Q4 2022 Office Properties Income Trust Earnings Call
Trust fourth quarter 2022 earnings conference call all participants will be in listen only mode should you need assistance. Please signal a conference specialist by pressing the Starkey followed by zero.
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I would now let's turn the conference over to Kevin Berry Retro of Investor Relations. Please go ahead.
Thanks, Gary and good morning, everyone. Thank you 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 fourth 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.
These forward looking statements are based on Opi's beliefs and expectations as of today Thursday February 16, 2023, 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 O P. I read dot com.
Or the SEC's website investors are cautioned not to place undue reliance upon any forward looking statements in.
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> 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 at.
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 charge.
As related to the disposition of real estate.
With that I will now turn the call over to Chris.
Thank you Kevin Good morning, everyone and thank you for joining the call today.
<unk> reported fourth quarter results that reflect strong leasing momentum solid financial results and further execution on our capital recycling plans amid continued economic uncertainty and challenging office sector fundamentals. We are pleased with our performance advancing on core strategies aimed at enhancing opi's operating performance.
Normalized <unk> of $1.13 per share exceeded the high end of our guidance range and the change in same property cash basis NOI was in line with our expectations.
We completed 705000 square feet of leasing activity, primarily with tenant renewals, resulting in our highest quarterly retention activity in three years.
Our fourth quarter performance capped a year in which we achieved many of the operating targets that we set for O P. I G.
During 2022, we completed two 6 million square feet of leasing for a weighted average term of more than nine years and a roll up in rent of five 6%, which was in line with the leasing spreads we had projected at the beginning of the year.
New leasing included 588000 square feet or 23% of our 2022 activity.
We sold non core properties for more than $210 million of aggregate gross proceeds and total portfolio occupancy increased approximately 110 basis points to 96% trending well above the national office market average.
Turning to capital recycling since the beginning of 2022, we sold 21 properties containing 2.4 million square feet for $216 $4 million. Although we started the year with a more aggressive disposition outlook. We are pleased with our ability to close on these transactions during a very tumultuous year for <unk>.
Capital markets and office real estate in.
In 2023 capital recycling will remain a principal strategy for OPI and catered toward ongoing portfolio enhancement opportunities management of capital requirements and reducing leverage.
We expect macroeconomic uncertainty in CRE financing to continue to weigh on the pace and magnitude of market activity. However, we are presently under agreement to sell two properties for approximately $7 $6 million in gross proceeds and we are in various stages of identify and marketing additional properties for sale most likely to transact in the back half of the year.
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We ended the year with 160 properties containing 21 million square feet with a weighted average lease term of six six years.
Approximately 63% of our annualized rental income was from investment grade rated tenants, which we believe is one of the highest such percentages in the office REIT sector.
Our balance sheet has nearly $570 million of liquidity with 92% of our debt at fixed rates and we have no senior notes maturing until mid 2024.
Turning to our fourth quarter leasing results, we entered into new and renewal leases for 705000 square feet, which is a 16% increase from the third quarter and a marginal improvement over the prior year.
This activity resulted in a weighted average lease term of 10, one years and leasing concessions and capital commitments of $8 46 per square foot per lease year.
Weighted average rent spreads for the quarter declined six 7%, primarily due to a 337000 square foot renewal for an 11 year term with a defense contractor located in northern Virginia.
We view this renewal is a strategic win with one of our largest tenant explorations in 2023 and recognition that our campus as part of a longer term real estate plan for the tenants.
Additional highlights are primarily attributed to renewals with two GSA tenants inclusive of renewal for 110000 square foot mission critical facility in Mississippi for 20 year term.
Generally speaking, we continue to see higher retention with the GSA agencies in mission critical facilities, along with willingness to consider longer lease terms mission critical facilities within our portfolio contributed to roughly 11% of our annualized revenue or just over half of our total U S government portfolio.
Looking ahead to opioids upcoming lease expirations.
Overall leasing activity has been healthy we believe 2023 and will move at a gradual pace while tenants continue to evaluate real estate needs. We continue to actively manage through proactive re leasing efforts along with select alternative use strategies to further diversify our portfolio and to capitalize on compelling value creation opportunities.
In 2023 lease expirations represent approximately 11% of our annualized rental income of 280 basis point decrease from where we stood at the end of Q3.
Annualized revenue for 2023 explorations that's comprised of the following that known Vacates for the year are trending between five and 6% of annualized rental income nearly 80 basis points represents planned dispositions and the balance of 5% to 6% as expected to renew of which 2.2% has either signed subsequent to year end.
Whereas in advanced stages of lease discussions.
We're currently tracking approximately two 7 million square feet of activity in our pipeline.
