Good morning and welcome to the City Office REIT, Inc. Fourth Quarter 2019 Earnings Call. 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 to you Mr. Tony Maretic, the company's Chief Financial Officer, Treasurer and Corporate Secretary. Thank you. Mr. Maretic, you may begin..

Good morning. Before we begin, I would like to direct you to our website at cityofficereit.com where you can view our fourth quarter earnings press release and 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 facts 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 can 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..

Good morning. I'd like to start off by reviewing our 2019 results, relative to the expectations we set for ourselves at the beginning of the year. 2019 was a tremendous year for City Office REIT. We exceeded the top end of our initial guidance for NOI, net property acquisitions and same-store cash NOI growth.

In doing so, we added Seattle as a new market in our portfolio and grew our footprint in both Portland and Denver. The 4.3% same-store cash NOI growth in 2019 was driven by executing on strategic leasing initiatives, contractual rents step-ups and strong conditions across our markets.

We also achieved the midpoint of our core FFO target and improved in-place occupancy by 1.5%. We accomplished these goals, while efficiently raising capital and growing the market capitalization of our common equity by 82% over the course of the year.

This strong execution resulted in a 42.6% total return for common shareholders in 2019 continuing the trend of double-digit average annual total returns since our IPO. Our focus continues to be on several main themes, improving property level cash flow, driving NAV growth and targeting high quality acquisitions to further build our portfolio.

Our Denver Tech property is a good case study of these themes. Denver Tech is comprised of two adjacent buildings, one that we acquired in 2015 and the other that we recently acquired in September of 2019.

We acquired the first building in 2015 at a price reflecting that the largest tenant would be significantly reducing its square footage, creating a major leasing opportunity. We have since completed a substantial renovation creating a fitness center, upgraded conference facilities, improved vacant space and a modernized lobby.

In late 2019, we acquired the second sister building and set in motion plans to combine the two into a campus, with a shared landscape courtyard and mutual access to complimentary amenities. These efforts have translated into solid leasing results.

At the end of 2019 the combined Denver Tech buildings were 62.7% occupied with 142,000 square feet of vacancy. In January, two previously disclosed new leases took occupancy totaling 58,000 square feet. We previously targeted to have these two tenants occupy in the late 2019, but completion of their buildups occurred just after year end.

This increased the current occupancy of Denver Tech to 78%. Even more impactful is the new leasing that also occurred after year end. We executed the 10-year lease in January with a new credit tenant to take 70,000 square feet of space, bringing overall occupancy to 93.7% when the tenant moves in during the third quarter of 2020.

The costs associated with this 10 year lease will be incurred during the first and second quarters, temporarily lowering AFFO. However, this is a great long term result and we now have a stabilized asset that is well positioned for the long term.

In addition to these activities, we completed 331,000 square feet of new and renewal leases across our portfolio during the quarter. We look to create similarly successful renovation and leasing outcomes at several other properties.

We have in process or recently completed major renovations at our Mission City, Sorrento Mesa, Pima Center and Camelback Square properties.

Of note, at our Sorrento Mesa property in San Diego the very strong life sciences market is driving potential for significant leasing opportunities both in our vacancies and by marking existing rents to much higher market levels.

Executing on these opportunities is one of management's highest priorities in 2020, which has the potential to be a major driver of cash flow growth and value creation. Turning to another key priority. Our acquisition pipeline remains robust, although we have witnessed higher valuations in recent months.

Low interest rates and the availability of both debt and equity capital has resulted in the compression of cap rates across our markets. This has made securing transactions more challenging and we're having to work harder to find the right properties with the characteristics we like at reasonable valuations.

The effects of the lower cap rates are partially offset by our lower borrowing costs and the acquisitions we are pursuing still generate healthy returns on invested equity. We continue to have a strong pipeline with over 750 million of transactions we are actively working on it.

