Good morning and welcome to the Office Properties Income Trust Fourth Quarter 2020 Earnings Conference Call. All participants will be in a listen-only mode. 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, Chris Bilotto and Chief Financial Officer and Treasurer, Matt Brown.

In just a moment, they will provide details about our business and our performance for the fourth quarter of 2020, followed by a question-and answer session with sell-side analysts..

Thank you, Olivia, and good morning. Welcome to the fourth quarter earnings call for Office Properties Income Trust. We entered 2020 with leverage below the low-end of our target range after completing our post-merger deleveraging plan as originally outlined which included a disposition of close to $1 billion in assets.

This outcome position the company with the strong balance sheet and a well diversified portfolio going into an unprecedented global health crisis that would soon impact our personal and professional lives, communities and activities from the global economy down to neighborhood businesses.

Despite these challenges, we continue to executing on our business and capital recycling plan, and I am pleased to report operating and financial results representative of our strong portfolio composition..

Thanks, Chris and good morning, everyone. Normalized FFO for the fourth quarter was $61.8 million or $1.28 per share, which beat consensus by $0.03 and the high-end of our estimate by $0.02 due to NOI coming in higher than forecasted, partially offset by an increase in G&A. CAD for the fourth quarter was $42.3 million or $0.88 per share.

Our dividend is well covered with a full year 2020 CAD payout ratio of 58.8%. Despite pressure from the 2021 vacancies that we have discussed, we expect our dividend to remain well covered. G&A expense for the fourth quarter was $7.1 million down from $7.3 million for the fourth quarter of 2019 and flat sequentially.

G&A expense for the fourth quarter includes approximately $600,000 of share grant accelerations from the retirement of three RMR officers and $450,000 of net G&A expense related to a lease obligation we assumed in connection with our 2017 acquisition of FPO.

This lease expired on January 31st, 2021, and we will result in a reduction of $300,000 of G&A expense in Q1 and $450,000 beginning in Q2..

We will now begin the question-and-answer session. The first question comes from Bryan Maher with B. Riley Securities. Please go ahead..

Good morning, Chris and Matt, and thanks for that update.

Can you talk a little bit about the Technicolor disposition and how it relates the pricing relative to expectations and other opportunities you may or may not have had at property?.

Yeah. Bryan, this is Chris. I think, kind of going back, as you know, the tenant gave us notice to vacate effective August of this year.

We originally kind of went out assembling a team and marketed this space for lease and at the same time, having an opportunity to spend a lot more time with the building and understanding kind of what the strategy could be from a leasing effort.

And I think as we continue to kind of work through things, we just found that more interest came from the acquisition side and kind of coupled that with the fact that this building, despite being industrial, is really 31% manufacturing with the balance of warehouse distribution.

And there's just some logistical challenges with dock doors and other things that really layered on additional capital required to reposition the asset.

And I think the last caveat there is -- as we started kind of looking around and seeing tenants in the market, we're seeing -- there were some bigger users maybe at 250,000 square feet, but on average, the users were 50,000 square feet.

And it just became more evident that the cost of reposition versus a strategic play and selling it at a price that we think is indicative of the value given the rent rates and kind of what capital are required, we'd be in a better to redeploy those proceeds into something more core to our business..

Okay. Great. And can you shift gears to Mass Ave in DC? It's been a couple of months since you last updated us on that asset and the potential for redevelopment.

Has anything changed in your thought process there?.

Nothing has changed. I mean, we're running dual pass. This building can support kind of the government uses that's currently in there today. We've seen some activity. We're in various levels of conversations with some government uses, certainly around the repositioning. We believe that adds additional value and provides attractive returns as well.

We've been running parallel paths meaning, from a use standpoint, we have flexibility with the different types of uses we can put in there and have done some work around design and other related items.

So, when we get down the path, which we hope to kind of have some direction here in the near term, we're not necessarily missing a beat on timing and our ability to get out and start construction and be in a position to deliver timely..

Okay.

And then, when we think about kind of the four big assets this year with vacate Technicolor, Plantation, Fresno and Mass Ave, if we were to back those out of the equation and just think about the core balance of the portfolio, where would you envision that occupancy being around year-end 2021, give or take?.

