Good morning, and welcome to the Office Properties Income Trust First Quarter 2023 Earnings Conference Call. [Operator Instructions]. I would now like to turn the call 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 first quarter of 2023, 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, April 27, 2023, 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.

On today's conference call, we will be discussing the planned merger with Diversified Healthcare Trust in our prepared remarks. We have not yet filed a preliminary joint proxy and registration statement with the SEC, and therefore, will not be taking questions about the merger.

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; and cash basis net operating income, or cash basis NOI.

A reconciliation of these non-GAAP figures to net income are available in our enhanced earnings release presentation that we issued last night, which can be found on our website. We believe this combined presentation of information will be helpful for analysts and investors to efficiently digest information about our company and our results.

And finally, we will be providing guidance on this call, including normalized FFO and cash basis NOI.

We are not providing 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. I will now turn the call over to Chris..

Net known vacates for the balance of the year are trending close to 6% of annualized rental income. Approximately 80 basis points represents planned dispositions and the balance of 3.5% is expected to renew.

Our leasing pipeline includes approximately 2.7 million square feet of potential leasing activity, with more than 1.1 million square feet attributable to new leasing and 782,000 square feet of potential absorption. The outlook for our projected activity includes a rent roll-up of 6% to 8% and an average lease term of 8 to 10 years.

Turning to our developments. Our mixed-use redevelopment in 20 Mass Ave in Washington, D.C. is scheduled to deliver in the coming months. With the project near completion, we are encouraged by growing interest in tour activity and the proposals we are discussing with multiple prospective tenants.

The property is 54% pre-leased to an anchor tenant, the Royal Sonesta Hotel, which intends to begin welcoming guests to the flagship location this summer. Additionally, our life science redevelopment in Seattle remains on track to deliver later this year.

In addition to the 84,000 square feet signed at this property late last year, we will deliver one full lab building with move-in ready spec suites, providing a needed outlook for small to medium companies with near-term space needs and therefore, reducing the timeline for lease-up and acceleration of NOI performance.

Across both projects, our development leasing pipeline includes more than 170,000 square feet of active proposals. Beginning as early as June 2023, we will see gradual NOI improvement related to both projects as tenants began to reimburse operating and tax expenses during their free rent periods.

Before I turn the call over to Matt, I want to acknowledge the recent publication of the RMR Group's Annual Sustainability Report, which provides a comprehensive overview of our manager's commitment to long-term ESG goals.

We are deeply committed to enhancing OPI's corporate sustainability practices and continue to advance initiatives that will position the company to thrive over the long term. For example, we recently garnered recognition as an ENERGY STAR partner of the year for the sixth consecutive year and has sustained excellence on for the fourth year in a row.

This recognition underscores our dedication to operating properties that benefit our tenants and communities. You can find links to the report and a tearsheet specific to OPI's highlights on our website at opireit.com. I will now turn the call over to Matt to review our financial results..

Thanks, Chris, and good morning, everyone. Normalized FFO for the first quarter was $52.7 million or $1.09 per share, $0.01 below our guidance range. This compares to normalized FFO of $54.5 million or $1.13 per share for the fourth quarter of 2022.

The decrease on a sequential quarter basis was primarily driven by higher utility expenses and interest expense. G&A expense for the first quarter was $5.9 million as compared to $5.8 million in the previous quarter. Same-property cash basis NOI decreased 4% compared to the first quarter of 2022, in line with the low end of our guidance range.

The decrease was mainly driven by elevated free rent levels related to 2022 leasing activity and operating expense increases, most notably utility costs, due to inflationary pressures and expenses previously paid by tenants, now being paid by OPI as a result of tenant downsizes.

On a rolling 4-quarter basis, CAD decreased sequentially by approximately 16% to $2.21 per share, resulting in a payout ratio of 99.5%. While our historical payout ratio had been well covered since the beginning of 2019, we began seeing pressure in the fourth quarter of 2022.

And with lower tenant retention levels in 2023, another year of elevated CapEx requirements and worsening office fundamentals, the dividend rate was becoming unsustainable. As a result, and as Chris previously discussed, earlier this month, we reduced our quarterly dividend to $0.25 per share or $1 per share annually.

The new level equates to approximately $60 million of retained capital annually, enhancing OPI's liquidity and financial flexibility. Turning to our outlook for normalized FFO and same-property cash basis NOI expectations in the second quarter of 2023, we expect normalized FFO to be between $1.07 and $1.09 per share.

This guidance includes a range of $6.1 million to $6.2 million of G&A expense, which includes expected annual trustee compensation.

We expect same-property cash basis NOI to be down 5% to 7% as compared to the second quarter of 2022, mainly driven by 2 full building vacates since the beginning of the prior-year period and increased inflationary pressure on operating expenses. Turning to the balance sheet.

At quarter end, our outstanding debt had a weighted average interest rate of 4% and a weighted average maturity of 4.7 years. Over 90% of our debt is fixed rate. We ended the quarter with $528 million of total liquidity, including $505 million of availability under our credit facility.

In connection with the proposed merger with DHC, we plan to recast our existing $750 million revolving credit facility and have commenced initial discussions to move this process forward. We believe the improved scale and diversification of the combined company will result in the successful recast of OPI's revolver.

Turning to our investing activities. Since the beginning of the year, we sold 3 vacant properties, containing 89,000 square feet, for $5.4 million and are currently under agreement to sell one vacant property, containing 107,000 square feet, for $4.9 million.

Our capital recycling to date has been impacted by the current transaction environment, and we expect our activity to be somewhat muted until market conditions improve. We spent $17.6 million on recurring capital and $49.5 million in redevelopment capital during the first quarter.

