Good morning, and welcome to the City Office REIT, Inc. Third Quarter 2023 Earnings Conference Call. [Operator Instructions]. As a reminder this conference call is being recorded. [Operator Instructions]. It is now my pleasure to introduce to you, Tony Maretic, the company's Chief Financial Officer, Treasurer and Corporate Secretary. Thank you. Mr.

Maretic, you may now 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 be achieved.

Please see the forward-looking statements disclaimer in our second 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 and thanks for joining today. As we move into the end of the year and look ahead to 2024 the office environment continues to experience both encouraging trends and macro headwinds.

We anticipate the macro environment next year will continue to be challenging, with a higher for longer interest rate environment and potential economic weakness. Despite that, we believe there will be subsets of the office sector that are going to perform well.

I'll highlight where we believe that is going to be and the decisions that we are making to optimally positioned ourselves. While the last few years have been less predictable than in the past, some clear leasing trends have become apparent.

New vintage buildings have dominated leasing, despite representing a relatively small percentage of the entire office stock. JLLs recent market research confirms this. Their data identifies that newly constructed office buildings delivered in 2015 or later have been winning most of the net absorption over the past three years.

We believe tenants' clear preference for premium quality space will continue to support this trend. Not surprisingly, future supply of new development has and will continue to dramatically taper given the sector's uncertainty and a lack of equity and debt capital.

Outside of projects already under construction, we expect limited delivery of premium new competitive buildings in the near to medium term.

The combination of these two trends, concentration of demand at the top part of the market, along with slowing new construction should result in rising rental rates and strong operating fundamentals at this top segment of the market. City Office is positioned to benefit as these trends play out.

Our three most recent acquisitions are top of market buildings, with new construction, great locations and leading amenities. The Terraces in Dallas' Preston Center delivered in 2017, and is 100% occupied. Block 23 in Downtown Phoenix delivered in 2019, and is now 95% occupied with two well positioned vacancies that we expect to lease.

And our two building Block 83 property in Raleigh, delivered in 2019 and 2021 and is 86% occupied with additional leases under negotiation and strong tour activity. These three assets are perfectly suited in today's leasing market and represent a very significant percentage of our overall value.

With rental rates for this category of properties likely to continue to grow, these are exactly the sort of assets that you want to own now and for the long term. Despite sector challenges, we expect these premium new construction buildings will continue to lease up and availability of vacant space within this category will diminish.

This supply reduction should lead to greater demand for the next highest quality tier of properties. This includes buildings that are extremely well located in great cities, and have been recently renovated to a very high standard with amenities.

The rental rates for this category of property are currently at a significant discount to new vintage buildings. We expect that as the premium buildings become unable to accommodate tenants, rental rate and demand growth will shift to this category.

Within our own portfolio, these views have shaped our strategy to position ourselves for winning occupancy. We've either been investing capital in or about to make enhancements to this category of buildings that we own. This includes renovation programs, and advancing ready to lease spec suites.

Across our portfolio, we have a number of examples within this category. Park Tower is a renovated building that we transformed in Downtown Tampa. The Square is a fully renovated asset in an incredible location in Old Town Scottsdale. The Quad in Scottsdale has been fully renovated and has achieved strong and consistent tenant demand.

City Center in Downtown St. Petersburg is a fabulous waterfront location. We're finalizing our plans to launch a major repositioning. 5090 is well located in Phoenix's Camelback corridor. We've just initiated a major upgrade that will complete mid next year.

And Pima Center located North Scottsdale is undergoing a transformational repositioning right now. We've already seen a pickup in leasing demand from the improvements at Pima Center and will further benefit from the new amenities as the adjacent $80 million entertainment development under construction completes.

Bottom line we see opportunities for outperformance and value creation despite the challenges in certain subsets of the office sector. On a separate note, we enhanced our supplemental financial information package to include additional detail for leases with WeWork, given their recent filings and restructuring.

