Q1 2023 Office Properties Income Trust Earnings Call
Correct.
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I would now like to turn the call 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 first quarter of 2023, 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.
Today April 27, 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 OPI dot com or the SEC.
<unk> web site.
Investors are cautioned not to place undue reliance upon any forward looking statements on today's conference call. We will be discussing the planned merger with diversified healthcare trust in our prepared remarks, we have not yet filed a preliminary joint proxy and registration statement with the SEC.
Therefore, we will not be taking questions about the merger.
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 enhanced earnings release presentation that we issued last night, which can be found on our website.
We believe this combined presentation of information will be helpful for analysts and investors to efficiently Digest information about our company and our results.
Finally, 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.
I will now turn the call over to Chris. Thank you Kevin Good morning, everyone and thank you for joining the call today.
Before I review Opi's performance for the first quarter of 2023 I want to start by briefly discussing current office fundamentals our decision to reduce our quarterly dividend and our recently announced merger with diversified healthcare Trust.
OPI has demonstrated solid operating performance over the past few years, while navigating through a global pandemic and amid an uncertain and evolving office environment.
Our favorable performance results through 2022 are attributed to several factors, including our diversified real estate holdings, our geographical footprint with properties in many premier growing markets and reflective of our leasing performance, our strong tenant roster with investment grade tenants, representing 63% of our portfolio continue.
A continuation of our capital recycling initiatives and our strong balance sheet.
As we stand here today, we're looking at post pandemic returned to office trends, which continue at a gradual pace across major U S markets, providing a bright spot for improving office fundamentals. However headwinds in the office sector remain with added pressure as a result of corporate cost cutting elevated sublease space a challenging financial.
Answering environment and continued macroeconomic uncertainty NASA.
National Office leasing volume declined for the third consecutive quarter through Q1 and much of this sector's occupancy gains achieved over the past several years has been given back negative absorption financing continues to be an obstacle for the investment sales market and widening credit spreads are putting additional pressure on office valuation.
These challenges will likely lead to declining cash flows and asset values, which may take years to stabilize.
Recognizing these challenges earlier this month, we announced a reduction in <unk> quarterly dividend, we recognize the value of the dividend to our investors and the decision was not made lightly.
It was the result of careful consideration on the part of the company and its board of trustees based on several factors, including the challenging outlook confronting the office sector tenant retention risk of rising payout ratio approaching a 100% in excess of our target coverage ratio and our focus on capital preservation to support leasing.
Activity and complete our two redevelopment projects with these factors in mind, we made the decision to lower the dividend to a sustainable level of $1 per share annually. While this decision was communicated at the same time as the merger announcement. It was independent of our merger plans and reflective of our outlook for OPI on a standalone basis.
It provides increased liquidity to navigate office headwinds and to fuel capital projects that we expect will improve <unk> competitive positioning as a path to increase returns in the future.
Earlier. This month, we also announced plans to merge with diversified health care Trust, providing us with a tremendous opportunity to create a larger scalable and more diversified REIT.
This transaction combines two institutional quality portfolios and better positions us to navigate office sector headwinds, while providing embedded near and long term growth and value creation.
Benefits to OPI include increased scale and diversity and cash flow stability with the addition of attractive mob and life science properties as a compliment to our established office portfolio access to additional capital sources with a more favorable interest rate outlook, including low cost GSE and agency debt and access to an institutional quality port.
Folio of senior living communities benefiting from growth through favorable health care sector tailwind and a turnaround strategy currently underway.
As a result of this combination we expect the transaction to be accretive to Opi's normalized <unk> CA D and leverage during the second half of 2024, and ultimately maximizing long term value for our shareholders.
Turning now to our first quarter leasing results, we began the year with uneven operating fundamentals and a deceleration in leasing volume consistent with broad market trends and in line with our expectation that new leasing activity will increase over the next several quarters as tenants reengage on their office plan needs along with increased renewal activity given our explorations.
They occurred during the back half of the year.
This is reflected in our leasing pipeline, where we have close to 725000 square feet of activity in advanced stages of negotiation.
Portfolio occupancy increased 170 basis points year over year to 95% and we completed 203000 square feet of leasing with a balanced mix of new and renewal leasing.
This activity resulted in a weighted average lease term of six eight years and leasing concessions and capital commitments of $6 37 per square foot per lease year.
Weighted average rent spreads for the quarter declined 18, 5%, which was influenced by elevated concessions associated with several leases at our property in greater Washington D. C, where we signed two strategic leases totaling 128000 square feet with a key tenant downsizing and another to backfill the available space.
