Q3 2020 City Office REIT Inc Earnings Call
Good morning, and welcome to the City Office REIT incorporated third quarter 2020 earnings Conference call. At this time all participants are in a listen only mode. A brief question and answer session will follow the formal presentation to ask a question you May Press Star then one on your Touchtone phone. If you are using a speakerphone please pick up.
Your handset before pressing the keys to withdraw your question. Please press Star then two as a reminder, this conference call is being recorded if you require operator assistance. Please press star zero. It is now my pleasure to introduce you to Tony Maretic. The chiefs, the Companys, Chief Financial Officer, Treasurer and corporate.
Secretary. Thank you Mr. Maretic you may now begin.
Good morning, before we begin I would like to direct you to our website at city office REIT Dot Com, we can view, our third quarter earnings press release, and supplemental information package. The earnings release and supplemental package. Both include a reconciliation of non-GAAP measures that will be.
He discussed today to their most directly comparable GAAP financial measures.
Certain statements made today to discuss the companys beliefs or expectations or that are not based on historical facts may constitute forward looking statements within the meaning of the federal Securities laws. The company believes these expectations reflected in such forward looking statements are based upon reasonable assumptions, we can give no assurance that 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 in the course of this call.
I will review our financial results after Jamie Farrar, our Chief Executive Officer discusses some of our quarters operational highlights I will now turn the call over to Jamie.
Good morning, Thank you for joining us today.
Before discussing our results for the quarter I'd like to start with an update on what we're seeing in the office market and our cities in particular.
Prior to covert our investment thesis was that our chosen markets in the southern and Western U.S. would provide outsized returns over time due to population and employment growth trends.
We believe that our cities continue to be poised to outperform and that coal that has accelerated the desirability of our high quality of life and lower cost of doing business markets.
The latest data from the Bureau of Labor statistics for employees on a non farm payrolls I like the impact that Kobin continues to have on the national economy.
It is noteworthy that our cities have been some of the strongest performers.
The number of employees on nonfarm payrolls nationally declined 6.7% in September 2020 relative to September 2019.
Gateway markets have seen an even greater employment reduction year over year at a 9.3% decline.
In city offices markets employment has held up much better experiencing an average decline of 5.3%.
We're encouraged that our markets continue to benefit from strong relative employment trends.
The effects of Covance and requirements of social distancing continue to impact utilization of office buildings in our markets.
In a recent internal survey utilization levels at our properties remained under 25% with large corporate tenants reporting the lowest levels of utilization of usage.
Despite lower utilization levels leasing activity has shown signs of stabilizing in many of our markets.
Nationally in the third quarter, new and renewal office leasing activity was up 14% over the prior quarter.
In our own portfolio, we've seen strong renewal activity.
Our largest upcoming expiration is in January 2022 at our Lake Vista property in Dallas and renewal discussions are progressing.
Well, there's no certainty that a transaction will be completed based on the current pace of discussions we could see a long term renewal signed by the end of the fourth quarter Twentytwenty.
In terms of new leasing activity tenant inquiries in many of our markets had been rising, albeit modestly.
However, life science continues to be a particularly strong sector and we're engaged in a least discussion at our remaining Sorrento Mesa vacancy in San Diego.
We're in discussions with the prospect for approximately 59000 square feet.
Should we come to terms with them at least could be signed early in the new year with a late 2020 one lease commencement date.
Moving on to our third quarter performance. Our results were some of the strongest we've had since our IPO in 2014.
Today, we've collected 99% of third quarter and October Ritz.
This ongoing high rate of collections allowed us to reduce our fourth quarter guidance provision for uncollectible, rips, which I'll discuss shortly.
Our diverse tenant mix with a high proportion of life Science healthcare Tech government and professional services tenants has underpinned our collection success.
During the third quarter, we completed 189000 square feet of new and renewal leases with a weighted average lease term of 8.1 years.
These are encouraging numbers and they're largely driven by the life science tenant at our Sorrento Mesa property in San Diego that we discussed last quarter.
On full occupancy in 2021 that lease will generate approximately 2.8 million of incremental base rental revenue per year as compared to the expiring rents.
In addition, as part of this deal we will benefit from a further mark to market on a 59000 square foot building in 2026.
That buildings lease was also extended to 2032 and the rental rate will automatically reset to market rental rates in 2026.
Today that building is receiving net rents of just $25 per square foot annually.
Good indication of the potential increase is the sister building with the same pad, where we just reset net rents to $54 per square foot annually, yes.
If this 54 dollar rate were achieved in 2026, we pick up a further $1.7 million a base rental revenue per year as compared to the red we're receiving today.
At the corporate level, we completed the 100 million dollar share repurchase program during the quarter.
Which has been accretive to our per share results.
