Q3 2022 Highwoods Properties Inc Earnings Call
Alright.
Greetings and welcome to the Highwood properties earnings call. During the presentation, all participants will be in a listen only mode. Afterwards, we will conduct a question and answer session at that time. If you have a question. Please press the one followed by the four new telephone.
If at any time during the conference you need to reach an operator, Please press star zero.
As a reminder, this conference is being recorded Wednesday October 26, 2022, I would now like to turn the conference over to Hanna true. Please go ahead.
Thank you operator, and good morning, everyone. Joining me on the call. This morning are Ted Klink, Our Chief Executive Officer, Brian Leary, Our Chief operating officer, and Brendan there on a our chief financial Officer.
For your convenience today's prepared remarks have been posted on the web.
If you have not received yesterday's earnings release or supplemental they're both available on the investors section of our website at high was dot com on.
On today's call I'll review will include non-GAAP measures such as F. S. A N O Y and EBITDA there the release and supplemental include a reconciliation of these non-GAAP measures to the most directly comparable GAAP financial measures.
Forward looking statements made during today's call are subject to risks and uncertainties. These risks and uncertainties are discussed at length in our press releases as well as our SEC filings.
Thanks, Hannah and good morning, everyone. We.
We had another excellent quarter with strong financial results.
Bus leasing activity and the third consecutive increase to our 2022 F F O outlook.
Given continued investor uncertainty around the post pandemic demand for office space. There are naturally questions about whether or not office landlords can sustain their operating performance.
We are enjoying we have enjoyed consistent healthy demand for office space across our sunbelt portfolio for seven quarters in a row. After only two quarters of below average new leasing during the first pandemic year of 2020.
Customers and prospects have been making decisions on leasing space.
And we have been benefiting from the flight to quality to our high quality portfolio.
In our portfolio since the beginning of 2021.
New customers, whether from organic growth in migration for flight to quality.
Generally offset those who downsize.
For work from home for hybrid work arrangements.
Our portfolio occupancy increased 40 basis points over those seven quarters. During this time.
We've averaged 322000 square feet of second Gen new leases per quarter 16.
16% above our prior 10 year average.
We've averaged 12.7% GAAP rent growth and 1.2% cash rent growth.
We've averaged 5.9 years of term.
In line with our long term average.
And we've averaged net effective rents, 1.5% higher than our average from 2018 in 2019.
While our second Gen leasing performance has been strong and consistent the third quarter was especially noteworthy.
New leasing volume of 518000 square feet was our highest since 2014.
Economics were robust on total volume more than 1 million square feet.
With an average term of seven four years.
One and a half years more than both our five quarter and 10 year averages.
And net effective rents, 22% above our five quarter average.
We believe this performance validates our strategy of owning high quality workplaces, and the most dynamic and vibrant baby DS of our growing sunbelt markets.
With this strategy, we have consistently delivered solid metrics throughout the ups and downs.
Calls and periods of changing office use patterns.
While we don't have a crystal ball there are obvious headwinds facing the U S and global economy.
To mitigate the impact of these potential headwinds.
We bolstered our liquidity and proactively addressed our largest pending lease explorations.
<unk> substantially <unk>, our largest 2023 lease exploration.
This de risks our forward leasing plan and leaves us with no remaining expirations representing more than 1% of revenues until late 2024.
Turning to investments in the Middle of August we completed the previously announced acquisition of $6 50 at legacy Union in Uptown Charlotte for $203 million.
We're seeing excellent activity at the recently completed building, which is 80% leased and we're confident in the long term outlook.
With this acquisition in less than three years since we entered the market Charlotte now accounts for over 10% of Oriental.
Occupancy in the rest of our Charlotte assets is 98%.
During the quarter. We also sold a mixed use land parcel enrichment and our Innsbruck bvd for 23 million.
Igniting a $9 million of F F O game.
This sale will facilitate the development of retail residential and hotel uses adjacent to our one 6 million square feet and hands Brook.
Importantly, the value of our existing and future office will be significantly enhanced.
A growing amenity base.
As we have mentioned previously our land bank has never been more attractive with full build out of nearly $4 billion.
The vast majority of this is master planned for mixed use development, including office and is adjacent to existing or future high woods assets.
We announced a 100% leased boutique office building at more graft in Charlotte South Park Bvd.
Our team creatively manufactured this opportunity to build a 12 million dollar high quality project on a surface parking lot that had previously not been considered for development.
This quarter, we placed in service, Virginia Springs, II in Nashville, and 100% leased.
This $38 million development encompasses 111000 square feet and was started in late 2019 on a fully suspect basis.
The ability to deliver this project on time on budget and 100% leased and is scheduled stabilization date despite.
Despite the pandemic is a testament to our development and leasing team and is a strong endorsement for the health of the Brentwood Bvd.
Our current development pipeline is $533 million at our share.
Our Midtown West project in Tampa is now 92, 5% leased and we'll move to our in service portfolio next quarter also in line with our original pro forma.
