Highwoods Properties, Inc.

Good morning and welcome to the Highwoods Properties Earnings Call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question and answer session. At that time, if you have a question, please press the 1 followed by the 4 on your telephone. If at any time during the conference you need to reach an operator, please press star 0. As a reminder, this conference is being recorded Wednesday, July 29, 2020. I would now like to turn the conference over to Brendan Mayorana. Please go ahead.

Thank you, Operator, and good morning. Joining me on the call this morning are Ted Klink, our Chief Executive Officer, Brian Leary, our Chief Operating Officer, and Mark Mulhern, our Chief Financial Officer. As is our custom, today's prepared remarks have been posted on the web. If any of you have not received yesterday's earnings release or supplemental, they're both available on the Investors section of our website at highwoods.com. On today's call, our review will include non-GAAP measures such as FFO, NOI, and EBITDAIR. Also, the release and supplemental include a reconciliation of these non-GAAP measures to the most directly comparable GAAP financial measures. Forward-looking statements made during today's call are subject to risks and uncertainties, which are discussed at length in our press releases as well as our SEC filings. As you know, actual events and results can differ materially from these forward-looking statements, and the company does not undertake a duty to update any forward-looking statements. Currently, one of the most significant factors that could cause actual outcomes to differ materially from our forward-looking statements is the potential adverse effect of the COVID-19 pandemic and federal, state, and local regulatory guidelines and private business actions to control it. on our financial condition, operating results and cash flows, our customers, the real estate market in which we operate, the global economy, and the financial markets. The extent to which the COVID-19 pandemic impacts us and our customers will depend on future developments, which are highly uncertain and cannot be predicted with confidence, including the scope, severity, and duration of the pandemic and the resulting economic recession, and potential changes in customer behavior, among others. With that, I'll now turn the call over to Ted.

Thanks, Brendan, and good morning, everyone. Let me start by saying I hope you are all well and your families are safe and healthy. We are pleased to report that our employees are healthy and that we have safely returned to all of our offices. To ensure our coworkers feel safe and productive while in the office, We have implemented a rotation schedule, giving everyone ample opportunity to comfortably practice social distancing. This helps us achieve our twin objectives, which are to prioritize the health and safety of our employees and realize the benefits of sharing our company's unique culture together in the workplace. Obviously, this has been an incredibly challenging time for our country and our economy. It remains difficult to predict the duration and severity of the COVID-19 pandemic and its overall impact on economic activity. We believe we are well positioned operationally to handle the near-term effects of this downturn, given our lack of large customer explorations over the next few years in our substantially pre-leased development pipeline. Plus, we continue to maintain a fortress balance sheet of ample available liquidity to fund leasing capital expenditures in our development pipeline while having dry powder to capitalize on future growth opportunities. In addition to having a high-quality portfolio and strong balance sheet, we are well-positioned given our geographic footprint. The Southeast continues to benefit from positive demographic trends, both population and job growth. Some notable office-using job announcements in our markets have occurred even in the midst of the pandemic. These include the Fortune 50 company Centene announcing a 6,000-job, $1 billion East Coast headquarters in Charlotte, Microsoft with 1,500 new jobs in Atlanta, and publicly traded software company Bandwidth in Raleigh with 1,200 new jobs and a planned new headquarters campus. These announcements illustrate the long-term attractiveness of our markets and support the notion that companies still value a collaborative, in-person environment to foster creativity and strengthen company culture. In the second quarter, we delivered FFO of 93 cents per share, which equals our first quarter results. Further, the second quarter reflected a full quarter of lost NOI from $338 million of property sold in the first quarter. Our financial results were excellent, especially considering the challenging economic conditions. In addition to strong FFO, our portfolio metrics were solid, with occupancy of 91.1%, up 20 basis points sequentially, same property cash NOI growth 2.4%, excluding the impact of temporary rent deferrals, and in-place cash rents of 5.1% year over year. We leased 821,000 square feet of second-gen office space with gap rent growth of 13.6% and cash rent growth of 5.5%. And this was done with limited leasing CapEx, which drove net effective rents 7.6% higher than our prior five-quarter average. We stated last quarter it was too difficult to predict where the economy would go from here, and we still feel like predicting the shape of the economic recovery is speculative, so we are maintaining our focus on the following items that we believe best position us in the near term. maintaining liquidity and a strong balance sheet, keeping our buildings fully open and operational, keeping our development projects on time and on budget, working with customers to maintain occupancy and timely rent payments, minimizing operating expenses without sacrificing operating performance or leasing opportunities, and capturing as many renewals and relets as possible given this uncertain environment. We've reported our rent collection figures each month since the start of the pandemic, which have been strong at 99% every month, including July. Temporary rent deferrals equate to 1.2% of annual revenues, up modestly since our first quarter call. Importantly, new rent relief requests have dropped off significantly since mid-May. We have long emphasized the importance of having significant customer, geographic, and industry diversification across our portfolio. No market accounts for more than 20% of revenues, no customer other than federal government accounts for more than 4%, and no industry category accounts for more than 25%. This diversification is serving us well in this uncertain macroeconomic environment. Turning to our updated 2020 FFO outlook, given the fluidity of the pandemic and its impact on economic activity, potential lost rents from customer defaults and non-cash straight-line write-offs are still too speculative to project. As a result, our updated FFO per share outlook of $3.59 to $3.68, which is up four cents per share at the low end excludes any such potential losses. All of our buildings and parking facilities have remained open and available to our customers throughout the pandemic. Obviously, usage of our assets was significantly lower than normal in the second quarter. As expected, parking revenue was negatively impacted, but we were able to offset this with lower operating expenses. We now expect building usage in the third and fourth quarters to remain low, which is reflected in our updated outlook. In early July, we sold two non-core properties in Memphis for $23.3 million. These properties were a combined 89% occupying and were sold at a low sevens cap rate based on projected 2020 gap NOI. We have another $72 million of properties under contract that are scheduled to close later this year. These dispositions comprise the low end of our outlook of $95 million, and we have other non-core dispositions in various stages of the sale process that could bring us to the high end of our outlook. Development continues to be a growth driver for Highwoods. Our 1.2 million square foot development pipeline represents a $503 million investment. that is 77% pre-leased and 60% funded. Construction work on our four in-process projects, Glen Lake 7 in Raleigh, Virginia Springs 2 in Nashville, Midtown 1 in Tampa, and Asurion in Nashville, has continued throughout the pandemic. We remain on budget and on schedule with these projects. As a reminder, our pipeline is projected to generate more than $40 million of annual NOI upon completion and stabilization, less than $5 million of which will be generated in 2020. New build-a-suit and anchor pre-lease conversations have slowed down compared to pre-pandemic levels, but there still are inquiries and activity from prospects. We remain hopeful we will be able to secure additional highly pre-leased development opportunities during the next several quarters. Before I turn the call over to Brian, I'd like to say a few words about our incredible teammates here at Highwoods. We greatly appreciate the hard work and dedication that our coworkers have exhibited every day since our normal daily routines and lives were disrupted by the pandemic. Their outstanding performance has shown through in our financial results in the second quarter, but it is also evident in so many areas also. whether working tirelessly to maintain building operations, adapting to new processes to seamlessly file our 10-Q, adapting to virtual leasing tours, or countless other examples. We couldn't be more proud of our team, and we sincerely thank them for our efforts. Brian?

