Q1 2022 City Office REIT Inc Earnings Call

Further modernize and update including renovating some of our older tenant suite inventory.

These properties are well located in great cities, and our past experience investing into the creation of desirable inventory gives us confidence with this strategy.

Completing attractive renovations, including enhancement of lobbies fitness facilities outdoor tenant spaces and environmentally sustainable property features is a great way to differentiate ourselves.

Within tenant suites, we've had success driving leasing by building, new and modern open spaces and in some cases installing furniture to make them move in ready.

With rising construction costs and elevated lead time for materials, making these investments upfront will help position us favorably.

Specifically in our portfolio, we are engaged in planning or implementing renovations at 190 office center in Dallas.

<unk> collection in Orlando, Pima Center, and Santana in Phoenix and City Center in Tampa.

We believe that the thoughtful execution of this strategy over the next 12 to 18 months will position. These properties for further leasing success cash flow growth and long term value creation.

Next I'd like to provide an update on our recent acquisitions in Raleigh, Phoenix and Dallas.

We have successfully integrated these properties into our portfolio and are thrilled with their position.

Block 83, our recently developed <unk> complex is 62% occupied and 81% leased including leases that are signed but have not yet taken occupancy.

In total we have 96000 square feet of quality vacant space remaining.

Today, we are in various stages of lease drafting with over 25000 square feet of potential new tenants with two of these being smaller retail tenants, which will enhance the overall experience at the property.

An important component of our acquisition strategy was to be very selective with the street level retail vacancies. This retail is a unique differentiator for our project that provides energy and excitement to the complex. We review each potential new retail tenant under the lens of ensuring it will enhance our overall project.

Beyond these leases we have over 50000 square feet of active prospects for the remaining space and expect we will convert this demand to further signed leases in the coming quarters.

At block <unk> three in Phoenix, 77000 square feet of new tenant leases have commenced since the end of last quarter, increasing occupancy from 62% to 87% at March 31.

Occupancy will increase to 94% by the end of the next quarter as signed leases take occupancy.

The new building, great location and unique amenity base continues to be a draw for leasing interest as we explore prospects for the remaining 17000 square feet vacant space.

And finally, the terrorists in Dallas is 96% occupied and 99% leased.

One other announcements this quarter is the pending sale of our latest point property in Dallas.

On our last call, we mentioned that tenant was likely to exercise its option to acquire the property.

During the first quarter this occurred and a purchase and sale agreement was finalized for $43 $8 million.

The sale price when adjusted for the amount that the tenants unspent Ti translates to a six 1% cash capitalization rate.

The sale is scheduled to close in mid June and is expected to generate a gain of approximately $22 million.

Upon closing, we will repay the mortgage on the property, which has a balance of $16 9 million as of quarter end.

The net proceeds from the sale will be held to either reinvest in a tax efficient exchange or potentially for other corporate uses which could include a combination of a special dividend distribution further debt reduction or stock buybacks.

Going forward, we will continue to actively evaluate other capital recycling opportunities. This has been a great strategy for us historically and over the last eight years, we've generated a remarkable $570 million of total games across 10 dispositions.

I look forward to providing further updates next quarter and we will turn the call over to Tony Werner Thanks, Jamie or.

Net operating income in the first quarter was $28 4 million, which was $3 $3 million higher than the amount reported in the fourth quarter of 2021.

This was primarily a result of the acquisitions completed in the fourth quarter of 2021.

We reported core <unk> of $17 6 million or <unk> 40 per share, which was $1 8 million higher than in the fourth quarter of 2021.

40, <unk> represents the highest core <unk> per share in the company's history and was driven by the sale of our life science portfolio in the fourth quarter and the recycling of that capital into the three acquisitions, we completed in December .

Our first quarter <unk> was $8 3 million or <unk> 19 per share.

The largest single item to impact <unk> was a $1 $2 million investment at a 190 office center property in Dallas to upgrade lobbies and common areas.

We also continued to invest in building out ready to lease spec suites and implementing vacancy conditioning, which is a key part of our 2022 business plan.

The total investment in spec suites in the first quarter was 800000 last we incurred 800000 of tenant improvement expenses related to the new 73000 square foot tenant at our park tower property, which is scheduled to take occupancy in Q2.

We expect to incur the bulk of the remaining $1 million of Ti for that tenant at park tower in the second quarter.

Our first quarter same store cash NOI change was in line with our expectations at negative four 7% or $1 million lower compared to first quarter of 2021.

First quarter same store cash NOI was impacted by lower occupancy year over year.

Distributing 500000 or half of that decrease BB&T vacated their space at park tower during the third quarter to accommodate a new 73000 square foot tenant that new tenants lease commences on may one 2022, but will not begin paying cash rent until February 2023.

That new tenant eight year lease increased the value of the property, but the downtime and free rent period, and a significant contributor to our negative Q1 same store results.

As Jamie mentioned, we have entered into an agreement to sell our Lake Vista Pointe property. According to the terms that were agreed when the tenant signed a lease renewal in 2020.

We expect the sale to close in mid June .

