Good morning and welcome to the Office Properties Income Trust First Quarter 2021 Earnings Conference Call. [Operator Instructions] I would now like to turn the conference over to Olivia Snyder, Manager, 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 Operating 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 first quarter of 2021, 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, Friday, April 30, 2021 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, cash available for distribution or CAD, adjusted EBITDA and cash basis, net operating income or cash basis NOI.

A reconciliation of these non-GAAP figures to net income 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 and cash basis NOI.

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. Now I will turn the call over to Chris..

in our Plantation, Florida property, the GSA lease expires in April and represents 80 basis points of annualized revenue. We had previously disclosed, the tenant vacating upon exploration, however, the tenant has been selected to holdover for upto 12 months and we anticipate continued occupancy through Q4 2021.

Despite this holdover activity for private sector leasing has been strong with several larger users having enquired into the building.

With our property in Fresno, California, the GSA is scheduled to expire in November, reflecting 1.5% of annualized revenue, plans for the tenant to vacate remain, however, we are actively marketing the property for sale and we anticipate an update on our marketing efforts will be available on future quarters.

And lastly for our property located at 20 Massachusetts Avenue in Washington DC, the tenant representing 2.8% of our annualized revenue has vacated the building on March 31 as originally disclosed and plans continue for advancement of a redevelopment of this property.

We continue to work through our plan and look forward to providing progress updates on activity as it materializes. Overall we are pleased with the activity we're seeing across the portfolio and trend of three consecutive quarters where our leasing pipeline exceeded 3 million square feet.

Before I turn the call over to Matt, I would like to highlight that OPI recently received the 2021 ENERGY STAR Partner of the Year Sustained Excellence Award.

This is the fourth consecutive year that we have achieved Partner of the Year recognition and the second year, we have earned the sustained excellence designation in the energy management category. We are proud of this effort and commitment to our sustainability initiatives across the RMR organization.

I will now turn the call over to Matt Brown to provide details on our financial results.

Matt?.

Thanks, Chris, and good morning everyone. Normalized FFO for the first quarter was $61.8 million or $1.28 per share, which beat consensus and the high end of our estimate by $0.04 mainly due to NOI coming in higher than forecasted. CAD for the first quarter was $47.7 million or $0.99 per share.

Our dividend is well covered with a rolling four quarter CAD payout ratio of 59%. G&A expense for the first quarter was $11.3 million, which includes $5.2 million of estimated business management incentive fees.

Excluding the estimated incentive fee, G&A expense was $6.1 million compared to $7.1 million for both the same period last year and the prior quarter, neither of which included any estimated incentive fee expense.

The decline sequentially is mainly due to elevated costs in the prior quarter due to share grant accelerations from the retirement of three RMR officers and $450,000 of rent expense related to a lease obligation that expired on January 31 as discussed last quarter, which resulted in a favorable impact of $300,000 in the first quarter.

Incentive fees under our business management agreement with RMR are payable after the end of each calendar year in which they are earned, but are recognized in the calculation of net income in accordance with GAAP in the first, second and third quarters if applicable.

We do not include such expense in adjusted EBITDAre or normalized FFO until the fourth quarter, when the final incentive fee amount is determined. The incentive fee accrued in the first quarter is based on OPI's total return in comparison to the SNL US REIT Office index over the three-year measurement period, which commenced on January 1, 2019.

OPI outperformed the index by approximately 15% with a total return of 22.4%. This equates to an annualized estimated incentive fee of $20.8 million, which represents the cap of 1.5% of our equity market capitalization.

The incentive fee accrual may increase or decrease over the remainder of the year depending on how OPI performs relative to the index.

Interest expense for the first quarter was $28.8 million, which was flat sequentially and up $1.6 million from the prior-year period, primarily due to proceeds from the issuance of $412 million of unsecured senior notes in 2020 that were used to repay amounts outstanding on our revolving credit facility, partially offset by secured debt repayments of $152 million during 2020.

Turning to property level results for the quarter. Same property cash basis NOI decreased $1.6 million or 1.8% compared to the first quarter of 2020, slightly outperforming our guidance range of negative 2% to 4%.

As expected, the decrease was mainly driven by a reduction in rental income of $1.4 million, most notably due to the Tailored Brands lease restructure and a decline in parking revenue of $690,000 due to the pandemic as well as an increase in snow removal costs of $1 million, partially offset by lower utility and cleaning costs.

Turning to normalized FFO and same property cash basis NOI expectations. We expect second quarter normalized FFO to be between $1.11 and $1.13 per share.

As highlighted on last quarter's call, the most significant declines from Q1 are driven by the following; $0.08 due to the expiration of the GSA lease at 20 Massachusetts Avenue; $0.05 due to the dispositions of our Huntsville, Alabama property in April and our Richmond, Virginia property in January and other known vacancies we have discussed; and $0.02 due to Trustee compensation expense in Q2 and higher business management fees based on our current share price.

We expect second quarter same property cash basis NOI to decline between 3.5% and 5.5% as compared to the second quarter of 2020. Turning to capital expenditures in the balance sheet.

