Good day, and welcome to the Office Properties Income Trust Fourth Quarter 2019 Financial Results Conference Call. All participants will be in listen-only mode. [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 fourth quarter and year ended December 31, 2019 followed by 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, Thursday, February 20, 2020, 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 revision 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, adjusted EBITDA and cash basis 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, which also can be found on our website.In addition, we will be providing guidance on this call, including normalized FFO.

We are not providing a reconciliation of these non-GAAP measures as part of our guidance because certain information required for such reconciliation is not available without unreasonable efforts or at all such as gains and losses or impairment charges related to the disposition of real estate.And now I will turn the call over to David..

Thank you, Olivia, and good morning. Welcome to the 2019 fourth quarter earnings call for Office Properties Income Trust. This morning, we reported normalized FFO of $1.38 per share, which beat consensus estimates for the quarter.

Matt will review our financial results in more detail shortly and will also provide financial guidance for the first time in OPI's history. We hope this additional disclosure will be helpful.

We also appreciate the continued feedback and look forward to further engagement.Heading into 2019, we set specific expectations for asset sales, our target leverage, expected year-end occupancy and full-year leasing spreads. And in all cases, we outperformed these expectations.

OPI's principal goal was to rightsize leverage following the merger with Select Income REIT.We announced plans to sell approximately $750 million of assets to reduce leverage to a targeted net debt-to-EBITDA range of 6x to 6.5x.

For the full-year, we sold $848.9 million of properties, plus we opportunistically sold all of our common shares in the RMR Group for $104.7 million in net proceeds, resulting in more than $950 million in aggregate asset sales.For the 58 properties we sold in 2019, the average cap rate was 5.7% for properties with an average age of 21 years and average occupancy of 70% and an average remaining lease term of 4.7 years.

As a result of these asset sales, we have reduced leverage to below our targeted range, our investment-grade ratings have been reaffirmed with stable outlooks, we improved key portfolio metrics and are well positioned to reenter the acquisition market.As it relates to occupancy and leasing spreads, we set expectations to end 2019 with occupancy at 91.5% and for new and renewal leasing spreads to be flat for the full-year.

We are happy to report that we ended 2019 with occupancy at 92.4%, which is 90 basis points higher than expected, and our total leasing for the year included more than 2.9 million square feet with new and renewal leases for a roll-up in rent of 4.2%.

Chris will provide more detail on our leasing activity shortly.As a result of achieving our target leverage range, we have pivoted asset sales to a capital recycling strategy that we believe will allow us to fund acquisitions with asset sales, while maintaining leverage within our targeted range.

We also believe our capital recycling strategy will position us to further improve key portfolio metrics, such as average property age and weighted average lease term, improve our prospects for tenant retention and position OPI to grow cash available for distribution or CAD.Our strategy will principally focus on selling properties with high capital requirements and to acquire properties with low ongoing capital needs.

Since capital spending can be uneven, our investment analysis will focus on the five-year average cash contribution, which is NOI minus capital expenditures for both asset sales and acquisitions.So far in the first quarter of 2020, we have sold or entered agreements to sell six properties for approximately $85 million that have an average age of 22 years, a weighted average lease term of six years and a five-year average cash contribution yield of approximately 4%.

This well positions OPI to acquire higher quality properties with low capital needs at competitive cap rates of around 6% and grow CAD.Although this maybe dilutive to normalized FFO, it will be net asset value-accretive, and we believe positioning the company for dividend growth is the right focus for OPI and its shareholders.

We have been actively underwriting potential acquisition opportunities and believe that acquiring properties that meet our investment criteria while executing our capital recycling program will require discipline.As stated on earlier earnings calls, our acquisition criteria is for properties with an average effective age of 10 years or less that have lease terms of seven years or longer and are located in markets where we believe we can grow rents over time and where we also believe our prospects for renewing tenants at least once are high.

We also expect our geographic diversification will evolve as we enter new markets and exit existing markets based upon our view of real estate fundamentals and on economic and demographic trends.I'll now turn the call over to Chris Bilotto to review OPI's operating and leasing activity..

Thank you, David, and good morning, everyone. As David mentioned, 2019 was an active year for leasing and property management as we work to reshape our portfolio and achieve the best operating results.

