Good morning and welcome to the City Office REIT Inc. Third 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 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 third 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 third 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 Jamie Farrar our Chief Executive Officer discusses some of the quarter's operational highlights. I'll now turn the call over to Jamie..

a $395 million first closing scheduled for December 2021 and a $181 million second closing scheduled for early 2023 with an acceleration option. Based on our confidence in redeploying the sale proceeds, we've accelerated the second closing date to December 2021 as well.

Our belief is that the best place to reinvest this capital is in the top submarkets of high-growth cities across the south and west. When we entered into the Sorrento Mesa sale, we set a goal to use these proceeds to strategically enhance our portfolio across exceptional locations.

As we consider acquisition prospects, we've been targeting newly built properties with vibrant amenities and superior tenant build-outs.

While the cap rates for this asset profile are lower than our historical average, buying these types of properties will enhance our company's future cash flow stability and add long in-place leases and quality tenants. We believe premier properties like these are positioned for continued healthy rental rate growth and will thrive over the long term.

I'm pleased to report that we've made great progress building our pipeline with exactly the sort of transaction. We've been very busy since August and have underwritten over $2 billion of potential acquisitions. We are focused on all of our existing cities as well as markets with similar growth and demographic characteristics in the South and West.

Today, we are advancing just over $600 million of potential acquisitions that fit our criteria perfectly. These acquisitions are still in the due diligence phase but we are very excited about their prospects. If we choose to proceed after completing our due diligence, we will provide further details in the months ahead.

Turning to the operating environment. Executing new and renewal lease transactions continues to be impacted by low tenant space utilization across the industry. The good news is that our properties are located in exciting and growing cities that are positioned well for a strong pickup in demand over time.

Across our portfolio, leasing to our activity continues to improve. This is translated into more lease inquiries and discussions with prospective tenants. However, it continues to take longer to finalize leases in today's environment. This applies to both new leases as well as renewal discussions.

The overriding comment we continue to hear from tenants is that they want employees back to the office, but likely this will be at least initially on a hybrid basis for many companies. With potentially changing needs in mind, tenants have been challenged determining how their offices should be configured.

Many real estate decision makers have, therefore, been hesitant to commit long-term with this uncertainty remaining. We believe this dynamic will continue to improve as we head into 2022 and more people return to the office. At the same time, we continue to hear how tenants want modern, dynamic space in highly amenitized locations.

Employers view this type of high-quality office space as a draw to help accelerate a return to the office. This is why we're targeting premier properties in our acquisition pipeline, and it's also shaping our own strategy to accelerate leasing across our portfolio.

In our experience, we found very strong demand for modern, pre-built and move-in ready spec suites. This strategy speeds up the decision making process and allows us to better control costs.

Learning from this, over the next year, we plan to invest in our existing properties through our spec suite program, common area upgrades and repositioning select buildings. We achieved tremendous leasing success with this approach in the past and believe now is the time to position our portfolio to win greater market share.

This will differentiate our properties from many of our local competitors, who are not actively reinvesting. We will discuss this further in the future as we execute these plans.

Tony will provide further details on our recent leasing activity in a moment, but I want to conclude by saying that driving leasing success is one of our top priorities as we enter 2022. We believe our quality portfolio along with some strategic enhancements will position us favorably and for cash flow growth.

We expect a very busy and exciting remainder of the year and I look forward to providing you further updates on our progress. With that, I'll turn the call over to Tony..

Thanks, Jamie. Our net operating income in the third quarter was $29.7 million, which was $3.9 million higher than the $25.8 million we reported last quarter. The increase was primarily a result of termination fees, which were $4.5 million higher than in the prior quarter. In total, we recorded $6 million in termination fees in the third quarter.

The largest contribution was $5.3 million from BB&T at Park Tower, which we reported on last quarter. This represents the full amortization as a tenant vacated the property at the end of the third quarter. We reported core FFO of $14.1 million or $0.32 per share, which was $1.2 million lower than the previous quarter.

The higher termination fee income was offset by higher general and administrative expenses. The G&A increase reflected a one-time $5 million employee incentive compensation accrual, as a result of the extraordinary $430 million gain that Jamie discussed earlier. Our third quarter AFFO was $8.5 million or $0.19 per share.

The largest impact to AFFO was a leasing commission paid at our Sorrento Mesa property of $1.5 million related to a 69,000 square foot, 12-year lease renewal, signed prior to the execution of the sale contracts and therefore, contributed to the value creation on that transaction. We also signed two other significant leases during the quarter.

We signed a 72,000 square foot, three-year renewal at our AmberGlen property in Portland. We have referenced this lease on previous earnings calls as one of our larger near-term expiries and are pleased we were able to come to terms. In addition, we signed a 41,000 square foot tenant to a five-year renewal at our Papago Tech property in Phoenix.

These two leases significantly stabilize the portfolio. Our third quarter same-store cash NOI growth was a positive 1.4% as compared to the third quarter last year. The leases we signed in 2020 particularly those at our Denver Tech property and our life sciences portfolio are the biggest drivers to these results.