Thank you, Ted, and good morning, everyone. I'd like to begin with a quick review of our performance in the second quarter and then provide an update on what we're seeing real-time across our markets. As Ted noted, signing 821,000 square feet of second-generation leases with gap rent spreads of a positive 13.6% and cash rent growth of 5.5% is a testament to the quantity and quality of work put in by our exceptional team across the portfolio. In addition to solid rent growth in the quarter, securing terms on average of 8.8 years, which was driven higher by our renewal of the FBI in Tampa, and with limited leasing capex, is a win for the company. Our payback ratio, or total capital committed compared to contractual revenue, was 6.7%, well below our recent average in the mid-teens. Consistent with the Highwoods playbook, We remain focused on reducing future lease expirations and not only have 21% of revenue expiring to the year end 2022, down from 29% at the end of 2019. The largest lease in the quarter was the 138,000 square foot full building long-term renewal with the FBI in Tampa. Following this lease and T-Mobile's known July move-out of 116,000 square feet, also in Tampa, we have one remaining expiration over 100,000 square feet to the end of 2022, which is the FAA in Atlanta, who remains in holdover status and with whom we continue renewal discussions. Our in-place cash rents grew 5.1% year over year, driven by higher rents on deals executed in the past 12 months, an improved portfolio mix as a result of the market rotation plan, and as always, in-place annual escalators. As you know, all of our buildings and parking facilities remain open and available for our customers who are returning to the workplace in varying degrees with any return at scale still ahead of us. As Ted mentioned, this reduced utilization has impacted our parking revenues, with transit revenue nearly nonexistent and some reduction from contractual monthly parkers. We have been able to offset the parking revenue delta with lower operating expenses. Moving forward, we expect parking revenues to remain tied to building occupancy, while we expect a sequential increase in op-ex as customers slowly return to their offices. The volume of rent relief requests received has slowed significantly, and we continue to work with those customers with a demonstrated financial need created by the COVID-19 pandemic. These customers account for 7.8% of our total annual revenues, and the temporary deferrals we've provided them represents approximately 1.2% of annual revenues. We continue to see most of the requests fall into a few broad categories. are amenity retail and restaurants, flexible office providers, elective medical practices, and other businesses impacted by social distancing measures. While there are no silver linings to a global pandemic and near shutdown of the economy, the second quarter has given us an opportunity to get even closer to our customers. Whether it's administering the protocols of a socially distanced and CDC-guided workplace, receiving inbound requests for help, or structuring win-win extensions, we believe these strengthened relationships will benefit us in the years to come. To that end, our rent collections have been strong throughout the pandemic, with 99% collected each month through July. We believe we have a unique opportunity and responsibility to create desirable workplaces for our customers, and we remain committed to working collaboratively and constructively with them during these unprecedented times. As expected, inbound inquiries and new leasing activity has clearly slowed, with only 91,000 square feet of new leases and 48,000 square feet of expansion signed in the second quarter. For perspective, we have little revenue at risk in 2020 attributive to speculative new leasing, and we've already completed the majority of spec renewals we forecasted for the year. At this point, and in response to the altered landscape, we've shifted most of the spec leasing in our outlook into 2021. However, we did see solid renewal activity with favorable economics in the second quarter. Recognizing the challenge before us was also an opportunity, our leasing teams have quickly pivoted to the challenging dynamics on the ground. This includes showing our available space virtually and bringing a level of flexibility and creativity to the leases as we navigate these uncertain times with our customers and prospects. Now turning to our markets. Already the second largest financial center in the United States and having passed the city of San Francisco this quarter with regard to population, Charlotte continues to benefit from the great affordability migration already underway prior to the pandemic. and consistent with all of our markets, continues to see strong inbound interest. This was illustrated most clearly and most recently by Centene's 6,000 new job announcement in July that they will build their own 1 million square foot campus in University City adjacent to UNC Charlotte. The continued economic attractiveness and diversification of our markets is a testament to having a low cost of doing business, a highly educated and diverse workforce, a strong transportation infrastructure, low cost of living, and the highest quality of life. Across the board, market rents are holding steady for the moment, while vacancy is marginally increasing, and the level of sublease activity is consistent with the onset of a recession. We continue to pay close attention to sublease activity across our markets. The wave of development projects launched pre-COVID continue to advance through various stages of construction and varying degrees of pre-leasing. Charlotte's 1.2 million square feet is 30% pre-lease. Atlanta's 5 million square feet, 60% pre-lease. Raleigh's 3 million square feet is 40% pre-lease. And Nashville's 2.8 million square feet is 28% pre-lease. Most of these projects don't deliver until 2021 or beyond, which grants them the benefit of time. As Ted mentioned, our development pipeline will deliver over $40 million of annual gap net operating income upon stabilization. This includes $32 million from three projects that are fully pre-leased, on schedule, and on budget. In closing, I couldn't be prouder of the effort and results our teammates delivered for Highwoods in the second quarter. Their support of our customers' short-term needs has positioned us favorably in our markets, while our long-term perspective and presence across the Southeast should benefit us in the changing landscape. Mark?