With more than $1 1 million square feet attributable to new leasing and 541000 square feet of potential absorption.
In light of the activity in our pipeline combined with our property disposition plans, we are projecting year end occupancy of 88% to 90%.
Turning to our developments OPI currently has two redevelopment projects underway that we expect will enhance our competitive positioning in the market and provide significant value creation and growth opportunities. Our redevelopment at 20 Mass Avenue in Washington D. C is on track to deliver during the second quarter of 2023 the property is.
54% pre leased to an anchor tenant the Royal Sonesta Hotel and we anticipate an opening date to take place at the end of the second quarter.
In Seattle, Washington, We continued to advance construction. However, our timing for completion has been moved out to Q4 2023, given supply chain impacts for delivery of certain equipment.
The delayed mostly deferred the timing of a potential at least the start of our spec suites. However, we anticipate our anchor lab tenant leasing 28% of the project will continue to commence in Q4 as originally planned.
We're off to a good start with pre leasing at both projects and maintain our outlook for lease up to stabilization of 18 to 24 months following delivery our development leasing pipeline includes more than 170000 square feet of active proposals across the two projects.
Total cost of stabilization or $377 million of which $197 million or 52% has been spent through year end 2022, we anticipate between $125 million to $135 million were up to 36% will be spent in 2023 with the balance incurred.
With future year lease up.
Upon stabilization estimated stabilized yields for Washington D C, our 8% to 10%.
For Seattle, our 10% to 12%.
In conclusion. Despite these achievements tenants broader view on office needs and plan for reentry remain in a period of transition.
Industry utilization continues to improve at a very gradual pace across most markets currently trending near 50% and consistent with what we were expecting across our national portfolio.
Well, we continue to experience gradual improvements supporting tenant decisions within our portfolio as highlighted with our leasing results are known vacates concerns of an economic recession and head count reductions along with cost containment measures continue to weigh on office fundamentals.
Heading into 2023, we take comfort in the many initiatives undertaken over the past several years to position OPI as a landlord of choice when managing through transition hurry periods.
Representative examples include enhancements to our overall portfolio with our capital recycling program and major Redevelopments, our focus on providing an exceptional experience through our property management and engineering teams, our many sustainability initiatives, including the company's recognition as a gold level green lease leader and steps taken to strengthen our balance sheet.
We believe these and other factors will benefit O P. I as we continue to navigate the headwinds facing the office sector.
I'll now turn the call over to Matt to review our financial results.
Thanks, Chris and good morning, everyone normalized <unk> for the fourth quarter was $54 $5 million or $1 13 per share <unk> <unk> above the high end of our guidance range. This compares to normalized F. F O of $53 $8 million or $1 11 per share for the third quarter. The sequential quarter increase was primarily driven by lower <unk>.
Lower G&A and interest expense I'd.
I'd like to highlight that Opi's fourth quarter income statement includes a decrease in expense reimbursements included in rental income and real estate tax expense of approximately eight one and $8 $2 million, respectively related to a favorable real estate tax assessment received during the quarter for a property located in Chicago that OPI acquired in June 2021.
G&A expense for the fourth quarter was $5 $8 million as compared to $6 $6 million for the third quarter and $6 $7 million adjusted for the reversal of previously accrued incentive fees in Q4 2021.
The sequential quarter decline was driven by Q3 share grants and a reduction in our business management fee as our share prices decline illustrating the fee structure alignment between RMR and OPI shareholders.
Same property cash basis, NOI decreased one 4% compared to the fourth quarter of 2021 in line with our guidance range the decrease.
It was mainly driven by higher levels of free rent related to leasing activity over the past year and higher operating expenses.
Turning to our outlook for normalized <unk> and same property cash basis NOI expectations in the first quarter of 2023 weeks.
We expect normalized <unk> to be between $1 10, and $1 12 per share. This guidance includes a range of five seven to $5 $8 million of G&A expense.
Justin for the real estate tax and related impact on tenant reimbursement income in the fourth quarter noted previously our estimated first quarter run rate for rental income is approximately $133 $5 million and real estate tax expense is approximately $16 million we.
We expect same property cash basis, NOI to be down 2% to 4% as compared to the first quarter of 2022, mainly driven by increased operating expenses as a result of higher utilization levels and continued inflationary pressure.
Turning to the balance sheet at quarter end, our outstanding debt had a weighted average interest rate of 4% and a weighted average maturity over five years with 92% of our debt at fixed rates, we remain well insulated from the rising cost of debt capital in today's environment, our only variable rate debt as our revolving credit facility and as Chris mentioned.
And OPI has no senior notes due until mid 2024.
