Q4 2021 City Office REIT Inc Earnings Call
Good morning, Andrew.
And welcome to the City office REIT incorporated fourth quarter 2021 earnings Conference call.
At this time, all participants in a listen only mode.
A brief question and answer session will follow the formal presentation.
To ask a question press Star then one you touched on so if youre using a speakerphone. Please pick up your handset before pressing the keys.
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You require operator assistance. Please press Star then zero. It is now my pleasure to introduce you to Tony <unk>, The company's Chief Financial Officer, Treasurer, and corporate Secretary.
Mr. Meredith you may begin.
Good morning.
Before we begin I would like to direct you to our web site at C. I O Dot Com, where you can view, our fourth quarter earnings press release, and supplemental information package. The earnings release and supplemental package. Both include a reconciliation of non-GAAP measures that will be discussed today to their most directly.
<unk> 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, we can give no assurance that these expectations will be achieved.
Please see the forward looking statements disclaimer in our fourth quarter earnings press release, and the company's filings with the SEC for factors that could cause material differences between forward looking statements and actual results. The company undertakes no obligation to update any forward looking statements that may be made in the 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.
Before we touch on the quarter's results I want to step back for a moment.
Collect on the incredible transformational year that our company has experienced.
Despite the challenges associated with Covid, we have found ways to create value for our shareholders.
To that end I want to recognize and thank our team.
Their hard work persistence and thoughtful execution has generated outstanding results.
As a recap during 2020 , one we sold our Cherry Creek property in Denver during the first quarter and then our San Diego Life Science portfolio in the fourth quarter.
Combined these two dispositions generated our company a $477 million gain on sale equating to approximately $10.80 per fully diluted share.
From a return perspective, our shareholders, we're well rewarded the market value of our common equity more than doubled and city office achieved a 112% total return during 2021.
This ranked us as the top performing public office REIT and one of the best performing companies in the entire REIT universe for the year.
Moving to our results in the fourth quarter, we completed $1 $2 billion of acquisitions and dispositions.
When we started the month of December with the sale of our San Diego Life Science portfolio for $576 million.
In anticipation of the sale, we used the five months, leading up to the closing to build a pipeline of properties to enhance our portfolio.
Following the sale, we efficiently completed three sequential acquisitions totaling $614 million.
These purchases are located in Phoenix, Dallas and Raleigh.
Each of these properties is exactly the type of asset that has the highest appeal to tenants and employees today.
Each property features a superb location new construction best in class amenities and modern tenant spaces.
There is an acquisition presentation for each of these on our website that conveys the quality of these properties.
The first action acquisition to close was blocked twenty-three in downtown Phoenix for $150 million.
<unk> 23, as a premier office building delivered in 2019.
It features an unmatched onsite amenity package. It has an incredible rooftop deck at a wide variety of nearby restaurants bar.
Lars and entertainment options.
307000 square foot property was 94% leased at close including signed leases that have not yet commenced with a 12 year weighted average lease term remaining.
Next we closed the terraces in the Preston Center Submarket of Dallas for $134 million.
Preston Center is a very special and high barrier to entry location.
The Submarket is surrounded by some of the wealthiest residential neighborhoods in all of Texas.
Proximity to these decision makers homes provides a competitive advantage and Lisa.
The terrorists as is the newest building in a submarket and is walkability to surrounding amenities.
The 173000 square foot property was 99% leased at close including signed leases that have not yet commenced with a weighted average lease term remaining of approximately eight years.
Last we finished the year by purchasing bloc eighty-three in Raleigh for $330 million.
Raleigh is a vibrant market add to our portfolio.
He possesses very similar characteristics to many of our other high growth cities in the south and west.
The transaction provided a great opportunity to enter Raleigh with immediate scale and one of the best assets in the entire market.
The Raleigh Metro area has experienced a 22% increase in population between 2010 and 2020 <unk>.
Ranking it as one of the fastest growing population centers in the U S.
Rallies also experienced strong GDP increases propelled by tremendous growth in the stem and a life science industries.
The research triangle with its multiple world class universities is a deep source of talent and innovation.
We believe these attributes will continue to make it a great city for future corporate expansion.
Our acquisition block 83 is a spectacular two building complex comprised of approximately 495000 square feet of office and street level retail.
The property is located in the preeminent live work play district of Glenwood cell in downtown Raleigh.
It's a unique location with walkability to restaurants bars, and coffee shops, and ample nearby quality housing options.
The newbuild construction and top of the line on site amenities have led to a rapid lease up a block 83.
