Good morning, and welcome to the City Office REIT, Incorporated First Quarter 2021 Earnings Conference 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 to 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 cioreit.com, where you can view our first 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 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 can give no assurance that these expectations will be achieved.

Please see the forward-looking statements disclaimer in our first 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'll review our financial results after James Farrar, our Chief Executive Officer, discusses some of the quarter's operational highlights. I will now turn the call over to Jamie..

Good morning. Thanks for joining today. I'm pleased to report that our results for the first quarter and our expectations for the balance of 2021 are trending positively. For the first quarter, we reported strong core FFO and AFFO growth. Our dividend was well covered by these metrics.

We continue to expect to generate cash in excess of our dividends over the long term. Our rent collections were solid once again with almost 100% collection. We've exceeded 99% collection of contractual base rent in every quarter since the start of the pandemic.

Further, of the $331,000 of rent deferrals that we granted in 2020 we have been repaid 84% to-date and expect to receive the balance before the end of the third quarter. Bottom line, the health of our tenancy is strong and collections continue to be excellent. We also achieved 5% same-store cash NOI growth compared to the first quarter last year.

This was driven primarily by prior leasing at our Denver Tech property and the substantial mark-to-market renewal at one of our Life Science Properties in San Diego. Other highlights of the quarter include the sale of our Cherry Creek property in Denver and the 93,000 square foot renewal and expansion at our Carillon Point property in Tampa.

We announced both of these events on our last earnings call, but the execution is worth noting again. The $95 million sale of Cherry Creek represented a 5.8% cap rate and generated a $47 million gain, the largest gain on sale in our company's history.

The lease at Carillon Point was with paychecks, our largest tenant at the property, we secured an eight year renewal on 78,000 square feet and a 15,000 square foot expansion commencing early in 2022. To touch on some other leasing metrics. Over the last 12 months, we've achieved a healthy lease renewal rate of 77%.

Of note, the first quarter of 2021 was also our strongest quarter for new leasing since the start of the pandemic. We signed 72,000 square feet of new leases, including five expansions and three leases of over 10,000 square feet. We see this as a great start to the recovery.

Overall, we're feeling increasingly more optimistic about the timing of a major return to the office. Based on our tenant discussions the combination of vaccination levels and a fall return to school for kids is giving us confidence that we will see higher utilization levels post Labor Day.

We anticipate this will further stimulate new leasing activity. Further, we continue to believe that the strength of our sunbelt cities will position us well over the long term. However, we do expect an element of tenant turnover as some companies will elect to reduce their space needs.

As detailed in our press release Toyota Motor Credit Corporation, who lease a 133,000 square foot building at our SanTan property in Phoenix, accelerated their lease maturity by two years to August 31, 2022.

Toyota will continue to pay full rent until then and it paid a $3.8 million termination fee representing approximately half of the rent that would have been due over the accelerated two year period.

Well, we had of course hope that Toyota would remain a tenant long term, we are well positioned with over 16 months of lead time to secure a replacement tenant in a great city.

Chandler is one of the most desirable sub markets of Phoenix for large corporate and technology tenants due to the abundance of professionals that live there, the strong demographics and the high quality of life. Turning to acquisitions, transaction volumes in our markets continues to be slow.

However, corn stabilized buildings are still trading at strong valuations with a lot of private capital looking for investment opportunities. We're actively searching for potential acquisitions, but the options for attractive entry points have been limited.

However, we secured an off market acquisition opportunity to purchase two properties adjacent to our existing Sorrento Mesa Holdings in San Diego for $43 million. We waive their due diligence conditions on this transaction and expected to close later this month.

We're very excited about the incremental value that this purchase creates for our portfolio. To provide investors with a better perspective we've included a slide in our main investor presentation on our website that includes a map of our holdings.

Effectively we're buying two smaller office buildings located on highly valuable infill development land contiguous with our own properties. The combination with our properties produced two solid development sites that generate holding income as we progress strategic options.