Our five in process developments represent a total investment of 476 million at our share.
A combined 22, 2% pre leased.
And Dallas granted park, six or 422000 square foot office development in the Frisco Plano Bvd continues to have healthy leasing interest with more than three years until projected stabilization.
And 23 Springs are 642000 square foot development in the Uptown Bvd has a scheduled completion date and <unk> 25, and an estimated stabilization date and <unk> 28.
We also have a strong pipeline of prospects for this project and continue to be confident about its long term outlook.
With rising interest rates and a reduced debt availability the.
The investment sales market has slowed to state the obvious.
Fortunately our balance sheet is in excellent shape with low leverage and no debt maturities until.
Until 2025.
We have existing liquidity to complete our development pipeline, while meaning maintaining ample dry powder, even without assuming any additional asset sales.
Early in the third quarter, we announced our plan to exit Pittsburgh, albeit with no preset timetable.
We are now preparing these assets for sale given the uncertainty in the investment sales market and our strong balance sheet, we can afford to be patient.
Over the long run operating with low leverage enables us to be opportunistic in seeking investments and improve the quality of our portfolio and increase our long term growth rate at.
All the while staying true to our mantra of being disciplined allocators of our shareholders' capital.
Turning to our results during the third quarter, we delivered F. F O have a $1.04 per share.
Which included seven cents per share of net land sale gains.
Our strong performance in the quarter gives us confidence to increase our 2022 F. F O outlook again this quarter.
The third consecutive increase since we first announced our outlook in February .
Even with one to two cents per share of higher anticipated interest expense in the fourth quarter.
The new range implies a midpoint of $4 three per share up three 5% from last year on an apples to apples basis, excluding land sales.
In addition to healthy <unk> growth as we've often said and can be seen clearly in our financial results. We continue to generate stronger cash flows.
To summarize our markets BB DS and portfolio has been resilient and continue to perform well as evidenced by our robust third quarter leasing and the derisking of our forward lease expirations.
Our attractive development pipeline has seen strong prospect activity and is well positioned to deliver future growth in NOI <unk> and cash flow.
Our land bank has never been more attractive and provides a pipeline of future growth opportunities.
Finally, our balance sheet is well positioned to allow us to capitalize on new investment opportunities.
This powerful combination together with our track record of delivering consistent and compounding growth.
Growth in earnings cash flow and dividends, while maintaining low financial leverage makes us confident that we are uniquely positioned to grow.
And we firmly believe the best days for high Woods are ahead of Us Brian .
Thank you Ted and good morning, everyone.
Our team delivered strong financial and operating results in the third quarter as we continued to provide our customers with the high quality and commute worthy workplaces, they need to retain recruit and return talent.
While we believe these metrics are definitive measures of past performance seven quarters in a row as Ted highlighted what conclusions can we draw about the future of work and the value proposition or B B D workplace, making both in urban and suburban locations presents to those who value culture.
Creativity and collaboration whether it would be five days, a week or via some hybrid model.
We can confidently conclude.
It's a flight to quality is first and foremost.
Flight to quality of life.
This is first apparent and the acceleration of the great migration to the shorter commute.
Lower cost of living opened for business and temporary climb of our Sun belt markets.
It is seconded by millennials discovering the benefits of homeownership.
Now the largest cohort of homebuyers, whom the National Association of Realtors note are choosing the suburbs as their destination odor over 85% of the time.
Been students of history.
We believe the geography and influences of household formation is a powerful leading indicator that is shaped economic activity and consumer decision making for generations.
Our balanced bvd portfolio is well served by both trends as our assets are and walkable amenity rich mixed use environments that deliver the best formula for acute worthy workplace experience.
And Nashville, where we signed 380000 square feet and ended the quarter over 95% occupied the team has been hard at work <unk> are high quality assets in Brentwood and in cool Springs, where a new central park, whether it's food and beverage options playground and live music venue led to our back filling.
Really all of our largest 20 twenty-three lease exploration.
We also placed into service, our 100% leased for genius Springs to development in Brentwood, which we announced in 2019.
As a 100% spec development, which delivered and stabilized on time and on budget without missing a beat throughout the pandemic.
Cushman and Wakefield noted the Nashville market at large posted positive net absorption for the quarter.
And increase rents 4% year over year.
Well, Nashville, and Tennessee deserve to be at the top of many rankings. It is the great state of North Carolina, where regenerate over a third of our NOI that is CNBC is number one state for business in 2022.
Additionally, rallies number one ranking by bank rate is the best place to live in the United States and the over $3 billion in annual R&D dollars deployed bias universities continues to drive growth for the triangle region.
The market posted positive net absorption for the fourth consecutive quarter and market rents increased 5% year over year per Abyssinia young.
We signed 186000 square feet of leases in Raleigh, and ended the quarter, 91.4% occupied.
Down the Interstate and Charlotte J O I reported that market rents are up four 5% year over year in the market realized positive net absorption for the second consecutive quarter.