I think a reasonable assumption at this stage -- and there's certainly a handful of variables that play into this, just given the level of capital recycling and then where we may buy -- right around 90% is probably a reasonable assumption..

Okay. And then just last for me.

When we look at what's happening with New York City and a couple other marketplaces out there really impacted by COVID, is there some level of discount on potential assets that would come available that could compel you into those markets? Or is there just really no appetite at OPI for that?.

I think it's more around kind of our core business strategy. We just see less opportunities in a market, like kind of some of these gateway cities and the CBDs.

As we look at single-tenant occupied assets or kind of how we've expanded the horizon a little bit, it's not that we don't find opportunities on the peripheral, like New Jersey, in California, in San Jose where we have assets Southern California and other markets, those are the likely candidates for opportunities for acquisition..

Yeah. Thank you very much..

Thank you..

The next question is from Jason Idoine with RBC Capital. Please go ahead..

Yeah. I was wondering about the Boston acquisition. It looks like that was 59% leased, but it sounds like that might be part of a larger plan.

I guess, what were your thoughts when pulling the trigger on that with the lower utilization and is it okay to just assume that you're going to operate that at the current level until that other opportunity kind of presents itself?.

I think that right. I mean, ultimately, we own two other buildings that connect to this building. And so, with the acquisition of this and they actually share party walls, we're able to assemble about 0.7 acres within kind of the North Station’s sub market.

And so I think the strategy with that building is that to be in a position where we have control of some of the space, and we can do short-term leasing with no capital or very little capital. And so that really is the play as we evaluate longer term options.

I think it's important to caveat that with the other adjacent building, we do have term on some of the leases. And so, this is not something I would expect to come to fruition in -- let's just say the next year or two, this is a probably likely a longer term strategy..

Got it. Okay. And then, in terms of the total recycling program going forward, I know you guys said in the past $100 million to $300 million annually came in at the low-end in 2020. But yeah, the $170 million sold are under agreement year-to-date.

So, I guess, what's the possibility of going above that range, I guess, is that something that you guys are open to and how open is the market today?.

I mean, it's not necessarily -- I don't know that we'll hit that. I think $100 million to $200 million -- excuse me -- $100 million to $300 million is kind of the range we're comfortable with. It really is on a case-by-case basis just where we're at with opportunities and strategies.

But I think at this stage it's a comfortable range to continue earmarking..

Okay. And then last one for me.

If you guys could just touch on the acquisition that was terminated in Georgia?.

The Georgia acquisition -- so we were originally looking at three buildings, that's part of a kind of a campus where we also own buildings, and really this was an opportunity to try to kind of assemble a larger piece.

But ultimately when we got into diligence, I think what we found that kind of the capital required to reposition those assets and the fact that there was still other assets in the park that we wouldn't control. It just wasn't the right strategy. I think we're comfortable with the buildings the way they are. They're fully leased.

And I think we're better suited just to kind of continue down the path we are there..

Got it. Thanks, Chris..

Thank you..

Your next question is from Omotayo Okusanya with Mizuho. Please go ahead..

Hi. Yes. Good morning, everyone. First question, it looks like there's an asset you guys own Eaglewood, Colorado, that the tenant is United Launch Alliance, looks like you're trying to lease that building as well, or at least up for lease.

So is that an additional vacancy we should be thinking about in 2021?.

I don't think so. I mean, that lease -- that building doesn't expire until late 2022. That location is strategic in the sense that their corporate headquarters is there within the park. There's several other buildings they occupy. That building specifically has their space program in it with skit space across a handful of floors.

And so I think at this stage, I wouldn't expect that -- we have any insight into them vacating. I think the focus right now is on conversations. They continue to keep them in the building..

Great. That's helpful. And then the Technicolor space again, understand industrial non-core -- but I guess when we take a look at the range you were getting there sale price, it just looks like a really big category. So kind of trying to wonder, even with your expectations of how much CapEx you would need to repurpose it.

How you kind of looked at that, that a sale was the best approach at the current sale price.