In total, WeWork leases 177,000 square feet at our three top tier properties that I discussed earlier in Raleigh, Dallas and Phoenix. WeWork's Raleigh and Dallas operations at our buildings appear to be well occupied. The Phoenix location opened approximately one year ago and is still in a lease-up mode with lower occupancy levels.

None of our three leases were listed for rejection on WeWork's November 7 filings. All three locations are open and operating and current on rent through the end of October. Despite this, we've been preparing for any potential scenario that could unfold at WeWork. Fortunately, WeWork leased at our most desirable assets and locations.

Each of the three properties and newly construction in a flagship type location for WeWork. In the event, they vacate any of these locations we already have strong interest from leading co-working operators and are ready to move quickly.

Alternatively, we have the option of pivoting to leasing to conventional tenants given the demand for premium buildings. Bottom line, while these challenges may create some short term disruptions, our premium locations and phenomenal buildings preserves our strong position.

Moving to our results for the quarter, they were in line with our expectations. During the quarter we executed 119,000 square feet of new and renewable leases, with a 3.1% increase in renewal cash rents versus expiring rents.

This follows the industry trend that despite negative absorption base rental rates have continued to rise driven by top tier and renovated assets. We also had another quarter of positive same store cash NOI growth and achieved a 2.2% increase over the prior year quarter.

Year-to-date, same store cash NOI increased by 4.2% as compared to the same period in the prior year. Consistent with our previous messages, we continue to see tenants wanting prebuilt space that can be quickly occupied with no construction build out uncertainty. As a result, we've been focused on ramping up our spec suite inventory.

We've increased our spec suite inventory from 54,000 square feet as of June 30 to 92,000 square feet as of September 30. We have an additional 67,000 square feet that is either under construction, or planned for the balance of 2023 and 2024, with active leasing conversations occurring at many of these locations.

Currently, we're exchanging proposals for or in final lease negotiations on six spec suites totaling approximately 27,000 square feet. As we head into yearend and 2024, our team remains focused on driving leasing activity and creating value for shareholders.

While Office REIT stocks continue to trade at steep discounts, we believe the quality of our portfolio and our focus on creating value will reward shareholders over the long term. I look forward to providing further updates on our progress. And will hand the call over to Tony Maretic to discuss financial results..

Thanks, Jamie. Our net operating income in the third quarter was $26.6 million, which is $800,000 lower than the amount we reported in the second quarter. This decrease is attributable to the deconsolidation of 190 Office Center during the second quarter, slightly lower occupancy and higher operating expenses quarter-over-quarter.

We reported core FFO of $13.7 million or $0.34 per share. This was $500,000 lower than in the second quarter for the same reasons that NOI was lower offset by slightly lower G&A in the quarter. Our third quarter AFFO was $6.3 million or $0.15 per share, which resulted in a well covered dividend this quarter.

The largest impact to AFFO was a 1.5 million tenant improvement at our Denver Tech property for a 37,000 square foot tenant who renewed their lease in 2022 for an additional 11 years. We also continue to invest in ready to lease spec suites and vacancy conditioning, which is a key part of our business plan.

The total investment in spec suites and vacancy conditioning in the third quarter was $800,000 or $0.02 per share. Moving on to some of our operational metrics. Our third quarter same store cash NOI change was positive 2.2% or $500,000 higher as compared to the third quarter of 2022.

Block 83 in Raleigh, and Park Tower in Tampa had the largest year-over-year increases due to slightly higher occupancy and free rent in the prior year comp period as a result of signed leases. For 2023 in total, we are tracking towards a 3% to 4% increase in same store cash NOI.

Our portfolio occupancy ended the quarter at 85.4% including 51,000 square feet of signed leases that have not yet commenced, our occupancy was at 6.3% as of quarter end. Our total debt as of September 30 was $671 million. Our net debt including restricted cash to EBITDA was 6.5 times.

