City Office REIT - Earnings Call - Q4 2024

Executive Summary

• Leasing momentum accelerated: 205,000 sq ft signed in Q4, in-place occupancy rose 200 bps q/q to 85.4% (87.6% incl. signed not yet occupied); Same Store Cash NOI up 3.3% y/y. NOI increased to $25.5M, up $0.9M q/q on higher occupancy.
• GAAP diluted EPS was $(0.31) due to an $8.5M non-cash impairment tied to the post-quarter sale of Superior Pointe; Core FFO per share was $0.28 and AFFO per share was $0.10 (AFFO impacted by $2.3M leasing commissions and $1.3M renovation spend).
• 2025 guidance initiated: Core FFO/share $1.10–$1.14; NOI $102.5M–$104.5M; Same Store Cash NOI +2.5%–4.5%; year-end 2025 occupancy 85%–87%.
• Portfolio actions: Disposed Superior Pointe (Denver) for $12.0M post-quarter; management emphasizing Sunbelt markets, spec suites, and approved St. Petersburg City Center redevelopment plans as forward catalysts.

What Went Well and What Went Wrong

What Went Well

• Occupancy and leasing: In-place occupancy rose to 85.4% (87.6% including signed not yet occupied), with 205,000 sq ft of new and renewal leases signed; Q4 cash re-leasing spreads were 12.3% and 5.9% for full-year 2024. “Strong leasing momentum continued into the fourth quarter across our portfolio” — CEO James Farrar.
• Same-store improvement and NOI: Same Store Cash NOI increased 3.3% y/y; NOI reached $25.5M in Q4, up $0.9M q/q, primarily driven by higher occupancy; Raleigh (Bloc 83) was a notable contributor as signed leases commenced.
• Strategic positioning: Management highlights sector turning point, focus on Sunbelt markets, and completed major renovations across key assets (Phoenix, Dallas, St. Petersburg); spec suites are >75% leased, supporting rent growth and occupancy.

What Went Wrong

• GAAP loss and non-cash charges: Q4 GAAP diluted EPS $(0.31) driven by an $8.463M impairment to align Superior Pointe’s carrying value to sale price; net loss attributable to common stockholders was $(12.6)M.
• AFFO pressure: AFFO per share was $0.10 with a 97% payout ratio; elevated leasing commissions ($3.203M) and recurring capex ($2.854M) weighed on AFFO; CFO cited a $2.3M commission tied to the 60,000 sq ft Terraces lease and $1.3M property renovation impact.
• Revenue softness y/y: Rental and other revenues of $41.9M declined versus $44.3M in Q4 2023 amid portfolio changes; interest expense remained elevated at $8.8M in Q4.

Transcript

Operator (participant)

Good morning and welcome to the City Office REIT Fourth Quarter 2024 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.

Anthony Maretic (CFO, Treasurer and Corporate Secretary)

Good morning. Before we begin, I would like to direct you to our website at cioreit.com, where you can view our fourth 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 a forward-looking statement within the meaning of the federal securities laws. Although 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 statement disclaimer in our fourth 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, discussed some of the quarter's operational highlights. I'll now turn the call over to Jamie.

James Farrar (CEO)

Good morning. After a challenging macro environment over the last few years, 2024 marked a clear turning point for the office sector. Supply-demand dynamics for office leasing have turned increasingly favorable for high-quality buildings in great locations. Across the country, the fourth quarter of 2024 reflected positive net absorption of office space. Overall leasing volume in the fourth quarter was over 90% of pre-pandemic volume levels. Sunbelt markets have performed particularly well and led the way at 95% of pre-pandemic volume. In addition, JLL estimates that since the onset of COVID, companies have collectively shrunk their office footprint by 8%, while their office-using headcount has actually grown by 5%. As the return to office continues, demand dynamics at desirable properties should steadily strengthen. As we've discussed throughout 2024, new office construction is the lowest it has been in the last 50 years.