Thanks, Brian. In the second quarter, we delivered net income of $37 million, or $0.36 per share, and FFO of $99.2 million, or $0.93 per share. As Ted mentioned and we discussed last quarter, the $338 million of dispositions completed in the first quarter had a dilutive impact of $0.02 per share in the second quarter compared to the first quarter. Additionally, the second quarter was negatively impacted by lower parking revenue, which also had an approximate two cent per share drag compared to the first quarter. Offsetting these items was a significant reduction in net operating expenses and lower G&A. Given the challenging economic environment, we are pleased with our performance. The quarter was relatively clean from an FFO perspective, except for a half a million dollar charge to straight line rents receivable excluded from ffo but included in net income is a 1.8 million dollar impairment on a non-core building in memphis our balance sheet is in excellent shape at quarter end we had 586 million of liquidity which has now increased over $600 million following the receipt of proceeds in early July from the sale of two non-core properties in Memphis. Our net debt to adjusted EBITDA ratio held steady in the quarter at 4.9 times, and our leverage ratio, including preferreds, is 36.8%. We have no debt maturities until June 2021, and expect to fund approximately $90 million on our development pipeline during the remainder of the year. As we discussed last quarter, we expect lower leasing capex than our original 2020 projections, which should drive higher free cash flow and dividend coverage. The combination of ample current liquidity, improving cash flows, and projected disposition proceeds later in the year puts us in a strong position to fund our remaining $201 million to complete our development pipeline and repay our June 2021 bond maturity without the prerequisite of raising additional capital. Turning to our outlook, we've updated our FFO range to $3.59 to $3.68 per share. which is up 4 cents per share at the low end. Adjusting for the dilutive impact from the $23 million non-core disposition completed in July and the second quarter straight-line rent credit loss, neither of which was included in our previous range, our outlook is up 5 cents per share at the low end and a penny per share at the high end on an apples-to-apples basis. Last quarter, we provided a list of projected impacts from the COVID-19-induced economic slowdown. We've updated these items and included a table in last evening's press release, and I'd like to provide a little more color. Number one, we lowered our parking forecast by an additional one to two cents per share for a total reduction of five to nine cents per share compared to our original February 4th outlook. We previously expected improved utilization of our garages in the third and fourth quarters, but we now expect parking income will approximate the second quarter level in the third and fourth quarters. Second, in OPEX, net of recoveries is now expected to be six to eight cents per share lower than our original February 4th outlook. which mostly offsets the reduction in parking income. And finally, the dilutive impact from the $23 million non-core disposition and straight-line rent credit loss has lowered our outlook by a penny per share. In addition to these specified COVID-19-induced changes to our outlook, we increased the low end of the prior range 3 cents per share. The result is an updated range of $3.59 to $3.68 per share. In total, the midpoint of our range is down 2.5 cents or less than 1% from our original February outlook. As we stated in our press release, our updated outlook excludes the potential impact of customers that file bankruptcy or otherwise irrevocably default on their leases and and non-cash credit losses of straight-line rent receivables. Given the fluidity of the pandemic and its effect on the collectability of rents over the remainder of existing lease terms, such losses are still too speculative to project at this time. Our year-end occupancy assumption is 89% to 91%, which we lowered 100 basis points at the high end due to slower new leasing activity. Our same property cash NOI growth outlook is 1% to 2%, excluding potential lost rental revenues attributable to COVID-19, but inclusive of the negative impact of temporary rent deferrals. Our prior range was 1.5% to 3%. The change from our prior outlook is driven primarily by the negative impact of temporary rent deferrals and free rent associated with early lease extensions. These items reduce 2020 cash NOI but will benefit cash flow in future years while they have no impact on current year GAAP NOI or FFO. As is our custom, we don't include the effect of future acquisitions, dispositions, or development announcements in our FFO outlook. Ted mentioned that we have 72 million of dispositions under contract that are scheduled to close later this year, and these have not been included in our updated FFO range. The low end of our disposition range is 95 million, and the upper end is 150 million. We have maintained the original upper end of our acquisitions and development announcement categories as a placeholder in our current outlook, with a low end of zero given the current uncertain economic environment. So to wrap up, we believe we are well positioned to weather the uncertain economic environment given our balance sheet, our portfolio, our development pipeline, and geographic diversification. Operator, we are now ready for your questions.