I guess we're trying to figure out this idea of transact -- portfolio repositioning you're doing, you're trying to make it had accretive and I guess we just struggled with the pricing on this transaction, how that ends up being accretive in the longer term, given what you end up investing the proceeds into..

Yeah. I mean, I think, kind of looking at it, if you may -- you may recall that last year with Technicolor we did a restructuring of their lease, I think later in the year, whereby the rent was reduced. They had a downsize right. We were trying to work with them to kind of continue to retain them in the building, albeit they had a termination right.

And so their rent was adjusted to something closer to market, which I think was to the tune of about $4.9 million. And so, fast forward today, I mean, we look at the building, despite there's being NOI, it's a vacant building. They're leaving in August. And so we're effectively starting from scratch.

And I think kind of going back to some of the feedback earlier, what we found with time is there's a lot of complexities with this building, and given kind of the shallow market itself I just -- with the capital required downtime, free rent and other elements that go into this, it really didn't make sense for us to kind of spend the time and the resources with an outcome that doesn't provide -- doesn't produce any value for the company..

And then one more for me. The Richmond asset that you sold, again, just remind me again, the sales price. And it sounds like you had a top 10 tenant in that building. Why they going to -- it didn't make sense to hold onto that, wasn't really the pricing -- the attractive pricing that kind of influenced you to kind of sell it..

Yeah. I mean, that wasn't part of our original plan to sell it. And again, as we continued to evaluate options -- again, I think, I mentioned the lion's share of that building is currently sublease. I think for us, there was real risk of vacancy on the horizon. And also at that building, it was a built a suit for the tenant at the time.

And we expected there to be a roll down in rent. And so as we started looking at it, we ultimately decided that based on the offer we see, which was extremely attractive, it was a better opportunity for us opportunistically to sell that and focus on redeploying that in something more stabilized..

And you said it was a 360 backlit ?.

Cash contribution yield. Yeah..

Cash contribution yield? Perfect. Thank you..

Thank you..

The next question is from Jamie Feldman with Bank of America/Merrill Lynch. Please go ahead..

Great. Thank you. I just wanted to make sure I heard you right on some of these FFO moves. So, you had said, 122 to 124 in the first quarter. And then were you saying sequentially you lose about $0.12 to get to the second quarter number of like 110 to 112.

Is that the right way to think about it?.

That is correct. .

Okay.

And so, I mean, how long do you think you stay at that level? Like, what are the offsets that give you a little bit of upside from that 110 to 112?.

Yeah. I'd say that our 2021 forecast is pretty conservative. We do have a very healthy lease pipeline that Chris highlighted in the prepared remarks. So, we are successful on some of that leasing activity that should help us. In addition, on the capital recycling front, we've sold a lot more than we've acquired.

So, if we can find acquisition opportunities, we'll see some upside there as well..

Okay.

And does that include the G&A benefit you mentioned on the call?.

It does. Yes..

That's baked into the 122 to 124?.

That’s right. And that really fluctuates quarter-to-quarter. In Q2 of each year, we have trustee share grant expense. So, G&A will naturally increase from the Q1 level that I had highlighted..

Okay. So that's a further drag into to 2Q..

Yes..

How much do you think that goes up?.

A penny..

So, if you're at this 110 to 112, I guess one 109 to 111 for the second quarter, how do you think about dividend coverage? I know you've sold stuff. That's kind of higher CapEx.

Where do you think your CAD payout ratio ends up trending?.

For 2021, we expect it to remain well covered. It'll be expected to be just north of 75%..

Okay. All right. That's helpful.

And then as we think about, both 2021 and 2022, I mean, what are the largest still unknown or potential vacancy risks -- potential move-outs in 2021 and 2022?.

Well, for 2021, the big four that we've highlighted are still stands. You probably saw that our expiring analyze revenue increased into -- this quarter for 2021, which was largely attributed to some tenants holding over. And so we think -- as we think about that added, let's call it, 2% increase in expiration this year.

There's only 30 basis points of that at risk. And those were known vacates that didn't conclude at the end of 2019. So, that's just more carryover. So, I don't think there's any real change to 2021. And same for 2022.

