Q3 2024 Orion Office REIT Inc Earnings Call
Speaker Change: Greetings. Welcome to Orion Office Reads 3rd Quarter 2024 Earnings Conference Call. As a reminder, this conference is being recorded. I would now like to turn the call over to Paul Hughes, General Counsel for Orion. Thank you. You may begin.
Thank you and good morning, everyone.
Speaker Change: Yesterday, Orion released its financial results for the quarter ended September 30, 2024, filed its Form 10-Q with the Securities and Exchange Commission, and posted its earnings supplement to its website at onlreit.com.
Speaker Change: Certain statements made during this call today are not strictly historical information and constitute forward-looking statements.
Speaker Change: These statements include the company's guidance estimates for calendar year 2024 and are based on management's current expectations and are subject to certain risks that could cause actual results to differ materially from our estimates.
Speaker Change: The risks are discussed in our earnings release, as well as in our Form 10-Q and other SEC filings. Orion undertakes no duty to update any forward-looking statements made during this call.
Speaker Change: Orion's earnings release and supplement including reconciliation of these non GAAP financial measures to the most directly comparable GAAP measure.
Speaker Change: Our presentation of this information is not a substitute for the financial information presented in accordance with GAAP.
Speaker Change: Hosting the call today are Orion's Chief Executive Officer, Paul McDowell, and Chief Financial Officer, Gavin Brandon. Our Chief Operating Officer, Chris Day, will join us for the Q&A session.
Speaker Change: With that, I am now going to turn the call over to Paul McDowell.
Paul McDowell: Thank you, Paul. Good morning, everyone, and thank you for joining us on Orion OfficeStreet's third quarter 2024 earnings call.
Paul McDowell: Today I will provide an update on our business and discuss our third quarter performance and operations. Following my remarks, Gavin will review our financial results and provide our outlook for the rest of the year.
Paul McDowell: With the completion of the third quarter we have made strong progress against our key initiatives of extending existing leases and pushing out weighted average lease term.
Paul McDowell: During the quarter, we signed four leases comprising 254,000 square feet, including a 10-year renewal for 152,000 square feet at our Longmont, Colorado property.
Paul McDowell: The other three leases were also renewals, and all four lease renewals combined represent a weighted average lease term of 8.9 years.
Our year-to-date leasing efforts have been successful.
Paul McDowell: As we see our well-located properties benefiting from both new and renewal leases. Through last week, we have completed over 830,000 square feet of leasing so far this year, more than three times our full year 2023 total.
Paul McDowell: Overall portfolio Walt now stands at five years up from 3.9 years at the same time one year ago.
Paul McDowell: Rent spreads on leasing activity have also been positive so far this year at 3.2 percent.
Paul McDowell: Tenant leasing sentiment continues to improve, which is another positive aspect of the third quarter.
Paul McDowell: We are seeing increased traffic at our vacant properties as prospective tenants have become more active throughout 2024, and we are responding to more inquiries from both these prospects and our in-place tenants.
Paul McDowell: Additionally, our forward leasing pipeline continues to be strong. At quarter end, the pipeline stood at over 1 million square feet in various stages of discussion, negotiation, and documentation.
Paul McDowell: Our recent leasing successes, while specific to Orion, do seem to be part of a slowly emerging broader trend. To that point, for the overall industry, net office absorption turned positive in the second quarter for the first time in two years.
Paul McDowell: Interestingly, while new office deliveries are falling and are expected to settle at negligible levels soon, the amount of space available in the newest and highest quality buildings continues to decline rapidly and is now below pre-pandemic levels.
Paul McDowell: As Superclass A space is rapidly absorbed, Orion and owners like us should start to see a positive benefit in our portfolios as tenants, by necessity, begin to search for available space more widely.
Paul McDowell: These fundamental industry dynamics are further strengthened by corporate management sentiment shifting dramatically.
Paul McDowell: with 79% of CEOs polled in September, expecting full-time return to work over the next three years, up dramatically from 34% in April.
Paul McDowell: Even with the macro positives and our own recent leasing progress, we still anticipate Orion's leasing activity will fluctuate and be quite lumpy between quarters.
Paul McDowell: We also expect to continue carrying substantial vacancy for the foreseeable future, as the overall office market recovery will still be measured in years, not months.
Paul McDowell: We also made further progress during the third quarter transforming the portfolio through the sale of vacant assets and properties that we believe do not align with our focus on owning properties in select growth markets around the country.
Paul McDowell: and a quarter and we own 70 operating properties and six unconsolidated joint venture properties comprising 8.3 million rentable square feet that were 74.6 percent occupied.
Paul McDowell: adjusted for three operating properties that are currently under agreements to be sold or have been sold are occupied. Rate was 76.9% at quarter end.