We ended the quarter 94, 3% occupied.
With the acquisition of the 367000 square foot 650, South try and tower, we now own 2 million square feet of the most compelling and commute worthy buildings or development sites in all three of our targeted Charlotte Dvds.
Down the south end.
And South Park.
Notably in Uptown, we are honored to have been chosen as the new home for the Atlantic Coast conferences headquarters and the University of North Carolina, Kenan Flagler business schools, New Charlotte campus to tremendous additions to our legacy Union customer base.
And South Park, we re envision and Rezoned more across this quarter and this work place, making is paying off with the announcement of a new 12 million dollar 100% pre leased boutique office building.
Four more aircraft will deliver in 2020, four along with new food and beverage options for the whole of more aircraft on land not previously envisioned or permitted for development.
<unk> had a busy three years considering at this time in 2019, we own no assets in Charlotte.
Look in a model or a Charlotte growth and success in our newest market of Dallas, Texas. The region's continued performance provides positive tailwind to our prospects there.
Dallas has once again grown population and jobs quarter over quarter now.
Now topping 8 million residents and over 4 million people employed both all time highs.
For Moody's analytics office using jobs grew eight 3% year over year with 93000 new positions.
With even the most conservative office density calculation job growth like this produces real demand for office space across the market.
As a reminder, we are under construction in partnership with Nae op developer of the year and Dallas based granite properties on the 422000 square foot granite parks six in Plano, and a 642000 square foot twenty-three springs development in Uptown.
In summary.
We believe the best and brightest our better together we are hearing this from our customers and our continued performance bears this out.
While office buildings are built out of concrete steel and glass. The most solid of materials talent now has the opportunity to be much more fluid with how it engages with the physical workplace and work week.
We are focused on making our portfolio much talent supportive and commute worthy it can be.
We believe in so doing we will create great value for our customers high woods and in turn our shareholders Brendan.
Thanks, Brian Thanks, Brian and good morning, everyone in the third quarter, we reported net income of $38 $3 million or <unk> 36 cents per share and <unk> of $111 $6 million or $1 four per share. The quarter included net land sale gains of seven cents, which we're not.
Included in our prior <unk> outlook adjusting for the quarter to quarter fluctuations and land sale gains term fees and credit reserves. The major drivers of the change from the second quarter to the third quarter were lower operating margins and three Q as we expected a full quarter impact of the two.
<unk> dispositions and higher average interest rates. These were partially offset by the contribution from the mid quarter acquisition of $6 50 at legacy Union in Charlotte.
As expected same property cash NOI growth was negative in the quarter due to higher Opex and straight line rent GAAP NOI growth was positive and that's what we've stated before when GAAP NOI growth is higher than cash NOI growth. It's often a forward indicator of an upward sloping future cash NOI trend.
At the onset of the pandemic, our parking revenues and operating expenses fell sharply.
Having slowly normalized over the past couple of years, we now believe for Q 'twenty two will be a good representation of stabilized levels of Opex and parking on a go forward basis.
Our updated <unk> outlook of four O two to four O four per share for the full year makes it three quarters of consecutive increases since we provided our original outlook in February this.
This includes seven cents per share of net land sale gains in the third quarter, which were not included in the prior outlook. But also includes one to two cents per share of higher anticipated interest expense in the fourth quarter driven by higher projected so for rates and early repayment of our January 2023 bonds.
Which is offset by higher projected NOI.
Excluding that third quarter land sale gains the midpoint of the outlook is essentially unchanged from our prior outlook. The other line items in our outlook were largely unchanged other than some minor adjustments to G&A and straight line rent.
Ted mentioned that core <unk>, which excludes land sale gains it's projected to be up three 5% year over year at the midpoint of our updated 2022 outlook. This annual growth matches, our compound annual growth rate since 2019, and as close to the three 9% annual growth we've delivered since 2010.
In addition, our cash flows have continued to strengthen at a faster pace than <unk> during the past few years.
Now to our balance sheet during the third quarter, we closed a $150 million delayed draw unsecured bank term loan, which we used to help fund the acquisition of $6 50 at legacy Union. This loan is scheduled to mature in May 2027, and bears interest at sofa, plus 105 basis points.
The same spread as the term loan that we obtained in may.
Early in October we obtained an additional $200 million unsecured bank term loan with the same so for our borrowing spread and a maturity date in the fourth quarter of 2025, we used the proceeds from this term loan plus cash on hand, and borrowings under our revolving credit facility to repay without penalty of 202.
$50 million, 375% unsecured bond that was originally scheduled to mature in January 2023, we now have no debt maturities until the fourth quarter of 2025.
We have approximately $360 million remaining to fund our share of the current development pipeline.
We have construction loans in place at our Dallas JV that will account for $190 million of this future spending, leaving only a 170 million remaining from additional sources our revolver balance adjusted for the early bond repayment is approximately $160 million, leaving us nearly 600 million.
<unk>.
Additional capacity.
