Anthony Maretic - Chief Financial Officer James Farrar - Chief Executive Officer.

Barry Oxford - D.A. Davidson Rob Stevenson - Janney Craig Kucera - FBR Capital Markets.

Good day, ladies and gentlemen and welcome to the City Office REIT Second Quarter Earnings Conference Call and Webcast. [Operator Instructions] Please note that this event is being recorded. I would now like to turn the conference over to Anthony Maretic. 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 second 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 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 duty to update any forward-looking statements that maybe made in the course of this call. I will review our financial results after James Farrar, our Chief Executive Officer, discusses some of the quarter’s operational highlights. I will now turn the meeting over to Jamie..

Good morning. Before starting the discussion on the results of our second quarter, I wanted to take a moment to highlight some of the trends going on within the office industry.

When City Office completed its initial public offering in 2014, we identified an opportunity to focus on metropolitan areas and non-gateway markets, characterized by having lower levels of participation from large investors.

We continue to believe that acquiring well-located real estate in these markets provides a high rate of return for our investors over the long-term. During the last few quarters, we have seen greater interest in our markets from large investors.

They have been attracted by excellent supply demand fundamentals and strong growth prospects relative to office markets in gateway cities. Recent industry data indicates that over the last 5 years, REIT holdings in secondary markets have increased at an average annual rate of 10%, while REIT holdings in gateway markets were essentially unchanged.

This trend has resulted in more capital pursuing real estate in our markets and in some cases increased sale price expectation from sellers and brokers. As demonstrated by the sale of two buildings at our AmberGlen property this past quarter and our pending Boise property sale, we have been able to opportunistically harvest value as well.

In the case of AmberGlen, we generated a net gain of $9.2 million for our 76% ownership stake. These are good examples, but we believe the rising valuation trends also apply to the rest of our portfolio. On the other hand, higher property valuations have slowed our acquisition pace this year.

Our disciplined approach to allocating capital has meant that we have passed on a number of recent opportunities, where we felt pricing expectations exceeded fair value. We also continue to be thorough with our due diligence process and conduct a very comprehensive investigation of potential purchases.

We have proven that we are not afraid to walk away from a transaction if we discover undisclosed issues and can’t come to terms with the seller. An example of this occurred during the quarter, where we elected not to proceed with the $51.5 million Orlando property that we mentioned was under nonbinding contract on our last conference call.

During our due diligence investigation, we discovered a number of mechanical issues at the property and were unable to finalize a satisfactory price concession. Our relationships and years of experience in our markets gives us the reputational advantage in acquiring assets on attractive terms.

We believe that patience and our disciplined capital allocation will reward investors over the long-term. In that regard, this morning, we announced that we are under contract to acquire a 10-building, 680,000 square foot off-market portfolio in San Diego, California.

San Diego is a high-quality new market for City Office that has many of the attributes of our other target cities. This includes strong demographics, positive job and population growth trends and high barriers to entry for new supply.

The purchase price is $174.5 million, offering us immediate scale in the market and equates to a pro forma net operating income yield of approximately 7.4%. This cap rate is inclusive of the purchase price, our estimated closing costs, reserves for planned capital improvements as well as the land parcel that forms part of the transaction.

At this time, we waived their due diligence conditions and posted a $10 million nonrefundable deposit. The closing is scheduled to occur at the end of September, subject to typical closing conditions. Due to a confidentiality provision, we are unable to provide further details until this transaction has closed.

In addition to the acquisition activity, the company had strong same-store sales and healthy leasing activity. Our year-to-date same-store cash NOI growth was 9.1%. Our total leasing activity for the quarter was 174,000 square feet, comprised of 151,000 square feet of renewal leases and 23,000 square feet of new leases.

Of note, after the end of the quarter, we signed a 10,000 square foot lease with a high-quality financial firm at our Park Tower property in Tampa. The lease comes on the heels of the previously announced multimillion dollar renovation and repositioning at Park Tower which has commenced.

