Anthony Maretic - CFO, Corporate Secretary and Treasurer James Farrar - - CEO and Director.

Barry Oxford - D.A. Davidson Craig Kucera - B. Riley FBR Vincent Chao - Deutsche Bank.

Good day, and welcome to the City Office REIT, Incorporated Fourth Quarter 2017 Earnings Conference Call and Webcast. At this time, all participants are in a listen only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder this conference call is being recorded.

[Operator Instructions] It is now my pleasure to introduce you to Mr. Anthony Maretic, the company's Chief Financial Officer, Treasurer and Corporate Secretary. Thank you. Mr. Maretic, you may begin, sir. .

Good morning. Before we begin, I would like to direct you to our website at cityofficereit.com, where you can download our fourth quarter earnings press release and a supplemental information package.

The earnings release and supplemental package both include a reconciliation of non-GAAP measures that will be discussed today to their most directly comparable GAAP financial measures.

Certain statements made today that discuss the company's beliefs or expectations, or that are not based on historical fact, may constitute forward-looking statements within the meaning of the Federal Securities laws.

Although the company believes that these expectations reflected in such forward-looking statements are based upon reasonable assumptions, we give no assurance that these expectations will be achieved.

Please see the forward-looking statements disclaimer in our fourth quarter earnings press release and the company's filings with the SEC for factors that could cause material differences between forward-looking statements and actual results.

The company undertakes no obligation to update any forward-looking statements that may be made in the course of this call. I will review our financial results after Jamie Farrar, our Chief Executive Officer, discusses some of the quarter's operational highlights. I will now turn the call over to Jamie. .

Thanks, Tony. Good morning. Restart valuations had a volatile start to the year, but we believe the fundamentals for office properties in our markets remain robust, and we are excited about our position and the opportunities that are in front of us.

With $255 million of acquisitions completed in 2017, the fourth quarter was the first complete period in which we were fully deployed. Our company generated strong core FFO and AFFO increases, and for a number of important reasons, we believe we are well positioned for healthy growth over the long term.

First, our acquisition strategy has concentrated on some of the fastest growing markets across the country. Industry projections indicate that these cities will continue to perform well, with healthy employment growth and limited competition from new development.

Rents in our markets continue to grow, and today, we estimate that our in-place rents are approximately 5% to 10% below current market levels. This spread, as well as our embedded 2.5% average contractual rent increases over the next 3 years, sets us up for continued NOI growth.

Second, we've been disciplined about locking down our debt cost on a long-term basis. We've spoken to the benefits of this strategy for some time, but with the recent rise in interest rates, these steps are proving to be valuable. Today, we are well positioned, and at quarter end, over 90% of our interest expense was fixed rate.

At year-end, our debt maturities averaged a healthy 6.2 years at a 4.2% weighted average interest rate. Third, we're in the enviable position of having ample liquidity, while other potential acquirers of real estate may have trouble efficiently accessing capital, given recent volatility in debt and equity capital markets.

Our common equity reigns in December, and our pending $86.5 million sale in Boise provides us with approximately $225 million of leveraged buying power. Many of our direct competitors are smaller operators or private equity funds that require higher leverage to finance the acquisitions.

However, these loans are becoming increasingly expensive and require greater structure, which positions our purchased offices favourably relative to alternatives. And finally, we're excited about the opportunities across our own portfolio that can drive long-term cash flow growth.

Our continued focus has been to push out-leased terms, with high credit tenants, reinvest in our buildings to elevate their market position and find creative ways to unlock value at our properties. Approximately, 34% of our leasing activity in the fourth quarter related to new leases or renewals in 2019 and beyond.

We have been actively taking steps to lock in stable and predictable long-term cash flow growth. A great example of this during the fourth quarter was the success at FRP Ingenuity Drive in Orlando.

When we acquired this building in 2014, we recognized an opportunity to purchase a well-located, single-tenant property in the Florida Research Park with leading attributes. The building was 100% leased, with 7 years of remaining lease term.

