that that you're looking at sort of a seven to eight percent cash-on-cash return over a long time frame. But you know, how should we think about you know, what what you're going to be buying on an initial cap rate bases here in in twenty-twenty. I think initially we were looking at kind of a low 7 a.m. But I would think we should be adjusting that down to maybe a high six or even lower than that in our own planning Craig. If you if you look at it, we're sub 7 and our own planning, you know, could it be a little lower if you were buying properties that have you know, ten twelve year weighted average lease terms you have absolutely no drag for many many years sure. It can be long it. Typically you'll get lower borrowing costs as well that bring you back to, you know, reasonable level on cash-on-cash. But within the six range is probably where we expect the bulk of the Acquisitions to be dead.

Okay.

One more for me just looking at your ebitda reconciliation page and the fact that you closed 7601 and September, you know, the the diet creation kind of quarter-to-quarter wasn't quite what we expected. I know your tenant reimbursements declined sequentially from third quarter to fourth quarter with is there any color there with you know, we're folks sort of build a bit more earlier in the year or can you give us some color? They're sure I'm so Denver Tech had a unique situation where we the the when we acquired 7601 wage in the year there was one tenant, um who who had signed a lease but it had not taken occupancy yet and under the terms of the purchase and sale agreement that we signed off Cellar was obligated to bridge the income to us until the tenants took occupancy that tenant didn't actually take occupancy in Q4. They actually took occupancy in q1 wage.

Well economically weren't any further.

Off for accounting rules, we could not book that cash stream as revenue and instead it's recorded as a reduction in the purchase price. And so that's part of the reason why we ended on the lower end of the of the range we had and probably why you're seeing that difference in the reconciliation.

Okay. Thanks guys. That's great. Thanks, Greg.

Is there are no additional questions. I will turn the call back to mister Ferrara to conclude. I want to thank everyone for joining today. We look forward to updating you further on our next call. Goodbye.

Thank you. The conference is now concluded. Thank you all for attending today's presentation. You may now disconnect your lines. Have a great day.