Our debt to EBITDA ratio ticked up this quarter to five six times with our acquisition and the funding of our initial investment into our Dallas Jv's and without meaningful disposition proceeds to be clear. Our plan is to fund our business on a leverage neutral basis over the long term, which means we'll likely.
Sell assets once the investment sales market stabilizes.
Our low leverage affords us the flexibility to fully fund our development expenditures without the prerequisite of selling any assets or raising equity and still maintain low overall leverage.
We estimate our net debt to EBITDAR ratio will remainder will remain under six times without any dispositions or equity issuances.
In summary, our balance sheet is in excellent shape with limited debt maturities and ample dry powder, giving us plenty of flexibility with our financing plans over the next several years and allowing us to be opportunistic with new investments operator, we are now ready for questions.
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And our first question comes from the line of Blaine Heck with Wells Fargo. Please go ahead.
Great. Thanks, good morning out there so.
So you guys had a very strong quarter from a new leasing perspective can you just talk generally about the types of tenants that are most active in your markets from a size and industry perspective.
Sure Blayne, it's Ted I'll start and maybe Brian can chime in.
Did we had a very active quarter in terms of our new lease.
We signed 36, new customers into our portfolio that would bring it in over the next several months are really led by most activity is financial services.
And then led followed closely by health care.
And then technology in terms of count.
So those have been the most active and then after that it's pretty diversified among several different several different categories.
Great that's helpful. Ted Thanks.
And then can you just talk about your asset recycling initiatives you talked about this a little bit in the prepared remarks, but I guess, how should we be thinking about the timing and pricing on Pittsburgh sales given that the transactional market seem to have ground to a halt here and how does that impact your willingness to invest incremental dollars in acquisitions or development.
Sure Great question I think in terms of the dispositions I think you hit it on the head.
Just given the dislocation in the capital markets.
I don't think we expect much in the way of dispositions in the near term as I mentioned in my prepared remarks, we are prepping.
Assets for sale, but we can afford to wait until the capital markets do come back.
As that relates to acquisitions look I think you know I think we've proven over the years, we're pretty good stewards of our shareholders' capital and are pretty conservative investors.
Brendan and his team stress test the balance sheet, all the time and even when you factor in our development spend that we've got coming up the next several quarters. We do have some dry powder to be opportunistic in this environment, but remain disciplined.
Any acquisition, we do it.
Have to be.
We're gonna be highly selective and have to be strategic you know, it's going to be probably be one of the best assets in the best Submarkets of one of our high growth markets and we're gonna look at replacement cost what is the stabilized yield hopefully we can get.
NASA with below market rents that we can grow over time. So it would have to be a highly strategic acquisition for us to do something.
Great very helpful last one for me.
Same store NOI was negative this quarter for the first time since 2018 I think you know can you just talk about the drivers behind some of that weakness and maybe expand on how we should think about the trend looking forward.
Yeah. Good morning, Blaine, it's Brendan I'll take that so.
That's right. It was negative this quarter that was as expected and as I think you saw in others. We did maintain that our outlook on same store for the year. So certainly <unk> was as we expected.
A lot of the reason for that is what we described in the beginning of the year, where expenses were higher and if you look at that page 15 in the south that gives our same property breakdown of overall operating expenses were up $6 4 million year over year in the third quarter now you don't have this detail.
But but recoveries did help out some of that increased expense. So net of recovery expenses were up $4 million, which is a big headwind on a on a NOI base of call it $115 million for the quarter. So that had a a big headwind and as we've talked about we think that that.
Headwind, probably dissipate sometime over the next few quarters, because as expenses continue to move up we're going to get back to.
The normalized expense levels, where we were pre COVID-19, which means our recovery rates will be much higher on any future increases in expenses. So we think that.
Line item that headwind will dissipate sometime over the next couple of quarters.
And then the other impact which is really timing related is straight line rent was much higher this quarter than it had been so that was a headwind of about $1.5 million.
And that's a timing issue that can either be a headwind or a tailwind but balances out over time. So we think that also gets better over the next couple of quarters. So if I normalize for both kind of the higher expenses net of recovery.
And the impact of higher straight line rent. We think if you think if we look at the core of what's going on with same store those trends are very positive and that's very much in the long term range of where we've grown at about positive 2.5% to 3% a year.
Super helpful. Thanks, guys.
And our next question comes the line of Jeff Spector with Bank of America. Please proceed.
Great. Thank you two follow up question to that conversation.
And how does that tie into.
Cash leasing spreads your last comments, how should we think about cash leasing spreads over the next let's say year or two.
Yeah, Jeff Good question. So so in general I would just say for.
The VAT for the average across our portfolio our average in place annual rent escalators are about two 5%, it's maybe been a little bit better than that on leases that we signed over the past several quarters, but let's call. It on average about two 5%.
Our cash re leasing spreads have been just a little bit lower than that they've been positive, but just a little bit lower than that over the past several quarters, let's say since the onset of COVID-19.
