Good morning, and welcome to the Office Properties Income Trust Second Quarter 2019 Financial Results Conference Call. [Operator Instructions] Please note this event is being recorded.I would now like to turn the conference over to Olivia Snyder, Manager of Investor Relations. Please go ahead..

Thank you, and good morning, everyone. Thanks for joining us today. With me on the call are OPI's President and Chief Executive Officer, David Blackman; Chief Financial Officer and Treasurer, Matt Brown; and Vice President, Chris Bilotto. In just a moment, they will provide details about our business and our performance for the second quarter of 2019.

We will then open the call to a question and answer session with sell-side analysts.First, I would like to note that the recording and retransmission of today's conference call is prohibited without the prior written consent of the company.

Also note that today's conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and other securities laws.

These forward-looking statements are based on OPI's beliefs and expectations as of today, Friday, August 2, 2019 and actual results may differ materially from those that we project. The company undertakes no obligation to revise or publicly release the results of any revisions to the forward-looking statements made in today's conference call.

Additional information concerning factors that could cause those differences is contained in our filings with the Securities and Exchange Commission or SEC, which can be accessed from our website opireit.com or the SEC's website.

Investors are cautioned not to place undue reliance upon any forward-looking statements.In addition, we will be discussing non-GAAP numbers during this call, including normalized funds from operations or normalized FFO and cash basis and net operating income or cash basis NOI.

A reconciliation of these non-GAAP figures to net income and the components to calculate cash available for distribution or CAD are available in our supplemental operating and financial data package also can be found on our website.And now I will turn the call over to David..

Thank you, Olivia, and good morning. Welcome to the second quarter earnings call for Office Properties Income Trust.On today's call, I will provide an update on our investment activity.

Chris Bilotto will review our quarterly leasing activity and operating statistics, while Matt Brown will review our financial results, balance sheet, and capital needs.As many of you may recall, OPI completed its deleveraging plan associated with the First Potomac acquisition in January of this year, and immediately rolled into a property disposition program to manage the increase in our leverage resulting from the merger with Select Income REIT.The following prepared remarks regarding our dispositions is associated with our merger related disposition program.

As of today OPI has either sold, has under agreement, or is negotiated agreements for $630.1 million property sales.

In addition to our property sales, on July 1st, OPI sold all of its RMR Group common shares for $105 million in net proceeds.As a result of this activity and assuming all of the $630.1 million of property sales close as expected, our pro forma net debt to EBITDA is approximately 6.1 times, which is at the low end of our target leverage range of 6 times to 6.5 times.

The breakdown of the $630.1 million cited above includes $138 million of closed property sales, $347.3 million of executed agreements, and $144.8 million of agreements under negotiation.The success of our deleveraging activity now positions OPI to commence an ongoing capital recycling program that is expected to extend our weighted average lease term, reduce the average age of our properties, and help us manage ongoing capital requirements with the ultimate goal of enhancing our cash available for disposition and positioning OPI to increase its dividend over time.Considering, we have achieved the low end of our target leverage range on a pro forma basis, the eight buildings in our disposition plan that we continue to market for sale, have been transitioned to our capital recycling program.

These eight properties have an estimated market value of approximately $90 million.As we begin to acquire properties again, we will primarily focus on first generation buildings with a minimum remaining lease term of seven years and target markets that we believe have drivers of economic growth to deliver above-average job creation.We believe the ability to grow rents is important to be successful in the office sector and that markets with above-average job creation is one of the key predictors of our ability to grow rents.

We will also focus on buildings with an appropriate amenity base such as live, work, play environments, adequate parking, and access to public transportation and continue to focus our property management and asset management efforts on creating high quality tenant experiences to drive above average tenant retention.In July, we entered in agreement to acquire a land parcel in Boston for $2.9 million.

This parcel is located at the gateway to Boston's North End, and is across the street from a 141,000 square foot building, we own at 251 Causeway Street.

This area of Boston, near the TD Garden is experiencing attractive mixed use development activity with a substantial increase in rents over the past couple of years.Our building is currently 100% occupied by government tenants for slightly less than a one-year weighted average lease term.

We believe this land parcel is strategic to the long-term value of our building either by earning premium brands because we can offer parking in a market where landlords are not expected to provide parking or to help OPI obtain entitlements to increase the size of the building in a long-term redevelopment plan.Before turning the call over to Chris Bilotto to review OPI's leasing activity and operating statistics, I'd like to highlight that since the beginning of 2018 through the completion of our deleveraging plan associated with the SIR merger, OPI sold slightly less than $1.2 billion of real estate.

These sales have allowed us to improve the quality of our real estate portfolio, which we expect to continue to enhance through our ongoing capital recycling program.Chris?.