This, combined with a record number of conversions, demolitions, and redevelopments, translates to decreasing inventory. The net effect of these industry trends is increasingly solid footing for office properties. However, not all markets in office properties will benefit from these improving fundamentals. You may note in our investor materials, we have split out our Sunbelt and non-Sunbelt markets in our portfolio tables. Our properties are predominantly located in Sunbelt markets, and we believe these will continue to outperform due to their favorable demographic and employment trends. We also believe that amenitized and modern spaces will draw the greatest share of leasing going forward. As discussed on prior calls, we have spent the last few years making impactful upgrades to our properties, enhancing amenities, and investing in ready-to-lease spec suites. These efforts are clearly working. Since 2021, we have completed significant property upgrades at nine of our properties.

Our most recently completed large projects are at Pima Center and 5090 in Phoenix, 2525 in Dallas, and City Center in downtown St. Petersburg. We also have one additional amenity enhancement project planned at Block 23 in Phoenix. The goal of these improvements is to drive occupancy as well as to capture growing rents. Also, over this period, we have constructed 231,000 sq ft of modern spec suites, which are over 75% leased today. These proactive efforts have resulted in strong leasing results in 2024. The 806,000 sq ft of new and renewal leases signed during the year represented a 35% increase over 2023. Over the course of the full year 2024, we also realized a robust 5.9% cash rent roll-up upon renewal. Turning to specific highlights from the fourth quarter, we signed a 60,000 sq ft lease at our Terraces property in Dallas.

The lease extended the tenant's existing 44,000 sq ft space until 2036 and expanded the tenant space by 16,000 sq ft also through 2036. The negotiated rental rate for the new expansion space is 17% higher than what the tenant's existing space is currently paying. This demonstrates how rental rates have increased for premium assets and aligns well with our thesis that rents are poised to grow for quality properties. Moving to a disposition transaction, subsequent to year-end, we sold Superior Pointe a smaller 152,000 sq ft property in the northwest submarket of Denver. The sale decision was largely driven by our view that we would achieve more value by selling the property as compared to investing considerable amounts to try to win leasing in a challenging submarket. We elected to sell Superior Pointe for a gross sale price of $12 million. The property was unencumbered by debt.

Moving to our potential redevelopment plans at City Center in downtown St. Petersburg, Florida, we continue to track our expectations. The redevelopment site plan application has now received unanimous approval from the City of St. Petersburg, and all appeal periods have expired. The approval was for the demolition of the standalone parking garage to allow for a new multi-use water-facing development. The site plan includes approximately 164 residential condos and 78,000 sq ft of retail and office. We continue to advance agreements and development plans with a very experienced developer who would be responsible for leading the project's execution. However, any redevelopment of City Center remains subject to a number of conditions, some of which are beyond our control. We will provide further updates on our progress on future calls. Last for me, in our earnings press release, we introduced guidance for 2025.

Our focus in 2025 remains on driving long-term cash flow growth through leasing, active asset management, and value creation opportunities. Our core FFO per share guidance range is effectively in line with our fourth quarter results on an annualized basis. Our expectation is that as signed leases take occupancy and we continue future leasing momentum, we will have improvements in occupancy and same-store results. We expect this will drive core FFO per share growth over time. While we are guiding that overall occupancy will increase during 2025, that growth is expected to occur primarily across our Sunbelt markets. As discussed earlier, these markets have the strongest leasing dynamics and value creation potential. With that, I'll turn the call over to Tony to discuss our financial results in more detail.