We closed the year with leasing activity covering 2.9 million square feet for a weighted average roll up in rent of 4.2%, a weighted average lease term of 8.6 years and leasing concessions and capital commitments of $3.08 per square foot per lease year.Through our deleveraging plan, we exited a few markets for an overall improvement to our geographic diversification and sold buildings with an average age of 21 years for an overall improvement to our portfolio now with an average age of 16.7 years.

As we look ahead into 2020, we will continue our focus to further improve key metrics to our portfolio. On a same-store basis, at year-end, we are targeting occupancy of 92% to 93%, with the roll-up in rents of 2% to 3%.Turning to the quarter.

As of December 31, 2019, OPI's portfolio consisted of 189 properties, totaling 25.7 million square feet with a weighted average lease term of 5.7 years.

In the fourth quarter, we entered into new and renewal leases for 779,000 square feet at weighted average rents that were 0.4% above prior rents, with a weighted average lease term of 7.1 years and leasing concessions and capital commitments of $2.86 per square foot per lease year.Total portfolio occupancy has increased by 140 basis points year-over-year to 92.4%.

Our current leasing pipeline of 2.1 million square feet includes 560,000 square feet that can continue to absorb vacant space across the portfolio.As discussed on last quarter's call, our property in Reston, Virginia was vacated during the fourth quarter, which represented 1.3% of our total annualized rental revenue.

The property is located in a prominent and growing Northern Virginia submarket and benefits from its access to the silver line, the Dulles International Airport and nearby live, work, play amenities.This vacancy has created a strategic opportunity for us to reposition the property for a roll-up in rent with minor building capital required to improve the property for leasing.

The submarket is expected to outperform the broader Northern Virginia market due to an expanding defense budget and strong growth from technology companies specializing in cloud computing and cybersecurity. We look forward to providing updates on the progress of leasing efforts in 2020.To highlight a few fourth quarter leasing transactions.

In Lakewood, Colorado, we executed a five-year lease extension on a 167,000 square feet with the GSA, which included capital of only $0.39 per square foot per lease year. In Boise, Idaho, we renewed the GSA in two full buildings with a total of 151,000 square feet.

The initial request from the GSA was to downsize of the short-term extension upon its lease expiration in 2021 due to several agencies occupying the building under one primary lease.Our GSA asset management and leasing team prepared an unsolicited utilization plan to provide the GSA a more holistic look at the building.

This proactive approach resulted in a successful completion of an 11-year extension for 100% of both buildings. This transaction highlights the benefit of the RMR platform, whose asset management team includes former GSA employees who maintain strong relationships with the GSA.

The team's experience and expertise with the GSA process helped turn an objection and potential problem into a long-term lease commitment.Turning to acquisitions.

In the fourth quarter, we acquired a 3,300 square foot land parcel for $2.9 million and are under agreement for a 13,500 square foot building for $11.5 million, both of which are located near or adjacent to our existing property at 251 Causeway in Boston.This area is a thriving submarket within the downtown Boston core, near 2 million square feet of newly delivered mixed-use development, the north station major transportation hub, the lively northern neighborhood and the TD Garden, the city's main indoor sports and entertainment facility.These acquisitions are strategic and provide flexibility for future value creation and NOI growth by repositioning our building, either through a tear down and rebuild beginning in 2022 or through upgrading the existing building as early as 2021.I will now turn the call over to Matt Brown, to provide an overview of our financial results, balance sheet and capital needs.

Matt?.

a decline in occupancy from 95.2% to 93.3%; $2.2 million of free rent in the fourth quarter of 2019, primarily related to two, 2019 executed lease renewals, one receiving free rent of $309,000 per month through March 2020 and the other receiving free rent of $188,000 per month through December 2019.$2 million of settlement income related to a tenant default and lease restructure recognized in October 2018, and increases in real estate taxes, labor, and insurance costs, partially offset by more significant repairs and maintenance incurred in the fourth quarter of 2018, and savings on our property management fee, primarily due to the free rent mentioned above.Turning to capital expenditures and balance sheet metrics.

