Brandywine Realty Trust

Good day and thank you for standing by. Welcome to the Brandywine Realty Trust first quarter 2022 earnings conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during this session, you will need to press star 1 on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star then 0. I would now like to hand the conference over to your host today, Jerry Sweeney, President and CEO. Please go ahead, sir.

Michel, thank you very much. Good morning, everyone, and thank you for participating in our first quarter 2022 earnings conference call. On today's call with me are George Johnstone, our Executive VP of Operations, Dan Palazzo, our Vice President and Chief Accounting Officer, Tom Wirth, 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 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 FCC. Well, the world has changed quite a bit since our last call. We've had record inflation. increases in construction and labor costs, an unprovoked attack by Russia on Ukraine's sovereignty, further disruption of global supply chains, and a dramatic increase in baseline interest rates have all created a near-term outlook different than only several months ago. Our portfolio stability, evidenced by our low forward rollover, protection from expense increases on 70% of our leases due to their structure, the preponderance of typical net leases we have in the portfolio, and our pragmatic approach to development, including below-market land basis and options, position us well for these events. In our business, those macro concerns are somewhat counterbalanced by the removal of federal and state COVID mandates, leading our portfolio to higher levels of physical occupancy. Even more encouraging is We have also seen much stronger tenant interest in high-quality work environments. Our tour levels, lease negotiations, and deal executions remain on a very positive trend line. Those trends position our existing portfolio and development pipeline extremely well. In fact, 25% of our operating portfolio pipeline is comprised of tenants looking to upgrade from lower quality, less amenitized buildings. During our prepared remarks, we'll review first quarter results, provide an update on our 22 business plan, and some color on recent activity. Tom will then review our first quarter results, frame out the key assumptions driving the balance of our 22 guidance, and after that, Dan, George, and Tom and I are available for any questions you may have. The first quarter has gotten off to a very solid start. Results are in line with our 22 business plan. During the quarter, we executed 428,000 square feet of leases, including 287,000 square feet of new leases. For the first quarter, we posted rental mark-to-market of 20.4 percent on a GAAP basis, and 12.9 percent on a cash basis. Our full-year mark-to-market range has remained between 16 and 18 percent on a GAAP basis and 8 to 10 percent on a cash basis. As outlined in our 2020 operating plan, we rolled that out last quarter, we had 252,000 square feet of known move outs or negative absorption scheduled to occur in the first quarter. Approximately 57 percent of that space has been re-let with scheduled second through fourth quarter 2022 occupancies. And the mark-to-market on those backfill tenancies was 26 percent on a GAAP basis and 11 percent on a cash basis. In looking at our numbers, while quarterly same-store cash outperformed our business plan range, the full-year impact of these known move-outs and the free rent on blank rooms renewal occurring subsequent quarters And as such, we're keeping our range in place. First quarter capital costs were in line with our business plan. Retention was 56 percent, slightly below the bottom end of our full-year forecast, but we are, again, as with the other metrics, maintaining our range. Core occupancy and lease targets were also within our ranges. We ended the quarter at 92.4 percent leased and 89.4 percent occupied, which was in line with our projection for the first quarter. It's interesting to note, when you look at our operating portfolio and look at Philadelphia CBD, University City, the Pennsylvania suburbs, and Austin, which covers 88% of our portfolio NOI, we are combined 94.8% leased and 91.8% occupied. Spec revenue remains in the $34 to $36 million range, with 29.4 million, or 84 percent, the midpoint achieved. Spec revenue range represents approximately 2 million square feet of leasing, of which we are 1.4 million, or 70 percent, complete. Over the last couple years, we have reduced our forward rollover exposure through 24 to an average of 7.5 percent. Our annual rollover exposure through 2026 is below 10 percent, and both of these metrics clearly indicate poor portfolio stability. On an FFO basis, and Tom will amplify this, we posted first quarter FFO of 35 cents per share, which was one cent above consensus. From an EBITDA standpoint, based upon the increased 2022 leasing activity, higher develop and a redevelopment spend we are maintaining our projected EBITDA range in the range of 6.6 to 6.9 times. As we framed out last quarter, the majority of this leverage increase is purely transitional, coming primarily through debt attribution from our joint venture and development activity. To amplify this point, on page three