The first of the two buildings was delivered in 2019 and is now 97% leased.
The second building delivered in 2021 and is tracking well for stabilization.
The building was 30% pre leased and has achieved an additional 100000 square feet of leasing during 2021.
We expect to make significant progress on the remaining 96000 square feet of vacancy this year.
Note that for each of these acquisitions I described the percentage leased which includes signed leases that will take occupancy in the future.
The property overview section of our financial supplement provides the percent occupied at December 31, which will be lower until these signed leases commence.
In summary, the fourth quarter was extremely busy with capital recycling activities.
Because of the scale of the net proceeds from the San Diego disposition, which equated to a roughly 2% trailing cap rate, including the land we were able to purchase these best in class properties and improve our earnings outlook at the same time.
The midpoint of our new 2022 core <unk> per share guidance is 16% higher than the core <unk> per share that we achieved in 2021.
Notably, we're generating this increase with lower leverage and we're positioned for growth as we lease our remaining vacancies and the signed leases commence.
It is also worth noting that these transactions allowed us to increase our dividend by 33, and a 3rd% in the fourth quarter.
Overtime, we will continue to evaluate further increases as our portfolio supports higher dividend levels.
With that I'll shift to discussing our focus for 2022 wouldn't be odd.
The main priority is to accelerate leasing and future cash flow growth across our portfolio.
As we've discussed in the past, we have and will continue to invest in our properties and our available inventory.
In addition over the next few years as opportunities arise, we intend to focus on capital recycling to further elevate the quality of our portfolio.
In terms of leasing velocity in our markets generally omicron caused office usage to take a step back over the last few months.
This appears to be changing now that we've passed the peak of new AUM of Crown cases, and we've been pleased by the improvement in new leasing prospects and tour activity in many markets.
However at the same time, we are seeing some tenants rethink their overall space needs for the near term, we continue to anticipate elevated downsizing and vacates, which we factored into our guidance.
Further we believe that tenants in today's marketplace want high quality properties with modern spaces to enhance the appeal of returning to the office.
They desire spaces that can be occupied with speed and minimal risk from potential delays in sourcing materials or construction labor.
Responding to this opportunity continues to be a focus for our team and we anticipate further investment in our portfolio. This year. We believe these investments will accelerate long term cash flow growth and the speed of new leasing.
As we look ahead, we continue to believe that our thesis of investing in great cities in the south and west will yield attractive results for our shareholders. We look forward to updating you throughout the year on our progress.
Now I'll turn the call over to Tony Marotic to discuss our fourth quarter results and our 2022 outlook in detail.
Thanks, Jamie.
Our net operating income in the fourth quarter was $25 1 million, which was $4 6 million lower than the amount reported in the third quarter.
This is primarily a result of the termination fees that were recorded in the prior quarter for BB&T at Park tower in Tampa.
We reported core <unk> of $15 8 million or 36 cents per share, which was $1 6 million higher than in the third quarter.
<unk> was higher despite lower net operating income due to lower general and administrative expenses.
G&A decreased due to a reallocation of the special employee incentive that was accrued for the life science portfolio sale.
During the third quarter 5 million was accrued in the fourth quarter, we reversed and reallocated $1 5 million of this amount from a cash payment that impacts G&A in 2021 to a grant of restricted stock units that will instead amortize over the next three years as the best.
<unk>.
Our fourth quarter, <unk> was $7 7 million or 17 cents per share the largest impact to episode was $1 4 million of tenant improvement costs incurred at our Carolyn point property in Tampa. This amount was for a 93000 square foot tenant that signed an eight year lease extension and expansion.
Pension in January 2021, we.
We also incurred approximately $600000 during the quarter to build ready to lease spec suites and implement vacancy conditioning, which is a key part of our 2022 business plan as Jamie mentioned.
We announced in December an increase of our quarterly dividend from <unk> 15 per share to <unk> 20 per share on a long term basis, we believe our dividend will be well covered but our <unk> numbers will continue to move around some from quarter to quarter in periods with large leasing investments our capital expenditures.
Our fourth quarter same store cash NOI change was negative 0.5% as compared to the fourth quarter of 2020.
But ended the full year 2021 at positive two 2%.
Fourth quarter same store cash NOI was impacted by lower occupancy year over year contributing to that decrease in occupancy BB&T vacated their space at park tower during the third quarter to accommodate the new 73000 square foot tenant whose lease commences on may 1st 2022, but will not begin.
Cash rent until February 2023.
