Q2 2023 Office Properties Income Trust Earnings Call
Please go ahead.
Thank you and good morning, everyone and thanks for joining us today.
With me on the call or O P I as President and Chief Operating Officer, Chris Balado, Chief Financial Officer, and Treasurer, Matt Brown.
Just a moment they will provide details about our business and our performance for the second quarter of 2023, followed by a question and answer session would 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 today's 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 opioids beliefs and expectations as of today Thursday July 27th 2023, an actual results may differ materially from those that we project.
The company undertakes no obligation to revise a publicly released the results of any revision to the forward looking statements maiden 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 S. E C, which can be accessed from our website <unk> dot com or the SEC's website <unk>.
Investors of caution not to place undue reliance upon any forward looking statements and edition, we will be discussing non-GAAP numbers. During this call, including Normalised funds from operations are normalized FFL cash available for distribution or C. A D and cash basis, net operating income or cash basis N. A Y a reconciliation of these non-GAAP .
Net income are available in O P. I's earnings release presentation that we issued last night, which can be found on our website.
And finally, we will be providing guidance on this call, including normalized F. F O in cash basis in Hawaii, we are not providing a reconciliation of these <unk> 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.
It is 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 us today.
On our call today, we will provide an update on the merger with diversified health care Trust discuss broader office fundamentals.
Biden update our operational and financial results.
Starting with the merger we remain on track to complete our merger with diversified a health care trust during the third quarter.
We filed a registration statement with the S E C and we're holding a special meeting of shareholders on August 30th to vote on proposals to approve the merger and the issue and it's an opioid common shares.
With shareholder approval, we expect to close the transaction shortly thereafter.
This merger represents a tremendous opportunity for our shareholders to create a larger scalable and more diversified read a combined two institutional quality portfolios and better positions us to navigate off the sector headwinds, while providing embedded near and long term growth and value creation.
As a reminder, immediate benefits OPI includes increase scale and diversity cashflow stability with the addition of attracted M O b and lifestyle properties complement to our established office portfolio Act.
Access to additional capital sources with a more favorable interest rate outlook, including low cost G. S. T. An agency that and access to an institutional quality portfolio senior living communities benefiting from growth through favorable health care sector Tillman.
Turnaround strategy currently underway.
You can expect the transaction to be accretive to okay, guys normalize F. F O C. A T and leveraged during the second half of 2024, and ultimately maximizing longterm value for our shareholders.
Based on the compelling benefits of the transaction, we support on board and the recommendation shareholders vote for the merger.
As a matter of will discuss during the second quarter, we commence our financing strategies to close the merger by completing more than $180 million mortgage financing since may.
Given the challenges related to financing office properties in today's capital markets. We believe our progress on this priority serves as a testament to opioid highly financial portfolio of properties.
An aggregate the finances reflected applied capitalization, great based on aggregate appraised value of 7.5% and include a mix of building fully occupied by government and private tenants.
Turning the highlights from the second cooler.
Nationally performance in within the office sector remains in a period of transition with.
With some recent bright spots related to increase leasing volume improving office utilization and a slowing of new sublease space. Conversely, the financing and transaction environment bolt remain challenging tenants continue to rationalize their space needs resolving that mix of renewals downsizing relocation and national.
Office vacancy is that a high of nearly 20%.
We believe there will be continued improvement some of these areas is returned to office mandates continued to unfold new supply continues to decrease in monetary policy I'm interest rate of stabilized.
Oh P I portfolio occupancy for the second quarter was 90.6% an increase of 120 basis points you over a year and that's 10 basis points over the third quarter supported by a new leasing activity and the disposition of properties with higher vacancy.
The property cash basis in a while I came in better than projected and normalize F. F O for sure exceeded both the prior quarter and the high end of our guidance ranch.
And it utilization across our portfolio is trending above the office national average a positive sign with the evolving returned to office outlook.
We also reach an exciting milestone with substantial completion of our 427000 square foot mixed use redevelopment at 20, Massachusetts Avenue in Washington D C, which is currently at 54% <unk>.
