Q4 2019 Earnings Call

Made in today's conference call additional information concerning factors that could cause those differences is contained in our filings with the Securities and Exchange Commission or SEC which can be accessed from a website o p I read or the website investors are cautioned not to place undue Reliance upon any forward-looking statements. In addition. We will be discussing non-gaap numbers during this call including normalized funds from operations or normalized ffo adjusted ebitda and cash basis net operating income or cash basis and Ally bank reconciliation of these non-gaap figures tonight income and the components to calculate cash available for distribution or C A D are available in our supplemental operating and financial data package, which also be found on our website.

In addition, we will be providing guidance on this call including normalized ffo.

We are not providing a Reconciliation of these non-gaap measures as part of our guidance because certain information required for such reconciliation is not available without unreasonable efforts or at all, suck gains and losses or impairment charges related to the disposition of real estate and now I will turn the call over to David.

Thank you, Olivia and good morning. Welcome to the 2019 fourth quarter earnings call for office properties income trust this morning. We reported normalized ffo of $1.38 per share which beat consensus estimates for the quarter will review our financial results in more detail shortly and will also provide Financial guidance for the first time, you know. Is history we hope this additional disclosure will be helpful. We also appreciate the continued feedback and look forward to further engagement.

Heading into 2019 we set specific expectations for a set sales our Target leverage expected year in occupancy in full in spreads. And it all cases. We outperformed these expectations. Opi's principal goal was to right-size leverage following the merger with select income read

we

No plans to sell approximately 750 million dollars of assets to reduce leverage to a targeted net debt-to-ebitda range of 626 and 1/2 * 4 Dead 4 year, we sold 848.9 million dollars of properties plus we opportunistically sold all of our common shares in the RMR group for a hundred four point six million dollars in that proceeds resulting in more than nine hundred and fifty million dollars in aggregate asset sales.

For the 58 properties we sold in 2019. The average cap rate was 5.7% for properties with an average age of 21 years and am occupancy of 70% in an average remaining lease term of 4.7 years.

As a result of these assets sales we have reduced leverage to below are targeted range are investment-grade ratings have been reaffirmed with stable outlooks. We improved a portfolio metrics and are well-positioned to re-enter the acquisition Market.

as

Waste the occupancy and leasing spreads. We set expectations to end 2019 with occupancy at 91.5% and for new and renewal leasing spreads out flat for the full year. We are happy to report that we ended 2019 with occupancy at 92.4% which is 90 basis points higher than expected and our total leasing for the year included more than 2.9 Million square feet with new and renewal leases for a roll up and rent a 4.2% off provide more detail on our leasing activity shortly.

As a result of achieving our Target leverage range, we have pivoted asset sales to a capital recycling strategy that we believe will allow us to fund Acquisitions wage asset sales while maintaining leverage within our targeted range. We also believe our Capital recycling strategy will position us to further improve key portfolio metrics such as average property age and weighted average lease term improve our prospects for 10 or attention and position OPI to grow cash available for distribution office or C A D. Our strategy will principally focus on selling properties with high Capital requirements and to acquire properties with low ongoing Capital news.

since capital

Spending can be uneven our investment analysis will focus on the five-year average cash contribution, which is noi minus Capital expenditures for both assets channels and Acquisitions. So far in the first quarter of 2020, we have sold or Ender agreements to sell six properties for approximately $85 million dollars. They have an average age of twenty-two years a weighted average lease term of six years and a five year average cash contribution yield of approximately 4% off.

This well positions OPI to acquire higher-quality properties with low Capital needs at competitive cap rates of around 6% and grow c a d ROM.

