Q2 2021 Office Properties Income Trust Earnings Call
Good day and welcome to the office properties income Trust second quarter of 2021 earnings Conference call.
All participants will be unless the only man shutting the assistant please signal a conference specialist by for instance, Turkey, followed by the true.
As of todays presentation.
The opportunity to ask the question.
Ask the question of me per store them, 1 on yourselves from keypad.
Your question. Please press Star then 2.
Please note that some of them as Gerry reported at this time of all of the turnover of Olivia Snyder.
Manager of <unk>.
Investor Relations. Please go ahead.
And good morning, everyone. Thanks for joining us today with me on the call RPI, President and Chief Operating Officer, Chris Blotto, and Chief Financial Officer, and Treasurer of Matt Brown in just a moment they will provide details about our business and our performance for the second quarter of 2021, followed by the question and answer session with sell side analysts first.
First I would like to note that the recording and retransmission of today's conference call is prohibited without the prior written consent of the company of.
Also note that todays conference call contains forward looking statements within the meaning of the private Securities Litigation Reform Act of 90, 95, and other securities losses.
These forward looking statements are based on Opi's beliefs and expectations as.
As of today Friday July 32021, and actual results may differ materially from those that we project. The company undertakes no obligation to revise or publicly released the results of any revision to the forward looking statements made in today's conference call <unk>.
Additional information concerning factors that could cause those differences is contained.
And in our filings with the Securities and Exchange Commission of our SEC, which can be accessed from our website OPI REIT dot com or the SEC 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.
<unk> operations for normalized <unk> cash available for distribution for <unk> and.
Adjusted EBITDA and cash basis, net operating income of cash basis NOI I.
A reconciliation of these non-GAAP figures to net income are available in our supplemental operating and financial data package, which also can be found on our website.
Funds from the addition, we will be providing guidance on this call, including normalized <unk> and cash basis NOI. 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 for at all such as gains and losses for impairment charges related.
Added to the disposition of real estate now I will turn the call over to Chris.
Olivia and good morning, welcome to the second quarter earnings call for office properties income Trust.
Yesterday, we reported normalized <unk> of $1.15 per share exceeding our expectations as well as consensus estimates for.
The quarter drew.
During the second quarter, we advanced many of our core business strategy focused on enhancing the overall quality and geographic footprint of our portfolio.
Moving healthy portfolio cash flow growth and retention through proactive asset management and leasing managing through areas of known risks and opportunity and effects.
The balance sheet management to execute on our deleveraging and refinancing initiatives.
Overall, we have seen office leasing activity begins to recover and remain encouraged by the long term outlook for our company.
Turning first to an update on our acquisition of capital recycling activity.
As previously Enel.
In June we acquired 2 core class a office properties for a total of $550 million.
These acquisitions are accretive to cash flows and enhance our overall portfolio metrics, including geographic diversification occupancy average building age and weighted average lease term.
With newer.
Construction and modern infrastructure and design.
Each of the properties have limited capital requirements deliver contractual annual rent growth of over 2% and offer of net lease structure for recoveries of operating expenses.
As a result, we believe these 2 new investment opportunities will provide attractive long term risk adjusted returns for.
Right.
The first property known as 1 case Bolton in Chicago was acquired for $355 million representing of GAAP cap rate of 4.7% of closing this 531000 square foot property is 73% leased to Google as its Midwest headquarters.
For opening of more than 99% leased overall with a weighted average lease term of 6.6 years.
We are pleased to add Google as our second largest tenant for OPI, providing double a plus rated cash flow and accounting for 3.6% of Opi's total annualized rental income.
This LEED certified properties.
<unk> under 1 of for redevelopment in 2015 and is located in the highly desirable Fulton Submarket of downtown Chicago of neighborhood, which has experienced strong population growth among young educated professionals, attracting fortune 500 companies such as Google of Mcdonald's, which has supported residential.
And mixed use development.
In addition, the Fulton Submarket continues to benefit from a rapidly growing presence of both technology and life science companies, providing OPI with the favorable market investment landscape.