Expect our leasing spreads will normalize as activity progresses throughout the year.
Looking ahead to opioids upcoming lease expirations, we continued to actively manage through proactive re leasing efforts to address elevated lease expirations during the second half of 2023 and into 2024.
In 2023 lease expirations represent approximately 10% of our annualized rental income a decrease of 90 basis points compared to the end of 2022.
<unk> revenue for 2023 exploration is comprised of the following.
That known Vacates for the balance of the year are trending close to 6% of annualized rental income approximately 80 basis points represents planned dispositions and the balance of three 5% as expected to renew.
Our leasing pipeline includes approximately $2 7 million square feet of potential leasing activity with more than $1 1 million square feet attributable to new leasing and 782000 square feet of potential absorptions.
The outlook for our projected activity includes a rent roll of about 6% to 8% and an average lease term of eight to 10 years.
Turning to our developments.
Our mixed use redevelopment and 20th mast out in Washington D. C is scheduled to deliver in the coming months.
The project near completion, we are encouraged by growing interest and tour activity and the proposals we are discussing with multiple prospective tenants.
Property is 54% pre leased to an anchor tenant the Royal Sonesta hotel, which intends to begin wellbeing guests to this flagship location. This summer.
Additionally, our lifestyle three development in Seattle remains on track to deliver later this year.
In addition to the 84000 square feet signed at this property late last year, we will deliver one full lab building with move in ready spec suites, providing a needed outlet for small to medium companies with near term space needs and therefore, reducing the timeline for lease up and acceleration of NOI performance.
Across both projects our development leasing pipeline includes more than 170000 square feet of active proposals beginning as early as June 2023, we will see gradual NOI improvement related to both projects as tenants began to reimburse operating and tax expenses during their free rent periods.
Before I turn the call over to Matt I want to acknowledge the recent publication of the RMR group's annual sustainability report, which provides a comprehensive overview of our managers commitment to long term ESG goals were.
We are deeply committed to enhancing <unk> corporate sustainability practices and continue to advance initiatives that will position the company to thrive over the long term.
For example, we recently garnered recognition as an energy star partner of the year for the sixth consecutive year and sustained excellence on our rate for the fourth year in a row.
This recognition underscores our dedication to operating properties that benefit our tenants and communities you can find links to the report tear sheets specific to opioids highlights on our website at <unk> Dot com.
I'll now turn the call over to Matt to review, our financial results. Thanks, Chris and good morning, everyone normalized <unk> for the first quarter was $52 7 million or $1 90 per share a penny below our guidance range. This compares to normalized <unk> of $54 $5 million or $1 13 per share for the fourth quarter of 2022.
The decrease on a sequential quarter basis was primarily driven by higher utility expenses and interest expense.
<unk> expense for the first quarter was $5 9 million as compared to $5 8 million in the previous quarter.
Same property cash basis, NOI decreased 4% compared to the first quarter of 2022 in line with the low end of our guidance range. The decrease was mainly driven by elevated free rent levels related to 2022 leasing activity and operating expense increases most notably utility costs due to inflationary pressures and expenses previously.
He paid by tenants now being paid by OPI as a result of tenant downsizes.
On a rolling four quarter basis CA.
Decreased sequentially by approximately 16% to $2 21 per share, resulting in a payout ratio of 99, 5%.
While our historical payout ratio had been well covered since the beginning of 2019, we began seeing pressure in the fourth quarter of 2022 and with lower tenant retention levels in 2023, another year of elevated capex requirements and worsening office fundamentals that dividend rate was becoming unsustainable.
As a result, and as Chris previously discussed earlier this month, we reduced our quarterly dividend to <unk> 25 per share or $1 per share annually.
The new level equates to approximately $60 million of retained capital annually, enhancing opi's liquidity and financial flexibility.
Turning to our outlook for normalized <unk> and same property cash basis NOI expectations in the second quarter of 2023.
We expect normalized <unk> to be between $1, seven and $1 nine per share.
This guidance includes a range of six 1% to $6 $2 million of G&A expense, which includes expected annual trustee compensation.
We expect same property cash basis, NOI to be down 5% to 7% as compared to the second quarter of 2022, mainly driven by two full building vacates since the beginning of the prior year period and increased inflationary pressure on operating expenses.
Turning to the balance sheet at quarter end, our outstanding debt at a weighted average interest rate of 4% and a weighted average maturity of four seven years over 90% of our debt is fixed rate.