Turning that our second quarter, losing results.
We've completed deals for 713000 square feet of new and renewal leasing.
Mmm fries, mostly a longterm leases with an average lease term of 10.3 years and a roll up and rent a three point 70 per cent.
The leasing volume for the quarter increase sequentially within 250% recycling a meaningful acceleration from the seasonally lighter first quarter and representing hope guys highest volume in over three years.
Approximately 80 per cent of this activity was with tenants in the real estate and financial and the technology and communications industries.
Concessions and capital commitments declined both on a sequential order basis and year over year to $5.53 per square foot or at least here.
We ended up what it was an investment grade ready to tenants, representing approximately 63 per cent of analyze rental income.
Turn into highlights from the second quarter leasing transactions.
In Duluth, GA, just northeast of Atlanta, we execute a full building lease renewal for the tenants headquarters representing 344000 square feet at a modest role open rant and Elise drove approximately 12.5 years.
We review the whole building lease for 93000 square feet in Austin, Texas occupied by a global technology solutions company that race that were largely unchanged at least turn over approximately 5.6 years.
Santa Clara, California.
We renewed a full building lease for 66000 square feet with a technology networking tenant for an 11 year term and a rental rate increase of over 9%.
And we sign a new lease with a health care contractor in Lincoln, Nebraska for over 100000 square feet at a monitor open red and a 10.5 year term.
Looking ahead the L. P I is upcoming lease expirations.
We continue to actively manage through leasing efforts to address these explorations during the second half of 2023 and beyond.
Subsequent to quarter, and we completed over 300000 square feet of leasing activity, including a short term extension and downsize with our tenant in Washington D C, representing 2.1% a annualized revenue previously communicated as a known vacated in 2023.
Or leasing pipeline includes approximately 2.7 billion square feet of potential leasing activity with nearly 1.5 million square feet attributable to new leasing and 800000 square feet of potential absorption, providing a year and occupancy outlook of 878%.
Turning to our development projects.
We reached an important milestone with a substantial completion of 20 mass out in Washington D. C. At the end of the quarter is 427000 square foot Trophy class a mixed use property is 54% leased Royal Sonesta Hotel, which plans to open to new guest since September .
Tour activity have been encouraging with close to 100000 square feet of active proposals.
We have a rockabilly $48 million remaining project cost a portion of which will be utilized during the back half of 2023 tour construction and the balance in future years to achieve stabilization with at least.
Ah lifestyle three development in Seattle, known as Unison Bay remain sidetracked delivered during the fourth quarter of this year the Prague.
Project is 28 per cent preleased with approximately $64 million remaining for completion of construction and for used towards stabilization with leasing.
We continue to field multiple prospects for both lab and office users that close to 45000 square feet of actor proposals and anticipate a ramp up an activity toward the back half of the year as our spec labs sweets are completed.
In summary, we had an active quarter for O P. I and are pleased with our training out across the portfolio. Despite office headwinds we ended the quarter with policing volume representative of the highest level of in three years are encouraged with the elevated utilization rates across the portfolio and continue to track on execution of our previously communicated.
Initiatives.
I will now turn the call over to match review, our financial results. Thanks, Chris and good morning, everyone North.
Normalized F S O for the quarter was $53.7 million or $1.11 per share coming in three cents above consensus and two cents above the high end of our guidance range.
This compares to normalize F F O a $52.7 million or one dollar nine per share for the first quarter of 2023.
The increase on a sequential quarter basis was primarily driven by higher in Hawaii do a decrease in seasonal usage or utilities or termination fee related to a tenant lease renewal and downsize and lower G&A expense, partially offset by increased interest expense.
It should be noted that determination fee was included in our queue to normalize <unk> guidance provided on last for his call.
<unk> expense for the second quarter was $5.8 million as compared to $5.9 million in the previous quarter. The sequential quarter decline was mainly driven by lower business management fees due to an increase in our stock price, which emphasizes the alignment between our manager <unk> Margaret and shareholders.