So that means probably on a same property basis, our top line is going to grow in the mid twos. So I think that that's a pretty good gauge going forward on a cash basis.
Cash rent spreads.
It's difficult to say, where they would be we don't guide to that number because it can vary based on leases that get signed but we've been pretty consistently signing levels in the very low positive single digits, and that's probably a reasonable guidepost of where we think will be as we go forward over the next several quarters.
Thank you very helpful and then.
Given the conversation around the balance sheet Brendan can you provide an update from what you're seeing on the capital markets. What are your how are your most recent conversations going with with your bankers.
Yeah. Good question. So as you know, we just closed the term loan.
In October which was a at.
A three year term loan with the one including the one year extension. So we were very pleased to get that done we think that worked really well for us.
And that was something that made a lot of sense for us to do.
Do because it provides us that flexibility so that is a.
Short term increase to liquidity, which if you think about the plan that we have which is ultimately to sell assets that gives us flexibility with those asset proceeds to pay down some of the short term variable rate debt that we have so so we were pleased to get that done we really don't have a lot of need for.
Financing going forward so.
You know I think it's no surprise that capital is less available now, but we feel like we're in great shape, given we've got about $600 million available on our line of credit and we have no maturities until 2025. So we don't have a lot of need to raise capital at this point.
Okay. Thank you.
Then last for me just Ted on your opening remarks, I just want to confirm just given all the concerns investors have.
Analysts have over potential.
Weakness in the economy, maybe we're seeing signposted that now just to confirm are you seeing any sign close into October of 10, slowing or changing leasing decisions over a P.
Concerned of a slowing economy.
This quarter in 'twenty three.
Sure look I think we're off to a really good start this quarter from a leasing volume.
Standpoint.
I think.
Tour activity still remains very strong.
Now having said that look we've had a few decisions put on hold right. A couple of deals that we thought we were going to make even last quarter. We had a few this quarter. We're hearing about a couple that they're not saying, they're not going to do the deal, but they're just putting a little bit of a pause whether that's a 30 or 60 day pause and I attribute that to you know potential headwinds that are out.
There, but in terms of just leasing that we see coming through our funnel.
It's continued the third quarter or the first month of this quarter October .
Continued the.
Momentum we've had last quarter.
Thank you.
Thank you.
And our next question comes the line of Michael Griffin with Citi. Please proceed.
Thanks, maybe to expand on that leasing question just asked earlier.
Just the difference in terms of kind of what tenants are asking for and sort of what theyre looking for now relative to Teresa.
Hey, Michael O'brien here, let me go ahead and take this one so.
In general, Yes, I would say that they are across the board.
Highly focused on whatever real estate decision in investment, they're making typically in negotiations with us and securing a lease with being kind of a competitive edge to get their talent back to work. So it is a deliberate move to make sure. They have the most compelling commute worthy kind of component of that.
Workplace to give people a reason to come back in and so they're leaning in on that they're leaning on amenity, they're leaning in with us as to TANF partner to realize additional building amenities. We've had some great success.
Take Nashville for example, where we just back filled our largest 2023 exploration, we backfill that into a.
A collection of really kind of three and a half buildings. One building is kind of two buildings almost connected in it and we're completely repositioning that place with a new park in a playground in food and beverage and all these things that we think are about making a commit worthy and the market's responding and so it's.
A very collaborative kind of conversation and effort that we're having with these customers to help them continue to retain and recruit and return their talent. So so it's a little different it not saying that people aren't out to get a deal because everyone's smart and savvy and they're well informed and well consulted.
But as you may have heard on calls it's it feels like years ago. When you look at what a typical company is going to spend every year, 1% will be on their utilities, 9% will be on their real estate, 90% will be on their people. So they're realizing that they need their 90% and because they're 90% more productive when they're together.
And that's kind of a universal course, we've heard.
Got you that's that's definitely helpful.
A question now just on sort of capital allocation just given the changing.
Backdrop and macroeconomic sentiment how does this change your strategy is around external growth, including development funding going forward. Brendan I know you mentioned about 101 hundred $70 million left to fund for development, just kind of how should we be thinking about that.
Yeah.
And Michael This is Ted let me start out in terms of the capital allocation I talked a little bit about acquisitions, obviously, it has to be something pretty special for us on that side and we'd have to be very comfortable with the pricing and all that but you know with respect to development look I think the bar for development is higher today.
We announced last night that we did the $12 million build to suit in Charlotte a little boutique building that we're really excited about we got that out of basically we're building. It on a parking lot. So we had no basis to the land, which gave us about a 50 basis point bip basis basis point lift in the development yield so.
That was very attractive to us and we have a handful of other discussions going on with potential prospects and every deal is different.
So we take a pretty measured approach.
We look at the market the Submarket.
You know what others under development, but key for US is really stress testing our underwriting, let's see what yields would look like.
Assuming lower rents longer lease up times higher Ti more concession packages.