While we expect to benefit from the current lease term and corresponding cash flow stability, we estimate current rent.
Both the 20% below market, providing the opportunity for further upside upon lease renewal.
We also acquired the property known as 12, 24, and Atlanta for $195 million representing of GAAP cap rate of 6.3% of closing.
This 346.
To be core foot property is 96% leased to insight global as its corporate headquarters and more than 98% leased overall with the weighted average lease term of 14.2 years.
Insight global is the third largest staffing company in the U S and has experienced solid growth over the last few years, including the addition.
5000 employees in 2020.
This core class a property was constructed in 2021 and is located in Atlanta Central perimeter, Submarket, which is the largest employment center in greater Atlanta, and homed of Fortune 5 hundreds of headquarters from Mercedes State Farm and NASDAQ.
Given these dynamics.
Additionally, we believe 12.24 should provide OPI attractive risk adjusted returns in a healthy market with the high quality of tenant.
Turning to dispositions as discussed last quarter enable we sold our property located in the Huntsville, Alabama that was of known Vacates in the third quarter for $39 million.
In July we also sold 2 properties for a total of $7 million, including our property in Fresno, California that was the known vacate in the fourth quarter.
We are pleased to sell these non core properties as part of our focus to reshape the portfolio and eliminate potential drags on occupancy as well as anticipated capital in downtown.
Hi.
Since the start of our capital recycling program in 2020, we committed to selling properties that are older in age more capital intensive or those that of maximize value and exit markets, where we see limited future growth and reinvest the proceeds into higher quality and stronger cash flow producing properties.
We have since sold $287 million of properties, while eliminating forecasted capital spending needs of $113 million over a 5 year period.
As part of these efforts we have reinvested those proceeds in the properties located in strong growing markets with an average age of close to 3 years and.
Out of the accretive 5 year cash contribution yield in excess of 5%.
We believe the execution of our capital recycling initiatives will continue to enhance the quality of our portfolio of supported by key metrics, including the increase of our portfolio of <unk> to $5.9 years from $4.9 years in Q1 and overall reduce.
In 1 hand of the average age of our portfolio and our expanded footprint and strong growth markets, such as Atlanta and Chicago.
We expect to continue with our capital recycling program into future quarters, which Matt will also touch on in his prepared remarks.
As was recently announced in June we commenced the redevelopment of 'twenty of Massachusetts.
Ducks Avenue in Washington D C.
This project will expand the existing 7 story 340000 square foot class B properties..2 of 10 storey 427000 square foot mixed use property that is expected to be completed in early 2023.
The redesigned property will feature of 1.
The usage from 84000 square feet of class a office space 14000 square feet of retail space of luxuriously appointed hotel and extensive amenities.
Of the art design and construction will underscore our commitment to sustainability with a focus on touch the systems as well as lead and well certifications.
100, <unk>. We're also pleased to be more than 50% pre leased at this early stage in the project timeline with the execution of of 230000 square foot lease for 270, <unk> Royal Sonesta Hotel.
Sonesta is 1 of the largest hotel management companies in the U S and the largest hotel brand and franchise company in America.
So that's the currently operates close to 3500 hotels with over 140000 rooms, and brings growing brand recognition to the distinctive Capitol Hill destination.
20th, Massachusetts, SAB is located adjacent to Union station of me.
Regional transit hub, and a short walk to the United States capital and Supreme Court.
Sure.
We anticipate total project cost of approximately $200 million with stabilized year returns of 8% to 10%, making this a highly accretive use of capital.
Turning to leasing results for the quarter.
We are encouraged by the momentum of our leasing dialog and activity in the second quarter importantly.
We have seen new leasing accelerate and new deals contributed nearly 50% of our total activity.
During the second quarter, we completed 548000 square feet of new and renewal leasing with of 17, 1% roll up in rent a weighted average lease term of $16.6 years and leasing concessions and capital commitments.
<unk> dollars 42 per square foot per lease year.
We ended the quarter with consolidated occupancy of 89, 5%.
In addition to the sonesta the Liza Sonesta, we renew the GSA in Cheyenne, Wyoming for 67000 square feet in a 20 year term and extended the GSA.
