Good morning, and welcome to the Office Properties Income Trust Third Quarter 2022 Earnings Conference Call. [Operator Instructions] 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 2022, 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 28, 2022, 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, everyone. Welcome to the third quarter earnings call for Office Properties Income Trust. Last night, we reported a solid third quarter despite an evolving office landscape in a rapidly changing economic environment.

Same property cash basis NOI growth came in near the high end of our range, and we continue to experience strong leasing momentum. Our balance sheet remains well positioned with $629 million of total liquidity and no senior notes maturing until May 2024, which Matt will expand upon momentarily.

We completed 606,000 square feet of new and renewal leasing, including a new lease for 84,000 square feet to anchor our Seattle Life Science development. Portfolio occupancy continues to outperform the broader market and ended of the quarter at 90.7% a 130 basis points improvement over Q2 and a 170 basis point increase over the prior year.

During the quarter, we sold 10 properties containing 1.3 million square feet for $118 million at a weighted average cap rate of approximately 6.2%. Year-to-date, dispositions totaled $196 million at a weighted average cap rate of 6.8% and close to the high end of our 2022 guidance range.

Further, we have five properties totaling 338,000 square feet for $20.5 million in advanced stages with a target of close by year-end. We have planx to continue our capital recycling efforts into 2023 and are pleased with our ability to close on the note of transactions today. However, we remain cautious given the overall economic environment.

Investor interest remains mixed with a thinning pool of buyers due to higher inflation, interest rates and changing portfolio strategies. To date, we have not completed any acquisitions with our primary focus on leasing, operational efficiencies, completion of our existing development projects and property sales.

Turning to an update on the leasing results. We reported a solid leasing momentum with 24 signed leases for 606,000 square feet, including a 21.6% weighted average roll up and rent and a 7.2 year weighted average lease term.

New leasing increased sequentially and represented 37% of our total activity for the quarter, including a 59% roll up in rent, primarily driven by leasing at our Seattle development. At a macro level overall U.S. leasing activity is trending at just over 70% our pre-pandemic level, with gateway markets trailing the pace of secondary growth markets.

Leasing demand is largely attributed to higher quality buildings, those with market specific amenities and better functionality.

Over the past several years, our real estate and asset management teams have been instrumental in capital deployment strategies towards improving the quality of our portfolio, which has positioned our buildings to benefit from the current economic demand drivers.

Year-to-date, we completed over 1.8 million square feet of leasing with an 11% roll up in rent and a weighted average lease term of nine years. New leasing included 585,000 square feet or 32% of our activity to date. Turning to leasing and property highlights from the third quarter.

At our redevelopment in Seattle, Washington, we signed a new lease with a clinical stage biotech company for 84,000 square feet and a 10 year term. This lease is a strategic win, as an anchor for the project and demonstrate the ongoing demand for premium, well designed R&D space in this market.

In Naperville, Illinois, we executed a new 57,000 square foot lease at a 14.5% roll up and rent and a 12-year lease term.

Over the past year, our real estate team has strategically allocated capital to improve common areas and expand the amenity base, which has resulted in an increase in occupancy from 58% in Q4 2021 to 82% of the Q3 and supported by close to 145,000 square feet of new leasing activity.

And in Atlanta, Georgia, we renewed a mission critical GSA tenant for 91,000 square feet and a 15-year term. Looking back at the past few years the GSA activity, on average lease terms for new and renewal leases are 11 years and 7 years respectively, highlighted the GSAs commitment to properties within our portfolio.

Looking ahead to OPI's upcoming lease expirations, we have minimal remaining lease expirations in 2022 with 80 basis points of annualized rental income expiring by year end. Of this, 30 basis points as attributed to properties under contract for sale, estimated for a Q4 close. The balance of expirations are mostly expected to renewable.

In 2023, lease expirations represent approximate 14% of annualized rental income. Nearly 4% of our 2023 expiring rental income has either signed subsequent to quarter ends or is in advanced stages of lease negotiations.

Approximately 1% represents planned dispositions, including 60 basis points driven by an expected Q4 2022 sale of our property in Englewood, Colorado. We are in active conversations with tenants that make up the remaining 2023 expirations and net known vacates for the year are turning between 3% and 5% of annualized rental income.