So we want to know are we want to go into a development where their eyes wide open, but I would say the bar is certainly higher today.
And Michael I'll, just you know just from a balance sheet perspective, so without you know without regard for the merits of any additional investment I think when we look at our balance sheet and stress test that.
As I mentioned just in the prepared remarks.
We don't think that we will be above six times based on six times debt to EBITDA based on the planned development spending that we have going.
Going forward, so that's even without getting of the corresponding NOI in the door from the development properties that are on the development pipeline as it stands right now so I think we feel good about where we are from a balance sheet perspective, one because overall leverage whether it's leverage as a person.
Or assets or debt to EBITDA. Those are both low and then also as I mentioned earlier, we just don't have any debt maturities until 'twenty late 2025 with a lot of capacity available on our lines. So I think we're in good shape from a balance sheet perspective. So we do feel like we've got dry power.
Or if there is some additional investment opportunity that we believe is compelling.
Okay. That's it for me thanks for the time.
And our next question comes from line of Rob Stevenson with Janney Janney Montgomery Scott. Please proceed.
About sublease space in your markets is it stable, increasing decreasing and how rational some of the competitors that maybe have large vacancy issues that you adult or being in terms of pricing concessions and length of lease and stuff like that.
Hey, Rob This is Ted maybe I'll start and then Brian can jump in.
Look subway.
Sublease space, it's still elevated I think in most of our markets. That's what happens now happened during the pandemic and that's what happens when the economy slows.
Some of the sublease space is definitely competitive we've lost.
Probably a handful of deals maybe over the last year or so to two competing sublease space, but you got to remember that not all sublease spaces competitive some of it has short term in nature Ti is may or may not be provided renewal options are not going to have so it's not ideal it's not the ideal situation for a lot of companies. So.
And I'm also a lot of its lower quality assets and lower quality submarkets as well so while it's elevated we compete with some of it but not not all sublease space.
Okay.
And then.
That's on using some of that dry powder, you've been talking about to potentially buy back stock if it stays in the mid to high twenties.
Sure Rob it's something certainly last few quarters.
We talk to our board about virtually every quarter. So just.
Just overall state, but we want to protect our strong balance sheet and really don't want to lever up to.
To buy our stock it's certainly a.
Compelling we understand.
The question.
Given the capital markets today maintain liquidity is pretty important as well. So it's something we contemplated something we think about we obviously look at it with respect to our development spend and other uses of capital as well. So it's definitely not off the table, but it's not a not something that we necessarily think we're going to be doing at this point.
I mean, I guess the other question would wind up being is how high of a cap rate would you have to buy something to make it more attractive than buying your own portfolio of bvd assets back at the implied cap rate that you're currently at.
Right no that's a math exercise right to a certain degree.
We're looking at are in the long term as.
Well, what our long term uses and again, it's something that we can contemplate but not necessarily want to lever up to do it but it's certainly at a compelling valuation it's something we think about.
And then last one for me Brendan.
What's the thought on swaps or anything else on the variable rate portion of the data I know, it's not huge in terms of the overall debt position, but how are you thinking about that in the whereas the pricing on that versus the risk reward type of situation for you guys.
Yeah. Good question, Rob, it's probably not something that's front burner for us as it stands now because.
Again, just the plan is to have disposition proceeds come in the door and fund the kind of our investment activities on a leverage neutral basis over time. So if we swap some of that floating rate exposure to fixed that hampers our ability to then freely use those disposition proceeds to pay down that debt.
So it does reduce the flexibility that we that we have so I think that that is probably something that we.
We will continue to look at but is I would say not front burner I will mention that we do have interest rate caps on the construction loans for the Dallas Jay vs that are in place we haven't drawn on those loans, yet we're still funding the equity piece, but we do have some protection with respect to <unk>.
Rising so for rates there what the interest rate caps that we have on those Dallas J B's.
That's helpful. Thank you guys appreciate the time.
Okay.
And our next question comes the line of Ronald Camden with Morgan Stanley . Please proceed.
Hey, just a couple of quick ones I'm going back to the dispositions I know you asked us on Pittsburgh at a little bit maybe you can talk a little bit more about what the environments like in.
Potentials out there thanks.
Sure you know.
Just not a lot of visibility in the transaction market today, Ron I think most people in the price discovery mode. We are seeing a couple of deals get done having said that we've seen a couple of assets that are tied up in either have closed or recently closed that are very high quality. It you know a.
Little bit of a discount you know roughly 10% or so.
But in general just given the illiquidity of the lack of liquidity in the debt markets. It's really impacted the transaction environment. So as I said well you know we've got several assets that are teed up for dispositions, but we're in no hurry, we're not forced to selling anything in this environment. So we can afford to be patient.
Great and then my last one was just on the leasing obviously, a pretty good leasing quarter, maybe can you update us if you haven't already on some of the larger lease explorations.
The activity that youre seeing on those spaces.
Sure so going into next year, we only have two leases greater than 100000 square feet.