Our strong year-to-date leasing, same-store sales growth and the large off-market portfolio acquisition are indicative of our ability to continue to successfully navigate the current trends in the office market. That concludes my remarks. And I will turn the call over to Tony to discuss our financial results..

Thanks, Jamie. On a GAAP basis, our net operating income in the second quarter was $14.5 million. This represents a $1.3 million decrease over the $15.8 million achieved in the first quarter.

The decrease is primarily a result of the disposition of two buildings at the AmberGlen property during the second quarter and a decrease in average occupancy at Florida Research Park collection and Plaza 25. We reported core FFO of $6.4 million or $0.21 per share.

Our core FFO ended the quarter $1.4 million lower than Q1, primarily due to the same reasons described earlier. Our core FFO adjusted NAREIT defined FFO for acquisition costs, change in fair value contingent consideration and the amortization of stock-based compensation.

During the quarter, we recorded a $2 million accounting gain from the change in fair value of contingent consideration related to our Park Tower acquisition late in 2016. As a condition to us buying Park Tower, we placed $2 million of the $79.8 million purchase price into a cash escrow account.

This cash was returned to us when certain specific renewal leasing thresholds were not achieved. The excess cash will be used to finance the first generation TI and LCs associated with the vacated space. Our second quarter AFFO was $5.3 million or $0.17 per share.

Our AFFO numbers will move around some from quarter to quarter due to the relative size of our portfolio and the impact of significant leasing in any one quarter. We expect to return to full dividend coverage on an AFFO basis in Q4 if the San Diego portfolio acquisition closes as expected at the end of the third quarter.

Our current dividend yield based on a closing stock price at June 30 was a very healthy 7.4%. Our leasing activity and capital expenditures are clearly laid out on Pages 16 and 18 of the supplemental package.

Consistent with our definition of AFFO, we have excluded some first generation leasing costs and the repositioning activities which have begun at Plaza 25 and Park Tower. Further details are disclosed on Page 18 under non-reoccurring capital expenditures. Our same-store cash NOI growth for the quarter was 19.1% and 9.1% year-to-date.

The largest drivers to the increase in same-store NOI were from AmberGlen and 190 Office Center. AmberGlen’s year-over-year occupancy increased due to the lease to Kaiser Foundation, which commenced paying rent late in 2016.

At 190 Office Center, the free rent related to the United Healthcare lease, which negatively impacted our cash NOI in the prior year burned off, which improved cash NOI from the property. During the quarter, we also launched an ATM program through which we may make placements of our common stock and Series A preferred stock from time to time.

The program was put in place to provide greater strategic optionality in accessing capital. No stock was issued under the program during the quarter. We have continued to see attractive terms for debt. During the quarter, we closed on two property level financings, which further increased our liquidity.

Both financings were long-term, fixed rate debt, with a weighted average interest rate of 3.8%. At June 30, we had cash of $68.1 million and $24.0 million in restricted cash.

We expect to put that cash to work in Q3 to partially finance the San Diego portfolio acquisition with the balance coming from a combination of our line of credit and property specific debt on a portion of that portfolio.

Following our acquisition of 2525 McKinnon and our capital raise in January, we indicated our target acquisition range for the balance of the year to be between $165 million and $185 million. This amount was increased by approximately $20 million, following the sale of two buildings at AmberGlen in Q2.

If the San Diego portfolio closes, we would have the remaining capacity to close another small acquisition and will have additional dry powder once the Washington Group Plaza sale closes.

Our total debt net of deferred financing cost at June 30 was $411.1 million or $402.2 million when deducting the non-controlling interest share of certain indebtedness. All of our debt was fixed rate as of quarter end. Our net debt to enterprise value was 40.4%.

Lastly, we are reiterating our prior guidance that we are anticipating fourth quarter 2017 run rate core FFO in the range of approximately $0.29 to $0.31 per share. That assumes the San Diego portfolio acquisition closes late in the third quarter and assumes no additional capital raising.