We generated C. A D 33 cents per share during the second quarter and $1.76 per share on a rolling fork water basis earlier.
Earlier this month, we declared our regular quarterly distribution of 25 cents per share, which represents a trailing four quarter C. A D payout ratio, 67% based on our annual dividend rate of one dollar per share.
Saint property <unk> decreased 3.7% compared to the second quarter of 2022 and beat our guidance range of down five to seven per cent.
The decrease was mainly driven by elevated free rent levels in the current year period.
Higher operating expenses as we continue to face inflationary pressure inexpensive previously paid by a tenant now being paid by O P. I as a result of tenant downsizes and changes and certainly structures.
Turning to our outlook for normalize Epiphone Saint property cash basis, NOI expectations in the third quarter.
<unk> be between 99 cents and one dollar and one cent per share. This guidance includes a range of $5.7 million to $5.9 million of G&A expense.
Decreased from Q2 was made up of several items, most notably seasonal increases in operating expenses lower amounts of capitalized interest with a substantial completion of the 20 Massa project and certain tenant vacancies in downsizes, partially offset by the commencement of the Sonesta, Lisa 20 mass Ave.
We expect same property cash basis, NOI to be down 8% to 10% as compared to the third quarter of 2022, mainly driven by free ranch in the current year period, and certain tenant vacancies and downsizes.
Turning to the balance sheet.
As Chris mentioned during the second quarter, we commenced our financing strategy for a merger with diversify health care Trust as a reminder, in connection with the merger. Okay. I secured a commitment for a 368 million dollar bridge loan facility to ensure we can close the transaction.
Use of this facility, we are entering mortgage loans secured by certain of the bridge loan collateral properties more attractive terms than the bridge loan facility.
Today, we are closed more than one or $108 million, an interest only mortgage financing with a weighted average term of 6.8 years and a combined total loan to value ratio over 52%.
Connection with these financings debris loan commitment has been reduced to $260 million.
This execution in these challenging market conditions highlights the benefit of are largely unencumbered balance sheet combined with our high quality assets. We are in active discussions to complete similar financing of other O P. I bridge loan collateral properties in the coming weeks.
At quarter end are outstanding that had a weighted average interest rate of 4.3% and a weighted average maturity of 4.7 years over 90 per cent of our debt is fixed rate and approximately 96% is unsecured.
In June we exercise, our second and final option to extend our credit facility to January 31st 2024 <unk>.
We ended the quarter with $535 million total liquidity, including $510 million of availability under a credit facility.
Turning to our investing activities since the beginning Sir we have sold five properties containing 296000 square feet $13.1 million and are currently under agreement to sell one property containing 80000 square feet for $10.5 million.
Given the current investment sales market, we continue to expect their disposition activity to be somewhat muted until market conditions improve.
We spend $33.6 million, a recurring capital and 40 $24 million redevelopment capital during the second quarter. We continued to expect 2000 twenty-three recurring capital of $100 million to $110 million and we are updating our redevelopment capital outlook to be approximately $125 million to 135 million.
Dollars.
With 20 mass Av substantially complete we have approximately $114 million of estimated remaining project cost to fund the development and least related capital to achieve stabilized occupancy of 20 mess app in unison.
That concludes our prepared remarks, operator, we are ready to open the call up for questions.
We will now begin the question and answer session.
To ask a question you may 1st stop them on your Touchtone phone.
Excuse me and a speaker phone please pick up your handset before pressing the keys.
To try your question please post on them too.
At this time, we will pause momentarily December roster.
Our first question will come from Brian Maynor would be around the F. B R. You may not <unk>.
The morning, Chris and that just a couple from me this morning.
Kind of sticking with the sale of assets and the proceeds and thus utilizing the bridge loan less assuming the deal with D. C is closed how long up until the deal closes and you need to tap that bridge loan <unk>.
Selling assets and aside from the 10 million dollar after that you just talked about are there any more than you suspect to close between now and then and then what is the delta roughly in the costs between the proceeds you're getting you know in in the new debt versus the.
<unk>, what is the delta and the cost of that.