of our SIP, we segment our EBITDA metrics between core and combined. The core EBITDA range of 6.0 to 6.3x focuses on our core portfolio by eliminating our joint venture and active development projects and is a much more accurate measure of how we manage our core portfolio. Turning to leasing activity, we continue to be encouraged by the increasing pace of on-the-ground activity. Tours in the first quarter of 22 outpaced the fourth quarter of 21 by 30 percent. We had a total of almost 1,800 virtual tours, inspecting over 470,000 square feet, which was up again 22 percent from our fourth quarter results. Our overall leasing pipeline stands at 4.1 million square feet, broken down between 1.3 million on our operating portfolio and 2.8 million square feet on our development projects. The 1.3 million square foot pipeline on our existing portfolio has approximately 350,000 square feet in advanced stages of negotiations, with, as I mentioned a moment ago, 25 percent of that pipeline consisting of prospects looking to move up the quality curve. The leasing pipeline on our development projects of 2.8 million square feet increased 493,000 square feet, or 20 percent, during the first quarter. Deal conversion rate in the first quarter was up from Q4 and trailed pre-pandemic levels only by single digits, so quite a close in the last couple quarters. We do see tenants starting to accelerate their decision timeline. During this past quarter, the median deal cycle time improved by two weeks and is now within two weeks of the pre-pandemic levels. In looking at liquidity and dividend coverages, we have excellent liquidity. Even with our targeted development spend and absent other financing or redeployment sources, we anticipate having $350 million available in our line of credit at year-end 22. And as Tom will touch on, we have efforts underway to renew both our line of credit and our term loan. The dividend is well covered with a first quarter payout of 54% on the FFO and a CAD payout ratio of 74%. We anticipate that coverage improving significantly as future leases commence and development redevelopment projects stabilize. From a capital allocation standpoint, we made progress on several fronts. We continued selling non-core land parcels. During January, we sold one parcel for $1.4 million, generating a $900,000 gain, and subsequent to the quarter end, We sold our land parcel in the riverfront district of DC for 29.7 million, generating a $3.4 million gain that we will recognize in the second quarter. We deployed 28.6 million of these land sale proceeds into a 20% equity stake in Sierra Square, which is an 863,000 square foot property located adjacent to our Sierra South and Schuylkill Yards projects in University City. You may recall we acquired the former post office project a number of years ago for $28 million, redeveloped it as a single tenant property for the federal government, sold that property in 2016, and generated a $115 million gain. That owner that we sold to decided to sell, So, this presented us with an unplanned opportunity to further solidify our university city market position. The property was purchased for $383 million at a well below replacement cost of $440 per square foot and a mid-five cash cap rate range and north of a 7 percent gap cap rate range. Our two partners, each owning a 40 percent stake, are a sovereign wealth fund and a family wealth office. The project is 100 percent occupied by the GSA through August of 2030. The existing lease rate is at least 40 percent below existing market rates, and the GSA has no renewal rights upon expiration. As such, as we evaluate this acquisition, it's really a proxy for either a material mark-to-market profit opportunity or a significant repositioning into a life science facility at the gateway to University City and adjacent to 30th Street train station. Based on current assumptions, either a renewal at market or a conversion of life science will generate at least a mid-teens IRR and equity multiples ranging between three and five times. The University City life science market, as you all know, has strengthened considerably since we sold this property in 2016. So acquiring this property created a preeminent profit and repositioning opportunity and bringing in two high-quality partners for 80% ownership stake also minimized our direct investment and effectively make this a leverage-neutral transaction. In looking at our other development opportunity set, at 405 Colorado and downtown Austin, we signed over 66,000 square feet of leases during the quarter. the project now stands at 81% leased. An additional full floor leases out for signature and an executed LOI for half a floor, so we do expect to be somewhere between 91% and 95% leased during the second quarter. Rental rates held strong in the mid-40s and concession packages remain very much in line with our pro forma. Given permitting delays with the City of Austin, and the timing of several of these occupancies, we have shifted the stabilization to the first quarter of 23. In the Pennsylvania suburbs, the Radnor Submarket, our 250 King of Prussia Road project is on time and on budget. We're now over 29 percent pre-leased, having signed 35,000 square feet of life science leases this past quarter. Our current