But as the tenant was not fully utilizing its space, we acquired it at an elevated 9% cap rate from a seller that was exiting its office investments, an acquisition we saw the opportunity to purchase the stability of the in-place lease through 2021 and to provide ourselves sufficient time to create auctions for the underutilized space.

During the fourth quarter, we came to terms with the subtenant to backfill the unused space and sign a direct lease with us for 63% of the building's net rentable area. The 78,000-square foot lease with Sedgwick Claims Management Services commences in almost 4 years time upon the expiration of their current sublease.

This diversified the rent role with another strong tenant, but also extended the contractual lease term for Sedgwick until 2027. The lease not only solidified our property's future cash flow, but we believe it repositioned the entire property at a superior market valuation.

Next, in terms of new acquisitions, we are under contract to acquire a 2-building property in Phoenix for $56.5 million. This approximately 270,000-square foot Class A property is nearly 100% leased and is located in the Scottsville submarket. The property has strong tenancy, excellent freeway access and a high parking ratio.

It's situated on a long-term ground lease with over 70 years of remaining term. The transaction is still subject to a number of closing conditions, but is anticipated to close early in the second quarter at over an 8% capitalization rate. We will provide further information about this acquisition after we complete the purchase.

In terms of other acquisitions, we continued to maintain a very robust pipeline of over $700 million and are evaluating a few portfolio opportunities. This is in addition to the $1.3 billion of opportunities that we passed on since the beginning of the fourth quarter. As I mentioned earlier, we believe it's a great time to have liquidity.

On the operational front, we ended the quarter at 88.5% occupancy, excluding our Boise property, which is scheduled to be sold on March 8.

As discussed on previous calls, our occupancy is below our targeted levels primarily due to a few known departures, like [indiscernible] Park Tower in Tampa and ProBuild's downsizing at our DTC Crossroads property in Denver as well as our ongoing efforts to reposition and lease vacant space at our Plaza 25 property.

We also had a setback at our FRP Collection property in Orlando, with a 44,000-square foot tenant closing its doors unexpectedly. Given our security deposit, there weren't any bad debt losses, but it contributed to our reduced occupancy.

We're confident in re-leasing this space, and the submarket continues to be very healthy with less than a 10% direct and indirect vacancy at year-end. Our focus continues to be on driving occupancy across our portfolio, which will lead to higher property-level NOI.

In that regard, our earnings press release provided our 2018 guidance, which highlights that we are targeting occupancy at between 90% and 93% by year-end. We have a number of highly desirable blocks of space at a handful of our properties, and it implemented renovation programs that will position these properties to maximize rents and absorption.

A good example of these efforts is our Park Tower project in Downtown Tampa. We are now well underway with our renovation, and our leasing activity has already picked up in anticipation of its completion. We recently completed a full floor of spec suites and have already leased 6 of the 7 units.

This has helped move our occupancy at Park Tower from 79.8% at September 30 to 88.7% today, including leases signed but not yet in occupancy. Given our success to date, we are in the process of launching another full floor of spec suites. We anticipate being at or above 90% occupancy by year-end, ahead of schedule.

We're also forecasting increasing the average asking rents for these suites to $27 per square foot full-service gross versus our in-place rents of approximately $24 per square foot.

While we expect that this leasing activity will have a material positive impact on our NOI, the resulting leasing costs as well as our renovation projects are going to drag our AFFO results for the first 3 quarters of 2018.

Last, I want to point out that as a quickly growing company, the drag associated with capital raises, timing of acquisition deployment and capital projects means it's helpful to look at our fully deployed or pro forma results in the fourth quarter as a measure of ongoing operations.

Tony will provide more details on our 2018 guidance in a few moments, but our expectation is that we will deploy our acquisition capital during the first 3 quarters, substantially complete the various renovations on leasing projects, and our fourth quarter results should provide a better view of normalized performance.

In addition to our press release, we've also updated our Investor presentation on our website, which provides helpful information relating to our performance and expectations. With that, I will turn the call over to Tony to discuss our financial results. .