I think just starting with the asset sales, Brian I think you know we've talked about.
You know maybe getting up 30 to.
40 million is probably an accurate number based on where we think we might land with transaction and that includes the $10 million and a few other.
Opportunities that are out there, but I would say that that's on the high end of the range as far as at least where we stand today, what we might clothes are in so.
There may be some outliers, but I think that's a good guy.
And on the on the financing success and the impact to the bridge loan.
Our goal from when we sign the merger back in April was to not draw on the bridge, it's more expensive than just traditional secured financing. We're very pleased with the progress. We've made today, having closed $108 million in proceeds I will say between the L. P I N.
D. H C properties that are part of the collateral pool, we have executed term sheets with various lenders totaling $450 million in potential loan proceeds which is far and above the total bridge loan commitment if they're OPI assets. We can continue to close prior to the <unk>.
Merger, if they are th the assets, we have to wait and and being a physician to close simultaneously or shortly thereafter.
So we're very pleased with wherever we positioned ourselves in very challenging financing environment and with where we are we also believe some of the bridge loan collateral of properties unencumbered. So we're gonna get a lot more and proceeds then we would on the bridge instead.
He'll leave certain properties unencumbered, which will help our debt covenants et cetera, and lastly, as we think about pricing you know the weighted average interest rate on the four loans. We close was about 7.9%. The bridge loan cost is north of 10%. So you've got a 200 plus basis point premium.
Or benefit to the cost.
So I guess, what I'm hearing is is with all the stuff that you're doing there's a very high likelihood that you won't need to tap. The bridge loan you know kind of hard to stop period and can you tell us how the extension of the credit facility to January impact any of the financing.
Towards the deal.
Yeah. So on the bridge like I said it remains our goal to not draw on it we have it in place as a backstop until we actually closed <unk> mortgages in this environment you never know so it it's there if we need it and if we do need it we expect it to be for a very short period of time.
Like I said, we're positioning to not need it as it relates to the revolver. Yes, we did extend the L. P. I stand alone mature you to January 31 to 24, a condition of closing the merger is that the combined company will have a recast or amended revolver, we've been progressing on that.
Nothing really to report publicly but we have executed term sheets with our admin agent. We've fielded a lot of diligence type questions from the bank group et cetera, and we're tracking nicely on that effort as well.
Okay and May be last for me you know fundamentally I think and you're prepared comments you talked about year and occupancy in Canada 80, 788 per cent range, you know assuming that 20 minutes add in Seattle kind of ramp. According to your expectations can you maybe look at a little bit further.
We're fast approaching urine to what you know occupancy might look like a year from now say mid 2024 with those two properties coming online.
It's hard to tell Brian I mean, the you know the occupancy or the kind of a new building square footage for 20 mass AV is is kind of an R square footage and so you know current occupancy is representative of that building come.
Ring online, there's really no change in the square footage for the Seattle property and so.
I mean, I think where we stand today or skiing, some positive momentum with absorption of new leasing with what we've seen today you know we've talked about the retention levels across the portfolio and what we anticipate those to be as a run rate for 2024, but.
It's difficult to sit here today and kind of pegging occupancy numbers. Because in addition to just you know development then leasing activity. There's also you know the disposition and capital recycling plan that will likely continue with and that kind of has a much more uncertain.
Approach, just given kind of the environment and where are we ultimately conclude will transact in the year. So.
I think at this stage you know the best guidance, we have is that 80, 788%.
Okay. Thank you.
Our next question will come from Ronald Camden with Morgan Stanley you.
You may not go ahead.
Hey, good morning is Timmy <unk>, yeah, just sticking to the occupancy again yeah.
80, 788, I think is the guy and through your and you know a little bit lower than the you know where it was previously so one you know occupancy it looks like it's trending just and teach you a little bit higher than than one Q.
So.
Is that the guy that production is that primarily to them just my.
Lower leaves me expectations for the development pipeline and.
He has just give us a sense for you know what what occupancy would look like you ran just for the same store portfolio itself.
