Jamie Farrar - CEO Tony Maretic - CFO, Corporate Secretary and Treasure.

Rob Stevenson - Janney Montgomery Craig Kucera - B. Riley FBR Barry Oxford - D.A. Davidson.

Good morning and welcome to the City Office REIT Inc. First Quarter 2018 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].

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 Web site at cityofficereit.com, where you can download our first quarter earnings press release and a supplemental information package.

The earnings release and the 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 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. Early April marked the fourth anniversary of our initial public offering. We wanted to take a moment to track the progress of our company since that time, before we discuss this quarter's results. We launched City Office with a handful of great properties in six markets, which we thought had outsized growth potential.

Over the past four years, we have exited approximately a third of those properties and generated over $70 million in gains from an initial portfolio of about $300 million. The remaining properties in that initial portfolio has seen in place annualized base rent increase by 23% in four years.

We believe this speaks to the strength of the markets we have selected and our success in negotiating favorable lease terms through active asset management. Meanwhile, our external growth strategy centered in expanding our portfolio through acquisitions in our existing markets and adding high potential new markets.

We have now acquired over $1 billion in assets, including the addition of Dallas, Phoenix and San Diego as new markets, while exiting Allentown and Boise, which were previously our two smallest markets.

These quality acquisitions and strategic dispositions have vastly increased their geographic diversification and tenant mix, and wholly aligned our footprint within our high growth markets in the southern and western United States. We have also focused on corporate governance and made improvements to our company structure.

We internalized management from 2016 and have undertaken additional initiatives, which further align our interest with those of shareholders. We have deleveraged our balance sheet and executed on a fixed rate debt strategy, locking in long term attractive rates.

Through capital raises and an expanding shareholder base, we have also improved the liquidity of our common shares. With all these initiatives, the company is well positioned to grow efficiently and flexibly, and benefit from increasing economies of scale.

We are grateful for the support from our shareholders along the way, and we believe our strategy and execution will continue to generate attractive long term returns. With that, I will turn to the topics of our operations and acquisitions. We are pleased to report that our first quarter results tracked our expectations.

Starting with our operations, on our last call, we stated that one of our key focuses for 2018 is leasing up vacancy within our portfolio. During the quarter, we executed 130,000 square feet of new and renewal leases. Despite the moveout of a 44,000 square foot tenant at our Sorrento Mesa property, which was expected in acquisition.

Our occupancy increased 60 basis points quarter-over-quarter to 88.3%. We have a number of highly desirable blocks of space at a handful of our properties, and have implemented renovation programs that will position these properties to maximize rents and absorption. We continue to target 90% to 93% occupancy through these efforts.

One case study for this, is Park Tower in Tampa, where a major renovation construction is tracking on schedule for substantial completion during the third quarter. During the first quarter, we executed seven new leases for a total of 26,000 square feet, bringing in place and committed occupancy to 89.2%.

The comprehensive upgrade and repositioning of the property has allowed us to execute those leases at rents approximately 20% higher than in-place rents at the time of acquisition in November 2016. Given our success to-date, we are in the process of launching another floor of spec suites and we anticipate eclipsing 90% occupancy ahead of schedule.

On the acquisition front, we ended the quarter with ample drypowder to pursue our growth strategy. Subsequent to quarter end, we acquired Pima Center, a 272,000 square foot two building complex located in the desirable Scottsdale submarket of Phoenix.

We are excited to add Scottsdale to our portfolio, a submarket known for its desirable amenity base, highly developed workforce, executive housing options, and the largest concentration of Class A office space in the region.

The asset itself is well located in central Scottsdale, with premium frontage along the Loop 101 Freeway, offering outstanding visibility, and direct freeway access.

The Class A finishes, large functional floorplates and above average parking ratio, have attracted a high credit tenant mix, with the three largest tenants rated A- or better by S&P The property was 99% leased and closed, and is situated on a favorable ground lease, with over 70 year of remaining term.

The pool of potential buyers for the property was thin, due to the protracted marketing process, asset size below $100 million and the ground lease, despite seven years of remaining term. These favorable dynamics helped produce an attractive 8.3% year one cash cap rate.

To review our expectations for future acquisitions, we previously provided guidance of total property acquisitions between $210 million and $240 million of 2018.

After the $56.5 million acquisition of Pima Center, we are targeting another $155 million to $185 million in acquisitions and based on our current pipeline, we continue to expect to deploy that capital by the end of the third quarter. Our pipeline remains healthy, and currently consists of over $700 million of properties.

With that, 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 first quarter was $19.9 million. This represents a $0.6 million increase over the $19.3 million achieved in the fourth quarter of 2017.

The increase was a result of a combination of a couple of offsetting factors; NOI increase due to the impact of a full quarter of income from the Papago Tech acquisition, and a further increase in termination fee income received at our Sorrento Mesa property.

These increases were offset by the disposition of our Washington Group Plaza property at the beginning of March 2018, which resulted in a $47 million gain. We reported core FFO of $10.3 million or $0.28 per share. Our core FFO ended the quarter $0.7 million higher than Q4 2017, primarily due to the same reasons described earlier.