We're targeting a midpoint of $360 million of acquisitions in 2020 that we expect to deploy by the end of the third quarter. If we're successful with that timing, we're projecting core FFO between $0.32 and $0.34 in the fourth quarter, which would be the first quarter that we're fully deployed.

Tony, will provide details on our 2020 guidance and we'll update our timing expectations on future calls as we deploy this capital. It is worth noting that while the acquisition environment is more challenging due to increased competition, these conditions have also led to an increase in the value of our own portfolio.

We're in the envious position of having bought 1.5 billion of well-located properties in great cities that are situated for continued cash flow growth. Separately over the next few years, we remain open to opportunities to harvest value at specific properties where we think we can accretively redeploy proceeds.

In the fourth quarter of 2019 we successfully completed the sale of our Logan Tower Property in Denver. Though it was the smallest asset in our portfolio, the sale generated a $2.9 million gain, combined with our other five prior asset sales.

We've produced an aggregate IRR of 17% and $72 million of gains in the last five years, while also better focusing our core portfolio. If we're successful in executing a number of the key leasing initiatives, more of these opportunities may present themselves.

In conclusion, we are optimistic about the company's prospects for 2020, underpinned by the continued leading performance of our targeted cities.

We believe the steps we are taking at the property level to improve cash flow, as well as the corporate actions to enhance our balance sheet and grow the company should drive net asset value for investors over the long term. And with that, I'll turn the call over to Tony to provide further details on our financial results..

Thanks, Jamie. On a GAAP basis our net operating income in the fourth quarter was $24.5 million. This represents a $0.1 million decrease relative to the amount reported in the third quarter. The small decrease was primarily attributable to the sale of Logan Tower in the quarter.

Overall, we reported core FFO of $13.4 million or $0.25 per share, which was $1.1 million higher than our third quarter.

Interest expense was lower in the fourth quarter as we benefited from the lower interest rates from the loan modifications that we completed in the third quarter, as well as from the full repayment of our line of credit balance with proceeds from our common stock offerings. Our fourth quarter AFFO was $7.9 million or $0.14 per share.

Our fourth quarter AFFO was affected by the costs of tenant improvements and leasing commissions incurred during the quarter.

The largest of which related to the tenants who took occupancy in Denver Tech after year end that Jamie mentioned and a significant renewal at our Mission City property from Q3 to 2019 where we extended 31,000 square foot tenant for an additional 10 years.

We also had some capital expenditures related to products at Sorrento Mesa, Mission City and 190 Office Center that impacted us in the quarter. 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 provided on page 16 and 18 of the supplemental packages. Consistent with our definition of AFFO, we have excluded some first generation leasing costs, the largest of which relate to our recently acquired Canyon Park property.

Further details are disclosed on page 18 under non-recurring capital expenditures.

We have enhanced our leasing activity disclosure this quarter by providing additional details on our leasing spreads and reformatting the information, with leasing spreads of 9.3% on a cash basis for the quarter, rolling up existing leases to market is proving to be a driver of same store NOI growth.

Our fourth quarter same store cash NOI grew 3.9% versus the fourth quarter last year. It also increased by 4.3% for the full 2019 calendar year, as compared to 2018.

Orlando, Portland and San Diego where our best performing markets in the fourth quarter, each with double digit same store cash NOI growth, which was primarily driven by combination of occupancy gains in those markets, free rent burn-off and mark-to-market or step-up in rents. Moving onto our balance sheet.

Our total debt net of deferred financing costs at December 31 was $607 million. Our net debt to enterprise value ration ratio was reported as 37.7%. In September 2019, we entered into a $50 million five year swap arrangement.

The term loan is priced off of LIBOR, so the swap fixes a 30 day LIBOR component of the borrowing rate at 1.27% for the five year term of the term loan. Given the positive differential in rates, the unrealized gain from this hedge is reflected in our 10-K in comprehensive income.

At quarter end 100% of our debt was effectively fixed and had a weighted average maturity of 5.6 years. Last, we have provided full year 2020 guidance in our press release. Our guidance does not include any capital raise assumptions and provides a range for acquisitions which will materially impact our results.