One of those is what we talked about it's the <unk> health in Nashville.
They expire at the end of February 23, and as we mentioned in our prepared remarks, and Brian mentioned it. We've we substantially backfill that already so we're excited about that there will be some downtime, but we're and we're excited about where we came out on that and then the only other one is about 137000 square foot customer.
In Raleigh that expires the end of January and we're downsides in them they went through a.
Merger.
With another company and they're gonna be downsize in the Raleigh operation. So we extended them there'll be downsizing them by about I think 75000 feet, if I remember right.
But we already have strong prospects for a vast majority of that so we think the downtime is going to be pretty nominal on that so other than that we don't have anything below 100000 square feet in 2023.
Great. Thanks, so much.
Thank you.
Yeah.
And as a reminder to register for a question. Please press the one followed by the four and our next question comes from line of Dave Rodgers with Baird. Please proceed.
Hey, Good morning, guys my questions fall a little bit on the same line. So maybe Brian start with you can you talk about the tenor of discussions just on the renewals that you are having it sounds like some new leases may be put on hold but you had a great quarter. So curious on the renewals specifically are people still typically looking to downsize a little bit more if they are staying with you and then what's the downtime on <unk>.
<unk>.
Hey, there so Dave a quick take the second one first downtime will be about most of the year as the building gets repositioned and we do the work outside so I think January one is when they are planning on moving and they may get a little earlier.
Fair and then back to your first question on renewals you know.
Folks are I think in the hole, we have more expansions and contractions.
There's always kind of a one off story of a merger and some other things and how folks are going to use space.
We are the beneficiary of being in growth markets and so if you look at corporations, we're in and the mix that Ted highlighted who is growing and who's doing the deals professional services financial services engineering firms I think we're seeing the infrastructure Bill snap now starting to get through the system and putting a lot of it.
These folks to work.
They are looking for some more tea I, you know to commit to a longer term. So you can look at that term. We had this year that while we're very happy with that you know we're optimistic that we'll continue around that same area for the coming quarters.
Because again these folks are committed to this space the ones that are making their decisions, we'd still have a few that might kick the can on the renewal side jargon might be bigger organizations that are looking at you know kind of a multi multiple city in multiple market kind of strategy.
But we've actually had a few that thought they wanted to downsize they gave us the heads up got in.
And then it came back and said now we're just going to keep keep the whole thing. So again I think it comes back to the the.
Calculus of what percentage of their spend is really just on this real estate when they're really talking about getting their people back together.
Great and then maybe I don't know if this is for Brendan or Ted but any comments on assure in in the in the sublease Theyre, obviously doesn't affect you guys for a long time from a direct standpoint, but do you share in any sublease proceeds and have you had discussions with them about how they plan to use the asset in the future.
Yeah, really they've announced publicly I think theyre, putting in roughly 90000 square feet on the sublease market, but at the same time, we're not I don't think they've totally decided what they're doing yet so I think those plans are still evolving.
So we really don't have a whole lot of details on it.
As far and that's really not too different from Bridgestone down the street, a couple of quarters ago, Bridgestone announced they're putting a few floors on the sublease market as well and I don't think they've been actively sublease unit. Despite the public announcement that they're going to do it. So I think time will tell.
Alright, great Thats helpful. Maybe.
Maybe one more on the acquisition at $6 50 can you talk about the opportunity there it looks like it's got some opportunity for lease up maybe some rent roll.
You've covered it earlier I missed some of the early portion of the call I apologize.
No Dave we didn't we didn't hit it earlier, it's Brian one of the extra hats I get to Where's the Charlotte market leader so.
650 is already improved with regard to its leasing from the moment, we got it under contract so from under contract to close it improve in its leasing up since we've closed it's physically connected to our bank of America tower, and they share kind of parking in some executive parking in and so it was a natural fit.
First and foremost.
That is the basically the epicenter for those that know Charlotte.
Center of where activity is in all of Charlotte basically abandoned south and has moved to the south try on formerly known as Stonewall intersection.
So we feel pretty good about that pick up in and the buildings filling up and.
In fact could give you a little story on the growing we had robinhood and there were two floors right and they.
Put it on the sublease market and they've already been felt back up so and we're going direct with one of them for an extension to have of who that would be so we think it's a great combination to the tower next door.
The only thing I would add is on the bank of America building, which we bought in late 2019, I think when we bought is roughly 90% leased and then Covid hit so leasing had been slow with bank of America.
During the Covid period, and coming out, but I think you know, Brian and leasing team have had great success. This year I think bofa is close to 98% today. So we're just seeing a lot of activity on that end of that and of our Charlotte downtown Charlotte.
That's really helpful.
I'll just extend one more sorry, one obscure question for Brendan.
I know you had talked about using Pittsburgh, and really reallocating that to Dallas and I realized that the big picture comment, but if you were to actually use those funds if Pittsburgh still had a gain going forward could.
Could you use that gain to buyout your partners because you can't use it on the developments I'm trying to figure out if that.
