Q3 2023 City Office REIT Inc Earnings Call
Good morning, and welcome to the City Office REIT, Inc. Third quarter 2023 earnings call. At this time, all participants are in a listen only mode.
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Alright.
My pleasure to introduce to you Tony birthday, the Companys, Chief Financial Officer, Treasurer, and corporate Secretary.
Thank you Mr. <unk> you may begin good morning, before we begin I would like to direct you to our web site at C. I O.
<unk> Dot Com, where you can view, our third 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.
Certain statements made today that 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. Although 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.
<unk> will be achieved please see the forward looking statements disclaimer in our third 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 company undertakes no obligation to update any forward looking statements that may be made in the course of this call I'll.
A review of 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.
As we move into the end of the year and look ahead to 2020 for the office environment continues to experience, both encouraging trends and macro headwinds.
We anticipate the macro environment next year will continue to be challenging with a higher for longer interest rate environment and potential economic weakness.
Despite that we believe there will be subsets of the office sector that are going to perform well.
Ill highlight where we believe that is going to be in the decisions that we're making to optimally position ourselves.
While the last few years have been less predictable than in the past some clear leasing trends have become apparent.
New vintage buildings have dominated leasing despite representing a relatively small percentage of the entire office stock.
Jay LLS recent market research confirms this their data identifies that newly constructed office buildings delivered in 2015 or later had been winning most of the net absorption over the past three years.
We believe tenants clear preference for premium quality space will continue to support this trend.
Not surprisingly future supply of new development has and will continue to dramatically taper given the sector is uncertainty and a lack of equity and debt capital.
Outside of projects already under construction, we expect limited delivery of premium new competitive buildings in the near to medium term.
The combination of these two trends concentration of demand at the top part of the market along with slowing new construction should result in rising rental rates and strong operating fundamentals at this top segment of the market.
City office is positioned to benefit as these trends play out.
Our three most recent acquisitions are top of market buildings with new construction great.
Great locations and leading amenities.
The terraces in dialysis Preston Center delivered in 2017, and it is a 100% occupied.
Block 23 in downtown Phoenix delivered in 2019. It is now 95% occupied with two well positioned vacancies that we expect to lease.
And our two building block 83 property in Raleigh Dill.
Delivered in 2019 and 2021, it is 86% occupied with additional leases under negotiation and strong tour activity.
These three assets are perfectly suited in todays leasing market and represent a very significant percentage of our overall value.
With rental rates for this category of property is likely to continue to grow. These are exactly the sort of assets that you want to own now and for the long term.
Despite sector challenges, we expect these premium new construction buildings, we will continue to lease up and availability of vacant space within this category. We will diminish this supply reduction should lead to greater demand for the next highest quality tier properties.
This includes buildings that are extremely well located in great cities and have been recently renovated to a very high standard with amenities.
The rental rates for this category of property are currently at a significant discount to new vintage buildings, we expect that as the premium buildings become unable to accommodate tenants rental rate and demand growth will shift to this category.
Within our own portfolio. These views have shaped our strategy to position ourselves for winning occupancy.
We've either been investing capital in or about to make enhancements to this category of buildings that we own.
This includes renovation programs and advancing ready to lease spec suites.
Across our portfolio, we have a number of examples within this category.
Park Tower is a renovated building that we transformed in downtown Tampa.
The square is a fully renovated asset in an incredible location in old town Scottsdale.
The quad in Scottsdale has been fully renovated and has achieved strong and consistent tenant demand.
City Center in downtown St. Petersburg is a fabulous waterfront location and we're finalizing our plans to launch a major repositioning.
50, <unk> 90 is well located in Phoenix is Camelback corridor, we've just initiated a major upgrade that will complete mid next year.
In Pima center located in North Scottsdale is undergoing a transformational repositioning right now.
We've already seen a pickup in leasing demand from the improvements of Pima Center and will further benefit from the new amenities is the adjacent $80 million Entertainment development under construction completes.