We spent $11.5 million on recurring capital during the first quarter and we expect recurring capital expenditures for the full year to be between $75 million and $80 million. At March 31, our leverage was 5.7 times. We currently have more than $930 million of liquidity, including full availability under our $750 million revolving credit facility.

We have no debt maturities until February 2022, when $300 million of unsecured senior notes mature, which become pre-payable without penalty in December 2021. In closing, our balance sheet remains strong and despite pressures from the 2021 vacancies that we have discussed, we expect our dividend to remain well covered.

Operator, that concludes our prepared remarks. We're ready to open the call up for questions..

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

Couple of quick questions. On the Boston property that you bought, we noticed it's 45% leased currently. Two questions on that.

Is there any opportunity to increase that occupancy until you move towards redevelopment or should we just expect it to stay there? And secondly, is that occupancy, did that kind of weigh down the portfolio? We noticed a modest downtick in total portfolio occupancy.

Is Boston responsible for that?.

Bryan, this is Chris. I think on the first part of your question, certainly, the goal is to go after short-term leases in the interim, while we evaluate a larger plant for the consolidated assets that we put together in Boston and so I think some of the space within that building is relatively turnkey.

So we expect that, we won't have any challenging with the kind of improved leasing on a short-term basis for that project. And then with respect to occupancy, no, I wouldn't say that that project will weigh down occupancy, I mean that's scheduled to close in May.

And then I think from the change in occupancy from Q4 to Q1, it's really driven by some known move outs at a building in the Chicago submarket where two tenants vacated.

One vacated just as part of this natural expiration and the other vacated given - as part of a renewal in downsize, so we've got a long-term renewal on a larger portion of the space in the balance - the downsize vacated..

And then, thanks for that update on the four big properties for this year, but on Mass Ave, with that property now vacated, I'm assuming you guys are definitively moving forward to redevelopment, correct me if I'm wrong there? And if that's the case, can you give us an updated on your thoughts on cost and timing.

Has that changed since you last discussed it?.

Yes, the plan right now is to continue to move forward and with respect to timing, this is looking for a Q1, 2023 deliverable. And total construction costs are about $150 million and then with leasing it's upwards of about $200 million, and we were targeting about an 8% to 10% cash return..

Okay. And then last from me, you touched upon your acquisition pipeline. I think you might have said it's around $400 million. How competitive is the bidding there and rate basis. And is that expected to grow meaningfully, the potential opportunity.

And do you see the cap rate shifting upward downward, what's going on bigger picture in the economy and all the discussion regarding the needs for office space?.

Yes, I mean I think the cap rates for the type of assets that we're looking at, those kind of with long-term leases credit tenants or other synergies around market have continued to remain competitive. And so there's not been a material shift in cap rates, other than there is just a lot of capital chasing similar type assets.

And so I would say that for some of the assets that we have been looking at and active on the smaller deals, just have a lot of different type of buyers chasing that and so it just becomes extremely competitive, and then some of the larger deals, I think it's very similar, but cap rates are really going to be consistent based on marketing kind of some of the parameters around that.

I think we've targeted cap rates in 6% to 7%. I think we showed some of that with the acquisition in Q4 of the building up in the Charlotte MSA. But as we look at other opportunities, I mean we're seeing cap rates that are 5% and 6% as well.

So I think it's really kind of part of a multi-tier strategy where we're going to start buying some properties that are lower and others that are at the higher range to kind of get to the balance we're looking for..

The next question is from Elvis Rodriguez with Bank of America. Please go ahead..

On your - your lease percentage went down, but yet you had the big tenant move-out at quarter end. I'm just curious, was that tenant included in the numbers or not included in the numbers. Just wanted to make sure..

When you say the occupancy went down..

The lease percentage went down about 40 basis points, but you lost, call it a 220 basis point tenant at the end of the quarter, but just wanted to make sure if that tenant is included in the numbers or not.

And should we see that come out in 2Q?.

Yes, I mean I think that for the quarter, with that March 31 exploration, we recognize that through quarter end, and so, we'll see that drop off in Q2..

Great. And then, with that, are you able to share trajectory. What will happen with occupancy throughout the year.

Obviously it's going to dip in 2Q, but where do you see sort of occupancy ending at the end of the year?.

I mean at the end of the year, there is a couple of different factors that are going to impact that kind of most notably around some of the dispositions that we're looking at.

We've talked about Fresno, that's 500,000 square feet and so certainly if that building transact that will have a favorable impact to occupancy, if they vacate in November that will have a negative impact on occupancy.

But I think right now, with that said aside, I think occupancy for us is looking at 89%, 90%, assuming kind of all other factors align..

Great, that's helpful. And then I just have a couple of more questions, but I'm happy to hop in the queue after this next one. You took a $0.16 impairment in the quarter. I know you highlighted a bid on it in the Q, but maybe if you can share any details, just so we have it here on the call. That will be helpful. Thank you..