As we execute on our business plan, we intend to continue to operate conservatively with lower levels of leverage and higher liquidity.
The net impact of the significant leasing transactions healthy rent collections the share repurchase program and continued operational execution is a sizable increase in core FFO per share this quarter.
Notably our AFFO per share also produced healthy dividend coverage.
Taking a step back and comparing our third quarter 2020 results to our pre cobot third quarter 2019 results, we've made positive strides.
Our core FFO per share has increased.
Our leverage has decreased on a net debt to EBITDA basis, our dividend is covered on an AFFO basis, our occupancy is higher and our risk collections are similar.
We don't believe this strong performance is reflected in our stock price today with our assets trading at an implied cap rate of over 9% based on Q3 annualized cash NOI.
Further almost 15% of our Q3 in Hawaii was derived from our Sorrento Mesa and Canyon Park buildings that primarily cater to the life Sciences industry.
These are extremely valuable properties and the private market valuations for these types of tenants remain very strong today.
At this point, we believe we have good visibility for the remainder of the year, which is why we've increased and tightened our guidance ranges.
We expect core AFFO to be higher than our prior guidance, primarily due to the impact of the reduced provision for uncollectible RIS and the impact of the substantial mark to market lease renewal extra rental Mesa discussed earlier.
We also expect same store cash NOI growth and occupancy to be higher than our prior estimates.
As we move into the end of the year and begin 2021.
We continue to focus on advancing strategic lease renewals, maintaining a diverse tenant base and finding opportunities to unlock value in our portfolio.
We're confident that we will be successful with this plan.
Our strong liquidity position and focus on driving future cash flow positions us well, despite the challenging macro environment caused by cold.
I'll now turn it over to Tony to provide further details on our financial results. Thanks, Jamie.
I'll address the third quarter's results and then turn to our updated outlook for the remainder of the year.
On a GAAP basis, our net operating income in the third quarter was 26.4 million, which was 0.9 million higher than the 25.5 million we reported in the second quarter we.
We benefited from the amortization of a lease termination fee payment at our Cherry Creek property.
As we discussed on our last call. The state of Colorado is expanding to occupy an additional 37000 square feet of space, we terminated the existing tenet generate a termination fee of zero point $9 million and create an expansion space for the state.
We previously recorded zero point $4 million of this termination fee income in the second quarter.
And the remaining zero point $5 million in the third quarter as the prior tenant departed on September Thirtyth.
<unk> com lease at Denver Tech and the Sorrento Mesa lease renewal at a significant increase in rates cash NOI did not benefit as a Denver tech tenant is under a free rent period for the balance of 2020.
And the Sorrento makes attendant new cash rents will not begin as I just mentioned until later this year.
As a result, we are expecting to return to positive same store cash NOI growth beginning in Q1 2021.
The Phoenix and San Diego markets contribute the largest to the decrease due to lower occupancy.
Moving onto our balance sheet or cash restricted cash at September 30th totaled $56 million as I mentioned, we decided to pay down a line of credit by 25 million earlier in the quarter.
Our total debt at September 30th with $679 million or.
Our net debt, including restricted cash to better with six four times.
At quarter, and our total that had a weighted average maturity of four five years and 89% of our that was effectively fixed.
We have no debt maturity as in 2020, and only one maturity in may of 2021.
We expect to have ample refinancing opportunities as these properties have a relative low level of leverage.
Last we have provided and updated full year 2020 guidance and our press release as.
As the impact of COVID-19 on our business in 2020 comes more into focus we have been pleased with our execution and high rate of collections and therefore have razor guidance for the balance of the year. The press release covers guidance ranges updates in more detail than I will highlight here.
The main driver revised guidance range is our estimates of bad debt provisions.
As our third quarter provision for bad debts, and total rent abatements was less than 0.5% we have lowered our general provision for the balance of the year for uncollectible rents two 0.5% of revenue.
The guidance was previously.
Based on 0.5% to 2% provision.
Guidance now also reflects a significant impact from the lease renewal, we announced that sorento Mesa at substantially higher rates.
Based on these revised operating assumptions are net operating income Same-store cash NOI change and <unk> expectations have all been increased.
A revised guidance estimates <unk> per share between $1.20 and $1.22 for the full year ending December 31 2020.
It is worth noting these levels exceeded our original pre covid guidance.
Are implied Q4 2020 guidance for core full per share is between 30 and 32.
One of the main drivers behind the lower expectations for the fourth quarter is at the third quarter benefited from the Cherry Creek termination fee income, whereas the fourth quarter will not have that termination fee income and the state of Colorado will not occupy that space until January one 2021.
We also have a few other previously discussed known move outs in queue for which will bring occupancy lower.
That concludes our prepared remarks, and we will be open up the lines of questions operator.
