Good morning and welcome to the Office Properties Income Trust Third Quarter 2021 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Kevin Barry, Director 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 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 third 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, October 29, 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. With that, I will now turn the call over to Chris..

Thank you, Kevin and good morning. Welcome to the third quarter earnings call for Office Properties Income Trust. Yesterday, we reported third quarter results that reflect continued execution on our financial and operating objectives.

Normalized FFO came in at $1.24 per share, exceeding the top end of our guidance range and consensus estimates for the quarter. Same property cash basis NOI grew 1% year-over-year and also performed better than expected.

We took action to strengthen our balance sheet with two bond offerings that favorably impacted our debt maturity schedule and we ended the quarter with more than $800 million of total liquidity.

Our portfolio continues to perform well and we remain well positioned to advance our core business strategies focused on the enhancement of the overall quality and geographic footprint of our portfolio through our capital recycling efforts, driving healthy portfolio absorption, cash flow growth and retention through proactive asset management and leasing, strategic development or major repositioning of properties providing for higher-risk adjusted returns and continued advancement of our sustainability initiatives across our portfolio.

Turning to our portfolio reshaping efforts. We are making steady progress on our capital recycling program. As a reminder, our focus is on reducing OPI's aggregate capital needs, improving the average age of our properties, better positioning properties in strong markets to grow rent and improving the likelihood of lease renewals.

To that end, we continue to market properties representing close to $275 million in value, with an average age of 23 years and average occupancy of 61% and a negative five-year average cash contribution yield.

We intend to use these proceeds to both reduce leverage following our recent investment in two core properties located in Chicago and Atlanta and to reinvest into our portfolio.

Year-to-date, we sold six properties for $227 million that contained approximately 2.6 million square feet at an average age of 25 years and average occupancy of 96% and a weighted average lease term of 1.2 years.

As a result, we have eliminated approximately $98 million of budgeted capital over the next five years with a negative five-year average cash contribution yield and accretive outcome with our reinvestment of these proceeds. Turning to an update on our leasing results.

We reported solid leasing momentum with 659,000 square feet of new and renewal leasing, an increase of 37% above the trailing 12-month average, along with a weighted average lease term of 10.9 years and leasing concessions and capital commitments of $6.40 per square foot per lease year.

New leasing activity increased sequentially and represented more than 40% of our total Q3 activity. Rent roll-up for the quarter was flat, however, year-to-date we are up 7% and continue to trend in line with our projections.

We ended the quarter with consolidated occupancy of 89% and our total leasing activity improved OPI's overall portfolio remaining lease term to six years.

Since last quarter, we have seen an uptick with tenants and their employees returning to the office with utilization across the portfolio increasing to 38% and we anticipate this will continue to escalate through the remainder of the year and in the early 2022.

We remain focused on proactive communications with our tenants to be a landlord of choice as they continue to evaluate their needs upon re-entry. These efforts focus on both near-term expirations along with strategies for expiring tenants over the next several years.

Representative outcomes of this effort include a 13-year renewal and downsize with micro focus at top 20 tenant expiring in 2024, complemented with a new lease to a University for Health Professionals for 170,000 square feet with a 15-year term, providing additional stability with a combined term at the property in excess of 13 years.

In Sunnyvale, California, we completed a 10-year renewal with a full building user for 96,000 square feet with an original expiration in late 2022. In Chesapeake, Virginia, we completed a renewal with our full building tenant for 107,000 square feet and a term of 5.8 years.

Our leasing pipeline remains robust with discussions covering more than 3.6 million square feet with a healthy mix of new and renewal activity with attractive lease term and proposed rent roll-up.

This includes more than 670,000 square feet in advanced stages of negotiation, with an additional 172,000 square feet that has since been executed subsequent to quarter end.

This is the fifth consecutive quarter where our leasing pipeline has been in excess of 3 million square feet, which highlights the growing interest from tenants across our portfolio. We currently expect to finish the year with occupancy around 89% and a 5% to 7% roll-up in rent. Turning to progress on upcoming expirations.

We continue to make progress with our upcoming expirations and known vacates, supported by a healthy lease pipeline inclusive of 1.4 million square feet or close to 6% of potential absorption across the portfolio.