Based on these assumptions and the delay in the timing of our prior guidance on acquisitions, we are revising our 2017 annual core FFO to between $0.96 and $0.99 per share for the full year ending December 31, 2017. That concludes our prepared remarks and we will open up the line for questions.

Operator?.

Thank you very much sir. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] Our first question is from Barry Oxford of D.A. Davidson. Please go ahead..

Great. Thanks guys.

I thought you guys did a nice job of laying out what was going on from an FFO standpoint in the portfolio Jamie, could you give a little more color, if there is any color to be given on the Washington Group Plaza sale, is that just tracking normally or could we see maybe an earlier sale?.

Thanks Barry. So the scheduled closings in April 2018, both sides have the ability to accelerate closing with 120 days’ notice. So expectations today is at the earliest, would probably be late this year and probably early next year, so somewhere in that range..

Okay.

Will this sale – when you look out over the horizon as far as capital needs for 2018 and to complete your acquisitions, will the Washington Plaza get most – will give you most of the money that you need to do what you want in 2018 or not necessarily?.

Hey Barry, it’s Tony here. Maybe I will answer that question and then Jamie can jump in here. So just as a reminder, we did sell two buildings early in the year, AmberGlen you may recall in Q2.

So that gives us another $20 million to $30 million of acquisitions that we could still do and still stay within the targets we set at the beginning of the year and also stay within our leverage targets. Washington Group Plaza, it’s under contract for $86.5 million. Current debt is about $33 million.

So if – we will harvest about $53 million of equity and so we could deploy that at our typical leverage range up to about $100 million of new acquisitions. So in our mind, things can move fast. We have a pretty robust pipeline.

That will probably take care of the start of the 2018 and we will have a better view of what our target range will be early next year..

And it’s really going to depend Barry, on acquisition opportunities we see and our belief in being able to create additional value from them..

Right.

Last question Tony, same-store NOI, when we look forward, where do you see that going as far as guidance because it’s kind of moved around in the last couple of quarters?.

Yes. And fair point, it does move around, just given the size of our portfolio Barry, we only have 11 properties in that same-store pool. We provided guidance at the beginning of the year that we would end the year somewhere between 4% to 6%, just given the quarter we had we are probably likely to end at the top end of the range for the year.

But Q2 was really the anomaly and Q3 and Q4 will – just given there isn’t a lot of lease rollover happening with most of the leasing already taking forward, it will be kind of a much more modest number that will take us to the – to kind of the top end of that range we gave at the beginning of the year..

Great. Thanks guys. I will give you the floor..

Thank you very much. The next question is from Rob Stevenson of Janney. Please go ahead..

Good morning guys.

Jamie, can you talk about the 1-year lease that you signed at Washington Group Plaza, I mean what was the catalyst there and was it something that once the buyer didn’t want to take position, near-term you wanted to just maximize your revenue for as long as you are going to hold that asset?.

Good question, Rob. So the buyer is a tenant and so they want to maintain flexibility in the future to grow into it. So that was the rationale behind a 1-year lease extension which will push us past the closing date of the Washington Group Plaza..

Okay.

And then in terms of the Orlando abandoned deal, has that asset been sold or is there a chance that, that comes back on your radar screen at some point later this year?.

Best information we have right now is that it’s under contract and may have already been closed to another group..

Okay.

And Tony, is there any abandoned deal costs associated that are going to hit the income statement with that?.

Yes. We did have some costs that we incurred. All of that was flushed through the G&A in the year, but they are relatively minor, Rob..

Was that in the second quarter or…?.

In the second quarter, correct..

Okay.

So that that run rate might come down a little bit as we go to the back half of the year from the second quarter?.

The run rate for Q3 may come down a little bit. Q4, our costs are typically a little bit higher just associated with kind of the year end audit costs and year end filings..

Okay.

