Q3 2021 City Office REIT Inc Earnings Call
Okay.
Good morning, and welcome to the City office REIT incorporated third quarter 'twenty, One earnings conference call. At this time, all participants are in listen only mode.
A brief question and answer session will follow the formal presentation.
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It is now my pleasure to introduce you to Tony robotic 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 web site at C. I O REIT Dot Com, where you can view, our third quarter earnings press release, and supplemental information package. The earnings release and supplemental package. Both include a reconciliation of non-GAAP measures that will be discussed today to their most.
Directly comparable GAAP financial measures certain statements made today that 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 you can give no assurance that these expectations will be achieved please see the forward looking statements disclaimer in our third quarter earnings press release, and the company's filings with the 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 that we made.
And of course of this call.
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 sensor.
Since our last earnings call, we've announced transactions that have completely repositioned our company.
Year to date through the end of the third quarter the market value of our common stock has nearly doubled and shareholders have experienced a 91% total return.
This makes city office, a top five performer among all property rates year to date.
These results are largely attributable to the tremendous value creation at our Sorrento Mesa property in San Diego.
As we announced we are under contract to sell all of our life science assets in San Diego for a gross sale price of $576 million.
The sale translates to a staggering gain on sale of approximately $430 million or almost $10 a share.
The sale was structured pursuant to two transactions of $395 million first closing scheduled for December 2021 and.
And a 181 million second closing scheduled for early 2023 with an acceleration option.
Based on our confidence in redeploying the sale proceeds we've accelerated the second closing date to December 2021 as well.
Our belief is that the best place to reinvest this capital is in the top submarkets of high growth cities across the south and west when we entered into the Sorrento Mesa sale, we set a goal to use these proceeds to strategically enhance our portfolio across exceptional locations.
As we consider acquisition prospects, we've been targeting newly built properties with vibrant amenities and superior tenant build outs.
Well the cap rates for this asset profile are lower than our historical average buying these types of properties will enhance our company's future cash flow stability and add long in place leases and quality tests.
We believe premier properties like these are positioned for continued healthy rental rate growth and will thrive over the long term.
I'm pleased to report that we've made great progress building, our pipeline with exactly the sort of transaction.
We've been very busy since August and have underwritten over $2 billion of potential acquisitions.
We're focused on all of our existing cities as well as markets with similar growth and demographic characteristics in the south and west.
Today, we are advancing just over $600 million of potential acquisitions that fit our criteria perfectly.
These acquisitions are still in the due diligence phase, but we are very excited about their prospects.
If we choose to proceed after completing our due diligence we will provide further details in the months ahead.
Turning to the operating environment.
Executing new and renewal lease transactions continues to be impacted by low tenant space utilization across the industry.
The good news is that our properties are located in exciting and growing cities that are positioned well for a strong pickup in demand over time.
Across our portfolio leasing tour activity continues to improve.
This is translated into more lease inquiries and discussions with prospective parents. However, it continues to take longer to finalize leases in today's environment.
This applies to both new leases as well as renewal discussions.
The overriding comment we continue to hear from tenants is that they want employees back to the office, but likely this will be at least initially on a hybrid basis for many companies.
With potentially changing needs in my tennis had been challenged determining how their offices should be configured many real estate decision makers have therefore been hesitant to commit long term with this uncertainty remaining.
We believe this dynamic will continue to improve as we head into 2022 and more people return to the office.
At the same time, we continue to hear how tenants want modern dynamic space and highly of monetized locations.
Employers view this type of high quality office space as a draw to help accelerate a return to the office.
This is why we're targeting premier properties in our acquisition pipeline and its also shaping our own strategy to accelerate leasing across our portfolio.
In our experience we've found it very strong demand for modern prebuilt and move in ready spec suites.
This strategy speeds up the decision, making process and allows us to better control costs.
Learning from this.
Over the next year, we plan to invest in our existing properties through our spec suite program commentary upgrades and repositioning select buildings.
We achieved tremendous leasing success with this approach in the past and believe now is the time to position our portfolio to win greater market share.
This will differentiate our properties for many of our local competitors, who are not actively reinvesting.
We'll discuss this further in the future as we execute these plants.
