Jamie Farrar - CEO Anthony Maretic - CFO.

Vincent Chao - Deutsche Bank Barry Oxford - D.A. Davidson.

Welcome to the City Office REIT Third Quarter 2016 Earnings Conference Call. [Operator Instructions]. I would now like to turn the conference over to Anthony Maretic, Chief Financial Officer. Please go ahead. .

Good morning. Before we begin, I would like to direct you to our website at cityofficereit.com where you can download our third quarter earnings press release and the 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 statement and actual results.

The company undertakes no duty 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'll now turn the meeting over to Jamie. .

Thanks for joining today. Before we start the discussion on our very productive third quarter, I want to briefly touch our progress towards several strategic growth and operational goals. Our ability to provide attractive risk-adjusted returns to our shareholders is driven by the performance of our assets and our target markets.

We continue believe that buying well-located real estate in high-growth secondary markets is a great strategy to create enduring value. Our select market footprint in the southern and western U.S. differentiates us from our peers.

Our target markets represent national leaders in population and employment growth projections, while at the same time, face less competition from institutions that have typically focused on gateway markets and larger acquisition sizes.

While cap rates have compressed in recent years across other asset classes and particularly in gateway markets, our focused strategy has allowed us to consistently acquire properties at cap rates between 7% to 8%, with increasingly favorable debt terms.

These attractive initial returns have been enhanced by contractual rent escalations and our focus on operational improvements. As I'll discuss shortly, recent disposition activity has also proven that the combination of our well-located real estate and targeting strong, long term tenants, can generate impressive capital appreciation over time.

The magnitude of the opportunity in these markets is driving our ability to execute on the strategic growth of our Company. In early October, we completed our largest equity capital raise to date and in doing so we're proud to recognize support from our existing shareholders and to welcome new investors to our growing equity base.

We also expanded our lending syndicate and increased the borrowing capacity under our secured credit facility subsequent to quarter end. We believe these relationships will continue to support our efforts to be a premier REIT focused on the acquisition of office properties in the southern and western U.S.

With that, I'll now turn to our results for the third quarter. For our overall leasing activity, we completed 288,000 square feet of new and renewal leases during the quarter, including 32,000 square feet of leases that will commence subsequent to quarter end.

Our weighted average portfolio occupancy at September 30 was 91.5%, including committed leases and ended the quarter at a healthy 92.4%. The most impactful leasing event during the quarter was the 148,000-square-foot space delivered to St. Luke's at Washington Group Plaza.

This was a very large project on a tight timeframe and we generated a lot of goodwill by delivering on time. It also created other interesting opportunity that we advanced during the quarter. Specifically, we entered into two separate transactions with St. Luke's. First, they've agreed to lease an additional 111,000 square feet space next year.

The lease is on a 10-year term commencing July 1, 2017 upon the expiry of another large tenant. Second, St. Luke's entered into a purchase and sale agreement to acquire the entire Washington Group Plaza property for $86.5 million. They are currently conducting their due diligence and have until December 2016 to wave conditions.

Assuming they wave conditions, closing is scheduled to occur in April 2018. However, both buyer and seller have the ability to accelerate the closing date, with the party triggering the early closing to be responsible for all fees and penalties associated with the early loan repayment.

Other major leasing activities during the quarter included the Fairwinds Credit Union waving their early termination option at our Central Fairwinds property in Orlando. This secured a 36,000-square-foot lease until 2026 and maintained a solid anchor tenant for the property.

At our Plaza 25 property in Denver, we encountered some challenges with two tenants representing approximately 64,000 square feet. One of these tenants, in the energy sector, was severely impacted by commodity prices and another tenant is a technology company that was forced to rapidly downsize operations.

After considering our options and the tenants' financial condition we elected to negotiate early terminations to get the space back early. We will be realizing termination fee income of approximately $300,000 from Plaza 25 during the third quarter.

In addition, these tenants effectively prepaid their rent that we would have otherwise received in Q4 and Q1 of 2017 to terminate early. As such, we will show another $400,000 of termination income in Q4. Leasing efforts are underway as the early terminations have allowed us to begin marketing the space.

However, we expect the income from this property to be lower during 2017 due to the downtime to release this block of space. Moving to our investment activity, we continue to expand both our pipeline of future opportunities as well as close new transactions.