It is worth noting that known vacates in 2023 predominantly expire during Q3 and Q4 minimizing the risk to 2023 operating results.

I would also point out that in addition to our active asset management re-leasing efforts and continued capital recycling initiatives, select known vacates are being evaluated for alternative use strategies to further diversify our portfolio and capitalize on compelling value creation opportunities as seen with our D.C.

and Seattle development projects. Looking forward, our leasing pipeline remains strong with a healthy mix of new and renewal deals, lease term and mark-to-market growth potential.

We are currently tracking approximately 3.2 million square feet of active prospects, of which, more than 1.3 million square feet is attributable to new leasing and 720,000 square feet of potential absorption. Turning to our developments. We continue to advance our value enhancing pre-development project.

Our development leasing pipeline includes over 223,000 square feet of active proposals. In Seattle, Washington, the project is now 28% pre-leased and we anticipate the delivery of our move-in ready spec space will further accelerate leasing at this project as we near completion. Construction at our 20 Mass Avenue Development in Washington D.C.

is also on time and on budget. Tour activity continues to progress, and we remain on track to deliver both our Seattle and D.C. projects in Q2 2023.

In conclusion, aggressive monetary policy inflation, along with the current interest rate environment, are weighing on market fundamentals and decisions around real estate needs, which we believe will continue to be a factor to 2023.

Our capital recycling efforts focused on upgrading and enhancing the overall physical quality and functionality of our buildings along with refining our geographical footprint is a further complement to the level of tenant interest and activity across our portfolio.

As we progress on core initiatives, we remain focused on leasing operational efficiencies, development and capital recycling and are pleased with our portfolio position, which includes 63% of our rental income coming from investment-grade tenants, a portfolio average lease term of 6.3 years and a well-positioned balance sheet.

I will now turn the call over to Matt to review our financial results..

Thanks, Chris, and good morning, everyone. Normalized FFO for the third quarter was $53.8 million or $1.11 per share. Our results came in $0.01 below the low end of our guidance range, mainly driven by the timing of property dispositions.

Earlier this month, we declared our regular quarterly distribution of $0.55 per share, resulting in a normalized FFO payout ratio of 50% and a rolling 4-quarter CAD payout ratio of 67%.

G&A expense for the third quarter was $6.6 million, which came in below our forecast and below the $7.1 million in Q3 2021 after excluding the reversal of previously accrued business management incentive fees in the prior year period.

These declines were mainly driven by a reduction in our business management fee as our share price has declined and highlights how the fee structure in our business management agreement with RMR is aligned with OPI shareholders.

Same property cash basis NOI increased 30 basis points compared to the third quarter of 2021 and came in at the high end of our guidance range.

The increase in our same-property results was mainly driven by higher levels of free rent in the prior year, partially offset by increases in operating expenses from higher rates and usage to support higher building utilization levels.

Looking forward to our normalized FFO and same-property cash basis NOI expectations in the fourth quarter, we expect normalized FFO to be between $1.08 and $1.10 per share. The decline from Q3 is mainly driven by our Q3 dispositions and in August lease expiration in a submarket of Denver.

For the full year 2022, we expect normalized FFO to be in the range of $4.71 and $4.73 per share. This guidance takes into account our planned disposition activity and includes a range of $24.5 million to $25 million of interest expense and $5.6 million to $6 million of G&A expense during the fourth quarter.

We expect same-property cash basis NOI to be flat to down 2% as compared to the fourth quarter of 2021. Turning to the balance sheet.

Our balance sheet remains well positioned in the current rising interest rate environment, the $1.1 billion of fixed rate refinancings that we completed in 2021 provided a solid foundation for us to deliver on our operating and redevelopment priorities.

At quarter end, we had $2.4 billion of outstanding debt at a weighted average interest rate below 4% and a weighted average maturity over 5 years. 97% of our debt is unsecured and 94% is fixed.

As a reminder, the company does not have any variable rate debt besides the revolving credit facility and our near-term maturity schedule is light with only $50 million of mortgage debt due in mid-2023. We have no senior notes maturing until May 2024.

