Q4 2020 City Office REIT Inc Earnings Call
Good morning, and welcome to the city office REIT.
For 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.
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And it's now my pleasure to introduce to you Tony <unk>, The company's Chief Financial Officer, Treasurer, and corporate Secretary and Mr. <unk> you may begin.
Good morning, before we begin I would like to direct you to our website at C. I O REIT Dot Com, where you can view, our fourth quarter earnings press release, and supplemental information package the earnings release and supplemental package. Both include a reconciliation of non-GAAP measure.
<unk> that will be discussed today to their most directly comparable GAAP financial measures.
Certain statements made today and 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.
Although the company believes that 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 and our fourth quarter earnings press release, and the company's filings with the SEC 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 and may be made and of course of this call.
And I'll review, our financial results after James Farrar, Our Chief Executive Officer discusses some of the quarters operational highlights I will now turn the call over to Jamie.
Good morning, Thanks for joining today since the inception of city office, we've consistently focused on several core elements of our business plus.
One invest in high growth markets in the southern and Western U S.
And to focus on the most desirable submarkets three lease space to strong tenants and a diversified mix of industries.
For operate conservatively to protect shareholder value and five drive cash flow growth and value creation through strategic leasing and capital recycling and renovations.
In 'twenty and 'twenty. This business thesis was put to the test.
Our exceptional results for the year indicate that our investment niche is well suited to endure and succeed and a challenging environment.
On a related note I'd like to touch on a few of the highlights for the year and.
In 'twenty and 'twenty, we collected over 99% of contractual base rent.
We completed over 1 million square feet of new and renewal leasing the largest amount of leasing completed in any year and our company's history.
We achieved positive same store cash NOI growth.
We executed a well timed share repurchase program and bought back $100 million of common stock at accretive prices and.
Last our 'twenty and 'twenty core <unk> of $1 22 per share exceeded our initial pre pandemic guidance and did so with lower leverage employed.
Within these broader results there are a few transactions and the fourth quarter and subsequent to year and that I want to call attention to.
First during the fourth quarter, we signed a 163000 square foot lease renewal with ally financial and at our Lake Vista property and Dallas.
Ally occupies 100 per cent of the property and at year end was the fourth largest tenant and our portfolio.
They extended their occupancy through April of 'twenty 32, with a renewal rate six 1% higher than the current rate on a cash basis.
In connection with the lease we also granted ally and the option to purchase the property, which can be exercised at any time prior to July 31, 'twenty and 'twenty two.
And if ally and were to exercise the option. The agreed upon sales price would effectively represents a cap rate of approximately $6 one per cent.
After a year and we signed another major lease renewal.
We renewed and expanded paychex, the largest tenant at our Carolyn point property and Tampa.
Paychex signed an eight year 78000 square foot renewal commencing in September 2021.
And a 15000 square foot expansion commencing early next year.
It's worth noting that both of these lease transactions run counter to the market narrative about office space.
In the case of these two tenants both were willing to commit to long term extensions to secure quality office space and great locations.
While there will be instances in which we grant shorter term renewals, we're generally finding that our largest tenants continue to view their office space is mission critical to their long term operations and corporate culture.
Another highlight from the fourth quarter was entering into a contract to sell our Cherry Creek property in Denver and subsequently completing the sale on February 10th.
Earlier in 'twenty and 'twenty, we completed a lease buyout with a tenant at our Cherry Creek property that paved the way for the state of Colorado to occupy 100 per cent of the three building campus.
This transaction reposition the campus is 100% leased to a strong government tenant with a long history of occupying the space.
This was attractive to a particular buyer and we ultimately negotiated a sales price representing a five 8% cap rate and generated us a $47 million gain.
Consistent with our past messaging, we will opportunistically sell properties and recycled capital from time to time.
Of note over the last 18 months, we've generated over $300 million in gross proceeds from either capital raises or property sales, while only deploying $100 million into our stock buyback.
This is reduced leverage to a low level relative to our historical operations.
It also positions us to take advantage of growth opportunities as market conditions improve while preserving a strong balance sheet.
One implication of this lower leverage and the Cherry Creek property sale is a reduction to our core <unk> guidance, and 2021, which Tony will cover in more detail.
However, our guidance shows that once we deploy $100 million of acquisition capital. We expect a run rate quarterly core <unk> will be approximately 32 to 34 per share.
This is in line with a fully deployed pre pandemic guidance that we provided this time last year and we expect to achieve it with lower overall leverage.
And as we look forward into 'twenty 'twenty, one we intend to be cautious with their capital.
The current investment sales activity is still a fraction of the pre pandemic volume.