All this all this may be diluted to normalized ffo. It will be net asset value accretive and we believe positioning the company for dividend growth is the right folk life and its shareholders. We have been actively underwriting potential acquisition opportunities and believe that acquiring properties that need our investment criteria off while executing our Capital recycling program will require discipline as stated on earlier earnings calls. Our acquisition criteria is for properties with an average effective age of 18 years or less that have lease terms of seven years or longer and are located in markets where we believe we can grow rent over time and where we also believe our prospects for tennis at least once our hi

we all

So expect our Geographic diversification will evolve as we enter new markets and exit existing markets based upon our view of real estate fundamentals and on economic and demographic Trends. I'll now turn the call over to Chris pilado to review opi's operating and leasing Activity. Thank you David and good morning everyone as David mentioned 2019 was an active year for Leasing and Property Management as we work to reshape our portfolio and achieve the best operating results. We close the year with leasing activity covering two point nine thousand square feet for weighted average roll up and rent a 4.2% a weighted average lease term of 8.6 years and leasing concessions in capital commitments of $3.08 per square foot police year.

Through our new leveraging plan. We exited a few markets for an overall Improvement to our Geographic diversification and sold buildings with an average age of 21 years for an overall Improvement in a portfolio Now with an average age of Sixteen point seven years as we look ahead and a 2020 we will continue our focus of further improve key metrics to our portfolio on a same-store basis at your end. We are targeting occupancy of ninety-two ninety-three percent with the roll-up and rent at 2 to 3, % turning to the quarter as of December 31st, 2019. Opi's portfolio consisted of 189 properties, totaling 25.7 million square feet with a weighted average lease term of 5.7 years in the fourth quarter, we moved into new and renewal leases for seven hundred seventy-nine thousand square feet at weighted average rents that were 4% above prior rims with a weighted average lease terms of 7.1 years.

and leasing concessions and

No commitments of $2.60. Excuse me, $2.86 per square foot for at least here total portfolio occupancy has increased by 140 basis points year-over-year to 92.4% are currently leasing pipeline of two point 1 million square feet includes five hundred and sixty thousand square feet that can continue to absorb vacant space across the portfolio page as discussed on last quarter's call our property in Reston, Virginia was vacated during the fourth quarter which represented 1.3% of our total annualized rental Revenue. The project is located in a prominent and growing Northern Virginia submarket and benefits from its access to the Silverline the Dulles International Airport and nearby live-work-play amenities this page. She has created a strategic opportunity for us to reposition the property for a roll up and rent with minor building Capital required to improve the property for Leasing.

The submarket is expected to outperform the broader Northern Virginia Market due to an expanding defense budget and strong growth from technology companies specializing in cloud computing and cybersecurity Page. Look forward to providing updates on the progress of leasing efforts in 2020. So highlight a few for leasing transactions in Lakewood, Colorado, we executed a five-year lease extension on a hundred sixty-seven thousand square feet with the GSA which included capital of only $0.39 per square foot for at least here in Boise, Idaho. We renewed the GSA into full buildings with a total of 151000 square feet the initial request from the GSA was to downsize of the short-term extension upon its lease expiration in 2021 due to several agencies occupying the building under one primary lease.

rgsa asset

Management and leasing team prepared an unsolicited utilization plan to provide the GSA a more holistic. Look at the buildings this proactive approach resulted in a successful completion of an 11:00 a extension for one hundred percent of both buildings this transaction highlights the benefit of the armoire platform whose asset management team includes former GSA employees who maintain strong relationships with the GSA the team's experience and expertise with the GSA process helped turn in the objection and potential problem into a long-term lease commitment Thursday to acquisitions.

And the fourth quarter, we acquired a 3300 sqft land parcel for 2.9 Million Dollars and are under agreement for a thirteen thousand five hundred square foot building for 11.5 million dollars both of which are located near or adjacent to our existing property at 251 Causeway in Boston. This area is a thriving submarket within the downtown Boston core pack or two million square feet of newly-delivered mixed-use development the North Station major Transportation Hub the Lively North End Neighborhood and the TD Garden the city's main indoor sports and entertainment facilities these Acquisitions our strategic and provide flexibility for future value creation and noi growth by repositioning our building either through a tear down and rebuild beginning in 2022 or through upgrading the existing building as early as two thousand twenty one point. I will now turn the call over to Matt Brown to provide an overview of our financial results balance sheet and capital.