In July, we completed the previously announced acquisition of the FRP Collection in Orlando Florida for $49.8 million at an 8.4 cap rate. This included five buildings totaling 272,000 square feet that were 92.9% leased to a strong and diversified tenant roster.

On November 2, we completed the acquisition of Park Tower, a 473,000-square-foot property in Tampa, Florida. The purchase price was $79.8 million, representing a 7.1 cap rate exclusive of closing costs and future renovation capital.

We think the Park Tower provides an ideal repositioning opportunity as it has a prominent location in the heart of downtown Tampa. The building is currently 86% occupied by a strong and diversified tenant roster. And we anticipate completing a renovation to the lobby and common areas to elevate the quality of the property.

Also, we were able to structure the purchase in a creative manner to derisk certain events. $2 million of the $79.8 million purchase price was funded into a third party cash escrow account and will be returned to us if certain renewal leasing thresholds are not achieved in the first year of ownership.

This structure allowed us to offer the seller a compelling valuation but derisk the transaction if our expectations are not met. And, finally, we've entered into a purchase and sale agreement to acquire 5090 North 40th Street for $42.6 million. This is a Class A multi-tenant property that is approximately 176,000 square feet in Phoenix, Arizona.

Our entry into the Phoenix market has been a strategic goal and we believe that geographic diversification within our high growth markets strengthens our portfolio. The property is located in the heart of Camelback Corridor, one of the leading submarkets in metropolitan Phoenix.

The property has undergone extensive renovations and is located in close proximity to solid amenities and executive housing. The purchase is anticipated to close in mid-November, subject to customary closing conditions. I'll now turn the call over to Tony Maretic to discuss our financial results. .

On a GAAP basis our net operating income in the third quarter was $11.4 million. This represents a $1.5 million increase over the $9.9 million achieved in the second quarter. The increase was primarily a result of the acquisitions of Carillon Point which occurred on the last day of second quarter and the FRP Collection which closed on July 12.

On a same-store basis, net operating income increased by $600,000 due to the move ins of St. Luke's and the termination fees we received at Plaza 25. We reported core FFO of $6.6 million or $0.27 per share. Our core FFO adjusts NAREIT-defined FFO for acquisition costs and the amortization of stock-based compensation.

Our core FFO end of the quarter $1.2 million higher than Q2, primarily for the reasons I just mentioned, offset by small increases in G&A and interest expense due to the acquisitions. Our third quarter AFFO is $4.6 million or $0.19 per share. AFFO was negatively affected by several straight-line rent adjustments totaling $1 million.

The largest adjustment related to the St. Luke's lease which we described on the last call. They received two months of free rent totaling $400,000 related to July and August. And therefore straight-line rent adjustments will return to a lower level beginning in Q4.

Our leasing activity and capital expenditures are clearly laid out on pages 17 and 19 of the supplemental package. Consistent with our definition of AFFO, we have excluded some minor first-generation leasing costs. Further details are disclosed on page 19 under nonrecurring capital expenditures.

From a liquidity standpoint, we closed on the $112 million preferred stock offering subsequent to our quarter end. At September 30, prior to that closing, we had cash of about $12 million and approximately $17 million in restricted cash.

Subsequent to quarter end, we also exercised the accordion feature on our secured line of credit and upsized the authorized amount from $75 million at September 30 to $100 million post quarter end. That facility was undrawn at quarter end.

Our total debt, net of deferred financing costs, at September 30 was $302.8 million or $294.2 million when deducting the non-controlling interest share of certain indebtedness. Our net debt to enterprise value was a 47.6% based on our closing common stock price at September 30.

Lastly, we have updated our full-year 2016 guidance to reflect the preferred equity raised after the quarter end. We have assumed that in addition to the $122 million of acquisitions in Tampa and Phoenix discussed earlier, we will close on an additional $60 million of acquisitions prior to the end of the year.

Based on these assumptions, we're estimating core FFO between $22.2 million and $22.6 million for the full year ended December 31, 2016. We will provide guidance for our 2017 expectations on our next earnings call, following the release of our year-end results. That concludes our prepared remarks and we will open up the line for questions.

Operator?.

[Operator Instructions]. Our first question comes from Vincent Chao of Deutsche Bank. Please go ahead..