Tony will provide further details on our recent leasing activity in a moment, but I want to conclude by saying that driving leasing success is one of our top priorities as we enter 2022.
We believe our quality portfolio, along with some strategic enhancements will position us favorably and for cash flow growth.
We expect a very busy and exciting remainder of the year and I look forward to providing you further updates on our progress with that I'll turn the call over to Tony.
Thanks Jami.
Our net operating income in the third quarter was $29 7 million, which was $3 9 million higher than the $25 8 million, we reported last quarter.
The increase was primarily a result of termination fees, which were $4 5 million higher than the prior quarter.
In total we recorded $6 million of termination fees in the third quarter. The largest contribution was $5 3 million from BB&T at Park tower, which we reported on last quarter.
This represents the full amortization as a tenant vacated the property at the end of the third quarter.
We reported core <unk> of $14 1 million or 32 cents per share, which was $1 2 million lower than the previous quarter.
The higher termination fee income was offset by higher general and administrative expenses.
The G&A increase reflected a one time 5 million dollar employee incentive compensation accruals as a result of the extraordinary $430 million gain that Jamie discussed earlier.
Our third quarter, <unk> was $8 5 million or <unk> 19 per share.
The largest impact of F O with a leasing commission paid at our Sorrento Mesa property of $1 5 million related to a 69000 square foot 12 year lease renewal signed prior to the execution of the sale contracts and therefore contribute to the value creation on that transaction.
We also signed two other significant leases during the quarter, we signed a 72000 square foot three year renewal at our <unk> property in Portland.
We have referenced this lease on previous earnings calls as one of our larger near term Expiries and are pleased that we were able to come to terms.
In addition, we signed a 41000 square foot tenant to a five year renewal at our Papago Tech property in Phoenix. These two leases significantly stabilize the portfolio.
Our third quarter same store cash NOI growth was a positive one 4% as compared to the third quarter last year.
The leases, we signed in 2020, particularly those at our Denver Tech property and our life Sciences portfolio are the biggest drivers to these results with the pending sale of our Sorrento Mesa portfolio and the previously announced departures relating to a few tenant terminations. We are projecting lower same store results over the next few quarters.
Our total debt at September 30th with 603 million, our net debt, including restricted cash to EBITDA was a healthy six one times.
At quarter end, our total debt had a weighted average maturity.
Four years, and 86% of our debt was effectively fixed our.
Our weighted average interest rate is now at three 6% and we have no property debt maturities until 2023.
Our only maturity in 2022 was with respect to our unsecured credit facility. We do have a one year term extension right, but we are making good progress on renewal discussions and expect to renew prior to the initial term expiring.
Last we have provided updated guidance in our press release, the only change to reflect the one time 5 million general and administrative expense accrual that I mentioned earlier, which had also impacts <unk>.
We refer you to our material assumptions and considerations set forth in our earnings release.
That concludes our prepared remarks, we will 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 one on your telephone Touchtone phone.
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Yeah.
Our first question comes from Jason Idaho on with RBC Capital markets. You May go ahead.
Hey, good morning, guys a question on redeploying the Sorrento Mesa sale proceeds.
How many transactions are you expecting to close before those proceeds are redeployed.
Thanks, Jason So as I mentioned in my prepared remarks, Yeah, we're looking north of 600 million that represents three transactions.
And all of them right now are under due diligence.
And how should we think about acquisition cap rates for Prime office assets.
So when you look at kind of the quality of the properties that we're looking at Jason just to give you. Some some kind of guidance overall, you're thinking top submarkets irreplaceable locations, new construction high quality amenities long leases in place.
Perfect predictable long term assets for growing cash flow and so when you look at cap rates in.
The markets today, you know think probably around a five cap.
Okay, and then last one for me. So you guys got Amber Glenn resigned.
The last remaining exploration in 2021 is the cap one lease which I think was a partial refund I guess, what's the plan with that asset and then could you also provide an update on I guess.
Fan-tan and Piedmont in 2022, and then any large lease rolls in 'twenty three.
Yeah. Good morning, Jason It's Tony here. So you basically hit all the all the large kind of role we have as you as you talk about you know for research Park, where you are getting that 46000 square foot space.