We expect this dynamic will start to shift with higher transaction activity in the coming quarters at.
At the same time, we also expect that office utilization levels will start to normalize and provide a more conducive environment for underwriting acquisitions.
To recap we are excited about the progress already achieved to date in 'twenty and 'twenty one and.
And we see improving conditions across our markets, where and a great position with a healthy balance sheet and can use that to our advantage in the coming year.
We will continue to prioritize operations and leasing to drive earnings per share growth and we'll continue to evaluate opportunities to expand our portfolio as market conditions improve.
I'll now turn it over to Tony to provide further detail on our financial results. Thanks, Jamie.
I'll address the fourth quarter's results and then provide our guidance for 'twenty and 'twenty one.
Our net operating income and the fourth quarter was $25 2 million, which was $1 2 million lower than the $26 4 million, we reported and the third quarter.
Two of our properties contributed to the bulk of these amounts.
First net operating income was 700000 lower at our Cherry Creek property in the fourth quarter as we discussed on our last call. We terminated a tenant at our Cherry Creek property at the end of the third quarter and that space remain vacant until the beginning of 'twenty 'twenty, one and when the state of Colorado took one.
100% occupancy ahead of a sale of that property.
We recorded a termination fee income of 500000, and the third quarter and that space was vacant and the fourth quarter and a further loss of approximately 200000.
Second net.
Net operating income was also down 300000 and at our circle point property due to a drop in occupancy caused by a scheduled move out of a 31000 and square foot tenant at the end of the third quarter.
Our collections remain very strong and we did not increase our provision in the fourth quarter.
We reported core <unk> of $14 1 million or 32 cents per share, which was also $1 2 million lower than the third quarter for the same reasons that NOI was lower.
Our fourth quarter, <unk> was $7 5 million or <unk> 17 cents per share.
The largest impact to <unk> was a $2 2 million leasing commission paid on the 10 year ally renewal at our Lake Vista property.
This lowered <unk> by approximately five cents per share and the fourth quarter.
Our fourth quarter same store cash NOI growth was a positive 0.4% versus the fourth quarter last year, and one 1% higher on a full year basis over 2019.
Considering the challenging environment in 'twenty and 'twenty. We believe this is an impressive result.
The leases, we signed in 2020, particularly those at our Denver Tech property and the Sorrento Mesa Mark to market renewal are the biggest drivers to these results.
Our total debt at December 31 was $677 million or net debt, including restricted cash to EBITDA was six nine times at.
At quarter, and our total debt had a weighted average maturity of 4.2 years and 89% of our debt was effectively fixed.
Simultaneously with the sale of Cherry Creek earlier this month, we repaid the $83 million Midland and life insurance loan, which bore and interest rate of 434%.
Our weighted average interest rate is now three 7% and we have no property debt maturities until 2023.
Last we have provided full year 'twenty 'twenty, one guidance in our press release.
Our guidance does not reflect any capital raising our share repurchase activities.
Our guidance does reflect the sale of Cherry Creek and February and provides a range for the potential redeployment of acquisition capital.
Specifically the low scenario assumes that we do not acquire any properties and 2021 and the high scenario contemplates $100 million of acquisitions closing midway through the fourth quarter of 2021.
As such we anticipate that we'll be operating with lower levels of leverage through most of 2021.
Based on these assumptions, we are estimating core <unk> per share between $1 20, and $1 20 for for the full year ending December 31 2021.
Due to the sale of Cherry Creek, and the corresponding lower leverage we anticipate in 'twenty and 'twenty one the full year core <unk> guidance is not indicative of our run rate as Jamie mentioned the sale of Cherry Creek has reduced our core <unk> guidance under the low scenario by approximately six.
<unk> per share and 2021.
If we were to have the benefit of $100 million of acquisitions deployed by the beginning of the fourth quarter, we would estimate that our core <unk> for the fourth quarter would be between 32 to 34 cents per share.
On the operational side, we expect same store cash NOI growth to be positive between 0.5, and 2% and 2021.
And that assumption assumes that new leasing activity remains muted through the first half of the year and begins to pick up in the back half of the year.
We have projected occupancy to be at 90% at the midpoint of our range by the end of the year. This reflects modest declines through the first half of the year offset by higher activity too and the year.
We refer you to the material assumptions and considerations set forth on our earnings release that.
That concludes our prepared remarks, and 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 you May press Star then one on your telephone keypad with Youre using a speakerphone. Please pick up your handset before pressing on the keys to withdraw your question. Please press Star then two.
At this time, we will pause momentarily to assemble our roster.
Yeah.
And the first question will be from Barry, Oxford with D. A Davidson. Please go ahead.
