Q2 2021 City Office REIT Inc Earnings Call
Good morning, and welcome to the City Office REIT, Inc. Second quarter 2021 earnings conference call.
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And question and answer session will follow the formal presentation.
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It is now my pleasure to introduce to you Tony Merit, the company's Chief Financial Officer, Treasurer, and corporate Secretary. Thank you. Mr. Meredith you may begin.
Good morning, before we begin I would like to direct you to our website and see I O REIT Dot Com, where you can view, our second 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 discussed today to their most directly comparable GAAP financial measures.
Certain statements made today that discuss the companys beliefs or expectations or that are not based on historical fact may constitute forward looking statements within the meaning of the federal securities laws.
He 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 and our second 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 it'll be made and of course of this call.
I'll review, our financial results after Jamie 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, our quarterly results continue to be strong and consistent.
And the second quarter, we achieved healthy dividend coverage positive same store cash NOI growth and strong leasing activity.
Major highlights for the second quarter include completing a large backfill of leaf, but unoccupied space at our park tower property and Tampa.
And advancing opportunities to unlock value with our life science assets and San Diego.
And I will cover both of these items and more detail momentarily.
Before going into our results I'll briefly touch upon what we're seeing across the office industry.
After labor day, we continue to expect a significant increase and tenant utilization of office space.
And it should accelerate as we approach the end of 2020.1.
To date, we have seen many smaller tenants embrace a return to the office larger tenants and generally been slower to return, but are expressing intentions to ramp up their utilization and the fall.
In terms of our operating results during the quarter, we completed a healthy 249000 square feet of new and renewal leasing.
We also continued with our strong rent collection and nearly 100 per cent and have now collected virtually all of the deferred rent granted during dependent.
While occupancy dip slightly at quarter and our second quarter same store cash NOI growth was a solid 2.7%.
Of note, we achieved a 4% increase in cash renewal rents versus the expiring debt.
As I mentioned, 1 of the most significant transactions in the quarter and bought back filling dark space at our park tower property.
BB&T Bank is a major tenant, but they consolidated into Suntrust location last year after the merger.
This left us with 51000 square feet of dark space leased through February of 2020.5.
Paying rent and having a new.
Seems like this is a drag on property value is it creates a known future vacancy.
During the second quarter, we secured a new tenant that will occupy the full 51000 square feet plus an additional 15000 square feet.
At the same time, we negotiated a lease termination with BB&T with a termination fee of approximately $5.4 million.
BB&T, we'll continue to pay their rent obligations through November 30th 2021.
The termination fee represents approximately 85% a day.
Future base rent and estimated reimbursement obligation that BB&T would have otherwise paid through 2025.
The new tenant is a fast growing fintech company and they executed and 8 year lease that starts in may of 2022.
When factoring and signage red and the new tenants will be paying approximately 5% higher rent per square foot and the party.
As part of the deal we intend to complete significant upgrades to their space, which will be accretive for future leasing.
The other significant transactions that occurred during the quarter was the acquisition of 2 properties adjacent to our Sorrento Mesa portfolio, which we announced on our last call.
And these properties are an important key to unlock greater development potential and value and those life science assets.
Rent and San Diego's life Science market continues to be at a record high with vacancy below 5 per cent.
Tenant demand for life Science properties is strong and growing fueled by record levels of venture capital funding and see.
<unk> estimated that there was approximately $2.8 million square feet of laboratory tenant demand with only 900000 square feet of availability.
San Diego's limited vacancy and development sites have left tenants with few options for expanding their operations given these market dynamics, we completed the purchase at an ideal time.
Since our last call we've made substantial progress exploring options for our full Sorrento Mesa portfolio, we executed a process that evaluated developing our land holdings and partnership with an experienced operator.
Selling the entire Sorrento Mesa portfolio or some combination thereof.
This process confirmed that the value of these assets has grown too impressive levels.
Which ever option, we select will have a transformative impact to our company.
Today, all alternatives remain on the table and we're getting significant consideration to a possible sale of the entire Sorrento Mesa portfolio.
Given where we are and our process. We are unable to provide further details at this time should a transaction come to fruition, we anticipate providing further information at that point.
