Orion Properties Inc.

Greetings. Welcome to Orion Office REIT's Third Quarter 2024 Earnings Conference Call. As a reminder, this conference is being recorded. I would now like to turn the call over to Paul Hughes, General Counsel for Orion. Thank you. You may begin.

Thank you, and good morning, everyone. Yesterday, Orion released its financial results for the quarter ended September 30, 2024, filed its Form 10-Q with the Securities and Exchange Commission, and posted its earnings supplement to its website at onlreit.com. Certain statements made during this call today are not strictly historical information and constitute forward-looking statements. These statements include the company's guidance estimates for calendar year 2024 and are based on management's current expectations and are subject to certain risks that could cause actual results to differ materially from our estimates. The risks are discussed in our earnings release, as well as in our Form 10Q and other SEC filings. Orion undertakes no duty to update any forward-looking statements made during this call. Today on the call, we will be discussing non-GAAP financial measures, such as funds from operations, or FFO, and core funds from operations, or core FFO. Orion's earnings release and supplement, including reconciliation, of these non-GAAP financial measures to the most directly comparable GAAP measure. Our presentation of this information is not a substitute for the financial information presented in accordance with GAAP. Hosting the call today are Orion's Chief Executive Officer, Paul McDowell, and Chief Financial Officer, Gavin Brandon. Our Chief Operating Officer, Chris Day, will join us for the Q&A session. With that, I am now going to turn the call over to Paul McDowell. Thank you, Paul. Good morning, everyone, and thank you for joining us on Orion OfficeReit's third quarter 2024 earnings call. Today, I will provide an update on our business and discuss our third quarter performance and operations. Following my remarks, Gavin will review our financial results and provide our outlook for the rest of the year. With the completion of the third quarter, we have made strong progress against our key initiatives of extending existing leases and pushing out weighted average lease term. During the quarter, we signed four leases comprising 254,000 square feet, including a 10-year renewal for 152,000 square feet at our Longmont, Colorado property. The other three leases were also renewals, and all four lease renewals combined represent a weighted average lease term of 8.9 years. Our year-to-date leasing efforts have been successful, as we see our well-located properties benefiting from both new and renewal leases. Through last week, we have completed over 830,000 square feet of leasing so far this year, more than three times our full year 2023 total. Overall, portfolio WALT now stands at five years, up from 3.9 years at the same time one year ago. Rent spreads on leasing activity have also been positive so far this year at 3.2%. Tenant leasing sentiment continues to improve, which is another positive aspect of the third quarter. We are seeing increased traffic at our vacant properties as prospective tenants have become more active throughout 2024, and we are responding to more inquiries from both these prospects and our in-place tenants. Additionally, our forward leasing pipeline continues to be strong. At quarter end, the pipeline stood at over 1 million square feet in various stages of discussion, negotiation, and documentation. Our recent leasing successes, while specific to Orion, do seem to be part of a slowly emerging broader trend. To that point, for the overall industry, net office absorption turned positive in the second quarter for the first time in two years. Interestingly, while new office deliveries are falling and are expected to settle at negligible levels soon, The amount of space available in the newest and highest quality buildings continues to decline rapidly and is now below pre-pandemic levels. As super class A space is rapidly absorbed, Orion and owners like us should start to see a positive benefit in our portfolios as tenants by necessity begin to search for available space more widely. These fundamental industry dynamics are further strengthened by corporate management sentiment shifting dramatically, with 79% of CEOs polled in September expecting full-time return to work over the next three years, up dramatically from 34% in April. Even with the macro positives and our own recent leasing progress, we still anticipate Orion's leasing activity will fluctuate and be quite lumpy between quarters. We also expect to continue carrying substantial vacancy for the foreseeable future as the overall office market recovery will still be measured in years, not months. We also made further progress during the third quarter, transforming the portfolio through the sale of vacant assets and properties that we believe do not align with our focus on owning properties in select growth markets around the country. Through the third quarter of 2024, We have sold over 15% of our portfolio or 18 properties representing about 1.9 million square feet and a quarter end. We own 70 operating properties and six unconsolidated joint venture properties comprising 8.3 million rentable square feet that were 74.6% occupied adjusted for three operating properties that are currently under agreements to be sold or have been sold. rate was 76.9% at quarter end. During November, we sold one 68,000-square-foot vacant property located in Dublin, Ohio, for a gross sales price of $3.2 million for approximately $47 per square foot, bringing our total properties sold since the spin to 19%. We also have an ongoing sales pipeline and expect to close on additional dispositions by year end or in early 2025. Regarding our vacant properties, we decided to step away from the pending contract to sell our six-building former Walgreen campus located in Deerfield, Illinois. As we have been communicating the past few quarters, After almost two