Brandywine Realty Trust

Welcome to the Brandywine Realty Trust Second Quarter 2022 Earnings Conference Call. My name is Hilda, and I will be your operator for today. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session. During the question and answer session, if you have a question, please press 01 on your touchstone phone. I will now turn the call over to Mr. Jerry Sweeney, President and CEO. Mr. Sweeney, you may begin.

Hilda, thank you very much. Good morning, everyone, and thank you for participating in our second quarter 2022 earnings call. On today's call with me, as usual, are George Johnson, 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 estimates reflected in these statements are based on reasonable assumptions, we cannot give assurances 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 follow at the FCC. Well, since our last call, our economy has seen record inflation, continued global supply chain disruption and a dramatic increase in baseline interest rates. These conditions have created significant cost increases and uncertainty in the equity and debt financing markets, at least in the near term. Our portfolio stability, evidenced by our low forward rollover, provides protection from operating expense increases on 81% of our leases, and that positions us as best as possible for this changing environment. Our operating and development business plan remains strong and very much on target. While overall return to work has been slower than we would like, we are benefiting from a decided tenant focus on quality. We continue to experience higher physical occupancy across our portfolio, with the highest level of density being in our Pennsylvania suburbs and DC operations. Tenant interest in high quality work environments is accelerating. We see that every day in our tour levels, lease negotiations, and deal execution. In fact, 32% of the new deals in our operating portfolio pipeline are tenants looking to upgrade from lower quality, less amenitized buildings. During the call this morning, Tom and I will review second quarter results, provide an update on our 2022 business plan and our guidance. After that, Dan, George, Tom and I are available to answer any questions. During the second quarter, we executed 686,000 square feet of leases, including 423,000 square feet of new leasing activity. We also posted rental rate mark to market at 18.4% on a GAAP basis, and 7.8% on a cash basis. Our full year mark to market range remains at 16 to 18% on a GAAP basis and 8 to 10% on a cash basis. Absorption for the quarter was positive and tenant retention was 70%. Second quarter capital costs were in line with our business plan range. Core occupancy and leasing targets were also within forecasted ranges and we ended the quarter 92.1% leased and 89.6% occupied. It's further worth noting that our Philadelphia CBD, University City, Pennsylvania Suburbs, and Austin portfolios, which comprise 93% of our NOI, are combined 93.8% leased and 91.9% occupied. Our spec revenue target remains in the range of $34 to $36 million, with 33.7 million or 96% of the midpoint achieved. This speculative revenue range represents approximately 1.8 million square feet, of which 1.6 million has already been leased, so 89% done on that metric. The portfolio is stable, and our forward rollover exposure through 2024 averages 7.2%, which ranks at 6 out of 17 office REITs. Further, our annual rollover through 26 is below 10 percent, ranking a 7 out of 17 office REITs. From an FFO standpoint, we posted first quarter results of 35 cents per share, which was one cent above consensus estimates. And looking at our 2022 guidance, Tom will articulate in greater detail, but the bottom line is our original 2022 business plan projected interest expense between $70 and $72 million. We have met that assumption for the first half of the year. However, looking to the second half, due to the rapid increase in short-term rates, our interest expense, including our share of joint ventures, will increase by about 3 cents per share. So while our operating plan remains fully on track, based on the rise in interest rates, We are narrowing and adjusting our FFO range from 137 to 145 per share to 136 to 140 per share. As I mentioned, Tom will articulate more detail on that in a few moments. Based on our 2022 leasing activity and development spend, we continue to project our debt to EBITDA range will be between 6.6 and 6.9 times. That leverage increase, the majority is transitional. coming through debt attribution, particularly on the development side. So to amplify that point, our core EBITDA range remains between 6.0 and 6.3 times by limiting our joint venture and active development and redevelopment projects. As we mentioned in the last call, we believe this is a more accurate measure of how we manage our core stabilized portfolio. Looking a bit ahead, despite the ongoing skepticism on Ford office demand drivers, our leasing velocity actually remains fairly encouraging. During the second quarter, physical tour volume equaled first quarter levels, with overall volume up over 30% from our previous year. Virtual tour volume was up 27% from the first quarter, and our total leasing pipeline is 4.8 million square feet. broken down between 1.4 million square feet on our operating portfolio and 3.4 million square feet on our development project. The 1.4 million square feet leasing pipeline on the existing portfolio is up 100,000 square feet from last quarter with approximately 130,000 square feet in advanced stage of lease negotiations. I should note that as an example of building velocity, Out of last quarter's pipeline, we executed 430,000 square feet of leases, while during the quarter, adding over 500,000 square feet of new prospects to the current pipeline. Also, 32% of our new deal pipeline are prospects looking to move up the quality curve. And we did experience this trend in terms of leases executed during the second quarter, where 67%, of the new leasing activity we executed were flight