A one for one swap or something else have to happen in that transition.
So yeah. Good question, but no that that wouldn't be we would have to deal with the game from attack I'm, assuming you're asking from attacks the taxability standpoint, and given that our.
Normalized taxable income is roughly in line with our $2 per share dividend. So theres not a lot of natural room to absorb.
Capital gains into the normal $2 per share annual dividend, but we do have tax strategies that are out there. So I think even if we got proceeds from from Pittsburgh realized the capital gain there I think we have enough strategies to to be able to offset that that those arent unlimited, but I think for the near term.
We've got strategies that where we'd be able to get disposition proceeds with capital gains and be able to generally freely use those dollars for reinvestment or debt reduction or what have you.
I appreciate that alright, thanks, everyone.
And our next question comes the line of Tom Catherwood with.
Please proceed.
Thank you Brendan looping back on operating expenses, just want to try to put the pieces together here, obviously as we got into 'twenty two guidance as you had talked about earlier you had mentioned the expected increase in operating expenses.
First two quarters, we did not see that it is obviously ramped as you talked about in the third quarter and you expect that fourth quarter run rate to kind of be the new normal going forward just by our back of the envelope it looks like.
That's another maybe 150 basis points increase in operating expense margin, which maybe is $2 million.
Of Opex before you hit your kind of your recovery limit doorbell recovery ability, which should carry you into 'twenty three kind of two parts then.
One what was the main reason for that lag in the operating expenses really ramping up in 'twenty, two and then kind of math wise are we at least putting the pieces together.
At a logical and reasonable way.
Yeah. Thanks, Tom I appreciate the question.
So for the first part of your question why didn't we see the sort of corresponding pick up kind of early in 'twenty. Two is it sort of taken to the third quarter.
So I would say, there's a few different things that are going on but but I'll distill it down to utilization rates have picked up kind of since the summer and even were a little bit higher post labor day. So that has driven operating expenses higher and then certainly we've seen some inflationary pressure.
On operating expenses. So the combination of those two items have have largely driven operating expenses to a level, where we feel like they are reasonably well normalized as as we kind of sit here certainly if inflation continues to be high than.
That's likely to filter its way into operating expenses going forward, but as I mentioned that we feel like on a go forward basis, we're reasonably well protected because operating expenses are kind of getting back to pre COVID-19 levels, which means we're protected with expense stops for the most part.
Across the vast majority of those buildings so.
So so that's why it's probably taken a little bit of time to kind of get back to where normalized levels are now with respect to how that's going to play out in terms of operating margins going forward and then how you think about that on same store.
It's a little bit different so I think from an operating margin perspective, it's probably fairly stable as we go forward from here or at least the fourth quarter I think that is a fairly stable level.
In terms of kind of comparing year over year with recoveries in Opex. There is the comparison to the prior year impact so that probably becomes as still a little bit of a headwind I would say opex net of recovery is still probably a little.
Bit of a headwind, albeit fairly modest in the first half of next year. There's the first quarter, that's probably the case and then should normalize kind of over the next few quarters. So.
Hopefully that's helpful. It is there's you know there's a lot of detail that's in there, but I do feel like we've kind of gotten to the point, where operating expenses are roughly normalized and parking revenues are roughly normalized so we feel like we're in a pretty stable environment as we go forward from here.
Got it got it I appreciate all of those pieces and color Brendan and then last one for me this might be looking out a little bit further but.
You placed the the last Virginia Springs development into the stabilized portfolio. This quarter, it's obviously fully leased up.
The next kind of opportunity there is is the YMCA site.
What is the kind of status on either entitling or or rezoning that asset and what are your expectations of when you can.
Start either marketing that or getting shovels into the ground over there.
Yeah.
Thomas Thank you for.
Asking that question.
Our leader in Nashville, Alec Chambers is chomping.
Chomping at the bit to get going so it's in Brentwood, Tennessee, which is a very high barrier to entry market.
B D that we're in is even higher so.
So we feel like we do have something unique in that Y M. C. A site, we do have a little bit of a tail for the YMCA to finish up their operations, there and to move to their new location. We are in design right now one of the great evolutions that we've had on that Master plan is that while we still have the three office.
<unk>, we've master planned going into the underwriting the purchase that we have found the ability to add a strong retail component that is being met with great response from the local market.
And so we think that will really add a differentiating mixed use factor to that two minute worthy value proposition. So we're working with the town of in.
But right now we're going to file the site plan this month and ideally be in a position to go as soon as we're ready next year, but thanks for the question.
Really appreciate that Brian that's it for me thanks, everyone.
Yeah.
And there are no other questions I will turn the call back over for any closing remarks.
Thanks, everyone for being on the call. This morning, and as always if you have any follow up questions. Please feel free to reach out and we look forward to seeing you all in a couple of weeks out in San Francisco. Thank you.
Thank you that does conclude the call for today, we thank you for your participation and ask that you. Please disconnect your lines have a great day.
Okay.
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