That new tenants eight year lease increased the value of the property, but the downtime and free rent period is a significant contributor to our negative Q4 same store results as well as our 2022 same store cash NOI guidance.
Our total debt at December 31 was $654 million or net debt, including restricted cash to EBITDA was a healthy five nine times during the quarter, we renewed and expanded our unsecured credit facility.
Our revolving credit facility availability has been increased from $250 million to $300 million with a maturity at the end of 2025 and a one year extension option.
We have no debt maturities in 2022, and two small maturities in 2023.
Last we have provided full year 2022 guidance in our press release, we are projecting core <unk> of $1 56 to $1 60 per share, which at the midpoint is a 16% increase over our 2021 results.
This is the highest in our corporate history and can be achieved utilizing substantially lower leverage.
For dispositions, we have indicated a range of zero to $44 million as a tenant at our Lake Vista Pointe property in Dallas has a purchase option that expires on July 31.
We believe there was a significant likelihood that the tenant will purchase the property.
Despite some of our acquisitions lowering our overall occupancy at the end of 'twenty 'twenty. One we expect occupancy will slowly rise throughout the year as signed leases and these newly built properties take occupancy.
We expect that our same store cash NOI will be negative in 2022 due to several anticipated move outs in free rent periods in 2022.
We expect it will rebound in 2023, all else equal as new acquisitions are added to the same store pool and certain free rent periods burn off.
We also anticipate significant tenant and capital improvement costs in 2022, as we expect to invest approximately $5 million in building out high quality spec suites to accelerate leasing we further intend to make a similar investment to upgrade lobbies and amenities at a select number of properties.
We also intend to incur approximately $5 million prior to any Ti and leasing commission costs to reposition and enhance the ingenuity drive property within our Florida Research Park portfolio in Orlando and one of the two buildings that are Santana property in Phoenix.
A good way to think about this investment in spec suites and repositioning is to view it as a pre funding tenant improvement costs. When leases are signed in those spaces. The ti cost at that time will be reduced and a tenant may commenced occupancy and pay rents sooner than it would otherwise be able to do.
While we expect this will lower 2022 F O. As these expenses are incurred the costs will normalize as leases are complete. We believe this is the best way to position, our vacant inventory and accelerate future leasing activity. We refer you to the material assumptions and considerations set forth in our earnings release for further details that can.
Our prepared remarks, we will open up a life for questions operator.
We will now begin the question and answer session to.
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At this time, we will pause momentarily to assemble our roster.
Our first question comes from Rob Stevenson with Janney You May now go ahead.
Good morning, guys, Tony given your comments on the spec suites, the lobby and the repositioning.
How should we be thinking about those three lines in your F. O numbers you guys gave guidance on a straight line, but in 2021 if I if I'm doing my math correctly your tenant improvements leasing commissions and Capex combined were a little over 23 million.
Are we anticipating that it's going to be you know into the you know mid thirties in 2022 with with those programs in place Howard is that stuff running through a F O or is this stuff being capitalized how should we be thinking about some of this stuff from a financial standpoint.
Yeah. That's a good question, Rob So as I said in the call a couple of items. There you know you have about $5 million for the spec suite program, which will run through a F. O. Yes that is higher than we than we've historically run hum by about a couple of million for sure. Similarly, we I say, they're roughly equal.
The amount that we're planning to do on the Capex programs to really enhance the amenities and lobbies or whatnot and that similar amount about 5 million again, that's it's elevated over over prior years. So combined the numbers are roughly an extra $5 million or what run rate would be and then in terms of the repositioning we will be.
Treating those two acquisition those two properties will be will be removed from <unk>. You know, we're taking to effectively single tenant properties are monetizing them, improving the lobbies and turn them into multi tenanted properties and so as a result, they wont run through <unk>. So you can expect.
Probably net net an additional call it in the neighborhood of $5 million are higher costs from those categories.
That's helpful.
Figure out.
Uh huh.
2022.
Another question.
Based off of what Youre seeing from a leasing perspective, how should we be thinking about the economic occupancy of the two block acquisitions that are still in lease up throughout the year is do we get to a point, where they're you know from an economic occupancy.
[noise] endpoint that they've got people paying for the vast majority of the space by yearend is that more of a 2023.
Thank you at this point.
For 2020.
Two lease up there.
Yeah. Thanks for the question Rob. So block 23 is in fact about 94% leased currently so leases have been signed they haven't commenced in some cases and so in the way we structured the deal is we were basically paid some bridge rent, but that doesn't flow through into our income statement. So effective.