Paul McDowell: During November, we sold one 68,000 square foot vacant property located in Dublin, Ohio for a gross sales price of $3.2 million for approximately $47 per square foot.
bringing our total properties sold since the spin to 19.
Paul McDowell: We also have an ongoing sales pipeline and expect to close on additional dispositions by year-end or in early 2025.
Paul McDowell: Regarding our vacant properties, we decided to step away from the pending contract to sell our six-building former Walgreens campus.
Paul McDowell: located in Deerfield, Illinois. As we have been communicating the past few quarters, after almost two years under contract and some significant progress on a proposed redevelopment plan,
Paul McDowell: There remain questions around when, whether, and at what price the buyer would close.
Paul McDowell: Given the persistent uncertainty with this buyer, we were unwilling to further extend their due diligence period without the buyer putting additional deposit funds at risk, which they declined and the contract was terminated.
Paul McDowell: We have already begun to remarket the property for sale and are talking with some potential interested parties.
Paul McDowell: I want to again emphasize how important our disposition efforts have been for the long-term health of this company.
Paul McDowell: We inherited a portfolio of assets that contained a relatively large number of less-than-ideal, generic office buildings in often tough markets, made all the worse by the historic collapse of the office market in the past two years.
Paul McDowell: Our sales have generated $63.8 million in gross proceeds, but far more important, these sales resulted in a very material reduction of carry costs and forward expected CapEx.
Paul McDowell: The sold properties will no longer weigh us down and have allowed us to focus on those assets where we believe we can achieve long-term leasing success in a recovering market.
Paul McDowell: In short, our overall portfolio, while smaller, is far more attractive now.
Paul McDowell: And although our disposition activities will continue, we believe one year from now, our revenues and earnings will flatten and then rise significantly in the out years as we re-tenant the vacant properties we decided to hold.
Paul McDowell: Since going public, we have devoted excess cash from operations and proceeds from asset sales to debt reduction to maintain maximum financial flexibility. We have consistently said that we intend to recycle some of that capital should the right opportunity arise.
Paul McDowell: Such an opportunity came in September when we purchased a 97,000 square foot mission-critical agricultural research and development lab located within the San Francisco Bay Area.
Paul McDowell: The property is 100% leased to Valent USA, a wholly owned subsidiary of Sumitomo Chemical Company, for a 15-year remaining net lease term through August 2039.
Paul McDowell: The tenant's parent company, Sumitomo Chemical, has an A-plus credit rating in Japan.
Paul McDowell: This location is strategic prevalent due to its proximity to graduate research talent throughout the Bay Area, particularly UC Davis, which has the largest agricultural technology program in the U.S.
Paul McDowell: Furthermore, Valant has invested over $25 million or approximately $260 per square foot into the property since 2019.
Paul McDowell: This includes various premium lab upgrades, supplemental HVAC, and various other renovations that support Valence Laboratory operations.
Paul McDowell: We acquired the property at below market rents and at a significant discount to replacement costs. The going in cap rate is 7.4 percent with an average cap rate of 9.2 percent over the term.
Paul McDowell: We will finance the property with a low-leverage, seven-year, non-recourse mortgage at a rate below six percent, making it cash flow accretive.
Paul McDowell: We believe that being selective and adding a property like this through capital recycling is a smart way to focus on complementing our ongoing asset sales and portfolio repositioning efforts by adding a very high quality, long lease duration assets.
Paul McDowell: while we intend to redeploy capital to strengthen our portfolio over time with very selective acquisitions like we did in September with this California property
Paul McDowell: Our first priority continues to be leasing our current properties followed closely by asset sales of those properties that have poor future leasing prospects.
Paul McDowell: As we have consistently discussed on previous calls, we are investing capital and adapting properties we want to keep in the portfolio, specifically those that are well-located in our target growth markets.
Paul McDowell: This strategy is the reason we have remained highly disciplined at maintaining a low leverage balance sheet over the past two years, so that we can appropriately fund capital expenditures, which will significantly enhance the long-term competitiveness of our assets.
Paul McDowell: Additionally, we are realizing the benefits of some of our past investments as they have resulted in increased showings and leasings.
Paul McDowell: That work continues, and we expect the pace of our CapEx spending will increase over the next couple of years, along with our leverage, as we lease vacant space and build long-term revenues.
Paul McDowell: We are increasingly confident that our recent leasing momentum will continue and that the stabilization of our portfolio and earnings are in sight.
Thank you.
Paul McDowell: That said, as we enter the final quarter of the year and look ahead to 2025, we want to point out that the combination of the rise in interest rates
Paul McDowell: The significant number of properties we have sold and the vacancy we continue to carry that has resulted from the tremendous lease rollover of the last few years has had a cumulative negative impact and will be particularly pronounced in our 2025 results.
