Q4 2022 City Office REIT Inc Earnings Call

Yeah.

Good morning, and well clearly to the city office REIT, Inc.

Fourth quarter 2022 earnings conference call at this time, all participants are in a listen only mode.

Brief question and answer session will follow the formal presentation to ask a question you May Press Star then one on your touch Titan side, if youre using a speakerphone. Please pick up your handset before pressing the keys to withdraw your question. Please press Star then two.

Reminder, this conference call is being recorded if you require operator assistance. Please press Star then zero and it is now my pleasure to introduce you to Tony <unk>, The company's Chief Financial Officer, Treasurer, and corporate Secretary. Thank you. Mr. <unk> you may now begin.

Good morning, before we begin I would like to direct you to our website at <unk> Dot Com, where you can view, our fourth quarter earnings press release, and supplemental information package. The earnings release and supplemental package. Both include a reconciliation of non-GAAP measures that will be discussed today to their most.

Directly comparable GAAP financial measures.

Statements made today to discuss the company's beliefs or expectations or that are not based on historical fact may constitute forward looking statements within the meaning of the federal securities laws.

While the company believes that these expectations reflected in such forward looking statements are based upon reasonable assumptions. We can give no assurance that these expectations will be achieved please see the forward looking statements disclaimer in our first quarter earnings press release, and the company's filings with the SEC for factors that could cause material differences between forward looking.

And actual results the company takes no obligation to update any forward looking statements that may be made in the course of this call.

I will review our financial results after Jamie Farrar, our Chief Executive Officer discusses some of the quarters operational highlights I will now turn the call over to Jamie.

Good morning, and thanks for joining today.

To start our call I'll provide a brief summary of our 2022 key accomplishments and then focus on where the company is headed in 2023.

In 2022, we achieved the highest annual core <unk> per share in the company's history.

The dollar 57 per share that we recorded was a 15% increase over the prior year.

The main driver of this increase with integrating and stabilizing the 975000 square feet of acquisitions in Raleigh, Phoenix and Dallas that we completed in December 2021.

These three newly constructed highly <unk> properties are performing very well.

Our 90% occupied and have a weighted average lease term remaining of approximately 10 years.

Also contributing to our strong core <unk> per share performance in 2022 was the completion of our share repurchase program.

We invested $50 million at.

At an average price of $12 48 per share, which was accretive to both earnings per share and net asset value per share.

Another highlight of 2022 was the closing of the sale of our Lake Vista Pointe property in Dallas, which generated a $22 million gain.

On the operational side, we completed approximately 800000 square feet.

New and renewable leases throughout the year with 108000 square feet of that amount occurring in the fourth quarter.

Our specialty program also had a positive impact on leasing.

During 2022, we signed new leases for 93000 square feet of spec suites.

We also signed new leases for 82000 square feet of space, where we had completed vacancy conditioning.

We started to benefit from the investment in this program, but the full extent will be realized overtime as suites are leased and free rent burns off.

And one last note on recent events before we move to our 2023 strategy I'm pleased to report that we announced today is a planned succession changes within our core.

John Sweet Who's been an independent director since 2017 has become the chairman of the board John's contributions to our company.

Extensive industry knowledge base and his prior leadership of a public company board make him an excellent fit as our chairman.

He assumed the position for John .

We will continue as an independent director John Mclaren has been our outstanding chairman since our IPO in 2014.

We're grateful to both of these terrific directors for their continued service to our company.

Additionally, we announced that Michael <unk> has been appointed to the board Mike highly experienced with 30 years as a private equity investor investment banker and management consulting.

Michael also brings an extensive finance and governance background, having previously served on 12 boards throughout his career, we look forward to Mike's involved.

And last we announced will flat has stepped down from the board. After nearly 10 years of service dating back to our IPO.

We will contribute the dimensionally the company over that time period and wed like to express our deepest. Thanks for is positive and thoughtful impact on our company.

Now moving to 2023 and beyond we continue to benefit from the tailwind associated with our sunbelt focus portfolio.

We're population employment and office occupancy trends are outperforming.

Counter balancing this are the challenges our industry has been facing including rapidly rising interest rates.

Wallace our conditions in the capital markets and headwinds across the office industry.

We spent a considerable amount of time formulating an approach to best position ourselves for strong performance of <unk>.

Planning continues to balanced caution and strategic initiatives.

To that end the layout of our focus areas for 2023, and how we expect that these steps will position us.