With the pending sale of our Sorrento Mesa portfolio and the previously announced departures relating to a few tenant terminations, we are projecting lower same-store results over the next few quarters. Our total debt at September 30th was $603 million. Our net debt including restricted cash to EBITDA was a healthy 6.1 times.

At quarter end, our total debt had a weighted average maturity of four years and 86% of our debt was effectively fixed. Our weighted average interest rate is now 3.6% and we have no property debt maturities until 2023. Our only maturity in 2022 is with respect to our unsecured credit facility.

We do have a one-year term extension write but we are making good progress on renewal discussions and expect to renew prior to the initial term expiry. Last, we have provided updated guidance in our press release.

The only change to reflect is the one-time $5 million general and administrative expense accrual that I mentioned earlier, which also impacts core FFO. We refer you to our material assumptions and considerations set forth in our earnings release. That concludes our prepared remarks and we will open up the line for questions.

Operator?.

We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Jason Idoine with RBC Capital Markets. You may go ahead..

Hi. Good morning guys. A question on redeploying the Sorrento Mesa sale proceeds.

How many transactions are you expecting to close before those proceeds are redeployed?.

Thanks Jason. So as I mentioned in my prepared remarks, we're looking north of $600 million that represents three transactions and all of them right now are under due diligence..

Okay.

And how should we think about acquisition cap rates for prime office assets?.

So when you look at the quality of the properties that we're looking at Jason, just to give you some guidance overall, we're thinking top submarkets, irreplaceable locations, new construction, high-quality amenities, long leases in place, perfect predictable long-term assets for growing cash flow.

And so when you look at cap rates in the markets today, I think probably around a five cap..

Okay. And then last one for me. So you guys got AmberGlen re-signed. I think the last remaining expiration in 2021 is the Kaplan lease, which I think was a partial re-sign.

I guess what's the plan with that asset? And then could you also provide an update on I guess SanTan and Pima in 2022 and then any large lease rolls in 2023?.

Yeah. Good morning, Jason it's Tony here. So you basically hit all the large role we have as you talked about Florida Research Park. We are getting that 46,000 square foot space back at the end of the year.

That building currently is really a triple-net single tenant building, and so we are -- have plans drawn up to convert that to a multi-tenanted building and really enhance some of the amenities and common areas and whatnot for that space. So we expect or are hopeful to lease that up later in 2022 at this stage.

In terms of the other rolls that you talked about SanTan, the Toyota space we're getting that back at the end of August of next year. That is the largest space that we're getting back over the next four quarters.

And really beyond those two there really is only one other lease over the next four quarters that is greater than 30,000 square feet and that is at our Florida Research Park. We have a GSA tenant rolling in Q2. That tenant has been there for a very long time and discussions are preliminary, but we are optimistic on a renewal for that tenant.

And those are the only three for -- in the next four quarters..

Okay. Thanks..

Thanks Jason..

Our next question comes from Rob Stevenson with Janney. You may go ahead..

Good morning, guys.

Jamie, how did the acceleration clause work? Was it all or nothing for December 2021? Could you have accelerated the second tranche into February or March or June of 2022 if you wanted to? How much flexibility did you have there?.

So the northern properties were hard for December 2 and the Southern which is the $181 million, we had the ability to accelerate on 45 days notice and looking at our pipeline and timing Rob and wanting to make sure we line everything up for a proper 10.31. We decided to bring it into this year, but we have flexibility around that. .

Okay. Just wanted to figure out like I assume then that it's pretty confident that you'll be under contract at some point in the not-so-distant future on some of these acquisitions at least in order to have you pulling that forward at this point and not pushing it to February or March or whatever to buy yourself a little bit more time.

So that was the reason why I was asking that. .

Yes. So we feel very good, Rob. .

Okay. And then Tony so you guys are 88.7 occupied, but 91.1 committed and occupied as of September. How should we be thinking about the committed and occupied number at year end with what you guys have in your leasing pipeline at this point? I mean the 88.7 is basically at the top end of your year end occupancy guidance range.

Is the committed and occupied at year end likely to be in that sort of similar sort of 91%.

You've got a bunch of stuff sitting on yours and Jamie's desk to sign that would push you guys higher than that from a committed and occupied standpoint? How should we be thinking about that at year end?.

Yes. So good question. If we talk about that the difference between occupied and the committed the single largest committed lease that we have that's in those numbers is the fintech tenant at Park Tower. They are expected to take occupancy in May and so that's a single largest item. So that item alone will not go into the occupied column at December 31.

That will remain in the committed column beyond that. So I would say at this point we're beyond the kind of the known move-outs that I talked about earlier. We're really not expecting a significant change in either of those numbers as we roll into December 31..

Okay. And then last one for me. As you guys are talking to both the tenants that you guys have signed over the last couple of quarters as well as the people you're in contracts or contact with now for renewals and new space.

How would you characterize where the demands are in terms of tenant improvements and other sort of cost -- leasing costs today versus where it would have been on that similar space pre-COVID? Is there a noticeable sort of demand? I'll take the space but I want either this much more free rent or this much more tenant improvements to build out my space.

