Q3 2022 Office Properties Income Trust Earnings Call
Good morning, and welcome to the office properties income Trust third 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 Sir.
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 and.
In just a moment they will provide details about our business and our performance for the third 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 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.
These forward looking statements are based on Opi's beliefs and expectations as of today Friday October 28, 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 addition.
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 O P. I 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 <unk>.
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 impair.
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 third quarter earnings call for office properties income Trust.
We reported a solid third quarter, despite an evolving office landscape in a rapidly changing economic environment same.
Same property cash basis NOI growth came in near the high end of our range and we continue to experience strong leasing momentum our balance sheet remains well positioned with $629 million of total liquidity and no senior notes maturing until May 2024, which Matt will expand upon momentarily.
We completed 606000 square feet of new and renewal leasing, including a new lease for 84000 square feet to anchor our Seattle life Science development.
Portfolio occupancy continues to outperform the broader market and ended the quarter at 97%, a 130 basis point improvement over Q2, and a 170 basis point increase over the prior year.
During the quarter, we sold 10 properties containing one 3 million square feet for $118 million at a weighted average cap rate of approximately six 2% year to date dispositions totaled $196 million at a weighted average cap rate of six 8% and close to the high end of our 2022 guys.
This range further we have five properties totaling 338000 square feet for $20 $5 million in advanced stages with a targeted close by year end.
We plan to continue our capital recycling efforts into 2023 and are pleased with our ability to close on the noted transactions per day. However, we remain cautious given the overall economic environment Investor interest remains mixed with ascending pool of buyers due to higher inflation interest rates and changing portfolio strategy to date, we have not completed.
Any acquisitions with their primary focus on leasing operational efficiencies completion of our existing development projects and property sales.
Turning to an update on our leasing results, we reported a solid leasing momentum with 24 signed leases for 606000 square feet, including a 21, 6% weighted average roll up in rent and a 7.2 year weighted average lease term.
New leasing increased sequentially and represented 37% of our total activity for the quarter, including a 59% roll up in rent, primarily driven by leasing at our Seattle development.
At a macro level overall U S leasing activity is trending at just over 70% of pre pandemic level with gateway market trailing the pace of secondary growth markets.
Leasing demand is largely attributed to higher quality building those with market specific amenities and better functionality.
Over the past several years, our real estate and asset management teams have been instrumental in capital deployment strategies towards improving the quality of our portfolio, which has positioned our buildings to benefit from the current economic demand drivers.
Year to date, we completed over $1 8 million square feet of leasing with an 11% roll up in rent and a weighted average lease term of nine years.
New leasing included 585000 square feet or 32% of our activity to date.
Turning to leasing and property highlights from the third quarter.
At our redevelopment in Seattle, Washington, We signed a new lease with a clinical stage biotech company for 84000 square feet and a 10 year term. This lease is a strategic win as an anchor for the project and demonstrates the ongoing demand for premium well design R&D space in this market.
In Naperville, Illinois, we executed a new 57000 square foot lease at a 14, 5% roll up in rent and a 12 year lease term over the past year, our real estate team has strategically allocated capital to improve common areas and expand the amenity base, which has resulted in an increase in occupancy from 58% in Q4 two.
<unk> thousand 21% to 82% of the Q3 and supported by close to 145000 square feet of new leasing activity.
And in Atlanta, Georgia, we renew the mission critical GSA tenant for 91000 square feet and a 15 year term.
Looking back at the past few years, the GSA activity on average lease terms for new and renewal leases are 11 years and seven years, respectively, highlighting the GSA a commitment to properties within our portfolio.
Looking ahead to opioids upcoming lease expirations, we have minimal remaining lease explorations in 2022 with 80 basis points of annualized rental income expiring by year end of.
Of this 30 basis points is attributed to properties under contract for sale estimated for a Q4 close the balance of explorations are mostly expected to right now.
In 2023 lease expirations represent approximately 14% of annualized rental income.
Nearly 4% of our 2023 expiring rental income has either signed subsequent to quarter end or is in advanced stages of lease negotiations approximately 1% represents planned dispositions, including 60 basis points driven by an expected Q4 2022 sale of a property in Englewood, Colorado.