Thank you we will now begin the question and answer session to ask you. A question do you may for a store then one on your Touchtone phone.
You're using a speaker phone please pick up your handset before pressing the keys to withdraw your question and please Chris stores in too.
This time, we will pause momentarily to assemble our roster.
Our first question comes from Rob Stevenson from Jenny. Please go ahead.
Guys, Tony just to follow up on your comments Earth, yet how significant should we be viewing the the fourth quarter first quarter, turning cost spend that you were talking about.
Good morning, Robert.
So Q4 currently.
We don't have any significant.
Ti is in progress and so we're not expecting significant costs in queue for from Ti's, However, leasing commissions could be impacted.
If some of the leasing activity that Jamie mentioned comes to fruition in queue for in Q1, so they're a little bit of an unknown at this point.
But if those leases because they are so large are significant it could have a significant effect on queue for in Q1, they're just not known today because those that activity hasn't been concluded.
Okay.
And how would you guys thinking about tenants warning shorter term lease was given the uncertainty versus.
Potentially smaller Ti improvements in leasing commission costs, and the sort of a tradeoff versus longer term leases, how is that sort of matrix sort of flushing out as you guys have discussions with tenants. These days.
Yeah. That's a good question is Jamie here.
I think as a general macro theme of across the board a lot of tenants, particularly larger ones are.
Trying to kick the can on making decisions and so from our perspective.
We've said this consistently quarter over quarter. The best thing. We can do is secure long term stable cash flow and that's been our focus now having said that if you were to evaluate your alternatives at the time on each of these transactions in an alternative is they're moving out.
Kicking the can and continue to work with them for better days and some stability sure. That's something we will consider but our overall preferences logging down long term cash flow and would we be prepared to give a better deal to do that absolutely. Okay and then.
Jimmy you guys brought back sock earlier, this year and recently renewed your authorization.
But with the equity market cap now down to around 300 million. How do you think about future repurchases, it's $6 and change given the 9% imply cough right that you talked about versus.
Size and liquidity or illiquidity. If you go much smaller size wise. If you continue to shrink the company How's that how are you and the board thinking about that sort of matrix as well.
It's been a robust conversation at our board meetings I mean, we're not happy at all Rob with where are share prices and we think there's a number of things. We can do that we're focused on the ultimately is going to drive that.
So we continue to evaluate it but at the same point as you mentioned.
Going into the end of the year next year, having liquidity, so keeping drive powder and making sure we're keeping our equity base as large as possible. It is a priority. So we haven't bought any stock as of today under that plan as a tool that's available and it's one we're looking at.
But we really are factoring liquidity and keeping our equity base as large as we can as a top priority.
Okay. Thanks, guys I appreciate it.
Thanks, Rob.
The next question comes from very Oxford from da Davidson. Please go ahead.
Great guys tell me question for you when we're also looking at.
A line item of straight-line rent, how should we think about that going forward.
In house that can honorand.
Yeah. So good question Barry I provided some guidance in the press release that you'll see that kind of outlines where we see straight line rent for the balance of the year. If you want to look a little bit forward to talking about one as I'm looking at 10, 21 21, yeah expect it to come down because the big straight-line rents adjusts.
<unk> that you are seeing right now are related to that Lisa Sorento Mesa, they start paying rent in December and so as soon as they start paying their higher rent that straight line rent will come down in our base rent will offset it and go up so our cash rents are going up and that was my comment with respect to same store sales, which is why I expect an increase for 2002.
21, and the other one is that.
Is at.
Sure Pardon me in Denver Tech.
Which is the calm lease, but I talked about their likewise, starting to pay rent and beginning of Q1, so roughly if you're talking rough numbers expect that straight-line rent calculation to to be cut in half in 2021.
Got it perfect now that that absolutely makes sense and then a question for you Jamie.
When you look at the office a couple of different theories about the office, but one good and one bad.
But how are you seeing that effect on on cap rates and are you seeing a little more opportunities when it comes to acquisitions and cap rates that that that you can buy at or look bury the cap rates are really not moved in our markets.
It's an interesting dynamic right now very when you look at what's happening in the markets. The deals. If you just look purely at the numbers you would say.
Cap rates and kind of thoughts around valuations really haven't moved and I think that's a major factor around the sort of assets that are transacting, so you're seeing life science being pretty prevalent and you're seeing really high quality low risk office assets trading still it very attractive cap rates and then you've got a.
Pretty wide.
Kind of gap, where you're not seeing a lot of transactions and ones that are core plus or value add in so there's still I think a bid ask spread they're so in terms of our own views on acquisitions, I think you're probably going to see some better opportunities in 2021 and beyond.
Just really are seeing compelling opportunities today.
Alright, thanks for the color guys.