Is that coming to fruition at this point, or is that not really what you're seeing these days today call it November 2021 versus November 2019?.

So good questions there, Rob. So again if you kind of step back and say what's happening you're seeing rents really hold in there. You're seeing concession costs higher and that's been driven.

If you look -- as far as what's been happening in the markets early in the year across our cities anyways there's about six million feet in Q1 of negative absorption and that dropped to about 2.5 million feet in Q2 of negative absorption. It's gotten better. We're down now to about one million feet of negative absorption.

So we feel like we're past the bottom. Generally in the market things are getting better on a leasing front, but costs for sure are higher to build construction costs and we're finding what tenants want is more impactful space to use as a lure to draw back employees. And so just generally as we've been having leasing discussions they've been slower.

Costs are a little elevated. And that really has factored into our own plan of getting in front of it and putting some capital to work here to have really high-quality spec suites where we can spread the cost over a number of units try to keep it more efficient and give tenants -- prospective tenant space that's ready to go.

And there's not a lot to haggle about or think about because it's plug and play and that's driving our strategy. .

Okay. Thanks, guys. Appreciate the time..

Our pleasure, Rob..

Our next question comes from Craig Kucera with B. Riley FBR. You may go ahead..

Yeah. Hi. Good morning.

Looking beyond the lease terminations that you captured this quarter, are you in discussion with any other existing tenants that are contemplating maybe moving out early?.

Craig, it's Tony here. We just kind of completed our kind of budget and kind of strategic review processes and part of that we actually went through all of the leases that had significant termination fee options, within their leases. And really, there's only a handful left. The ones that, we've announced were by far the largest.

We could see another one in early 2022, but it's really down to – you can count them on one hand, and we're only expecting maybe one or two beyond that. Beyond that, in terms of that space dialogue, there will always be the opportunity.

If we have another tenant that we want to push out, as we've had the deal – I'm thinking about the Park Tower, where we have a tenant until, I mean, those discussions are always ongoing, but nothing significant at this point..

Got it.

And obviously, you can't give too much color on what you look to acquire with the three transactions at north of $600 million, but given that you've had since August to kind of be working on this and building your pipeline, how are you thinking about how quickly you can deploy that capital that's coming in the door? Is that a first quarter 2022 event? Is that maybe take you to the middle of the year? Just any thoughts there would be helpful..

Faster than that. So our own expectation, again, if they come together is we're going to have a lot of closings in Q4..

Okay. Great. So more or less match funded then..

Correct. .

And there wasn't a huge amount of delta between what the cash you're getting and maybe the number of transactions you're looking at, but Tony are you thinking about plugging the gap with the line of credit? Are you thinking at all about mortgage finance, or just sort of your thoughts on what you're thinking about leverage in regard to those transactions?.

Yeah, good question, Craig. So yeah, so Jamie mentioned that the transactions that we have are just north of $600 million. The estimated proceeds from Sorrento Mesa is approximately $546 million. I mean, so there potentially is $50-ish million to finance. And just given our line of credit today we have a $250 million availability.

We have $88 million drawn at September 30. So, certainly a lot of room there and as I mentioned in my remarks we are talking about – are making good progress on a renewal on that line where we potentially could have a little bit more availability. So that's the most likely outcome of the financing..

And are you thinking just bigger picture beyond maybe this first tranche of acquisitions of levering up kind of what you're buying and buying even more just given the amount of money coming in the door, or are you thinking that this is what the balance sheet may effectively be looking like with an overall much lower leverage amount going forward?.

Yeah. So a very good question, and I think the best way to answer that question is just given where the delta in NOI that will be achieved once we complete these acquisitions, there will be excess cash flow that we will be generating over our dividend, and as a result, slowly reducing our overall leverage.

So I think over time, there will be an ability to perhaps do more acquisitions, or if we find something that we're particularly excited about. But in the short term, I think that's what you'll see the balance sheet at for a little while..

Okay. Thanks. Appreciate it..

Thanks, Craig..

[Operator Instructions] Our next question comes from Barry Oxford with Colliers. You may go ahead..

Great. Thanks, Jamie you had mentioned doing some rehab work on some of your older buildings. What type of IRR can we expect from that? And Jamie, of course, as some people have already indicated on the call you've got labor costs and you got material costs.

Is that going to eat into that IRR?.

I guess, when you step back Barry, and you've got vacant space that's earning no return, currently, and you can put some capital in and turn that into probably very healthy rents and overall returns.

I don't have the IRR on that exact expenditure per sequential, but I just know from, an overall cash flow and what it impacts on that particular building in each case, it's a meaningful pickup to both cash flow and value creation at the property. And so costs are rising. We factored that into kind of our own planning here.

We're trying to finalize our numbers, but we think we can accelerate leasing and generate a really good return on that capital..

Okay. Perfect. That makes sense. Thanks, guys..

You’re welcome..

Thanks, Craig..

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

Thank you for joining today. Please don't hesitate to reach out, if you have any other questions. Goodbye..

This concludes the call. You may now disconnect. Thank you..