Anthony Maretic (CFO, Treasurer and Corporate Secretary)

Thanks, Jamie. Our net operating income in the fourth quarter was $25.5 million, which is $900,000 higher than the amount we reported in the third quarter. Higher occupancy was a primary driver of the NOI increase. We also reported core FFO of $11.7 million, or $0.28 per share, for the fourth quarter. Core FFO was $600,000 higher than the amount we reported in the third quarter. Similar to NOI, the increase was driven primarily by higher occupancy but marginally offset by higher interest expense. Our fourth quarter AFFO was $4.3 million, or $0.10 per share. The success of our leasing efforts elevated tenant improvement costs and leasing commissions. The largest impact to AFFO was a $2.3 million leasing commission on a 60,000 sq ft lease at The Terraces. The significant property renovations underway in the fourth quarter that Jamie described resulted in a $1.3 million reduction to AFFO.

We also invested $300,000 on spec suites and vacancy conditioning. Net income was impacted by an $8.5 million non-cash impairment of real estate charge in the fourth quarter to reflect the sales price of Superior Pointe, which closed after quarter end. Moving on to some of our operational metrics. Our same-store cash NOI trended higher in the fourth quarter. There was a healthy increase of 3.3%, or $760,000, as compared to the fourth quarter of 2023. The largest contributor to that was Raleigh, where NOI continues to materially increase at Block 83 as signed leases take occupancy. Our portfolio occupancy ended the quarter at 85.4%, an increase of two full percentage points from the prior quarter. Our occupancy was 87.6% inclusive of the 122,000 sq ft of signed leases that have not yet commenced. Our total debt as of December 31 was $647 million.

Our net debt, including restricted cash to EBITDA, was 6.9x. As of December 31, we had approximately $42 million undrawn and authorized on our credit facility. We also had cash and restricted cash of $34 million at 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 renewal. We have only two property debt maturities in 2025. The loans for both Greenwood Boulevard in Orlando and IntelliCenter in Tampa mature in the fourth quarter. We have begun discussions and expect to provide an update on next quarter's call.

We also have two high-value properties, Block 83 in Raleigh and City Center in Tampa, that are completely unencumbered. We continue to see improvements in debt markets. As liquidity comes back, potential refinancing terms are improving despite long-term interest rates trending higher recently. We expect to place debt on some of our unencumbered assets to increase liquidity in 2025, given this backdrop. Lastly, for me, as Jamie mentioned, we have provided our 2025 guidance. The guidance includes the recent disposition of Superior Pointe in Denver but assumes no other acquisitions or dispositions. Despite two known vacates in our non-Sunbelt properties totaling 102,000 sq ft in the first half of the year, we are anticipating an increase in overall portfolio occupancy by year-end, driven largely by the leasing momentum in our Sunbelt markets that Jamie described.

Overall, we are anticipating a healthy increase in same-store cash NOI with a range of 2.5%-4.5% growth as compared to the prior year. That concludes our prepared remarks, and we will open up the line for questions. Operator.

Operator (participant)

Thank you very much. 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. Upal, your line is now open. Please go ahead.

Upal Rana (Senior Equity Research Analyst)

Great. Thank you. I wanted to kind of talk about the disposition of Superior Pointe. What was the reasoning behind selling it? Could you characterize how the market is currently in terms of the transaction market?

James Farrar (CEO)

Sure. Thanks for the question. As we've indicated in our prepared remarks, really, there's kind of a real thrust for value creation and ability to grow rents in some of the top markets, including in the Sunbelt. Some other markets are a lot slower. Denver kind of is a mixed bag in that respect. Superior was a bit of a challenge submarket, high vacancy. When we looked at the lease terms of what we could execute upon, we weren't thrilled. We didn't see that changing for a long time. It's not a place where we wanted to invest capital. We opted to exit that one and really focus our efforts on the best markets and the best submarkets where we're in great value. In terms of what are we seeing overall, the capital markets for office have significantly improved.

I mean, they were completely illiquid. You are starting to see transactions now for the top of the market, the best assets. There is investor interest. You are also starting to see more interest in smaller assets and smaller asset buyers. Just case in point would be our Superior transaction. I would say the market is definitely improving in terms of liquidity, and we think that is going to continue.