For 2021 expirations, we've previously discussed the vacancy of our GSA tenant located in Plantation, Florida and have since signed a new lease this quarter for 70,000 square feet with a 10-year term, which represents over 50% of the building.

Activity within this market remains robust and we are in conversations with various tenants, presenting a positive outlook for further leasing within the building. In Sacramento, California, the State of California will be vacating roughly 158,000 square feet in November 2021 representing less than 1% of annualized revenue.

This class A building is located in Sacramento CBD is one block from the Golden 1 Center, the home of the Sacramento Kings and entertainment district. The building amenities and elite platinum designation make it an attractive destination for space not previously available in the market.

We have varying levels of activity for the building, including conversations with state agencies and private sector tenants. And as previously disclosed, F5 a tenant in Seattle, Washington representing 2.2% of annualized revenue will be vacating in 2022 and we have plans for a redevelopment of this campus, which I will highlight in a moment.

Turning to our development. We continue to make steady progress on our redevelopment project at 20 Massachusetts Avenue in Washington DC and remain on track to deliver in Q1 2023.

The development is currently 54% pre-leased and we have varying levels of early stage interest from a variety of tenants, including technology, consulting services, legal and related uses and look forward to providing updates in future quarters.

We are also advancing plans to redevelop our property at Elliot Avenue in Seattle, Washington that is currently leased to F5 through July of 2022. Our plan for this 300,000 square feet campus is to convert two of the three buildings to life science, while maintaining an office use for the third building.

The greater Seattle market continues to climb the rankings as a premier life science cluster, giving us access to venture capital funding major universities, access to an educated talent pool, combined with this existing tech presence.

Rental rates for life science users have increased more than 15% year-over-year and current demand continues to outpace supply in the market. We feel we are well positioned to deliver a Premier class A development, offering an extensive amenities package, campus connectivity with an outdoor experience and both LEED and Fitwel certifications.

Our current schedule includes commencement of construction in 2022 with a planned delivery in early 2023. Total construction on leasing costs are expected to be close to $140 million, generating a stabilized return on cost of 10% to 12%.

Currently, we are in advanced stages of negotiations with tenants representing close to 60,000 square feet, a solid start towards advancing this development. Turning to operations. We are proud of the progress we continue to make enhancing OPI's energy and sustainability program and remain fully committed to elevating our ESG profile.

In 2021, our real-time energy monitoring program has yielded close to $1.7 million and year-to-date cost savings.

We are on track to end the year with approximately 5.7 million square feet of LEED certified building, an increase of 1.25 million square feet and plans continue toward advancement of these initiatives in the 2022, along with the introduction of new programs such as Fitwel strategies across the portfolio.

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 third quarter was $59.6 million or a $1.24 per share, which beat consensus and exceeded our guidance. CAD for the third quarter was $30.9 million or $0.64 per share, resulting in a rolling four-quarter CAD payout ratio of 69%.

G&A expense for the third quarter was $448,000, which includes the reversal of $6.6 million of previously accrued estimated business management incentive fees. This reversal represents the amount that the estimated incentive fees as of June 30th exceeded the amount estimated as of September 30th.

Excluding this reversal of fees, G&A expense was $7.1 million, consistent with the same period last year and the prior quarter. The incentive fee accrued is based on OPI's total return in comparison to the Index over the three-year measurement period. OPI outperformed the index by 3.8% with a total return of 18.7%.

If September 30th was the end of the measurement period, the incentive fee owed to RMR will be approximately $6 million. The incentive fee accrual may increase or decrease over the remainder of the year depending on how OPI performs relative to the index.

As a reminder, incentive fees 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.

Interest expense for the third quarter was $26.9 million, a decrease of $2.1 million from the prior quarter, primarily due to our accretive bond offerings in May and August and subsequent redemption of higher interest rate debt.

In September, we issued $400 million of 3.45% 10-year bonds and used the proceeds to repay all amounts outstanding on our revolving credit facility. We expect interest expense to be between $27 and $28 million during the fourth quarter.