Bottom line, we see opportunities for outperformance and value creation. Despite the challenges in certain subsets of the office sector.
On a separate note we enhanced our supplemental financial information package to include additional detail for our leases with we work given their recent filings and restructuring.
In total we work leases 177000 square feet at our three top tier properties that I discussed earlier, and Raleigh, Dallas and Phoenix.
We works Raleigh, and Dallas operations at our buildings appear to be well occupied.
The Phoenix location opened approximately one year ago and is still in a lease up mode with lower occupancy levels.
None of our three leases were listed for rejection on Reworks November 7th filing.
All three locations are open and operating and current on rent through the end of October.
Despite this we've been preparing for any potential scenario that could unfold that we work.
Fortunately, we work lease at our most desirable assets in locations.
Each of the three properties are newly construction in our flagship type locations, where we work.
In the event they vacate at any of these locations. We already have strong interest from leading co working operators and are ready to move quickly altered.
Alternatively, we have the option of pivoting to leasing to conventional tenants given the demand for premium buildings bottomed.
Bottom line, while these challenges may create some short term disruptions our premium locations and phenomenal buildings preserves our strong position.
Moving to our results for the quarter they were in line with our expectations.
During the quarter, we executed 119000 square feet of new and renewal leases with a three 1% increase in renewal cash rents versus expiring rents.
This follows the industry trend that despite negative absorption face rental rates have continued to rise driven by top tier and renovated assets.
We also had another quarter of positive same store cash NOI growth and achieved a two 2% increase over the prior year quarter.
Year to date same store cash NOI increased by four 2% as compared to the same period in the prior year.
Consistent with our previous messages.
We continue to see tenants wanting prebuilt space that can be quickly occupied with no construction build out uncertainty.
As a result, we've been focused on ramping up our spec suite inventory.
We've increased our spec suite inventory from 54000 square feet as of June 30 to 92000 square feet as of September 30th.
We have an additional 67000 square feet that is either under construction or planned for the balance of 2023 and 2024 with active leasing conversations occurring at many of these locations.
Currently we're exchanging proposals four or in final lease negotiations on six spec suites totaling approximately 27000 square feet.
As we head into year end and 2024, our team remains focused on driving leasing activity and creating value for shareholders. While office REIT stocks continue to trade at steep discounts, we believe the quality of our portfolio and our focus on creating value will reward shareholders over the long term.
I look forward to providing further updates on our progress and we'll hand, the call over to Tony <unk> to discuss our financial results.
Thanks, Jamie.
Our net operating income in the third quarter was $26 6 million, which is 800000 lower than the amount we reported in the second quarter.
This decrease is attributable to the deconsolidation of 190 office center during the second quarter slightly lower occupancy and higher operating expenses quarter over quarter.
We reported core <unk> of $13 7 million or <unk> 34 per share. This was 500000 lower than in the second quarter for the same reasons that NOI was lower offset by slightly lower G&A in the quarter.
Our third quarter, <unk> was $6 3 million or <unk> 15 per share, which resulted in a well covered dividend this quarter, the largest impact to <unk> with a $1 5 million tenant improvement at our Denver Tech property for a 37000 square foot tenant who renewed their lease in 2022 for an additional.
<unk> 11 years.
We also continue to invest in ready to lease spec suites and vacancy conditioning, which is a key part of our business plan.
Total investment in spec suites and vacancy conditioning in the third quarter was 800000 or <unk> <unk> per share.
Moving onto some of our operational metrics, our third quarter same store cash NOI change was positive two 2% or 500000 higher as compared to the third quarter of 2022 block.
Block 83 in Raleigh, and Park tower in Tampa had 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.
For 2023 in total we are tracking towards a 3% to 4% increase in same store cash NOI.
Our portfolio occupancy ended the quarter at 85, 4%.
Including 51000 square feet of signed leases that have not yet commenced our occupancy was 86, 3% as of quarter end.
