Q2 2023 City Office REIT Inc Earnings Call

In our 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 certain statements made today that discuss the companys beliefs or expectations or that are not based on historical fact may constitute forward looking statements within the meaning.

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

Looking statements and actual results the.

The company undertakes no obligation to update any forward looking statements that maybe made in the course of this call.

I'll 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.

Through the first half of 2023, our portfolio has continued to perform in line with our expectations.

Our second quarter results reflect our focus on steadily progressing leasing as we continue to upgrade and position our premium sunbelt portfolio.

We believe that this strategy will generate strong future results as we execute on our property level business plans youth.

Utilization levels of our properties continued to trend slightly higher throughout the quarter ending at approximately 61%.

In 2022, we experienced an uptick in utilization after labor day, and we anticipate that will also be a catalyst for further returns to the office policies. This year after the summer vacation season.

Our focus on driving leasing activity paid off during the quarter. After a slow start to the year. During the second quarter. We completed 224000 square feet of total leasing activity with a healthy seven 2% improvement in renewal cash rents versus the expiring rates.

Quarter over quarter, we achieved an increase in occupancy at nine of our properties maintained occupancy at 11 and experienced a decline that only four assets.

As we've mentioned on prior calls our continued focus is on enhancing overall occupancy, particularly at our best assets with the highest rental rates.

In that regard are ready to lease modern spec suites continued to be a driver for leasing activity.

We've leased 16000 square feet of spec suites. This year, which is a function of the limited spec suite inventory that we had available.

Our expectation is that as we continue to deliver space is under construction the spec suite leasing totals will accelerate.

As of June 30, with a recent deliveries we have 54000 square feet of built spec suites and our inventory.

We also have approximately 31000 square feet under construction or delivery and over 69000 square feet planned to commence construction during the second half of 2023.

We focused our new inventory decisions at locations that we believe will be absorbed the fastest we expect that this program will continue to drive long term results.

Of note related to property upgrades during the second quarter renovations to the park amenity connected to our circle point campus in Denver were completed.

We led the transformation of the adjacent to six acre park with new Hardscape landscaping amenity areas and outdoor work parts.

Accessibility to the part from our buildings was also enhanced making this incredible garden like amenity truly integrated with our buildings.

The approximately $4 million renovation was completed with funds from our special tax district financing. So we were able to secure these major property improvements without coming out of pocket for the costs with.

With the park upgrades, the existing tenant lounge restaurants, and high end fitness amenity circle point is well positioned from a leasing perspective.

From a high level point of view there continues to be headwinds across the commercial real estate industry and in particular, the office real estate sector.

Nonetheless, we believe our portfolio of premium Sunbelt properties is well positioned to weather these headwinds and outperform.

As we move into the second half of the year, we will continue to focus on optimizing our properties to achieve leasing.

We will also continue to operate in a strategic and conservative manner to ensure ample liquidity and to provide ourselves with the flexibility to pursue opportunities as they arise.

I look forward to providing future updates on our progress and we'll hand, the call over to Tony <unk> to discuss our financial results.

Jamie the most significant accounting transaction during the quarter was related to a 190 office center property in Dallas as we had indicated was likely to occur on previous calls during the quarter, we consented to hand possession of 190 office center to the lender.

We made the strategic decision based on our opinion of value of the property and its future prospects relative to the non recourse loan balance.

As a result of this transaction, we deconsolidation the asset value associated with the property as well as the corresponding debt of $38 6 million.

As we had written down the property's value in 2022. This transaction resulted in a minor book loss of $134000 during the quarter.

Moving onto our financial results, our net operating income in the second quarter was $27 $4 million, which is 800000 lower than the amount we reported in the first quarter. This decrease is primarily attributable to the deconsolidation of <unk> Office center during the second quarter.

Related to net operating income we have seen recent increases in operating expenses on a year over year same store basis operating expenses increased 7%. This was a result of both inflation across various operating cost categories, but also a function of the increased utilization at our bill.

<unk> year over year.

We reported core <unk> of $14 2 million or <unk> 35 per share, which was 800000 lower than in the first quarter.

This decrease was also primarily a result of lower NOI from 190 Office center or.

Our second quarter, <unk> was $7 3 million or <unk> 18 per share.

The largest impact <unk> with continuing investment and ready to lease spec suites and vacancy conditioning, which is a key part of our business plan. The total investments spec suites and vacancy conditioning in the second quarter was $1 9 million or <unk> <unk> per share.

Moving on to some of our operational metrics are second quarter same store cash NOI change was positive seven 5% or $1 7 million as compared to the second quarter of 2022.

Block <unk> three in Raleigh, and Park tower in Tampa has the largest year over year increases due to slightly higher occupancy and free rent in the prior year comp period as a result of signed leases.

We expect our same stores results will moderate during the second half of the year as prior year comparable free rent periods burn off overall for 2023, we are tracking towards a 3% to 4% increase in same store cash NOI, which is the higher end of our previous guidance range.