Great. Thanks, guys, Jamie on the acquisitions that you may have here in 'twenty and 'twenty, one does it give us a little color as far as what you're seeing out there in the in the marketplace right now and then also maybe talk a little bit about what markets, you're finding most attractive right now is for.
For us where you might want to deploy your capital.
Thanks, Barry So yeah first quoting a traditional pipeline number it's still a bit early and we are looking at a number of opportunities. When you look at them a lot of the opportunities are falling into the category of insufficient visibility today, which means.
The tenants aren't utilizing the space yet they may have termination options. There their usage is unknown and what's really important for us is making sure when we buy we get the value right and we get the acquisition right and for US you know talking to the tenants seat and their utilization of the space understanding you know what.
Centrally could happen and go wrong.
It's still a bit early from that standpoint for a lot of the transactions that we're watching and so we do have a few that that still fit quite nicely, what we like and it is going to come down to valuations and we think later in the year, we're going to have better visibility both on.
And as far as more transaction opportunities and people coming back to work. So that we can understand the requirements that we need and so when you look at our markets again, Florida, Arizona, and Texas, all doing extremely well and.
Arizona and particular Phoenix is really picking up as far as leasing activity and new inquiries, which we think is a great science and so those would be the tall.
Perfect Perfect and then Jamie and last question in conjunction with that you guys. Correct me, if I'm wrong and you have a relatively new $50 million share buyback. How are you thinking about utilizing that in 'twenty and 'twenty one.
Yeah.
Consistent I'd say Barry.
We've said on prior calls I mean, we put it in place we don't expect to be using it and it's there as a tool you know maintaining a significant flow and our liquidity is top of mind for us.
Okay that makes a lot of sense alright.
Alright, Thanks, guys appreciate it.
Thanks Barry.
And the next question comes from Rob Stevenson with Janney. Please go ahead.
Hi, good morning, guys.
And what type of capital projects are you anticipating.
<unk> and 'twenty and 'twenty one on the portfolio.
This is a this is Tony here are Rob.
In terms of capital projects you know the one thing that we talked about previously that we're starting to two two.
Launches and Theres, a number of spec suites that we're investing and youll see that and the impact of that a little bit and Q4, and you'll start to see more of that as well and Q1 and Q2, we just want to have our spaces are ready to go and the best condition possible as leasing activity as Jamie mentioned picks up.
Outside of that on the capital expenditure side.
Our largest expenditure for 2020 was the camelback square a repositioning.
And that is basically being finalized as we speak here so you'll see some costs roll into the beginning of Q1.
And then we don't really have any anything of that significant nature for the balance of the year.
Okay, so occupancy guidance more or less flat, so Tony if I add up the tenant improvements leasing commissions from 'twenty and 'twenty. There were about $19 6 million and then the Capex was another $5 2 million so should the capex be decreasing.
Meaningfully there or a little bit and then what about the tenant improvements leasing commissions given your leasing assumptions for 2021.
Yeah. So that's a very good question.
Jamie mentioned, we are basically expecting leasing activity to remain muted through the first half of the year and then to pick up and the second half of the year and so as you know those costs, usually precede the actual income and occupancy being generated so I would expect it to start to pick up.
Beginning Q3, and Q4, but you may not have the occupancy move until 2022, just due to the timing of the moving.
Okay, but I mean.
I mean, those tenant improvements leasing commissions and Capex was roughly 20 call it $25 million in 2020.
Are you anticipating and that's going to be somewhere more 15 ish and that sort of range is it that big of a falloff given the lack of activity, especially early in the year because that has a meaningful boost to <unk> numbers and if so yeah. I mean, it's a very good question and and the reality is that number is very sensitive to the year.
Sing assumption and so we have quite a range on that Ah I will point out that we have some very good blocks of space that there's leasable, particularly we've talked in the past about Sorrento Mesa Theres. One particular building there. If we are successful in concluding a lease there that ti will be quite significant which would push it to the higher end of the range of numbers you are talking.
About and if it doesn't happen or happens kind of spread over 13 for Oh.
For the Q4 and into 'twenty and 'twenty, two and then our numbers would be lower and what we showed this year. So I guess, that's a long way of saying, there's a number of factors here could it be lower than from and where it was and our 2020 and the short answer is yes.
But could some big transactions move the needle for us the answer to that is also yes, which is good news, which is good news.
Okay, but I mean, almost half of the Capex was that.
With that.
Net of Allied.
Or is that was that was leasing commissions as you said it was $2 2 million and the quarter. Yeah. So the leak exactly right. So that that was the Ti has not been spent yet for Q4 amount was just the Ti with just the leasing Commission correct.