Just a question on the St. Luke's, both the lease as well as the potential deal to sell the assets, I just want to be clear.

That's the state of Idaho that's moving out, they're taking over that lease, is that correct? And then, two, in terms of the deal itself, I'm just curious how that came about and what some of the conditions might be in terms of a closing there. .

Yes, it is the state of Idaho's 111,000 feet that they will be stepping into. In terms of the deal itself, I think it is a testament of having, actually, really well-located real estate in the markets that we're in. St. Luke's is a tenant. They want to grow throughout the campus. They approached us about buying the property.

Interestingly enough, the state of Idaho recently publicly said that they were interested in buying the property is well so it just provided a great dynamic for us. As is typical, we've signed the purchase and sale agreement. They have a conditional period to review physical due diligence which they are undergoing, as we speak.

And so December 16, they need to decide whether to go hard which is a $5 million nonrefundable deposit. .

From your perspective, though, the big roll over has been addressed with St. Luke's taking that space anyway, so whether or not you sell it or not, that whole is filled.

But if they choose not to go forward with the sale, are you actively trying to market that asset?.

We actually did not formally market the asset. We had dialogues with both of our major user groups. From our standpoint we really wanted to derisk, if we were going to pick a group -- IE, St. Luke's. That's why we have the 10-year lease as a backup on the 111,000 square feet.

It just provides certainty that if they decide not to purchase it that we have locked down that space for the next 10 years at attractive rates. .

Okay, but if they don't buy it, you're not necessarily trying to sell that asset. .

That's correct. .

Okay. And then there were a couple other big leases in 2017 that we talked about, I think, last quarter. Can you just give us an update on some of those? I think one of them was with the GSA in Orlando, I believe and then there was a Denver lease ProBuild Holdings.

Can you just give us an update on where you're at with those discussions?.

Sure. For 2016 there's nothing really material for the rest of the year. 2017, the three largest that we mentioned last time, first was the state of Idaho, the 111,000 square feet. That's been dealt with. The second largest is ProBuild Holdings which is at the DTC property. That's 93,000 feet, that rolls at the end of October 2017.

So, we're making good progress, as we expected. They're going to want to downsize partially on that property at renewal. But we're having dialogue with them right now about extending about 34,000 feet on a five-year term, another 17,000 feet on a two-year term, So, we will get back net about 42,000 feet, about a year from now.

That gives us lots of time to start repositioning and planning to lease that additional space. And, finally, the third major when we talked about on our last call was the Fairwinds Credit Union which we had the termination option. It was a 10-year deal but they had the right to terminate the lease.

That termination option burned off so that lease has been extended out until 2026. .

Sorry, I thought there was another government lease that was coming due.

So, nothing in Orlando, the recent acquisition that is coming due in 2017?.

The recent acquisition is well. We're in the process of extending that one out, as well. .

And when does that actually expire?.

There's a few different ones with rolling dates. It's a number of different races at the FRP Collection. Individually they're all not a large leases. It varies throughout the year. .

And is it safe to say that they're not making any decisions until the election is done? Is that a fair assessment?.

There's been some discussion that the research park in general, with the large military presence, that that has been a factor. I think we're in dialogue on a couple of spaces already. So I think we'll see good progress hopefully towards the end of the year. .

Okay. And, sorry, last one for me, just from a dry powder perspective, you outlined some deals that closed here recently and then you've got another $60 million that you're planning for.

Assuming you get the $60 million done, how do you see the dry powder left to spend in 2017 and beyond based on your current capital raising?.

Why don't I start with a quick recap of what we've done to date. The three transactions we've closed to date is about $155 million with 5090 in Phoenix that we're hard under contract and we're closing here in November. We'll be about $198 million, we will be up to.

We mentioned another transaction on the call which is $60 million, that one we've completed our physical due diligence. We're about to enter into a purchase and sale agreement so we're feeling very confident that that will close during this calendar year. That will bring us up to $258 million.

In terms from there, Tony?.

Beyond there, Vin, for 2017, we've put a range between $90 million and $110 million in transactions in 2017.

I think the only thing I should also mention is we plan to place a blended average of about 40% to 45% debt on the pool of acquisitions from the last capital raise and probably a similar amount to leverage on successive capital raises in order to drift our overall leverage levels to those levels. .

