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spk00: Good morning and welcome to the Office Properties Income Trust third quarter 2022 earnings conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on a touch-tone phone. To retry your question, please press star then two. Please note today's event is being recorded. I would now like to turn the conference over to Kevin Berry, Director of Investor Relations. Please go ahead, sir.
spk01: Thank you, and good morning, everyone. Thanks for joining us today. With me on the call are OPI's President and Chief Operating Officer, Chris Bellotto, and Chief Financial Officer and Treasurer, Matt Brown. In just a moment, they will provide details about our business and our performance for the third quarter of 2022, followed by a question and answer session with sell-side analysts. First, I would like to note that the recording and retransmission of today's conference call is prohibited without the prior written consent of the company. Also note that 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 OPI's beliefs and expectations as of today, Friday, October 28, 2022, and actual results may differ materially from those that we project. The company undertakes no obligation to revise or publicly release the results of any revision to the forward-looking statements made in today's conference call. Additional information concerning factors that could cause those differences is contained in our filings with the Securities and Exchange Commission, or SEC, which can be accessed from our website, OPIREAP.com, or the SEC's website. Investors are cautioned not to place undue reliance upon any forward-looking statements. In addition, we will be discussing non-GAAP numbers during this call, including normalized funds from operations, or normalized FFO, cash available for distribution, or CAD, adjusted EBITDA, and cash basis net operating income, or cash basis NOI. A reconciliation of these non-GAAP figures to net income are available in our supplemental operating and financial data package, which also can be found on our website. In addition, we will be providing guidance on this call, including normalized FFO and cash basis NOI. We are not providing a reconciliation of these non-GAAP measures as part of our guidance because certain information required for such reconciliation is not available without unreasonable efforts or at all, such as gains and losses or impairment charges related to the disposition of real estate. With that, I will now turn the call over to Chris.
spk05: Thank you, Kevin, and good morning, everyone. Welcome to the third quarter earnings call for Office Properties Income Trust. Last night we reported a solid third quarter despite an evolving office landscape and a rapidly changing economic environment. Same property cash basis NOI growth came in near the high end of our range and we continue to experience strong leasing momentum. Our balance sheet remains well positioned with $629 million of total liquidity and no senior notes maturing until May 2024, which Matt will expand upon momentarily. We completed 606,000 square feet of new and renewal leasing, including a new lease for 84,000 square feet to anchor our Seattle life science development. Portfolio occupancy continues to outperform the broader market and end of the quarter at 90.7%, a 130 basis point improvement over Q2 and a 170 basis point increase over the prior year. During the quarter, we sold 10 properties containing 1.3 million square feet for $118 million at a weighted average cap rate of approximately 6.2%. Year-to-date, dispositions totaled $196 million at a weighted average cap rate of 6.8% and close to the high end of our 2022 guidance range. Further, we have five properties totaling 338,000 square feet for $20.5 million in advanced stages with a targeted close by year end. We have plans to continue our capital recycling efforts into 2023 and are pleased with our ability to close on the noted transactions to date. However, we remain cautious given the overall economic environment. Investor interest remains mixed with a thinning pool of buyers due to higher inflation, interest rates, and changing portfolio strategies. To date, we have not completed any acquisitions with our primary focus on leasing, operational efficiencies, completion of our existing development projects, and property sales. Turning to an update on leasing results, we reported a solid leasing momentum with 24 signed leases for 606,000 square feet, including a 21.6% weighted average roll-up in rent and a 7.2-year weighted average lease term. New leasing increased sequentially and represented 37% of our total activity for the quarter, including a 59% roll-up in rent, primarily driven by leasing at our Seattle development. At a macro level, overall U.S. leasing activity is trending at just over 70% of pre-pandemic level, with gateway markets trailing the pace of secondary growth markets. Leasing demand is largely attributed to higher quality buildings, those with market-specific amenities and better functionality. Over the past several years, our real estate and asset management teams have been instrumental in capital deployment strategies toward improving the quality of our portfolio, which has positioned our buildings to benefit from the current economic demand drivers. Year to date, we completed over 1.8 million square feet of leasing with an 11% roll-up in rent and a weighted average lease term of nine years. New leasing included 585,000 square feet, or 32% of our activity to date. Turning to leasing and property highlights from the third quarter. At a redevelopment in Seattle, Washington, we signed a new lease with a clinical stage biotech company for 84,000 square feet and a 10-year term. This lease is a strategic win as an anchor for the project and demonstrates the ongoing demand for premium, well-designed R&D space in this market. In Naperville, Illinois, we executed a new 57,000 square foot lease at a 14.5% roll-up in rent and a 12-year lease term. Over the past