Really that one has already stabilized by the end of the year occupancy will will match kind of where the leasing is in terms of block 83, the bigger block in Raleigh.
That one has call it just under 100000 feet of vacancy and that's where we're focused and so we've got some very good activity on that where we're actually very pleased.
With how some lease discussions have moved along and so we think we're going to make substantial headway to stabilize that by the end of the year.
Okay.
And then beyond the purchase option assets. How are you guys thinking about dispositions you know this year and going forward I mean, you've got basically.
Two parts of the portfolio right is that you've got the legacy portfolio that you guys acquired it you know plus or minus a seven cap ish right and then you've got the more recent acquisitions that have been on a much much lower cap rate do you guys continue to whittle down and us recycle some of the the.
Higher cap rate assets into lower was that just the redeployment of Sorrento Mesa. How are you guys thinking about acquisitions and capital recycling you know as we.
2022 2023.
So you'll see in our guidance, we haven't assumed any net new acquisitions. This year that could change based on recycling. So we are constantly looking at our portfolio and if you were to step back for a second and say you know how do you feel about the categorization of the assets you have.
I'd say, 60% of the value of our assets are phenomenally positioned a 30% are well positioned you know they aren't the class double a but they are well positioned great markets, great tendency, we might put a little bit of capital into some of the spec suites and those to really drive and then you've got about 10% of our port.
Palio, where you know some of the the larger back office type properties and those are the ones today that are harder to lease and there's more competition and so we haven't made any conclusions I mean, we're focused on trying to position. Those so that we can drive as much cash flow out of those as we can.
And create value in some of those might be recycled and others I think we'll reposition and shifted up to a higher category and so that'll play out over probably the next 24 months and so we're not really concluded on any particular strategy with that aspect of the portfolio, but where we're playing out all of our options right now.
Okay, and then last one for me, Tony any incremental known move outs of size.
That you guys have.
Come to terms with over the last couple of months since the last earnings call.
In terms of new I don't think Theres, new but I can recap some of the larger ones that we know well and so we do have a 46000 square foot tenant at FRP ingenuity drive that is vacating that vacated in January .
We have a 31000 square foot tenant at our Pima Center in Phoenix that is a known move out at the end of Q1.
And then.
Beyond that.
It's just the Toyota lease, which we've talked about before in Q3 of 2022, so nothing new.
Okay. Thanks, guys appreciate the time.
Thanks, Rob.
Yeah.
Our next question comes from Michael Carroll with RBC capital markets. You May now go ahead.
Yeah. Thanks, Jamie in your prepared remarks, you kind of highlighted that in this current office environment that you're expecting and elevated level of downsizing and Vacates. I mean can you provide some color on what youre seeing and is that kind of got reflected in your guidance and in your 2022, our exploration schedule.
So it has been reflected in how we projected for the year, Mike and so as we look forward historically, you've always been in that 70%, 75% renewal I think if you look at 2021 were a little under that and then we might be a little bit under that for the balance of 2021, we're having good dialogue with.
A number of tenants that that have roll over the next call. It 12 to 18 months, but there might be some downsizing there. So a lot of it is really going to depend on these.
These tenants coming back in and starting to really utilize their space and right now utilization is low across the industry right. It's more like 30% and so it's not an easy time to predict exactly what's going to happen with tenants needs. His role occurs and so we're taking a bit more of a conservative view.
Okay. There are tenants when their leases come due or I mean are they looking more active of trying to reinvest in their space like change their footprint around are they asking for more T is or is it too early to tell.
It's a mixture it really depends on the condition of the existing space, but for some of the larger back office users yeah, they're trying to get their arms around what they need and how they want that space to be laid out and so T is you're probably going to be a little bit higher going forward.
Okay.
And then just going back to your your investment strategy that you're kind of highlighting earlier. So should we assume that if you do a new acquisition that is going to be funded through capital recycling is that kind of a good way to think about it.
Probably a good way to think about it and so with our guidance. We have said no zero at this time on new acquisitions for the year that could change depending if we decided to monetize some additional assets.
And is there any unique within potential capital recycling within land parcels or or or a higher better use within the portfolio kind of like the life science deals or anything like that still in the portfolio.
Yeah, there's nothing really imminent like that Mike I'd say, the one thing that's worthy of commenting on and particularly as you look to get your arms around our tenants thinking about coming back to the office and what their own thoughts are if you look at our single tenant that we have at our Lake Vista property and we mentioned in the past.
