Q3 2021 Office Properties Income Trust Earnings Call
Good morning, and welcome to the office properties income Trust third quarter 2021 earnings Conference call.
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Please note. This event is being recorded I would now like to turn the conference over to Kevin Berry Director of Investor Relations. Please go ahead.
Thank you and good morning, everyone. Thanks for joining us today.
With me on the call are Opi's, President and Chief operating Officer, Crystal Auto and Chief Financial Officer, and Treasurer, Matt Brown in just a moment they will provide details about our business and our performance for the third quarter of 2021, followed by a question and answer session with sell side analysts first I would like to note that the recording and retransmission of today's conference call is.
Without the prior written consent of the company.
Also note that todays conference call contains forward looking statements within the meaning of the private Securities Litigation Reform Act of 1995 and other securities laws.
Forward looking statements are based on Opi's beliefs and expectations as of today Friday October 29, 2021, and actual results may differ materially from those that we project.
The company undertakes no obligation to revise or publicly release 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 in our filings with the securities and exchange Commission or SEC, which can be accessed from our website OPI red dot com or the SEC's website investors are cautioned not to place undue reliance upon any forward looking statements. In addition, we will be discussing non-GAAP numbers during this call.
Including normalized funds from operations or normalized <unk> cash available for distribution or <unk>.
Adjusted EBITDA and cash basis, net operating income or cash basis NOI.
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. In addition, we provided 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 or at all such as gains and losses or impairment charges related to the disposition of real estate.
With that I will now turn the call over to Chris.
Thank you Kevin and good morning, welcome to the third quarter earnings call for office properties income Trust, yes.
Yesterday, we reported third quarter results that reflect continued execution on our financial and operating objectives normalized <unk> came in at $1 24 per share exceeding the top end of our guidance range and consensus estimates for the quarter same.
Same property cash basis, NOI grew 1% year over year and also performed better than expected we.
We took action to strengthen our balance sheet with two bond offerings that favorably impacted our debt maturity schedule and we ended the quarter with more than $800 million of total liquidity.
Our portfolio continues to perform well and we remain well positioned to advance our core business strategy is focused on the enhancement of the overall quality and geographic footprint of our portfolio through our capital recycling efforts driving healthy portfolio absorption cash flow growth and retention through proactive asset management and leasing.
<unk> development, our major repositioning of properties, providing for higher risk adjusted returns and continued advancement of our sustainability initiatives across our portfolio.
Turning to our portfolio reshaping efforts.
We are making steady progress on our capital recycling program as a reminder, our focus is on reducing opioid aggregate capital needs improving the average age of our properties better positioning properties in strong markets to grow rent and improving our likelihood of lease renewal.
To that end, we continued to market properties, representing close to $275 million in value with an average age of 23 years, an average occupancy of 61% and a negative five year average cash contribution yield.
We intend to use these proceeds to both reduce leverage following our recent investment in two core property located in Chicago, and Atlanta and to reinvest into our portfolio.
Year to date, we sold six properties for $227 million that contained approximately two 6 million square feet at an average age of 25 years, an average occupancy of 96% and a weighted average lease term of one two years as a result, we have eliminated approximately $98 million of budgeted cat.
Over the next five years with a negative five year average cash contribution yield and accretive outcome with our reinvestment of these proceeds.
Turning to an update on our leasing results.
We reported solid leasing momentum with 659000 square feet of new and renewal leasing and increase of 37% above the trailing 12 month average along with a weighted average lease term of 10 nine years and leasing concessions and capital commitments of $6 40 per square foot per lease year.
New leasing activity increased sequentially and represented more than 40% of our total Q3 activity.
Rent roll up for the quarter was flat however year to date, we're up 7% and continued to trend in line with our projections.
We ended the quarter with consolidated occupancy of 89% and our total leasing activity improved OPI as overall portfolio remaining lease term of six years.
Since last quarter, we have seen an uptick with tenants and their employees returning to the office with utilization across the portfolio increasing to 38% and we anticipate this will continue to escalate through the remainder of the year and into early 2022.
We remained focused on proactive communications with our tenants to be a landlord of choice as they continue to evaluate their needs upon reentry.
These efforts focus on both near term explorations, along with strategies for expiring tenants over the next several years.
Representative outcomes of this effort include a 13 year renewal and downsize with micro focus a top 20 tenant expiring in 2024 complemented with a new lease to a university for health professionals for 170000 square feet with a 15 year term, providing additional stability with the combined <unk>.
At the property in excess of 13 years.