year, our real estate team has strategically allocated capital to improve common areas and expand the amenity base, which has resulted in an increase in occupancy from 58% in Q4 2021 to 82% as of Q3, and supported by close to 145,000 square feet of new leasing activity. And in Atlanta, Georgia, we renewed a mission-critical GSA tenant for 91,000 square feet in a 15-year term. Looking back at the past few years of GSA activity, on average, lease terms for new and renewal leases are 11 years and 7 years respectively, highlighting the GSA's commitment to properties within our portfolio. Looking ahead to OPI's upcoming lease expiration, We have minimal remaining lease expirations in 2022 with 80 basis points of annualized rental income expiring by year end. Of this, 30 basis points is attributed to properties under contract for sale estimated for a Q4 close. The balance of expirations are mostly expected to renew. In 2023, lease expirations represent approximately 14% of annualized rental income. Nearly 4% of our 2023 expiring rental income has either signed subsequent to quarter end or is in advanced stages of lease negotiations. Approximately 1% represents planned dispositions, including 60 basis points driven by an expected Q4 2022 sale of a property in Englewood, Colorado. We are in active conversations with tenants that make up the remaining 2023 expirations, and net known vacates for the year are trending between 3% and 5% of annualized rental income. It is worth noting that known vacates in 2023 predominantly expire during Q3 and Q4, minimizing the risk to 2023 operating results. I would also point out that, in addition to our active asset management, releasing efforts, and continued capital recycling initiatives, select known vacates are being evaluated for alternative use strategies to further diversify our portfolio and capitalize on compelling value creation opportunities as seen with our DC and Seattle development projects. Looking forward, our leasing pipeline remains strong with a healthy mix of new and renewal deals, lease term, and mark-to-market growth potential. We are currently tracking approximately 3.2 million square feet of active prospects, of which more than 1.3 million square feet is attributable to new leasing and 720,000 square feet of potential absorption. Turning to our developments. We continue to advance our value-enhancing redevelopment projects. Our development leasing pipeline includes over 223,000 square feet of active proposals. In Seattle, Washington, the project is now 28% pre-lease, and we anticipate the delivery of our movement-ready spec space will further accelerate leasing at this project as we near completion. Construction at our 20 Mass Avery development in Washington, D.C. is also on time and on budget. Tour activity continues to progress, and we remain on track to deliver both our Seattle and D.C. projects in Q2 2023. In conclusion, aggressive monetary policy inflation, along with the current interest rate environment, are weighing on market fundamentals and decisions around real estate needs, which we believe will continue to be a factor to 2023. Our capital recycling efforts focused on upgrading and enhancing the overall physical quality and functionality of our buildings, along with refining our geographical footprint, is a further complement to the level of tenant interest and activity across our portfolio. As we progress on core initiatives, we remain focused on leasing, operational efficiencies, development, and capital recycling, and are pleased with our portfolio position. which includes 63% of our rental income coming from investment-grade tenants, a portfolio average lease term of 6.3 years, and a well-positioned balance sheet. I will now turn the call over to Matt to review our financial results.
spk02: Thanks, Chris, and good morning, everyone. Normalized FFO for the third quarter was $53.8 million, or $1.11 per share. Our results came in a penny below the low end of our guidance range, mainly driven by the timing of property dispositions. Earlier this month, we declared our regular quarterly distribution of 55 cents per share, resulting in a normalized FFO payout ratio of 50% and a rolling four-quarter CAD payout ratio of 67%. G&A expense for the third quarter was $6.6 million, which came in below our forecast and below the $7.1 million in Q3 2021 after excluding the reversal of previously accrued business management incentive fees in the prior year period. These declines were mainly driven by a reduction in our business management fee as our share price has declined and highlights how the fee structure in our business management agreement with RMR is aligned with OPI shareholders. Same property cash basis NOI increased 30 basis points compared to the third quarter of 2021 and came in at the high end of our guidance range. The increase in our same property results was mainly driven by higher levels of free rent in the prior year, partially offset by increases in operating expenses from higher rates and usage to support higher building utilization levels. Looking forward to our normalized FFO and same property cash basis NOI expectations in the fourth quarter. We expect normalized FFO to be between $1.08 and $1.10 per share. The decline from Q3 is mainly driven by our Q3 dispositions and an August lease expiration in a sub-market of Denver. For the full year 2022, We expect normalized FFO to be in the range of $4.71 and $4.73 per share. This guidance takes into account our planned disposition activity and includes a range of $24.5 to $25 million of interest expense and $5.6 to $6 million of G&A expense during the fourth quarter. We expect same property cash basis NOI to be flat to down 2% as compared to the fourth quarter of 2021. Turning to the balance sheet, Our balance sheet remains well positioned in the current rising interest rate environment. The $1.1 billion of fixed rate refinancings that we completed in 2021 provided a solid foundation for us to deliver on our operating and redevelopment priorities. At quarter end, we had $2.4 billion of outstanding debt at a weighted average interest rate below 4% and a weighted average maturity over five years. 