Perfect and then Jamie how much undeveloped land do you are you guys still sitting on and what's the plan there and rough value of that portfolio.
So we've never quoted what the value is robb.
And as 40 acres.
Most valuable is our Sorrento Mesa.
Five acre parcel and and San Diego and the development potential on that is over 400000 feet. So and so there's real value and that particular site directly across from <unk> World headquarters Life Science is absolutely on fire and that market and so as we look for.
That is one asset that we're continuing to spend a lot of time on what is our best path forward, there and I think over the coming quarters.
We will have a better answer of how we unlock value, but it's a meaningful number.
Okay. Thanks, guys I appreciate it.
Thanks, Rob.
And the next question comes from Craig Kucera with B Riley FBR. Please go ahead.
Hey, Good morning, guys I wanted to talk about the Cherry Creek disposition, particularly the timing.
A decision to sell that without and additional acquisitions teed up.
Driven by the price and you were getting on with their considerations surrounding the Midland loan refinancing.
No it had nothing to do with the Midland loan refinancing, but we had sufficient capital to be able to do that and still be extremely comfortable Craig. So it really was.
And the opportunity that we saw to monetize an asset that's 60 Seventy's vintage property. It was one of them well. It is our oldest assets that we had and we really like the pricing the buyer was and institution, that's really focused on a 100% lease government properties and.
Were quite aggressive in terms to acquire.
Got it and and just as a housekeeping item did the large renewal at Sorrento Mesa begin paying cash rents and December or is there any free rent period there.
Yes, so they started a year you're right. They started paying the cash rents December one.
Okay and.
And one more for me I just wanted to talk about your occupancy assumptions.
You know your euro and your prepared remarks, you said that you know leasing it and this was the largest amount of at least and you've ever done and clear.
Clearly fourth quarter was strong as well, but you also mentioned and that you were assuming sort of muted leasing and the first half of the year is that just being conservative and your guidance or have you seen any real shift here.
And we move sort of midway through first quarter as far as demand.
Yeah. It's a good question Craig So if you look across our markets.
Some are picking up a lot quicker than others and so the top I would say right now is Phoenix as far as.
Tenants that maybe put their requirements on hold.
And going into Covid coming out of it are starting to get a lot more aggressive with tours and looking life science is very strong as wells of San Diego.
On the other markets are a little slower and so we really think youre going to need to see a greater return to work before that's really going to start to accelerate and we tried to link that assumption into how we forecasted our occupancy through the year.
Okay.
Okay. Thanks, I appreciate the color.
And.
And the next question is from Michael Carroll with RBC capital markets. Please go ahead.
Yep, Thanks, Jamie I wanted to talk a little bit about the strength of Mesa asset I know, Tony kind of mentioned on and maybe it was you Jamie sorry, but about the.
<unk> leased a bacon and block I mean, what's the discussions like on on that property and the prospects of leasing that.
So we mentioned.
And one prospect early on on our call last year.
And that didn't get across the finish line that tenant was acquired before we signed the lease and the buyer chose not to complete the lease negotiations.
But irrespective of that it continues to be Red Hot and we've had really good tour activity.
I think when you look in that particular sub market theres not a lot of vacancy.
And for US it's about finding the right user and the buildings just under 60000 square feet, we don't really want to break it up if we don't have to.
And judging by the prospects we have.
We think we'll get it leased and our own assumptions, we don't have income from that coming in and 2021. So in our mind. It's a 2022 event, but that's material for us I mean, that's north of two and $5 million a year of cash flow.
Based on the rates that we're seeing.
And once that leases signed I guess, how long will the build out will take and how quickly could rents commenced and is there how much free rent would be provided and let's say if you signed at the day with the cash rent and not commence until the end of this year.
Using the example of the one that we were talking to going into the fourth quarter. It would have been paying cash rent I believe and the third quarter of 'twenty. One so it was a.
About a year kind of term.
From signing the lease it really is going to depend on the extent of the buildout and the terms but.
And that range.
Okay, and then can you talk a little bit about the upcoming lease expirations and and I think you still have about eight percentage of your leases rolling in and 21, how are those discussions going and specifically I think you still have a large standard that Florida Research Park, what's the progress of that leased.
Yeah, Hey, Mike, It's Tony here I can speak to that so.
If you look at the stats on page 17, and our sub.
And so you're right. There is about just over 8% 60 leases 500000 square feet I will say within that total the largest is actually that Carolyn lease, which we signed after year end and therefore that reduces the total by about 78000 square feet. So after that there really is only one other lease that's above 50000 square feet and is exactly the one that you mentioned.
And that GSA tend to Florida Research Park.
They have 65000 square feet.