Thank you. If you'd like to register for a question, please press the 1 followed by the 4 on your telephone. You will hear a three-tone prompt to acknowledge your request. If your question has been answered and you would like to withdraw your registration, please press the one followed by the three. Once again, that's one for to register for a question, one brief moment for the first question. And we have a question from Rob Stevenson from Jenny. Please go ahead.

Good morning, guys. How are you guys thinking about the potential for additional dispositions beyond what you guys have just talked about? in the back half of the year. Have you guys thought about putting more onto the market if the rhetoric on making changes at 1031 exchanges continues to grow? Are you pretty much comfortable with that? With where you are now, is that a situation where you'd need to identify some acquisitions or developments for use of capital? Help me understand how you guys are thinking about the back end of 2020 and into 2021 on that front.

Hey, Rob, it's Ted. You know, so as we mentioned, you know, we sold 23 million in early July. We've got another 72 million of properties that are under contract. And then we do have additional assets that are in various stages of marketing. So if you add all those together, that's about the high end of our guidance, so about 150 million or so. And historically, in any typical year, we, you know, we're in that 100 to 150 million of dispo range. So I'd say this is It's going to be somewhat of a typical year for us, the sort of way we look at it.

Rob, the only thing I'd add, if it's Mark, we've got some flexibility from a tax perspective, so we don't necessarily need to do all 1031 exchanges on that. We've got some room and an ability to manage some of that. With respect to the maybe future of 1031, I think it's a little too early to speculate on that. We really haven't gone through and analyzed maybe the impacts of that going into 21 just yet.

Thank you. We have a question from Dave Rogers from Baird. Please go ahead.

Yeah, I was wondering if you guys can update us on where that activity or utilization is in the buildings, whether through parking or key fob swipes. And I guess maybe trying to get a better sense on when you will have visibility on kind of that new leasing volume. Where do you think those numbers need to get to here in the near term to start to see that speculative leasing pick up a bit?