97% of our debt is unsecured and 94% is fixed. As a reminder, the company does not have any variable rate debt besides the revolving credit facility and our near-term maturity schedule is light with only $50 million of mortgage debt due in mid-2023. We have no senior notes maturing until May 2024. While our revolver matures at the end of January 2023, we have the option to extend the facility for two additional six-month periods and expect to exercise our first extension option next month. We ended the quarter with $629 million of total liquidity, including $615 million of availability under our revolver. Subsequent to quarter end, we repaid a 4.8% mortgage with a June 2023 maturity at a discounted amount of $22.2 million using cash on hand, making this an accretive transaction. We are currently under agreement to sell five properties containing 338,000 square feet for an aggregate sales price of $20.5 million. We spent $25.9 million in recurring capital and $36.8 million in redevelopment capital during the third quarter. For the full year, we expect recurring capital expenditures of approximately $100 million and redevelopment capital of approximately $180 million. In 2023, we anticipate recurring capital expenditures to be flat year-over-year and redevelopment spend of approximately $100 to $120 million as we complete our two ongoing redevelopment projects in Washington, D.C. and Seattle. Operator, that concludes our prepared remarks. We're ready to open the call up for questions.
spk00: Thank you. We will now begin the question and answer session. To ask a question, you may press star then one on your touch-tone phone. If you're using a speakerphone, we ask that you please pick up your handset before pressing the keys. To withdraw your question, please press star then two. Today's first question comes from Brian Marr with B. Reilly FBR. Please go ahead.
spk04: Good morning, Chris and Matt. Just a couple from me. We were surprised by the 10 asset sales for sure in 3Q. And I think that you mentioned that the buyer pool is thinning. Can you give us, you know, kind of what your level of confidence is closing on the five that you talked about and what your outlook is for, you know, kind of number of properties for 2023 and the ability to close on those?
spk05: Yeah, thanks, Brian. I think for the balance, for the dispositions that we kind of noted in our prepared remarks, I think we feel pretty confident about those closing. You know, those are really in advanced stages under kind of PSA or LOI, and so at this stage, there's no reason to believe that they won't be able to close in Q4, you know, and maybe in the turn of the year. For 2023, we've talked about a couple quarters ago, we pulled back on some dispositions just to kind of see where the market's going. Again, you know, we're in a position where we can be disciplined and don't have to sell. And so, you know, right now we're working through kind of what that list looks like to then determine what we want to put out in 2023. So I don't know that we have a determined list of assets specifically. It remains fluid, but I would say that We've talked about re-upping on dispositions and continuing where we slowed down this year, which was in the neighborhood of $300 million. I think it's going to be very ebb and flow just as we watch where the market goes.
spk04: Maybe a two-part question. I think your leverage is around seven times or so currently. Where do you want to take that, given the cash that you're going to receive from these asset sales and how do you think about deploying capital in 2023? You know, if the transaction market gets as tight as we're currently hearing generally across all our covered companies, you know, might you expect to see some opportunities to act upon giving your strong balance sheet and what might those look like maybe from a type of asset and maybe geographic location?
spk02: Hey, Brian, this is Matt. I'll start on the leverage question and turn it to Chris on capital use for potential acquisitions. Leverage seven times at Q3, looking at a trailing 12-month EBITDA base. We want leverage to get back in that six to six and a half times rate. We've been investment grade rated and we want to remain investment grade rated. So that is our focus as it relates to leverage and our overall target. You know, we are comfortable where leverage is today in running the business this way, but we do want to see that tick down over time.
spk05: Yeah, and for acquisitions, I mean, you know, as we've discussed, our focus is more so on just completing our developments, leasing, and other related operational items. But, I mean, I think in general, I mean, there's a handful of different markets we like. You know, we like kind of the southeast. We like the Pacific Northwest. And it's just really going to depend on the opportunities there. You know, we, we see, we generally see just about everything that's out there and it's there hasn't been a lot of activity with opportunities. But I think it's safe to say that cap rates are widening. And as opportunities present themselves, we'll see them and we'll be in a good opportunity or in a good position to kind of execute on that strategy. But I think as we get into the turn of the year and kind of see where things shake out, again, with our capital recycling and other initiatives, we'll then be in a position to kind of better quantify what that might look like.
spk04: Okay, thanks. And maybe just last for me, I mean, clearly where the shares are trading and the 15% yield on the dividend, You know, obviously there's people out there, you know, in the market who don't believe that that dividend is sustainable, and yet we continue to highlight the low payout ratio, either on CAD or on FFO. You know, what world would we have to be in for you to envision, you know, a period where, you know, that dividend would be sustainable?
