Q2 2022 Office Properties Income Trust Earnings Call
Good morning, and welcome to the office properties income Trust second quarter 2022 earnings conference call.
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I'd now like to turn the conference over to Kevin Berry Director of Investor Relations. Please go ahead.
Thank you and good morning, everyone. Thanks for joining us today with me on the call are Opi's, President and Chief operating Officer, Chris Blotto, and Chief Financial Officer, and Treasurer, Matt Brown in just a moment they will provide details about our business and our performance for the second quarter of 2022, followed by a question and answer session with sell side analysts.
First I would like to note that the recording and retransmission of today's conference call is prohibited without the prior written consent of the company.
Also note that todays conference call contains forward looking statements within the meaning of the private Securities Litigation Reform Act of 1995 and other securities laws.
Forward looking statements are based on Opi's beliefs and expectations as of today Friday July 29, 2022, and actual results may differ materially from those that we project.
The company undertakes no obligation to revise or publicly release the results of any revision to the forward looking statements made in today's conference call.
Additional information concerning factors that could cause those differences is contained in our filings with the securities and exchange Commission or SEC, which can be accessed from our website OPI reap dot com or the SEC's website.
Investors are cautioned not to place undue reliance upon any forward looking statements. In addition, we will be discussing non-GAAP numbers during this call, including normalized funds from operations or normalized <unk> cash available for distribution or adjusted.
Adjusted EBITDA and cash basis, net operating income or cash basis NOI. A reconciliation of these non-GAAP figures to net income are available in our supplemental operating and financial data package, which also can be found on our website. In addition, we will be providing guidance on this call, including normalized <unk> and cash basis NOI, we are not.
Providing a reconciliation of these non-GAAP measures as part of our guidance because certain information required for such reconciliation is not available without unreasonable efforts or at all such as gains and losses or impairment charges related to the disposition of real estate.
With that I will now turn the call over to Chris.
Thank you, Kevin and good morning, everyone and welcome to the second quarter earnings call for office properties income Trust.
Last night, we reported second quarter results that reflect solid financial growth strong leasing momentum and continued progress on our capital recycling plans normalized <unk> and same property cash basis NOI exceeded our prior year results and the high end of our guidance range.
We are pleased with our strong quarterly performance, however, broader office fundamentals remain in a period of transition.
Tennant's continued to assess the longer term space needs and the balance of our hybrid work environment National vacancy remains elevated in office utilization continues at a modest pace.
We anticipate market fundamentals will remain in transition over the next several quarters.
As part of our ongoing commitment to offering best in class options. The tenants, we have selectively deployed capital into our properties over the years focused on better operation market specific tenant experiences and sustainability.
Through our manager we.
We have local professionals, specifically focused on our real estate in each market and have certified building engineers managing maintenance of our properties with the highest level of care.
This has positioned many of our properties that would be a first consideration with tenant tours and we believe our pipeline activity and corresponding new leasing activity over the past. Several years are a result of this proactive investment despite the noted market uncertainty.
During the second quarter, our leasing activity increased sequentially to 679000 square feet and same property occupancy increased 50 basis points over the prior quarter to 94, 3% attributable to new leasing activity and advancement of our disposition program for non core assets.
We continue to take a disciplined and thoughtful approach to our capital recycling efforts with the goal of reducing capital expenditure and improving our portfolio and geographic footprint and operating fundamentals.
Since the beginning of the second quarter, we sold or agreed to sell noncore properties or properties, where we believe value has been maximized for aggregate proceeds of $167 $9 million that contained over one 7 million square feet at an average age of 18 years.
For us as we continue to market, we have seen some thinning of the buyer pool, along with volatility and pricing expectations in light of macroeconomic changes and in certain real estate market conditions.
As a result, we are moderating our expectations for the pace of our 2022 property dispositions and now anticipate aggregate 2022 sales proceeds in the range of $100 million to $200 million.