An important way for us to create long term value is to grow quality net operating income at the property level, we intend to achieve this primarily by completing select renovations and building ready to lease spec suites, both of which we believe optimize their leasing potential and have long term cash.

Flow benefits.

Specifically, we currently have 18000 square feet of spec suites, and our inventory and over 150000 square feet of spec suites under construction or planned for 2023.

We're also advancing significant renovations at our San Tan and Pima Center properties in Phoenix.

As we believe these investments will drive leasing.

On a related note our Pima center buildings in Scottsdale are set to benefit from a new $80 million of entertainment development called the Sydney, which is directly adjacent to our properties.

This development recently broke ground and is slated to provide a number of walkable restaurants bars and entertainment venues that will greatly enhance pima centers amenity offering.

It's an ideal time for us to launch the Pima Center renovation and we've already experienced a pickup in leasing activity with approximately 17000 square feet leased so far in 2023.

Another important element of our strategic plan selectively pruning our portfolio to optimize the alignment with today's leasing trends and what we believe are the leasing trends in the future.

We've identified approximately 900000 square feet of our portfolio that we are targeting to divest over the next few years.

This amount could fluctuate up or down depending on opportunities and market conditions.

Our guidance reflects a portion of this occurring in 2023 with a range of dispositions assumed to be between $25 million and $75 million.

These noncore dispositions when they occur will benefit our already strong liquidity and leverage profile.

And then his balance sheet will position us to take advantage of future opportunities that drive shareholder value.

So in summary, we will continue to operate with caution while focusing on strategic positioning.

This plan will help to maintain a fabulous core portfolio lower overall leverage and enhance our dry powder to take advantage of future opportunities.

Given our outlook on our portfolio and strategy.

We are not at all satisfied with our current stock price, which we believe is a major discount to the inherent value of our company.

As one data point recall in December of 2021, we sold our life science portfolio in San Diego for $576 million, which generated a $429 million gain.

We have reinvested those proceeds into $614 million.

Best in class properties in the top Submarkets of Raleigh, Phoenix and Dallas.

The aggregate purchase price of these transactions equated to about $14 per share at the time and were closed without property level debt.

The magnitude of these acquisitions as compared to the size of our company significantly raised the quality of our portfolio as a whole while reducing risk.

Despite challenging capital markets. This.

While premium asset is exactly what investors continued to desire today.

We don't believe that these considerations are reflected in our current stock price.

We look forward, we believe that we've carved out an attractive niche premium sendoff properties and Thats, a proactive steps outlined earlier will help unlock value and close the share price gap.

I look forward to providing further updates on these initiatives and we'll hand, the call over to Tony <unk> to discuss our financial results and our 2023 guidance.

Thanks, Jamie.

Net operating income in the fourth quarter was $27 6 million, which is 500000 lower than the amount we reported in the third quarter.

This decrease is primarily a result of the departure of Toyota from our Santana property in Phoenix in the middle of the third quarter.

While operating expenses have increased as a result of inflation and various categories. The impact on net operating income has been muted as recoveries, mostly offset this impact.

We reported core <unk> of $15 4 million or <unk> 38 per share, which was $1 $1 million lower than in the third quarter. The.

The drivers of that decrease were primarily lower net operating income at our same time property due to Toyota vacate.

Along with higher interest rates on our floating rate credit facility.

Our fourth quarter, <unk> was $5 million or <unk> 12 per share.

The largest single item to impact April was 700000 of tenant improvement expenses related to a 13000 square foot new tenants at our circle point property in Denver, whose lease commenced in January 2023.

As Jamie mentioned, we also continue to invest in building out ready to lease spec suites and implementing vacancy conditioning, which is a key part of our business plan.

The total investment in spec suites and vacancy conditioning in the fourth quarter was $1 4 million or <unk> <unk> per share.

During the quarter, we recorded a noncash impairment of real estate charge of $13 4 million.

This represents a write down of the book values of two of our properties to their estimated fair market values.

Those two properties were 190 office center in Dallas.

And Cascade station Portland.

The combined 430000 square feet of these two properties represents approximately half of the anticipated selective pruning of noncore assets that Jamie described.

We are considering all of our options at those two properties, both of which advantageously have property level nonrecourse debt.

For 190 Office Center in particular, our best strategic option may be to transfer the property to the lender given our view of the value of the asset relative to its loan balance.

That will eliminate approximately $39 million of debt and we anticipate would also have a positive impact on near term core FIFO as interest costs for that property are expected to exceed the property's NOI.