Included in our core FFO, we recognized $0.9 million of a $1.6 million termination fee related to a tenant at our Sorrento Mesa property that departed in February. We recognized the other portion back in Q4 of 2017.

The $1.6 million payment represented 77% of the tenant's base rent, and estimated reimbursement obligation through its lease expiration in March 2020. We underwrote its departure at the time of acquisition.

Our continued expectation is that NOI and FFO will be lower in the second quarter, due to the disposition of WGP and the reduction in termination fee income just discussed, which together, contributed $1.8 million of NOI in Q1. This decrease will be partially offset with NOI from the acquisition of Pima Center, which occurred at the beginning of Q2.

We expect NOI to resume increasing in the third and fourth quarters, as the impact of the stated acquisition, which Jamie described, come online later in the year. Our first quarter AFFO was $6.7 million or $0.18 per share.

As several planned value enhancing capital and leasing costs were incurred during the quarter, which had been previously disclosed and which we expect to continue into the next quarter.

Due to the relative size of our portfolio and the impact of significant leasing in any one quarter, our AFFO numbers will continue to move around some, from quarter-to-quarter.

As far as our expectations for the remainder of 2018, we continue to track our previously issued guidance and we believe the assumptions underlying our guidance remain intact at this time. Our leasing activity and capital expenditures are provided on pages 17 and 19 of the supplemental package.

Consistent with our definition of AFFO, we have excluded some first generation leasing costs, and the repositioning activities at Plaza 25, Park Tower and FRP Ingenuity Drive. Further details are disclosed on page 19 under non-reoccurring capital expenditures.

Our same store cash NOI decreased 1.4% for the quarter, despite a 2.7% decrease in average same store occupancy, as compared to the same quarter in the prior year, revenue actually increased, due to our rent escalators and renewals occurring at higher rates. However, this was offset by some expense inflation and the timing of certain other expenses.

We continue to expect that same store cash NOI will turn positive by the fourth quarter of 2018, due to the impact of expected normalized occupancy levels, rent escalators, and below market rent rollovers. We believe our strategy over the past four years to lock in long term fixed rate debt has been prudent.

At March 31, fixed rate debt represented 100% of our total debt, with the weighted average interest rate of 4.2% and a weighted average maturity of 6.8 years. During the quarter, the company replaced its secured credit facility, with the new unsecured credit facility.

The new facility was undrawn at quarter end, and is authorized for up to $250 million, a $100 million increase over our old facility. Furthermore, it reduces our boring [ph] costs, through lower spreads and will provide us with ample drypowder to execute on our acquisition program for the remainder of the year.

Our total debt, net of differed financing costs at March 31 was $421.8 million. Our net debt-to-enterprise value was 42.9%. That concludes our prepared remarks. And we will open up the line for questions.

Operator?.

[Operator Instructions]. And your first question will be from Rob Stevenson of Janney. Please go ahead..

Good morning guys. Jamie, you were saying that you had drypowder.

What are you looking at now? Do you have enough capacity right now to close on this additional $150 million plus of acquisitions that you are expecting for the remainder of the year, without raising additional equity, either common or preferred?.

That's correct Rob. So if you look at our pipeline right now, so north of $700 million, we have got opportunities across many of our existing markets. A few potential new markets that we have discussed in the past, got a lot of irons in the fire right now.

So I think we are feeling very good about our pipeline, and we are excited about the number of the opportunities that we are seeing. There does continue to be significant private capital in the market. So the success on closing them, we will find out here over the next little while. But we are feeling very good about our position..

Okay.

And then, the 91,000 square feet of leases signed in the quarter that will commence after March 31, how far out does that go? And if I am doing my math right, that looks like -- as of close to 200 basis points of occupancy to the March 31 portfolio?.

Hey Rob, it's Tony here. It's going to add 140 basis points to the portfolio, that's contracted, and most of that will start hitting in the second and third quarters..

Okay.

And then these occupancy gains, are these leases in same store assets predominantly, or predominantly in some of the recent acquisition portfolio; because just curious, as to how we should be thinking about same store occupancy over the remainder of the year, given your comments on same store NOI?.

Yeah. It's a bit of a split. Park Towers, where we have seen a lot of the activity, Rob. So I would say, that you will see a good chunk of it there. And in terms of our same store, this lease activity that we have discussed, will help us kind of turn positive later in the year..

Okay.

And then, Tony, you said that the same store expense increase was timing related, and that that goes away in the back half of the year, but it's going to be with you for the next couple of quarters, in terms of elevated expense growth?.

It's a little bit of a combination of factors, included in the expenses, as we have had some higher property taxes. Property taxes typically lag, two years after acquisitions, when the taxing authorities have a chance to update their values, based on the sales. And so some of that is permanent, but some of it, I do expect to timing.

So there is a little bit of both going on there..

Okay.

But the revenue should be positively impacted by occupancy gains and then whatever you wind up doing on rental rate, is the wildcard there?.

Exactly right..

Okay.

