Brandywine Realty Trust

Ladies and gentlemen, thank you for standing by. And welcome to the Brandywine Realty Trust third quarter 2021 earnings conference call. At this time, all participants are on a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press the start and the one key on your touchtone telephone. Please be advised that today's conference may be recorded. If you recall operating systems, please press start and zero. I would now like to hand the conference over to your speaker host today, This is Jerry Sweeney, President and CEO. Please go ahead, sir.

Jerry Sweeney Livia, thank you very much. Good morning, everyone, and thank you all for participating in our third quarter 2021 earnings call. On today's call with me are George Johnstone, our Executive Vice President of Operations, Dan Palazzo, our Vice President and Chief Accounting Officer, and Tom Worth, our Executive Vice President and Chief Financial Officer. Prior to beginning, Certain information discussed during our call may constitute forward-looking statements within the meaning of the federal securities law. Although we believe these estimates reflected in these statements are based on reasonable assumptions, we cannot give assurance that the anticipated results will be achieved. For further information on factors that could impact our anticipated results, please reference our press release as well as our most recent annual and quarterly reports that we file with the SEC. Well, first and foremost, we hope that you and yours continue to be safe, happy, healthy, and engaged. And I think looking at our business, despite reopening delays related to the Delta variant, the office market continues to improve. Tour activity, lease negotiations, and deal executions remain on a positive trend line. Our portfolio occupancy has increased to approximately 35%. The predominance of tenants returning has, though, expanded beyond just small employers as occupancy for tenants 50,000 square feet and below is now over 50 percent. During our prepared comments, we'll review our third quarter results, discuss progress in our business plan, and update you on a recent capital and development activity. Tom will then also provide a financial overview. And after that, Dan, George, Tom, and I are available to answer any questions you may have. From a portfolio management standpoint, we remain focused on reducing forward rollover and providing a solid platform for growth. These efforts have been successful. We have reduced our forward rollover exposure through 2024 to an average of 6.8%, a slight improvement over last quarter. Our forecasted rollover exposure is now below 10% annually through 2026. Revenue and earnings growth remain a top priority. Key near-term earnings drivers for us are, as you all know, we have several key vacancies that upon lease-up will generate between 7 and 10 cents per share of growth. We're delighted to report that we have now leased about 46%. of that targeted square footage and achieved about 45% of that forward revenue growth at an average mark-to-market of 12% cash and 19% gap, and that income will be substantially in place by the third quarter of 2022, which can create a good growth opportunity for us. Some notable components of that during the quarter, the last 38,000 square feet vacated by SHI in Austin has been leased And we've also signed a replacement lease for the 42,000-square-foot tenant in Radnor, Pennsylvania. And lastly, we did sign three new leases at Commerce Square, totaling just shy of 29,000 square feet. We do see clear trend lines of tenants requiring higher-quality space, which we do think positions our portfolio extremely well. From a financial standpoint, for the third quarter, we posted FFO of $0.35 per share. which is 1% per share above consensus estimates, which Tom will walk you through. We've also made excellent progress on all the other components of our 2021 business plan. We do anticipate about 100,000 square feet of positive absorption during the fourth quarter, and we will achieve our year-end occupancy and lease percentage guidance ranges. And to reinforce our leasing progress to date, We are increasing our speculative revenue target by $500,000 from our midpoint range of $20.5 million to $21 million, and we are over 99% complete on that revised target. It's important to note that that $21 million target that we're now circling is about 15% above the bottom end of our original range, and it does reflect ever-improving office market conditions. Looking at some other operating statistics, we also posted great results there for the quarter as well. Tenant retention was above our 2021 business plan range. Of the 59 new deals that we signed this year, the weighted average lease term is 7.8 years. 