Moving on to some of our operational metrics are fourth quarter same store cash NOI change was in line with our expectations at negative one, 2% or 200000, lower as compared to the fourth quarter of 2021.

Fourth quarter same store cash NOI was impacted by free rent periods associated with new leases at a number of our properties.

Our total debt as of December 31 was $690 million.

Our net debt, including restricted cash to EBITDA was six four times.

I have two small maturities in the fall of 2023.

Both of these loans are secured by high quality properties at relatively low leverage levels.

Completing a refinancing later in the year.

As far as our liquidity as of December 31, we had over $95 million of Undrawn availability on our credit facility.

We also had cash and restricted cash of $44 million as of quarter end, along with highly financeable unencumbered properties as an additional source of liquidity.

Subsequent to quarter end, we executed two debt related transactions, which enhance liquidity reduce our exposure to interest rate fluctuations and give us better visibility into our future earnings.

First we expanded our credit facility by $25 million by entering into a new three year term loan.

We entered into a swap that fixed the term loan interest rate at five 9% and use the term loan proceeds to reduce the floating rate portion of our credit facility.

Second we fixed the majority of our floating rate credit facility at five 6% by executing a $140 million interest rate swap.

After the swap transactions over 90% of our total debt is effectively fixed as of today.

Moving to guidance, we have provided full year 2023 guidance in our press release, our guidance is reflective of the 2023 strategic business plan that Jamie outlined.

We are projecting core <unk> of.

The $1 38 to $1 43 per share at the midpoint that would represent a 16 cents per share decline as compared to our 2022 results.

Approximately <unk> of the projected 16 decrease as our expectation of higher interest expense year over year.

The completion of our recent swap transactions will help mitigate the potential impacts from further movements in the federal funds rate.

The balance of the decrease is primarily attributable to expected net dispositions during the year, which will result in operating with lower leverage we assumed property dispositions between 25 and $75 million for the year with no acquisitions.

We expect that our same store cash NOI will grow between a positive two and 4% in 2023.

The three acquisitions, which we closed in December 2021 will be added to the pool beginning in 2023.

Our occupancy guidance reflects relatively flat occupancy throughout the year.

We also anticipate continuing to invest in vacancy conditioning and building out high quality spec suites, we expect <unk> will be impacted by up to $10 million. If we are successful in completing all of that we have planned for 2023.

We believe these investments will drive earnings growth, primarily commencing in 2024 and beyond we refer you to the material assumptions and considerations set forth in our earnings press release for further details.

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

As a reminder, if you'd like to ask a question you compress star one on your telephone keypad.

Patrick a question you May press star two.

Please ensure you're on mute locally when asking your question.

First question for today comes from Robert Stevenson from Janney. Your line is now open. Please go ahead.

Hi, good morning, guys.

Tony just on that last point, when you said that <unk> could be impacted by $10 million is that versus 2022 or is that just in general.

Good morning, Rob.

So that is in total for 2023, which is higher than what we spent in 2022 and we spent about $1 3 million in Q4 and that was pretty typical of what we are spending we are ramping up the program. So it is a significant increase year over year, but it is the total.

Okay. So I guess in aggregate I mean, you guys between on the <unk> line between the tenant improvements instead of leasing commissions and recurring capex at about $35 million in 'twenty, two how should we be thinking given those comments.

What that number sort of looks like.

Yes.

Within reason for 2023, given your plans for the remainder of the year.

Yeah. So obviously a lot of that will depend on leasing activity.

So.

A lot of that is hard to predict for the later part of the year, but what I can say is we are spending more on spec suites and the spec suites and vacancy conditioning ramping up that program as we just talked about capital expenditures.

We're going to be really in line of what we've been spending the last couple of quarters, maybe even a little bit more as well.

Adam entities at the properties, and then again Ti and leasing commissions will depend on leasing activity.

Okay and then.

What's the how are you guys thinking about the sort of ebbs.

Ebbs and flows of occupancy throughout the year, given the explorations known move outs et cetera. You ended at like 86, two the guidance is 85% to 87% so.

Midpoint is right, where you sort of ended.

Two other quarters, where you expect to have sort of peaks and troughs occupancy wise throughout the year or is it all going to be sort of one washes out the other and it sort of remains sort of in.

That band pretty narrowly throughout the year, how should we think about that.

Yes, I think the best way to think about it is the latter what you just suggested.

It's going to move within that band and kind of maybe bottom out at the bottom end of the range around expecting significant spikes in either direction.