In total these two sites including our own land, our zone for over 1 million square feet of life science development, [of note] when you look at the map in our presentation you will see that both of these development sites have a fantastic location directly across the street from Qualcomm's world headquarters campus.

As we mentioned in the past, the life science sector continues to be very attractive. San Diego is one of the top three life science markets across the United States and vacancy hit a record low 4.3% at the end of the first quarter. At the same time, rents continue to grow to new highs.

CBRE's 2020 data showed that San Diego's life science rental rates grew by 7% in 2020, and an impressive 96% over the last 10 years. Upon closing this purchase we intend to operate the existing buildings to maximize cash flow in our holding income.

We're considering all of our options, including participating in a phase development with an experienced partner. In the meantime, we're excited to further build one of the dominant holdings in Sorrento Mesa.

And lastly for me, as we head into a busy spring and summer, management is focused on driving cash flow growth and completing strategic leasing across our portfolio. We have a number of exciting opportunities that we're working on. We look forward to providing updates in the future.

I'll now turn the call over to Anthony to provide further detail on our financial results..

Thanks, Jamie. I'll address the first quarter's results, and then provide an update to our guidance for the balance of 2021. Our net operating income in the first quarter was $25.4 million which was $200,000 higher than the $25.2 million we reported last quarter. The increase was a result of a combination of factors.

We had an increase in NOI at our Carillon Point property as a result of the straight line rent increase from the major lease we signed in the quarter which Jamie described. We had lower operating expenses in the first quarter at a number of our properties and we recorded slightly higher termination fee income.

In the aggregate, these positive variances more than offset the reduction in income from the Cherry Creek sale midway through the quarter. As Jamie discussed, Toyota paid us a termination fee of $3.8 million related to the SanTan property. We recorded just $57,000 of this amount during the first quarter.

A total of $2 million will be recorded in the remaining three quarters of 2021 and $1.75 million will be recorded in 2022. We reported core FFO of $14.5 million or $0.33 per share, which was $400,000 higher than in the fourth quarter for the same reasons that NOI was higher. Our first quarter AFFO was $11.2 million or $0.26 per share.

The largest impact AFFO was a $1.3 million leasing commission paid on the paychecks eight year renewal and expansion at our Carillon Point property. Our first quarter same-store cash NOI growth was a positive 5.0% as compared to the first quarter of last year.

The leases we signed in 2020 particularly those at Denver Tech property and our life sciences portfolio are the biggest drivers to these results combined the slightly lower property operating expenses over the prior year. Our total debt at March 31 was $573 million, which was $104 million decrease over our year end figure.

That decrease was primarily a result of the repayment of an $83 million loan with the proceeds from the sale of Cherry Creek during the quarter. Our net debt, including restricted cash to EBITDA was a healthy 6.0 times. At quarter end, our total debt had a weighted average maturity of 4.7 years and 91% of our debt was effectively fixed.

Our weighted average interest rate is now 3.7% and we have no property debt maturities until 2023. Last we have provided updated full year 2021 guidance in our press release.

The primary drivers of the guidance changes are the termination fee income, reduction to our general provision due to strong rental collections and the acceleration of our acquisition timing. These operational updates positively impacted our forecasted net operating income, core FFO and same-store cash NOI growth.

We refer you to the material assumptions and considerations set forth in our earnings press release. That concludes our prepared remarks. And we'll open up the line for questions.

Operator?.

We will now begin the question and answer session. [Operator Instructions] Our first question comes from Rob Stevenson with Janney. Please go ahead..

Good morning, guys.

Jamie, what's the plan for Sorrento Mesa post closing of this acquisition? Do you lease up the current vacancy? Do you now with the incremental development capability and the ability to put larger office there, do you market this to a large user with the builder suit element here and keep the vacancy and hold that back for somebody who's going to occupy half a million square feet or something like that? How are you guys thinking about that at this point?.

Sure Rob. So there's a couple elements there. One in our existing portfolio, we have one building 59,000 square feet, that's vacant and action on that it's starting to pick up as far as prospects and we're feeling pretty good about that. So that's one we want to get leased up. That's a pretty sizable increase in our overall cash flow by doing that.