Of 8 in wholesale in New York for 101000 square feet and a 3 year term.
Both of these tenants renewed with the roll up in rent the close to 20% and the overall economic serve as a Prime example of how a strategically located agency can deliver strong investment of leasing results for OPI.
Our leasing.
Pipeline remains robust with discussions covering 3.8 million square feet, including more than 890000 square feet of new and renewal leasing in advanced stages of negotiations more than 130000 square feet that has been executed subsequent to quarter end.
And $1.2 million square feet that could absorb vacant space.
The leases this is the fourth consecutive quarter, where our leasing pipeline has been in excess of 3 million square feet, which highlights the growing interest from tenants across our portfolio.
I'll discuss 3 of our for known larger Vacates for 2021 as mentioned last quarter at the fourth property implantation of Florida the GSA.
The lease expired in April and represents 80 basis points of annualized revenue.
The tenant of elected to hold over for up to 12 months and we now anticipate continued occupancy through mid December 2021.
Despite this holdover activity for private sector of leasing has been strong with several large users having.
<unk> of the building, including of signed term sheet for half of the total square footage.
Despite the pressure of the last 18 months, our investment strategy and portfolio composition of key industries and tenants has continued to perform well.
We are pleased with the successful execution of our capital recycling program and believe we are well positioned.
Wired to continuing to advance our growth objectives, I will now turn the call over to Matt Brown to provide details on our financial results Matt.
Thanks, Chris and good morning, everyone.
Normalized <unk> for the second quarter was $55.4 million or of $1.15 per share, which beat consensus and the high end of our estimate by <unk>.
Mainly due to operating expenses lagging our forecast based on building utilization levels remaining below our estimates and NOI from the properties we acquired in June.
CA day for the second quarter was $33.8 million or <unk> 70 per share, resulting in a rolling 4 quarter <unk> payout ratio of 63%.
<unk> G&A expense for the second quarter was $13 million, which includes $5.9 million of estimated business management incentive fees excluding estimated.
<unk> estimated incentive fees G&A expense was $7.1 million.
Compared to $7.2 million for the same period last year and $6.1 million for the prior quarter the.
The increase.
It really is driven by annual trustee share grant expense as well as higher base business management fees due to the increase in our average share price in the quarter.
As a reminder, incentive fees under our business management agreement with RMR are payable after the end of each calendar year in which they are earned but are recognized in the calculation of net income in accordance with.
Sequentially in the first second and third quarters if applicable.
We do not include such expense and adjusted EBITDA of our E for normalized <unk> until the fourth quarter when the final incentive fee amount is determined the.
The incentive fee accrued in the second quarter is based on Opi's total return in comparison to the index over the 3 year measurement period.
GAAP.
<unk> outperformed the index by 15, 1% with a total return of 31, 5%. This equates to an estimated annual incentive fee of $22.2 million the.
The incentive fee accrual may increase or decrease over the remainder of the year, depending on our OPI performs relative to the index.
<unk>.
Interest expense for the second quarter was $29 million, an increase of $200000 from the prior quarter.
While interest expense increased sequentially, we expect interest expense to be between 26 and $27 million for each of the third and fourth quarters of 2021. The expected decline from Q2 is.
Is primarily due to the accretive bond offering in may in which we raised $300 million of.
Of $2.6 5% unsecured senior notes and used the proceeds to redeem $310 million of 5.875% senior notes and the prepayment of $71 million of 355% mortgage debt in June using cash.
Cash on hand, and borrowings under our unsecured revolving credit facility.
The may bond offering was 6 times oversubscribed and we believe this indicates a positive investor outlook look for office real estate.
The opportunistic debt management for a result of interest expense savings of approximately $10 million annually.
Turning.
Property level results for the quarter same.
The same property cash basis, NOI decreased $2.7 million or 3.1% compared to the second quarter of 2020 slightly outperforming the low end of our guidance range of negative 3.5 to 5.5 percentage.
As expected the decrease was mainly driven by a reduction in rent.