Space back at the end of the year you know that building currently is really a triple net single tenant building and so we are have plans drawn up to convert that to a multi tenant building and really enhance some.
Some of the amenities and common areas, and and and and and whatnot for that space. So we are we expect or hopeful to kind of lease that up later in 2022 at this stage.
And in terms of the other roles that you talked about.
Santana the Toyota space, we're getting that back at the end of August of next year that is the largest space that we're getting back over the next four quarters and really beyond those two there really is only one other lease over the next four quarters that is greater than 30000 square feet and that is at our floor.
<unk> Research Park, we have a GSA tenant rolling in Q2 that has been there for a very long time and discussions are preliminary but we are optimistic on our renewal for that tenant and those are the only three for the next four quarters.
Okay. Thanks.
Thanks, Jason.
Our next question comes from Rob Stevenson with Janney.
Go ahead.
Good morning, guys Jamie.
Jamie how did the <unk>.
Acceleration clause work was it an all or nothing for December 'twenty 'twenty. One could you have accelerated the second tranche into February or March or June of 'twenty 'twenty. Two if you wanted to how much flexibility did you have there.
So the northern properties, where hard coded for December 2nd and the southern which is the 181, we have the ability to accelerate on 45 days notice and looking at our pipeline and timing Robyn wanting to make sure we lined everything up for a proper 10 31, we decided to bring it into this year, but we have flexibility around that.
Okay, just wanted to figure out like I assume then that you know its pretty confident that you'll be under contract at some point in the not too distant future on some of these acquisitions at least.
In order to have you're pulling that forward at this point and not pushing it to February or March or whatever to buy yourself a little bit more time. So that was the reason why I'm asking that.
So I feel very good Rob Okay, and then Tony. So you guys are 88, seven occupied but 91, one committed and occupied as of September how should we be thinking about the committed and occupied number at year end with what you guys have in.
Your leasing pipeline at this point I mean, the 88 seven is basically at the top end of your year end occupancy guidance range is committed and occupied at year end likely to be in that sort of a similar sort of 91% you've got a bunch of stuff sitting on yours and Jamie's death.
The sign that would push you guys higher than that from a committed unoccupied standpoint, how should we be thinking about that at year end.
Yeah. So good question, if we talk about that the difference between occupied and the committed the single largest committed.
Lease that we have that's in those numbers is the fintech a tenant at park tower. They are expected to take occupancy in may.
And so that's the single largest item so that item alone will not go into the occupied column at December 31st that will remain in the committed column beyond that so I would say at this point.
Beyond the the kind of the known move outs that I talked about earlier, we're really not expecting a significant change in either of those numbers as we roll into December 31st.
Okay.
And then last one for me is you guys are talking to.
Both of the tenants that you guys have signed over the last couple of quarters as well as the people you are in contracts or contact with now four renewals and.
And new space, how would you characterize where the demands are in terms of tenant improvements and other sort of cost leasing costs today versus where it would've been on that similar space pre COVID-19 is there a noticeable sort of demand you know I'll take the space, but I want either.
You know this much more free rent or this much more tenant improvements to build out my space is that coming to fruition at this point or is that not really what you're seeing these days you know today, you know call. It November.
2021 versus November 19.
So good questions there Rob so again, if you could kind of step back and say, what's happening you're seeing rents really hold in there.
Are you seeing concession costs higher and that's been driven if you look.
As far as what's been happening in the markets you know early in the year across our cities anyways. There was about 6 million feet in Q1 of of negative absorption and that dropped to about two and a half million feet in Q2 of negative absorption. It's gotten better we're down now to about 1 million feet of negative absorption. So we feel like we are.
The bottom generally in the market things are getting better on our leasing front, but you know costs for sure are hired to build construction costs and we're finding what tenants want is you know more impactful space to users allure to drawback employees and so just generally as we've been having.
<unk> discussions they've been slower cost are a little elevated and that really has factored into your own plan of getting in front of it and putting some capital to work here to have really high quality spec suites, where we can spread the cost over a number of units try to keep it more efficient and give tenants.
Prospective tenants space, that's ready to go in and Theres not a lot to handle a boat or think about because it's plug and play and that's driving our strategy.