To conclude as we move forward into the second half of the year, our focus remains on advancing our Sorrento Mesa process, achieving leasing success through both renewals and the leasing of vacancy and building our acquisition pipeline at a time when tenants are returning to the office environment.
We believe that we're well positioned on all of these fronts.
With that I'll turn the call over to Tony to provide further detail on our financial results.
Thanks, Jamie.
I'll address the second quarter's results and then provide an update to our guidance for the balance of 2021.
Our net operating income and the second quarter was $25.8 million, which was 400000 higher than the $25.4 million, we reported last quarter.
The increase was a result of higher termination fees offset by the reduction in income from the Cherry Creek sale midway to the prior quarter.
In total we recorded $1.5 million and termination fees and the second quarter.
Of that amount 700000 was related to the total lease at our Santana property does.
Last quarter, we will be amortizing the fee to August 2022.
500000 was related to the leasing transactions that Jamie described at our park tower property.
Tenant B B and T signed an agreement that became effective at the end of June.
The agreement releases them from their obligation to pay rent. After November 30th of this year and connection with the agreement we received a termination fee of $5.4 million, we will amortize the fee until the end of the tenants new lease term.
We reported core for flow of $15.3 million or <unk> 35 per share, which was 800000 higher and in the first quarter for the same reasons that NOI was higher in.
In addition interest expense was also lower as a result of using proceeds from the Cherry Creek sale to reduce our overall leverage.
Our second quarter, <unk> was $9.9 million or <unk> 22 cents per share.
The largest impact to April was the leasing commission on the lease transaction at our park tower property, which equated to 3 cents per share.
The $3.6 million of tenant improvements related to that lease are expected to begin to impact <unk> in Q4, with the bulk expected and the first half of 2020.2.
Our second quarter same store cash NOI growth was a positive 2.7% as compared to the second quarter last year.
The leases, we signed in 2020, particularly those that are Denver Tech property and our life science portfolio are the biggest driver of these results.
Our total debt at June 30th with $613 million, which was a $40 million increase over last quarter.
That increase was due to funds drawn on our credit facility for the Sorrento Mesa acquisition during the quarter.
Our net debt, including restricted cash to EBITDA was a healthy 6.2 times.
At quarter, and our total debt had a weighted average maturity of 4.2 years and 84 per cent of our debt was effectively fixed our weighted average interest rate is now 3.6 per cent and we have no property debt maturities until 2020.3.
We also wanted to make 1 note on our disclosures. This quarter, we have decreased disclosure related to our rental collection rate and exposure to select industries impacted by COVID-19, we essentially have not had any collection issues to date and do not currently expect material changes and our collection rate.
Lastly, we have provided updated full year 2021 guidance and a press release the primary driver of the guidance changes at the park tower termination fee income that I mentioned earlier, which positively impacts our forecasted net operating income and core FIFO the.
And the expected departure of BB&T in 2020, 1 has lowered our year end occupancy guidance as a replacement tenant is not expected to take occupancy until may of 2020.2.
We refer you to the material assumptions and considerations set forth and our earnings release that concludes our prepared remarks, and we'll open up the line for questions operator.
We will now begin the question and answer session to ask a question you May Press Star then 1 on your telephone keypad.
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At this time, we will pause momentarily to assemble the roster.
And our first question will come from Rob Stevenson of Janney. Please go ahead.
Good morning, guys.
Jamie So if you decided that you did that.
The best alternative was to sell Sorrento Mesa and its entirety, what would you do with the proceeds and the 2 legacy properties are something like $20 million of annual revenue do you sort of look to fund acquisitions, and some combination of acquisitions and common stock buyback. How would you you know given you know what's the your alternative.
Saar today me and what is that look like for you. If you do get that capital inflow.
Yeah. Thanks for the question Rob So we'll go into more detail if we complete a transaction, but it's fair to say that we'd love to continue to build further depth and our markets that we're in and continue to expand into new markets.
And as we look to kind of the fall and into 2020..2 we think it's going to be a great time to have dry powder as tenants are returning to the office.
And how does pricing look.