They have two floors and the building.
What I can say is I guess, the best way to characterize it as that.
We're having very constructive late stage discussions.
And were for.
And maybe the best way to phrase. It is we're feeling confident on a long term renewal on one full floor.
But a little less confidence on the second floor, but as I said those conversations are ongoing.
Okay.
Great and then I guess, Jamie can you talk a little bit of balance the investment activity I know you talked about it and the earlier part of the call.
I guess, what do you have to see to get comfortable to start deploying some capital I mean are these going to be more stabilized type acquisitions. You are looking for I guess, how do you view the post COVID-19 type of environment and is there a different types of deals youre looking at versus let's say 12 months ago.
So to just kind of on overall stat on activity 2020, the office market transaction was down by over 40%. So.
What's happened since kind of late September is you've started to see a number of transactions come back the ones that are getting done are what I'd say is the lowest risk I great tenants very long term leases.
And valuations for those are not dissimilar to pre COVID-19 and pre pandemic very low cap rates and the challenge. We have is if you do or the buildings, there's nobody there.
And for the most part and so that's a big factor for US again, we underwrite every space, we walk through and we try and understand what the likelihood is of that tenants day or leaving.
And that's a very important component for us to get valuation metrics right and so I think what we're seeing you know that can be solved somewhat by getting a sense of tenants are coming back on.
And you're seeing their utilization valuation consult that that's just not what we're seeing though today of great deals I think when you look at rolling forward Theres a number of properties that we have and interest in that are getting teed up and so could our timing be faster than what we said absolutely we'd like to have.
Great tenants great assets.
And we want to be very comfortable that those tenants are committed long term and so as the year rolls on and I think we're going to get more and more comfortable we love the life science space when I think in the past we've made common saying that that's a portfolio once we've unlocked the value that we need to do there that we would consider monetizing and that.
<unk> true. It's also a sector, where we're actively looking at how can we add on to that and build that portfolio further and so I think over the next year.
And hopefully advance what we need to there and then we can reassess that decision.
Okay, great. Thank you.
Once again, if you have a question. Please press Star then one.
The next question will be from Bill Crow with Raymond James. Please go ahead.
Hey, good morning, guys.
Two questions number one on that stabilized run rate and assuming you make the acquisition and the fourth quarter.
What would that number be if you finance that acquisition and 60 or 70% equity.
And good morning Bill.
And your question is if we are in essence.
Use.
Tap the capital markets to two.
To finance net acquisition as opposed to just yeah.
Oh, Yeah, yeah, Yeah, just to not change your capital structure from where you are today.
Yeah, So I mean in essence, what you're saying and hold and what would a $50 million of equity.
James that number too I mean that that would obviously depend on the on the price that you are raising funds that and so it.
It would be a different answer of where we've been trading over the last year than where we trade.
A year and a half ago, but roughly it would probably drop that number by a penny.
On a more a little more than that if we can successfully raise the equity at an attractive rate.
Yes.
You've done a good job, bringing the leverage level down.
Wouldn't you want to keep it and this range if not total bit lower is that fair.
Yeah, and you know over the long term Bill absolutely. We've stated our goal is to is to work down our leverage over time.
And the very short term.
I think as and Jamie his prepared remarks, he indicated that over the last 18 months and that's.
Mm $300 million and proceeds from from equity raises and from sales and we've only deployed 100 million to date and this would be so it's still even if we were to do 100%.
Through that it would still represent a $100 million reduction and leverage versus where we were 18 months ago, which for US is a significant number and given our size. So while yes. The answer is.
Long term, that's where we want to get too you know along the way Keith.
Keeping things relatively where we are on that is probably most likely.
Yes, Okay fair.
On the land parcel you you discussed earlier, it really sounds like interesting and exciting value creating opportunity but.
You you wouldn't contemplate doing.
On balance sheet ground up development when you for 400000 square feet.
You're looking at all options right now Bill we haven't excluded anything.
And we recognize that.
A significant size development and there's ways to do it where we sell the land there's JV potentials.
There's a lot of options.
But what do you think the cost per foot.
Depending on whether it's on life science, Buildout or potential office expansion.
And it's.
$5, 600, and maybe higher than that depending on the life science.
Life science could be north of a 1000 and okay.
Appreciate it thank you guys.
Thanks Bill.
Ladies and gentlemen, as there are no additional questions I will turn the call back over to Mr. Farrar to conclude the call.
One and thank everybody for joining today, if we missed any of your questions. Please feel free to reach out directly to us at anytime and goodbye.
The conference has now concluded. Thank you for attending today's presentation you may now disconnect.
Okay.
And.
Okay.
[music] reported.