Our total debt as of September 30 was $671 million or net debt, including restricted cash to EBITDA was six five times during the third quarter. We were successful in completing the renewal of two property loans that were set to mature in September and October the loans at our FRP collection and Carolyn properties in flu.
<unk> were both extended for five years to 2028 in connection with the extensions we entered into five year swap agreements effectively fixing the interest rates for each loan at approximately 7%.
Our next loan maturity is the nonrecourse property loan at our Cascade station property in Portland, which has a principal balance of $21 million and matures in May 2024.
In December 2022, we recorded an impairment and that asset value that effectively wrote off our equity value and we have begun discussions with that lender.
<unk> continues to be a challenging market and without some form of material loan concessions. It is difficult to justify investing further equity into this asset today.
Lastly, as of September 30, we had over $90 million of Undrawn authorized on our credit facility. We also had cash and restricted cash of $52 million as of quarter end that concludes our prepared remarks, and we will open up the line for questions operator.
Thank you, we will now and a Q&A session. As a reminder, if you'd like to ask a question. Please press star followed by one on your telephone keypad.
Ask your question. Please ensure that your devices underneath it lately.
Question today comes from Stephen Kim from Janney.
Your line is open your.
Question.
Thank you and good morning, everybody.
Jamie how are you approaching.
So we worked bankruptcy some office owners just want to rip the band aid off and get the space back if they can do better than what we work once in terms of new rates and without the risk that are just implodes at some point it sounds like from your commentary that they have not put these back to you yet, but I assume that eventually there'll be coming to you to try to renegotiate how do you approach that at this point given the reserves.
Three of your top assets rather than assets along the bottom.
So thanks, Thanks for the question and you've hit the nail on the head. We work are trying to get concessions from all landlords. They publicly stated that and I guess, it really comes down to the position that you're in.
As a landlord and we think we work are excellent operators it sounds like they're making headway on solving their balance sheet issues and exiting some locations that had been a drag but bottom line, we care about maximizing our own position and we're in a good spot overall, we've got three fabulous locations.
As I said in my prepared remarks, the rally in Dallas locations are doing extremely well Phoenix Theres, a little lighter given they just reopened it about a year ago and so from our position we've been focused on getting our alternatives ramped up and that could be moving to another co working operator it could.
Be leasing the space directly in the analysis, we've been doing is.
Despite what direction. We go we think we can do the same or better in terms of rents and if we ultimately end up having a switch which may happen may not we don't know there'll be a period of kind of ramping back up and then we'll get to the same or better spot. So we're being pragmatic about it Rob.
I think we've got fabulous locations that we weren't probably don't want to give up and it sounds like theyre doing.
The rate moves on their side to position themselves for success. So we're going to play it out and keep all of our options open.
Okay. That's helpful.
Tony any incremental known move outs over the next 24 months from last quarter.
Really no update in that respect the same ones, we talked about before I can review it really quickly for tenants that are greater than 30000 square feet that are set to expire over the next 12 months.
Two of which totaled 84000 square feet are at or a cascade station in Portland.
Which are known move outs.
And those are the only known move outs. We have we have a couple of other larger tenants that were were.
Optimistic on renewals for.
Okay. When do you guys expect to come to a decision or a final sort of process on Cascade station is that sometime here in the fourth quarter or is that likely to be some time.
<unk> early 'twenty four is the debt expires, how should we be thinking about that.
We engaged in discussions with the lender a number of months ago and they are ongoing so it's hard for us to say exactly when that's going to transpire.
Okay, and then Tony the <unk>.
700.
A free rent in the quarter, how is that sort of look in terms of the fourth quarter and as we sort of migrate into early 'twenty four is that dropping off for their new leases of magnitude that you guys have signed over.
Over the last few months that will continue to have you sort of in that three quarters of a $1 billion to $1 billion of free rent or is that burning down closer to de minimis levels.
I would expect that you'll still see the free rents or line item continue by Q4, you may see a little bit of a burn down some of it of the free rent.
Sure.