Thanks.

Chris and good morning, everyone. Opi's results for the fourth quarter and year ended December 31st, 2019 include the impact of the merger with selecting Camry or sir, which closed on December 13th 2018 in addition in connection with opi's deleveraging efforts. We sold 848.9 million dollars of properties during 2019, including 264 million dollars of properties in the fourth quarter. The impact of these events is driven the majority of the changes in opi's Consolidated Financial results as compared to the same period in the previous year as a result. Our dispatch on Consolidated results will focus on changes as compared to the third quarter of 2019 normalized ffo for the quarter with sixty six point four million dollars or a dollar $38 per share which package census this compares to normalized ffo of 69.7 million dollars or a dollar forty-five per share for the third quarter of 2019 the decline in normalized ffo on a sequential birth

this is mainly the result of our

Property Disposition activity during the quarter. We recognize the net gain on property sales of 71.6 million dollars primarily due to a sixty million dollar gain on are opportunistic sale of a property in Houston, Texas in December.

Gina expense for the fourth quarter was 7.3 million dollars compared to G&A expense of eight million dollars for the third quarter of 2019. The decline in G&A expense is mainly the result of the issue of share-based compensation in the third quarter our business management fee expanse remained relatively flat on a sequential quarter basis as the debt repaid with disposition proceeds was offset by appreciation and OPI share price as a reminder. Our business management fee is paid based on the lesser of total Market capitalisation or assets under management and is currently being paid on total Market capitalisation. We believe this calculation is indicative of the alignment of interests with shareholders built into our management contract with the RMR group.

interest expense for the fourth quarter

With Thirty million dollars compared to interest expense of thirty two point four million dollars in the third quarter of 2019. The decline in interest expense is mainly the result of $585 million dollars off debt repayments since July 1st, 2019 net of borrowings on our revolving credit facility.

Turn to property level results for the quarter for the fourth quarter of 2019. Same property Cash basis noi pro forma for the merger declined 5.3% compared to the fourth quarter of 2018. Mainly driven by the following a decline in occupancy from 95.2% to 93.3% 2.2 million dollars of free rent in the fourth quarter of 2018 primarily primarily related to to 2019 executed lease renewals one receiving free rent of $309,000 per month through March 2020, and the other receiving free offer of $188,000 per month through December 2019.

Two million dollars of settlement income related to attend to fall at least restructure recognized in October 2018 and increases in real estate taxes labor and insurance costs partially offset by more significant repairs and maintenance incurred in the fourth quarter of 2018 and savings on our property management fee primarily due to the free rank mentioned above turn to Capital expenditures and balance sheet metrics. We spent twenty point nine million dollars on recurring Capital during the fourth quarter including 10.6 million dollars on building improvements and 10.3 million dollars on leasing Capital are recurring Capital spent in 2019 was below our estimate mainly due to the timing of leasing Capital being deferred the 2020 which resulted in a c a d payout ratio of 56% off to our Target payout ratio of 75% Despite a conservative payout ratio our dividend yield of 6.8% at year end remains High compared to the peer group at 4.4%

Start hiring projections. We expect 2020 recurring Capital expenditures to be approximately $110 which includes thirty-eight million dollars of speculative leasing Capital based on these directions are dividend will be within our targeted range of 75% as of quarter-end. We had approximately fifty six million dollars of unspent leasing related Capital obligations of which 45% represents tenant Improvement allowance has managed by our tenants and 17.5 million dollars is leasing Capital designated and leases for future years.