Sure, Dave. It's Ted. I'll start maybe – Brian and Brendan may jump in. In terms of building utilization, we track that weekly. Every Tuesday or Monday night or Tuesday morning, we get a report from all of our divisions. It's somewhat subjective in that we're looking at the paid parking buildings are easy because we can check, swipe in, swipe out from a parking standpoint. But otherwise, it's counting cars in the parking lot and walking the buildings. But on average, depending on the market, it's, I'd say, 20% to 30%. utilized our buildings today. And that really, we were expecting an uptick after the 4th of July and really haven't seen that. So it's been fairly consistent starting, I'd say maybe mid-May up till now. You know, it might go up or down a little bit week over week, but generally most of our markets are in that 20 to 30% range from a building standpoint. Brian, do you want to touch on the leasing?

Sure, Ted, just following up on that, I think the occupancy and the leasing activity have sort of tracked each other a little bit. To Ted's point on the July 4th date, we did start to see more people coming back in the buildings. Previous quarter, no tours whatsoever. Everything was virtual. We have absolutely seen people touring the buildings now, kicking the tires. The number of proposals are up. but it's slow, right? We're seeing the sublease market start to track similar to what you would expect at the beginning of a recession, generally larger users, you know, with the excess space that they may have taken previously to it. But, you know, we have gone ahead and projected most of the new spec leasing into 21 that we had in the remainder of 20, so we feel pretty conservative in our thinking through year end.

And then, Dave, just to answer the parking question, So I think we did a little bit better than what our internal forecast was in the second quarter on parking. But what we've seen thus far, I'd say in the latter part of the second quarter and then thus far in July, is maybe less of a ramp-up than what we had projected when we updated guidance in July. in April. So our expectations are that parking revenues in the third and fourth quarter are likely to be roughly in line with the level that we experienced in the second quarter. And previously, I think we thought there would be some ramp up in those parking revenues in the back half of the year.

Thank you. We have a question from Jamie Feldman with Bank of America. Please go ahead.

Thank you. You know, there's been a lot of discussion around work from home and suburban satellite offices and, you know, are people going to prefer less urban settings, more urban or more suburban. As you think about your market footprint and the balance, what are the conversations like with tenants when they're even considering that? Or is their view like there's really no advantage either way given the commute times are probably pretty equal in the You're not really saving that much. I'm just curious what the discussions are like.

Yeah, Jamie, it's Ted. Let me start and maybe Brian will add on to it. Look, I think it's still pretty early in terms of these discussions. As you know, companies first and foremost have been making sure their employees are safe and healthy as they plan for the return to the office. And as we've talked about, most of the companies are even pushing off that return. lot of these decisions I'm sure they're in the background we're hearing they're having discussions internally but they haven't made it up to actual talking about making new leases or or or moving or doing the hub and spoke or what have you I do think in our markets you know we think we may become both more hubs as well as spokes right whether it be you know Microsoft's big takedown you know, obviously other technology companies and all that, but we're also seeing corporate headquarters coming, whether it be the Centene, or there's been three or four here in Raleigh that continue to grow. So we think the southeast is well positioned, both if the hub and spoke concept starts to get some traction, we could be both a hub and a spoke in a lot of our markets. Brian, do you want to jump in?

One thing maybe to pull a thread on your question, Jamie, and thanks so much for asking it. It's obviously something we're paying a close attention to, and we think we're in a pretty good spot. So you asked about, you know, is a chance you're really not saving that much in these maybe lower costs, non-transit dependent, low friction for commute markets that we have here in the Sunbelt. I think you've probably heard this kind of 1-9-90 rule where Most organizations, their annual investment every year, 1% is in kind of utilities, keeping the lights on. 9% is in real estate, and 90% is in people. And if ever what we've heard from companies, in fact, one of our largest customers, CEOs' quote is, it's not if we will return to work, but when. They focus on the 90%, focus on culture and productivity, where value is truly created in the companies. We're generally feeling and hearing that. specifically that it's within an office under a roof together. Now, it might be with a little more room between each other. I would also argue I think we've seen different experiments in this space before COVID, and folks continue to talk about when they're getting back in, not if.

We have a question from the line of Emmanuel Corchman from Citi. Please go ahead.

Hey, everyone. Good morning. If we go back to the corporate expansions that you highlighted at the beginning of the call, I think you mentioned Cingy, Microsoft, Bandwidth, and others. Is there any change or sort of – I don't know if you were part of the discussions with them or if you know people that were, but are they talking about sort of the way that they're using the space, whether that be the densities, whether it be the flexibility? or otherwise as they make those decisions. So that's my first question. On the same topic, it looks like a lot of those were driven or at least supported by grants or other financial support from the states. Is there any conversation on that environment changing either to the better or worse? Thanks.