Paul McDowell: We have been consistently communicating these dynamics over the past few years and they are not a surprise.
Paul McDowell: However, we continue to want to be as transparent to the markets as we can be.
Paul McDowell: and while we are not issuing formal guidance for 2025, we expect that these cumulative impacts on core FFO could be as much as 20 to 24 million dollars versus 2024.
Paul McDowell: Given our initial portfolio and the highly challenged office market conditions of the past few years, while we are disappointed we could not overcome the earnings impact, we believe this lower expected earnings level in 2025 should be at the bottom for the business.
Paul McDowell: We expect that level to stabilize and then start to grow as newly leased space comes online and associated vacancy costs recede.
Thank you.
Paul McDowell: This space should give us a solid platform from which we can start to grow meaningfully and potentially give us additional options from a strategic standpoint.
Paul McDowell: As we continue to execute and build on our substantial progress made to date, repositioning the portfolio.
Speaker Change: I want to emphasize the company remains profitable on an FFO and core FFO basis and we expect that to continue. With that I will now turn the call over to Gavin.
Gavin Brandon: Thanks, Paul. I will start by reviewing our third quarter financial results and provide an update on our outlook for the remainder of the year. Orion's 2024 third quarter financial results compared to the third quarter of 2023 are as follows.
Revenues of $39.2 million compared to $49.1 million.
Gavin Brandon: Net loss attributable to common stockholders of $10.2 million, or $0.18 per share, compared to $16.5 million, or $0.29 per share.
Gavin Brandon: Core funds from operations of $12 million, or $0.21 per share, compared to $24.1 million, or $0.43 per share. Adjusted EBITDA of $19.1 million, compared to $30 million.
Speaker Change: As Paul mentioned, and as we have previously communicated, lease expirations and dispositions of non-core assets to right-size our portfolio have negatively impacted the company's financial results quarter over quarter.
Speaker Change: Quarterly, GNA was 4.5 million compared to 4.4 million in the third quarter of 2023.
Speaker Change: CapEx was $6.1 million compared to $8.4 million in the third quarter of 2023.
Speaker Change: CAPEX timing is dependent on when leases are signed and when property and tenant improvements are completed.
Speaker Change: The timing of CapEx for tenant improvements is controlled by our tenants, and therefore, there is uncertainty when it will be spent. However, we expect that CapEx will begin to accelerate as we move into next year.
Speaker Change: As of the end of the quarter, $512.1 million of debt was outstanding, comprised of $355 million of a non-recourse fixed rate CMBS loan that matures in February of 2027.
Speaker Change: 130 million of floating rate debt on the revolving credit facility that matures in May of 2026, and $27.1 million representing our portion of the Arc Street Joint Venture debt, which is scheduled to mature on November 27, 2024.
Speaker Change: At quarter end, net debt to annualized year-to-date adjusted EBITDA was 5.6 times and total liquidity was $237.3 million.
Speaker Change: Total liquidity is comprised of 17.3 million of cash and cash equivalents including the company's pro-rata share of cash from the Ark Street Joint Venture and 220 million of available capacity on the company's 350 million dollar revolving credit facility.
Speaker Change: As we have communicated, we intend to maintain significant liquidity on the balance sheet for the foreseeable future and provide the financial flexibility required to execute on our business plan over the next several years, including the funding of expected capital commitments to support our continuing leasing efforts.
Speaker Change: As it relates to the York Street joint venture debt, the joint venture has two successive one-year options to extend the non-recourse loans maturity date until November 27, 2026, subject to satisfaction of certain financial and operating covenants and other conditions.
Speaker Change: In connection with the recent amendment of a loan agreement, the joint venture exercised the first extension option and is working with the lenders to satisfy all conditions to extend the maturity until November 27, 2025.
Speaker Change: We expect the joint venture will satisfy the conditions for the first extension.
Speaker Change: Starting to our dividend, Orion's Board of Directors declared a quarterly cash dividend of $0.10 per share for the fourth quarter of 2024, tabled January 15, 2025, to stockholders of record as of December 31, 2024.
Speaker Change: As it relates to our outlook for the remainder of 2024, we are narrowing the range of our 2024 guidance expectations for core SFO and reaffirming our expectations for net debt to adjusted EBITDA and G&A.
Speaker Change: Core FFO is now anticipated to range from $0.99 to $1.01 per diluted share, increasing the low end of the range by two cents from $0.97.
Speaker Change: Our net debt to adjusted EBITDA range is unchanged and is anticipated to be 6.2 times to 6.6 times.