At December 31st, we had no amounts outstanding on our 750 million dollar unsecured revolving credit facility and our net debt to annualize adjusted. Ebitda re was 5.9 times. When a lower Target leverage range as David mentioned our investment-grade ratings were reaffirmed during the quarter with stable outlooks subsequent to quarter-end. We repaid are four hundred million dollars of unsecured senior song due in February with proceeds from fourth quarter and January property sales and borrowings under our revolving credit facility. We currently have 335 million dollars outstanding on a revolving credit facility, which we plan to reduce with the proceeds from three properties currently under agreement to sell for an aggregate sales price of 64.3 million dollars, including one property with secured debt in the amount of 13.2 million dollars that will be repaid upon the sale of the property based on our current expectations of our portfolio in the timing of the dispositions currently under agreement to sell we expect normal job.

ffo per share to be between

Dollar Thirty and a dollar $33 for the first quarter of 2020 the decline from Q4 2019 normalized ffo of a dollar thirty eight per share is mainly driven by the noi reduction of $3,000 from the property sold in Q4 and another $900,000 from q1 property sales. We expect our same property Cash basis and a line to be flat to down 2% as compared with the first quarter of 2019, which is an improvement from the 5.3% decline. We reported for the fourth quarter of 2019. As Chris mentioned. We expect same property occupancy at the end of 2020 to be between 92 and 93% It is our intent to provide guidance for normalized ffo and same property Cash basis and Ally for the next quarter during our earnings calls in 2020 operator that concludes our prepared remarks. We're ready to open the call up for questions.

We will now begin the question-and-answer session to ask a question. You may press * then 1 on your touchtone phone. If you're using a speaker phone, please pick up your handset before pressing the keys to withdraw your question, please press * then two at this time. We will pause momentarily to assemble our roster.

Our first question comes from Adam gabalski with Morgan Stanley, please go ahead. Hey guys. Thanks for taking the question. Definitely appreciate the thought the color on and guidance for for 1 Q 20. Can you just talk about some of the drivers of of same-store guidance as people look towards, you know one q and also just throughout the year just given that sort of lapping some easier comps and just kind of walking through some of the biggest moving pieces.

Yeah, I think as we roll forward our same-store performance from Q4 where we reported a decline of 5.3% to our expectation for q1 of 2020 of flat to down 2% off a couple of major drivers that I talked about in the prepared remarks one of which was the two million dollars of settlement income that was included in Q4 2018 Revenue that was non-recurring the other month was free rent. One of the two major leases that we executed in 2019 had free rent of $188,000 per month that expired in December 2019. So we'll see that's the fit of that cash rent, which is helping the same store performance in q1 of 20.

got

And then just on sort of mark-to-market for 2020 or sort of targeting low single-digit sort of back-to-back years in that range. Is that sort of a reasonable run rate for how you would sort of expect it to track kind of longer-term or there any sort of one one time large move out to Renewal that you think are kind of skewing that or or just kind of how you see that that number tracking. Yeah. We look back. I mean looking back at 2019 year-end just over 4% and then to to 3% in 2020 I think is indicative of where we see the run-rate, you know, at least for the foreseeable. I'm near future.

Got it. And then just one more quick one for me just on the the Acquisitions and sort of the the broader Capital Recycling and Market rotation plan. As far as the acquisition this quarter wage. Would you sort of call that a part of that plan or is that sort of like a one-off, you know unique opportunity because it was close to another asset and just sort of as far as the the broader, you know Capital rotation and what kind of you know deal volume are you looking at? What is the pipeline look like, you know, can you expect that to sort of match dispositions for twenty twenty and how how does that sort of pipeline seem at this point? I'm sure Adam the the Acquisitions that Chris talked about were strategic to our property 251 cost way. You know, that's a downtown Boston located building in the epicenter of an area that's getting a lot of growth. We have an opportunity as we look into 20 21 22. Yep.

to reposition

That for significant rent growth. So, you know owning those two assets give us substantially greater flexibility in that we do with that property in the future. So you I would not consider it part of the capital recycling program as it relates to Capital Recycle, you know, we have a decent pipeline of potential opportunities. We are being I think very thoughtful around our Capital allocation and making sure that as we buy potential opportunities, we understand how we are going to fund those with assets sales and what our cost of capital is associated with those assets sales so that we not only are improving our portfolio metrics in the process, but we are positioning ourselves off.