While our revolver matures at the end of January 2023, we have the option to extend the facility for 2 additional 6-month periods and expect to exercise our first extension option next month. We ended the quarter with $629 million of total liquidity, including $615 million of availability under our revolver.

Subsequent to quarter end, we repaid a 4.8% mortgage with a June 2023 maturity at a discounted amount of $22.2 million using cash on hand, making this an accretive transaction. We are currently under agreement to sell 5 properties containing 338,000 square feet for an aggregate sales price of $20.5 million.

We spent $25.9 million in recurring capital and $36.8 million in redevelopment capital during the third quarter. For the full year, we expect recurring capital expenditures of approximately $100 million and redevelopment capital of approximately $180 million.

In 2023, we anticipate recurring capital expenditures to be flat year-over-year and redevelopment spend of approximately $100 million to $120 million as we complete our 2 ongoing redevelopment projects in Washington, D.C. and Seattle. Operator, that concludes our prepared remarks. We're ready to open the call up for questions..

[Operator Instructions] Today's first question comes from Bryan Maher with B. Riley FBR..

Chris and Matt. Just a couple for me. We were surprised by the 10 asset sales for sure in 3Q. And I think that you mentioned that the buyer pool is thinning.

Can you give us kind of what your level of confidence is on closing on the 5 that you talked about? And what your outlook is for kind of number of properties for 2023 and the ability to close on those?.

Yes. Thanks, Bryan. I think for the balance for the dispositions that we kind of noted in our prepared remarks, I think we feel pretty confident about those closing. Those are really in advanced stages under kind of PSA or LOI. And so at this stage, there's no reason to believe that they won't be able to close in Q4 and maybe in the turn of the year.

For 2023, we've talked about a couple of quarters ago, we pulled back on some dispositions, just to kind of see where the market is going, again, we're in a position where we can be disciplined and don't have to sell. And so right now, we're working through kind of what that list looks like to then determine what we want to put out in 2023.

So I don't know that we have a determined list of assets specifically, it remains fluid. But I would say that we've talked about kind of re-upping on dispositions and continuing where we slowed down this year, which was in the neighborhood of $300 million.

And so I think it's going to be very ebb and flow just as we watch kind of where the market goes..

And maybe a 2-part question. I think your leverage is around 7x or so currently.

Where do you want to take that, given the cash that you're going to receive from these asset sales? And how do you think about deploying capital in 2023? If the transaction market gets as tight as we're currently hearing generally across all our covered companies, might you expect to see some opportunities to act upon given your strong balance sheet? And what might those look like maybe from a type of asset and maybe geographic location?.

Bryan, this is Matt. I'll start on the leverage question and then turn it to Chris on capital use for potential acquisitions. Leverage 7x at Q3, looking at a trailing 12-month EBITDA base. We want leverage to get back in that 6x to 6.5x rate. We've been investment-grade rated and we want to remain investment-grade rated.

So that is our focus as it relates to leverage and our overall target. We are comfortable where leverage is today and running the business this way, but we do want to see that tick down over time..

Yes. And for acquisitions, I mean, as we've discussed, our focus is more so on just completing our developments, leasing and other related operational items. But I mean, I think in general, I mean, there's a handful of different markets we like. We like kind of the Southeast. We like the Pacific Northwest.

And it's just really going to depend on the opportunities. We see -- we generally see just about everything that's out there and there hasn't been a lot of activity with opportunities. But I think it's safe to say that cap rates are widening.

And as opportunities present themselves, we'll see them, and we'll be in a good opportunity -- or in a good position to kind of execute on that strategy.

But I think as we get into the turn of the year, and kind of see where things shake out, again, with our capital recycling and other initiatives, we'll then be in a position to kind of better quantify what that might look like..

Okay. And maybe just last for me. I mean clearly, where the shares are trading and the 15% yield on the dividend, obviously there's people out there in the market who don't believe that, that dividend is sustainable and yet you continue to highlight the low payout ratio either on CAT or on FFO.

What world would we have to be in for you to envision a period where that dividend would be sustainable?.