We spent $20.9 million on recurring capital during the fourth quarter, including $10.6 million on building improvements and $10.3 million on leasing capital.Our recurring capital spend in 2019 was below our estimate, mainly due to the timing of leasing capital being deferred to 2020, which resulted in a CAD payout ratio of 56% compared to our target payout ratio of 75%.

Despite a conservative payout ratio, our dividend yield of 6.8% at year-end remains high compared to the pear group at 4.4%.Based on our current projections, we expect 2020 recurring capital expenditures to be approximately $110 million, which includes $38 million of speculative leasing capital.

Based on these projections, our dividend will be within our targeted range of 75%.As of quarter end, we had approximately $56 million of unspent leasing-related capital obligations, of which 41% represents tenant improvement allowances managed by our tenants and $17.5 million is leasing capital designated in leases for future years.At December 31, we had no amounts outstanding on our $750 million unsecured revolving credit facility, and our net debt to annualized adjusted EBITDAre was 5.9x, which is below our target leverage range.

As David mentioned, our investment-grade ratings were reaffirmed during the quarter with stable outlooks.Subsequent to quarter end, we repaid our $400 million of unsecured senior notes due in February with proceeds from fourth quarter and January property sales and borrowings under our revolving credit facility.

We currently have $335 million outstanding on our revolving credit facility, which we plan to reduce with the proceeds from three properties, currently under agreement to sell for an aggregate sales price of $64.3 million, including one property with secured debt in the amount of $13.2 million that will be repaid upon the sale of the property.Based on our current expectations of our portfolio and the timing of the dispositions currently under agreement to sell, we expect normalized FFO per share to be between $1.30 and $1.33 for the first quarter of 2020.

The decline from Q4 2019 normalized FFO of $1.38 per share is mainly driven by the NOI reduction of $3 million from the properties sold in Q4 and another $900,000 from Q1 property sales.We expect our same-property cash basis NOI to be flat to down 2% as compared to the first quarter of 2019, which is an improvement from the 5.3% decline we reported for the fourth quarter of 2019.As Chris mentioned, we expect same-property occupancy at the end of 2020 to be between 92% and 93%.

It is our intent to provide guidance for normalized FFO and same-property cash basis NOI for the next quarter during our earnings calls in 2020.Operator, that concludes our prepared remarks. We're ready to open the call up for questions..

We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Adam Gabalski with Morgan Stanley. Please go ahead..

Hey guys. Thanks for taking the question. Definitely appreciate the color and guidance for 1Q 2020.

Can you just talk about some of the drivers of same-store guidance as you look towards 1Q? And also just throughout the year, just given that you're sort of lapping some easier comps and just kind of walking through some of the biggest moving pieces?.

Yes. I think as we roll forward, our same-store performance from Q4, where we reported a decline of 5.3% to our expectation for Q1 of 2020 of flat to down 2%, there's a couple of major drivers that I talked about in the prepared remarks, one of which was the $2 million of settlement income that was included in Q4 2018 revenue, that was non-recurring.

The other item was free rent. One of the two major leases that we executed in 2019 had free rent of $188,000 per month that expired in December 2019. So we'll see the benefit of that cash rent, which is helping the same-store performance in Q1 of 2020..

Got it. And then just on sort of mark-to-market. For 2020, you're sort of targeting a low single-digit sort of back-to-back years in that range.

Is that sort of a reasonable run rate for how you sort of expect it to track kind of longer term? Or are there any sort of one-time large move-outs or renewals that you think are kind of skewing that? Or just kind of how you see that number tracking?.

Yes. When we look back, I mean, looking back at 2019 year-end, just over 4% and then 2% to 3% in 2020, I think, is indicative of where we see the run rate at least for the foreseeable near future..

Got it. And then just one more quick one for me. Just on the acquisitions and sort of the broader capital recycling and market rotation plan.

As far as the acquisition this quarter, would you sort of call that a part of that plan? Or is that sort of like a one-off unique opportunity because it was close to another asset? And just sort of as far as the broader capital rotation, what kind of deal volume are you looking at? What does the pipeline look like? Can you expect that to sort of match dispositions for 2020? And how does that sort of pipeline seem at this point?.