for

Growth in cash available for distribution and I'll give you an example, you know, we've got six properties that we've either sold or have under the agreement as of the first quarter of two of twenty-twenty roughly eighty-five million dollars at a cash contribution yield of 4% off. So by selling those assets we're giving up approximately 3.4 million dollars of free cash flow to pay a dividend if we acquire $85 million dollars of assets at a six cap. We will be picking up 5.1 million dollars of free cash flow depending upon the level of capital associated with those buildings. You know, that one point seven million dollars is 3 and 1/2 cents a share in additional fee that we can log.

to grow to Dividend, so

You know that is the real Focus for us as we try to reposition our portfolio create a net asset value accretion and see I'm not seeing that makes sense.

Yeah, absolutely. That's very helpful. Thanks.

Again, if you have a question, please press * then 1 or next question comes from Bryan Mayer with Riley FBR, please go ahead. Yes, good morning kind of following up on on Adams question. Can you discuss the kind of anticipated volume that you expect in twenty-twenty? I think I might recall you previously saying Capital recycling would be about three hundred million a year. Is that correct? And and do you still see that being the case? Yeah. It's a good question Brian. You know, we've we've got the $85 million dollars that currently in process. We are marketing an asset in Northern Virginia right now and are evaluating 1520 additional properties for potential disposition depending upon what the outcome is of those 20 properties. We could very easily birth.

Hit 300.

$10 in capital recycling this year a lot of it's going to depend upon how the markets continue to perform and and frankly a lot of us going to depend upon our ability to acquire assets that that we think meet our investment criteria.

And and kind of to that point how how deep is the market of assets that you're currently looking at? Has it grown has it has it shrunk, you know, is it is it dead ten properties properties?

It's not a t properties right now Brian. It's probably closer to ten properties. It's been relatively consistent as we moved out of June 2019 and into 2020 and so we're you know, we remain optimistic. I think the the real thing I'd like to highlight is dead. You know while we're optimistic. We also expect to be disciplined and we're very focused on what our acquisition criteria is and how we're going to pay for those off Acquisitions. So but no we're very optimistic that you know, we're off to a good start for twenty twenty and then just last for me given that we're basically done with the, you know, kind of large-scale dispositions and you've moved into Capital recycling, you know, is it safe to say that I I kind of stays around a for four and a half billion dollar read over the Dead.

2 to 3

years, or do you see an opportunity to take the size of the higher and if so, you know kind of when and how

Brian I think it depends a lot on how the share price performs this year as we demonstrate an ability to execute on the capital recycling program and the discipline we show in capital allocation. We are certainly not prepared today to issue an issue, and Equity to fund growth, you know, we obviously could look at joint ventures. But frankly, we think we have plenty of opportunity to recycle capital and reposition the portfolio and gross EAD without having to really worry about growing the company cuz if we can grow cash available for distribution while maintaining the same asset level, you know shareholders dead.

will benefit from

Our ability to increase the dividend.

Hey. Thanks, David. Thank you, Brian.

This concludes our question-and-answer session. I would like to turn the conference back over to date a black men president and CEO for any closing remarks.

OPI started 2019 as a new company with increased scale greater diversification in an evolved investment and operating strategy. It was a year for OPI to represent a fresh business plan to the market and importantly to deliver on our stated goals. We have repositioned the company with a healthy Financial profile while enhancing our portfolio quality and successfully managing our properties for strong occupancy and rent growth in 2020. We will continue to focus on executing our business plan off Hanson key portfolio metrics and recycling Capital to grow c a d we believe this strategic focus is important considering trading discounts who are your group and the meaningful value proposition to our shareholders as we work to narrow that discounts

We're dedicated to proving that are.

Energy involves long-term thoughtful management and a commitment to creating shareholder value. Thank you for joining us today operator that concludes the call.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.