pipeline is north of 200,000 square feet. including 12,000 square feet in lease negotiations. You may recall this project is our first delivery in our Radnor Life Science Center, which will consist of more than 300,000 square feet of life science space in the region's best performing sub-market. Our D-Labs project at CIRA Center, the 50,000 square foot incubator, opened in January and is 97 percent leased to 12 companies. It's doing very well, and based on tenant feedback, we do anticipate between 150 to 200,000 square feet of demand out of these tenants in the next 12 to 24 months. Based on this success, we do plan to add another floor to our incubator, totaling approximately 27,000 square feet by year-end 22. And in addition to that, plans are underway to add another 78,000 square feet of life science capable space through floor nine in the Sierra Center project. The target delivery of that space is the second quarter of 23. In looking at some of our developments at Schuylkill Yards and Uptown ATX, Schuylkill Yards West, our life science office and residential tower is on time and on budget for a Q3 23 delivery. We have an active pipeline totaling about 550,000 square feet. That's up significantly from the previous quarter for both the, that's for the life science and the office components. And we expect that pipeline to continue to progress as construction continues to move forward. Our entire equity commitment in that project of $56.8 million is fully funded, and our partner's equity investment is currently being made with the first funding of the construction loan occurring in the second quarter of 22. Our life science push does continue at Schuylkill Yards. As we've noted before, we can develop between 3 and 4 million square feet of life science space. And we do anticipate our next start will be 3151 Market Street, a 424,000 square foot dedicated life science building, buildings fully designed and fixed priced, We have a leasing pipeline of about 350,000 square feet on that project, which is up about 150,000 square feet from last quarter. And our goal does remain to start that project in the next couple quarters. Turning the attention down south to Uptown, which is our 66-acre mixed-use community, where we have the development capacity approaching close to 7 million square feet, construction is underway on Block A. which as we've identified in the SIPP is 348,000 square feet of office, 341 residential units, and 15,000 square feet of ground floor retail. We anticipate completion of that office component in the third quarter of 23 and the residential component a year later in the third quarter of 24. Important to note here as well, Brandywine's equity commitment of $57 million only has a remaining balance to be funded of $1 million, which will occur in the second quarter. The CAT Metro train station uptown ATX that will provide direct access to downtown Austin had our groundbreaking. We're expecting that to be open for service in 2024. We further anticipate that the first days of Block F which is 272 apartment units, will be starting in the second quarter of 22. Just a general comment about our forward development pipeline given macro conditions. You know, we do have significant development opportunities ahead of us that we believe can create significant shareholder value. But we also have tremendous flexibility. Our land base at Uptown is about $5 an FAR foot, which is obviously well below the market value, which affords us the opportunity for not only a land profit, but also minimizing carry on that land through the development cycle. And our land control at Schuylkill Yards, as you know, is via options, so there's very little carry costs on those land holdings, and we have a takedown based on the milestone schedule with significant extension options. So, both of these facts provide us with significant flexibility to develop per real estate and capital market demand drivers. The second key point is the diversity of the product in our forward development pipeline, as we highlighted on page 13 of our SIP. Of the 14.2 million square feet we can build, only about 25% is dedicated to office with the ability to do between three and four million square feet of light science space and incorporate in that square footage pipeline is the ability to do about 4,000 apartment units. So, further overlay approvals on both of those sites give us a degree of flexibility to further adjust that mix to meet future market demand drivers. So, key takeaways, low basis, land under auction, low carrying costs, and demand driver flexibility. Looking at the investment market, Our 22 plan does not incorporate any dispositions or additional acquisitions, but we do anticipate being active on these fronts. As we have done thus far this year, we do anticipate continuing to sell select non-core land parcels. With the office recovery underway, we believe we have several opportunities to harvest profits with low cap rate sales. We also anticipate sales of select properties out of our existing joint ventures. And dollars generated from these activities we'll use to fund our development pipeline, reduce leverage, and, where appropriate, redeploy the higher growth opportunities. So, Tom will now provide an overview of our financial results.