The income of $2 million driven by declines in occupancy as well as an increase in operating expenses of $700000, mainly due to increases in real estate taxes.
Turning to normalized <unk> and same property cash basis, NOI expectations, we expect third quarter normalized <unk> to be between $1.20 <unk> of $1.
Turning to <unk> <unk> per share driven by the following.
An increase of 16.
Including <unk> 11 from the June acquisitions, and <unk> from the Q2 bond offering and redemption activities described above.
Offset by a decrease of <unk>, including <unk> <unk> due to increased operating expenses and <unk> <unk> from the sale of the Fresno, California properties.
Operating in July.
We expect third quarter same property cash basis, NOI to be flat to down 2% as compared to the third quarter of 2020.
Turning to capital expenditures and the balance sheet.
We spent $19 million on recurring capital during the second quarter, and we expect recurring capital expenditures for the full year 2.
$2075 to $80 million as Chris mentioned, we also commenced our redevelopment of 20 Mass Avenue June and spent $10.3 million in the second quarter we.
We anticipate delivery in the first quarter of 2023, and total project cost of approximately $200 million.
Of which $46 million is expected to be spent in 2000.
'twenty 1.
At June 30, our leverage was 6.9 times pro forma for the 2 property acquisitions in June which were funded using cash on hand, and approximately $350 million of borrowings under our $750 million revolving credit facility.
We expect to dispose of non core properties under our capital.
Recycling program to repay debt and manage our leverage levels and have approximately $300 million of properties in the market or identified for disposition that we plan to bring the market in the near term.
We currently have $380 million outstanding and $370 million available on our revolving credit facility.
We.
We are pleased with the execution of many of our core business strategies in the second quarter, which have enhanced the quality diversity and security of our portfolio of.
Operator that concludes our prepared remarks, we're ready to open the call up for questions.
Sure.
Pardon me. Our first question today comes from Bryan Mayer of B Riley FBR. Please proceed.
Hello questions on mass Av.
Which looks fantastic on the website that you have of explaining what it's all about.
The 200 million of core.
Of course is that going to be of fixed cost yeah. The guarantees by the builder on that.
Yeah, I mean typically Brian this is Chris so good morning, typically with these projects of this side, it's kind of of GMP. So on the onset.
We structure of kind of the agreement, where we kind of lock in pricing.
Reising and then anything that is in excess would be borne by either of the contractor or if needed through use of contingencies. So for that particular project, we bought down a lot of the job already and so I think we feel.
Pretty comfortable where that number is trending.
Okay, and I think you said 40.
2 million will be spent on it in 'twenty 'twenty..1 does that include the $10 million I think you referenced into Q.
Yes, that's inclusive.
Okay. So roughly 150 once at the 5 in 2022 or do you expect some of the balance of the carryover into 2023.
Theres a portion of that will carry into 2023, and I think the numbers trending right now of less than $20 million.
Okay.
As it relates to those 2 office properties, you recently bought in Chicago and Atlanta.
How did you source the and the via that source.
Thing you know kind.
How deep is the pipeline of of other similar assets that you could acquire.
Well I think from a sourcing initiative I mean through kind of our manager of our acquisition team. We're sourcing opportunities regularly I think we see most if not all deals out there whether individual acquisitions or other.
Sorry sooner needs and so the.
These 2.
Deals came to us through that kind of venue and then our relationships with brokers and so.
With respect to how many other deals like this are also here I mean as far as our pipeline goes I mean, our focus now coming out of these acquisition.
Offer for this is kind of back end of some capital recycling.
But there.
There is a handful of deals out there in the market.
Kind of a similar quality and so I think we evaluate them on a case by case basis, but again these kind of came through our channel and relationships.
Great and then just last for.
And I think you call.
Comment on this in the last quarter's earnings call, but the based upon how you know the last 3 months of unfold. The can you give us your updated thoughts on where you are and the occupancy shakes out maybe plus or -50 bps.
Yes, I think it's relatively the same Brian I mean, I think we've talked about.
Kind of the 89% to 91% and I think it kind of stands.