to quality tenants. The leasing pipeline on our development projects is at 3.4 million square feet and that did increase over half a million square feet or 28% during the second quarter. Deal conversion rates in the second quarter was up to 38% from 33% the last quarter. And another good sign is that tenants continue to accelerate their decision timeline. This past quarter, the median deal cycle time improved by an additional week and is now within five days of our pre-pandemic levels. From a liquidity standpoint, even with our targeted development spend and absent any other financing or sales sources, we anticipate having $300 million availability under our line of credit. And along those lines, during the quarter, we did renew both our $600 million line of credit and our $250 million term loan on very similar terms to those that were previously existing. Our 76 cents per share annual dividend is well covered, is a very attractive yield in our current stock price, and is accompanied by a 54% FFO payout ratio. In looking at capital allocation, we made progress on several fronts. We continued during the quarter and will continue to sell non-core land parcels. During the last quarter, we sold our land parcel in the riverfront district of D.C., generating a $3.4 million gain. We also sold some non-core buildings and land in New Jersey, generating an incremental $800,000 gain. In looking at our development opportunity set, our remaining Brandywine net funding obligation on all of our active development projects is just about $110 million. Our equity requirements on Schuylkill Yards West and uptown ATX Block A is fully funded. We have $24 million to fund on our new start at 3151 market. The balance of that remaining funding requirements really tie directly to leasing activity. During the quarter, we did commence the redevelopment of 2340 Dulles Corner. That property is 85% leased under an 11-year lease. and we anticipate completing that project by the fourth quarter of 23. 405 Colorado made incremental progress during the quarter. We're now 91% leased based upon the 22,000 square feet of leases that we signed during the quarter. We have two leases out for final execution that will completely fill the building. So we're happy to deliver that project at our original anticipated yield. 250 King of Pressure Road, which is our first life science delivery in the Radnor sub-market, is now over 36% leased. Current pipeline totals 237,000 square feet, and we're making great progress as that building approaches final delivery. In looking at our developments at Schuylkill Yards and Uptown ATX, Schuylkill Yards West which is our life science office residential tower on time, on budget for a Q3-23 delivery. The project will continue to deliver a 7% blended yield. As I mentioned a moment ago, our entire equity commitment is fully funded. Our partners' equity investment is also fully funded, and the first funding of the construction loan recently commenced. You may recall in Schuylkill Yards, we can develop about 3 million square feet of life science space. And as another step towards realizing that vision, we are excited to announce the start of our 3151 Market Street project, a 440,000 square foot dedicated life science building. The building has an estimated cost of $308 million, will deliver a yield of 7.5%, and we are targeting a second quarter 2024 completion. Our leasing pipeline on that project right now is over 400,000 square feet. We have obtained an equity commitment from our existing institutional partner at Schuylkill Yards and the 3151 structure is consistent with our existing Schuylkill Yards West project with Brandywine having a 55% ownership stake and our partner having a 45% ownership position. Looking at Uptown ATX Block A, the first phase of our 66 acre development is underway. Construction there is also on time and on budget. And we certainly anticipate that that project will continue to generate additional leasing activities as we go through the development pipeline. In fact, even this early in the process, our leasing pipeline stands at 1.6 million square feet. In addition to those ongoing developments, we have seen an increase in tenant interest in several of our build-a-suit projects. and we are exploring several opportunities in both the Pennsylvania and Austin regions. Two key points just to close out on our development discussion on our forward pipeline is our low land basis per FAR and our product diversity. Of the 14.2 million square feet that we can build, only about 25% is office, with the ability to do between 3 to 4 million square feet of lifestyle space and over 4,000 apartment units. Furthermore, the overlay approvals we have on both of those master plan communities gives us a degree of flexibility to further adjust that mix to meet market demand drivers. So our key takeaways on the development pipeline is a very quantifiable forward funding basis, a low land basis, low carrying costs, demand driver flexibility, and product diversity. And in terms of generating additional liquidity, while 2022 business plan does not incorporate any additional disposition, we do anticipate being active on these fronts. We anticipate continuing to sell select non-for land parcels. And even with the recent volatility in the debt markets in particular, we believe that we have ongoing opportunities to harvest profits from the sale of several properties. As such, we are currently testing the investment market with several assets for sale. Obviously, volatility in the debt markets over the last 45 days has slowed that process, but we remain confident of being able to generate additional liquidity over the next several quarters. We also anticipate the sales of select properties out of some of our existing joint ventures over the next four quarters. Dollars generated from these activities will be used to fund our development pipeline, reduce leverage, and redeploy into higher growth opportunities. Tom will now provide an overview of our financial results.