Under accounting rules ASC 840, <unk> for sales type leases, we have recorded a receivable on our balance sheet at March 31 to reflect all the future cash flows from the property until the expected June closing net of anticipated transaction costs that resulted in the gain on sale of $22 million being recur.

In our first quarter results.

Our total debt at March 31 was $662 million.

Our net debt, including restricted cash to EBITDA was a healthy six zero times.

We have no debt maturities in 2022, and two small maturities in the fall of 2023.

Our debt is primarily fixed rate.

Last we continue to track the 2022 guidance ranges, we issued last quarter. The expected loss of income from the sale of the 100% leased Lake Vista Pointe property would push us toward the lower end of the previously provided guidance ranges for occupancy net operating income and <unk> per.

Sure.

This impact could be offset in 2022 through the redeployment of sale proceeds we expect to provide an update to our guidance ranges next quarter. When we can provide more clarity as to how and when the proceeds from that sale will be used.

That concludes our prepared remarks, we will open up the line for questions operator.

Thank you if you would like to ask a question it stock for that by one and your telephone keypad and if you do change your mind on staff.

Our first question today comes from Rob Stevenson of Janney.

Your line is open. Please go ahead.

Hi, good morning, guys.

Tony.

Jamie given the comments in terms of the leases starting et cetera, and then what you know in terms of tenants vacating how are we expecting this to play out over the remainder of 2022 or the lease of the revenue coming in from the new leases that will start paying rents.

So if anything that vacates or are we likely ex the disposition to have a quarter where.

The Vacates are greater the loss revenue from the Vacates is greater than the new revenue from the new leases.

Hey, Rob its Tony here good morning.

I think the short answer is we're effectively.

We're expecting it to be flat. So a couple of things I wanted to point out one was on page 16 of our leasing activity schedule Youll see that the number of leases that are not commenced that are already signed and so we have approximately 330000 square feet of lease.

<unk> that are signed that will be taking occupancy with the bulk later this year and a big chunk happening in Q2, particularly with the recent acquisitions and then we have a number of.

I've known move outs later this year.

Really speaking briefly you mean, the largest being Toyota, which we've previously disclosed that the 133000 square feet.

That's the largest.

And then the other the second largest is.

During the quarter, we renewed a tenant at our Pima property on 36000 square feet, but they will be vacating 61000 of.

Their existing 97000 square feet. So we do have a couple of significant move outs that effectively offset the signed leases for the year.

Thank Rob what you're really getting at is.

The key thing to get your mind around is the trends and I think.

Theres been a real turn in our mind and worthy of spending a moment on so when you look where we were this time last year. There has been a quantum leap forward in many respects when you look at People's personal lives.

They have largely returned to normal airplanes or full vacation spots or pack concerts in bars or Jim the return to the office, though is lagging and slower and I think the good news for us.

And the message that we keep hearing from companies and our tenants as they want their people and a collaborative environment long term, but many of them have been hesitant to be kind of an outlier and push people back too quickly.

So what we've seen in whats picked up lately is.

Partial returned to work that's increasing the usage of our own space is picking up recently the GSA started to come back in a number of our larger tenants has started to come back. So we're seeing a lot of positive things, but the challenge and gets to the point of why it's been choppy as well.

Tenants today have a number of quality options for space.

And they can comfortably look today and say, we can downsize and save money.

And what trends that has turned into some shorter term leases and some smaller space requirements, and we think thats going to persist over the short term, but what tenants keep telling us they want great quality space diluted their people back and so if we look forward and say this time next year.

Our belief.

Is we're going to continue to evolve this narrative in our favor and advisors. The tenants right now are saying Hey, you can pull back in your lease space requirements Theres lots of options I think for quality properties, that's starting to change and it's going to continue to change and as that space. The good space in our cities starts to be absorbed.

I think we're going to see real movements in rental rates and Thats really whats been driving our strategy as I mentioned on our prepared remarks at the beginning is invest.

Really well located properties bring them up to the next level of quality.

And they're going to be well positioned as that trend continues.

Okay, and I guess, how are you thinking about redeploying that.

Talked about redeploying the sale proceeds to paying down the debt and then either temporary wanting et cetera. How are you thinking about the trade. These days. If you were to redeploy those proceeds is it likely to be in something thats relatively lower cap rate assets like the ones that you've been buying recently.

Are you still in the market looking at stuff.

Hi, <unk> sevens cap rate assets, whereas the sort of focus from a if you were to buy.

Any assets. These days is it in the higher value assets as the lower cap rate assets, how should we be thinking about that.

It's still too early to say, Rob I mean, we're looking at all of the above I would say, we're also looking as I mentioned at our own stock and where we're valued and trading and we think we're undervalued and so thats something thats on the table as well.

Okay, and then last one for me.

What's the thought on the preferred at this 0.6625 I think it is.

Is that given the cost for the rest of your capital today still likely to be attractive in the near term until something changes there.

Yes, I think Thats fair and obviously with the rise in interest rates over the last couple of months.

Math on kind of refinancing that has changed.