There with some of the moving pieces that we still have we've kind of leases out there for pending execution things around kind of capital recycling I think we feel that thats a pretty good number the standby.
Okay.
Thank you that's all from me.
You.
And as a reminder, if you of a question. Please press Star then 1.
Just kind of of our next question comes from Vikram Malhotra of Morgan Stanley. Please proceed.
Thanks, so much for taking the questions I guess, just maybe first 1.
You know given the GAAP.
Given sort of the acquisition disposition kind of pace and just the differing GAAP rates in terms of what you're being for acquiring versus the disposition I think some of these cap rates seem pretty high I'm. Just wondering if you can give them the sense of like how and then obviously the capex.
The issue of the newer assets can you give the sense of how God is likely to trend.
Maybe even just from a dividend payout perspective over.
Over the next few quarters.
Yes, the acquisitions from a cash perspective are accretive.
So we expect it to the.
Simply Google as it relates to the dividend coverage of our rolling 4 quarter coverage of 63% currently.
Absent of potential incentive fee paid to our manager, we expect 2021 payout of about 70%.
And that excludes the the incentive.
Favorite that's right with the incentive fee, it's right around 80%.
80% Okay.
Okay, and then I guess, the if we think about the.
The overall.
Occupancy you mentioned kind of a.
View of where the checkup.
Check out near term I'm just wondering.
If you pick up picture given sort of the government exposure and I think of couple of days ago, the GSA announced that theyre going to be offering them space or build out them space for other for federal different federal branches.
And they expect their office space to the.
<unk> to shrink over time I'm, just wondering kind of how are you.
Can you combine that with sort of the known move outs.
Other risks of the portfolio you see in terms of.
Potential declining use of just based on a more permanent basis from the from the government agencies.
Yeah, So I think of couple of different things.
Right now I'm kind of the offer.
For us of personal management had a memorandum that went out I think it was in June.
To kind of get feedback from the agencies around.
1 kind of their reentry plans and timing on utilization and then 2 at an agency level about kind of how they think about the future of the workplace.
Place and so it's going to be heavily driven by agency. In addition to kind of the New Commission and the GSA and then that administration and so I say that because I think the outcome of some of the feedback is going to drive that decision, which I think over time, we'll learn more about I would.
Today, where we stand when you kind of look at our make up 22% of our annualized revenue is with the federal government I would say about half of it today is more kind of defense mission, driven meaning highly secure facilities and in those cases.
Those.
The tenants want to retain control of the building or certain areas within a building and so the likelihood of them can consol.
Consolidating or condensing within a building it seems less likely.
And then outside of that.
I think it's just going to be I think forward facing.
Pacing agencies.
We would expect to see.
Some shifts in their program, which represent the lesser percentage for us.
And I kind of look to our results I mentioned a few.
Leases are transactions this quarter with the GSA and both of those.
I would say are kind of the non partisan meaning the ones that are more highly likely in our view to to downsize or consolidate and in those cases, they're extending.
In 1 case for a 20 year term of the other case for 3 and so I.
I think the short of it is is it remains highly.
Those of all along what agencies will do and I think our experience with the government is that it's much more difficult to get space given the process. If you give space back and so I think there'll be very mindful of kind of how they rollout that plan and how much they elect to give back if any depending on the circumstances.
Yes.
That makes sense.
Just related to that if you could clarify any update or any <unk>.
Just to kind of the the.
The known move outs over the call. It the next 18 months into 'twenty 2.
Yes, so typically we like to provide 12 months.
Guidance on known move outs and so when.
When you kind of carve out of the disposition of Fresno, we of about 5.6% of our annualized revenue expiring.
Between kind of Q3 and the end of Q2 next year and so we think about.
The 2% of that is of known vacate.
And really.
It's kind of smaller tenants that make up that.
Of that list, we talked about.
The lease with plantation, Florida, being 80% of 80 basis points and also how we have a.
Signed term sheet for half the space already and then the rest of this just a handful of smaller tenants.
The portfolio.
Okay, Great and sorry, just last 1.
On Capex.
You talked about incremental investment redevelopment you gave the.