Yes, Bryan, it's a good question, and I'm glad you highlighted the low payout ratio we've had, which has really been a constant since the merger at the end of 2018. So we've been very satisfied with our dividend coverage and level.

I think as it relates to dividend coverage in the future and any risk to that, it really is going to be upon factors outside of our control with the future of Office in any potential recession. But where we are today, we remain very comfortable with our dividend..

[Operator Instructions] Our next question comes from Ronald Kamdem with Morgan Stanley..

Yes, Tamim on for Ronald. I just wanted to follow up on some of the development you guys expect to complete next year.

Could you walk us through kind of the cash and the GAAP NOI you expect from those 2 developments on completion?.

Yes. I mean I think right now, just as a reminder, for -- we'll start with 20 Mass Ave. We have kind of a cash-on-cash, stabilized return projection of between 8% and 10%. And so you can kind of use that as a good barometer with what we’re -- respect for kind of cash yields.

And then I think for Seattle, we're currently targeting 10% to 12% with respect to that asset. And so that's a good barometer with respect to cash yields. I mean I think from a GAAP perspective, it's going to depend a lot on what those lease terms look like as things shake out.

And what I mean by that is when you look at -- Seattle is a good example where we just signed the lease that we referenced in our script, the GAAP roll-up there was 109% increase albeit with the conversion to kind of life science. And that was a 10-year term.

But what we're also doing in that project as we're doing spec deliverable suites, and we would expect that the terms at that location would vary just depending on the circumstances. And so that would have an impact on the overall GAAP aspect. So it's a bit of a moving target..

And just a follow-up on that.

I mean do you expect any cash contribution from either of those properties next year?.

Cash contribution from the assets, I mean will be more in the form of mitigating some of the loss that's coming with the carrying costs on the expense side.

And so from a timing perspective, we have the lease signed at 20 Mass Ave, representing 54% of the project, and that's -- they're scheduled to take occupancy in Q2 but there's a free rent period that goes with that. As part of that free rent, they're going to pay their proration of operating expenses. So we'll mitigate any cash drag as part of that.

And then same with Seattle, while we're excited about signing the lease with Seattle, there's a timing for tenant improvements and prep to get into the space. And so we don't think they'll physically occupy the space until Q4 2023.

And at that point in time, there's a -- some free rent upfront, but the same story on the full building or the majority of the building will mitigate the cash drag given that they'll pay OpEx until they pay full rent at the turn of the year..

Got it. That makes sense. And then just on some of the debt maturities that are coming up over the next couple of years.

How are you thinking about that? Any chance you pay down the debt with some dispositions that may come? Or is it a plan right now just to refinance most of that?.

Yes. We're in a very good position right now with our balance sheet. We have $50 million of mortgages that are maturing in mid-2023. We'll likely use cash on hand and the line of credit to pay those off. And then our next maturity isn't until May of 2024. So we have plenty of time to be watching the market.

But right now, we're not going to try to accelerate paying off those, 24 is a good in-place rate and we'll kind of see the market settle and we have plenty of liquidity in the meantime..

And ladies and gentlemen, our next question today comes from [indiscernible] with RBC..

Sorry if I missed this in the beginning, but can you just give us a quick update on the leasing activity at 20 Mass Ave right now?.

The leasing activity, as I mentioned in the prepared remarks, we have a couple of hundred thousand square feet between the 2 projects, just shy of 100,000 square feet is attributable to 20 Mass Ave. And when we talk about lease activity, it's more in the form of a proposal stage.

And so in addition to that number, there's the benefit of the tours that are coming through the property. And so nothing far enough along to kind of speak to with respect to definitive timing, but I think on the positive, we're seeing kind of an increase in tours now that we're nearing completion and are starting to kind of trade more proposals.

So everything is trending in the right direction..

And ladies and gentlemen, this concludes our question-and-answer session. I'd like to turn the conference back over to Chris Bilotto for any closing remarks..

Thank you for joining us for your interest in OPI, and we look forward to speaking with you again soon..

Thank you. Ladies and gentlemen, this concludes today's conference call. We thank you all for attending today's presentation. You may now disconnect your lines, and have a wonderful day..