When you look at the development land, we're early days, I'd say. We're looking at all of our options there.

What we know is by adding these two other properties, we've created two really solid development sites that have a lot of value and potential and kind of all options are on the table and including participating in a phase development with an experienced developer..

Okay.

And then, Tony in terms of the comments earlier about potential downsizings, etc, any incremental move outs that are known at this point or downsizings of note that we should be aware of this year or early next?.

Yes. Hey Rob. To address that question. The first one to make note of is in Q2 coming up here, we have 65,000 square feet that's coming up for renewal in Florida Research Park. We've talked about this on previous calls.

We're expecting to sign a lease in very short quarter here for approximately half the space which means we'll be getting back just over 30,000 square feet. That's an immediate space that's coming back to us in Q2. Beyond that there really isn't anything too significant for the balance of this year.

At the end of the year on December 31, we're expecting to get that 46,000 square feet also in the Florida Research Park. That's field ingenuity drive property that we refer to. We have some time yet to go there. But just as you recall that 125,000 square foot building we've signed a direct deal with a subtenant for 79,000 square feet.

And 46,000 square feet is coming back to us on December 31..

Okay.

On the second quarter, give back, is the current tenant staying in? Is that a new tenant that's taking half the space? And is there any material of improvements that we need to be aware of?.

Yes, so that's a, it's a GSA tenant that's in there now. And they are giving back half. So we're renewing the existing tenant on reasonable terms..

Okay. And then last one for me.

When you wind up closing the acquisition you've got the disposition proceeds? What is the capital position look like? I mean how much capital do you have essentially to invest in the remainder of the year without going to the upper ends of your leverage levels, etc?.

So maybe I'll start on that one, Rob. So we've got another call it 57 million from our guidance of the top end at 100 million. We're still comfortable that we could go a bit above that. As far as timing, the way we've model internally was kind of mid Q4, as far as a follow on acquisition. Look there are a number of things we're looking at right now.

It could be sooner it could be later. It's really hard to say. So I think as far as best guess on timing, I wouldn't change what we put there..

Okay, thanks, guys. Appreciate the time..

Yes. Thanks , Rob..

The next question comes from Jason Idoine with RBC. Please go ahead..

Hey, guys. Just touching on the SanTan Toyota lease. So I guess my first question is why does the tenant looking to leave that space? If you have any idea around on that? And then could you tell us a little bit about the prospects for that space? I think you guys have two buildings there.

So just wondering if there's anything creative there that you could do? Maybe you bring in one tenant to lease both of those buildings? Or are you planning on multi tenant and the Toyota one or kind of what's the plan there?.

Sure. So, Jason, as far as the there's two buildings, you're correct, Toyota occupies one. They put a lot of money into their space. What we were advised by Toyota is they were taking three buildings they have across the country and shifting the bulk of those workers to remote. And so they moved in that direction on three different locations.

One in Phoenix, two in other parts of the country. So it was disappointing from our standpoint, it's early days. We still have a lot of time almost 16 months here before we get the space back. And so we've fired up our leasing team. We're starting to spend time on looking at what we can do with that particular building as far as enhancing amenities.

It could be we're thinking of multi tenant building, but at the same time there are some large users in Chandler looking for space to follow. Intel are making a huge investment and commitment in the area. And there could be some ancillary benefit from that.

So we're feeling really good about the time we have and the prospects and the rate we're going to get, but obviously, we'd love to have kept Toyota but I think we're in a good spot there..

Okay. And I guess, on the redevelopment opportunities in Sorrento Mesa. So I think that those are going to be conversions from traditional office to lab. Some of your other peers who are in the life science space have noted that it's exceptionally difficult to kind of bring some of those traditional office spaces up to spec for lab tenant users.

So just kind of curious to hear your thoughts around that or I guess what the ultimate development plan is there?.