spk02: Yeah, Brian, it's a good question, and I'm glad you highlighted the low payout ratio we've had. which has really been a constant since the merger at the end of 2018. So we've been very satisfied with our dividend coverage and level. I think as it relates to dividend coverage in the future and any risk to that, it really is going to be upon factors outside of our control with the future of office and any potential recession. But where we are today, we remain very comfortable with our dividend. Okay, thank you.
spk00: And, ladies and gentlemen, as a reminder, if you'd like to ask a question, please press star then 1. Our next question comes from Ronald Camden with Morgan Stanley. Please go ahead.
spk03: Hey, you got some e-mails for Ronald. I just wanted to follow up on some of the development you guys expect to complete next year. Could you walk us through kind of the cash and the gap and why you expect from those two developments upon completion?
spk05: Yeah, I mean, I think, you know, right now, just as a reminder for, you know, we'll start with 20 Mass Ave. You know, we have kind of a cash-on-cash stabilized return projection of between 8% and 10%. And so you can kind of use that as a good barometer with what we would respect for kind of cash yields. And then I think for Seattle, we're currently targeting 10 to 12% with respect to that asset. So that's a good barometer with respect to cash yields. I mean, I think from a GAAP perspective, it's going to depend a lot on, you know, what those lease terms look like as things shake out. And what I mean by that is, you know, when you look at, you know, Seattle is a good example where we just signed the lease, you know, that we referenced in our script, you know, the GAAP roll up there was, you know, 109% increase. albeit with the conversion to kind of life science, and that was a 10-year term. But what we're also doing in that project is we're doing spec deliverable suites, and we would expect that the terms at that location would vary just depending on the circumstances, and so that would have an impact on the overall GAAP aspect. So it's a bit of a moving target.
spk03: And just to follow up on that, do you expect any cash contribution from either of those properties next year?
spk05: Cash contribution from the assets will be more in the form of mitigating some of the loss that's coming with the carrying costs on the expense side. From a timing perspective, we have the lease signed at 20 Mass Ave. representing 54% of the project. And they're scheduled to take occupancy in Q2, but there's a free rent period that goes with that. As part of that free rent, they're going to pay their proration of operating expenses, so we'll mitigate any cash drag as part of that. And then same with Seattle. While we're excited about signing the lease with Seattle, there's a timing for tenant improvements and prep to get into the space. And so we don't think they'll physically occupy the space until Q4 2023. And at that point in time, you know, there's some free rent up front, but the same story on the full building or the majority of the building will mitigate the cash drag given that they'll pay OpEx until they pay full rent at the turn of the year.
spk03: Okay, that makes sense. And then, you know, just on some of the debt maturities that are coming up over the next couple of years, You know, how are you thinking about that? Any chance you pay down the debt with some dispositions that may come? Or, you know, is it planned right now just to refinance most of that?
spk02: Yeah, you know, we're in a very good position right now with our balance sheet. We have $50 million of mortgages that are maturing in mid-2023. We'll likely use cash on hand and a line of credit to pay those off. And then our next maturity isn't until May of 2024, so... You know, we have plenty of time to be watching the market. But right now, we're not going to try to accelerate paying off those 24s. It's a good in-place rate, and we'll kind of see the market settle, and we have plenty of liquidity in the meantime. Great. Thank you, guys. Thank you.
spk00: Thank you. And, ladies and gentlemen, our next question today comes from Aditi Anand. Barbara Batron with RBC. Please go ahead.
spk06: Hi, good morning. Sorry if I missed this in the beginning, but can you just give us a quick update on the leasing activity at 20 Mass Ave right now?
spk05: The leasing activity, as I mentioned in the prepared remarks, we have a couple hundred thousand square feet between the two projects. Just shy of 100,000 square feet is attributable to 20 Mass Ave. And when we talk about lease activity, it's more in the form of at proposal stage. And so in addition to that number, there's the benefit of the tours that are coming through the property. And so nothing far enough along to kind of speak to with respect to definitive timing. I think on the positive, we're seeing kind of an increase in tours now that we're nearing completion and are starting to kind of trade more proposals. So, you know, everything is turning in the right direction.
spk06: Okay, cool. Thank you.
spk00: And, ladies and gentlemen, this concludes our question and answer session. I'd like to turn the conference back over to Chris Bellotto for any closing remarks.
spk05: Thank you for joining us, for your interest in OPI, and we look forward to speaking with you again soon.
spk00: Thank you. Ladies and gentlemen, this concludes today's conference call. We thank you all for attending today's presentation. You may now disconnect your lines and have a wonderful day.
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