So, yeah, good question. I think certainly state incentives are important. I think it always has been in the southeast. I think It's, you know, states are battling each other for, to bring jobs to their states. So I think that is an essential element, but it's only one piece of the puzzle. And I think what we're seeing on the inbounds is these companies want corporate campuses, right? They are designing them around having their employees in the office and, you know, work like they traditionally have. It's not necessarily going to be a work from home aspect. They want the people together so they can collaborate. They can create this corporate culture that's so hard to do if you're doing it on Microsoft Teams and all that. So those are some of the things we're seeing is that, again, Southeast is attractive. The economic incentives, I think companies or states are chasing these companies like they always have been. But the corporate campus is very important.

Hey, Manny, it's Brian here. The grants, the open-for-business nature of these Sunbelt markets is not the defining factor that is securing these wins. It's first and foremost that 90% we talked about earlier, 1,990, it's the talent factor. And the quality of life and the people are being drawn here. You're seeing the inbounds. And so we are actually seeing on a number of our leasing calls across the different markets some of the same code-worded prospects coming inbound in multiple markets. So it's interesting to see that there's that. And just to that end, too, the economic development officials, the EDCs, have been receiving the same amount of activity in the last few months as they did pre-COVID. So we think that's a good sign. Thanks very much.

And we have a question from Vikram Malhotra with Morgan Stanley. Please go ahead.

Thanks for taking the questions. Just maybe on the topic of density and as it pertains to work from home, in any kind of early indication of, you know, tenants, any conversations you've had with tenants on how they may look to reuse their space now and maybe post-vaccine, and relate that. Do you have a sense of what density is across your portfolio today?

So, Vikram, this is Brian. Good question on the last one. It's so varied. in terms across the portfolio and the actual densities, whether it's 250 square feet per person, 350 square feet per person. I do think, as a general statement, we are probably less dense than something you might see in a 50-story tower because we've had the ability to spread out. Land costs are lower. Construction costs are lower. Operating costs are lower. We have a number of tenant fit-ups, and whether it's anchor tenants or customers, excuse me, going into our buildings, they are not making wholesale changes to their layouts. So they are not, you know, going ahead and spreading people out even farther beyond the guidelines that are out there. But I think their thinking and the way that they were laying out the space previously met the guidelines. So I think that's generally what we're seeing is that there's no big changes. And a lot of folks are, in terms of coming back to work, they are waiting and seeing, taking a wait and see approach in terms of whether it's a spike in incidences or changes in the science. But that's what we're seeing is a more wait and see approach.

Okay, fair enough. And then just a second one. You talked about kind of activity or maybe alluded to activity or interest, you know, for students. looking for incentives for corporates to move continuing in the last few months versus pre-COVID at similar levels. I'm just wondering, you know, has COVID maybe on the margin changed your minds or brought in new ideas in terms of, you know, markets you'd want to look at or explore or even sub-markets? I know you've obviously done the rotation plan into Charlotte, but any changes on the margin that you can give us a sense of?

Hey, Vikram. It's Ted. Not really. I think, you know, most of our footprint is in the high-growth southeast markets, and I think those are the ones that we think this historical population growth, in-migration, job growth has been very strong and have outperformed other markets. So we want to continue to be in the high-growth markets. We think long-term they're going to continue to outperform. So really no changes on what we're looking at.

Thank you.

We have a question from Brendan Finn with Wells Fargo. Please go ahead.

Great, thanks. You guys mentioned that Q2 leasing volume included some of these blended extend leases or early lease extensions. So I'm just wondering, are you still having these types of discussions with tenants or have you already kind of executed on most of these opportunities And then maybe could you just comment on the economics of these types of extensions, like maybe how much free rent you guys are offering up front relative to the length of the extension?

Hey, Brendan, Brian here. So I would say these kinds of conversations regarding blend and extend with customers are They are kind of real-time. As they come in, you know, different customers are getting to the end of their initial occupancy throughout the year, through the end of this year into next year. And so we do have the opportunity to engage some of them as they actually are coming to the end or in advance. So I think we have the opportunity to continue to use that as a tool to maintain occupancy and strengthen these relationships. Maybe turn over to Brendan on some of the different mechanisms on the economics.

Yeah, Brendan. Hi, good morning. So it, you know, in terms of the economics, I'd say, you know, on balance, it's probably, let's call it, you know, a month of abated rent for a year term kind of, you know, give or take rough numbers. I think in terms of, you know, how that's impacted our financials and cash flow for 2020, you It's probably about a 25 basis point reduction to cash, same property, NOI growth. So that's outside of the deferrals that we disclosed in last night's press release. So the combination of kind of the abatements, that's about 25 basis points. The deferrals, the net impact in 2020, which will be repaid over time primarily in 2021, is probably about 100 basis points on those same property numbers. And then just to kind of tie it back to our original outlook that we had in February, we disclosed how much we expected rents to be impacted due to the COVID changes. And that's probably, let's call it about 75 basis points. So all in, that's kind of a 200 basis point reduction in terms of the original range in February that we provided of same property growth compared to the 1% to 2% that we updated last evening.