Our portfolio occupancy ended the quarter at 85, 6%.

Including 83000 square feet of signed leases that have not yet commenced our occupancy was 87% as of quarter end.

Our total debt as of June 30 was $678 million or net debt, including restricted cash to EBITDA was six five times that.

The deconsolidation of 190 Office center property in Dallas, and it's nonrecourse mortgage reduced our total debt by $38 6 million.

We have two smaller maturities in the fall of 2023 and both of these loans are secured by high quality properties. We are currently in late stages of renewing these loans each on five year terms with our existing lender.

The effective interest rate, we expect will be in the high 6% range.

As far as liquidity as of June 30, we had approximately $90 million of Undrawn authorized on our credit facility. We also had cash and restricted cash of $53 million as of quarter end.

Last we have provided updated guidance to reflect year to date performance and our expectations for the balance of the year. Our revised guidance ranges are all within the initial guidance ranges. We provided at the beginning of the year, we tightened each of these ranges around the most likely outcome based on information we have today.

Leasing volumes through the first half of the year were slower and as a result, we have reduced our expectations for income from speculative leasing in the second half of the year our guidance adjustments had a net effect of lowering the top end of our prior core full per share range lowering the midpoint by one five.

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

Thank you if you would like to ask a question. Please press star followed by one on your kind of thank you Pat.

Mpg's withdraw your question. Please press Star and then if I can.

To answer your question Peter.

Like many.

Thank you and also ask questions sorry, guys you're welcome.

Stevenson of Janney. Please go ahead your line is open.

So my first question was the Tony any additional known move outs that we haven't talked about on previous calls.

You should be aware of.

I can go through them, but there really isn't any new move outs.

Whatsoever versus ones I've already spoken to in the past.

Okay, and then what is the incremental revenue assumed by the leases that have been signed but havent commenced how.

How much does that add going forward.

Yeah.

So the math behind that is if you offset the known move ins versus the known move outs were expecting occupancy to effectively remained flat through the end of the year.

Okay.

And then you talked on the.

The prepared comments about some of the.

Coming up on.

And Carlton point.

Later this year is there anything in the pipeline at this point, where youre looking at Youre, saying, Hey, if things don't turn around materially.

We may wind up turning keys in on anything else or as those two assets that you have done thus far pretty much likely to be at in the near term.

So we talked about the 190 on the call Rob and previously we mentioned Cascade station in Portland, which we took an asset write down at the end of last year, we're in the midst of the.

Marketing process there. So it's a little early to comment we probably have more of an update next quarter.

On what our strategy is going to be around that asset, but that loan does mature in may of 2024.

Okay, and then Jamie I mean, I guess the last one for me is that you talked about the utilization coming back up expenses are increasing.

The office REIT stocks have had a little bit of a bounce back here.

Over the last.

30, 60 days et cetera.

I guess, how are you guys thinking about.

The next six months to 12 months and.

The current state of the office industry.

So it's a good question.

I think you've hit on a couple of the highlights there there really are a few important factors I think that investors really need to consider when the Gainesville, the macro position to the office industry as well as how each company's position in the first which had some changes recently.

He is really understanding the loan renewal environment.

And what we've seen is the banking sector has actually started to stabilize and I think lenders are far more willing to work with quality borrowers and that's a big improvement that will help overall stability for strong bores, but not everyone falls in that category and when you look at see MBS loans, which require working with.

Servicers those are likely to have a much greater challenge.

In terms of securing new loans that remains extremely difficult lenders generally want to reduce their overall office exposure.

And they have been working with existing loans and seem to have a little appetite for making new loans and why that's important.

It means an owner must reefer.

Refinance.

Effectively with their existing lender, there really isn't much of a bid outside of that and.

It also means theres very little debt available for buying new office assets today, and many sellers if they want to transact and have unencumbered properties really are trying to look at providing seller financing in order to be able to transact in today's environment. So bottom line, we think the <unk>.

<unk>.

Is likely to result in limited trades. The time period, you talked about Rob and it's going to also add stress to owners, who are unable to finance refinance or work with their existing lenders and as a result, we think theres going to be a lot more assets that are likely to go back to lenders over the next year.

I suspect youre not going to see many of the the trophy your best quality assets going back to the lenders, it's going to be concentrated.

Probably on properties with lower occupancy.

Lower utilization or assets that really aren't well position.

In today's leasing world and in the lenders as those assets are likely to bleed tenants and so the third kind of main factor, which really is impacted by the two things I just mentioned there is leasing.

And overall, we're starting to feel better about this part of our business for well located and well positioned assets and what we've seen as tenants have really deferred a lot of their leasing decisions over the last three and a half years since COVID-19 started.

And they continue to express the desire to have employees come back for the majority of their time.

So that's an important differentiator that really impacts how each company's position and in our case, we have over 300 tenants across our portfolio. We generally have smaller average tenant sizes, which is a stronger sub sector of the market, we average around 15000 feet.