68% of those lease terms are longer than four years, and our medium lease term has remained fairly consistent with what we're able to achieve in 2018, 19, and in 2020. Third quarter capital costs came in below 8% of generated revenue, so well within our business plan range. Cash mark to market was a positive 12%, and our gap mark to market was a positive 16%. Our year-to-date mark to market results are above our full year ranges. However, as we noted on last quarter's call, Based on leases already executed and commencing the fourth quarter, with lower mark-to-market results, we will finish the year within our business plan ranges. We also expect that every region will post positive mark-to-market results on both a cash and GAAP basis this year. Our third quarter GAAP same-store NOI was 2%, and year-to-date results are within our 21 range. Our third quarter Cash same-store NOI was 5.5%, and above our 2021 range of 3% to 5%. But again, similar to our mark-to-market dynamic, tenant schedule take occupancy later this year will accelerate same-store growth and will enable us to achieve our 2021 business plan ranges. We are still forecasting a 21% year-end debt to EBITDA in the range of 6.3 to 6.5 times. And in looking at leasing velocity, we know that everyone is keenly focused on recovery data points, and we have several encouraging signs to report. The Philadelphia suburban market produced more than 350,000 square feet of leasing activity in the second quarter, which is a 42.7% increase quarter over quarter. The CBD market also posted 181,000 square feet of leasing activity. And Philadelphia generally is making a strong recovery from the pandemic in comparison to a number of other major American cities. Our vacancy rate is lower than the national average. And based upon a major brokerage report, Philadelphia is in the top ten of all American cities for pandemic recovery as measured by recovery rates and employment. vaccination, and leasing activity. During the quarter, we had a total of over 1,500 virtual tours that inspected over 758,000 square feet in line with second quarter results. Physical tours were down slightly from the second quarter, and we attribute this really more to the summer months as third quarter physical tours outpaced first quarter tours by over 13%. Our overall pipeline stands at 1.6 million square feet, which increased by about 600,000 square feet during the quarter, another good sign of more tenants entering the marketplace. And while these recovery data points are encouraging, they also do compare favorably to the pre-pandemic leasing trends. So, our pipeline today is 7 percent better than our third quarter 19 results. Deal conversion rate was on par with previous quarter results as well. Now, as you might expect, and we reported last quarter, median deal cycle time continues to trail pre-pandemic levels by approximately 30 days. On a very positive note, during the quarter we executed 464,000 square feet of leases, including 347,000 square feet of new leasing activity. We also continue to see two favorable trends that we think positively impact our portfolio. First, quality product does matter. Since the beginning of the pandemic, approximately 100,000 square feet of deals have moved up into Brainy Wine buildings versus lower quality competitors. Secondly, we have seen approximately 20 tenants expand their premises by approximately 122,000 square feet. since the beginning of the pandemic. In looking at our liquidity and dividend coverages, as Tom will report, we have excellent liquidity and anticipate having approximately $550 million available in our line of credit by the end of the year. We have no unsecured bond matures until 2023, have a weighted average effective rate of 3.73%, and they fully unencumbered wholly owned asset base. Our dividend remains extremely well covered with a 54% FFO and 81% CAD payout ratio. And as we noted, our five-year dividend growth rate has been 5.3%, while our five-year CAD growth rate has been just shy of 8%, well in excess of our core peer averages. From a capital allocation standpoint, it was frankly another quiet quarter, but we continue to make progress on many other fronts As part of our land recycling program, we did sell three non-core land parcels, generating just shy of $11 million of proceeds and a $900,000 gain. Also, as we noted in our supplemental package, during the quarter, our $50 million preferred equity investment in two office properties in Austin, Texas, were redeemed. We did record a $2.8 million incremental investment income during the quarter due to that early redemption. That $50 million preferred equity generated just shy of a 21% internal rate of return during the whole period. Taking a