In November we exercised our first option to extend our credit facility by six months until the end of July 2023, and we have one remaining option to extend the maturity date to January 2024.
We plan to pay off our only remaining mortgage debt at its June 2023 maturity date, which is a $50 million principal balance at a three 7% interest rate.
This will leave OTI with a fully unencumbered balance sheet.
We ended the quarter with $567 million of total liquidity, including $555 million of availability under our credit facility.
Turning to our investing activities since.
Since the beginning of the fourth quarter, we sold five properties for $25 million and are currently under agreement to sell two properties for an aggregate sales price of $7 $6 million, including a vacant property with 107000 square feet.
We spent $42 $1 million on recurring capital during the fourth quarter, bringing our full year recurring capital spend to $100 million in line with our 2022 guidance.
Our redevelopment capital totaled $44 $5 million during the fourth quarter and $159 million for the full year.
Looking ahead to 2023, our recurring Capex guidance remains unchanged at $100 million, our redevelopment Capex guidance is expected to approximate $150 million.
In January we declared a regular quarterly dividend of 55 cents per share, resulting in a normalized <unk> payout ratio of 49% and a rolling four quarter see a payout ratio of 84%.
Operator that concludes our prepared remarks, we're ready to open the call up for questions.
We will now begin the question and answer session.
To ask a question you May press Star then one on your telephone keypad.
If you are using a speakerphone. Please pick up your handset before pressing the keys to withdraw your question. Please press Star then two at this time, we will pause momentarily to assemble our roster.
Our first question is from Bryan Mayer with B Riley FBR. Please go ahead.
Thank you good morning, Chris and Matt a couple of quick questions for me.
Can you talk a little bit more about the capital recycling plan I mean, you know what you've sold and have under LOI.
In the first quarter, but what are the what's the outlook for 2023 to now and maybe also the counter to that what if anything are you looking to buy in a year, where we're hearing there could be opportunity as owners have problems refinance.
I think that.
Yeah, Brian This is Chris So I. Thank you for the question I guess a couple of things.
I think currently where we stand today you know we're more focused on our business plan, which is the leasing of vacancy you know wrapping up these redevelopments and then continuing through capital recycling with a bigger focus on selling assets to just kind of manage level leverage levels at the kind of fun to other capital initiatives and so I.
That's where we sit today with regard to capital recycling and kind of the disposition focus.
It's a it's going to be somewhat muted in 2023, I think there's a lot of uncertainty around just kind of capital markets and financing, which is going to weigh on our ability to transact.
If you kind of look back at 2022, and kind of selling north of $200 million I think we would view that as a successful year and kind of you know showing some you know you know opportunity to transact and what was also I think a challenging marketing market for capital markets I think what we're selling assets or have.
Ben are there there are smaller in deal size and so perhaps that's opened up kind of more window for owner users and other groups, which is part of the reason why I think we ended the year, where we did but to put kind of a number to 2023, it's difficult I mean, you know our plan over the last several.
Years' worth of always you know focus on kind of that $100 million to $300 million in activity as part of kind of a longer term strategy I think we'd like to see that but I would be a little bit cautious to say that that will get there I mean I think in addition to the $7 6 million, we've talked about we have about another $15 million in the market.
We're working through business plans, now and kind of identifying other opportunities that we think might be ripe to bring to the market, but anything on that front is going to happen more towards the back half of the year.
Okay, and I think in your prepared comments it is hard keeping up are you.
You mentioned I think 5% to 6% known Vacates in 2023, maybe I had that wrong and 80 80 bps of that was to be so maybe you can clarify that but if those numbers are the case what are you looking at prospect wise for the balance of the known Vacates or are any of those prop.
Pretty well really likely to be released or are they on the tense to be sold maybe a little bit more color there.
Yeah. So I think when you think about the known Vacates that 5% to 6% I think it's probably best to kind of wind back the clock, a little bit and put ourselves kind of out last quarter.
So now that we are.
Renewed the 336000 square feet with a larger tenant that has kind of come out of the denominator and so you're seeing kind of a larger spread on known Vacates just given that we have less annualized revenue expiring because we've been able to successfully secure renewables and.
So barring any disposition or leasing with some of those other known Vacates. We would expect that that number is going to continue to increase.
As those explorations near which are mostly in the back half of the year as well.
There is various levels of activity on some of those known Vacates I think you know some examples we've talked about the building in Washington D C representing about just over 2% of our annualized revenue you know the the tenant there was kind of it was on the fast about whether or not they stay.
It looks like they're going to renew but downsize and so that will you know what.
Once that transact that'll kind of you know reduce or open up some additional vacancy.