We refer you to the material assumptions and considerations set forth in our earnings release. Based on these assumptions, we are estimating core FFO per share between a $1.13 and a $1.18 for the full year ending December 31 2020.

Core FFO should increase beginning in Q2 through the end of the year, as the full impact of the future acquisitions take effect. Once we are fully deployed, we are projecting a quarterly run rate core FFO of $0.32 to $0.34 cents per share. Our projections assume this will occur in the fourth quarter.

Based on our 2020 fully deployed core FFO expectations, average dividend coverage on an AFFO basis will be close to 100% depending on significant leasing transactions and capital projects in any one quarter.

This incorporates a reduction in our overall leverage as compared to leverage levels prior to our common stock offerings in the second half of 2019. We are comfortable with this interim coverage dynamic given numerous planned increases in cash flow, the high growth nature of our recent acquisitions and the lower targeted leverage.

On the operational side, we expect same store cash NOI growth to be between 1% and 3%. We expect to post strong same store cash NOI growth in the first and fourth quarters, but the middle part of the year we expect will be flat, as we have a combination of known vacates and some free rent periods.

The two most significant are at 5090 in Phoenix and 190 Office Center in Dallas. At 5090, we are downsizing and relocating a 19,000 square foot tenant at the end of May to accommodate a larger tenant the desired expansion space. This will temporarily bring occupancy down as we prepare the expansion space.

At 190 Office Center, United Healthcare is downsizing and giving back 25,000 square feet in March. By year end, we expect cash flow and occupancy will return to Q1 levels.

We expect continued positive trends and overall portfolio occupancy and we have provided a guidance range of 92% to 94% at year end, implying a healthy increase over current occupancy at the midpoint of the range. That concludes our prepared remarks and we'll open up the line for questions.

Operator?.

[Operator Instructions] The first question will come from Michael Carroll of RBC Capital Markets..

Yeah. Thanks. This is Jason on for Mike. Just wondering, it looks like you guys were able to fill up some of the vacant space at Camelback Square and FRP.

I was wondering if you could touch on kind of the leasing success of those assets and what other large blocks of space you have available right now?.

Sure. So it's Jamie. Thanks for the question. Camelback Square is one where we're about to launch our repositioning. So we did have some move-ins. We had some move-outs that were higher than where we were previously, but we really expect to get the major impact there. Post renovation plans look fabulous. We're excited about it.

We expect to have it done by the end of the year. And given how hot that little pocket is we think that's going to be really transformational for the asset.

In terms of overall kind of blocks of vacancy, when you look at kind of the major ones across the company, we talked about on the call at our Denver Tech property where we're going to bring that one to 93.7 by the end of the year. We are in discussions with some tenants to take some additional space.

That will probably be early next year, but we think we can get that one even higher. In our Sorrento Mesa properties in San Diego with the life science portfolio, we have one full vacant building, probably 60,000 square feet. That's great space, it's a hot submarket.

We're waiting for the right tenant there and that's going to be very impactful when we can lease that one up. We do have a significant mark-to-market opportunity later this year in that same portfolio. Those are the big ones. Pima Center, we do have some space there.

We're doing some work in renovating, as well as at 190 we have a little bit of space as well that Tony mentioned with getting back that floor from UnitedHealthcare later this year..

Okay, great. And secondly, I think you guys have two larger expirations coming up in about a year with Ally Financial and Kaplan.

Just wondering if you guys could give any insight on to what your expectations are with those?.

Sure. So, Ally Financial rolls in the end of 2020, 163,000 feet to full building. Ally we are in early discussions about a renewal, they're exploring their options as well in the market. They have a need for potentially some expansion space. And we've looked at potentially adding onto our building to accommodate that.

So we think we'll have better visibility on that property in the second half of the year. Kaplan is 124,000 feet rolls December 31 of ’21. We've already done a renewal with a sub-tenant that's in there for 70,000 feet and push that over five years.

