Office Properties Income Trust

Good morning and welcome to the Office Properties Income Trust first quarter 2023 earnings conference call. All participants are in a listen-only mode. Should you need assistance today, 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 your touch-tone phone. If you're using a speaker phone, we ask that you please pick up your handset before pressing the keys. To answer your question, please press star then two. I would now like to turn the call over to Kevin Berry, Director of Investor Relations. Please go ahead.

Kevin Berry 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 first quarter of 2023. 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 security laws. These forward-looking statements are based on OPI's beliefs and expectations as of today, Thursday, April 27, 2023, 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. On today's conference call, we will be discussing the planned merger with Diversified Healthcare Trust in our prepared remarks. We have not yet filed a preliminary joint proxy and registration statement with the SEC, and therefore will not be taking questions about the merger. 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, and cash basis net operating income, or cash basis NOI. A reconciliation of these non-GAAP figures to net income are available in our enhanced earnings relief presentation that we issued last night, which can be found on our website. We believe this combined presentation of information will be helpful for analysts and investors to efficiently digest information about our company and our results. And finally, we will be providing guidance on this call, including normalized FFO and cash basis NOI. We are not providing 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. I will now turn the call over to Chris.

Thank you, Kevin. Good morning, everyone, and thank you for joining the call today. Before I review OPI's performance for the first quarter of 2023, I want to start by briefly discussing current office fundamentals, our decision to reduce our quarterly dividend, and our recently announced merger with Diversified Healthcare Trust. OPI has demonstrated solid operating performance over the past few years while navigating through a global pandemic and amid an uncertain and evolving office environment. Our favorable performance results through 2022 are attributed to several factors, including our diversified real estate holdings, our geographical footprint with properties in many premier growing markets and reflective of our leasing performance, our strong tenant roster with investment-grade tenants representing 63% of our portfolio, continuation of our capital recycling initiatives, and our strong balance sheet. As we stand here today, we are looking at post-pandemic return to office trends, which continue at a gradual pace across major U.S. markets, providing a bright spot for improving office fundamentals. However, headwinds in the office sector remain with added pressure as a result of corporate cost-cutting, elevated sublease space, a challenging financing environment, and continued macroeconomic uncertainty. National office leasing volume declined for the third consecutive quarter through Q1, and much of the sector's occupancy gains achieved over the past several years has been given back through negative absorption. Financing continues to be an obstacle for the investment sales market, and widening credit spreads are putting additional pressure on office valuations. These challenges will likely lead to declining cash flows and asset values. which may take years to stabilize. Recognizing these challenges, earlier this month we announced a reduction in OPI's quarterly dividend. We recognized the value of the dividend to our investors and the decision was not made lightly. It was the result of careful consideration on the part of the company and its board of trustees based on several factors, including the challenging outlook confronting the office sector, tenant retention risk, a rising CAD payout ratio approaching 100% and in excess of our target coverage ratio, and our focus on capital preservation to support leasing activity and complete our two redevelopment projects. With these factors in mind, we made the decision to lower the dividend to a sustainable level of $1 per share annually. While this decision was communicated at the same time as the merger announcement, it was independent of our merger plans and reflective of our outlook for OPI on a standalone basis. It provides increased liquidity to navigate office headwinds and to fuel capital projects that we expect will improve OPI's competitive positioning as a path to increased returns in the future. Earlier this month, we also announced plans to merge with Diversified Healthcare Trust, providing us with a tremendous opportunity to create a larger, scalable, and more diversified REIT. This transaction combines two institutional quality portfolios and better positions us to navigate office sector headwinds while providing embedded near and long-term growth and value creation. Immediate benefits to OPI include increased scale and diversity and cash flow stability with the addition of attractive MOB and life science properties as a complement to our established office portfolio. Access to additional capital sources with a more favorable interest rate outlook, including low-cost GSE and agency debt, and access to an institutional quality portfolio of senior living communities benefiting from growth through favorable healthcare sector tailwinds and a turnaround strategy currently underway. As a result of this combination, we expect the transaction to be accretive to OPI's normalized FFO, CAD, and leverage during the second half of 2024, and ultimately maximizing long-term value for our shareholders. Turning now to our first quarter leasing results. We began the year with uneven operating fundamentals and a deceleration in leasing volume, consistent with broad market trends and in line with our expectations that new leasing activity will increase over the next several quarters as tenants reengage on their office plan needs, along with increased renewal activity given our expirations mostly occur during the back half of the year. This is reflected in our leasing pipeline, where we have close to 725,000 square feet of activity in advanced stages of negotiation. Portfolio occupancy increased 170 basis points year-over-year to 90.5%, and we completed 203,000 square feet of leasing with a balanced mix of new and renewal leasing. This activity resulted in a weighted average lease term of 6.8 years and leasing concessions and capital commitments of $6.37 per square foot per lease year. Weighted average rent spreads for the quarter declined 18.5%, which was influenced by elevated concessions associated with several leases at a property in greater Washington, D.C., where we signed two strategic leases totaling 128,000 square feet one with its key tenant downsizing and another to backfill the available space. We expect our leasing spreads will normalize as activity progresses throughout the year. Looking ahead to OPI's upcoming lease expirations, we continue to actively manage through proactive releasing efforts to address elevated lease expirations during the second half of 2023 and into 2024. In 2023, lease expirations represent approximately 10% of our annualized rental income, a decrease of 90 basis points compared to the end of 2022. Annualized revenue for 2023 expirations is comprised of the following. Net known vacates for the balance of the year are trending close to 6% of annualized rental income, approximately 80 basis points represents planned dispositions, and the balance of 3.5% is expected to renew. Our leasing pipeline includes approximately 2.7 million square feet of potential leasing activity, with more than 1.1 million square feet attributable to new leasing and 782,000 square feet of potential absorption. The outlook for our projected activity includes a rent roll-up of 68% and an average lease term of 8 to 10 years. Turning to our developments. Our mixed-use redevelopment in 20 Mass Ave. in Washington, D.C. is scheduled to deliver in the coming months. With the project near completion, we are encouraged by growing interest in tour activity and the proposals we are discussing with multiple prospective tenants. The property is 54% pre-leased to an anchor tenant, the Royal Sonesta Hotel, which intends to begin welcoming guests to this flagship location this summer. Additionally, our Lifesign 3 development in Seattle remains on track to deliver later this year. In addition to the 84,000 square feet signed at this property late last year, we will deliver one full lab building with move-in ready spec suites, providing a needed outlet for small to medium companies with near-term space needs, and therefore reducing the timeline for lease-up and acceleration of NOI performance. Across both projects, our development leasing pipeline includes more than 170,000 square feet of active proposals. Beginning as early as June 2023, We will see gradual NOI improvement related to both projects as tenants begin to reimburse operating and tax expenses during their free rent periods. Before I turn the call over to Matt, I want to acknowledge the recent publication of the RMR Group's Annual Sustainability Report, which provides a comprehensive overview of our managers' commitment to long-term ESG goals. We are deeply committed to enhancing OPI's corporate sustainability practices and continue to advance initiatives that will position the company to thrive over the long term. For example, we recently garnered recognition as an Energy Start Partner of the Year for the sixth consecutive year and a Sustained Excellence Honoree for the fourth year in a row. This recognition underscores our dedication to operating properties that benefit our tenants and communities. You can find links to the report and a tear sheet specific to OPI's highlights on our website at opireet.com. I will now turn the call over to Matt to review our financial results.