Thanks, Jamie. On a GAAP basis, our net operating income in the fourth quarter was $19.3 million. This represents a $5.2 million increase over the $14.1 million achieved in the third quarter. The increase was primarily a result of the $208 million of acquisition closings that straddled the third and fourth quarters.

We acquired the San Diego portfolio on the second to last day of the third quarter and acquired Papago Tech at the beginning of the fourth. We reported core FFO of $9.6 million or $0.31 per share. Our core FFO ended the quarter $3.8 million higher than Q3 primarily due to the same reasons described earlier.

Including our core FFO, in Q4, we recognized $700,000 of a $1.6 million termination fee related to a tenant at our Sorrento Mesa property that departed in February of this year. We will recognize the remaining termination fee income in Q1 of 2018.

The $1.6 million payment represented 77% of the tenant's base rent and estimated reimbursement obligation through its lease expiration in March of 2020. We underwrote this departure at the time of acquisition.

Our fourth quarter AFFO was $6.6 million or $0.21 per share as net recurring capital and leasing costs were higher at 16% of our property's NOI relative to our historical average of approximately 10% to 11%. This was partly due to the leasing activity in the quarter and the timing of tenant improvements related to deals previously signed.

Due to the relative size of our portfolio and the impact of significant leasing in any one quarter, our AFFO numbers will continue to move around some from quarter-to-quarter. Our leasing activity and capital expenditures are clearly laid out on Pages 17 and 19 of the supplemental package.

Consistent with our definition of AFFO, we have excluded some first-generation leasing costs and repositioning activities of Plaza 25, Park Tower and some of the costs associated with transitioning our FRP Ingenuity Drive property into a multi-tenanted building, as Jamie discussed.

Further details are disclosed on page 19 under nonrecurring capital expenditures. Our same-store cash NOI change for the quarter was impacted by a couple of tenant move-outs, which Jamie described, and therefore, was a negative 3.6%. Our year-to-date figure, however, was a healthy 4.1% and within our beginning of the year guidance range.

During the quarter, we closed on a 10-year fixed rate financing for Mission City in San Diego, which further increased our liquidity. The interest rate on that property financing was a very attractive 3.78%. We believe our strategy over the past 4 years to lock in long-term, fixed-rate debt has been prudent.

At December 31, fixed-rate debt represented 93% of our total debt with a weighted average interest rate of 4.2% and a weighted average maturity with 6.2 years. Our total debt net of deferred financing costs at December 31 was $489.5 million or $480.6 million when deducting the non-controlling interest share of certain indebtedness.

Our net debt to enterprise value was 44.8%. In line with the weak stock market indices, our common stock has begun the year trading lower and is seen at 52-week lows while our dividend yield at the time has been north of 9%. We are also trading at a significant discount to analysts' consensus net asset value and our own internal estimates.

As such, through discussions with our board, we have determined that it's prudent to put in place a $40 million discretionary common stock repurchase program.

They emerge of the ATM, which we put in place last year, we believe having this additional tool at our disposal provides the most flexibility for management to make capital allocation decisions in the best interest of shareholders. Lastly, we have provided full year 2018 guidance.

With our capital raise late in Q4 and the pending sale of Washington Group Plaza, we have ample dry powder to take advantage of opportunities in 2018. Our guidance assumes we'll make total property acquisitions between $210 million and $240 million in 2018. And all those acquisitions will occur in the second and third quarters.

The guidance also reflects an increase in occupancy from 90% to 93% by year-end. Our same-store NOI growth will face headwinds during the first 3 quarters of the year as the occupancy levels in our same-store portfolio will be lower at the start of the year.

As occupancy levels normalize, we expect the impact of rent escalators and below-market rent rollovers will turn the number to positive by the fourth quarter. Based on these assumptions, we are estimating core FFO between $1.08 and $1.13 per share for the full year ending December 31, 2018.

The actual timing of our acquisitions will impact our guidance estimates.