So we've basically taken care of 63% of that building and we're looking at either potential renewal with Kaplan, discussions with the existing sublease tenant or looking to market that last block of space. But we don't get it back for a year and three quarters at this point. So it's a little bit early..

Got it. Thank you..

You’re welcome..

The next question comes from Rob Stevenson with Janney..

Good morning, guys.

Tony, what are you expecting in terms of the sort of CapEx in TI leasing commissions spend in 2020, given the comments around you know, some of those leasing that you're going to do in some of these tenant moves et cetera?.

Yeah. Good morning, Rob. So you know, particularly the first half of the year we are expecting the impact from these leases and Jamie spoke about the tenant movement at Denver Tech.

And so I would expect that the first part of the year is going to be on the higher end of the [Technical Difficulty] expected be near that higher end of the range for the first three quarters as we deal with the move-out of these tenants.

So the first part of the year will be impacted by some of this move-out, but that will normalize [Technical Difficulty] that core FFO range of $0.32 to $0.34 which effectively would put us way back on top of dividend coverage..

Okay.

So the $0.11 Delta is in the second quarter though?.

I'm expecting it in the – it will be spread between the second and third quarter. So both quarters will be impacted..

Okay. And then the acquisition guidance of 340 to 380 seems like a very specific amount.

Can you talk about what - you know, I think you said that there was like 750 that you're working on? I mean, what's this? Is there anything that's under contract or LOI at this point?.

At this point Rob just to give you a high level sense, so pipeline, the top of the pipelines over 750. It's more substantial than that. Wide variety deals smallest is about 30 million. The largest is around $200 million, but for a multi-building portfolio. So pretty wide range.

We've really targeted exactly you know, that level based on where we want to get to on our overall leverage. So could be a little higher, could be a little lower depending on where our cap rates are. Today we do not have anything under contract..

Okay.

And in terms of the stuff you're looking at, any new markets?.

Yeah, we've really been proactive over the last six months spending time in a few new markets. So a lot of the pipeline is in our existing cities. We've spent a fair bit of time Salt Lake, which we've talked about in the past. Nashville is one we spent a lot of time in lately, that we like the fundamentals of a lot..

Okay. Thanks, guys. Appreciate it..

Thanks, Rob..

The next question will be from Barry Oxford of D.A. Davidson..

Great. Thanks, guys.

When you guys were talking you know, about your acquisitions and the cap rates, I guess nudging down slightly, given where the 10 year is and stuff, has your spread on your cost of capital going to remain the same or is that going to come in 2020 when you're doing these acquisitions?.

So I'll start on that one and Tony can jump in, Barry, so. Basically if you look at where we've been getting quotes for really good quality lifeco debt, it's kind of treasuries plus or minus about 150. So today that's you know, a little under three on the debt side.

We certainly are modeling that for the course of the year, but probably around that range. The cap rates are coming down, that's substantially lower than where we were before.

And so one of the things we've been cognizant of doing is really trying to, as we deploy these funds, find newer vintage, really high quality assets with rock solid tenancy, you know, sleep well at night assets. And so that will as well nudge the cap rate down a little bit.

But when you take the cost of borrowing, we're still seeing cash on cash returns over very long periods of time, 10, 15 plus years in the 7 to 8 plus percent range. So still very healthy, and that's basically what we're targeting today..

Okay, great. And then when you guys talk about no capital guidance or not issuing capital here in 2020.

Do you guys think you may not be having that in your guidance, but given your 360 midpoint pipeline of acquisitions if you want to do, can you do that without issuing?.

Hey, Barry. Its Tony here. So a couple of points there. You know, we raised right around $200 million of equity between the end of the third quarter and the beginning of the fourth quarter. So 300 midpoint, taking the midpoint of that range 360 million and that effectively represents a 45% leverage on that equity.