Yeah, a couple of things I think that you know we had some tenants that were known vacates in queue to carry over and so we would anticipate that you know the impact of occupancy upon them vacating absent of any lease being signed with come in.
Two three Q for depending on the circumstances, and then with respect to year and occupancy. There's a couple of drivers one is gonna be contingent on again disposition activity and what and and the reason why I say that is because some of the buildings being contemplated have high.
Her vacancy and so that in itself would have somewhat of a favourable impact on occupancy.
And then we did have a tenant the GSA, who was an exploration and early in 2024 provide early notice of a vacated so that had a slight impact on a negative impact on occupancy at least for your red but it was.
Would've been something that would've been impacted and you know the first part of 2024.
Got it and then you guys talked about 80 per cent financial and real estate tenants, making up the leasing activity during the quarter just as we as we go forward you see you know Pearl P. As a stand alone basis.
Just less government exposure overall.
For the portfolio because of apparently some friends or how should we think about that.
Yeah, I mean, I think just generally speaking you know we've seen a slight pull back and the overall government peace and that's just been you know through a variety of circumstances I mean, the 20 mess. It up development is a good example, where we've gone from what was kind of a GSA strategy with an older.
Class of your property into a private sector strategy with a kind of a new trophy class a mixed use development Ah.
And then in some circumstances, where you know the GSA no different than the private sector is rationalizing their space needs outside of those mission critical facilities. I think just generally generally seeing that kind of the there's not a lot of GSA deals tracking out there to kind of drive absorption and.
So to the extent that we see space come back to us that is GSA at least.
The likely path there is to focus on private sector leasing so that would have a negative effect on our overall GSA exposure. So there will be some some changes in that you know I don't know if it'll be material kind of in the near term, but over time it'll continue to have an impact.
Got it and then you have to talk about the second half 24 accretion with the merger just wanted to confirm that includes you know you guys contemplating the you know the non-cash mark to market from assuming you can't keep that.
If that's included within the guidance and <unk>. If you guys can just give us a sense for what that number might look like and if if that would be included at all.
Do we think about covenants and whatnot.
Yeah. So it is included in the guidance forecast on the combined company basis for second half of 24, I think the best proxy to look at is probably D. H sees 10-Q from Q1 in their fair value footnote it shows the Carrie carrying value.
As compared to the fair value I believe it's about a 600 billion dollar Delta as of March 31st.
So that's a good proxy to use as it relates to covenants, that's not gonna impact our covenants negatively.
Got it. Thank you guys. That's all I had.
Again, if you have a question. Please press start didn't want.
Our next question will come from a D T <unk> with RBC capital markets you.
You may not go ahead <unk>.
Thank you. Good morning can you just get some more details on that type of contamination that you guys talk about in that came out earlier. This month, what's the plan for the building and when will the 8 million dollar termination feed me without the ninth.
So on the termination notice you know I don't think it was unexpected you know tyson's had been.
Public about consolidation and so for you know for US we had been planning assuming that termination would in fact be exercise and so.
You know with that in mind I mean, I look this building was completely redeveloped in 2013, and so I think as we step back and kind of look at you know just the quality and the footprint or the landscape of you know the.
The greater Chicago area, you know, we're getting a building back that is kind of checks all the boxes with respect to you know where tenants our focus today I mean, so it leaves certified buildings that has numerous other awards tied to it. It's got you know it's within a short walking distance to three.
Three different modes of rail transportation, it's in the West loop, which is one of the stronger submarkets behind the Fulton Submarket, which is the strongest where we don't want another property and the show is extremely well and so you know we have a team teed up it's been in the market and I think.
We're generally optimistic that we'll be able to you know released this building to an office user in short order.
And then on the termination fee that's gonna be amortized over the remaining term of of January 31st 2025.
Alright, thank you.
This concludes our question and answer session I.
I would like to turn the comes back over Chris Blotto, President and Chief operating officer for any closing remarks.
Thank you for joining us today and for your interest in <unk>.
The conflict has not concluded. Thank you pressing today's presentation you may know disconnected.