Yes, the impairment charge in the quarter was related to the two properties that we had classified as held for sale at quarter end. One of which was the Huntsville, Alabama property that we sold in April for $39 million..

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

I had a question just on the Boston acquisition. So I guess last quarter you guys acquired the property in Boston that was close to sharing walls with one of your existing properties and now it looks like this quarter you did as well and both last quarter and this quarter, the occupancy rate on those two properties was lower.

So I guess is this new acquisition in that same area with the one from last quarter in your existing assets.

And I guess if you are building scale there, what's the long-term goal?.

So the acquisition is one and the same, it's just been delayed with respect to closing given kind of some ongoing diligence at the property. So it's the same asset. And then really what this does is that gives us about 0.7 acres within kind of a combined parcel, and I think the goal is just to evaluate what our options are.

I mean we do have leases in place with the adjoining buildings that have some term on them, which gives us plenty of runway to evaluate decisions and see where the market goes. So in the near term, I think we would benefit from those in-place leases while we kind of evaluate plans.

And so my guess is that any updates on opportunity for this project are likely going to be something we would see maybe next year, but a big - a major repositioning here is pretty far out..

Okay. And then could you provide some color on the leasing pipeline. It sounds like it dropped about 700,000 square feet since last quarter.

So just wondering if that's all due to leasing activity?.

Yes, it is. I mean I think in par we converted $575,000 to execute deals. And so we're left with $3.1 million and so that pipeline generally ebb and flow, but as I noted, I think it's been consistently above $3 million for three quarters which is on the high end of the range when you kind of look back over the last couple of years..

The next question is from Vikram Malhotra with Morgan Stanley. Please go ahead..

Thanks so much for taking the question. Good morning, everyone. Maybe just first to clarify on the CapEx that you plan for this year. I think it's modestly lower than the last call where you said about $85 million. So just wondering if there has been a push out or just a change in plans.

What's the difference?.

Yes, the difference is really timing of expected leasing capital being pushed out. That's really caused the number to come down $5 to $10 million from our initial projection..

Got it, okay.

And then the occupancy target that you have, does that assume the sale of certain assets specifically Fresno?.

Not Fresno. There are some assets in the pipeline albeit much smaller in size. But that does not assume Fresno. So I think that was - Fresno would increase or help increase occupancy if that were to increase..

Increase, okay. Okay that makes sense. And then just two more quick ones. Just overall, the incentive fees that you had this quarter, I know it's a calculation every quarter, but if you include the incentive fees assuming like the next two quarters, you still have to - there is still an allocation.

What is the dividend kind of coverage post the incentive fees?.

Sure. So our year-end projection right now, including the $28 million incentive fee would be a payout ratio of about 84%. Excluding the incentive fee, that payout ratio will be about 72%..

Got it.

And that's on a FAD or a CAD basis?.

That's right..

Okay.

And then just last one, if you could just clarify, you outlined, obviously last quarter all the vacates, but I'm just wondering over the next, like 12 to 18 months have there been any moving pieces to the vacates that you had outlined like last quarter, if you could just clarify the larger ones in the magnitude?.

Yes, I mean, I think, last quarter, we talked about the known vacates and where we are today for 2021 where that 7.2% of annualized revenue is still the target and again that's going to come down as the 20 Massachusetts kicks in with the next quarter.

And really the four assets that we continue to go - talk about, represent over 6% of that total number. So other than that, it's just smaller moving pieces across the portfolio. So that's what we expect for 2021..

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

Yes.

The $3 million leasing pipeline, could you break that out in regards to what's new leasing versus what's potential renewals?.

So it's probably 60%-40%. So 60% renewal, 40% new leasing..

Okay. That's helpful. And then the Bank of America lease, it's one of your top five tenants. It looks like there was a sequential decline in the annualized rent.

Was there a reduction of space associated with BoA?.

Yes. Bank of America was one of the tenants that expired December 31, which was a known vacate, and so that was I think close to 40,000 square feet or $700,000 that fell off at year-end..

Then just to clarify the renewed but took less space going forward or just - is that what happened?.

Can you repeat that?.

Was it that they just moved out of that particular space and the remaining balances for other space to have within the portfolio?.

Correct, yes. So, Bank of America, we have various locations with them and so that was one of the spaces that they moved out of..

The next question is a follow-up from Elvis Rodriguez with Bank of America. Please go ahead..

Just one more on the incentive fees being backed out of FFO.

Can you just share what you've done historically with these incentive fees and how you'll recognize these in the future?.

Sure. So for recognition in net income, the $5.2 million is part of that which is the accrual at March 31.

We don't include any estimated incentive fees in Q1, Q2 or Q3 in our normalized FFO or adjusted EBITDAre metrics, because they are just estimates during the quarters and the fee can be pretty volatile quarter-to-quarter depending on our share price performance relative to the peer group.

So when we calculate our final fee at the end of December 31 of this year, any fee will then be deducted from normalized FFO and adjusted EBITDAre at that time..

So we should see - so we should be adjusting our models for, call it, a $20 million fee in 4Q.

Is that correct?.

That's right, yes..

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