And Sunnyvale, California, we completed a 10 year renewal with a full building user for 96000 square feet with an original exploration in late 2022, and Chesapeake, Virginia, We completed a renewal with a full building tenant for 107000 square feet and a term of five eight years.
Our leasing pipeline remains robust with discussions covering more than three 6 million square feet with a healthy mix of new and renewal activity with attractive lease term and proposed rent roll ups.
More than 670000 square feet in advanced stages of negotiation.
With an additional 172000 square feet that has since been executed subsequent to quarter end.
This is the fifth consecutive quarter, where our leasing pipeline has been in excess of 3 million square feet, which highlights a growing interest from tenants across our portfolio.
We currently expect to finish the year with occupancy around 89% and a 5% to 7% roll up in rent.
Turning to progress on upcoming exploration.
We continue to make progress with our upcoming extra explorations and known Vacates supported by a healthy lease pipeline inclusive of $1 4 million square feet for close to 6% of potential absorption across the portfolio.
For 2021 exploration, we've previously discussed the vacancy of our GSA tenant located in plantation, Florida and has since signed a new lease this quarter for 70000 square feet with a 10 year term, which represents over 50% of the building activity within this market remains robust and we are in conversation.
With various tenants presenting a positive outlook for further leasing within the building.
In Sacramento, California.
Date of California will be vacating roughly 158000 square feet in November 2021.
Then in less than 1% of annualized revenue.
This class a building is located in Sacramento CBD is one block from the Golden One center the home of the Sacramento Kings and Entertainment District.
Building amenities and LEED platinum designation.
Make it an attractive destination for space not previously available in the market.
We have varying levels of activity for the building, including conversations with state agencies and private sector tenants.
As previously disclosed F. Five a tenant in Seattle, Washington, representing two 2% of annualized revenue will be vacating in 2022, and we have plans for our redevelopment of this campus, which I will highlight in a moment.
Turning to our development.
We continue to make steady progress on our redevelopment project at 20th Massachusetts Avenue in Washington, D. C and remain on track to deliver in Q1 2023. The development is currently 54% pre leased and we have varying levels of early stage interest from a variety of tenants, including technology consulting services.
<unk> and related users and look forward to providing updates in future quarters.
We are also advancing plans to redevelop our property at Elliott Avenue in Seattle, Washington that is currently leased to F. Five through July of 2022.
Our plan for this 300000 square foot campus is to convert two of the three buildings to life science, while maintaining an office use for the third building the.
The greater Seattle market continues to decline the ranking as a premier life science cluster given us access to venture capital funding major universities access to an educated talent pool combined with its existing tech presence.
Rental rates for life science users have increased more than 15% year over year and current demand continues to outpace supply in the market.
We feel we are well positioned to deliver a premier class a development offering an extensive amenities package campus connectivity with an outdoor experience and both lead and footwall certifications.
Our current schedule includes commencement of construction in 2022 with a planned delivery in early 2023 total construction and leasing costs are expected to be close to $140 million generating a stabilized return on costs of 10% to 12%.
Currently we are in advanced stages of negotiations with tenants representing close to 60000 square feet, a solid start towards advancing the development.
Turning to operations, we are proud of the progress we continue to make enhancing <unk> energy and sustainability program and remain fully committed to elevating our ESG profile in 2021, our real time energy monitoring program has yielded close to $1 $7 million and year to date cost savings.
We're on track to end the year with approximately $5 7 million square feet of LEED certified buildings and increase of 125 million square feet and plans continued toward advancement of these initiatives into 2022, along with the introduction of new program, such as fit while strategies across the portfolio.
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 third quarter was $59 6 million or $1 24 per share, which beat consensus and exceeded our guidance.
For the third quarter was $30 9 million or.
Or <unk> 64 per share, resulting in a rolling four quarter <unk> payout ratio of 69%.
G&A expense for the third quarter was $448000, which includes the reversal of $6 6 million of previously accrued estimated business management incentive fees.
This reversal represents the amount that the estimated incentive fees as of June 30 exceeded the amount estimated as of September 30th excluding this reversal of fees G&A expense was $7 1 million <unk>.
Consistent with the same period last year and the prior quarter.
The incentive fee accrued is based on Opi's total return in comparison to the index over the three year measurement period.
<unk> outperformed the index by three 8% with a total return of 18, 7%.
September 30th was the end of the measurement period, the incentive fee owed to RMR will be approximately $6 million.
The incentive fee accrual may increase or decrease over the remainder of the year, depending on how OPI performs relative to the index.
As a reminder, incentive fees 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 GAAP in the first second and third quarters. If applicable we do not include such expense and adjusted EBITDA are E or normalized <unk> until the fourth quarter when the final incentive fee amount is determined.