Thank you, David, and good morning, everyone.As of June 30, OPI's portfolio consisted of 209 buildings containing 29.3 million square feet with a weighted average lease term of 5.8 years.

Occupancy for the quarter increased by 200 basis points from the previous quarter to 91.6%.65.2% of our annualized rent is paid by investment grade rated tenants, which we believe is one of the highest percentages of revenue from investment grade rated tenants in the office REIT sector. The U.S.

government is our largest tenant, accounting for 25.6% of annualized rent and no other tenant accounts for more than 2.9% of annualized rent.Turning to our leasing results for the quarter, we entered into new and renewal leases for 571,000 square feet with a weighted average lease term of 6.7 years, leasing concessions and capital commitments of $4.01 per square foot per lease year, and a weighted average roll down in rent of 5.3%.

Year-to-date, we have a weighted average roll up in rent of 5.7%.

Recall that last quarter we generated a weighted average roll up in rent of 12.8% and stated that our expectation is for the change in rent to generally be flat for 2019.Our leasing activity also included the execution of leases for almost 65,000 square feet that absorb vacant space across our portfolio.

We are in active discussions with tenants for more than 2.6 million square feet of space, including 276,000 square feet that would absorb vacant space, and as a result, we expect our leasing momentum to continue for the remainder of the year.One of the leases, that we executed during the quarter, was for 173,000 square feet with the State of New Jersey, for a 10-year lease extension.

This 267,000 square feet building is a dominant Class A office building in the Trenton, New Jersey, CBD and is located adjacent to the state capitol building.

By executing this long-term renewal for almost 65% of the building, we created value and expect to market the building for sale during the second half of this year.We thought it would be helpful to highlight some of the industry recognitions we have received by actively managing our carbon footprint and environmental impact.

This quarter, OPI was recognized by the Institute for Market Transformation and the U.S.

Department of Energy's Better Building Alliance as a 2019 Silver Green Lease Leader.The Green Lease Leader program sets national leasing standards that are energy and environmentally friendly and recognizes leaders in the industry who have effectively developed owner and tenant agreements as a collaboration tool to promote high-performance, energy-efficient properties.OPI also received the 2019 ENERGY STAR Partner of the year award from the U.S.

Environmental Protection Agency and the U.S. Department of Energy. This is a second consecutive year that OPI has achieved this honor.

As these recognitions can attest environmental stewardship is a core value of our business and we remain committed to our sustainability initiatives as we manage and shape our portfolio.Currently 70 properties in OPI's portfolio are ENERGY STAR certified and 29 properties are LEED certified.

Additionally, 18 properties are designated as 360 Performance Buildings by BOMA which recognizes best operational practices in the commercial real estate industry.I will now turn the call over to Matt Brown, to provide an overview of our financial results, balance sheet, and capital needs.

Matt?.

Thanks Chris.OPI's results for the second quarter in six months ended June 30th, 2019 include the impact of the merger with Select Income REIT or SIR, which closed on December 31st, 2018. In addition, OPI sold $297.5 million of properties during the six months ended June 30th, 2019, including $29 million during the second quarter.

The impact of these events, has driven majority of the changes in OPI's consolidated financial results as compared to the same period in the previous year.Earlier today, we reported normalized funds from operations or normalized FFO for the second quarter of $79.3 million or $1.65 per diluted share.

Our results for the second quarter were positively impacted by certain items that increased net revenue by approximately $8.2 million or $0.17 per diluted share.The main contributor of these items was a net $7.4 million early termination fee related to a single-tenant building located in San Jose, California.

This building was a legacy SIR property with 75,621 square feet and contributed 0.28% of OPIs total annualized rental income.The original lease expiration was in November 2026, and the termination fee represented approximately 60% of the tenant's remaining contractual rent obligation.

This property has been opportunistically included in our disposition program as we believe the combination of the lease termination fee and the value as vacant is greater than the return, we could generate by re-leasing the property.G&A expense for the second quarter was $8.7 million, which was flat as compared to the first quarter of 2019.

Our base business management fees are currently being calculated using market capitalization, because it is lower than the historical undepreciated cost of assets.

As of June 30th, 2019, OPI did not accrue any estimated business management incentive fees.Interest expense for the second quarter was $35.3 million, which compares favorably to interest expense of $37.1 million for the first quarter of 2019.

The decline in interest expense is mainly the result of $336 million of debt repayments during the six months ended June 30th, 2019.Now turning to the property level results for the quarter. Our focus will be geared towards comparisons on a same-property basis.