So the answer to your first question is yes, can we do it with our existing capacity, and the answer is yes. In terms of future needs you know, we do intend to refresh our S3 and ATM program here shortly, just to give us the flexibility, so that if you know the pipeline activity increases and it makes sense to do further activity we can do so.

And could we do so in later 2020? I think there's a possibility. For sure that's the case, but there isn't any short term intention to draw any further capital and we have the capacity now to execute on this plan..

Great. Thanks for the color, guys..

Thank you..

Thanks, Barry..

[Operator Instructions] The next question will come from Craig Sarah of B. Riley FBR..

Hey. Good morning, guys. I just want to circle back to your commentary on acquisitions.

Just given that nothing is under contract, it's probably fair to assume that nothing will close here in first quarter, and you're really going to see the bulk of the activity weighted to more likely third quarter, or how should we think about it?.

I think that's fair Craig. Q1 we don't anticipate having any closings. I think Q2 and Q3 is where we expect and our own planning to be fully deployed. So starting Q4 fully deployed. When you look at the transactions, again, there's a number that are later stage, as far as our underwriting and whatnot.

So it's really hard for us today to pinpoint exact dates, but we think that's a reasonable target..

Got it. And I appreciate the color on the large move-outs here over the next couple of quarters. But I think you closed 2019 with about 160 basis points of leasing that hadn't commenced yet.

Can you handicap when you anticipate those tenants beginning paying rent throughout 2020? Is that going to be weighted towards back half or front half? Or how do you think about that?.

So some of the known leases that we signed, for instance some of the larger ones that Jamie described in the call, there are some free rent periods and so therefore their cash rents will be back, we'll hit the back end of 2020 and that really ties into the guidance we gave on same store results, where we talked about Q1 and Q4 being strong, but Q2 and Q3 being flat because some of the new tenants are in free rent periods..

Okay. Got it. And given the commentary on cap rates and looking at your cost of capital today, I know you mentioned that you're looking at sort of a 7% to 8% cash-on-cash return over a long time frame.

But how should we think about what you're going to be buying on an initial cap rate basis here in 2020? I think initially, we were looking at kind of a low 7, but I would think we should be adjusting that down to maybe a high 6 or even lower than that?.

Yeah. In our own planning Craig, if you look at it, we're sub 7 in our own planning. It could it be a little lower if you were buying properties that have 10, 12 year weighted average lease term, so you have absolutely no drag for many, many years.

Sure, it can be lower and typically you'll get lower borrowing costs as well that bring you back to a reasonable level on cash on cash. But within the 6 range is probably where we expect the bulk of the acquisitions to be..

Okay. One more for me. Just looking at your EBITDA reconciliation page and the fact that you closed 7601 in September, the NOI accretion kind of quarter-to-quarter wasn't quite what we expected. I know your tenant reimbursements declined sequentially from third quarter to fourth quarter.

Is there any color there? Would folks sort of build a little bit more earlier there in the year? Or can you give us some color there?.

Sure. So Denver Tech had an unique situation where we - the – when we acquired 7601 in the year there was one tenant who had signed a lease but it had not taken occupancy yet. And under the terms of the purchase and sale agreement that we signed, the seller was obligated to bridge the income to us until a tenant took occupancy.

That tenant didn't actually take occupancy in Q4. They actually took occupancy in Q1. And so while economically, where it weren't any further off, for accounting rules we could not book that cash stream as revenue and instead it is recorded as a reduction in the purchase price.

And so that is part of the reason why we ended on the lower end of the quarter four of range we had and probably why you're seeing that difference in the EBITDA reconciliation..

Okay. Thanks, guys..

That's, great. Thanks, Craig..

As there are no additional questions, I will turn the call back to Mr. Farrar to conclude..

I want to thank everyone for joining today. We look forward to updating you further on our next call. Goodbye..

Thank you. The conference is now concluded. Thank you all for attending today's presentation. You may now disconnect your lines. Have a great day..