City Office REIT - Earnings Call - Q1 2025

Transcript

Operator (participant)

Good morning and welcome to the City Office REIT First Quarter 2025 earnings conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. To ask a question, you may press star, then one on your touch-tone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star, then two. As a reminder, this conference call is being recorded. If you require operator assistance, please press star, then zero. It is now my pleasure to introduce you to Tony Maretic, the company's Chief Financial Officer, Treasurer, and Corporate Secretary. Thank you, Mr. Maretic. You may begin.

Tony Maretic (CFO, Treasurer, and Corporate Secretary)

Good morning. Before we begin, I'd like to direct you to our website at cioreit.com, where you can view our first quarter earnings press release and supplemental information package. The earnings release and supplemental package both include a reconciliation of non-GAAP measures that will be discussed today to their most directly comparable GAAP financial measures. Certain statements made today that discuss the company's beliefs or expectations, or that are not based on historical fact, may constitute forward-looking statements within the meaning of the federal securities laws. While the company believes that these expectations reflected in such forward-looking statements are based upon reasonable assumptions, we can give no assurance that these expectations will be achieved. Please see the forward-looking statements disclaimer in our first quarter earnings press release and the company's filings with the SEC for factors that could cause material differences between forward-looking statements and actual results.

The company undertakes no obligation to update any forward-looking statements that may be made in the course of this call. I'll review our financial results after Jamie Farrar, our Chief Executive Officer, discusses some of the quarter's operational highlights. I'll now turn the call over to Jamie.

Jamie Farrar (CEO)

Good morning. I wanted to start today with a status update on the planned redevelopment of our City Center property in downtown St. Petersburg, Florida. On our last call, we mentioned that we received site plan application approval from the city of St. Petersburg. This plan was for the redevelopment of City Center's existing parking structure into a 49-story residential condominium and mixed-use tower. We're excited to announce that after quarter end, we entered into an agreement with Property Markets Group, or PMG, to lead the development. PMG is a very experienced developer who is currently building the Waldorf Astoria Residences in Miami. That project will rank as one of Miami's tallest residential towers upon completion. Our project is also expected to be sold under the luxury Waldorf Astoria Residences brand and capitalizes on our site's incredible water views and exposure.

The agreement with PMG charges them with responsibility for all pre-development activities and the associated costs, which we anticipate will require them to invest $17 million of cash. There are various preconditions to be completed prior to the contribution of our land to the venture, including achievement of pre-sales, financing, and return on cost targets. Upon contribution of our parking structure land to the development venture, we would receive a 50% interest in the partnership. Today, the project sales center is nearing completion at City Center, and we expect that pre-sales will commence shortly. Upon achieving the conditions to commence construction, we anticipate a construction period of approximately 3 years. Downtown St. Pete has seen a dramatic transformation over the past 10 years, with luxury condo development in high demand and neighboring projects selling out quickly.

We believe the announcement of this project is set to meet that demand as one of the premier offerings in the marketplace. In sum, we've created a unique venture that positions us to benefit alongside a highly experienced development partner. This exciting project has tremendous longer-term value creation potential for our shareholders. Turning to other highlights of the first quarter, we continue to see a positive trend in overall office real estate fundamentals. Nationally, office leasing volume was 15% higher than a year ago. JLL estimates that office leasing volume has returned to approximately 89% of typical pre-pandemic levels. Higher quality office spaces in Sunbelt markets continue to outperform. Moving to our leasing activity, the first quarter is typically one of the slowest quarters of the year. Despite this, we completed a healthy 144,000 sq ft of new and renewal leasing.

Our largest lease completed during the quarter was a 34,000 sq ft new lease at our Papago Tech property in Phoenix. This lease represents the last vacancy that we have at that property. Subsequent to quarter end, we achieved another impactful new lease. Our Greenwood Boulevard property in Orlando was 100% leased to a single tenant with a lease expiration in 2028. We were successful in negotiating a transaction to bring a new 66,000 sq ft tenant into the building prior to that existing tenant's expiration. The new tenant signed a 10-year lease expected to commence in the fourth quarter of this year. The current tenant will vacate that space and pay a sizable termination fee.

On the remaining 89,000 sq ft in the building, the current tenant will keep its 2028 expiration on 31,000 sq ft and agreed to extend the remaining 58,000 sq ft on a longer-term basis to 2033. Overall, these were very important lease transactions that provide certainty around this asset's long-term cash flow. The transactions also position us favorably to extend the property's upcoming loan maturity, which is expected to be achieved in the second quarter. Portfolio-wide, we continue to see rent growth upon renewals and have realized an 8.5% positive cash releasing spread on our renewals over the last 12 months. Our same store cash NOI also increased 4.4% in the first quarter as compared to the prior year. As far as our overall earnings and occupancy trends for the year, we are still on track within the guidance ranges we provided at the end of February.