We are in active conversations with tenants that make up the remaining 2023 exploration and net known Vacates for the year are trending between three and 5% of annualized rental income.
It is worth noting that known Vacates in 2023 predominantly expire during Q3 and Q4 minimizing the risk to 2023 operating results.
I would also point out that in addition to our active asset management re leasing efforts and continued capital recycling initiatives select known Vacates are being evaluated for alternative use and strategies to further diversify our portfolio and capitalize a compelling value creation opportunities as seen with our D C and Seattle development projects.
Looking forward, our leasing pipeline remains strong with a healthy mix of new and renewal deals lease term and mark to market growth potential. We're currently tracking approximately three 2 million square feet of active prospects of which more than one 3 million square feet is attributable to new leasing and 720000 square feet of potential absorption.
Turning to our developments.
We continue to advance our value enhancing the redevelopment projects our development leasing pipeline includes over 223000 square feet of active proposals in Seattle, Washington. The project is now 28% pre leased and we anticipate the delivery of our move in ready spec space will further accelerate leasing at this project as we near completion.
Construction at our 20th math add redevelopment in Washington D. C is also all time and embarked on budget.
Our activity continues to progress and we remain on track to deliver both our Seattle D. C projects in Q2 2023.
In conclusion aggressive monetary policy inflation, along with the current interest rate environment are weighing on market fundamentals and decisions around real estate needs, which we believe will continue to be a factor in 2023, our capital recycling efforts focused on upgrading and enhancing the overall physical quality and functionality of our buildings along with refining.
Our geographical footprint as a further complement the level of tenant interest and activity across our portfolio.
As we progress on core initiatives, we remain focused on leasing operational efficiencies development and capital recycling and are pleased with our portfolio position, which includes 63% of our rental income coming from investment grade tenants. Our portfolio average lease term of six three years and a well positioned balance sheet I will now turn the call over to Matt.
To review our financial results.
Thanks, Chris and good morning, everyone normalized <unk> for the third quarter was $53 8 million.
Or $1 11 per share our results came in a penny below the low end of our guidance range, mainly driven by the timing of property dispositions.
Earlier this month, we declared our regular quarterly distribution of <unk> 55 per share, resulting in a normalized <unk> payout ratio of 50% and a rolling four quarter see a payout ratio of 67%.
G&A expense for the third quarter was $6 $6 million, which came in below our forecast and below the $7 $1 million in Q3 2021. After excluding the reversal of previously accrued business management incentive fees in the prior year period.
These declines were mainly driven by a reduction in our business management fee as our share price has declined and highlights how the fee structure in our business management agreement with RMR is aligned with OPI shareholders.
Same property cash basis, NOI increased 30 basis points compared to the third quarter of 2021 and came in at the high end of our guidance range. The.
The increase in our same property results was mainly driven by higher levels of free rent in the prior year, partially offset by increases in operating expenses from higher rates and usage to support higher building utilization levels.
Looking forward to our normalized <unk> and same property cash basis NOI expectations in the fourth quarter, we expect normalized <unk> to be between $1 eight and $1 10 per share.
The decline from Q3 is mainly driven by our Q3 dispositions and in August lease exploration in a submarket of Denver.
For the full year 2022, we expect normalized <unk> to be in the range of $4 71.
And $4 73 per share.
This guidance takes into account our planned disposition activity and includes a range of 24, 5% to $25 million of interest expense and five 6% to $6 million of G&A expense during the fourth quarter.
We expect same property cash basis, NOI to be flat to down 2% as compared to the fourth quarter of 2021.
Turning to the balance sheet, our balance sheet remains well positioned in the current rising interest rate environment. The $1 1 billion of fixed rate refinancings that we completed in 2021 provided us out solid foundation for us to deliver on our operating and redevelopment priorities at quarter end, we had $2 $4 billion of outstanding debt.
Debt at a weighted average interest rate below 4% and a weighted average maturity over five years, 97% of our debt is unsecured and 94% is fixed.
As a reminder, the company does not have any variable rate debt. Besides the revolving credit facility and our near term maturity schedule is light with only $50 million of mortgage debt due in mid 2023.
We have no senior notes maturing until May 2024.
While our revolver matures at the end of January 2023, we have the option to extend the facility for two additional six month periods and expect to exercise our first extension option next month.