And so it's something that we're going to be watching over the next little bit, but I don't anticipate we'll be making any decisions on that short term.

Okay. Thanks, guys I appreciate the time.

Thanks, Rob.

Okay.

Thank you. The next question on the line comes from Michael Carroll of RBC capital markets Mike.

Michael Your line is open. Please go ahead.

Yeah. Thanks, Jami I know a couple of times in your prepared remarks, and I think in the prior question you kind of talked about some of the renovations at a handful of your projects I mean, how should we think about these renovations or is this really just kind of pre building out those spaces on making it more attractive and easier for potential tenants to move in or is it more.

Then that across the board.

So it's a mixture and it really depends on the property, Michael but what we're seeing today is having <unk>.

Outdoor space refresh the amenities fitness facilities those are big draws and lures that tenants are using to help bring their people back and then when you get into the space.

Pre investing and building out.

The high quality condition, that's fast can be moved into quickly in some cases, we're putting furniture in.

We're just seeing that as a strategy, that's really accelerating discussions and moving us above of other discussions correctly.

And then how big is these investments over the next I guess quarter or this year I mean is it a substantial investment that you're putting in your portfolio is there a way to kind of quantify that.

Hey, Mike It's Tony here I can answer that question I can give you kind of hear numbers. So maybe specifically talk about since you asked about the spec suite program and so the.

Our spec suite program typically typically that involves us doing kind of a ready to move in.

Typically the square footage is under 7000 square feet 5000 typical size are smaller and we have another approximately 20 units that represent about 70000 square feet that are either under construction or planned for the balance of this year. That's approximately $1 5 million just for the spec suite program.

But stepping back just generally if you look at.

Where our Ti and capital expenditure dollars are going to be for the next little while I mean, they're really if you take the average of the past two quarters for Ti and Capex that averages about $6 million per quarter. I mean, we're expecting those numbers to continue for the balance of the next four quarters.

As we kind of finish out this program that Jamie described and then there's leasing commissions above that obviously, depending on leasing volume just to give you a sense, though the spec suites Mike.

We lease those all up that's roughly just over 2% of our portfolio from an earnings potential that drives about <unk> <unk> a share. So it is really meaningful for a relatively small percentage of our portfolio. So it's a big focus.

Okay, Great and then how are those I guess, what's the timeline and knows how many of the spec suites have you already built out I know there has been several at park tower I believe youre kind of building out have you seen an uptick of activity at those sites that you've already completed.

Yes, I think that's pretty steady and I know.

It's averaging I think one or two a month of lease up over the last quarter. We have 19 spec suites and current inventory that are ready to go and Thats about 60000 square feet.

Okay, Great and then just last one from me on the <unk>.

The remaining 2022 lease explorations I know that you kind of Tony you kind of highlighted some of the expected move outs.

But can you kind of quantify the smaller tenants in there I mean, how much do they typically represent and how are those discussions going.

I believe last time, we were saying that theyre going well, but you expect some of them to downsize I mean, how should we think about that.

Yes, it's a fair question. So maybe I'll just recap we do have with the.

The next four quarters about 700000 square feet rolling.

There are kind of five leases that are greater than 30000 square feet I've already talked about two of them.

One we have a move out at Pima Center 31000 square feet on April 1st that we previously discussed.

We have 30000 square foot GSA tenants, Florida Research Park that straddles Q2, and Q3 and we are optimistic on a renewal on that 3000 square foot space.

And then we have.

We have another tenant at that rules at the end of the year December 31 at our Pima property, that's 36000 square feet.

That we do now expect to vacate but.

But beyond that to your question on small to medium sized leases in those are going I would say, we're pretty well and consistent with historical and our historical renewal rate worked out to an average of about two thirds and thats kind of what we're expecting and what we're seeing with the remaining small to medium sized leases.

Okay, great. Thank you.

Thanks, Mike.

Thank you as a reminder, if you would like to ask a question it staff for that pipeline.

Pat do you have a question now from Craig Kucera B by Securities Craig. Your line is open. Please go ahead.

Yes, thanks, good morning, guys.

I know you didn't change your disposition guidance.

But given where your stock is now trading on an implied cap rate versus where <unk> been selling assets in a lake.

Pricing was actually struck a while ago.

Are you revisiting, perhaps selling other assets and looking at share repurchases again.

Yeah.

Yes. So we are constantly looking at our own portfolio, Craig and I would say.

Pick that up recently.

For us.

We try and spend a lot of time and be thoughtful if we're going to execute what could we do.

To help enhance value and so we're looking at a number of properties right now and trying to get our arms around what's the best execution.

To position those and then we will make decisions over the coming quarters and again, when we look at where we're trading and our implied cap rate. We think we're very much.

Below where we should be and so that's our focus.

Sure.

Okay. Thanks, that's it for me.

Yeah.

Yes.

We have no further questions on the line is now I'll hand back over to Mr. Foss for closing remarks. Thank you.

Thank you for joining today and we look forward to updating you on our progress next quarter Goodbye.

Thank you very much for joining us today. This concludes today's call. You may now disconnect your lines have a great afternoon.