Q2 2022 City Office REIT Inc Earnings Call

Contrasting this to our stock buyback, we purchased our own portfolio at a blended $221 per foot, including our three most recent acquisitions, which should be more equivalent to premium new construction today.

As we navigate the noise in the office sector and the markets broadly we will continue to focus on creative ways to unlock value and grow cash flow.

This approach has served us well and has led us to achieve the second highest total shareholder return in the office sector since our IPO in 2014 second only to Alexandria real estate.

I look forward to updating you further next quarter and we'll hand, the call over to Tony <unk> to discuss our financial results.

Thanks, Jamie.

Income in the second quarter was $28 7 million, which was 300000 higher than them.

Amount reported in the first quarter.

This is primarily a result of the increased income generated by the properties in first generation lease up that were acquired in the fourth quarter of 2021 as tenants take occupancy at those newly developed properties.

For instance block 23 in Phoenix, which started the year at 62% occupancy was 94% occupied at the end of the quarter.

While operating expenses have seen increases as a result of inflation and various categories. The impact on net operating income was muted as recoveries, mostly offset their impact.

We reported <unk> of $17 6 million or <unk> 40 per share, which was equal to the amount we reported in the first quarter. The increase in net operating income was offset by slightly higher interest costs on our credit facility.

Our second quarter, <unk> was $8 million or <unk> 18 per share the largest single item to impact <unk> was $1 million of tenant improvement expenses related to the new 73000 square foot tenant at our park tower property, which took occupancy during the quarter.

As Jimmy mentioned, 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 spec suites, and the second quarter was 700000.

Last we also completed the property upgrade project at our 190 Office Center property in Dallas, which Jamie just discussed that investment during the quarter was 400000, completing the $2 $1 million upgrade.

Moving on to some of our operational metrics are second quarter same store cash NOI change was in line with our expectations at negative seven 1% or $1 $5 million lower as compared to the second quarter of 2021 second.

Second quarter same store cash NOI was impacted by lower occupancy year over year and free rent periods associated with new leases contributing 500000 to that decrease BB&T vacated their space at park tower during the third quarter of 2021 to accommodate the new 73000 square foot tenant the new tenants lease commenced on May <unk> 2002.

Two but will not begin paying cash rent until February 2023 that new tenants eight year lease increased the value of the property, but the downtime and free rent period is a significant contributor to our negative Q2 same store results.

Further decreases are attributable to scheduled to free rent periods at our superior point and FRP collection properties. As a result of recent lease renewals. We expect same store cash NOI results in the remaining quarters of the year will improve as these free rent periods burn off.

Our total debt at June 30 was $654 million or.

Our net debt, including restricted cash to EBITDA was a healthy five eight times.

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

Our debt is primarily fixed rate.

Restricted cash was elevated at quarter end as we held the net proceeds from the Lake Vista point sale and a 10 31 eligible restricted cash account subsequent to quarter end. The net proceeds of $25 6 million of restricted cash were released and applied against our line of credit.

Last we have provided updated guidance in our earnings press release, there are several pluses and minuses. The net effect of which is a slight decrease in the midpoint of <unk> per share guidance for the year.

First we are anticipating higher interest rates on our floating rate credit facility for the balance of the year.

Second while we had healthy quarter leasing we are reducing the expected 2022 income derived from new leasing assumptions that were included in our prior guidance, we still expect to make leasing progress through the balance of the year, especially a block <unk> three in Raleigh, and our spec suites, but we now forecast an income or more likely commence in 2023.

But in the fourth quarter of this year.

These same leasing related factors that impacted our core <unk> per share range are the same factors that led us to adjust occupancy guidance.

Offsetting part of the downward impact from guidance is the positive accretion generated by the share buyback program <unk>.

During the quarter and subsequent to quarter end, we completed $30 million of share repurchases of the $50 million that our board is currently authorized.

That concludes our prepared remarks, and we'll open up the line for questions operator.

Thank you. So if you would like to ask a question. Please press star followed by one telephone keypad now if you change your mind. Please press star followed by two web preference. So ask your question. Please ensure your phone on.

Muted locally.

First question comes from Michael Carroll from RBC. Please go ahead Michael.

Yeah. Thanks, Jamie the larger move outs that you mentioned that you expect over the next 12 months is that mostly the previously announced tenants that we've been talking about for the past few quarters now, including this health care company in Dallas too.

Hey, Good morning, Mike. This is Tony here I can I can take that question. So I can just break it down for you. So.

Over the next four quarters, we have roughly 850000 square feet rolling.