Upal Rana (Senior Equity Research Analyst)

Okay. Great. That was helpful. I noticed you guys broke out the Sunbelt occupancy and the total portfolio occupancy in this quarter. Any reason behind that that you can maybe add some color to?

James Farrar (CEO)

Yeah. If you think again back to where are we going to create the most value over time, it's going to be in our high-growth Sunbelt markets. It gets a bit lost when you look at portfolio. We thought it was helpful to provide both. We think Sunbelt, you're going to see significant rent growth over the next few years, as well as occupancy growth.

Upal Rana (Senior Equity Research Analyst)

Okay. Do you think that does this maybe suggest that those four assets that are in the other category could potentially be up for consideration for sale?

James Farrar (CEO)

We didn't put any dispositions beyond Superior in our guidance. I guess what I would say is Portland almost needs to be ignored. I mean, it's a tiny asset. It's a really tough market. And so we don't see significant value in that market. Seattle's different. Our asset there, it's leased to Pfizer. That's one that at some point we'll find a way of exiting. We think it's a very good asset. It's a great tenant. It's a great location. As capital markets improve, that's one that we'll take advantage of. I don't think it's near-term, but longer-term. In Denver, it's kind of a mixture. It's been a bit of a slower market with respect to our whole portfolio. We're looking at ways of creating value. We've had a lot of success at Circle Point. The Denver Tech Center has been a little slower.

We are seeing leasing activity starting to pick up there. We are trying to get our arms around how do we best create value overall. They certainly are not markets that we are going to expand in or grow over time.

Upal Rana (Senior Equity Research Analyst)

Okay. Great. The last one for me would be just on your GSA exposure. It seems like you have the U.S. Attorney's Office as one of your tenants, and it makes up about 1.9% of your portfolio. Do you have any expectations for this lease, given the expiration is in 2026? If you can give any color on that, that would be helpful. Thank you.

James Farrar (CEO)

Sure. So effectively, that's in our Park Tower building. You nailed the stats. It's the top seven floors, I believe. Phenomenal views, great location. They're leased through the end of 2026. We're at the natural point of having some discussions with them. It's too early to say where that's going to land. What I can say is they heavily utilize their space. It's logical that they'd like to be there long-term. Obviously, there's some uncertainty around that until we can advance it.

Upal Rana (Senior Equity Research Analyst)

Okay. Great. Thank you for your help.

James Farrar (CEO)

Yeah. Our pleasure.

Operator (participant)

Our next question comes from Barry Oxford with Colliers. Barry, your line is now open. Please go ahead.

Barry Oxford (Head of Real Estate Securities Research)

Great. Thanks, guys. Jamie, as you look at acquisition opportunities, number one, are you seeing any distressed opportunities or look, Barry, I'm not playing in the distressed opportunities? Secondly, how do you balance the acquisition cap rate with your cost of capital?

James Farrar (CEO)

What are we seeing overall, Barry? We haven't seen huge amounts of lenders taking back properties yet and then turning them over in distressed sales. I do think that's going to pick up over the next few years. I don't know if those assets are going to be ones that we want to necessarily own, although we've had a lot of luck in the past buying value-add assets and creating value and then monetizing them. It's not something that I'd close completely. Right now, as we look forward for the next year, we see good opportunities within our portfolio to put capital to work and leasing to our best assets through renovations, other improvements, pick up NOI at the asset level, which translates to higher value for those assets. That's really where our focus is right now, is internally.

I would say external growth will come down the road, if it makes sense.

Barry Oxford (Head of Real Estate Securities Research)

Great. Jamie, how do you look at your spec space? Do you want to do more of it?