years under contract and some significant progress on a proposed redevelopment plan, there remained questions around when, whether, and at what price the buyer would close. Given the persistent uncertainty with this buyer, we were unwilling to further extend their due diligence period without the buyer putting additional deposit funds at risk, which they declined, and the contract was terminated. We have already begun to remarket the property for sale and are talking with some potential interested parties. I want to again emphasize how important our disposition efforts have been for the long-term health of this company. We inherited a portfolio of assets that contained a relatively large number of less than ideal generic office buildings in often tough markets made all the worst by the historic collapse of the office market in the past two years. Our sales have generated $63.8 million in gross proceeds, but far more important, these sales resulted in a very material reduction of carry costs and forward expected capex. The sold properties will no longer weigh us down and have allowed us to focus on those assets where we believe we can achieve long-term leasing success in a recovering market. In short, our overall portfolio, while smaller, is far more attractive now. And although our disposition activities will continue, we believe one year from now, our revenues and earnings will flatten and then rise significantly in the out years as we re-tenant the vacant properties we decided to hold. Since going public, we have devoted excess cash from operations and proceeds from asset sales to debt reduction, to maintain maximum financial flexibility. We have consistently said that we intend to recycle some of that capital should the right opportunity arise. Such an opportunity came in September when we purchased a 97,000 square foot mission critical agricultural research and development lab located within the San Francisco Bay Area. The property is 100% leased to Valent USA a wholly owned subsidiary of Sumitomo Chemical Company, for a 15-year remaining net lease term through August 2039. The tenant's parent company, Sumitomo Chemical, has an A-plus credit rating in Japan. This location is strategic for Valent due to its proximity to graduate research talent throughout the Bay Area, particularly UC Davis, which has the largest agricultural technology program in the US. Furthermore, Valant has invested over $25 million, or approximately $260 per square foot, into the property since 2019. This includes various premium lab upgrades, supplemental HVAC, and various other renovations that support Valant's laboratory operations. We acquired the property at below-market rents and at a significant discount to replacement costs. The going-in cap rate is 7.4%, with an average cap rate of 9.2% over the term. We will finance the property with a low-leverage seven-year non-recourse mortgage at a rate below 6%, making it cash flow accretive. We believe that being selective and adding a property like this through capital recycling is a smart way to focus on complementing our ongoing asset sales and portfolio repositioning efforts by adding a very high quality, long lease duration assets. While we intend to redeploy capital to strengthen our portfolio over time with very selective acquisitions like we did in September with this California property, our first priority continues to be leasing our current properties, followed closely by asset sales of those properties that have poor future leasing prospects. As we have consistently discussed on previous calls, we are investing capital and adapting properties we want to keep in the portfolio, specifically those that are well located in our target growth markets. This strategy is the reason we have remained highly disciplined at at maintaining a low leverage balance sheet over the past two years so that we can appropriately fund capital expenditures, which will significantly enhance the long-term competitiveness of our assets. Additionally, we are realizing the benefits of some of our past investments as they have resulted in increased showings and leasings. That work continues and we expect the pace of our CapEx spending will increase over the next couple of years along with our leverage as we lease vacant space and build long-term revenues. We are increasingly confident that our recent leasing momentum will continue and that the stabilization of our portfolio and earnings are in sight. That said, as we enter the final quarter of the year and look ahead to 2025, We want to point out that the combination of the rise in interest rates, the significant number of properties we have sold, and the vacancy we continue to carry that has resulted from the tremendous lease rollover of the last few years has had a cumulative negative impact and will be particularly pronounced in our 2025 results. We have been consistently communicating these dynamics over the past few years, and they are not a surprise. However, we continue to want to be as transparent to the markets as we can be. And while we are not issuing formal guidance for 2025, we expect that these cumulative impacts on core FFO could be as much as 20 to $24 million versus 2024. Given our initial portfolio and the highly challenged office market conditions of the past few years, While we are disappointed we could not overcome the earnings impact, we believe this lower expected earnings level in 2025 should be at the bottom for the business. We expect that level to stabilize and then start to grow as newly leased space comes online and associated vacancy costs recede. This space should give us a solid platform from which we can start to grow meaningfully and potentially give us additional options from a strategic standpoint. As we continue to execute and build on our substantial progress made to date, repositioning the portfolio, I want to emphasize the company remains profitable on an FFO and core FFO basis, and we expect that to continue. With that, I will now turn the call over to Gavin. Thanks, Paul.