You're welcome.
Again, if you have a question. Please press Star then won.
The next question comes from Michael Carol from RBC Capital markets. Please go ahead.
Yeah. Thanks, Jamie in your prepared remarks, you talked about some renewal discussions that you're having with a a tenant right. Now can you provide some additional color on that's my guess is that one of the large explorations that we expect in 21 was that the Florida Research Parker Carlin point, I guess, which leaves are we talking about.
So I really highlighted on too and the first one is that our lake Vista, which is with our tenant ally financial base.
Basically summarized we're having good dialogue on a long term lease renewal no certainty that we're ultimately going to get there, but we're feeling good and give that a my own indication that if it comes together I think it's a Q4 of it.
Sorry, I mean can you get found out that question that you asked the second piece, which was.
The other one I mentioned, we've got a vacancy at Sorrento Macer, which is about 59000 feet with a life science Dennett. That's one that we've been looking for a while for the right tenant someone who will take it down as an entire blocks it as opposed to breaking it up tenant that's potentially going to put in a significant investment in.
Into it as well for the life science build out and so that's one that is the first time, we've said on our call where we're actively in discussions and if that transaction comes together, we think it's probably.
In early 2021 possible it could come together, a little sooner than that but it's something that if it comes together we're very excited about.
And then can you talk a little bit about the two larger explorations you have an 21 I believe you have a photo research parking Karlan point I mean, how are those discussions going.
Hey, Mike I'll I'll I'll answer that so just as a reminder, you have Carolyn we have 74000 square feet that expires at the end of August of 21, and then we have another one at Florida Research Park that has a may 31, 21 expiry and.
The short answer is there is no update we can say, we're having constructive discussions on both of them. The discussion, they're just taking a little bit longer and we're hoping that it to have an.
An update on the next call, but at this point.
It's kind of the status quo constructive discussions, but nothing has been concluded.
Okay, and then it gets excluding those two large lease expiration. So I mean, you have what about 400000 square feet expiring next year can you kind of talk a little bit about.
I guess, where are those tenants and what's the expected retention ratio or progress that you've made on some of those discussions.
Yeah sure so so.
I think we've basically covered all of the large ones.
We do have one expiry at the right at the end of the year December 31st.
Under Florida Research Park, one of the buildings, we used to call it ingenuity drive.
Our in our stats.
That is 125000 square foot building.
It's least as I mentioned office next year, but at the end of the year. The main tenant is departing in the subtenant will take occupancy of 79000 square feet. So we are expecting to get back 46000 square feet of space.
We're already actively leasing and.
Have.
15 months to try to backfill that that's the last of the of any space. That's larger than 30000 square feet everything else is frankly, probably normal course, and I would expect of our renewal rates to be.
And we've actually just completed our budgeting process and we're kind of budgeting similar renewal rates that we've had historically on the rest of the leases.
Okay.
I know Tony you had obviously in the past few quarters, which you reduced your your bed that expectations for 2020, and you're going into 21, I mean, how should we think about bad expectations. Moving forward is it going to be more in line with that historical run radar are we kind of away from from those.
Pretty conservative estimates that you had at the beginning of the year.
I think the reason we became more conservative is the timeframe got shortened and so my answer would be in the short term yes.
Q for Q1.
I would expect it to be in that lower range, but the longer we go out here I just don't have a lens and I think the range of probability possibilities is still quite wide.
Until there is a vaccine until enough clarity frankly, when it was election and we think there is a lot of unknowns out there and so I think likely when we do provide guidance further out we go.
10, a conservative outlook, so Q4 likely have a more conservative but that's just because we don't have good clarity just to put some ranges around that though like I think when when we initially Gabe are overall guidance. This was right in the height of the pandemic, we had some pretty wide ranges of a bad debt provisions and <unk>.
Moved out that we've had great collections.
With only minimal loss. So I think when you look into next year, we're still finalising kind of what we think and it's like better but that range, probably isn't going to be as wide as it was at the height of the pandemic were feeling better overall about what we're seeing we're feeling better about our tenant base, how things are starting to come back as for.
Far as utilization utilization levels.
And we're feeling good about the future as we've kind of build through each of our assets and re underwritten them.
We're feeling good frankly about our own ability without any sort of additional growth or equity raises the drive substantial <unk> growth over the medium to long term here and so we've spent a lot of time kind of looking internally at our assets that are tenants.
And what we can do to help kind of unlock value and drive cash flow and that's what our focuses today.
Okay, great. Thank you.
As there are no additional questions I will turn the call back over to Mister Ferrara to conclude.
Thanks for joining today, if we did miss any of your questions. Please feel free to reach out to us directly goodbye.
The conference has now concluded.
Thank you for attending today's presentation you may now disconnect.
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