James Farrar (CEO)

We've got about 50,000 sq ft right now. A lot of it is in Phoenix, Tampa as well. I think Phoenix, out of all of our markets, as far as leasing activity right now, has significantly picked up. It would be top of our list. We're feeling good there as far as what we have and getting that leased. We're planning, actually, right now, kind of the next phase of spec suites that we're going to do in 2025 and where we think we're going to be most successful based on the demand. I think that's a question I could probably give you a little better color on on the next call or two. We still find, particularly for smaller suites, if we build those out, we build out the right product in the right location, we're getting great rents. We'll be doing more over time.

Barry Oxford (Head of Real Estate Securities Research)

Perfect. Thanks so much, guys.

James Farrar (CEO)

Yeah. Thanks, Barry.

Barry Oxford (Head of Real Estate Securities Research)

Yep.

Operator (participant)

Thank you very much. Just as a reminder, if you would like to ask a question, you may press star, then one on your touch tone phone right now. Our next question comes from Craig Kucera with Lucid Capital Markets. Craig, your line is now open. Please go ahead.

Craig Kucera (Managing Director, Equity Research)

Yeah. Thanks. Good morning, guys. I'm curious about the buyer of Superior Pointe. Are they expecting to utilize that as office for the longer term or potentially convert it to another use?

James Farrar (CEO)

It was a family office. My understanding is they're going to significantly invest in the property, build out a lot of amenities, and then maintain it as office.

Craig Kucera (Managing Director, Equity Research)

Got it. Changing gears, you mentioned in your guidance there's no dispositions, but are you contemplating any lender transfers?

Anthony Maretic (CFO, Treasurer and Corporate Secretary)

Hey. Good morning, Craig. We have two loans that are maturing at the end of this year, both in the fourth quarter. At this point, we've started discussions on both, advancing one that the Greenwood Boulevard property is 100% leased. Those discussions are going a little more of an advanced stage and then starting discussions on the other loans. At this point, we have not assumed in our guidance that we are making any dispositions, including the assets with mortgages that are maturing this year.

James Farrar (CEO)

Just to jump on and add to that because you raised a good point, the asset Greenwood Boulevard in Lake Mary that Tony mentioned is leased long-term. That's actually a submarket that started to pick back up.

We are in discussions with a potential tenant to come in and take down some of that space on a very long-term basis, which could position us to extend the balance of the space as well. It is one example where it has been an asset in the past. I think we have talked about that had a little bit of lack of utilization that could be completely changed.

Craig Kucera (Managing Director, Equity Research)

Got it. You mentioned the large known vacates in the first half of 2025. When do you anticipate the leased but not commenced will begin paying rent in 2025?

Anthony Maretic (CFO, Treasurer and Corporate Secretary)

They're spread out pretty evenly through the year. We have 122,000 sq ft, as you mentioned. A lot of that is in Phoenix, as Jamie talked about, some market that's been picking up. It is spread to the end of the year. We have a deal in Dallas that's later in the year. We're still figuring out the timing of how long the tenant improvement work will work. It is pretty evenly spread.

Craig Kucera (Managing Director, Equity Research)

Okay. Great. Just one more for me. I just wanted to follow up on St. Petersburg. Can you talk or give us any color about what the anticipated economics of a deal there might look like? Given that there's condo sales that might start 2025, is there any impact to guidance or in the guidance?

James Farrar (CEO)

There is no impact in the guidance. Maybe just touch on that. The way we are contemplating the structure, and we can't give too many details on who our development partner is yet. It's at a late stage. We hope that that will change soon where we can provide a little more color. Think of a very experienced developer leading the development. The way we're participating is rolling in our parking garage at a certain point when the project has been de-risked, and then we share the economics going forward. It's too early to talk about project economics.

Craig Kucera (Managing Director, Equity Research)

Okay. Fair enough. Thanks.

James Farrar (CEO)

Thanks for the question.

Anthony Maretic (CFO, Treasurer and Corporate Secretary)

Thanks, Craig.

Operator (participant)

Thank you very much. We currently have no more questions. I will now hand back over to Jamie for any closing remarks.

James 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 concludes our conference call. You may now disconnect your lines.