And that $90 million to $110 million, is that assuming full use of the proceeds that will have been generated to date or does that assume some additional capital raise?.

No, that is just from the most recent preferred offering. .

Our next question is from Barry Oxford of DA Davidson. Please go ahead..

Just piggybacking on that one last question, those leases that are being extended or renewed, were there any significant step downs in rents or step ups or are we looking at pretty much the same rates?.

Just touching on the three I mentioned, the GSA in Idaho, assuming that the St. Luke's takes effect and they don't buy it, there's a step up from about $17 gross to about $18.50 gross, so, a nice pickup in rents. ProBuild Holdings, I'd say similar rates with the 2.5% to 3% step ups on average. That one has attractive terms, as well.

Fairwinds is the one where there is a bit of a roll down. Our expiring rents are in the low $30 range today. Market is a fair bit lower than that so the blended rate is about $24 with 3% bumps. The one thing, though, we do have signage on the building. That is stepping up to $150,000 per year from a current rent of about $60,000.

So, If you think about it on a per foot basis, that's a pickup of about another $2.50 a foot. So it brings us blended from the $24 to $26.50 versus the low $30 rate that's in place today. .

One more question, on Park Tower being 86% occupied, how much of the renovations are you going to be putting into that building? And, then, what's your timing as far as stabilization for occupancy in that building?.

We're in the process right now of finalizing what our renovation plans are going to be. In the past we've done two very successful repositionings in the St. Petersburg market where we've had great pickup in both occupancy and rental rates. So, we're using the same renowned architect to plan on Park tower.

Likely the renovation cost is going to be $5 million $8 million to do the lobbies, some exterior work, multitenanted corridor work, as well as fitness, conference, the basic things that are really going to help to drive the rents up to the level of what some of the competing product is.

Timing of that is probably 18 months for us to complete the work. Overall, return on cost post-renovation we see around 8% unlevered. And if you look at the levered FFO yield, it's in the low double digits, but that's a few years out, post renovation and with the step up in rates. .

And BB&T, can I assume that's the bank side of the division?.

That's correct. .

[Operator Instructions]. Our next question comes from Robert Stevenson of Janney Montgomery Scott. Please go ahead. .

This is [indiscernible] on for Rob Stevenson. On your lease roll down, we see that about 17% of leases are rolling off between 2016 and 2017. I know you mentioned that you've seen some renewals.

Do you have any known moveouts for that time period?.

Do you mind repeating the question, the first part?.

Sure. About 17% of the leases are rolling off in the 2016 to 2017. So, we were wondering if you have any known moveouts for that time. .

Just to reiterate, ProBuild Holdings, again, they're 93,000 feet. We've renewed or in final discussions for 34,000 feet on a five-year term, 2017 on a two-year term. So, about 42,000 feet will roll starting November 1 of 2017. We're roughly one year out from that.

tony, other major ones that come to mind?.

Beyond that there are some small tenants, 4000 or 5000 square feet, that are known departures but nothing [indiscernible]. .

Apart from the Washington Group are there any other assets that you have that you're thinking about selling?.

Washington Group Plaza we covered. In Portland, we own a total of five buildings. Three of them are really strong, long term assets. Two of the smaller buildings do require some leasing over the next couple of years because there is a dark tenant that will roll in 2018.

There's been a very strong market in Portland for value-add plays, so we're exploring some options there. I'd say it's too early to decide whether or not there's going to be something that we want to pursue but we're testing the markets on two buildings. .

And one more quick question, on Park Tower, as you lease up and stabilize, what trends are you seeing in terms of leasing volume for that asset?.

We just closed on Park Tower Thursday. Our expectation is -- and I should mention we held $2 million of the purchase price in cash and that's related to successful completion of a renewal that happens mid 2017 -- our expectation is that that tenant is not going to renew and we'll lower our overall basis. The market in Tampa is very strong.

So, I think post-renovation at the downtown core, this is going to be an asset that we're going to be able to lease up. It's probably 12 to 24 months by the time we get it north of 90% and the renovation is complete but we also think there's going to be a good pickup in our base rentals. .

There are no additional questions. I would like to turn the conference back over to Jamie Farrar for any closing remarks. .

Thanks for joining today. We're pleased with our progress during the quarter. And we look forward to speaking with you further over the coming months ahead. Have a great day. .

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