With that, I'll turn the call over to Tony to discuss our financial results in more detail.

Tony Maretic (CFO, Treasurer, and Corporate Secretary)

Thanks, Jamie. Our net operating income in the first quarter was $26.0 million, which is $500,000 higher than the amount we reported in the fourth quarter. Higher revenue, partially driven by strong same store results combined with lower operating expenses, was the primary driver of the NOI increase. We also reported core FFO of $12.3 million, or $0.30 per share for the first quarter. Core FFO was $600,000 higher than the amount we reported in the fourth quarter for the same reasons NOI was higher. Our first quarter AFFO was $6.5 million, or $0.16 per share. There was no single TI or LC amount that impacted AFFO by more than $500,000. Our spending on property renovations also decreased in the first quarter relative to last year as we completed several property renovation projects and amenity upgrades in the fourth quarter. Moving on to some of our operational metrics.

Our same store cash NOI trended higher in the first quarter. There was a healthy increase of 4.4%, or $1.1 million as compared to the first quarter of 2024. The largest contributor to that was Raleigh again, where NOI continues to materially increase at Block 83 as signed leases take occupancy. Our portfolio occupancy ended the quarter at 84.9%. This was slightly lower than the prior quarter, which we expected as a result of a couple of known vacates at our Denver Tech and 2525 McKinnon properties. These vacates occurred later in the quarter and as a result did not have a significant impact to NOI. We expect occupancy will decrease in the second quarter. This will be driven by the existing tenant at Greenwood Boulevard downsizing by 66,000 sq ft that Jamie described prior to the commencement of a new tenant later this year.

Also due to a 72,000 sq ft tenant that vacated our AmberGlen property in Portland after quarter end on April 1, as expected. At quarter end, we had 143,000 sq ft of signed leases that have not yet commenced. As those signed leases take occupancy, we expect occupancy will increase, and therefore we still anticipate year-end occupancy will end within the 85%-87% range contained within our original guidance. Our total debt as of March 31 was $646 million. Our net debt, including restricted cash to EBITDA, was 6.7x. As of March 31, we had approximately $42 million undrawn and authorized on our credit facility. We also had cash and restricted cash of $37 million as of quarter end. Our credit facility matures in November 2025 with an ability to extend it to November 2026.

That option can be exercised in August, 90 days prior to the maturity, as long as we remain in compliance with our debt covenants, which we are comfortably projected to be. As such, we expect to exercise that option and continue discussions on a longer-term renewal. We have two property debt maturities in 2025. The loans for both Greenwood Boulevard in Orlando and Intellicenter in Tampa mature in the fourth quarter. We are at an advanced stage of discussions on a three-year term extension with the existing lender for Greenwood Boulevard and have initiated discussions on a short-term extension with the existing lender in Intellicenter. We expect to provide an update on next quarter's call. Last, we also have two high-value properties, Block 83 in Raleigh and City Center in Tampa, that are completely unencumbered.

As the office debt capital markets continue to come back, we may explore options to add financing to those properties to generate additional liquidity. That concludes our prepared remarks, and we'll open up the line for questions. Operator.

Operator (participant)

Thank you very much. Just as a reminder to ask a question, you may press star, then one on your touch tone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star, then two. Our first question comes from Upal Rana with KeyBanc Capital Markets. Upal, your line is now open. Please go ahead.

Upal Rana (Director and Equity Research Analyst)

Great. Thank you. I was wondering, was this new development project, how did that come about? Was this something that you seeked out, or was it something you were approached on?

Jamie Farrar (CEO)

Sure. It's Jamie here. This is something we started about 2 years ago, recognizing how strong the downtown St. Petersburg market was for development. We did a fairly deep canvas on options and how to best execute. We landed on, I think, a great structure that will generate significant value over time for us. Actually, on that point, for more information, Forbes published an article earlier this week, which has a lot of good information. You could search Forbes, Waldorf Astoria St. Petersburg, and get a really good summary of the project.

Upal Rana (Director and Equity Research Analyst)

Okay. Great. I understand there's a lot of work still needs to be done prior to the shovel hitting the ground. Can you give a sense of timing and what that looks like and how that's shaping up to be? You did mention three years of construction in your prepared remarks, but I wonder if there's any other color you can provide us.

Jamie Farrar (CEO)

Sure. Pre-sales are about to commence. We're building out a sales center within the ground floor of City Center that's almost finished. Internally, we think it'll be about a year plus or minus of pre-sales and then 3 years construction. If things go according to plan, it's probably 4 years for the full project.

Upal Rana (Director and Equity Research Analyst)

Okay. Will there be any disruption to the existing property that use that garage space?