Thank you, Jerry. Our second quarter net income totaled $44.5 million, or $0.03 per diluted share, and FFO totaled $60.5 million, or $0.35 per diluted share, and $0.01 above consensus estimates. General observations regarding our second quarter results. Our second quarter results were above consensus. We had some moving pieces and several variances to the first quarter guidance. On GNA, 1.7 million below that forecast, primarily due to the timing of expenses, and we have not changed our range for the full year. Portfolio operating income totaled approximately 69.2 and was slightly below our first quarter guidance of 70 million. Land gains were above forecast by 600,000 due to a higher gain on the sale of our New Jersey portfolio. Our second quarter fixed charge interest coverage ratios were 3.7 and 4.0, respectively, and sequentially below the first quarter results, but in line with forecasted results. Our first quarter annualized net debt to EBITDA was 7.4, above the high end of our range. However, we are not changing that range at this time. As looking at our guidance for the rest of 22, as Jerry mentioned, we narrowed our guidance ranges for both net income and FFO by 4 cents a share. In addition to that narrowing our guidance, we also reduced the midpoint of the guidance by 3 cents per share. The reduction is due to a higher interest expense based on, you know, we issued guidance, the interest rate curve forecasted at that time for the third and fourth quarter. were 71 basis points and 92 basis points, respectively. Current curve is higher by approximately 175 basis points in the third quarter and 240 basis points in the fourth quarter. Through that, we have anticipated floating rate debt averaging $500 million in the third quarter and $695 million in the fourth quarter, which includes about $148 million of JV floating rate debt in the third quarter and $125 million in the fourth quarter. Our fourth quarter increase in floating rate debt is primarily due to the $250 million term loan, which is fixed through mid-October 22, and floating thereafter, and partially offset by some in-place caps in our joint venture properties. We believe there will be opportunities to mitigate some of the floating rate interest through hedging and potentially asset sales that will lower our line of Looking to the third quarter of 2022, we have some following assumptions. Our portfolio operating income will approximate $71 million and will be above the second quarter as we anticipate net absorption to continue through the balance of the year. FFO contribution from our unconsolidated joint ventures will be $6.5 million for the third quarter. G&A will remain unchanged roughly at $8 million. Total interest expense will increase to $19 million, primarily due to the anticipated higher rate, and capitalized interest will approximate $2 million. Term fee and other income will approximate $2 million. Net management fee and development income will be $3.5 million, and we do have a land gain sale and tax provision that will net around $1.5 million per little area of it. Refinancing activity, as Jerry mentioned, we did recently refinance the $600 million credit for June of 2026 and our $250 million term loan for June 2027 on very similar terms to the current facility. Looking at our capital plan, fairly straightforward and totals $200 million. Our 2022 CAD payout ratio will continue to be 84% to 95% and likely be at the higher end of that range. The 22 range is above our historical run rate, primarily due to higher capital costs associated with higher leasing activity in our wholly owned and joint venture portfolio. The uses for this remainder of the year is $74 million of development and redevelopment projects, $65 million of common dividends, $30 million of revenue maintained, and $20 million of revenue create capex, and $10 million of net equity contributions to our joint ventures. Primary sources are $90 million of cash flow after interest, $81 million use of the line of credit, and $29 million cash on hand. Based on the capital plan outlined above, our line of credit balance will approximate $300 million at the end of the year, leaving $300 available. This needs to be adjusted in our SIP where we have $330 million. We'll be adjusting and reposting that SIP this morning. We also present our net debt to EBITDA range of 6.6 to 6.9, but the main barrier will be timing and scope of our development activities. With regards to liquidity, we have ample capacity through our line of credit. We do expect to invest an incremental $96 million in our active development project after 2022. And our plan is to complete targeted asset sales later this year and into 2023 to lower that line of credit balance. We anticipate our fixed charge ratio to be approximately 3.5 and our interest to be 3.8, a slight decrease from the prior quarter, and our debt to GAV will be between 40% and 41%. We believe these ratios are elevated due to our growing development and redevelopment pipeline, and we believe they are transitory, and once these developments are stabilized, they will decrease. To further highlight how the investment in future development is impacting our current leverage metric, as outlined in our development page, we currently have $397 million invested in development projects that are providing none or minimal 2022 earnings. That $397 million investment has a 1.4 times increase to our leverage at the end of the quarter. We anticipate those projects generating $57 million of cash NOI over time and are confident on reaching those stated investment yields. Once these active projects are stabilized, we forecast that that leverage will go back down into the low six range. As mentioned above, we plan to partially offset the current development leverage with some targeted sales in 2022 and 2023. While the above development activity takes place, we included an additional metric of core net debt to EBITDA, which was 6.6 at the end of the quarter, which excludes our joint ventures and active fully-owned development projects. I'll turn the call back over to Jerry.