But assuming these acquisitions close on the timeline we currently expect, we are anticipating fourth quarter 2018 run rate core FFO in the range of approximately $0.31 to $0.34, which represents significant increase over the fourth quarter of 2017, which would have been $0.29 per share when excluding the termination fee income.

Further details on how we arrived at our guidance, including a more complete discussion of our material assumptions, including a discussion of our tenant improvement, leasing commissions and capital improvements, can be found in our press release. That concludes our prepared remarks, and we'll open up the line for questions.

Operator?.

Thank you, sir.[Operator Instructions] The first question we have will come from Barry Oxford of D.A. Davidson..

Great. Thanks, guys. Jamie, when you look at your stock price where it is right now, obviously, I'm a little frustrated, I'm sure you are too, and kind of leaves me scratching my head as to why it's trading down here at $10, it seems to be rallying a little bit today.

But, I mean, do you have any comments on it?.

Yes, I mean, Barry, we're very frustrated as well. We did our $12.60 equity raise in December. We closed 2017 just over $13, which felt good. The rise in the tenure, I mean, we've had a lot of pressure on us and other REITs. Our focus is really on running the business and driving occupancy and putting capital to work.

So can't really say, I mean, and part of it is a general view that small caps trade poorly when there is perceived challenges in accessing capital. And I think, we're really well positioned with both the sale of WGP and the capital raise that we did. But we're, obviously, a little frustrated. .

Right, got you. Yes, I agree with everything that you said.

Why is your guidance for same-store NOI for 2018 maybe lower than what I might have expected? Is that just the known move outs in the renovation space?.

Yes, I think that's fair. Barry, its Tony here. If you look at our guidance for Q4 2018, you will note that we are actually projecting strong growth year-over-year, while at the same time, same-store is actually flat, which actually is a bit -- looks a little odd. And really, the main reason for this is that our same-store pool is relatively small.

It only contains assets held for the full kind of 2 full year-over-year quarters, and it excludes any assets that we call repositioning. So most notably, it's being dragged down a little bit by FRP and DTC Crossroads that you -- and you mentioned that before we have the move outs.

But some of the biggest gains we anticipate this year will come from assets that are excluded from this pool. So Jamie talked about Park Tower as well as anything else going to an ongoing renovation program. So that's really excluded from our same-store numbers but will be driving a lot of growth.

And then the other item, that's going to be driving growth is the redeployment of proceeds from the WGP sale. We announced, at the time, there was a 5A cap on in-place occupancy so that redeployment will be very accretive to FFO and AFFO. .

Right.

Is it then fair to say, I mean, not to talk about 2019, but just from a general -- I'm thinking about it, your same-store NOI would return to more of a normalized rate in '19?.

Exactly. And the same-store pool with [indiscernible] as well. So absolutely. That's what our expectations are. .

And next we have Craig Kucera of B. Riley FBR. Please go ahead..

Hi, good morning, guys. Appreciate the color on your tenant improvement and leasing costs this quarter, but I wanted to dig a little bit into the renewal TIs and NLCs, which really seem to have picked up.

And I guess, were there any -- was there any concentration in any given market where that activity occurred? Or were there any sort of surprises there given the pickup there?.

Craig, its Tony here. It's certain renewals. We did have one significant renewal relating to 2019, and in that case, the term on that was actually effectively 9 years. So in a longer-term, which led to a slightly higher cost associated with that. But I think that may be part of it, but really wasn't concentrated in any one particular market..

Okay.

And just talking about, as we look forward to financing in 2018, can you comment on where you're seeing sort of debt and spreads relative to where they were last year and how you are thinking about financing this year? Will you use a line of credit a little bit more or continue to be more asset-level fixed rate?.

Yes, I mean, I think that's fair. Late in 2017, we executed a couple of financing, long-term tenure financing was sub-4%. We are projecting that to be higher probably in the neighborhood for all the way in property-loan financing, call it 4.5%, is what my expectation is for 2018.

But you also mentioned a line of credit, and I think I also mentioned this on previous calls that our line of credit is set to mature in middle of this year. And although, we do have a 1-year extension option, I do expect us to conclude on a new line of credit this year, which will further improve both our terms and our pricing.