And then any new incremental known moveouts in the remainder of 2018 or 2019 at this point, from a tenant perspective?.

Yeah. If you look at the balance of 2018, the largest roll we have is VICAL, which is a tenant of ours at Sorrento Mesa property in San Diego. They fully occupied a 68,000 square foot building. When we acquired the property, we actually expected them to vacate. Their lease ends at December 31, 2018. But we already have strong interest in this space.

We are in discussions with a few prospective tenants, who actually just want to step right into their completely built out space. So that is the largest roll we have in 2018..

Okay. Thanks guys..

Thanks for the questions Rob..

The next question will be from Craig Kucera of B. Riley FBR. Please go ahead..

Hey, good morning guys.

Wanted to circle back to the Pima Center; just kind of your expectations for financing there, and maybe, what quotes you are currently seeing, that you might be doing there?.

Hey, it's Tony here Craig. In terms of financing, this is an asset that we are plying to add to the line of credit, so we just completed the unsecured line of credit. And so we did go out and get some quotes on that, and what we are finding is, despite the -- and again, I was looking at quotes on long term fixed rate at the property level debt.

And so we have seen that move, but when we kind of did a preliminary discussion with some of the brokers, we are still seeing rates kind of in the mid-4s, 4.5, a little bit above that. But still lot of lenders wanting to put out money, and spreads are tightening, despite the tenure [ph] really moving..

Got it. And would like to talk about your TIs; on the table on page 17, when I look at that trend as sort of tenant improvements on new leasing and renewals, kind of from this year versus a year ago, it looks like your new lease TIs have may be tripled on a per square foot basis, and your renewals are up 50%.

Does that table include your first generation TIs, or is this really sort of an apples-to-apples basis, and that being said, is it mix related, is it that in St.

Petersburg, tenants are requiring more TIs, or is it really just across the board, you are finding that you have to spend more to get new tenants, and keep the ones you have?.

It's a good question. I think a few questions there. The first one is, this thing [ph] does include all of the leasings, so it hasn't been kind of reduced by first generation, this is a complete total of all the leasing totals. The sample size here, I would point out, is relatively small. There is not a ton of leasing.

So I am not sure, if this indicative of major changes. I think speaking to it just more generally. Certainly, we are seeing some growth in costs for TI buildouts. I wouldn't just consider tripling in stock. And so this is just a factor of a couple of spaces that may have been first gen, like you pointed out about Park Tower.

But generally, we are seeing some inflation in TI costs, but nothing that dramatic..

Just to add to that Craig, one of the renewals here, is a tenant that had a very substantial increase in rate, which we are able to keep. But there was a bit of an elevated TI, in order for them to fix up their space. So that was more than offset by the pickup in rent..

Okay. Thanks guys..

Thank you..

Thank you..

[Operator Instructions]. The next questions will come from Barry Oxford of D.A. Davidson. Please go ahead..

Great. Thanks guys. Two questions. Jamie, when it comes to the acquisition pipeline, could you give us a little color, maybe how far you are down the line with maybe some of the properties that you are looking at or final negotiations or LOIs.

And then, maybe talk broadly, not specifically about one property, but maybe broadly about the cap rates we might be seeing from this acquisition pipeline?.

Sure. So first part of the question, as far as the number we quoted $700 million, north of $400 million of that, we have traded LOIs. We are in late stage, in process. So there is a few other groups still at the table like ourselves. So we have done full underwrites, full teams toward the property, we have had our engineers through.

So we are very advanced, as far as our knowledge base and desire to own it, and we understand, in many of those cases, the submarkets very well. So I think we are well positioned there Barry.

It needs to kind of conclude a process here, which I think, depending on the particular deals, some of them will be over the next few weeks, some a little bit longer. But we are pretty far along..

In terms of cap rates, when we did our initial forecast, it was generally year one cash NOI between 7 and 7.5 is what we kind of modeled internally. The Scottsdale deal was just above an 8. I'd say the 7 to 7.5 is pretty good. In some cases it maybe a little higher, in some cases a little lower.

And if it's a little lower, typically, there is longer leases in place, a lot of capital has been spent. So over the next 10 years, we expect much lower, both TIs, our capital has to go into the building. So from a math standpoint, numbers and dividend coverage in growth, we still feel very comfortable about that..

Okay. Great. Great. Thanks for the color there. And then Tony, just a quick question for you.

The straight line rent, kind of popped up, how should we think about the straight line rent number moving into the second, third, and fourth quarters here?.

Yes. So it has moved up a little bit, and that's really a result of some of the acquisitions we did, Barry. If you look back at the last press release we put, where we provided guidance for straight line rent, which is a little bit higher than it was last year, but we are still tracking in that range..

Okay. All right. So no change in the range. Okay. Great. Thanks a bunch guys..

Thanks Barry..

Thanks for the questions..

Yes..

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

Thanks for joining everybody today. We appreciate everyone's time and look forward to discussing our continued progress with you. Have a great day..

Thank you, sir. Ladies and gentlemen, the conference has concluded. Thank you for attending today's presentation. You may now disconnect your lines..