quick look at our development opportunity set, 250 King of Pressure Road, which we noted in our supplemental package, is a 169,000-square-foot project under renovation in the Radnor sub-market. That was started in the second quarter and will be wrapped up by the second quarter of 22. The project will accommodate heavy life science as well as office use. Our costs did increase quarter over quarter due to some additional MEP work to facilitate broader life science penetration as well as adding an additional generator for power redundancy. Those two items did impact our targeted yields by reducing it about 20 basis points. The project, as we noted before, is really the first delivery in our Ratner Life Science Center, which will consist of more than 300,000 square feet of life science space in one of the region's best performing submarkets. Our current pipeline for 250 King and Pressure Road totals more than 200,000 square feet, including 51,000 square feet in lease negotiations. Looking at Schuylkill Yards, our Schuylkill Yards West project is on time, on budget for a Q3 23 delivery. That project will deliver a 7 percent blended yield. As you may recall, it consists of 326 apartment units, 200,000 square feet of commercial and life science space, and 9,000 square feet of street-level retail. We have an active pipeline continuing to build on that project, and our $56.8 million equity commitment is fully funded. Our partner's equity investment is currently being made, and the construction loan that we closed recently really will not have its first funding until the first quarter of 2022. Looking at 405 Colorado and Austin, Texas, this project is now complete. During the quarter, we did increase our lease percentage from 24% to 44%. We do have a growing and active pipeline now that that building's been fully delivered. We did slide our stabilization date a couple quarters to reflect the timing of these new lease signings as well as the timing of our targeted pipeline. The 522 space garage did open during the summer and is currently just shy of about 12% occupied, and we have signed already 102 monthly contracts since we opened the garage. 3000 Market Street in University City of Philadelphia is a 91,000 square foot life science renovation as part of our Schuylkill Yards neighborhood. Base building construction is complete. The building is fully leased for 12 years at a development yield of 9.6%. The redevelopment did include increasing the building size from 64,000 to 91,000 by converting below-grade space into labs. This property was placed into service on October 1st. CIRA Labs, which we announced a couple quarter ago, is where we partnered with the PA Biotech Center to create a 50,000-square-foot, 239-seat life science incubator within the CIRA Center project. that will be completed later in the fourth quarter and will open January 1st, 2022. Since the announcement, we have had great leasing success and now stand just shy of 50%, about 49% leased with 118 of the 239 seats leased and a pipeline with 17 additional proposals aggregating more seats than we have available capacity. So very excited about delivering that project. on a substantially pre-lease basis. And just looking at some future development at Schuylkill Yards and Broadmoor, you know, within Schuylkill Yards, the life science push really continues. We can develop about 3 million square feet of life science space. We've already delivered 3,000 markets, a bulletin building, 3,151 market, which is our 424,000 net rentable square foot life science building. It's fully designed. ready to go, and with a strong leasing pipeline. And our goal remains to be able to start that project in early 2022, assuming market conditions permit and the pipeline continues to build. At Broadmoor, Block A, which consists of 363,000 square feet of office and 341 apartments at a total cost of $321 million, will be starting later in the fourth quarter. We are finalizing documentation, including construction financing with our partner. The first phase of Block F, which is 272 apartment units, will be starting in the same venture format in Q1 of 22. And on the office leasing component, our leasing pipeline right now is slightly over 500,000 square feet. with about an additional 1.5 million square feet of inquiries. Just one additional note related to our third quarter earnings cycle. As we outlined last quarter, we would normally have provided 22 guidance for earnings in our business plan and FFO during the third quarter cycle. However, consistent with what we did last year and based on the continued uncertain business climate, we will announce our 22 guidance on our fourth quarter earnings call. Tom will now provide an overview of our financial results.