These debt refinancing activities have strengthened our balance sheet, increased the weighted average remaining term of our debt to approximately six years and reduced our weighted average cost of fixed rate debt.

In aggregate, these 2021 opportunistic offerings raising over $1 billion in proceeds will result in net interest expense savings of $5 million annually. We ended the quarter with more than $800 million of total liquidity including full availability on our $750 million revolving credit facility.

We expect fourth quarter normalized FFO to be between a $1.17 and a $1.19 per share excluding incentive fees that impact normalized FFO in the fourth quarter and a $1.5 to a $1.7 per share, including our current estimates of incentive fees of $6 million, which represents $0.12 per share. Turning to property level results for the quarter.

Same property cash basis NOI increased 1% compared to the third quarter of 2020 and came in better than our guidance range of flat to down 2%.

This increase was primarily due to a decrease in operating expenses of $1.1 million, mainly a decrease in real estate taxes as a result of successful appeals and reductions in assessed value at certain of OPI's properties in 2021, as part of RMR's abatement program and lower repairs and maintenance costs.

The RMR managed real estate tax abatement program has saved OPI approximately $7.5 million since the beginning of 2018. We expect fourth quarter same property cash basis NOI to be negative 1% to negative 3% as compared to the fourth quarter of 2020. Turning to capital expenditures and the balance sheet.

We spent $26.3 million on recurring capital and $13.3 million on development capital during the third quarter. The main contributor of the development spend was from our 20 Mass Ave project that incurred $11.3 million in the quarter. We expect recurring capital expenditures for the full year to be between $75 million and $85 million.

At September 30th, our leverage was 7.3 times. We expect to dispose of non-core properties under our capital recycling program to repay debt and manage our leverage levels and have approximately $300 million of properties in various stages of disposition, including two vacant land parcels that were sold earlier this week for $28.5 million.

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

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

Good morning, Chris and Matt. A couple of questions from me.

Starting with the point of clarity, on the Plantation, Florida property, I think you mentioned in your prepared comments that you released about half of this space, 70,000 square feet for 10 years, was that back to GSA or is that to another tenant?.

Yes to a private sector tenant, Bryan..

Okay.

So is GSA still planning on vacating the whole building and do you have a date for that?.

So they are. And so I think right now we had originally talked about them vacating the full building in December of this year. It looks like that now trickling into early next year with them to vacate. So that would leave approximately 65,000 square feet that they would vacate kind of when you net out the new lease we've done..

And then you talked a lot about - you have $800 million in liquidity, you want to keep an eye on your leverage, which I think is at 7.3%. In conjunction with those two things, what is your acquisition appetite going forward.

And I know to some extent it has to do with successfully closing on the $300 million of dispositions that you have in the pipeline, but can you give us some view as to what you expect over the next two, three, four quarters?.

We can kind of talk, Matt and I. I would say, we're just coming off the two acquisitions, which we've discussed and certainly have kind of jumped into the deleveraging program supported by our capital recycling.

As noted, we have the $300 million that we're currently focused on and kind of continue - want to continue to advance that going into next year as well. And so that you'll continue to see. I think from an acquisition standpoint, we're always kind of looking in the market.

I think it's a little bit kind of more tame today just given that we don't necessarily have a big of a pipeline of acquisition opportunities just because of where we're focused and kind of the markets we want to be in. And so, I think it's going to be somewhat muted kind of in the near-term versus kind of having a broader acquisition strategy..

Okay. And then you talked a little bit about the expirations coming up in the potential for releasing those and it seems like you are a bit ahead of the game, approaching 2022, '23 and '24.

Do you have any thoughts on what we might see kind of in aggregate as far as rent roll ups or roll downs go?.

I mean from a rent roll-up, we're targeting the 5% to 7% this year.

I think our pipeline is showing good roll ups, but I think we're going to kind of have to wait till we get into next year to see how some of that shakes out, I mean, there's still a lot of moving pieces with tenants getting back into the office and kind of finalizing decisions around space and some of that may impact the overall metrics downstream.

But I think for the most part, we feel pretty good about where we're going to end the year and so far it looks like we're continuing down the path with roll ups of these what our pipeline has currently..