Interest expense for the third quarter was $26 9 million.
A decrease of $2 1 million from the prior quarter, primarily due to our accretive bond offerings in May and August and subsequent redemption of higher interest rate debt in September we issued $400 million of 345% 10 year bonds and use the proceeds to repay all amounts outstanding on our revolving credit facility.
We expect interest expense to be between 27% and $28 million during the fourth quarter.
These debt refinancing activities have strengthened our balance sheet increased the weighted average remaining term of our debt to approximately six years and reduced our weighted average cost of fixed rate debt in aggregate. These 2021 opportunistic offerings raising over $1 billion in proceeds will result in net interest expense savings of five.
$5 million annually.
We ended the quarter with more than $800 million of total liquidity, including full availability on our $750 million revolving credit facility.
We expect fourth quarter normalized <unk> to be between $1 17, and $1 19 per share excluding incentive fees that impact normalized <unk> in the fourth quarter and $1 five to $1 seven per share, including our current estimate of incentive fees of $6 million, which represents <unk> 12 per share.
Turning to property level results for the quarter same property cash basis, NOI increased 1% compared to the third quarter of 2020 and came in better than our guidance range of flat to down 2%. This increase.
This was primarily due to a decrease in operating expenses of $1 $1 million, mainly a decrease in real estate taxes. As a result of successful appeals and reductions in assessed value at certain of Opi's properties in 2021, as part of Rmr's abatement program and lower repairs and maintenance costs.
RMR managed real estate tax abatement program has saved OPI approximately $7 $5 million since the beginning of 2018.
We expect fourth quarter same property cash basis, NOI to be negative one to negative 3% as compared to the fourth quarter of 2020.
Turning to capital expenditures and the balance sheet, we spent $26 3 million on recurring capital and $13 $3 million on development capital during the third quarter. The main contributor of the development spend was from our 'twenty massive project that incurred $11 3 million in the quarter.
We expect recurring capital expenditures for the full year to be between 75% and $85 million.
At September 30, our leverage was seven three times, 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 various stages of disposition, including two vacant land parcels that were sold earlier this week for $28 5 million.
Operator that concludes our prepared remarks, we're ready to open the call up for questions.
Thank you.
We will now begin the question and answer session.
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At this time, we will pause momentarily to assemble our roster.
And the first question comes from Bryan Maher with B Riley. Please go ahead.
Good morning, Chris and Matt a couple of questions for me.
Starting with a point of clarity on the plantation, Florida property I think you mentioned in your prepared comments that you released about half of the space 70000 square feet for 10 years was that back to GSA or is that to another tenant.
Yes to a private sector tenant Brian.
Okay. So as GSA still planning on vacating the whole building and do you have a date for that.
So they are and so I think right now we had originally talked about them vacating. The full building in December of this year. It looks like that's now trickling into early next year with them to vacate so that would leave approximately 65000 square feet that they would vacate.
Kind of when you net out the new lease we've done.
Okay, Great and then you talked a lot about.
You have $800 million of liquidity you want to keep an eye on your leverage which I think is at seven 3% in <unk>.
In conjunction with those two things what is your acquisition appetite going forward and I know to some extent it has to do with successfully closing on the 300 million of dispositions that you have in the pipeline, but can you give us some view as to what you expect over the next 234 quarters.
I wasn't when we can kind of talk Matt and I I would say you know, we're just coming off the two acquisitions, which we've discussed and certainly have kind of jumped into the deleveraging program supported by our capital recycling.
Note that we have the $300 million.
That we're currently focused on and kind of continue.
We want to continue to advance that going into next year as well and so that youll continue to see I think from an acquisition standpoint, we're always kind of looking in the market I think it's a little bit.
Kind of a more tamed today, just given that we don't necessarily have a fever of a pipeline of acquisition opportunities just because of where we're focused in kind of the markets, we want to be in and so.
I think it is going to be somewhat muted kind of in the near term versus kind of having a broader acquisition strategy.
Okay, and then you talked a little bit about.
Yeah, the explorations coming up and the potential for re leasing those and it seems like you're a bit ahead of the game approaching.
Approaching 2022, 23, and 24 do you have any thoughts on what we might see kind of in aggregate as far as rent roll ups or roll Downs go.
I mean from a rent roll off we're targeting the 5% to 7%. This year I think you know.
Our pipeline is showing good roll ups, but I think we're going to kind of have to wait until we get into next year to see how some of that shakes out I mean, there's still a lot of moving pieces with tenants getting back into the office and kind of finalizing decisions around space and some of that may impact the overall metrics downstream.