Okay. Thanks, guys I appreciate the time.
Our pleasure it's Rob.
Okay.
Our next question comes from Craig <unk> with B Riley FBR.
Go ahead.
Yeah, Hey, good morning, guys I'm looking beyond the lease terminations that are that you captured this quarter are you in discussion with any other existing tenants that are contemplating.
Maybe moving out early.
Hey, Craig its Tony here, we just kind of completed our kind of budget and our strategic review process as a part of that we actually went through.
All of the leases that had significant termination fee options.
Within their leases and really there's only a handful left to the ones that we've announced where we're by far the largest.
We could see another one and in early 'twenty, two but that's really down to you can count them on one hand in there and we're only expecting maybe one or two beyond that beyond that in terms of that.
Space dialogue.
Yeah.
There will always be the opportunity if we have another tenant that we want to push out as we've had to deal with that.
I'm thinking about the park tower, where we have a tenant until I mean, those discussions are always ongoing but nothing significant at this point.
Got it and and you know obviously you can't give too much color on what you're looking to acquire with the three transactions that at north of $600 million, but.
Given that you've had since August ER to kind of be working on this and building. Your pipeline. How are you thinking about how quickly you can deploy that capital that's coming in the door is that is that our first quarter 'twenty. Two event does that maybe take it to the middle of the year, just any thoughts there would be helpful.
Faster than that so are our own expectation again, if they come together is we're going to have a lot of closings in Q4.
Okay, great so more or less match funded then.
Correct.
And there wasn't a huge amount of a delta between what the cash you're getting in and maybe the number of transactions you're looking at but Tony are you thinking about plugging the gap with our line of credit are you thinking at all about mortgage finance or just sort of your thoughts on you know what you're thinking about leverage and in regard to those transactions.
Yeah. Good question, Craig So yeah, so Jamie mentioned that the transactions that we have or are just north of $600 million. The estimated proceeds from Sorrento Mesa is approximately $5 46. So there potentially is you know 50 ish million.
Two to finance and just given our line of credit today, we are at $250 million availability, we have $88 million drawn at September 30th So certainly a lot of room, there and as I mentioned in my remarks, we are talking about.
We're making good progress on our renewal on that line, where we potentially could have a little bit more availability. So that's the most likely outcome on the financing.
And are you thinking just bigger picture beyond maybe this for this first tranche of acquisitions.
Of levering up kind of what you're buying and buying even more just given the amount of money coming in the door are you thinking that this is what the balance sheet.
You know may effectively be looking like with an overall much lower leverage amount going forward.
Yes, so very good question and I think the best way to answer that question is just given where the.
The Delta in N O Y that'll be achieved once we complete these acquisitions there'll be excess cash flow that we will be generating over our dividend and as a result.
Lowly, reducing our overall leverage so I think over time there'll be an ability to.
Perhaps do more acquisitions or if we find something we're particularly excited about but in the short term I think that's what you will see the balance sheet at for a little while.
Okay. Thanks I appreciate it.
Thanks, Greg.
Okay.
Again, if you have a question. Please press Star then one our next question comes from Barry, Oxford with Colliers you May go ahead.
Great. Thanks, Jamie.
Jamie when you had mentioned doing some rehab work on some of your older buildings, what type of IRR can we expect from that and you know Jamie that you know of course as you know some people have already indicated on the call you've got labor cost.
Cost you got material cost is that going to eat into that IRR.
You know I guess, when you step back Barry and you've got vacant space, that's earning no return currently and you can put some capital in and turn that into probably very healthy rents and overall returns.
I don't have the IRR on that exact expenditure per se, but I just know from an overall cash flow and what it impacts on that particular building in each case, it's a meaningful pick up both cash flow and value creation at the property and so costs are rising we factored that in to that of our own.
<unk> planning here, we're trying to finalize our numbers, but we think we can accelerate leasing and generate a really good return on that capital.
Okay, perfect that makes sense thanks, guys.
Youre welcome.
Yeah.
As there are no additional questions I will turn the call back over to Mr. Farrar to conclude.
Thank you for joining today, please don't hesitate to reach out if you have any other questions goodbye.
Okay.
This concludes the call you may now disconnect. Thank you.