Book Today, given you know assets that you'd want to own without taking you know some substantial re tendered and rest today.
So if you look good more traditional assets I mean, right now were and kind of the slow summer period, and and we think internally that as we get to the fall things are going to pick up.
But what we're still seeing is you know very high quality assets with great credit new construction.
You know great locations still trading at prices that would be accretive to us long term.
Okay.
And and addition to park tower are there any other dark spaces of note and the portfolio, where youre getting rent, but the tenant is and occupying a substantial part or even all of the space.
Yes, BB&T was hey, Robyn, it's Tony here BB&T was by far the largest of those items.
Obviously, you know just given where we are you know utilizations rates in our portfolio are still right around call it low 30% utilization.
But no other significant blocks, where we where we know of 10 and has fully vacated.
And then last 1 from me.
You know as you sit here today, how does the leasing picture look for the second half of the year and how should we be thinking about tenant improvements leasing commissions and the like and the need to fund some of that stuff and the back half of the year.
So it was low in terms of market in general and again, we think leasing will pick up kind of as we get to later in the year and and into early next year, just as far as you know tour activity that we've been seeing and and you know tenant interest and they returned back to the office.
I'd say generally concessions.
And we're gonna be terribly dissimilar to where they had been in the past and probably a bit more elevated free rent and if anything.
Construction costs, a little bit higher probably as costs all over the board have gone up a bit.
But generally in line with what we've been seeing recently.
Okay. Thanks, guys I appreciate the time.
Thanks, Rob.
The next question comes from Michael Carroll of RBC capital markets. Please go ahead.
Yeah, Thanks, Jamie related to the Sorrento Mesa portfolio I kind of want to walk through the options that you highlighted I mean, where are the 2 options that you kind of highlighted in your prepared remarks was 1 and sell the entire portfolio or to form a joint venture to pursue a development on the available land side are those the 2 that you're thinking about right now.
And that's exactly right Mike. So we had the 2 processes. When we started the primary thrust really was to pick a joint venture partner, who would lead the development for our holdings and and we have a great option, there and before we decided to consummate a transaction given how strong the life science.
Market is we felt we really needed to look at our options and detail and so we had a broker target the most active and sophisticated buyers and we had tremendous interest and very compelling valuations and so the focus and trust of the direction were going and has shifted.
In that direction at this point.
Yeah, and I know last quarter that the talk with that available land site was to potentially do a JV to do the development and or just sell that land and it seems like you're not planning on just selling and Atlanta anymore.
I'm, assuming and correct me if I'm wrong here is that the potential acquirer would prefer to have the entire portfolio within Sorrento Mesa, including that land and that's why you're pursuing that potential disposition.
You know, we could pretty much pursue any option that we wanted Mike, but the special thing about the portfolio. We put together is it has great existing cash flow and then it has a million square feet plus of potential development that that could be out of the ground pretty quickly and so when you put the whole portfolio together.
And that becomes a very attractive package and so as we went through a process that was the direction, we decided to head.
Okay and then what we heard is 1 of the stats is that the what developable and life Science land is trading and these top cluster markets is about $200, a developable square foot I mean does that kind of in line with what you're thinking on the 1 million square feet that you have within Sorrento Mesa.
Yeah, again, given where we are and our process, Mike and we won't provide any further comments on value right now.
Great and then just last 1 from me on the on this front and Mesa portfolio.
I know you have the available block there is that something that you're pursuing to lease right now or does a potential acquirer of this but prefer to have that available for them to lease it up or do with what they want I mean are you still actively pursuing tenant discussions to lease that space today.
We are actively pursuing and and.
And some of the potential buyers really like having that vacancy is if youre going to launch and development having <unk>.
Swing space. That's immediately available is helpful and potentially securing a tenant and so.
Our focus right now is to try and find a great long term tenants there.
And that could change obviously, if we decided to exit the property.
Okay, Great and then Tony related to the lease expiration schedule is ally and Toyota are those leases still reflected and although at the 2020, 2 and 2023 explorations or have those been and it says it's a specific allies since they renewed is that kind of out there new exploration day.
