Orion Office REIT Inc.

Greetings. Welcome to Orion Office Reads 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 September 30th, 2024, filed its Forum 10Q with the Securities and Exchange Commission, and posted its earnings supplement to its website at onlreap.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 Forum 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-GAF financial measures such as funds from operations or FFO and core funds from operations or core FFO. Orion's earnings release and supplement include a reconciliation of these non-GAF financial measures to the most directly comparable GAF measure. Our presentation of this information is not a substitute for the financial information presented in accordance with GAF. 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 Office Read'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 -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 wall 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 percent. 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 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 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 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 at quarter end, we own 70 operating properties and six unconsolidated joint venture properties, comprising 8.3 million rentable square feet that were .6% occupied. Adjusted for three operating properties that are currently under agreements to be sold or have been sold are occupied. Rate was .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 remain 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 re-market 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 worse 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 growing 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 U.S. Furthermore, Valent 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 Valent's laboratory operations. We acquired the property at below-market rents and at a significant discount to replacement cost. The going-in cap rate is 7.4%, with an average cap rate of .2% over the term. We will finance the property with a low-leverage, seven-year non-recourse mortgage at a rate below 6%, making a 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 asset. 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 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 leasing. That work continues and we expect the of our cap 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 dollars 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 18 cents per share compared to 16.5 million or 29 cents 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 GNA 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. However, 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 CNBS 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 Arch Street Joy Adventure debt, which is scheduled to mature on November 27, 2024. At quarter end, net debt to annualized -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 pro-rata share of cash from the Arch Street Joy Adventure, 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 Arch Street Joy Adventure debt, the Joy Adventure 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 Joy Adventure 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 Joy Adventure will satisfy the conditions for the first extension. Turning to our dividend, Orion's board of directors declared a quarterly cash dividend of 10 cents per share for the fourth quarter of 2024, able 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 FFO and reaffirming our expectations for net debt to adjusted EBITDA and GNA. Core FFO is now anticipated to range from 99 cents to a dollar and one cent per diluted share, increasing the low end of the range by two cents from 97 cents. Our net debt to adjusted EBITDA range is unchanged and is anticipated to be 6.2 times to 6.6 times. Our GNA range of 19.5 million to 20.5 million is unchanged. With that, we will open the line for questions. Operator?

Thank you. At this time, we'll be conducting a question and answer session. If you'd like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. Our first question comes from Mitchell German with JMP Securities. Please proceed with your question.

Hi, good morning. Can a new buyer leverage the work done from the previous buyer for the Walgreens property or do you think that now the whole process gets reset? Good

morning, Mitch. No, the answer is a new buyer we believe can leverage the work that's been done by the previous buyer. That buyer had done quite a bit of work for the redevelopment of the property and we are the owner of all of those files. The buyer also got put in place a tax increment financing district with the City of Deerfield, which is now owned by us. So, a significant amount of work has been done, which would be more to the benefit of a new buyer, assuming they wanted to pursue a similar development plan.

Okay, that's super helpful. Just shifting over to the acquisition that you did in the quarter, was there anything unique about the seller? Was there some distress or was there some impending debt? Was there anything that was unique on that deal? I might have missed a yield, though you talked about the debt, so obviously it's above that. But if any color you can provide there, I'd be appreciative. Sure.

I don't think the seller was under any particular distress. I will say that the market has been pretty thin. So, our ability to purchase the property for an all cash transaction was attractive, which we think gave us some additional pricing power when we negotiated the transaction with the seller. So, we were very, very pleased with not only the cap rate that we were able to pay, but we bought the property at way below replacement costs, and the rents the tenants are paying are significantly below market. So, we feel very, very comfortable there. We are financing the asset with, as I mentioned in my prepared remarks, with long-term debt at a rate below 6%, a second year loan, and a relatively low LTV loan of call between 50 and 55%, which will, you know, the combined rate will make the transaction for us very cash flow accretive.

And the yield is north of 7, is that the way you think about it?

Can you repeat that?

The cap rate, going cap rate, if I missed it, I apologize. Is that north of 7? Is that the way to think about

the

yield? The cap

rate is 7.24%, and the average cap rate is 9.2%.

Oh, you know what? I did read that. I apologize. Great. Last one from me. How do you, looking out, I think you and also Gavin referenced, you know, obviously, increasing debt levels, increasing capex spend. So, how do you start to balance these unique investment opportunities against the potential requirement for cash related to capex, whether it be building improvements or leasing related? How do you start navigating that as you continue forward?

That's a terrific question, Mitch, and one we debate internally, you know, pretty much all of the time here. I think the best way to describe it is our first and foremost focus is on the assets we own already on the balance sheet. So, our best use of capital for the most part is to put into the assets we already own. And when I say put capital into assets we already own, I mean by that generally, it makes sense for us to lease up the vacancy, and the capital we use to lease up that vacancy is, you know, the most recreative way that we can use that capital to generate returns rather than just using capital to try to, you know, fix up a building to attract investors. We are doing that, but when you look at a vacant building, we look at what's the capital we would have to invest without a guaranteed return versus investing that capital in an acquisition opportunity, and that's where we try to make where we think is the best judgment. If we don't think it makes sense to invest capital in the building, we've been selling them, and utilizing that capital we might otherwise have invested to potentially buy new assets. But going forward from here, I think it's fair to say, and you should expect, and investors should expect, that we will focus most of our capital expenditures in the coming years on our existing portfolio.

Great. Thank you.

Thank you, Mitch.

As a reminder, if you'd like to ask a question, please press star one on your telephone keypad. One moment, please, while we poll for questions. There are no further questions at this time. At this point, I'd like to turn the call back over to Mr. McDowell for closing comments.

Thank you all for joining us on our third quarter call, and we look forward to updating you further in the new year with our results. Thank you.

This concludes today's conference call. You may disconnect your lines at this time. We thank you for your participation.