Jamie Farrar (CEO)

We have been working on alternative parking arrangements. We have been keeping all of our tenants up to speed on what is going to happen. There will be a period of time where tenants are offered alternative arrangements, including valet. When the structure is done, it replaces the parking for the office building.

Upal Rana (Director and Equity Research Analyst)

Okay. Great. Last one from me. You're currently just below the low end of your occupancy guidance here. Could you give us some color on the pace of occupancy this year in order to get you to the midpoint of 86%? I know you do have about 300,000 sq ft expiring over the next couple of quarters here. That'd be great. Thank you.

Tony Maretic (CFO, Treasurer, and Corporate Secretary)

Yeah. Sure. Upal, this is Tony. Yeah. We have 143,000 sq ft of leases at March 31st that have yet to take occupancy. That represents about 2.7% of our portfolio. That is where the bulk of that is going to come from. The majority of that will move in over the next two quarters. Beyond that, we have the move-out that I mentioned on my prepared remarks in Portland. We have the activity that is happening at Greenwood Boulevard, which is a net positive, but will result in kind of occupancy dipping through the first two quarters. We expect that new tenant will take occupancy before the end of the year to get us back within that range.

Upal Rana (Director and Equity Research Analyst)

Okay. Great. Thank you.

Operator (participant)

Our next question comes from Craig Kucera with Lucid Capital Markets. Craig, your line is now open. Please go ahead.

Craig Kucera (Managing Director)

Yeah. Hey, good morning, guys. I just want to circle back to the Greenwood Boulevard transaction. I wasn't able to do the math quick enough in my head, but is there going to be ultimately any vacancy in that asset, or is this a new tenant taking the remaining space and the other tenant just downsizing and extending their lease? Thank you.

Tony Maretic (CFO, Treasurer, and Corporate Secretary)

Yeah. Yeah. Hey, Craig. It's Tony here. Yeah. It's the latter. It's going to take the occupancy. It's currently 100%. It'll dip down for this vacate and then get back to 100% before the end of the year. What it does do is it dramatically extends the WALT of the property as that maturity was scheduled for 2028. Now the bulk of the space has been extended out. The new lease that we have is a 130-month, so just over 10 years, 10-year term. The existing tenant is extending their space out by 5 years on two of the three floors. It's a big win for the property.

Craig Kucera (Managing Director)

Right. As far as the rent there, I think the existing tenant was paying $2,575. Were there any changes in the rent per square foot either for the new tenant or for the existing tenant?

Tony Maretic (CFO, Treasurer, and Corporate Secretary)

For the new tenant, it kind of steps back up over a period of time and gets back slightly above where the current rent is. It will dip down a little bit and then be back.

Craig Kucera (Managing Director)

Okay. Fair enough. Just one more for me. I mean, heading into this year, I think your expectation was that you would see the most leasing activity and traffic in Phoenix. And congrats on the lease at Papago. I just would be curious to hear your read on sort of how your top Sunbelt markets are performing and with Phoenix in particular, if that's helpful. Thank you.

Jamie Farrar (CEO)

Sure. I'll start. Tony might have some comments as well. If you actually have our investor presentation on slide three, it shows the maps of really where our current markets are and our overall value. I think what you can see is the bulk of our value is in the Sunbelt markets. We're feeling really good about leasing there. When Tony mentioned about some occupancy dipping down in Portland, that's unfortunate, but that's not a market that we're looking to invest capital in. Where we're investing capital is in the Sunbelt where we're creating the most value. Phoenix has been very strong. In fact, a significant portion of the leasing this quarter was in Phoenix. We continue to feel really good there and across the other Sunbelt markets that we have.

Tony Maretic (CFO, Treasurer, and Corporate Secretary)

Yeah. Just to echo some of Jamie's comments, the bulk of the leasing activity this quarter, the 144,000 sq ft of leasing this quarter was in Phoenix. If you look at where the cash spreads are this quarter, you can see how strong that is. That was largely driven by that activity in Phoenix.

Craig Kucera (Managing Director)

Okay. Thanks, guys.

Jamie Farrar (CEO)

Thanks for the question, Craig.

Tony Maretic (CFO, Treasurer, and Corporate Secretary)

Thanks, Craig.

Operator (participant)

As a reminder to ask a question, you may press star, then one on your touch tone phone right now. We currently have no further questions, so I will hand back over to Jamie for any closing remarks.

Jamie Farrar (CEO)

Thank you for joining today. We look forward to updating you further next quarter. Goodbye.

Operator (participant)

Thank you very much, Jamie and Tony, for being our speakers today. That comes to the end of our conference call. We appreciate everyone for participating. You may now disconnect your lines.