We ended the quarter with $629 million of total liquidity, including $615 million of availability under our revolver subsequent to quarter end, we repaid a four 8% mortgage with a June 2023 maturity at a discounted amount of $22 2 million using cash on hand, making this an accretive transaction.
Action.
We are currently under agreement to sell by properties containing 338000 square feet for an aggregate sales price of $25 million.
We spent $25 9 million on recurring capital and $36 $8 million on redevelopment capital during the third quarter for the full year, we expect recurring capital expenditures of approximately $100 million.
In redevelopment capital of approximately $180 million.
In 2023, we anticipate recurring capital expenditures to be flat year over year and redevelopment spend of approximately $100 million to $120 million as we complete our two ongoing redevelopment projects in Washington D C and Seattle.
Operator that concludes our prepared remarks, we're ready to open the call up for questions.
Thank you.
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Today's first question comes from Bryan Maher with B Riley FBR. Please go ahead.
Good morning, Chris and Matt just a couple for me.
We were surprised by the 10 asset sales for sure in <unk> and I think that you mentioned that the buyer pool is Denny can you give us.
What your level of confidence is closing on the five that you talked about and what your outlook is for kind of a number of properties for 2023 and the ability to close on that.
Yeah. Thanks, Brian .
Thank for the balance for the dispositions that we've kind of noted in our prepared remarks, I think we feel pretty confident about those closing those are really been advanced stages under Psa or LOI and so at this at this stage. There is no reason to believe that they won't be able to close.
In Q4, and maybe in the turn of the year.
For 2023.
We've talked about you know a couple of quarters ago, we pulled back on some dispositions just to kind of.
See what the market's going again, we're in a position where we can be disciplined and don't have to sell.
And so right now we're working through kind of what that list looks like.
To then determine what we want to put out in 2023. So I don't know that we have a determined list of assets specifically a remains fluid, but I would say that we've talked about kind of re upping on dispositions and continuing where we slowed down this year, which was in the neighborhood of $300 million and so I think it is.
Be very ebb and flow just as we watch kind of where the market goes.
And maybe a two part question I think your leverage is around seven times or so currently you know where do you want to take that and given the cash that you're going to receive from these asset sales and how do you think about that.
Weighing capital in 2023.
If the transaction market gets as tight as we're currently hearing generally across all of our covered companies you know might you expect to see.
See some opportunity to act upon giving you our strong balance sheet.
Mike those look like maybe from a type of asset and maybe geographic location.
Hey, Brian This is Matt I'll start on the leverage question and turn it to Chris on.
Capital use for potential acquisitions leverage seven times at Q3 looking at a trailing 12 month EBITDA base.
We want leverage to get back in that six to six five times right. We've been investment grade rated and we want to remain investment grade rated.
That is our focus as it relates to leverage in our overall target.
We are comfortable where leverage is today and running the business. This way, but we do want to see that tick down over time.
Yeah and for acquisitions I mean, you know as we've discussed our focus is more so on just completing our development leasing and other related operational items.
But I mean, I think in general I mean, there's a handful of different markets. We like we like kind of the southeast we like the Pacific Northwest.
And it's just really going to depend on the opportunities there.
We see what we generally see just about everything that's out there and it's there hasn't been a lot of activity with opportunities, but I think it's safe to say that cap rates are widening.
And as opportunities present themselves, we'll see them it will be in a good opportunity or in a good position to kind of execute on that strategy, but I.
I think as we get into the turn of the year and kind of see where things shake out again with our capital recycling and other initiatives. We will then be in a position to kind of better quantify what that might look like.
Okay. Thanks, and then maybe just last for me I mean, clearly where the shares are trading in the <unk>.
15% yield on the dividend obviously, there's people out there in the market you don't believe that that dividend is sustainable and yet you continue to highlight the low payout ratio either on cat are on SSL.
What world would be have to be in.
Or do you envision.
Where that dividend.
Sustainable.
Yes, Brian it's a good question and I'm glad you highlighted a low payout ratio, we've had which has really been a constant since the merger at the end of 2018, So we've been very satisfied with our dividend coverage and level.