We have well located in the monetized buildings in great cities and a strong financial position. So we're feeling like we're in a good spot here.

But what we believe is going to happen is tenants are going to continue to firm up their leasing plans.

We're really going to focus on the best locations and the best monetize buildings focus on buildings that have a strong financial position.

And that's going to be an area, we think we're going to benefit from.

Across the office industry. There are a lot of properties that have high leverage.

Less well capitalized owners and as some of those properties go back to lenders.

We think leasing is really going to concentrate into a limited subset subset of the overall industry.

And it's going to happen at a time when there is virtually no new development starting and so.

<unk> said there to summarize all that I think youre going to see refinancing challenges and limited sales outside of lender repossessions for the next while.

I think assets that are quality and well located in the hands of well capitalized owners.

Are going to result in a good opportunity to really drive the rent roll and wind tenancy and everybody has some tenant right sizing that theyre going to need to do over the next little while but if you're strongly capitalized I think it's going to create an opportunity to grow your overall cash flow and your position.

Okay, I guess one follow up.

Given the comments about.

Debt renegotiation et cetera, Tony.

The renewals that you are looking at that Youre renegotiating now in the high six range is that impacted in the updated interest expense guidance to 32, 5% to 33 or is that in addition to that we need to be thinking about earnings wise.

No. It's included in that range and depending on where rates fall when we.

We're going to be doing a five year floating rate debt with a corresponding swap to effectively fixed the rates, so depending where that lands when we close.

We will land.

We either lower the top end of that range.

Okay. Thanks, guys have a great weekend.

Thanks, Rob.

Thank you and the next question.

Oxide of Kony as Perry. Please go ahead your line is open.

Great. Thanks, guys looking at the spec suite.

You said you had 69000 planned for construction in the second half have you put most of those dollars to work or are we going to see those dollars being put to work in the back half of the year.

Yes, so just to clarify hey, Barry its Tony here.

31, 31000 square feet that is currently under construction there isn't right.

Correct.

Yes. So another 69000 in addition to that that's in planning stages, now and we expect to commence before the end of the year, but probably not complete off though in terms of what that translates into dollars.

We have budgeted about 6 million more that will be spent in the second half of the year.

Okay. That's the number I was looking for.

Are you guys also are you getting the rents on the spec suites that justify the irr's that youre looking for you're still getting.

Fairly healthy rental rates.

Hey, variance Jamie Yes, we've been pleased with the rental rates, particularly when you are building quality spec suites.

We've been happy with where rates are landing for those and then again, we've concentrated our program and kind of are better asset highly leasable assets and so.

The rendering that we're achieving is in line with where we expected it to be.

Right, so Lisa but it feels like at least it looked like you indicated that the leasing was a little slower than what you had anticipated.

Yes, I think Thats fair on the specs, we signed the delivery has been a little slower as well.

Okay.

Is that just kind of an aberration or is it something to be concerned about.

Yes.

At the beginning of the year. If you remember we had bank failures and basically when that happen leasing just kind of froze right and so with the ability over the last few months, we seem to be getting back onto a trend of kind of normal business and we believe kind of our own thoughts of what we're going to achieve on leasing and pushed it out a bit.

But it seems to be improving.

So loosely translated foot traffic is picking up.

Yes.

Perfect Alright, thanks, guys for the color on that.

Thanks for the question Sir.

Yes.

Thank you and as a reminder, if you would like to ask a question. Please press star followed by one on your telephone keypad.

And our next question Craig <unk> of B Riley. Please go ahead. Your line is open.

Yeah. Thanks, good morning, guys.

I appreciated the color on the second half of 'twenty three spec suites spending I think you mentioned 6 million can you give us a sense of what was the expense to ramp a Boe in the second quarter.

Yes sure. So we have spent a total of $3 2 million year to date on those spec suites and vacancy conditioning $1 3 million in Q1, $1 9 million in Q2, and as I mentioned, we're expecting approximately another $6 million for the second half of the year and.

Effectively what that what that shows is we had a little bit delayed in terms of permitting and construction delays.

The catch up by the second half.

Okay, Great that's helpful.

Are the renovations that chemo and camelback had they been expensed or capitalized.

Capitalized.

So in terms of.

You asked about Pima and.

Camelback passenger highlighted on your investor presentation.

Each of $3 million I believe.

Yes. So camelback was effectively finished last year and in isn't in this year's numbers and the promo renovations.

<unk> is currently ongoing and there is there is a.

A portion of that hit the first half of the year and the remainder in the second half.

Okay got it.

There's obviously been some pretty extreme heat in the southwest in particular Phoenix are you expecting to have a meaningful impact on NOI. This quarter or you think you'll actually be able to pass that through.

We're not anticipating.

Major change because of that Craig and a lot of these leases have pass throughs. So.

We're not going to impact us too much.

Okay, great. Thanks, that's it for me.

Thanks, Greg.

Thank you we have no further questions I'll now hand back to Mr. James <unk> for any closing comments.

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