2023 CapEx guidance is currently $100 million to $110 million of recurring capital and approximately $140 million to $150 million of redevelopment capital. Before we turn the call over to Q&A, as a reminder, we will be taking questions related to OPI on a stand-alone basis.

We have not yet filed a preliminary joint proxy and registration statement and therefore, will not be taking questions about the merger. That concludes our prepared remarks. We are ready to open the call up for questions..

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

I guess I can throw out maybe half my questions ahead. So I'll tighten it up. The -- can you walk us through slowly the occupancy outlook for this year? So we're starting off at 90.5% total occupancy, 93.5% same-store. We have a series of known vacates that you discussed. Obviously, you'll try and backfill some of those with leasing activity.

And then we also have 20 Mass Ave and Seattle coming online.

How do you think that the year progresses from an occupancy standpoint?.

Thanks, Bryan. I think historically, we provided the range of 88% to 90%, and some of that is predicated on our ability to sell assets that we currently have in the market, are those that we were projecting to bring to the market.

And so I think as we sit here today, based on what we're seeing, we're looking at kind of the low end of that guidance being kind of the target today. What I'll add is that most of the expirations for 2023, where we have known vacates, are scheduled to occur in November or at year-end.

And so the impact on performance is heavily weighted towards the back half of the year, with occupancy then following. So that's where we're at today. And I think, again, an important piece of that is our ability to sell certain assets. The ones that we've talked about are mostly vacant. And so that has a direct impact to occupancy..

Okay.

And then when we think about the credit facility, can you give us any update as to kind of the timing and what the size might be of that new facility? And is that needed to be completed before a potential merger?.

So Bryan, it's a good question. Let me just first address the maturity of the revolver absent the merger. So right now, the revolver matures at the end of July. However, we do have a 6-month extension option to push out that maturity to January of '24. A recast or amended revolver is a condition to closing the merger.

So we have started our discussions with Wells Fargo on that. They are preliminary. We are expecting a proposed term sheet from the bank group in the coming days. So it's in process. And I think as we progress into 2023, there'll be more to provide as it relates to the revolver..

Okay.

And kind of circling back to fundamentals, did I hear you correctly say that you expected 6% to 8% rent roll-ups for this year 2023?.

The 6% to 8% roll-up is attributable to our leasing pipeline. And so I think historically, for 2023, we've talked about 4% to 5% roll-up.

And I think some of that -- I think we'll stick to that for now, but I think a lot is going to be predicated on how this pipeline matures as we talked about with the Q1 results and the roll-down, I mean that was heavily concentrated for a couple of specific deals.

And so we expect that will normalize, and then we'll see improvement on overall rent spreads as we execute on some of this pipeline. But it's a lumpy process. So it's not exactly something quarter-to-quarter that we have definitive projections on just given the timing it takes to negotiate some of these leases..

Okay. And just on the periphery of the transaction, I don't know if you can answer this or not, but we know Vanguard and BlackRock own an awful lot of shares of both DHC and OPI.

Is it safe to expect that, a, they will be able to vote on the transaction, b, that they'd probably follow the guidance of ISS and Glass Lewis, et cetera?.

We're not going to speculate today. As we mentioned, we're in the process now of the filings of the S-4 in the proxy. And I think as we get through that, there'll be more kind of color on kind of next steps and expectations..

Okay. And just last on Seattle. I think you said something about having one lab building completed by -- over in 4Q for prospective tenants.

Is that above and beyond the leasing activity you've already communicated with Sonoma Biotherapeutics?.

That's correct. Yes. I mean, Sonoma, that is expected to transact in the form of them finishing and moving in, in Q4. And then we're assuming some leasing to occur with the spec suites that we're delivering. And so it's a lighter touch, and we think more of that will transact as we get into 2024..

[Operator Instructions]. And our next question today comes from Ronald Kamdem with Morgan Stanley..

This is Tamim on for Ronald. Yes, just maybe just a question on development again. You talked about the Seattle development and expected in the fourth quarter of this year. Maybe just on 20 Mass Ave, an update on timing of when you expect the move-ins actually occur? I understand that's completed in the second quarter.

But just from a revenue recognition point of view, how should we think about that for the rest of the year?.

No, good question. So for 20 Mass Ave, we have the hotel representing 54% of the leasing. We expect to deliver at the end of Q2 and -- at which point, the lease on that side would commence, so let's just call it early Q3. And with that, the tenant is going to have 18 months of free rent.

And so the benefit to the property during that time frame is the reimbursement of operating expense. So we'll start to see some of the recovery of the cost outlay that's occurring today. And then from a lease-up perspective, what we've talked about is a trajectory of roughly 18 months for kind of lease-up of the balance of the property.

And so we're in advanced -- on advanced stages. We have several tours that have taken place across the property and also have several proposals out to tenants. And so I think at this stage, we don't have anything definitive. But hopefully in the next few quarters, we'll have feedback on the status of those proposals..

Great. And then just on leasing. I think you guys mentioned in the prepared remarks expectations for a sequential increase throughout the year.

So is that based off of the current pipeline and most of that's locked in? Or how much of that is just expectations for things to improve versus kind of what you guys already have locked in?.

Yes, the number I provided on advanced stages, just north of 700,000 square feet. Advanced stages for us represents signed LOI or those where we're negotiating a lease document. And so look, there's risk, but I think we feel like the risk is somewhat mitigated at that stage.

So I would imagine that we'd start to see a good portion of that mature for Q2..

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..

Thanks for joining the call today. We look forward to seeing many of you at NAREIT and other industry conferences in the upcoming months..

Thank you, sir. 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..