I think as it relates to dividend coverage in the future and any risk to that it really is going to be upon factors outside of our control with the future of office.
And any potential recession, but where we are today, we remain very comfortable with our dividend.
Yeah. Thank you.
Ladies and gentlemen, as a reminder, if you'd like to ask a question. Please press Star then one our next question comes from Ronald Camden with Morgan Stanley . Please go ahead.
Hey, you got to me I'm on for Ronald.
Wanted to follow up on some of the development you guys expect to complete next year could you walk us through kind of like the cash and the.
And the GAAP NOI you expect from those two developments.
Completion.
Yeah, I mean, I think I'm.
Right now just as a reminder.
Four we will start with 20th mass Av.
We have a kind of a kind of a cash on cash stabilized return projection of between eight and 10% and so you can kind of use that as a good barometer with what would respect for kind of cash yields.
And then I think for Seattle.
We're currently targeting 10% to 12%.
With respect to that asset and so that's a good barometer with respect to cash.
Cash yields I mean, I think from a GAAP perspective, its going to depend a lot on what those lease terms look like as things shake out and what I mean by that is when you look at.
You know Seattle is a good example, where we just signed the lease.
You know that we referenced.
Our script you know the GAAP roll up there was a 109% increase.
Albeit with a conversion to kind of life science.
And that was a 10 year term, but what we're also doing in that project.
As we're doing spec deliverable spec suites, and we would expect that the terms at that location with very just depending on the circumstances and so that would have an impact on the overall GAAP aspects. So it's a bit of a moving target.
And just to follow up on that I mean, do you expect any cash contribution from either of those properties next year.
Yeah.
Our cash contribution from the assets I mean, we'll be more in the form of.
Mitigating some of the loss is coming with the carrying costs.
On the expense side and so.
From a timing perspective.
You know we have the lease signed at 20 mass Av representing 54% of the project.
And that's you know that's they're scheduled to take occupancy in Q2, but there is a free rent period that goes with that as.
As part of that free rent, they're going to pay other proration of operating expenses that will mitigate any cash drag.
As part of that and then same with Seattle.
While we're excited about signing a lease with Seattle Theres, a timing for tenant improvements and prep to get into the space and so we don't think they'll physically occupy the space until Q4 of 2023 and at that point in time.
Some free rent upfront, but the same story on the full building or the majority of the building.
We'll mitigate the cash drag given that they'll pay opex until they pay full rent at the turn of the year.
Got it that makes sense and then just on some of the the debt maturities that are coming up over the next couple of years.
How are you thinking about that a chance you pay down the debt with the dispositions that may come or you're.
Your plan right now just to refinance most of that.
Yes, we're in a very good position right now with our balance sheet, we have $50 million of mortgages that are maturing in mid 2023 will likely use cash on hand, and our line of credit to pay those off and then our next maturity isn't until May of 2024. So we have plenty of time to.
To be watching the market.
But right now we're not going to try to accelerate paying off those 'twenty for us is a good in place rate and what kind of see the market settle and we have plenty of liquidity.
In the meantime.
Great. Thank you guys.
Thank you.
Thank you.
Gentlemen.
Question today comes from DB.
But trauma with RBC. Please go ahead.
Hi, good morning, I'm, sorry, if I missed this in the beginning but can you give us a quick update on the leasing you can get.
Right now.
The leasing activity you know as I mentioned in the prepared remarks, we have a couple of hundred thousand square feet.
Between the two projects just shy of 100000 square feet is attributable to 20 mass Av and when we talk about lease activity. It's more in the form of a proposal stage and so in addition to that number there is the benefit of the tours that are coming through the property and so.
You know nothing far enough along.
To kind of speak to with respect to definitive timing, but I think on the positive we're seeing kind of an increase in tours now that we're nearing completion and are starting to kind of trade more proposal. So you know everything is trending in the right direction.
Okay. Thank you.
Okay.
Ladies and gentlemen, this concludes our question and answer session I would like to turn the conference back over to Chris Blotto for any closing remarks. Thank.
Thank you for joining us for your interest in OPI and we look forward to speaking with you again soon.
Thank you ladies and gentlemen. This concludes today's conference call. We thank you all for attending today's presentation.
Now disconnect your lines and have a wonderful day.