If you look at we've discussed this a number of move outs that we have coming in the year, but we also have 167000 square feet of new leases at December 31st which will be taking occupancy over the year. So they do balance each other out.

Okay, and then the 2% to 4% same store NOI growth.

Is that.

What's the sort of breakdown there in terms of what you expect it to be driven by occupancy versus rental rate on renewals et cetera.

It was mostly occupancy gains.

It's a mixture of both I mean, a lot of again will be coming from the acquisitions that we did in December of 2021, those three properties that are being added to the same store pool.

And that number is a cash basis.

And many of those leases that took occupancy during 2022 of free rent periods.

So a lot of the increase is being driven from those three properties from the burn off of free rent.

Alright, and then just one last one from me Jamie How's the board thinking about the common dividend today, given the 100% plus <unk> payout ratio, but a sub 60% <unk> payout ratio is the view more that this is a temporary point in time thing and you'll be able to grow out of it or more of a secular thing thats going to eventually need to.

Addressed.

Yes, I think.

The position we're in pretty much the same as when we had the discussion last quarter. So were completely comfortable with the level of dividend that we're at today.

But the board is reflecting on challenging operating conditions, and we are having a thoughtful dividends each quarter and assessing a number of things the impact of interest rates overall conditions on the business. So.

I think the repeat we're comfortable with the dividend level today, but we don't have a crystal ball on future operating conditions, and we're going to pragmatically to look at it each quarter until we're at a point of being fully covered.

Okay. Thanks, guys I appreciate the time.

Thanks, Rob.

As a reminder, if <unk> like to ask a question star one on your telephone keypad.

Our next question comes from Craig <unk> from.

<unk> Securities your.

Your line is now open. Please go ahead.

Yeah, Hey, good morning, guys.

Apologize if I missed this theres quite a few calls going on right now, but I just wanted to go back to your Capex kind of budget and expectations for 'twenty three.

Tony I think you thought you were or Jamie I should say I think you thought you maybe would spend $5 million to $10 million.

And in a couple million dollars at Pima, but kind of what is your all in sort of breakout between some of those.

More in depth projects as well as the spec suites for 'twenty three.

Okay.

So I can address some of those some of those comments Craig. So if we look at 2023 Pima as you mentioned that that that.

That property is in line with the number that you just threw out there that we're expecting to play in 2023.

<unk> is a little larger but what one thing about Santana is we have what we're doing there. There's two buildings and one has been completely got it and as a result, we treated that as a repositioning for 2023 and as a result, it won't have any ethical impact, but that number is larger as you indicated.

So really the biggest impact that we're looking at to April 2023 is <unk> as you mentioned Capex, we're going to continue to sort of add amenities at some of the other properties. In addition to Pima.

And then a spec suite program, which I talked about.

Just to add one thing on that so Santander is at a point where.

We're trying to finalize the level of renovation that we're doing so.

The upper end could be higher than what you position, but we think we can get a premium on rents and so we're just assessing where.

They are not that makes sense to do today.

Okay great.

<unk>.

Moving directions on the disposition front have you brought any of those assets to market and I'd be curious as to sort of what kind of appetite youre seeing out there right now if you have.

So we have not brought any of those to market I guess I would say the investment sales market remains very slow and so theres not a lot of transactions if youre looking at premium type assets across our markets. The one transaction that did close which is public is high.

In mid December bought Mckinney, and all are in Uptown Dallas and metrics. There you can you can get from their release, but effectively a five 5% cash cap rate and just over $700, but there hasn't been many transactions.

Right and just.

One more for me Tony.

You've got the two.

Third and fourth quarter debt maturities and I think the price just over 3%.

I guess kind of what are you seeing currently as far as comparable mortgage debt and kind of how are you thinking about dealing with with those two debt maturities.

Yes, sure Craig so.

Both of those to mature later this year September and October .

Exploration both of those are with a regional bank.

And so we have started preliminary conversations with them one renewal as well as starting to canvas weather or there might be other lenders of interest.

Today, you are looking at.

Probably refinancing those.

I'd say in the low sixes, if youre looking at a rate probably 250 basis points whatever the.

The index that you choose.

But given both of those assets are pretty buttoned up in terms of occupancy and significant lease term im not anticipating any problems with refinancing those two properties.

Okay. Thanks for the time guys.

Thanks, Rick Thanks, Greg.

Thanks Keith.

Additional questions I will turn the call back over to Mr. Farrar to conclude.

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

Thank you for joining the <unk> you may now disconnect your lines.

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Yeah.