Yeah, I mean, the way, we treat that schedule is and if a leases signed prior to our reporting date, so and as case June 30th than we do update the the rules scheduled to reflect their new ending lease.
So the and it out.
And then when did al I officially right now.
Ally, we officially renewed I wanted to say it was because it was in Q1. It was Q4 of last year, Okay. Great. Thank you.
Thanks, Mike.
The next question comes from Craig Kucera of.
B Riley FBR. Please go ahead.
Hey, Good morning, guys I noted that you pulled your acquisition and disposition guidance from your from your overall guidance here I think and the first quarter guide acquisitions Woods.
43 million and 100 million a couple of questions here I guess first of all does the high and the range and your revised guidance include that additional acquisition.
So the low Rob basically reflects the $43 million, we've already put the work and the high and reflects an additional $57 million completed late in the fourth quarter. So there really isn't much of an impact to our overall results.
Okay got it and and I guess I'm looking to your leasing volume.
You know and accelerated again this quarter, particularly on the new leasing front would.
Would you say a lot of that activity is from tenants that you would be kind of discussions previously with or are these effectively new folks that are walking in and and wanting space and more recent discussions.
Yeah, you know everything's been slower Rob given COVID-19 and whatnot. So discussions we've been having generally had been ongoing for a longer period of time of cycles, just a little bit longer at this point.
Okay. That's it from me thank you.
Yeah.
Once again, we would like to ask a question. Please press Star then 1.
And the next question will come from Bill Crow of Raymond James. Please go ahead.
Hey, guys.
Jamie you seem pretty confident that we'd see a push and the return to office.
I guess September on I'm, just wondering whether whether their tenants are starting to talk about pushing that back because of the delta outbreak.
Yeah, Yeah. Some of our so we basically have been going through every couple of weeks and and doing counts of whose didnt desks and what tenants are thinking and their latest plans and and for sure Thats been happening Bill where some are pushing it back later in the year and and some are still planning kind of post labor day to be coming back so I think and at our own internal view, we think.
As I said, it's going to accelerate post labor day, and I think it'll continue to accelerate for the balance of this year.
When you when you talk to the tenants how much uncertainty exists silver over commitment to space versus.
About a year ago and they become more.
Definite and their and their plans or is there still this massive amount of uncertainty and how hybrid work Mike might play out.
And I don't think there's a definitive answer right now bill and how we feel a year ago, you know the the buzzwords, where about hybrid as is the way to go or remote work and the future and and I think that's really told him down, particularly in our markets and so I think you know kind of the latest feeling we have from our tenants is there'll be a REIT.
Turn the question is is it going to be 5 days a week is it 3 days a week, how do they ramp back into it and so we're feeling way better than where we were a year ago, but theres still some uncertainty on kind of timing and how that's going to rollout.
Okay and then.
And finally from me on Park Tower.
Uh huh.
And I don't know how long.
Hmm.
BB&T had been in this space, but a 5% increase seems on the modest side, but hey.
And it's 5% positive so that's good.
Hardly actualized economics per tower, playing out relative to your underwriting originally.
So park tower of BB&T had been in the space for a substantial period of time, and we renewed them I'm thinking it was pre COVID-19, maybe 2019, and so we had a healthy kind of mark to market terms at that point and so we were very happy with with Red and kind of where we are and so having 30.
Dollar full service gross on the new leases are starting point with.
Sub just under 3% kind of annual step ups and healthy sign of Dread. We're very happy it's worked out really well and when you look at our overall cost base and returns and I think were and are really good spot with that asset.
Sure sure Youre running in line with expectations when he bought it is that fair.
Yeah and in line or ahead, I'd say across the board the renovation really accelerated.
And kind of where we thought we would be on rents. So we're pleased with how that came together and obviously COVID-19 has kind of slowed things down and the market, but as far as this transaction and and.
And others that we've been doing there where we're very pleased with the economics.
Terrific. That's it from me thank you.
Thanks Bill.
And as there are no additional questions I will turn the conference back over to Mr. Jamie Farrar to conclude.
Thanks again for joining today and please don't hesitate to reach out anytime if you have any questions goodbye.
The conference has now concluded. Thank you for attending today's presentation and you may now disconnect.