Okay and then just last from me. As it relates to what we're hearing in the marketplace regarding supply chain issues, inflation costs, etc. Is that impacting at all what your cost thoughts were for 20 Mass Ave, which is underway and Seattle, which you're going to embark upon next year? And that's all from me..

So for 20 Mass Ave, I mean, we have contingencies with the project no different than Seattle. And so I think we have what we feel like we have a pretty good cushion. I think in some aspects, there's been some increase in pricing, but I think for the most part of 20 Mass Ave, we really went into that project, which we started earlier this year.

So kind of in the midst of what was - we're already seeing kind of some of the logistics challenges. And so I think for now, we feel pretty good with where our budget is and how things are trending including kind of the delivery timeframe. And then it's the same thing with Seattle, with us kind of moving forward on that project.

Our pricing has largely taken into consideration where things stand today and what we foresee kind of in the near term with respect to the actual schedule. And so I think we feel pretty good today about where those costs are..

[Operator Instructions] The next question comes from Ronald Kamden with Morgan Stanley. Please go ahead..

Just a couple of quick ones. The first one was I think I heard the same-store NOI guidance for 4Q was, I think you said down 3% to 4% apologies if I got that wrong, but just what's causing the delta between 3Q, which I'm looking at plus 1% versus that down 3% to 4%.

Is it all just known vacates or is there something else that we should think about? Thanks..

Hey, Ron. This is Matt. So the range that we provided was down 1% down 3%, it sounded like you may have heard 3% to 4%, but just to confirm, it's down 1% to down 3%.

We have a little bit on the revenue side from the vacate of the State of California that Chris commented on in the prepared remarks that's about $400,000 and then the rest is really on the expense side. We are forecasting some snow removal and then increases in utilities and cleaning from Q4 of 2020..

And then just switching gears to sort of acquisition and disposition. Just on the acquisitions - the acquisition in the quarter, what's the plan there, so it's almost 60%.

just curious what sort of the strategy there with that property?.

Yes. So, this is Chris. So that is really kind of a value add acquisition and really the plan there is we actually own two other properties adjacent to that, so combined kind of control the full block and kind of given its location, we felt like that was a great opportunity to just be in a position for, I guess, continued growth downstream.

I think as we look at that location. There's - I think there's opportunity for potential redevelopment, but that's certainly not something in the near term. So that really was the goal is just to kind of control that asset adjacent to our other two properties..

And then just on the disposition side, can you just maybe comment on who are the buyers, what the market - like who sort of looking at these properties and any comments on pricing would also be helpful, whether it's cap rates or you're seeing increased interest would be helpful. Thanks..

Yes. So I think from who the buyers are, I mean these - given kind of the size of these assets, a lot of these properties are kind of more local, local, regional groups, not necessarily institutional investors.

And so it really is a mix, just kind of given the fact that these properties, it's not necessarily a portfolio, but they're individual dispositions.

And so I think from kind of looking at the financial aspect, I would say that from kind of a cap rate for these assets and at least what we've sold, we're seeing kind of collective cap rates in between 7% and 8% and that can kind of vary on one side or the other depending on the circumstances.

And I think it's just kind of important to note that these are buildings we're selling as part of our capital recycling strategy because they're buildings that we feel like where we would rather maximized value.

These are buildings that are older in age, capital intensive and in some cases kind of have short-term vault and so by way of example from what we've sold to-date, as I noted, the weighted average lease term was 1.2 years.

And so as we look at this program, it really kind of complements the broader strategy with respect to kind of where we're acquiring properties, at the cap rates we've talked about historically and kind of when you look at NOI minus capital, looking at economic yield, it turns out to be very accretive as a whole.

And then I think kind of the layer on the last pieces when you kind of round out the capital recycling where we're acquiring and then now looking at development and focusing on leasing of vacancy, we feel pretty good about some of kind of the yield spreads that we're getting across the spectrum, kind of what the overall plan for the company..

This concludes our question-and-answer session. I would like to turn the conference back over to Chris Bilotto, President and Chief Operating Officer for closing remarks..

Thank you everybody. We look forward to talking to many of you at NAREIT and will be in touch..

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