I mean, I think we've talked about the kind of the bigger exploration risk in 2022 and outside of that, at this stage, we don't necessarily have anything meaningful to report on..

Okay.

And then for 2021, do you have anything beyond the 7% of move-outs you highlighted in the third -- on the third quarter call?.

Yeah. There's probably another 30 basis points added to that..

Okay. But that's included in what you gave for the second quarter in terms of the drag on earnings..

I'd say of the expire -- of the expiring annualized revenue, we have 7.3% at risk or expected to vacate for 2021 and with respect to the earnings..

Yeah. I mean, I think the biggest drag on Q2 is the 20 Mass Ave vacancy at March 31. There's nothing else significant impacting Q2 forecast on a vacancy side..

Okay.

I mean, are there more vacates in the back half of the year? Or everything is already in by the second quarter?.

No. We have -- I mean, we've highlighted -- I mean, Technicolor is August. We have the Fresno, tenant that expires in November. There's conversations that they may continue into early 2022, but our forecast assumes that they don't. And so, those are the larger ones on the back half..

Okay.

And so what are your expected to vacate in 2022 on a percentage basis?.

Right now, the only one that we're tracking is the building in Seattle with that size..

What percentage of that is that?.

It’s about 2.2% of annualized revenue. And I would say with that building, while the tenant is expected to vacate, which has been something that we've communicated historically and have been in front of. I think, in general, we're pretty optimistic about the potential for that with alternative uses in addition to just office.

And so, I think, as we think about that, there's a real opportunity to put some of these proceeds to work, which could again, put us in a position where we're getting attractive yields kind of in the high single digits as strategies outside of just acquisitions..

Okay. And then, I guess -- sorry to jump around here.

But then for the -- if -- so with Huntsville, does that mean that the third quarter can go even lower than that 110 to 112? Like, I guess, I was thinking that 110 to 112 is your bottom for the year, but it sounds like maybe you go even lower than that before stabilizing?.

No. I think that's a pretty good run rate where Q2 ends up..

Okay.

And then, I mean, what would you say is your portfolio mark-to-market right now?.

As far as on rental rate?.

Yeah. I know rents have moved in most markets..

They have. I mean, if you think about -- we originally thought we would end 2020 at 2% to 3%, and certainly, ended the year at roll up of just under 7%. I think, based on our pipeline today, I think we're kind of seeing that trend in the range of, let's just call it 4% to 5%..

4% to 5% below?.

Increase..

Increase? Okay. Got it. And then, as you think about your just kind of sources and uses, I know you said the 100 to 300 of acquisition activity.

But how do you think about your capital position today? And if you do any more dispositions, just kind of -- when you think you'll need capital again?.

We have $900 million of liquidity. So, we have a lot of cushion to find acquisitions to source. In addition, we do have some properties in the market for disposition as well. Well, not material, but it could increase our liquidity position..

Yeah. We would also use proceeds for kind of the redevelopment, like 20 Mass Ave and some other strategic opportunities as well, in addition to just acquisitions..

But that's in addition to the $100 million to $300 million, the redevelopment spend?.

With respect to just kind of being a net neutral, meaning buying 300 and selling 300, is that what you're referring to?.

Well, no. You said earlier that $100 million to $300 million of acquisition seems about right for a given year. I assume that….

That was capital recycling. That was disposition..

Capital recycling?.

Yeah..

Okay.

Do you include -- are you talking about the redevelopment spend in that $100 million to $300 million or there's an additional capital spent?.

It'd be additional..

So like what's your total capital expected spend this year on the redevelopment side?.

If we do move forward with the 20 Mass Ave redevelopment, it's about $60 million..

Develop project?.

In 2021..

We're targeting cost for that project before leasing at $150 million. So, the balance would be in 2022..

Okay.

And any other big projects in the portfolio that you're thinking about?.

No. Not at that scale..

Okay. All right. Great. This is really helpful. Thank you..

We appreciate your time..

Thanks..

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

Thank you for joining us today. We look forward to updating you on our progress this year and hope to see many of you at the upcoming conferences and events..

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