Of that total we do have five tenants that are greater than 30000 square feet that are known Vacates. We have discussed three of these on previous calls.

To take you through those so one is Toyota they're vacating 133000 square feet at the end of this month tight.

Title company at our Pima property is downsizing by 61000 square feet in October of this year and we have a 10% to 50 90, who is vacating 49000 square feet at December 31, 2022. So all of those have previously been discussed.

Adding to those as the one in the health care company that Jamie just spoke about a 190 there'll be downsized by 130000 square feet and then we have one other tenant.

<unk> 3000 square feet and Thats also a 190 center there'll be vacating 44000 square feet at March 31, 2023.

One other thing I just wanted to highlight is offsetting these known move outs, we do have signed.

292000 square feet of new leases that will be taking occupancy over the next year, which includes at 49000 square foot tenant at 190 Center completed after quarter end, which will help offset these known vacates.

Okay, Great and then Tony I know what does the term fee and <unk>, what did that relate to and I believe that the new guidance range includes the bigger.

Term fees in the prior guidance range can you kind of talk about that a little bit.

And thanks for that question Mike.

Create the opportunity to sort of explain that so the single largest item in our termination fee income continues to relate to that Toyota lease and so just to review that we announced in 2021 last year that Toyota paid us a total of $3 8 million and that we would amortize that until they depart at the end of August of this year at the <unk>.

We announced that we would amortize $2 million in 2021, and a further $1 8 million was scheduled to be amortized in 2022 until they are scheduled departure at the time, we published our guidance in February we announced an additional $1 million of termination fee.

So really the total number that we that we were anticipating was two eight at the beginning of the year and therefore the change in guidance for this quarter is an additional 600000 and.

And that relates to that tenant at 190 office property, which I, which I mentioned 44000 square feet.

Who've exercise a termination option.

In March and they are expected to vacate in March of 2023, So I hope that kind of clears that up.

No. That's very helpful and then related to the share repurchase program I mean, how should we think about.

I guess I guess future activity under that I mean is it going to really depend on your ability to sell assets within your portfolio to kind of continue to fund repurchases is that how we should think about it.

So we have 20 million remaining that's authorized.

And our own view is we're trading at a major discount to what real estate is worth and so we're going to continue to reassess that and we will be using cash in the line I mean basically today the bulk of it has been funded from.

Lake Vista sale, but when we look at our own portfolio and using the average price of $13 11 were basically buying an incredible portfolio at around an eight cap and $221 a foot.

Just can't buy anywhere near comparable real estate at that metrics.

And so we're going to continue to reassess as we go into the fall and.

We'll we'll see versus alternatives and where our prices and we will report back on where we land.

Great and I know Jim there was other asset sales that you were kind of contemplating within the portfolio are you still looking at some of those right now.

Yes, I mean, we're constantly looking at our own portfolio, what we can do to create value held best to position assets Theres nothing.

Imminent today I don't think today would be a great time to be trying to monetize some assets I think what we've really tried to do.

As laid out in our Investor presentation. There is a new slide slide eight that really talks about how do we create value and this applies to our core portfolio and it's also going to apply to some assets that we may want to dispose over the next few years and it's really how do we best position those properties.

Capital that we can put into it to drive leasing and ultimately create value for our investors and so across our portfolio. What we're seeing today is the best assets. The premier properties are getting the most leasing interest.

And youre getting excellent rental rates and so that side of the market is great that covers a large portion of our properties. We do have a number of assets that are.

A little bit older, but in great condition, and fabulous locations and our experience is you can put capital into it.

Have a feeling that when a tenant or a prospective tenant walks through the door. It ticks all the boxes. It is a fabulous lobby, it's got an incredible fitness facility outdoor space all the things that tenants want and you can offer those products and great locations at a big discount to what the double a buildings are and we think that.

Strategy makes all the sense in the world and so that's a big focus for US we're going to do that we've talked about certain properties that will benefit from that and over the next few years. Some of those assets may be candidates to dispose of but we think will create incremental value by doing that.

Okay, great. Thank you.

Thanks for the questions.

Our next question comes from Rob Stevenson from Janney. Please go ahead. Your line is now open.

Hey, good morning, guys.

You talked about the spend on the spec suites in the second quarter.

Spend on that business in terms of per square foot cost. What are you guys on average, it's probably differs by market, but what are you guys on average spending per square foot.

Build out of spec suites.

Yeah I'll answer that.

So basically it really to your point it depends on the condition of the space Youre getting back but on average it's anywhere from.