I will start by reviewing our third quarter financial results and provide an update on our outlook for the remainder of the year. Orion's 2024 third quarter financial results compared to the third quarter of 2023 are as follows. Revenues of $39.2 million compared to $49.1 million. Net loss attributable to common stockholders of $10.2 million or $0.18 per share compared to $16.5 million or $0.29 per share. Core funds from operations of $12 million, or 21 cents per share, compared to $24.1 million, or 43 cents per share. Adjusted EBITDA of $19.1 million, compared to $30 million. As Paul mentioned, and as we have previously communicated, lease expirations and dispositions of non-core assets to right-size our portfolio have negatively impacted the company's financial results quarter over quarter. Quarterly G&A was $4.5 million compared to $4.4 million in the third quarter of 2023. CapEx was $6.1 million compared to $8.4 million in the third quarter of 2023. CapEx timing is dependent on when leases are signed and when property and tenant improvements are completed. The timing of CapEx for tenant improvements is controlled by our tenants, and therefore, there is uncertainty when it will be spent. we expect that CapEx will begin to accelerate as we move into next year. As of the end of the quarter, $512.1 million of debt was outstanding, comprised of $355 million of a non-recourse fixed-rate CMBS loan that matures in February of 2027, $130 million of floating-rate debt on the revolving credit facility that matures in May of 2026, and $27.1 million representing our portion of the Arc Street Joy Venture debt, which is scheduled to mature on November 27, 2024. At quarter end, net debt to annualized year-to-date adjusted EBITDA was 5.6 times, and total liquidity was $237.3 million. Total liquidity is comprised of $17.3 million of cash and cash equivalents, including the company's prorated share of cash from the Arc Street Joint Venture and $220 million of available capacity on the company's $350 million revolving credit facility. As we have communicated, we intend to maintain significant liquidity on the balance sheet for the foreseeable future, provide the financial flexibility required to execute on our business plan over the next several years, including the funding of expected capital commitments to support our continuing leasing efforts. As it relates to the Arc Street joint venture debt, the joint venture has two successive one-year options to extend the non-recourse loans maturity date until November 27, 2026, subject to satisfaction of certain financial and operating covenants and other conditions. In connection with a recent amendment of a loan agreement, the joint venture exercised the first extension option and is working with the lenders to satisfy all conditions to extend the maturity until November 27, 2025. We expect the joint venture will satisfy the conditions for the first extension. Starting to our dividend, Orion's Board of Directors declared a quarterly cash dividend of $0.10 per share for the fourth quarter of 2024, tabled January 15, 2025, to stockholders of record as of December 31, 2024. As it relates to our outlook for the remainder of 2024, we are narrowing the range of our 2024 guidance expectations for Core SFO and reaffirming our expectations for net debt to adjusted EBITDA and G&A. Core SFO is now anticipated to range from $0.99 to $1.01 per diluted share, increasing the low end of the range by $0.02 from $0.97. Our net debt to adjusted EBITDA range is unchanged and is anticipated to be 6.2 times to 6.6 times. Our G&A range of $19.5 million to $20.5 million is unchanged. With that, we will open the line for questions. Operator?