We remain committed to utilizing capital recycling proceeds to manage leverage levels and strengthen our portfolio and anticipate dispositions to continue as we move into 2023.
Turning now to the second quarter in more detail.
We completed 18 deals for 679000 square feet of new and renewal leasing with a four 9% weighted average roll up in rent and a $9 two year weighted average lease term.
Quarter over quarter leasing volume increased in excess of 18% and by 23% over Q2 2021.
Government agencies accounted for approximately 30% of our total leasing volume followed by tenants in the government contractor life Science and medical industries.
Since the first quarter of 2021, new leasing activity contributed to close to $1 2 million square feet, which we believe represents the highlighted initiatives with how we manage our buildings and has a good indications of tenants appetite to commit the space.
We ended the quarter with investment grade rated tenants, representing approximately 63% of annualized rental revenue.
Turning to highlights from our second quarter leasing transactions.
In Chantilly, Virginia, we executed a lease renewal with a defense contractor for 159000 square feet. This represents a key strategic win and which OPI secured a renewal for a mission critical locations at a 10% roll up in rent and a now a 17 year term.
We renewed 168000 square feet in Florence, Kentucky occupied by the GSA at an 11% roll up in rent and a five year term and in Naperville, Illinois, We signed a new lease with the health care equipment manufacturer for 86000 square feet at a modest roll down in rent and an eight year term.
Looking ahead to opioids upcoming lease expirations approximately 4% of our total annualized revenue is scheduled to expire during the back half of 2022.
We are actively managing through and limited number of known Vacates, including our previously discussed tenants located in the vibrant and growing submarket of Denver, Colorado, resulting in a net impact of 135000 square feet and 80 basis points of annualized revenue.
We continue to build interest from a variety of prospects looking to lease portions of the buildings beyond the Colorado lease our remaining 2022 rent roll is comprised of mostly smaller tenants and properties currently being marketed for sale.
Looking ahead to 2023, roughly 13, 5% of opioids annualized revenue is scheduled to expire with the largest known vacate being a tenant located in Washington, DC, CBD, representing 2% of annualized revenue and a lease exploration during the back half of the year.
Given the timing for this exploration later in 2023, we have ample time to market the building and are well into plans to support lease ready initiatives for what is currently a LEED gold class a property in a prominent submarkets downtown D C.
While explorations may be somewhat mitigated by asset sales renewal conversations with many of our tenants have been positive and we anticipate strong leasing momentum will continue for the remainder of the year.
Exploration schedule also presents an opportunity and this high inflationary environment to rightsize rents and reset base year expense agreements to grow the top line.
Our current leasing pipeline remains strong with a balance of new and renewal deals healthy lease term and mark to market growth potential in the high single digits, we have over $3 2 million square feet of active prospects of which $1 6 million square feet is attributable to new leasing.
<unk>, we are in advanced stages of negotiation with nearly 670000 square feet, which includes over 250000 square feet of potential new tenants. We are reaffirming our expectation for the year end 2022 occupancy of 80 to 90, 90% along with expectations for rollout rent roll ups of 5% to 7%.
Turning to development.
Redevelopment efforts in Washington, D C and Seattle, Washington, both remain on track despite broad industry challenges associated with rising construction costs and longer lead times for materials. We continue to work towards a favorable stabilized year return on cost of 8% to 10% or 20 mass Av.
10% to 12% in Seattle and plan to deliver both projects in April of 2023.
We believe the rigorous planning and disciplined execution of these projects have positioned us for leasing success cash flow growth and long term value creation tenant tours and pre leasing interest remain active at both locations as each project takes shape.
Before turning the call over to Matt I wanted to comment on the recent publication of the RMR group's annual sustainability report the report highlights insight accomplishments and data regarding our managers commitment to long term ESG goals. For example earlier this year OPI was recognized as an energy star partner of the year.
Year for the fifth consecutive year in a gold level 2022 Green lease leader.