$40, a foot to $60 a foot some might be a little bit higher depending on the condition and some are lower depending on the condition. What we're finding though is when you build out suites and you're opening up the ceilings.

Youre, creating really cool modern space lots of glass Polish concrete the cost is a little higher but when the lease comes due.

And if you have to backfill it it's very economical to backfill at the floors are already polished concrete ceiling has already opened and so it is changing some color. So we've found.

<unk>, particularly in the first roll or two of those spends even though they're a bit higher upfront, it's far more economical long term.

Okay and then what are you spending you talked about the the other type of improvements that youre doing the sort of.

Improved space or I forget what your terminology was where it wasn't the spec suites, but it was the other what are you guys spending per square foot.

To do that type of building.

So right now the one example that we highlighted on the call was our 190 center and if you have a chance slide nine in our presentation kind of shows before and after and when you go into this space.

Lobby looked good before it looks like a brand new building today when you go into it and then write off the lobby you've got spectacular built out tenant suites and incredible fitness facility I wish the pictures that we've put in here.

Did justice to it and we just we haven't done the professional photography, yet incredible conference room tied into foodservice.

In particular building has been a slow sub market and so doing this we have immediately seen the tour activity.

Pick up and we've already done two sizable lease deals and so.

That was a modest $2 $1 million seven Bucks a foot I'd say in some cases, it's going to be around that range or a little more in a few other cases, we think it could be above that but we're going to get a much bigger payoff in the rent differential and so I think thats probably on average.

Good number with something a little higher and some being a little lower.

Where we're at for the bulk of these were really focusing in on nailing. The plans and we spent a lot of time with our design team are Fabulous, we think we pretty much are getting there and now we're going to bid and value engineer. So I can't quote exactly where we are yet.

But it will it should be in that range. The only other thing I will add to that Rob is on the call. I think you may have referenced the when we talk about vacancy conditioning or space conditioning or at least up some space and thats typically kind of equivalent to what we've heard often referred to as white boxing and thats a much lower cost.

12 to $15 a square foot.

Okay. That's helpful and then last one from me.

The $2 54.

Square feet of leases that you guys signed when do the bulk of that.

Start.

Producing revenue for commencing.

So it's really staggered over the next.

Number of quarters pretty equally.

I'd have to go and look but it's equally stagger over the next four quarters.

Okay and is there any big quarters coming up from previous quarter signage.

It's where it's abnormal or is it fairly smooth when we go back and look at the first quarter signings etcetera or is there anything big coming up in terms of third or fourth quarter first quarter of next year.

In terms of the lease commencement.

Sure to focus on one property and specifically if you look at our new acquisition in Raleigh.

We expect that the vacant the occupancy in that property will move into the <unk> by Q4, So youll see a movement in that property specifically.

That's a significant amount of the increases.

Okay perfect. Thanks, guys appreciate the time.

Youre welcome.

Our next question comes from Craig Kucera from <unk> Securities. Please go ahead Craig.

Yeah, Hey, good morning, guys.

You mentioned some changes in your leasing assumptions during the back half of this year and I'd be curious are there are there any particular markets that are maybe running a little slower than you had expected or is it a little bit more broad based.

I'd say, it's more broad base I mean, the return to office. When we went back to our original assumptions was starting to pick up and I'd say, we've seen definitely an improvement in our own utilization is kind of in the in the mid <unk> in the summer, which which actually mean.

It means it should be a fair bit higher than that right thats kind of peak vacation time, and we're still in the mid <unk>. So we think it's going to continue to pick up through the balance of the year and talking to our tenants.

We're seeing good thoughts on returning back in the fall. So we're feeling good about that but as far as getting leases inked it's been a little slower than we initially thought and we we thought Q4 would pick up a little bit more and we're pushing some of those based on our latest discussions into early next year.

But I would say it's broadly spread.

Got it and just kind of circling back to your comments on kind of pushing things a little bit into 2023 is that our tenants now requiring more more free rent or is it just the period that they are ready to start and take occupancy.

From their perspective.

Yes, I don't think really metrics have changed that much I mean construction costs. We're elevating the tis were going up has leveled off a little bit I would say recently, so we're feeling better their free rent still a little elevated from where it's been historically that really hasnt changed so it's really a function of.

Getting lease discussions across the finish line and then looking at the buildup time to get people in it's going to push into next year and probably a number of cases.

Okay. Thanks for the color.

Our pleasure.

Today's Q&A session is keen to then I'm going to hand, it back to Jamie for any final remarks.

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

This concludes today's call. Thank you for joining you may now disconnect your lines.

Okay.