But I think for the most part we feel pretty good about where we're going to end the year and so far it looks like we're continuing down the path with Rollouts of these folks what our pipeline has currently.
Okay, and then just last for me as it relates to what we're hearing in the marketplace.
Regarding supply chain issues inflation costs et cetera is that impacting at all what your cost thoughts were for 'twenty mass app, which is underway.
Seattle, which youre going to embark upon next year and that's all for me.
So for.
For 'twenty mass Av I mean, we have.
Contingencies with the project no different in Seattle, and so I think we have where we feel like we have a pretty good cushion I think in some aspects there has been.
Some increase in pricing, but I think for the most part with 20th mast out we really went into that project.
Which we started earlier this year, so kind of in the midst of.
What was what were already seeing a kind of some of the logistics challenges and so I think for now we feel pretty good with where our budget is and how things are trending.
Including kind of the delivery timeframe and then it's the same thing with Seattle.
With us kind of moving forward on that project all our pricing has largely taken into consideration where things stand today, and what we foresee kind of in the.
Near term with respect to the actual schedule and so I think we feel pretty good today about where those costs are.
Yeah. Thank you.
Thank you.
As a reminder, if you have a question. Please press star then one can be joined into the queue.
And then wanted to be joined into the question queue.
Next question comes from Ronald Camden with Morgan Stanley. Please go ahead.
Hey, just a couple quick ones from me.
The first one was just I think I heard the.
Our same store NOI guidance for Q was I think you said down three to four apologies, if I've got that wrong, but.
Whats, causing the delta between <unk>, which I'm looking at plus one versus that down three to four is it all just known Vacates or is there something else that we should think about.
Ron This is Matt so the range that we provided was down 1% to down three it sounded like you may have heard three to four but just to confirm its down one to down three.
We are a little bit on the revenue side from the Vaca to the state of California that Chris commented on.
In the prepared remarks, that's about $400000 and then the rest is really on.
On the expense side, we are forecasting some snow removal.
And then increases in utilities and.
And cleaning from Q.
Q4 of 2020.
Got it helpful. And then just switching gears to sort of acquisitions and dispositions just on the acquisitions and the other acquisition in the quarter.
What's the plan there so it's almost 60% leased.
Just curious what what sort of the strategy there with that property.
Yeah. So this is Chris so.
That is really kind of a value add acquisition and really the plan. There is we actually own two other properties adjacent to that combined kind of control.
The full block and kind of given its location, we felt like that was a great opportunity to just be in a position for.
I guess continued growth downstream.
I think as we look at that location.
I think theres opportunity for potential redevelopment, but thats certainly not something in the near term so.
That really was the goal just to kind of control that asset adjacent to our other two properties.
Got it and then just on the disposition side.
Can you just maybe comment on who are who are the buyers.
What the market cycle.
Who's sort of looking at these properties.
And any any comments on pricing would also be helpful, whether it's cap rates or.
Youre seeing increased interests would be helpful. Thanks.
Yes, so I think from who the buyers are I mean, these given kind of the size of these assets a lot of these properties are kind of more local local regional groups.
Not necessarily institutional investors and so it really is a mix just kind of given the fact that.
These properties, it's not necessarily a portfolio, but theyre individual dispositions.
And so I think from kind of looking at.
The financial aspect I would say that you know from kind of a cap rate for these assets and at least what we've sold we're seeing kind of collective cap rates between 7% and 8% and that can kind of vary on one side or the other depending on the circumstances and I think it's just kind of.
According to note that these are buildings, we are selling as part of our capital recycling strategy because they are buildings that we feel like where we have either maximize value. These are buildings that are older in age capital intensive and in some cases kind of have short term Walt and so by way of example from what we've sold to date as I know.
The weighted average lease term was one two years and so as we look at this program. It really kind of complement the broader strategy with respect to kind of where we're acquiring properties at.
The cap rates, we've talked about historically and kind of when you look at NOI minus capital looking at that economic yield.
It turns out to be very accretive as a whole and then I think kind of a layer on the last pieces. When you kind of round out the capital recycling, where we're acquiring and then now looking at development and focusing on leasing of vacancy.
We feel pretty good about some of kind of the yield spreads that we're getting across the spectrum kind of what the overall plan for the company.
Helpful. Many thanks, that's all I got.
Okay.
This concludes our question and answer session I would like to turn the conference back over to Chris <unk>, President and Chief operating officer for closing remarks.
Thank you everybody, we look forward to talking to many of you at NAREIT and we'll be in touch.
The conference has now concluded. Thank you for attending today's presentation you may now disconnect.