In addition, we have included quarterly pro forma same property information in our earnings release and supplemental as if the SIR merger had closed on January 1, 2018.On a same-property basis, for the quarter ended June 30th, 2019, rental income decreased $2.6 million or 2.9% year-over-year and pro forma same property cash basis NOI was a $107.3 million or 2.9% decline on a year-over-year basis.

These decreases were driven by overall declines in occupancy.I will now switch focus to discuss capital and ongoing deleveraging efforts. We spent $7.3 million on recurring building improvements, and $13.9 million on tenant improvements and leasing costs in the second quarter of 2019.

As of quarter end, we had approximately $61.3 million of unspent leasing related capital obligations, of which 35% represents tenant managed TIs and $17 million cannot be spent until future years.In July, we sold our 2.8 million shares of the RMR Group and received net proceeds of approximately $105 million, which was used to pay down our term loan.We currently have $65 million outstanding on our term loan.

The dividend yield on our investment in the RMR Group was 3% based on the June 30th closing price, and we were able to accretively pay off debt at 3.8%.During ownership period, we generated a 261% net return on this investment. At June 30th, OPI has $65 million outstanding on our $750 million revolving credit facility.

On a pro forma basis for the sale of the RMR Group shares, OPI's net debt to annualized adjusted EBITDA was 6.6 times at quarter end.As David previously stated, once we close on the $630.1 million in property sales as expected, our pro forma net debt to EBITDA will be approximately 6.1 times.

Subsequent to quarter end, we sold two properties for an aggregate sales price of $39 million.

In addition, in July, we prepaid all $350 million of our 3.75% senior notes due in August 2019 using cash on hand and borrowings under our revolving credit facility.We currently have $400 million outstanding on our revolving credit facility, which we plan to reduce with the proceeds from the sale of properties over the next 60 days.Operator, that concludes our prepared remarks.

We're ready to open the call up for questions..

[Operator Instructions] Our first question comes from Bryan Maher with B. Riley FBR. Please go ahead..

A couple of questions.

When it comes to the lease renewals and the new leases for the second quarter, was there anything special or unusual in the rent concessions?.

It's good question, Bryan. I don't know that there was anything unusual. We did have a couple of government tenants that we did short-term renewals for, that while they continue to work through their housing plan.

So that actually reduced the wall, below what we would normally expect it to be.We also did, as Chris highlighted in his prepared remarks, we did a 10-year lease extension with the state of New Jersey in Trenton. That's not a very dynamic market and you haven't really seen much in the way of rent growth over the last five or six years.

So while we extended the term, 10 years, we had a slight roll down in rent there, but we also think we created value by locking in over 60% of the building's leasable square footage for over a 10-year term.But generally, we have some markets where we've seen better rent growth than others, and it just so happened, this quarter had some of our weaker markets where we had success in leasing space..

And how much would you say the variability in the rent increases, the quarter before this past one and then this quarter, is related to kind of all the disposition activity? Is that contributing to some of the variability or no?.

No, I don't think that contributes to leasing spreads at all Bryan. But remember, we've said on the last call that we expect that leasing spreads will be flat this year, and first quarter was up big. So we would expect that we're going to have flat to slightly down in the third and fourth quarters..

And then just kind of a two part question as it relates to the dispositions.

Do you think everything still gets done in 2019 or does some of it roll over into 2020? And then second part of the question is, as you move through the process, is pricing coming in better or worse or in line with your prior expectations?.

Yes, it's a good question, Bryan. Most of what we have under agreements, I think actually everything that we have under agreement, so that's, call it $347 million, we expect that's going to close in the third quarter.

I think some of the stuff we're negotiating contracts on, could close in late September.So I think all of the stuff that we have under agreement and are negotiating, that's all going to close this year. We've got a handful of assets in our capital recycling program. Some of that could close late this year or some of it could close early next year..

And then just lastly on that capital recycling program comment.

Are you actually finding stuff out in the marketplace in the markets and with the asset type that you want at respectable pricing that you could pursue?.

Yes. We've looked at some stuff. We haven't really found anything at this point, Bryan, that we're prepared to buy.

We don't think we've got the right match yet, but when you look at the capital that we would be selling in some of these dispositions over, call it a five year basis, and you analyze an acquisition based upon your cash contribution and you're buying a first generation building that doesn't have a lot of capital requirements, we can get reasonably aggressive on a cap rate and still create accretion to our ability to increase the dividend.

And that's really the focus that we have as we consider ongoing acquisition through our capital recycling program..

Our next question comes from Vikram Malhotra with Morgan Stanley. Please go ahead..

This is Adam Gabalski on for Vikram. I just had another one on the capital recycling program. Can you call out any sort of key markets, you mentioned you want to be in markets where the job growth is strong and the rent growth is strong.