Sure. Adam, the acquisitions that Chris talked about were strategic to our property, 251 Causeway. That's a downtown, Boston, located building in the epicenter of an area that's getting a lot of growth. We have an opportunity as we look into 2021, 2022, to reposition that for a significant rent growth.

So owning those two assets give us substantially greater flexibility in what we do with that property in the future. So I would not consider it part of the capital recycling program.As it relates to capital recycling, we have a decent pipeline of potential opportunities.

We are being, I think, very thoughtful around our capital allocation and making sure that as we buy potential opportunities, we understand how we are going to fund those with asset sales and what our cost of capital is associated with those asset sales, so that we not only are improving our portfolio metrics in the process, but we are positioning ourselves for growth in cash available for distribution.And I'll give you an example.

We've got six properties that we've either sold or have under agreement as of the first quarter of 2020, roughly $85 million at a cash contribution yield of 4%.

So by selling those assets, we're giving up approximately $3.4 million of free cash flow to pay a dividend.If we acquire $85 million of assets at a 6% cap, we will be picking up $5.1 million of free cash flow, depending upon the level of capital associated with those buildings.

That $1.7 million is $0.035 a share in additional CAD that we can use to grow the dividend. So that is the real focus for us as we try to reposition our portfolio, create net asset value accretion and CAD accretion.

Does that make sense?.

Yes. Absolutely. That’s very helpful. Thanks..

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

Yes, good morning. Kind of following up on Adam's question.

Can you discuss the kind of anticipated volume that you expect in 2020? I think I might recall you previously saying capital recycling would be about $300 million a year, is that correct? And do you still see that being the case?.

Yes, it's a good question, Bryan. We've got the $85 million that's currently in process. We are marketing an asset in Northern Virginia right now and are evaluating 20 additional properties for potential disposition. Depending upon what the outcome is of those 20 properties, we could very easily hit $300 million in capital recycling this year.

A lot of it's going to depend upon how the markets continue to perform. And frankly, a lot of it's going to depend upon our ability to acquire assets that we think meet our investment criteria..

And kind of to that point, how deep is the market of assets that you're currently looking at? Has it grown? Has it shrunk? Is it 10 properties, is it 80 properties?.

It's not 80 properties right now, Bryan. It's probably closer to 10 properties. It's been relatively consistent as we move out of 2019 and into 2020. And so we're – we remain optimistic. I think the real thing I'd like to highlight is while we're optimistic, we also expect to be disciplined.

And we're very focused on what our acquisition criteria is and how we're going to pay for those acquisitions. But no, we're very optimistic that we're off to a good start for 2020..

Okay. And then just last for me.

Given that we're basically done with the kind of large-scale dispositions and you've moved into capital recycling, is it safe to say that OPI kind of stays around $4 billion, $4.5 billion REIT over the next two to three years? Or do you see an opportunity to take the size of the REIT higher? And if so, kind of when and how?.

Bryan, I think it depends a lot on how the share price performs this year as we demonstrate an ability to execute on the capital recycling program and the discipline we show in capital allocation. We are certainly not prepared today to issue common equity to fund growth.

We obviously could look at joint ventures.But frankly, we think we have plenty of opportunity to recycle capital and reposition the portfolio and grow CAD without having to really worry about growing the company, because if we can grow cash available for distribution, while maintaining the same asset level, shareholders will benefit from our ability to increase the dividend..

Thanks David..

Yes. Thank you, Bryan..

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

OPI started 2019 as a new company with increased scale, greater diversification and an evolved investment and operating strategy. It was a year for OPI to present a fresh business plan to the market, and importantly to deliver on our stated goals.

We have repositioned the company with a healthy financial profile, while enhancing our portfolio quality and successfully managing our properties for strong occupancy and rent growth.In 2020, we will continue to focus on executing our business plan of enhancing key portfolio metrics and recycling capital to grow CAD.

We believe this strategic focus is important considering OPI's trading discount to our peer group and the meaningful value proposition to our shareholders as we work to narrow that discount.

We are dedicated to proving that our strategy involves long-term thoughtful management and a commitment to creating shareholder value.Thank you for joining us today. Operator, that concludes the call..

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