Thank you, Jerry. Our third quarter net income totaled $900,000, or one cent per diluted share, and our FFO totaled $61.1 million, or 35 cents per diluted share, and that was one cent above consensus estimates. Some general observations about the third quarter. While our results were above consensus, there were a number of moving pieces and several variances to our second quarter guidance. Portfolio operating income at $68.5 million was in line with our guidance for the second quarter. Interest in investment income totaled $4.5 million and was $2.5 million above our $2 million guidance number. As Jerry mentioned, this variance was due to the early termination of the $50 million preferred equity investment, which resulted in the acceleration of of some fees, totaling about $1.5 million, and to make whole interest on the investment income side, about $1.3 million. That all was recorded in the third quarter. We forecasted $2.3 million in land gains and tax provision, which was $1.4 million below our actual results. Two land sales were delayed, and we believe they will both close in the fourth quarter. As a result of those two, that nets to a one penny increase to the reason we're above consensus. Interest expense of 15.2 was below our second quarter forecast by $800,000, and that was primarily due to a higher than anticipated capitalized interest on 405 Colorado. Termination and other income totaled $1.8 million and was $400,000 above second quarter forecast. primarily due to the timing of some anticipated transactions. G&A was $7.1 million, $400,000 below our $7.5 million second quarter guidance, and that was primarily due to lower employee costs. Our third quarter fixed charge and interest coverage ratios were 4.3 and 4.1, respectively. Both metrics improved from the second quarter, primarily due to the higher investment income. Our third quarter annualized net debt to EBITDA decreased to 6.5 and is currently at the high end of our 6.3 to 6.5 guidance. This metric also benefited from the increase in investment income. On the additional reporting, as we look at cash collections, they were over 99%, continued to be very strong. We did have some net operating write-offs of tenants that totaled about $700,000 and and did lower our portfolio operating income for the quarter. For portfolio changes, 3,000 market. Based on Brandywine completing our base building obligations, 3,000 market will be added to our core portfolio during the fourth quarter as it's 100% least life science to Spark Therapeutics. Looking at fourth quarter guidance for 2021, we anticipated the fourth quarter results to improve compared to the third quarter, and we have some of the following assumptions. Portfolio operating income will total $70 million and be sequentially higher from the third quarter. That's due to the approximately 212,000 square feet that's going to be moving in during the quarter at a positive mark-to-market and will commence in addition to 3,000 markets. FFO contribution for unconsolidated joint ventures will total about $6.1 million for the fourth quarter, relatively flat compared to the third quarter. G&A will total roughly $7.1 million, again, sequentially flat to the third quarter. Interest expense will be approximately $15.5 million with approximately $2 million of capitalized interest. Termination fees and other income should total about $2.5 million. Net management fees will be about $3 million. and interest in investment income about $400,000. We do anticipate land sales and tax provision to be about $1.3 million, mainly based on the slides from the land sales that didn't occur in the third quarter, and this will generate about $6 million in net cash proceeds. On other business plan assumptions, though, there will be no property acquisitions, We did note one JV sale in our Allstate portfolio, which should generate about $12 million of net cash proceeds, no anticipated ATM or share buyback activity, no financing or refinancing activity in the quarter, and our share count will be about 73.5 million diluted shares. On the financing front, as previously mentioned, we did close on our construction loan at Schuylkill Yards. which represents a 65% estimated loan to cost. The initial interest rate will be about 3.75%. Based on our current capital plan, we will start drawing on that during the fourth quarter of 2022. We plan to restructure and extend our current loan in covering our joint venture at 4040 Wilson, and that will lower our borrowing costs by about 100 basis points, generate minimal initial proceeds, but allow for increased borrowings to complete the leasing of the vacant office space. While we have no other financing or refinancing activity in our plan, we continue to monitor the debt markets ahead of our 2023 secured bond maturity. Looking at our capital plan, our second quarter CAD was 65% of our common dividend, and year-to-date coverage is within our range. Our fourth quarter 2021 capital plan is very straightforward at $140 million. It includes $70 million of development and redevelopment activity, $33 million of common dividends, $15 million of revenue maintained, and $15 million of revenue create capital expenditures, and contributions to our joint ventures totaling about $5 million. The primary sources will be cash flow from interest payments after interest payments of $38 million, 42 million use of the line of credit, 42 million cash on hand, and cash, other sales and land totaling about 18 million. Based on our capital plan, we will have about 558 available on the line of credit. The increase in our projected line of credit is partially due to the build-out of our incubator at Cirrus Center, and we also project the net debt to EBITDA to fall within the 6.3 to 6.5 range, with a big variable being the timing and scope of capital development payments that could reduce cash. Our net debt to GAV will be 39% to 40%. In addition, we anticipate our fixed charge ratios to approximate 3.6% on interest coverage, and we'll approximate 3.9% fixed charge at 3.6%, interest coverage at 3.9%, which will present a sequential decrease, again, primarily due to some of the investment income that we received in the third quarter. I'll now turn the call back over to Jerry. Great, Tom. Thank you very much.