Speaker Change: Our G&A range of 19.5 million to 20.5 million is unchanged. With that, we will open the line for questions. Operator?
Speaker Change: Thank you. At this time we'll be conducting a question and answer session. If you'd like to ask a question please press star 1 on your telephone keypad.
Speaker Change: A confirmation tone will indicate your line is in the question queue. You may press star 2 if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys.
One moment please while we poll for questions.
Speaker Change: Our first question comes from Mitchell German with JMP Securities. Please proceed with your question.
Hey, good morning. Um, can a new buyer...
Speaker Change: Leverage the work done from the previous buyer for the Walgreens property or do you think that now the whole process gets reset?
Good morning, Mitch.
Speaker Change: No, the answer is a new buyer we believe can leverage the work that's been done from the previous buyer. That buyer had done quite a bit of work for the redevelopment of the property and we are the owner of all of those files.
Speaker Change: The buyer also got put in place a tax increment financing district with the city of Deerfield, which is now owned by us. So there's a significant amount of work has been done.
Speaker Change: which would endure to the benefit of a new buyer assuming they wanted to pursue a similar development plan.
Okay, that's super helpful.
Speaker Change: Just shifting over to the acquisition that you did in the quarter.
Speaker Change: Was there anything unique about, you know, the cellar? Was there some distress or was there...
you know, some, you know, impending debt, was there anything?
Speaker Change: that was unique on that deal. And I might have missed a yield, though you talked about the debt. So obviously it's above that, but if any color you can provide there, I'd be appreciative.
Speaker Change: sure I don't think the sale was I don't think the seller was under any particular distress
I will say that the market has been pretty thin.
Speaker Change: So, you know, our ability to purchase the property for an all-cash transaction was attractive, which we think gave us some additional pricing power when we negotiated the transaction, you know, with the seller.
Speaker Change: We're very, very pleased with not only the cap rate that we were able to obtain, but we bought the property at way below replacement costs, and the rents the tenant are paying are significantly below market, so we feel very, very comfortable there.
Speaker Change: We are financing the asset with, as I mentioned in my prepared remarks,
Speaker Change: with long-term debt at a rate below 6% a seven-year loan.
Speaker Change: and you know a relatively low LTV loan of call it between 50 and 55 percent which will you know the combined rate will make the the transaction for us very cash flow accretive.
Speaker Change: and the yields north of seven, is that the way you think about it?
Speaker Change: I can you repeat that the cap rate going cap rate I'm if I missed it I apologize is that north of seven is that the way to think about yes the yield the going cap rate is seven point two four percent and the average cap rate is nine point two percent
Speaker Change: Oh, you know what? I did read that. I apologize. Great. Last one from me.
Speaker Change: How do you, looking out, I think you and also Gavin referenced, you know, obviously increasing debt levels, increasing capex spend, so how do you start to balance these
unique investment opportunities
against the potential requirement
Speaker Change: for CAFs related to CAFx, whether it be building improvements or leasing related. How do you start navigating that as you continue forward?
Speaker Change: That's a terrific question, Mitch, and one we debate internally, you know, pretty much all of the time here. I think the best way to describe it is
Speaker Change: Our first and foremost focus is on the assets we own already on the balance sheet. So our best use of capital...
for the most part.
is to put into the assets we already own.
Speaker Change: and when I say put capital into assets we already own.
Speaker Change: And I mean by that generally, it makes sense for us to lease up the vacancy and the capital we use to lease up that vacancy is, you know, the most accretive way that we can use that capital to generate returns.
Speaker Change: rather than just using capital to try to, you know, fix up a building to attract investors. We are doing that.
Speaker Change: But when you look at a vacant building, we look at what's the capital we would have to invest without a guaranteed return versus investing that capital in an acquisition opportunity. And that's where we try to make where we think is the best judgment. If we don't think it makes sense to invest capital in the building, we've been selling them.
Speaker Change: and utilizing that capital we might otherwise have invested to potentially buy new assets.
Speaker Change: But going forward from here, I think it's fair to say, and you should expect and investors should expect, that we will focus most of our capital expenditures in the coming years on our existing portfolio.
Great. Thank you.
Thank you, Mitch.
Speaker Change: As a reminder, if you'd like to ask a question, please press star 1 on your telephone keypad. One moment, please, while we poll for questions.
Speaker Change: There are no further questions at this time. At this point, I'd like to turn the call back over to Mr. McDowell for closing comments.
Paul McDowell: Thank you all for joining us on our third quarter call, and we look forward to updating you further in the new year with our fourth quarter results.
Thank you.
Speaker Change: This concludes today's conference call. You may disconnect your lines at this time, and we thank you for your participation.