During the third quarter we were successful in completing the renewal of two property loans that were set to mature in September and October. The loans at our FRP Collection and Carolyn properties in Florida were both extended for five years to 2028.

In connection with the extensions, we entered into five year swap agreements, effectively fixing the interest rates for each loan at approximately 7%. Our next loan maturity is the non recourse property loan at our Cascade Station property in Portland, which has a principal balance of $21 million and matures in May 2024.

In December 2022, we recorded an impairment in that asset's value that effectively wrote off our equity value, and we have begun discussions with that lender. Portland continues to be a challenging market, and without some form of material loan concessions, it is difficult to justify investing further equity into this asset today.

Lastly, as of September 30, we had over $90 million of undrawn authorized on our credit facility. We also had cash and restricted cash of $52 million as of quarter end. That concludes our prepared remarks. And we will open up the line for questions. Operator..

Thank you. We will now enter our Q&A session. [Operator Instructions] Our first question today comes from Rob Stevenson from Janney. Rob, your question is open. Please go ahead with your question..

Thank you. Good morning, everybody. Jamie, how are you approaching the WeWork bankruptcy? I mean, some office owners just want to rip the band aid off and get the space back and think they can do better than what WeWork wants in terms of new rates without the risk that it just implodes at some point.

Sounds like from your commentary that they have not put these back to you yet, but I assume that eventually they'll be coming to you to try to renegotiate.

How do you approach that at this point given that these are three of your top assets rather than assets along the bottom?.

So thanks for the question and you hit the nail on the head. WeWork are trying to get concessions from all landlords. They've publicly stated that. And I guess it really comes down to the position that you're in as a landlord. And we think WeWork are excellent operators.

It sounds like they're making headway on solving their balance sheet issues and exiting some locations that have been a drag but bottom line, we care about maximizing our own position. And we're in a good spot overall. We've got three fabulous locations.

As I said, in my prepared remarks, the rally in Dallas locations are doing extremely well, Phoenix is a little lighter, given they just reopened it about a year ago. And so from our position, we've been focused on getting our alternatives ramped up, and that could be moving to another co-working operator. It could be leasing the space directly.

And the analysis we've been doing is, despite what direction we go, we think we can do the same or better in terms of rents. If we ultimately ended up having a switch, which may happen, may not, we don't know, there'll be a period of kind of ramping back up, and then we'll get to the same or better spot. So we're being pragmatic about it, Rob.

I think we've got fabulous locations that WeWork probably don't want to give up. And it sounds like they're doing the right moves on their side to position themselves for success. We're going to play it out and keep all of our options open..

Okay, that's helpful.

Tony, any incremental known move outs over the next 24 months from last quarter?.

Really no update in that respect, the same ones we talked about before. I can review it really quickly. We have four tenants that are greater than 3,000 square feet that are set to expire in the next 12 months, two which total 84,000 square feet are at our Cascade Station in Portland, which are known move outs.

And those are the only known move outs we have. We have a couple of other larger tenants that we are optimistic on renewing for..

Okay, what do you guys expect to come to a decision or a final sort of process on Cascade Station? Is that sometime here in the fourth quarter? Is that likely to be sometime in early 24 as the debt expires? How should we be thinking about that?.

We engaged in discussions with the lender, a number of months ago and they're ongoing. So it's hard for us to say exactly when that's going to transpire..

Okay, and then Tony, the $700,000 and some of free rent in the quarter, how is that sort of look in terms of the fourth quarter? And as we sort of migrate into early 24? Is that dropping off? Are there new leases of magnitude that you guys have signed over the last few months that will continue to have you sort of in that three quarters of a million dollar to a million dollars of free rent? Or is that burning down closer to de minimis levels?.

I would expect that you'll still see the free rents line item continue. By Q4 you may see a little bit of a burn down, some of it are the free rent that's properties that are that are known to be burning off but not material -- not a material movement in that direction. .