Are there any sort of token markets that you guys are looking at? Or that are sort of at the top of the list?.

Well, I think the way we prioritize capital recycling is buildings where we don't believe we can achieve long term rent growth, and where we have ongoing capital requirements that we don't believe are economic.

And some of that might be in some of our, I guess, lower secondary type markets, but that could also be in more primary markets.So it really, I guess it's not markets per se that we're looking to exit, it's more exiting buildings where we don't believe we can achieve long-term rent growth that can contribute to increasing the dividend..

And then just I wanted to touch on one comment you made earlier. Just about the availability of deals at attractive pricing.

And as far as deploying capital goes, would you guys consider pivoting more towards a development projects or even potentially share buybacks if it turns out that there aren't enough deals in the market to sort of deploy all that capital near term..

I think the only types of development we would consider were buildings that we own, where we think we can accretively reposition that asset, either through adding additional square footage or up-tiering the class of the asset. We have no intention of buying buildings for redevelopment or buying land for development.

Would we consider a share buyback? Sure, we might consider that. We haven't socialized that with the Board and it's not particularly high on our list of things to do, but I wouldn't say, we would never consider that..

Our next question comes from Mitch Germain with JMP Securities. Please go ahead..

So David, just curious about the sales pipeline. I think you're originally doing $750 million, but then since you sold the RMR shares, you, I guess, scaled that back.

How should I think about it?.

It's a good question, Mitch. Well let me first kind of tell you a little bit about some of the stuff that we've sold. So of the $138 million of assets we have sold so far in this program, the weighted average remaining lease term has been less than five years, and the average age of the buildings have been greater than 30 years.

And because some of those buildings were vacant, the cap rate less than 3%. Of the buildings that we have either under agreement or are negotiating agreements on, those buildings also average 30 years or older, and they have weighted average lease terms of around six years.So maybe right around where the portfolio averages.

Those are going to sell for, call it a 7.5% cap rate or slightly less than that.

So we're achieving what I think are pretty good cap rates, particularly where you look where our implied cap rate is where we're trading today.So kind of back to your question, we had talked about selling $750 million of properties, because we sold the RMR shares, we can sell, call it $650 million of properties or $100 million less and be at the low end of our target leverage range.

I think that it makes more sense given that we've achieved our target leverage to start thinking about capital recycling and trying to position us to grow the dividend.So while we may not sell $750 million specifically associated with the - or $750 million of assets with deleveraging, we certainly expect that we're going to sell $750 million of assets between now and the end of the year or maybe mid-first quarter.

Does that make sense?.

That makes a lot of sense.

I'll follow-up, do you think you get credit for the dividend?.

I'm sorry..

Do you think that the company gets credit for its high dividend yield?.

So that's a very interesting question. And I think the answer is no. Otherwise, it wouldn't be a high dividend yield..

I guess I asked that David, because, why not just, so if you have other instances in the portfolio, whether it'd be some high CapEx or move-outs, why not sell the $750 million or more now, while the market is giving you the opportunity, and I don't think the dividend growth is necessary, as part of the near-term thesis.

I think it's probably deleveraging more if you have assets that you think you could trade into that are compelling..

Yes. I understand the question better now, Mitch. Because we're trying to position the company to grow the dividend, doesn't necessarily we will grow the dividend.

Right? I think ILPT probably had similar comments on their call this week, which is until they start trading in line with the peer group, we may see leverage instead of buying things.So it really depends on what the opportunities are.

We hope that if we continue to talk to investors, and we continue to execute on our strategy, people will recognize the value not only in our ability to grow NAV, but also position the company to increase the dividend over time depending upon how the stock performs..

Last one from me.

The land parcel that you acquired in Boston, you might have implied it, maybe I missed it, is the tenant moving out?.

No, it's basically a parking lot..

I meant the property across the street?.

We don't know at this point. I mean, I'll be honest with you, half the building is occupied by the VA, and we would love for them to leave. We've been actually been trying to get them out of the building for several years, and the other half is occupied by the state of Massachusetts.

We'd like them to stay, but if both of them leave, we have a very interesting opportunity to create value with that asset..

This concludes our question-and-answer session. I would like to turn the conference back over to David Blackman for any closing remarks..

Thank you, Operator. We've made tremendous progress in executing our deleveraging strategy and positioning our company for long-term growth. We remain committed to shaping the portfolio through the capital recycling program that is expected to enhance our cash available for distribution over time.

We also remain focused on renewing leases, pushing rents, and leasing vacant space across our portfolio. Generally, we're pleased with our accomplishments year-to-date and look forward to updating you on our successes next quarter.Operator, that concludes our call..

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect..