City Office REIT, Inc.

All participants are in the listen-only mode. A brief question and answer section will follow the formal presentation. To ask a question, you may press star then 1 on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then T. As a reminder, this conference call is being recorded. If you require operator assistance, please press star then 0. It is now my pleasure to introduce you to Tony Maratic, the company's Chief Financial Officer, Treasurer, and Corporate Secretary. Thank you, Mr. Maratic. You may begin.

Good morning. Before we begin, I would like to direct you to our website at cioreit.com, where you can view our second quarter earnings press release and supplemental information package. The earnings release and supplemental package both include a reconciliation of non-GAAP measures that will be discussed today to their most directly comparable GAAP financial measures. Certain statements made today that discuss the company's beliefs or expectations or that are not based on historical fact may constitute forelooking statements within the meaning of the federal securities laws. Although the company believes that these expectations reflected in such forelooking statements are based upon reasonable assumptions, we can give no assurance that these expectations will be achieved. Please see the forward-looking statements disclaimer in our second quarter earnings press release and the company's filings with the SEC for factors that could cause material differences between forward-looking statements and actual results. The company undertakes no obligation to update any forward-looking statements that may be made in the course of this call. I will review our financial results after Jamie Farrar, our Chief Executive Officer, discusses some of the quarter's operational highlights. I will now turn the call over to Jamie.

Good morning. Throughout 2024, office leasing fundamentals have continued to strengthen across our markets. During the first quarter of this year, we had healthy leasing activity that was comprised of 110,000 square feet of new leases and total leasing activity of 191,000 square feet. I'm pleased to report that these volumes have continued to improve in the second quarter. We reported today that new leasing activity increased to 162,000 square feet and total leasing activity increased to 269,000 square feet. In fact, this was the highest quarter of new leasing in our company's history. There are several positive industry trends that have contributed to these results. New office construction has declined to all-time lows. A record number of office conversions and demolition of obsolete buildings has also occurred. At the same time, a significant portion of the premium space in our markets has now been leased, and subleased space has decreased for four quarters in a row. As a result of these trends, competition from the supply of new or high-quality leased space is decreasing. On the demand side, we are also seeing a shift. There are more large tenants in the market looking to fill bigger space requirements. JLL estimates that nationwide tenant requirements have increased by 28% year over year. At the same time, renewal prospects are improving with JLL reporting that 60% of tenants over 10,000 square feet nationwide renewed in place in the second quarter. This is up 15% from the prior year. The improvements on the supply and demand side have translated to an overall more conducive leasing environment. We expect the pace of these improvements to be gradual but favorable for our long-term strategic execution. Today, one of the biggest challenges in the office market continues to be a lack of liquidity in real estate transactions, which we believe has been driven primarily by the office real estate debt market. Over the past few years, there have been very few options for new loan originations in the office sector. This has heavily suppressed office sale transactions. While debt markets are still muted, there has been a slight thawing. The CNBS market has started to open up, which will help facilitate some liquidity and capital flexibility. On the whole, the office market still faces challenges. Despite this, the pathway to longer-term success is becoming clearer for quality properties and growth markets operated by well-capitalized owners. We believe that our portfolio is positioned to benefit from these trends. And now shifting to specifics of our leasing and operational results. The largest new lease this quarter was at FRP Collection in Orlando, where we signed a 30,000 square foot five-year lease with a strong credit energy tenant. At Block 23 in Phoenix, we signed a 24,000 square foot lease with a co-working operator. This lease backfilled over half of the 46,000 square feet that WeWork previously occupied at that property. The new lease is structured where we share the economics of the tenant's operation in the space. We were able to execute this transaction within five months of WeWork vacating. This leaves 22,000 square feet of prime space from the WeWork give back, which we plan to further subdivide into smaller suites. As we indicated was the expectation on our last call, we did finalize terms with WeWork at the two remaining spaces they lease in our portfolio. In that regard, in July, we took back a 25,000 square foot floor at the Terraces in Dallas, And in November, we expect to take back a 28,000 square foot floor at Block 83 in Raleigh. We already have prospects looking to lease these spaces, which are some of the best suites in our entire portfolio. WeWork, who has emerged from bankruptcy, will ultimately lease 78,000 square feet of well-utilized space from us when the right sizing is completed. Aside from leasing, We are also focused on executing strategic property upgrades in some of our strongest submarkets. We're making significant enhancements in Scottsdale at Pima Center, in Phoenix's Camelback Corridor at 5090, in St. Petersburg at City Center, and in Uptown Dallas at 2525 McKinnon. These renovations are designed to provide a competitive leasing advantage and will greatly enhance the profile of all four properties. Of the $9 million we expect to invest into these four projects, we have spent approximately $4 million as of quarter end. At the conclusion of this renovation program, the vast majority of City Office's portfolio value will reside in well-located, newer vintage or recently renovated and amenitized properties that are very well positioned for leasing success. While the renovation of our city center property in downtown St. Petersburg, Florida is underway, we have separately been exploring a value enhancing initiative at that property. St. Petersburg has become an increasingly desirable office and residential market. It is a special waterfront community with a great quality of life and amenity offerings. The population has grown over 11% in the last five years and office occupancy rates are some of the highest in the country. This has created strong demand for both residential and commercial development. For some time, we've been advancing the potential of redeveloping City Centre's standalone parking garage into a mixed-use development with premium, high-rise residential condominiums. Today, we are in advanced discussions with a highly regarded developer to progress this opportunity. The form of the venture would likely entail us contributing the parking garage land and participating in future development profits. While any possible redevelopment of city center remains subject to a number of conditions, some of which are beyond our control, we hope to provide an update later in the year. As we did with our transformational San Diego life science portfolio acquisition and disposition, We continue to focus on creative ways to generate meaningful shareholder value and will provide further updates on future calls as these plans are enacted. Aside from the updates I have mentioned, our results this quarter continue to track our expectations. Accordingly, we reiterated all aspects of our prior guidance this quarter. For the balance of the year, we will remain focused on leasing, completing our property upgrades, and other value-enhancing opportunities. With that, I'll hand the call over to Tony to discuss our financial results in more detail.

Thanks, Jamie. Our net operating income in the second quarter was $24.9 million, which is $1.8 million lower than the amount we reported in the first quarter. NOI was lower in Q2 than in Q1 as a result of lower occupancy and a $900,000 termination fee recognized in the first quarter at Block 23 as a result of the WeWork departure. We reported core FFO of $11.5 million or $0.28 per share for the second quarter. Core FFO was $2 million lower than the amount we reported in the first quarter, driven primarily by the net operating income decrease. Our second quarter ASFO was $5.3 million or $0.13 per share which resulted in continued dividend coverage this quarter. The largest impact to AFFO was a $1 million tenant improvement deduction related to a new lease at Mission City in San Diego, which we expect will take occupancy in Q3 2024. We also spent $500,000 on spec suites and vacancy conditioning. The four significant property renovations underway, which Jamie described, resulted in a $1 million deduction to AFFO this quarter. Moving on to some of our operational metrics. Our second quarter same-store cash NOI change was 2.0% or $500,000 lower as compared to the second quarter of 2023, primarily driven by lower portfolio occupancy year over year. Our portfolio occupancy ended the quarter at 83.0%, including 241,000 square feet of signed leases that have not yet commenced. Our occupancy was 87.3% as of quarter end. Our total debt as of June 30th was $649 million. Our net debt, including restricted cash to EBITDA, was 7.0 times. As of June 30th, we had approximately $92 million undrawn and authorized on our credit facility. We also had cash and restricted cash of $43 million as of quarter end. We expect to use a portion of that liquidity to repay our $50 million term loan that matures in September of this year. We also have two properties of significant value, Block 83 in Raleigh and City Centre in Tampa, that are unencumbered, and we are exploring potential financing alternatives at Block 83. The remainder of our property level debt maturities for 2024 were addressed in the second quarter. First, as indicated on previous calls, During the quarter, we completed the transfer of our Cascade Station property in Portland to the lender, which reduced our overall debt by approximately $21 million. Second, at Central Fairwinds in Orlando, we extended the $16 million loan by five years to June 2029. Including the effect of a swap agreement, the effective fixed rate is 7.68% for the new five-year term. Third, at FRP Ingenuity Drive in Orlando, We extended the loan by two years to December 2026 with a one-year extension option. The loan modification for $14 million included a principal repayment of $1.6 million and maintains the existing 4.44% interest rate. We view the debt transactions this quarter as an upgrade to our balance sheet as we have addressed all near-term maturities. Our next property level debt maturity is not until October 2025. And lastly for me, on our guidance, we are reiterating the guidance that we updated last quarter. With the significant amount of signed leases that are expected to commence later in the year, our expectation is that our occupancy levels will increase in each of the last two quarters of the year. That concludes our prepared remarks, and we will open up the line for questions. Operator?

Thank you. As a reminder, if you would like to ask a question, please press 1 on your telephone keypad now. If you would like to withdraw your question, please press . When preparing to ask you a question, please ensure your device is unmuted locally. We'll pause here briefly as the questions are registered. The last question is from Rob Stevenson with Jenny. Your line is open.

Good morning, guys. Tony, any additional known move-outs of consequence today? I mean, the 430 basis point gap between your occupancy and signed lease is not yet occupied. It's pretty material. So trying to figure out how much of the move-ins are canceled out by move-outs or whether or not you're going to be able to start, you know, pulling down some of that gap in the back half of the year as you talked about occupancy increasing.