We are proud of the progress we continue to make to strengthen opioid sustainability practices and enhance our ESG transparency and disclosure you can find links to the report and a tear sheet specifics to opioid highlights on our website at <unk> Dot Com I will now turn the call over to Matt to review our financial results.
Thanks, Chris and good morning, everyone.
Our results for the quarter exceeded our expectations and improved over the same period last year normalized <unk> increased 6% year over year to $58 $9 million or $1 22 per share exceeding the high end of our guidance range by nine mainly.
Mainly due to managing our operating expenses and the timing of certain expenses, such as repairs and maintenance.
<unk> increased 12% year over year to $37 8 million or <unk> 78 per share for the second quarter, resulting in a rolling four quarter <unk> payout ratio of 66% earlier. This month, we declared our regular quarterly distribution of <unk> 55 per share, which represents a current quarter payout.
<unk> of 71%.
Same property cash basis, NOI increased 1% compared to the second quarter of 2021 and beat our guidance range of down 2% to 4%. The increase was driven by rental income growth due to an increase in occupancy year over year free rent during the 2021 period and increased parking income.
Looking ahead to our normalized <unk> and same property cash basis NOI expectations in the third quarter, we expect normalized <unk> to be between $1 12, and $1 14 per share.
The decline compared to Q2 is mainly driven by <unk> <unk> due to a $2 2 million dollar termination fee earned in the second quarter with the balance accounting for expected increases in operating expenses.
This guidance takes into account our planned disposition activity and includes a range of $24 five to $25 5 million of interest expense and $6 $9 million to $7 million of G&A expense during the third quarter.
We expect same property cash basis, NOI to be flat, plus or minus 100 basis points as compared to the third quarter of 2021.
Turning to capital expenditures and the balance sheet we.
We spent $28 million on recurring capital and $40 $3 million in redevelopment capital during the second quarter.
We continue to expect 2022 recurring capital to approximate $100 million, plus or minus $10 million and redevelopment spend to approximate $200 million to support our 20 mass out in Seattle redevelopment projects.
In Q2, we repaid approximately $325 million of debt with cash on hand, and borrowings under our revolving credit facility. We intend to continue to pay down debt with our property disposition proceeds and ended the second quarter with $546 million of total liquidity, including $520 million of availability under our roof.
Oliver.
More than 90% of our $2 $5 billion of outstanding principal balance is fixed at a weighted average interest rate below 4% and over 97% of our debt is unsecured our exposure to rising interest rates is limited to our revolving credit facility and we have no senior notes maturing until May 2024, leaving us.
Well positioned to support our priorities going forward.
Operator that concludes our prepared remarks, we're ready to open the call up for questions.
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Yes.
The first question today comes from Bryan Maher with B Riley. Please go ahead.
Good morning, Chris and Matt a couple of quick questions.
On the 3 million plus are active pipelines for thing how much of that do you think.
To fruition over the next three to four quarters considering the.
Expirations, you have coming up in 2023, and 2024 and are you seeing any sense of urgency on the part of tenants to maybe lock in leases I think we've talked about this before.
Fearing inflation might drive those prices higher.
Yeah. Thanks, Brian This is Chris.
You know I think from tenants kind of pushing to kind of lock in leases I would say that it's very much just tied to kind of overall plans for office space I think more so than kind of driving rate and so that is.
In many ways kind of dictating kind of how they think about timing.
As we think about kind of our explorations over 2022 and even into 'twenty three I.
I guess it can be hard to kind of articulate as to kind of how those leases maybe sign and kind of the lumpiness with the process.
With respect to signing an LOI and negotiating a lease document et cetera, but I think to provide a little bit more color I would say so if we look at 2022, we've got about four 2% of our annualized revenue expiring.
Subsequent to quarter end, we signed about 345000 square feet.
Which includes 2% of those explorations and so.