We ended the quarter with $548 million of total liquidity, including $505 million of availability under our credit facility.
In connection with the proposed merger with DHT, we plan to recast our existing $750 million revolving credit facility and have commenced initial discussions to move this process forward.
We believe the improved scale and diversification of the combined company will result in the successful recast of Opi's revolver.
Turning to our investing activities.
Since the beginning of the year, we sold three vacant properties containing 89000 square feet for $5 $4 million and are currently under agreement to sell one vacant property containing 107000 square feet for $4 9 million.
Our capital recycling to date has been impacted by the current transaction environment, and we expect our activity to be somewhat muted until market conditions improve.
We spent $17 6 million on recurring capital and $49 $5 million in redevelopment capital during the first quarter two.
2023, Capex guidance is currently $100 million to $110 million of recurring capital and approximately 140 million to $150 million of redevelopment capital.
Before we turn the call over to Q&A as a reminder, we will be taking questions related to OPI on a standalone basis, we have not yet filed a preliminary joint proxy and registration statement and therefore will not be taking questions about the merger.
That concludes our prepared remarks, operator, we are ready to open the call up for questions.
Thank you we will now begin the question and answer session.
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Today's first question comes from Bryan Maher with B Riley Securities. Please go ahead.
Yes.
Good morning, Chris and Matt I guess I can throw out maybe half my questions I had.
All tightened it up.
Can you walk us through slowly.
Occupancy outlook for this year, so we're starting off at 95% total occupancy 93, 5%.
Same store.
We have a series of known Vacates that you discussed obviously, you'll try and backfill some of those with leasing activity and then we also had 20 mass Avenue Seattle coming online.
How do you think that the year progressive somewhat occupancy standpoint.
Yes, Thanks, Brian I think historically, we've provided the range of 88% to 90%.
And some of that is predicated on our ability to sell assets that we currently have in the market are those that we were projecting to bring to the market.
So I think as we sit here today based on what we're seeing we're looking at kind of the low end of that guidance.
<unk> kind of the target today.
What I'll add is that.
Most of the expirations for 2023, where we have known Vacates are scheduled to occur in November or at year end and so the impact on performance is heavily weighted towards the back half of the year with occupancy then following so.
That's where we're at today and I think again, an important piece of that is our ability to sell certain assets. The ones that we've talked about are mostly vacant and so that has a direct impact to occupancy.
Okay, and then when we think about the credit facility.
Can you give us any update as to kind of the timing and what the size might be of that new facility and is that needed to be completed before a potential merger.
So Brian it's a good question, let me just first address.
The maturity of the revolver absent the merger so right now the revolver matures at the end of July . However, we do have a six month extension option to push out that maturity to January of 'twenty four.
A recast of our amended revolver is a condition to closing the merger. So we have started our discussions with wells Fargo on that they are preliminary we are expecting a proposed term sheet from the bank group in the coming days. So it's in process and I think as we progressed.
Into 2023, there will be more to provide as it relates to the revolver.
Okay, and kind of circling back to fundamentals did that did I hear you correctly say that you expected, 6% to 8% rent roll ups for this year 2023.
The 6% to 8% rollout is attributable to our leasing pipeline.
So I think historically for 2023, we've talked about 4% to 5% Rollouts and I think some of that.
I think we will stick to that for now, but I think a lot is going to be predicated on how this pipeline matures.
We talked about with the Q1.
Results in the roll down I mean that was heavily concentrated for a couple of specific deals and so we expect that will normalize and then we'll see improvement on overall rent spreads as we execute on some of those pipeline, but it is a lumpy process. So it's not exactly something quarter to quarter that we have definitive projections.
Just given the timing it takes to negotiate some of these leases.
Okay, and just on the periphery of the <unk> transaction now that if you can answer this or not but we know vanguard and blackrock own an awful lot of shares.
<unk> and OPI.
As we mentioned we're in the process now of the filings of the S. Four in the proxy and I think as we get through that there'll be more kind of color on kind of next steps and expectations.
Okay, and just last from me on Seattle.
<unk> by over in four Q4 perspective tenants is that above and beyond the leasing activity you've already communicated with Sonoma biotherapeutics.
And with that.
Property and so we're in advance at advanced stages, we have several tours that have taken place across the property and also have several proposals out to tenants and so I think at this stage.
The current pipeline and most of that's locked in or how much of that is just.
Thank you and ladies and gentlemen, this concludes our question and answer session I would like to turn it.