So, Rob if we do what we're striving to do, which is really drive a lot of occupancy and growth, which is going to drive cash flow, that's going to keep free rent elevated for a bit because virtually all deals have some component of free rent. That's a good thing,.

Which is typically at the front end of a deal..

Okay, and to that point, what have you guys spent thus far in '23 on the Spec Suite program, and how much you guys likely to spend in '24 given your comments about continuing to expand that program? How should we be thinking about that?.

Yeah, sure. So you know, we made some significant headway in 2023. Year-to-date, we've spent just over $4 million. I just mentioned, it's about $800,000 in Q3. So I think the best way to think about it is, Q4 will probably be in that $1 million dollar range, and you probably expect that same trend to continue throughout 2024..

Okay, thanks, guys. That's all for me. Have a great day..

Thanks a lot..

Thank you. Our next question today comes from Barry Oxford from Colliers. Barry, your line is open. Please go ahead..

Great, thanks, guys. On the same store NOI, Tony, it looks like you had a pretty nice reduction in expenses.

Was there one particular thing that was driving that and would we look for that to continue?.

Good question. Barry. That was a little bit of an anomaly if you're looking at the year-to-date in that pool, if anything operating expenses are remaining. There's still inflation challenges. So I would expect to be flat to increasing moderately going forward..

Okay, and what caused the occupancy and same store to drop just a little bit..

And so the occupancy, we had in terms of the quarter, the largest move out we had was at Papago Tech. We had a 34,000 square foot tenant vacate at the beginning of July,.

Leasing was a little slower in Q3. We see as of right now, a few leases post quarter end have been done. And we're seeing it pick up a bit. So we're feeling better about that particularly at our best properties..

Right. Great, great. Jamie, question for you. When you're -- I would imagine you're still kind of looking at acquisitions, or distressed opportunity starting to hit the market where you'd be like, gosh, if I can get my hands on that building and rehab it, I know, it'll be the best building in that sub market, and I can lease it up..

We're staying active in looking at opportunities. I think it's still quite early Barry. I think what you're seeing generally is a lot of lenders playing ball with owners. And that's delaying kind of transactions being forced out. And you're also seeing virtually zero availability of debt if you're acquiring assets.

And that just means, if you don't have to sell, you're not right now. And so I think that's going to continue. My guess is if it starts to change in 2024, you'll start to see more activity..

Do you think it's going to be the banks that will eventually drive that?.

I think that's probably the number one question..

Yes. Okay, guys, thanks for the time. .

Thanks, Barry. .

Thank you. Our next question today comes from [indiscernible] from KeyBanc. Pupul, your line is open. Please go ahead..

Hey, thanks for taking my question.

So just real quickly from me, I was wondering, do you are you in any kind of appeal processes with any municipalities that may help reduce property tax, heading into next year?.

Yeah. So generally, we appeal every year, virtually every property. So the answer is yes. And we're hoping that is more and more transactions happen and values come down, that we're going to see some reductions there in 2024. I'd say we haven't really had that much in savings so far.

But I think that's going to be a line item as we go forward, that hopefully starts moving in our direction a bit..

Okay, great. And then, you know, you've highlighted some of the moving pieces on occupancy, there's some known move outs and movements that may offset each other where occupancy could stay flat head into the rest of the year.

As we look into '24, and possibly what happened with Cascade Station, is there any kind of sense on where occupancy could trend heading into '24?.

Yeah, so we'll be giving our full guidance, obviously in February, but looking at where levels are today, Cascade Station is one that certainly has -- we're expecting some -- there's some known move outs there. If you exclude that property then we're effectively expecting the guidance to come out pretty flat..

Okay, got it.

And just one last one is, how are the conversations with some of the lender in order to extend out these loans? Was there a sort of fee that you've paid? What with that? And how do you feel confident about the some of the maturities that are coming up next year?.

Yeah, sure, I can answer that question. So in terms of the two deals that we completed during the quarter, the execution there was effectively not materially different than when we first did those loans seven years ago, 275 basis over normal kind of fee.