Is that some properties that are that are known to be burning up but not material not a material movement in that direction. So Rob if we do what we are striving to do which is really drive a lot of occupancy or in growth, which is going to drive cash flow, that's going to keep free rent elevated for a bit because virtually all deals have some component of free rent that's a good thing.
Typically at the front.
Okay and to that point.
I spent thus far in 2003 on the spec suite program and how much you guys likely to spend in 'twenty four given your comments about continuing to expand that program, how should we be thinking about that.
Yes, sure. So we made some significant headway in 2023 year to date. We've spent just over $4 million I. Just mentioned, it's about 800000 in Q3. So I think the way best way to think about it is Q4 will probably be in that $1 billion range and you would probably expect that same trend to continue throughout 2024.
Yeah.
Okay. Thanks, guys Thats all from me and have a great day.
It's a lot.
Thank you. Our next question today comes from Barry that you call it.
Your line is open. Please go ahead.
Great. Thanks, guys on the same store NOI.
NOI.
Tony It looks like you had.
A pretty nice reduction in expenses was there one particular thing that was driving that and we look for that to continue.
Good question Barry.
A little bit of anomaly, if youre looking at.
Year to date in that pool, if anything operating expense savings.
Our remaining.
There's still inflation challenges, so I would expect to be flat to increasing.
Moderately I'm going forward.
Okay.
What caused the occupancy and same store.
Drop just a little bit.
And so the occupancy we had.
In terms of the quarter.
Yeah, I'll just move on.
Ed was at Fr Pardon me at Papago Tech, we had a 34000 square foot tenant vacate at the beginning of July leasing was a little slower in Q3, we see as of right now a few leases post quarter end have been done and we're seeing it pick up a bit so we're feeling better about that particular lease.
Our best properties.
Alright, great.
Jamie a question for you.
I would imagine youre still kind of looking at acquisitions or.
Our distressed opportunity starting to hit the market, where you'd be like gosh, if I can get my hands on that building a rehab it.
I know it will be the best building in that Submarket and I can lease it up.
We're staying active in looking at opportunities I think it's still quite early Barry.
I think what Youre seeing generally has a lot of lenders playing ball with owners.
And thats delaying kind of transactions being forced out and Youre also seeing virtually zero availability of debt. If you are acquiring assets.
And that just means if you don't have to sell.
Not right now and so I think thats going to continue my guess is it starts to change in 2024, and Youll start to see more activity.
Do you think it's going to be the banks that will eventually drive that.
I think that will drive that number one.
Yes, yes.
Okay guys. Thanks for the time.
Thanks, Mark Thanks, Barry.
Yep.
Thank you. Our next question today comes from people ran from Keybanc your.
Your line is open. Please go ahead.
Hey, Thanks for taking my question.
So just real quickly for me.
I was wondering are you in any kind of appeal processes with.
Municipalities that may help reduce property tax heading into next year.
Yes, so generally we appeal every year virtually every property. So the answer is yes.
We're hoping that as more and more transactions happen in values come down that we're going to see some reductions there.
In 2024, I'd say, we haven't really had that much in savings so far, but I think thats going to be a line item as we go forward that hopefully starts moving in our direction of it.
Okay great.
And then you highlighted some of the moving pieces on occupancy there was some.
Known move outs and move in that May offset each other where occupancy could stay plugged into the rest of the year.
As we look into 'twenty four.
And possibly what happened with Cascade station is there any kind of sense on where occupancy could trend heading into 2004.
Yes, so we will be giving our full guidance obviously in February but looking at where levels are today.
Cascade station is one that certainly has we're expecting some there are some known move outs there.
You exclude that property, then we're effectively expecting the guidance to come out pretty flat.
Okay got it.
And just.
One last one is.
How has the conversations with some of the lender.
In order to extend out these loans.
Was there a sort of fee that you paid and what was that in.
How do you feel confident about and there's some of the maturities that are coming up next.
Next year.
Yes, sure I can answer that question. So in terms of the two deals that we completed during the quarter.
The execution there was effectively no.