And then we have a project in Boston, where the tenants are going to leave or is expected to leave mid year.
And I would say that there is some activity there, but nothing far enough along to speak too so it really depends.
We have 10% vacancy across the portfolio. So you know so there's there's gonna be ebb and flow of about whether or not we see leasing on the known vacates or or kind of augmenting that over towards some of the vacancy I think I think in general we would expect to see leasing on both fronts I think just as in.
Another kind of anecdotal piece, we have.
I think close to 200000 square feet and.
In advanced discussions of new leasing.
Some of which May hit this quarter, and so I think that'll be kind of a path towards addressing you know or kind of countering some vacancy.
And again with some activity around some of these known Vacates.
Okay. Thanks for that and just really quick last Jeremy if memory serves me you have cobbled together I think an entire city block in downtown Boston.
For possible redevelopment and is there any update there.
On the redevelopment side, there's not I mean, I think that it's something it's a great site are you know I think long term you know I think we're optimistic about options there, but you know in Boston in General is just a very lengthy process to.
Worked through potential development, and so I think where we sit today, it's still something you know where we're focused on but nothing to really speak to as far as progress and so and I think to complement that it's not a scenario in the near term, where we would see any real significant capital spend and so.
Part of that project.
Okay. Thank you.
Again, if you have a question. Please press Star then one please standby as we poll for questions.
And the next question is a follow up from Bryan Mayer with B Riley FBR. Please go ahead.
Well I guess, if there's no questions I'll I'll throw in one more.
When it comes to your dialogue with existing tenants.
When their properties are coming up for renewal can you give a little color on how those are going when it relates to the fact that they might think that they have a little leverage with you know the whole work from home scenario in the macro environment versus.
Versus your argument that hey, we have inflationary costs that we need to pass through.
Can you give us a little color on how that's progressed.
Yeah, I think it's a couple things I think for tenants, who find that it's important to control their space or the building. So let's just use single tenants for our single building occupied.
Occupied by single tenant for example, and in that particular case I think it's really just a function of market because in most cases, if a tenant wants to control the space you know its hard to negotiate.
Something other than you know a downside because we all know they don't want to give back space, but.
Really this is a function of just overall space needs I don't know that there's a there's a scenario where there's more leverage I mean, I think clearly we want to be in a position, where we can retain a tenant and so you know we're going to focus on what our market deals and at the same time recognize that there's a significant amount of value in retention.
Versus the alternative.
With either a downsize or vacancy and so some of that comes in the form of concessions. You know, we can potentially maintain face rates, but we're seeing a inflated free rent or other types of concessions to kind of support those needs and I think that's reflected in some of kind of the impact with our capital spend.
Related to leasing that has trended over the last several quarters and so I think the shorter answer is no more about you know less about just true leverage and more about just being creative to make it a win win situation.
Okay, and maybe lastly, when it comes to the D C and Seattle Redevelopments and I know you had the anchor tenant you know in each of those two projects, but can you give us a little more color on what the other discussions are for other tenants to fill out those space.
So yes, as we noted that we have about 170000 square feet of activity across those two buildings are you know about 40% of that is for 'twenty mass Av and the balances for Seattle.
I'd say for 'twenty mass AV we know there are other positive theres been kind of a good influx of tour activity, which is expected given the project is nearing completion.
And it's just it's easier to kind of walk through that and see the opportunity from a tenant's perspective, theres nothing far enough along to speak to as far as you know when or if those would transact, but I think in general that activity is more catered towards you know tech tenants.
Law firms nonprofits and similar type agencies, which is I think generally consistent with what we see in D. C.
For Seattle, It's twofold, I think that you know what the anchor tenant theres potential upside for them to take down additional space in the lab building the activity that we have today at that project is mostly geared towards the office side of the project.
As a reminder, two of the three buildings are alive and the third is office.
And really that's a function of on the on the second lab office. These are gonna be spec suites are you know more move in ready for smaller tenants kind of partial floor full floor tenants and those conversations typically come later closer to delivery given that the tenants themselves just.
Have a near term need and so we.
We did see a flurry of activity I think it's somewhat muted on that side given kind of we've pushed out our delivery day, but we would expect that there'll be more to talk about on more specific spec suite lab opportunity in the upcoming quarters, but right now.
That that activity has catered towards the office building.
Great. Thanks, Chris.
This concludes our question and answer session I would like to turn the conference back over to Chris Blotto for any closing remarks.
Well, thank you for joining us today and your interest in OPI and we look forward to speaking with you again soon.
The conference has now concluded. Thank you for attending today's presentation you may now disconnect.
Okay.
Yeah.
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