So we're in a bit of a different position where the five buildings we have, four of them are already life science with lab. One of them is leased to Intel is an R&D building with a lot of infrastructure that could be easily sorry, Qualcomm, which could be easily converted to lab.

So when you look at the two buildings that are on the sites that we're buying our view there is we're going to maximize holding income. It's likely would be a phased development that would happen over time. So it's a number of years before those ones would be ultimately taken down and then wrapped into a larger overall development..

Okay, got it. And then I guess my last one on the FRP GSA lease.

I know, I think last quarter, it was you guys gave an update that you were confident on the one space and the second space, you guys are still working through some discussions, but I guess we just had those discussions and why did they end up deciding to give back the one space? And I guess what are the prospects of leasing the remaining 30,000 that's going to be vacant out?.

Yes. So in terms of the discussion, so the discussions were revolving around whether another department could utilize the space. Ultimately what they decided to do and is that they needed one floor and the second floor at the end of the day, we weren't able to come to terms with another department to take it over.

Ultimately, we're going to do a very short term extension for two months on half of the space and then they'll vacate. In terms of prospects for that space, again, this is just a reminder for Florida Research Park is around the military base there. There is a number of contractors and so demand has remained steady. And we feel good about our prospects.

They'll be downtime probably through the balance of this year and then hopefully to have a replacement tenant paying rent in the new year..

Okay. Thanks..

Your next question comes from Craig Kucera with B. Riley Securities. Please go ahead..

Hey, good morning, guys. We're hearing more from Office REIT this earnings season about leasing and traffic coming back to pre-pandemic levels.

You clearly sound optimistic, but I'd be curious as to any color on which markets you're seeing which are maybe showing greater strength versus those that might be lagging in that regard?.

So Craig I think that's a fair comment. So when you look at actual starting with utilization, it's picked up a little bit, but it's still kind of in the mid 20%. But where we are feeling a lot more optimistic is hearing directly from tenants as far as their plans on coming back and the timing, which is starting to circle around summer, fall Labor Day.

And so we're feeling good about that. And then when you translate into tour activity, it's come up a lot, and really the markets like Phoenix, Dallas, Tampa, Orlando, I would say are kind of at the forefront. San Diego on life sciences is absolutely white hot. So those would be kind of the leaders across our portfolio.

The other thing we're spending some time on is looking at a few of our larger blocks of space where utilization hasn't been as high or in the case of merger or something spaces being used.

And we're getting some good action around bringing in replacement tenants that could potentially really extend the overall lease terms that we have in those assets. And so that activity is picking up as well. And that would be in space that we couldn't otherwise accommodate in our vacancy. So we're feeling pretty good about what we're seeing.

I think it's going to be back end of the year before that really starts translating to seeing leases done in a meaningful way..

Okay, I appreciate that.

Tony, will the remainder of the Toyota motor credit lease termination fee be recognized ratably until they vacate? Or is there any sort of lumpiness in there?.

No, it's really straight line between now and the end of August 2022. They signed. We got information notice really at the end of March which is why you only see 57,000 recognized in Q1, but it'll be a straightline until the departure..

Okay, great. And one more for me. Jamie, you mentioned that you really have to find any attractive entry points in the acquisition market.

Is that because there's just not a lot of product to evaluate now or are you actually seeing cap rate compression relative to maybe we were year to year and a half ago?.

There's both Craig. There is just not a lot of transactions that really fit and the ones that we are interested in there's been a lot of competitors and pricing has moved and some of the cases of transactions we're working on move well beyond what they were initially asking.

And so I think there is a lot of capital on the sidelines for good quality assets. And that's making it a little bit more difficult.

And then we kind of known that and that's why we timed in our own acquisition model the back end of the year and so we're going to be disciplined and make sure what we buy and where we put our capital they're going to be good value for us..

Okay, great. Thanks..

Thanks Craig..

[Operator Instructions] As there are no additional questions, I would like to turn the conference back over to Mr. Farrar for any closing remarks. .

Thanks for joining the call today. Please don't hesitate to reach out to us at any time if you have any further questions. Goodbye..

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