Thank you, Jerry. Our first quarter net income totaled $5.9 million, or $0.03 per diluted share, and FFO totaled $60.3 million, or $0.35 per diluted share. and one cent per share above consensus estimates. Some general observations regarding our first quarter results. While our first quarter results were above consensus, we had a number of moving pieces and several variances from our guidance in the fourth quarter. Portfolio operating income totaled $70 million and was below our fourth quarter guidance of about $2 million. primarily due to higher seasonal portfolio operating expenses, but sequentially flat as compared to the fourth quarter, despite the 252,000 square feet of negative absorption. Land gains were below forecast by $400,000 due to the delay of one land sale. We anticipate the second land sale to occur in the second quarter. Termination of other income totaled $6.5 million and was $3 million above our fourth quarter forecast. primarily due to accelerated insurance proceeds that we anticipated receiving throughout 2022. Our first quarter fixed charge and interest coverage ratios were 4.3 and 4.0, respectively, and sequentially better than our fourth quarter results. Our first quarter annualized net debt to EBITDA was 7.0 and slightly above our slightly above the high end of our 6.6 to 6.9%, six times guidance, our net debt to EBITDA was negatively impacted by the acquisition of Sierra Square in mid-March. Based on a normalized quarterly income from Sierra Square, the ratio would have been 6.9. For 2022, our full-year same-store portfolio increased by two properties, which were the Bulletin Building and 426 West Lancaster. Regarding 22 guidance, as Jerry mentioned, we have maintained our guidance ranges for both net income and FFO. Normally, we narrow our guidance throughout the year. However, we do have several reasons for not doing that. Timing of capital spend and the anticipated significant rise in interest rates, we have increased our interest expense range by $1 million at the midpoint. We also have potential asset sales and related redeployment opportunities. Those are the reasons for not narrowing our guidance range. Turning to the second quarter guidance, looking more closely at the general assumptions, our property level operating income will total approximately $70.5 million and be slightly above the first quarter, as we estimate net absorption will now occur through the remainder of the year. FFO contribution for unconsolidated joint ventures will be $6.5 million for the second quarter, G&A for the second quarter will remain flat at $10 million. Total interest expense will approximate $17 million and capitalized interest approximately $1.9 million. While we believe we have forecast interest rates throughout the balance of 22, we have some incremental exposure in the second half of the year if our assumptions are too low and the Federal Reserve increases rates at a more aggressive pace. Termination and other Income will total about $1.5 million. We think net management, leasing, and development fees for the quarter will be $3 million. And we do have land sales and net of tax provision of $3.5 million. Our capital plan is fairly straightforward for the balance of the year and totals $335 million. Our 2022 CAD ratio will continue to be 84% to 95%. The range is above our historical run rate primarily due to the high capital costs associated with the higher leasing activity for this year in our wholly owned and JV portfolios. The uses of cash are primarily going to be for development, $155 million, $99 million of common dividends, $45 million of revenue-maintaining capital, $30 million of revenue-creating capital, and $10 million of equity contributions to our joint ventures. Primary sources for that are going to be cash flow after interest payments of $130 million, $108 million use of our line of credit, our cash on hand of $39 million, and $33 million of land sales, of which two of those are going to happen in the second quarter. Based on the capital plan outlined, our line of credit balance will be approximately $250 million, leaving $350 million of availability. We also project that our net debt to EBITDA ratio will still range between 6.6 and 6.9, with the main variables being the timing and scope of our development activities. And our net debt to GAD is 39 to 40 percent range. In addition, we anticipate our fixed charge ratio will approximate 3.8, and our interest coverage will approximate 3.7, which represents slight decreases from the prior quarter. While we believe these three ratios are elevated due to the growing development and redevelopment pipeline, we believe they are transitory, and once the developments are stabilized, we expect our overall leverage to decrease. Therefore, we have included an additional metric of core net debt to EBITDA, which was 6-2 as of the end of the quarter, and excludes our joint venture and active development projects. We believe this core leverage metric better reflects the leverage of our core portfolio and eliminates our more highly leveraged joint ventures and our unstabilized development and redevelopment projects. I now turn the call back over to Jerry. Thank you, Tom.