They have a purchase option and we put that in in the book ends of a disposition guidance of $44 million our own best thought today is they're likely going to purchase that building and when you step back and say, okay, they're not utilizing the building at all today, yes, they're going to make a substantial investment to buy it.
That's the sort of conversation, we're hearing quite often in the market tenants want to get their employees back to the office and so we've made some some general comments here about being conservative, but we are feeling incrementally more optimistic that that's going to happen.
So that'll be one property to your point that I think theres, a real likelihood that gets sold recycled we'll decide what we're going to do with those proceeds there's a number of different.
Considerations on the table right now and we'll firm that up as the year evolves.
Okay, Great and then just last one for me I guess.
Tony could you talk a little bit about the the G&A increase I believe you said you've kind of mentioned this in your prepared remarks, but what's the reasoning for the such the large uptick that we're expecting in 2022.
So you know what one component of that is the is the $1 5 million of of Rs use that were issued in January that vest over three years. So you have another half a million from that component alone and then the rest of the increases in G&A.
It is really you know we're seeing it a little bit from our professional service providers. You know are costs going up there are we are expecting to incur more travel than we have over the last couple of years, there's a little bit increases across the other components combined with the higher stock compensation expense.
Okay, great. Thank you.
Thanks, Mike.
Okay.
Our next question comes from Craig Kucera with B Riley FBR you May now go ahead.
Yeah. Thanks, Good morning, guys. If if the option at Lake Vista is executed.
Would you anticipate using those proceeds to pay down debt or would you look at other alternatives with those proceeds.
So all options are on the table they could be recycled into another acquisition could be used to lower leverage could be used to.
Retired the preferred as well so we're considering all options right now.
Got it.
And Ah Tony and in the guidance there is mention of a million dollars.
Lease termination income is that just the remainder of the Toyota motor Credit's being amortized or is that based on conversations you've had with another tenant who's maybe looking to exit early in 'twenty two.
Yeah. So the termination Theres a total of actually three tenants Toyota is the largest representing nearly two third or just over two thirds of the amount and then two other smaller tenants that were amortizing for.
Including a tenant that gave us an Ah Ah one option at our circle point property.
No superior point part of the superior part thank you.
Okay.
That's helpful and which I may have missed this but and your <unk>.
Since you mentioned their words.
One lease signed with a lot of free rent, which which building was that did you and I could read it but did you mention that.
So in terms of looking at our same store for four for next year the largest is related to the.
Fin Tech tenant that we signed at park tower in Tampa to replace BB&T. Their lease starts may 1st they've actually grown from the initial lease they signed to now 70 79000 square feet and they don't actually start paying cash rents until February of 2023.
Perfect Alright, thanks, that's it for me.
Thanks, Greg.
Our next question comes from Barry, Oxford with Corners, you May now go ahead.
Great. Thanks, guys.
Real quick on the Raleigh acquisition, what was that pricing to the extent that you can talk about it because.
I guess it is a very dynamic market that a lot of people want to get get into so just kind of trying to get a feel for pricing.
Sure Nice to hear from you again, Barry as well so yes that was $330 million $667 a foot a cap rate was lower right based on where occupancy was.
It was a closing in and that stabilizes in the in the low fives with our numbers and based on everything we're seeing on lease activity and what's happening there.
We're feeling good about that and we think that's going to be a nice.
Cash flowing asset over the long term and there is a.
Two buildings in the portfolio, there's another piece of ground that's adjacent to it.
The original developers may build into kind of the third building in the portfolio and we have structured ourselves that we can participate in that.
If we'd like to and we think that that economics, there could be extremely attractive coming in on the development side and so over the next call it year or so we will send out whether we want to kind of enhance our overall returns by participating in that part as well.
Yeah, Jimmy sure any near term mark to market.
In there in Raleigh, they're all brand new long term leases. So they have nice step, okay, where we're really going to get the cash flow pick up areas by leasing the vacancy and when you tour. The asset is spectacular the amenities are spectacular we feel really good and I think the upside also is we've already moved rents are.
Above.
Where we had underwritten them and so that market continues to really strengthen and I think we're going to do really well on where we settle out on the the rental rates on the remaining space.
Great. Thanks, guys.
Our pleasure.
As there are no additional questions. So I'll now turn the call back over to Mr. Jamie Farrar to conclude.
Thank you for joining today, please don't hesitate to reach out if you have any other questions goodbye.
Thank you for joining.
This conference has now concluded you may now disconnect. Thank you.