When we kind of sum it up we have 2% accounted for we talked about the 80 basis points tied to the Colorado lease vacating, we're selling some properties as part of our capital recycling program, which accounts for about 70 basis points and then we have.
Some new lease activity as well that are signed as part of that 345000 square feet and so I think that kind of just shows some of the cadence at least coming right out of Q2, and how we're addressing 2022 for <unk> 'twenty three as.
As you've seen we have about 13, 5% of our annualized revenue expiring and I think the highlighted there are the 2% of known vacate on the back half of the year was I just mentioned in our prepared remarks, we're selling about 60 basis points and then I would say we're in advanced conversations with a lot of those.
Exploration is representing about 4% of our annualized revenue and depending on the circumstances, it's not signed until it's signed but.
Those could be leases that were able to get in front out for execution in.
In Q3 and Q4 this year, so really what that does is it leaves us with about 7% of our annualized revenue and.
2023 that will continue to work through and I think I would also note on that most of those leases are expiring.
In Q4 for example of next year and so it's not surprising where we sit today knowing that a lot of that has been.
Sure to the extent some of these other ones have because they are still a ways out but I think what that means in our view is whether there is upside in rents with that remaining 7% or some fallout. It's not something that we would expect it will impact 2023 too much just given the timing of those explorations.
Got it and then as it relates to the disposition.
You know I know that you've curtailed your expectations from four to 500 million to $100 million to $200 million, what kind of discounts where potential buyers looking for on some of the stuff that you know maybe you were out there you know shopping around that you've pulled.
And given that you have net debt to gross asset value of around 49%.
With the pullback in disposition expectations are you comfortable hanging out at that kind of 48, 49 50 level for a while.
So I'll take the first half and I'll turn it over to Matt, but I would say that.
It varies depending on disposition strategy. So we do have some buildings that had been out in the market that have shorter wall.
And I would say in some cases buyers are kind of sitting on the sidelines all together for some of the more stabilized assets.
A good example is one that has some long lease term that we're selling.
And the Midwest.
As we were kind of concluding diligence the buyer came back and wanted a 10% discount on the price and so I mean for us in specific given that this particular property has longer term.
And there as you know we're pretty disciplined in how we want to approach. This.
We're not necessarily in a rush to run out and.
Kind of sell an asset at a discount just given kind of where we are so.
It really runs the full gamut, but I would say that 10% discount as a good indicator based on what we've seen more specifically and I'll turn the other portion over to Matt.
Yeah, Brian on net debt to gross assets and the high Forty's even into low <unk>, we are comfortable running the company at those levels, while we reduce the expectation on 2022 dispositions.
Alright. Thank you that's all for me.
Okay.
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The next question comes from a bottle of Camden with Morgan Stanley . Please go ahead.
Yes, I mean for Royal Kingdom, just wanted to ask about the recurring Capex guidance I noticed brooks firms relative to last quarter.
It does imply a ramp in the second half of this year.
Could you talk about what's driving that ramp.
That's the first time and then also you're asking about.
<unk> Capex.
Thanks, Steve.
The content of lease expirations and whatnot.
Sure. So our full year guidance for 'twenty, two is $100 million as we noted in prepared remarks.
Recurring capital we've spent about $32 million to date, so we have about 68 million.
<unk> and that spread pretty evenly in our forecast for Q3 and Q4.
Reason, it's higher is 2022, we've done a lot of leasing activity and we're trying to get ahead in 2023 leasing as well so that's.
Thats really the reason of the increase over the first half of the year and then beyond 'twenty two.
For now I would say that that $100 million recurring capital remains a good.
And we will provide updates on our Q3 call as we continue fine tuning the budget for 2023.
And if I could just ask a follow up there how do you feel about it.
The Capex is being $100 million next year.
I do see kind of an answer.
Current ratio touched.
Touched on that depending on what.
Kind of what you expect for two months or so.
How do you feel about the dividend.