One other little thing on the blend and extend concept, Brennan, is that many times they are low CapEx opportunities, you know, so maintaining occupancy. And they're not, at least many of them, long-term. So we know at some point you'll have to come back to that. But they are, you know, good payback ones for us.

Great. Thanks, guys.

We have a question from Jamie Feldman with Bank of America. Please go ahead.

Thank you. I was just hoping, I know you said there's really not a lot of speculative leasing going on and you've pushed out your estimates or your expectations till 21, but can you just talk us through the largest vacancies in the portfolio and where your discussions do stand and have any of those fallen out of bed?

Sure, Jamie, it's Ted. In terms of largest vacancies, obviously the largest would be T-Mobile. T-Mobile's lease expires at the end of this week, at the end of this month, I guess on Friday. We have signed about 11,000 square feet, so we got a good start. But other than that, you know, prospects are slow, activity is slow, just like it is, you know, for most space in most of our markets. So we're encouraged that we got our first bite done, and that starts later this year. A second largest would be 5332, also in Tampa, former Laser Spine Building. We have about 84,000 square feet left to lease there. And again, really, I'd say no strong prospects on that one right now as well. We've had pretty good activity a month or two ago, and then activity sort of died back down after that. So I think those two are biggest. And then after that, we've got a couple, well, really on top of that, a couple of our development projects as well. They're in that same category. We've got Virginia Springs, too. In Nashville, about 111,000 square feet. We've got strong prospects for a little 6,000 square foot kickoff prospect that we feel pretty good about. And then activity there in Virginia Springs, Jamie, you know, pre-COVID, we had incredible activity. We probably had a prospect list that was two or three times the size of the building. Hopefully a lot of those are on hold. We're staying in close contact with the brokers on those. And hopefully those will maybe come back to fruition over the next several months as things get better. And then finally on Midtown Tampa, it's about 150,000 square foot building. We've got a strong prospect for 10,000 feet that we're negotiating a lease with right now. And outside of that, again, we're getting tours there as well, but activity in general in terms of companies willing to step up and make the decisions. It's certainly slow.

Okay. And then you had mentioned Centene's headquarter moved to Charlotte. Do you think there's going to be – I know they're doing it on their own project, but like any overfill demand you think you might see in that market, or it's pretty much going to be self-contained?

Well, you certainly hope so, right? I mean, just given the size of the transaction, a billion-dollar, million-square-feet-type transaction. But Can't say we know for sure, but typically these have overflow and add-on type requirements. So I think we're hopeful for the market.

And, Jamie, to your question, Brian here, I think most economic developers will tell you on an inbound move like that for a headquarters, it's a low end, a one-to-one, but typically a two-to-one job creation. Those two-to-ones aren't all taking office space, so that would include all kind of jobs generated by those inbound folks. But I think that's what Charlotte feels pretty good about in the state of North Carolina and the investment they've made.

Okay. And then finally for me, you had mentioned an expectation that sublease space will take up in some of your markets. Which markets are you most concerned about that having an impact on market rents or vacancy?

Well, you know, good question, Jamie. So one of the things we look at, right, as a canary in a coal mine is the sublet space. And I would say, again, out of the gate, Atlanta and Nashville are are the ones that are starting to get our attention first. Atlanta is just the largest market in general. They've got 2.5 million square feet in sublet space. The majority of that are in one single place, a million square feet in the central perimeter. But from a high-wage perspective, we have very little kind of within our portfolio or customers within our portfolio looking at sublet from an Atlanta perspective. Nashville, much smaller market, but a higher percentage of that market, about 8% of that market's got some sublet activity. Again, you want to talk about a nominal number, it's about 375,000 square feet. So those are the two we're highly focused on. Those are also the two with a great deal of construction underway. So if you fast forward over the next couple of years, you'll see new product being brought in and with long stabilization periods probably. So those are where we're focused and keeping an eye on it. But, you know, next quarter we'll have more to talk about probably.

Okay. And you have a big position in central perimeter. Do you think that's not competitive space or it's just not in your portfolio?

So, yeah, Jamie, really our position is it's really three buildings. It's about 625,000 feet or so that's pretty well leased. So it's not a, you know, not a huge position, but certainly it's competitive space without a doubt.

Okay. All right. Thank you.

If you'd like to register for a question, please press the 1 followed by the 4 on your telephone. Sorry, that's 1-4 on your telephone. And we do have a question from Chris Lucas from Capital One Securities. Please go ahead. Hey, good morning, guys.