Not materially different than when we first did those loans seven years ago 275 basis over normal kind of.
See there are pressures banks to charge more fees.
We can maybe expect going forward, but there was nothing too unusual for that if we look forward to 2024.
Cascade Central <unk>.
Is the next maturity.
In June of 2020 for that loan is with the exact same lender that we just executed those two extensions.
Extensions this quarter.
So we have described as started discussions on that we were in <unk>.
<unk> is part of that process and so.
Hopeful that we can we can get sort of a similar execution on that one and then looking further out but the only other one we have it on a property level loan as FRP ingenuity drive that is at the end of December 2024.
So we still have more than a year out but nonetheless, we have started discussions on a possible extension of the maturity date, a little early to comment further, but I'm, hoping to give an update next quarter on that one.
And then the other comment I really want to make is that we still do have two completely unencumbered properties <unk> 83 in Raleigh, which we acquired for 330 million in December 2021, as well as city Center and <unk>.
Downtown St. Pete that are also sources of additional liquidity if needed in the future.
Okay got it thanks, thanks for the time.
Thank you Youre welcome.
As a reminder, if you'd like to ask a question. Please press star followed by 110, Thank you Pat.
Our next question today comes from Bill Quirk from Raymond James Your line is open. Please proceed.
Great. Thank you good morning.
Did you say.
Good morning, you say you signed the lease with we work in Phoenix a year ago.
So no that was acquired are assigned before we acquired the property. We work open that location I think right before COVID-19 and so they closed it as soon as Covid happened.
Reopened it.
Approximately one year ago. So it was back in that ramp up mode of building their occupancy.
Perfect, Okay I misunderstood.
Broadly speaking, we still see tenants downsize renewals.
I think it really depends asset by asset Bill so.
We've been in this almost four years and so the average lease term in many of our markets is around five and some of the newer buildings seven to 10. So we've hit quite a few of the vacates or right sizing over the last few years. There is still a number to go in and the big ones really.
We are more in the suburban properties I would say the more urban assets have a higher utilization.
People are back and generally using it at a pretty pretty high level. So those conversations were not seeing as many of the downsizes in kind of big suburban locations and I'm talking across the industry, where corporate America really hasnt forced the workforce back on mass Thats, where youre seeing a lot more <unk>.
Sizing and vacating.
Okay.
With me.
Kind of like the progression you laid out about the premier buildings, and then tenants reinforced in the.
Let's call it less than trophy buildings.
Appropriate voting so I'm just wondering.
It feels like that.
A process that's going to take a number of years to play out at this point is that is that a fair way to think about it.
I think bill if you look at all the absorption net absorption over the last couple of years is all in that top tier right and if you look at occupancy levels of those they are filling up.
Development pipeline is basically coming to a halt and those are still being demanded and so as tenants roll theyre generally wanting to upgrade their space.
That's going to fill up I think 2024, youre going to start to see the benefits in really well located assets that had been renovated that have a great feel.
And Thats, where were playing to be not with all of our properties, but a good segment of our properties match that.
I Hope you can help me understand the supply in a market like Dallas.
Phoenix.
Okay.
They've seen a lot of supply and it's all been class a properties is that done now or do we still have.
More of the leverage to go.
Theres still some underway in Phoenix I think actually the most recent one just delivered I'm not sure. What's left there I don't think Theres a lot Dallas Goldman is doing there kind of a dedicated tower in uptown.
That's going to get done there is a handful of others, but right now it doesn't pencil for new development and you can't get the capital for it and so you're going to always see a little bit, but I think thats going to come to a grinding halt until the.
The economics is going to get back in balance, which for US is a good thing.
Yes.
Perfect. That's it for me thank you.
Thanks, Bill Thanks Bill.
Thank you that would like to ask the question from the lines I would like to hand back to Jamie for any closing remarks.
Look forward to updating you on our progress next quarter and thank you for joining goodbye.
That concludes today conference call everybody. Thank you very much for joining you may now disconnect your lines.
Okay.