<unk>.
Yes.
Ever since the merger back in 2018, we set a payout.
Payout ratio of about 75% I think every quarter since the merger we've been well below that so we've been very comfortable with our dividend.
We expect to see a little pressure on that with recurring capital and our lease explorations in 'twenty three but at where we sit today were comfortable with our dividend.
Thank you.
Yeah.
The next question comes from Michael Carroll with RBC capital markets. Please go ahead.
Ahead.
Yeah. Thanks, I'm, sorry, if I missed this but Matt in your prepared remarks, you talked about <unk> termination.
Termination fee can you remind us on and provide some color what that is driven.
Where was that related to.
Sure. So we knew about that when we gave guidance with with Q2 earnings for Q2, So that was factored into our range of $1 11 to $1 13 that we had provided but it was a tenant contraction in the <unk>.
Columbia, Maryland.
The tenant is likely to sign an eight year renewal, but they did give back about 50% of the space in exchange for a $2 $2 million termination fee.
Did they sign 98 year renewal or is that still under discussion. It has been signed I think subsequent to the quarter.
Okay.
And then.
Are there any other tenants within your portfolio that you are having discussions about termination options or our specific tenants that have approached us, saying that they're needing to downsize some of their space.
Not specifically I think you know.
Some of the larger ones that we have.
<unk> experienced over the last couple of quarters, where either.
You saw kind of the five downsize that hit Q1, which was much more strategic with respect to that redevelopment in Seattle from a timing perspective.
But other than that there's nothing material on the horizon.
We can speak to today.
Okay.
I know you talked about the no.
No new valves, so theyre going to occur towards the end of 2023, but what about the rest of 2023 lease explorations.
How have those discussions gone in and our tenants.
Do you feel confident that theyre going to renew or we're going to have some more move outs in the beginning of 'twenty three just don't know about them yet.
I mean look it's hard to say ultimately what will happen I think we'd like to think we have a pretty good indication on kind of what's going on at least in the near term, which which we've kind of alluded to somewhat.
I think right now kind of with the based on the breakdown I provided earlier, we've got about 7% that's unaccounted for with the majority of that really being kind of in the back half of the year I mean other than the 2% I noted late.
Later in the year, we have 60 basis points with the tenant.
That is expected to vacate at the end of Q2 next year and Thats a property that we're also we have in the market as part of our capital recycling, but outside of that it really just it's smaller tenants and it's just a function of kind of where conversations go with them. So again I think I think just kind of recap.
<unk>, we've got about 7% that we're still working on.
The balance I think we have a good indication of what's going on.
Okay, great. Thanks.
The next question comes from Bryan Maher with B Riley. Please go ahead.
Oh. Thanks, just just while we have you can you give us an update on leasing activity at 20 mass add in maybe early indications on what's going on with Seattle since we're less than a year out from those properties coming online now.
Good question, Brian So.
And we have about.
250000 square feet plus or minus.
Of activity between the two properties.
I would say for <unk>.
Seattle, Washington, we're pretty far down the road with a large user for.
Close to one for building of the three.
And so I think.
Hopefully we will be in a position, where we can talk about that kind of in the next couple of months.
And so that that would be kind of a life science user within one of those buildings that we're converting and we also have some other smaller and larger users across the portfolio that are executing across that property that are in various ranges of discussion and then for 'twenty mass AV you know as we've talked about our 54.
Our percent pre leased in that building.
And we've got kind of a range of tenant activity more early stages, I think with that property in specific.
<unk> completed the topping off all the projects.
Close the building.
So now we're kind of starting to see more tenants come to the table given that theres kind of a known indication on timing in the building having come together so.
We look forward to providing more updates on that property in the near term as well.
Okay. Thank you very much.
This concludes our question and answer session I would like to turn the conference back over to Chris <unk>, President and Chief operating officer for any closing remarks.
Thank you for joining the call.
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