I guess, Ted, on the build-to-suit RFPs, are you seeing much change in that relative to, say, a year ago in terms of the level of activity and stuff you're looking at?

Certainly, it's slowed down quite a bit. The level of activity, I would have told you, pre-COVID was very strong. We had you know, numerous conversations, more than a handful of conversations going on as recent as March. And we had one come in actually even post beginning of COVID that has since gone on hold. So we're hopeful that these didn't go away. They're just put on hold. But right now things are, you know, just pretty slow from a transaction standpoint. The brokers are saying They haven't died, but they're just on hold. Whether that's an indefinite hold or what have you, we don't know yet. But still encouraging, though.

And then as it relates to CapEx, Ben, how do you guys think about sort of your building improvement program that you would normally schedule? Are you trying to accelerate that given the lack of activity in the building from tenants so that you can sort of respond and deal with that in a less intrusive environment? Or are you managing that CapEx from a cash flow perspective or just going about it as you normally would?

Well, I'd say the answer, I'll start off and Brennan can jump in, is probably both, right? So, you know, the onset of COVID when the buildings really emptied out or became much less used, we were. We were using that time to do some CapEx projects, some customer work that otherwise would be done over having overtime needed to do it or nights and weekends and all that. So we used it. We did a lot of painting and other smaller projects over the last few months. From a CapEx standpoint, again, we looked at what's the nice-to-have versus the need-to-have a lot, and so somewhat to manage cash flow and all that, we kept the need-to-have and dialed back on the nice-to-have. Brendan, do you want to give more detail? Sure.

Yeah, Chris, I think just to set expectations maybe for the balance of the year, I think what we expect is the leasing capital spend will go down relative to the first half of the year or certainly over the next several quarters we expect that to happen. You can probably see between the leasing page, the commitments that we've had both on a TI and leasing commission basis in the first half of the year are about $20 million less than what we expensed through the AFFO or CAD statement. So I think typically those commitments run ahead of the expense. So we think leasing capital will go down over the next few quarters. And seasonally, we do typically see a pickup in terms of BI spending in the second half of the year. And to your point, we have decided to accelerate some BI projects because, one, it's efficient for us to do so, as you mentioned, while buildings are empty. And then, two, as we disclosed last quarter, we do think cash flow is improving for the company, so we took the opportunity to go ahead and accelerate some of those BI projects.

One other just footnote I might add to Ted and Brendan, this is Brian, that we're able to self-perform some of this work with our own team since we operate and maintain our own buildings. And so we have a fantastic set of maintenance techs who are able to do some of this stuff, including some make-ready and kind of preliminary work with regard to our spec suites. So that way we had space that was ready, plug and play, for folks when they come back. Thank you. That's all I have today.

And we have a question from Daniel Ismail with Green Street Advisors. Please go ahead.

Great. Thank you. Understanding that things have been limited given the COVID-19 related shutdowns, but any signs of life on the investment sales markets across any of your markets? And then related to that, given the drop in overall debt costs, is it your expectation that cap rates could actually move lower for well-located, stabilized Sunbelt office properties?

Sure. Hey, Danny, it's Ted. Look, I do think, as you know, transaction activity probably was down 70-plus percent in the second quarter. I think there are some signs of life. Virtually every building that was on the market in the first and second quarter got pulled, and we're starting to see a few of those come back to market. And from what we're understanding from the brokers, there's pretty good activity and a lot of capital chasing that. And it's both unlevered buyers, but also levered buyers, sort of to your point on the interest rates. Historically, as you know, interest rates have voted well for prices and for real estate. And so I do think there's a chance that cap rates can, whether they go down or not or stay stable and prices stay high, I think to be determined. But I do think we've even heard one example of a deal where that is actually going under contract at a higher price than it was pre-COVID when it was under contract. So it fell out of contract, went under contract recently at a higher price. So I think there's a lot of capital out there with low interest rates. I think that bodes well for the transaction market when properties start coming back to market.

Given some of the headline issues facing some of the coastal markets, have you noticed any changes in the bidding tents or the potential buyers who might be looking at some of the markets here?

You know, I don't think we've got anything where we've seen that yet. The transactions we're working on, just, you know, it's largely phase two of the market rotation plan. And those assets are more geared towards buyers of more local and regional buyers for the most part. So we haven't seen any indicators of new buyer, new capital sources coming for those transactions yet.

Great.

Thank you. And there are no further questions at this time.

All righty. Well, thank you, everyone, for joining the call this morning and your continued support support and interest in Highwoods. I hope everyone stays safe and healthy. Thank you very much.

That does conclude the call for today. We thank you for your participation and ask that you please disconnect your line.