That's that -- the line of credit will be an attractive way to finance acquisitions. .

Okay. And one more for me, going back to your guidance.

Just wanted to understand your commentary, I know you're looking at, sort of a, call it, 200, even 500 basis point pickup in occupancy but it sounds like the vast majority of that is going to occur certainly late in the year as opposed to sort of seeing more of a steady pickup throughout the year, is that fair to assume?.

I think that's fair to assume. Park Tower is one that we've been talking about a little bit, and so just based on sort of when those leases will start, again, start in the back half of the year. And so even with the activity we are doing now, the impact will really be noticeable in the fourth quarter. .

Okay, thanks..

Thank you..

[Operator Instructions] Next we have Vincent Chao of Deutsche Bank..

Hey. Good morning, guys. Just a quick question. Just on the G&A line, and I'm talking excluding the stock comp, looked like it was a bit higher than we were anticipating, looks like a fairly steep growth rate year-over-year. Just curious if you could comment on sort of what that's going towards. .

Sure. Good morning, Vin. It's Tony here. Really it's a combination of couple of things. One is the reduction in the reimbursement that we have been receiving from Second City, if you recall that arrangement, its set to burn off in the next 12 months. And so that's part of the equation.

And the rest of it is really just simply a higher headcount than we anticipate this year with additional personnel in our Dallas office, just to [indiscernible] manage the growth, given the acquisition program from last year and another $250-ish million -- pardon me, $225-ish million this year, it's really anticipating that growth. .

Okay.

And is that headcount now in place? Or is that coming online over the course of the year?.

Some of it is in place, but most of it is actually coming in place later [indiscernible]. So I wouldn't be surprised at all if we end up at the lower end of the range. .

Okay. And then just maybe on the investment side. Sounds like the pipeline is pretty healthy, but curious how things are tracking from a cap rate perspective relative to your past history. It seemed like, for a little while, cap rates were coming down a little bit but then this quarter back to the mid-7s. .

Vin, its Jamie here. So we started 2018, I'd say, there wasn't a lot of products in the market. There was a fair bit of profit in some acquisitions. So we held back a little bit. That's changed over the last little while. It seems like there's a lot more product coming out, better buying dynamics from our perspective.

So if you look at transactions, we're looking at our pipeline, I mean, we're still expecting to be in that 7% to 7.5% cap rate range, some maybe a little lower, some a little higher, but it's trending in that direction. .

Got it. Okay. And then, maybe, a question just on the stock buyback, which obviously makes sense to have everything in the toolkit.

But just given the size of the company and the liquidity, I mean, how realistic is it for you guys to really buy back a lot of stock at this point?.

I think your comment is fair, Vin. As you mentioned, and as I mentioned in my comments, we just think it was just prudent to put in place.

We are a growth company, and which you alluded to, which -- and we still see a lot of opportunities in our markets to deploy the capital, but at the same time, we want to be mindful of what the discount to NAV is and where we'll go and so just doing what's best for our shareholders. So I think we're going to take out a very pragmatic approach to it. .

Got it. And then just maybe one request. You guys do a nice job on the disclosure side, but from a same-store pool perspective, you alluded to the fact that not that many of your assets are in the same-store pool.

Would it be possible to somehow, maybe on the property overview slide, to just mark of which ones are included or not included?.

I think the best part to look at it. I think it is important to highlight, so we'll find a way to do that. .

Okay, great. Thank you.

Thanks, Vinc..

Well, at this time, we are showing no further questions. We'll go ahead and conclude our question-and-answer session. I would now like to turn the conference call back over to Mr. Jamie Farrar for any closing remarks.

Sir?.

Thank you, everybody, for joining today. We look forward to discussing our continued progress with you in the coming quarters. Have a great day..

And we thank you, sir, and the rest of the management team for your time also today. The conference call has now concluded. At this time, you may disconnect your lines. Thank you, again, everyone. Take care, and have a great day..