Highwoods Properties, Inc.

Good morning, ladies and gentlemen. Welcome to the Highwood Properties Q2 2023 earnings call. My name is Jaquita. I will be your moderator for today's call. All lines will be muted during the presentation portion of the call with an opportunity for questions and answers at the end. Please press star 1 on your telephone keypad if you would like to ask a question. I would now like to pass the conference over to your host, Hannah True, Manager, Finance, and Corporate Strategy. Hannah, please go ahead.

Thank you, Operator, and good morning, everyone. Joining me on the call this morning are Ted Klink, our Chief Executive Officer, Brian Leary, our Chief Operating Officer, and Brenda Majorana, our Chief Financial Officer. For your convenience, today's prepared remarks have been posted on the web. If you have not received yesterday's earnings release or supplemental, they are 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. 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 risk and uncertainties. These risk and uncertainties 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. With that, I'll turn the call over to Ted.

Thanks, Hannah, and good morning, everyone. During the second quarter, we once again had strong financial and operational results. We further improved our portfolio quality and balance sheet by selling 51 million of non-core assets. Leasing activity was healthy. We demonstrated resiliency with our FFO results in the face of higher interest rates, and we posted solid cash flows. Our markets continue to attract talent, as seen by the outsized population and job growth compared to other major U.S. cities. CNBC recently published its annual ranking of top states for business. Every core market in which we operate had its state ranked number eight or higher. North Carolina, our home state, which garners the largest share of our total revenues and where we generate 35% of our NOI, was ranked number one for the second straight year. It's no secret that the state's two biggest metros, Raleigh and Charlotte, generate the majority of the economic growth for North Carolina. Virginia, Tennessee, and Georgia followed right behind at two, three, and four, while Texas was number six and Florida number eight. We've long highlighted the benefits of the Southeastern U.S. with its strong demographic trends, business friendly environments, low cost of living and high quality of life. In fact, according to Bloomberg, the Southeast has accounted for two thirds of all job growth across the country since early 2020, almost double its pre-pandemic share. The main question, however, is how do these demographics and national trends translate into results for Highwoods? Let's take a step back and look at our performance. We've generated positive same property cash NOI growth for 10 consecutive years. Our total NOI over the last four quarters is 16% higher than full year 2019. Our net effective rents on leases signed over the last four quarters is 8.5% higher than our 2019 average. And at the midpoint of our 2023 outlook, our FFO per share implies 7% growth over 2019, despite the headwind of higher interest rates. While availability rates are at cyclical highs, according to JLL, construction starts are down 75% over the past 12 months compared to the prior five-year annual average. And lower quality office is being taken out of stock at an unprecedented pace. These governors on supply should lead to a reduced amount of available office space, particularly after sublease space continues to get absorbed. This plays directly to our strengths, as users strongly prefer high-quality office space in BBD locations with well-capitalized landlords. Population and job growth continue to be strong across our footprint, demonstrated by 12 leases signed this quarter from users new to market. Most of these are small to medium-sized leases, which is our sweet spot. Our customers continue to bring their talent back to the office, and they are increasingly determining their long-term space needs. As an example, we signed two sizable renewals this quarter far in advance of the lease expirations, and they maintained or increased their leased space. At quarter end, occupancy was 89%. Leasing volume was strong with 918,000 square feet of second-gen space, including 222,000 square feet of new leases. Our leasing count was robust with 110 total signed leases, including 39 new leases. Leasing economics were healthy. Rent spreads were plus 14.7% on a gap basis and plus 0.5% on a cash basis. And net effective rents were almost 6% higher than our trailing four-quarter average and 12% higher than our pre-pandemic average in 2019. Average rental rates in our portfolio were 3% higher on a cash basis compared to one year ago. Turning to our results, we delivered FFO of 94 cents per share in the second quarter. As expected, same property cash NY growth was minus 1.1% as we absorbed higher OPEX and lower occupancy, driven by the temporary downtime on the formativity space. As a reminder, we do not take vacant buildings out of our same property pool. On the investment front, we sold three non-core office buildings for total proceeds of $51.3 million at a combined 7% gap cap rate. These sales were in Raleigh and Tampa, in non-BBD locations. Given the current capital markets environment, we are lowering our 2023 disposition outlook to a total of $200 million, including assets sold to date. Our $518 million development pipeline continues to progress well with all projects on time and on budget. We're 23% pre-leased with at least two years until projected stabilization across all of our spec projects. We have 300 million left to fund and we project annualized NOI of 40 million upon stabilization. We're seeing good prospect activity across our development projects. At Glen Lake 3 in Raleigh, we signed an 18,000 square foot user and are seeing increased interest as this project nears completion. We have strong demand at 23 Springs and Uptown Dallas, and we expect 2827 Peachtree in Atlanta to stabilize by year end. Following lease up at Midtown West and Tampa to 100% earlier this year, we are seeing early interest at Midtown East, which has only just broken ground. Midtown East is the only office development under construction in the entire Tampa market and doesn't deliver until the first quarter of 2025. Turning to our 2023 outlook, we now project full-year FFO of $3.69 to $3.81 per share, flat at the midpoint from our outlook in April, despite a meaningful interest rate headwind in the past 90 days. Before I turn the call over to Brian, I do want to acknowledge the challenges currently facing the office sector, including hybrid work, higher interest rates, the difficulty of obtaining financing for office buildings today. In addition, despite the resilient jobs market, office owners are impacted by the cyclical demand headwinds when heading into a recession or a low-growth environment. As businesses become more cautious about their own growth prospects, they typically become more cautious about their space needs. This will likely pressure occupancy and net effective rents until the office market regains its footing. However, we remain confident over the long term because our Sunbelt portfolio is in a region of the country with the strongest demographics and job growth. We have a high-quality office portfolio in BBD locations that we believe will continue to outperform the market. Our purposeful diversification, whether it be by market, by industry, by customer, or by lease size, should enable us to deliver resilient operational performance, which has been among the strongest in the office sector over the past several years. Our $518 million development pipeline will generate meaningful NOI as it delivers and stabilizes. And our balance sheet is strong, with ample liquidity to fund the remainder of our development spending and all debt maturities until 2026. Brian?