The invest the capital.
Capital spend for this year I'm, just wondering like as you make these portfolio changes.
Combined with potentially.
A little bit more of a work from home work from anywhere model, where do you see sort of the the capex load on a per square foot basis, the percentage of NOI.
This is where do you see that trending kind of over the next 2 or 3 years.
I mean from.
I can answer it in 2 parts I'll talk quickly about kind of leasing related capital I think from a leasing related capital I think over the last call it 6 quarters slightly.
Increased.
Mostly due to kind of concessions and maybe being a little bit more heavily weighted on ti.
Just kind of given changes to the economic environment, and so I think that cash.
End of over the over the short term I would expect that kind of the leasing capital per square for.
Slightly would be elevated but we've started the kind of see it level out a little bit and from a building capital yes. So on a building capital standpoint, as we execute on our capital recycling and sell out of older more capital intensive properties and acquire kind of first generation buildings, we would expect that to.
The trend down.
Okay, great. Thanks, so much.
As the final reminder of fee of a question. Please press Star then 1.
Our next question comes from Jason.
The <unk> of RBC capital markets. Please proceed.
Just following up on victims question.
On the leasing I'm curious to ask the how concessions and.
The tenant requests are changing today versus pre COVID-19.
If you could kind of touch on where the market is that today and I know you said that.
You would expect that the trend lower but I guess, what would the timeline for that day.
Yeah, So I guess kind of just going back to my previous comment I think we're seeing.
Kind of the capital cost per square foot per year slightly.
Slightly increasing from pre Covid.
And Thats I think that while it's leveled off I think it will stay elevated.
Into the to the to the near term or maybe into the kind of early next year, just based on where our pipeline debt.
And from a kind of other concession standpoint, I would say.
Things around the free rent has have leveled off, albeit they still are elevated from where they were several years ago.
I think what we're seeing more of with respect of tenant request of things about.
Kind of expansion of controlling kind of ROFO of roper's being requested or baked into the leases and so I think that's just the function of tenants, who want to kind of commit today, having room to.
Pro with some form of controlling their lease and so I would say that those are really kind of the 3 areas, where we're seeing various levels of movement.
Got it Okay and then on the other.
For the Seattle lease with F..5 any updates on that I think that that's the right outside the <unk>.
18 months.
Window, but.
Any updates on like leasing activity of what the tenants plans are there.
Yes, so thats the.
The lease that expires in July of next year.
The plan there is continues with what we've talked about historically aware of.
We're focused on evaluating.
<unk> for a partial conversion of the life science of 3 buildings and so we're in the kind of the process of evaluating.
How much of that square footage, we want to consider converting and so from an activity standpoint, we do have activity from life science users.
For the space and.
And so I think it's it's promising thats the market Thats continued to kind of see an uptick in trends with respect to gravitation towards more of life science users.
And we would expect that you know there is an outcome where a portion of those buildings will be converted and so I would venture to guests.
Within this next quarter.
That should have a little bit more definitive direction on timing cost kind of returns and other things to share.
Got it Okay, and then last 1 for me just on the acquisition market could you just touch on like the volume of deals Youre seeing in the market relative to.
I guess the the last.
Quarters.
Are you seeing more deals come to the market.
And also what type of assets are you seeing coming to market.
I think the activity has been pretty consistent I mean, we've seen elevated transactions come into the market ever sense of kind of the turn of the year and so I think that flow is.
It's been relatively.
Couple of consistent so and again this is.
Yes.
Creation of.
Kind of the <unk>.
Single tenant high credit well leased buildings and then you know what I might consider as maybe a little bit more core plus as well, so but otherwise the volume itself.
<unk>.
At least deals out there has been pretty consistent.
Got it thanks, Chris.
Yeah.
This concludes the question and answer session. At this time I would like to turn it back over to Mr. <unk> for any closing remarks.
Thanks for joining us today, we look forward.
To updating you on our progress this year and hope to see many of you at some of the upcoming conferences.
Sure.
The conference has now concluded. Thank you for attending today's presentation you may now disconnect.
Yes.
[music].