Yeah, good morning, Rob. Yeah, you're exactly right. The short answer to your question is no, there's really no new amounts. There is really only one of significant size that is a known vacate over the next four quarters. And that's what we've talked about before. There is a 72,000 square foot tenant at Amber Glen that's scheduled to depart at the end of January. And that's the only known move out greater than 30,000 square feet over the next coming quarter. So you're absolutely right. Our midpoint of our guidance range is 84.5% occupancy. And we're on track to hit that or maybe a tick higher.

OK. I mean, when you're looking at the pipeline of leasing today, how is it looking in the back half of the year versus what you've seen over the last couple of quarters? Is it still as strong as what you did in the first half of the year? Is it sort of moderating as people wait and see what's going to wind up happening? How would you sort of characterize the leasing pipeline versus the last four or five quarters?

Hey, Rob, it's Jamie here. So, you know, there's a natural slowdown over the summer. So where that ultimately lands in the summer, you know, it's probably a little slower. But I would say as far as requirements we're seeing, discussions we're having, it's really, really strong. And so, you know, my own prediction is kind of looking forward a year, a market that's been a little softer for us is Phoenix. And that one's really turned the corner. In fact, of the 240,000 feet of leases we've signed that haven't commenced, about 70,000 of it is in Phoenix. And I think we're going to continue to see some really good traction there.

Okay. And then last one for me. Tony, I think you talked about taking the term loan and paying that off as it comes due in September. Is that part of what you're thinking on interest rates in terms of waiting and seeing what's going to wind up happening before you put longer-term debt back in place? Is that sort of more permanent, do you think, in terms of got enough property-level debt and whatever you wind up doing at Block 83 in addition to that? How are you guys thinking about addressing some of the, you know, addressing debt in the current sort of not very stable environment where rates could go down, could stay the same? And we've had a bunch of head fakes here.

Yeah, I mean, it's a very good question. And if anyone guess where things will land, obviously, there's a lot of indications that rates could be coming down as early as September. But in terms of how we're looking at it, if you look at our overall facility with KeyBank, paying down the term loan and shrinking that facility a little bit as we go forward, given our exposure to that, is probably a good idea. We have unencumbered assets. I mentioned that we are exploring placing debt. The CMBS market in particular seems to be improving. If you look at the recent originations, the percentage of the pool that's being allocated to office has just been increasing and kind of returning to more normalized levels. So we're sort of exploring the various options and feel like we don't necessarily have to do something right away and see how things play out.

Okay. I mean, I guess as a follow-up to that, if you were to do something, put mortgage debt on block 83 at some point here, what type of rate are you looking at in the marketplace for an asset like that? today, you know, if you were doing something in the next, you know, call it three or four months?

Yeah, the current spreads on the reference rate is in that 275 to 300 basis point range for CMBS type deals, which is the most active in the market today.

Okay. Thanks, guys. Appreciate the time this morning.

Thank you. The next question is from Opaul Rana with KeyBank Capital Market. Your line is open.

Great. Thank you for taking my question. Jamie, you mentioned the turnaround in the Phoenix market. You know, anything in particular that's driving that turnaround?

You know, it's pretty broad. When you look at our portfolio of submarkets, we cover a lot of different submarkets. We're seeing a pickup in activity all around. I'd say the one that still is slow and has a lot of space in the sublease market is the tech side, but pretty much all other industries have started to pick up. We're having constructive discussions about longer-term leases and bigger blocks of space. So we're feeling really good about Phoenix, what we're seeing.

Okay, great. That was helpful. And then You know, I wanted to see how your spec suites were trending. And you mentioned that three million number last quarter, you know, and expectations for the year. And just curious on interest and tour activity there for those.

Sure. So spec suites are really moving. So we started, I think, last quarter, we had 82,000 square feet in inventory. We're at 48,000 right now. That's vacant. A big piece of that is two larger suites. that are fabulously built up. We've got to find the right tenant. That's about 30,000 of the 48. And we've got a whole bunch of smaller suites in that. So they're continuing to lease. We're going to build about another 32,000 right now, mostly smaller spread across our portfolio. And that's where we're seeing a great amount of our activity.

Okay, great. Thanks. And then just quickly on a central fairwind loan extension, you know, what was your thought process there on swapping that out on the floating rate and fixing it given where interest rates may be headed?

Yeah, that's a very good question. It was a requirement from the lender that we do so at closing. Okay.

All right. Thank you for your time. Thanks, Paul.

Thank you. As a reminder, if you would like to ask a question, you may press stop, followed by one on your telephone keypad now. We currently have no further questions, so I'll hand back to Jamie for closing remarks.

Thanks for joining today. Have a great rest of your summer. Goodbye.

Thank you. This concludes today's call. Thank you all for joining. You may now disconnect your lines.