There are pressures banks to charge more fees for which we can maybe expect going forward but there was nothing too unusual for that. If we look forward to 2024, beyond Cascade, Central Fairwinds is the next maturity and in June of 2024, that loan is with the exact same lender that we just executed those two extensions this quarter.

So we have started discussions on that. We've done an appraisal as part of that process, and so I'm hopeful that we can get sort of similar execution on that one. And then looking further out, the only other one, we have it on a property level loan is FRP and Genuity drive. That is at the end of December 2024. So we still have more than a year out.

But nonetheless, we have started discussions on a possible extension of the maturity date. A little early to comment further, but I'm hoping to give an update next quarter on that one.

And then the only comment I really want to make is that, we still do have two completely unencumbered properties Block 83, and Raleigh, which we acquired for $330 million in December 2021, as well as City Center in downtown St. Pete, that are also sources of additional liquidity if needed in the future..

Okay, got it. Thanks. Thanks for the time..

Thank you. You're welcome..

Thank you. [Operator Instructions]. Our next question today comes from Bill Crowe from Raymond James. Bill, your line is open. Please proceed..

Great. Thank you. Good morning.

Did you say you signed the lease with WeWork in Phoenix a year ago?.

So no, that was acquired or signed before we acquired the property. WeWork opened that location, I think right before COVID. And so they closed it as soon as COVID happened. And they reopened it approximately one year ago. So it was back in that ramp up mode of building their occupancy..

Perfect. Okay. Yeah, misunderstood.

Broadly speaking, we still see tenants downsize renewals?.

I think it really depends asset by asset Bill. So we've been in this almost four years, and so the average lease term in many of our markets is around five. In some of the newer buildings 7 to 10. So we've hit quite a few of the vacates or right sizing over the last few years. There's still a number to go.

And the big ones really are more in the suburban properties. I'd say the more urban assets, have a higher utilization, people are back and generally using it at a pretty high level.

Those conversations, we're not seeing as many of the downsizes in kind of big suburban locations, and I'm talking across the industry, where corporate America really hasn't forced the workforce back en-mass. That's where you're seeing a lot more downsizing and vacating..

Yeah. Okay, and then finally, for me, I kind of like the progression you laid out about the premier buildings, and then tenants being forced into what's called less than trophy buildings, [indiscernible] I'm just wondering how it feels like that's a process that's going to take a number of years to play out at this point.

Is that a fair way to think about it?.

I think, Bill if you look at all the absorption, the net absorption over the last couple of years is all in that top tier, right. And if you look at occupancy levels of those they're filling up. And so development pipeline is basically coming to a halt. And those are still being demanded.

And so as tenants roll they're generally wanting to upgrade their space. And that's going to fill up. I think 2024, you're going to start to see the benefit in really well located assets that have been renovated, that have a great feel.

And that's where we're playing to be not with all of our properties, but a good segment of our properties match that..

Help me help me understand the supply in a market like Dallas or Phoenix? I mean, they've seen a lot of supply and it's all been Class A properties.

Is that just done now or do we still have more deliveries to go?.

There's still some underway, Phoenix I think actually the most recent one just delivered I'm not sure what's left there. I don't think there's a lot -- Dallas, Goldman's doing they're kind of dedicated power and uptown. So that's going to get done. There's a handful of others.

But right now, it doesn't pencil for new development and you can't get the capital for it. And so you're going to always see a little bit but I think that's going to come to a grinding halt until the economics kind of get back in balance, which for us is a good thing..

Yeah. Perfect. That's it for me. Thank you. .

Thanks, Bill. .

Thank you. There are no further questions on the line. I'd like to hand back to Jamie for any closing remarks.

Look forward to updating you on our progress next quarter and thank you for joining. Goodbye..

That concludes the conference call for today. Thank you very much for joining. You may now disconnect your lines..