And then lastly San Diego, I mean in terms of looking at that market from a bigger picture standpoint, how much – what’s the opportunity there for you over the next couple of years, was this just an isolated instance and that the pricing here was better than you have seen on anything else or is it reasonable to expect that you can find similar properties at similar pricing over the next couple of years?.

Yes. So we have been waiting for a good entry point into San Diego. We love the fundamentals of it. So we do see the ability to grow further. As far as cap rates, this is a very attractive cap rate. So it may not be quite to that level, but still within our range and healthy.

And number of transactions we are looking at right now in that market, we feel pretty good about expanding our footprint over time..

Okay.

And just lastly in terms of the overall pipeline that you guys are exploring at this point, where is that mostly located?.

So pretty mixed, Rob. If you look at what we have done so far in ‘17, including San Diego, we will be at about $220 million close. Still quite a bit of time left in the year. Pipeline today is about $680 million, which is really healthy. It’s mix between San Diego, Dallas, Phoenix, Seattle, some new markets as well but earlier stage.

So we are feeling pretty good about overall opportunities. Having said that, what we have seen is a lot more competition. And so we have been very selective in making sure the deals that we are pushing forward we are extremely excited about and San Diego portfolio, that we are under contract, fits that perfectly..

Is there a minimum dollar value that you would need or a square footage that you would need to go to Seattle? I mean, would you enter Seattle with a 1 building, $25 million purchase or does it need to be something of the size and scale of the other markets in order to get you in? I mean, obviously, San Diego is one big bite-sized chunk here, but how much do you really need in a market – in a new market like Seattle to make it worth your while?.

So we have been looking at individual transactions. So, I think that’s most likely how we will enter Seattle eventually. The dollar size of those transactions often is quite a bit higher than what you said. So I think we will hopefully plan one that will give us a modest amount of scale and then be able to build up over time around that..

Okay, thanks, guys. Appreciate it..

Thank you. Next question is from Craig Kucera of FBR Capital Markets. Please go ahead..

Hey, good morning guys. I noted that you re-classed, I think, about $38 million for sale.

Is that just the Washington Group and you are just doing some accounting in the event that you accelerate the sale or is there something else that you guys might be disposing?.

No, you are exactly right, Craig, that’s related to Washington Group Plaza under the accounting rules under GAAP. We can only list something as held-for-sale once it’s under contract if it’s planned to be closed within 12 months or 1 year.

And so once we hit Q2 and knowing it’s going to sale at the very latest in Q2 next year, we re-classed all the balances to held-for-sale and stopped depreciating it, but there is nothing else in there..

Got it. Circling back to San Diego, I know you guys are kind of tight about the disclosure, so I respect that.

But could you tell us how you sourced the transaction? Do you have any capital partners in that market or could you give us some color on that?.

So, it was an off-market transaction that a relationship of ours was able to point us in the direction and then we approached the current owner and had a very positive discussion and experience with them..

Got it. And again, not getting too deep in the details here, but I know that you had a pro forma 7.4% cap rate.

What would be the initial at least for modeling purposes going into fourth quarter and first quarter assuming you do close it at the end of third quarter?.

So, how we have calculated that 7.4% is our view of forward income divided by purchase price plus closing costs plus capital plus a land component. So, I think that’s a good analysis for you to use..

Okay.

And one more for me, just wanted to hear an update on the renovation at Plaza 25 and maybe how leasing conversations are progressing?.

Sure. So renovation planning is well accelerated. We will be starting two of the buildings probably in the next 2 to 3 months. Third building will be probably at the beginning of ‘18. Renewal discussions are going well and we are seeing some good leasing activity. So, we are feeling good about that one..

Okay. Thanks, guys..

Thanks, Craig..

Thank you very much. Ladies and gentlemen, that is all that we have time for questions for today.

Gentlemen, do we have any closing comments?.

Thanks for joining today. We appreciate everybody’s time and we will keep everyone informed as we progressed over the coming months. Have a great day..

Thank you very much. Ladies and gentlemen, that concludes this conference call and you may disconnect your lines..