Hello and welcome to the City Office REIT First Quarter 2019 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, this event is being recorded.

I’d now like to turn the conference over to Anthony Maretic. Mr. 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 fourth 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 first quarter earnings press release and the Company’s filings with SEC for factors that could cause material differences between forward-looking statements and actual results.

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. We are pleased to report that through the first quarter of 2019 the growth characteristics in our target 18-hour cities continue to lead the nation. This strong environment has helped us drive higher occupancy and same-store NOI growth across our portfolio.

This also allowed us to progress capital recycling initiatives at some of our properties. Overall, our portfolio continues to be well-positioned to take advantage of the vibrant demographic and employment trends favoring our cities.

Sunbelt and tech-oriented markets are expected to see the strongest percentage gains in employment during 2019, which bodes well for continued office space demand and absorption. In the first quarter of 2019, all of our cities experienced positive net absorption and higher market rents.

This translated into same-store NOI growth, which Tony will discuss further in a few minutes. Our management team continues to be focused on leveraging the well-located nature of our properties and proactively positioning them to drive leasing.

To that end, we continue to upgrade and amenitize our properties, including significant common area enhancements in progress at five of our properties. This includes Mission City in Sorrento Mesa and San Diego; AmberGlen in Portland; and Pima Center and Camelback Square in Phoenix.

These efforts have yielded success, as reflected in our increased portfolio occupancy of 92.6% at quarter end, the highest level achieved since the fourth quarter 2015.

The significant leases that commenced in the first quarter included a 68,000 square foot lease at our Sorrento Mesa property in San Diego, a 17,000 square foot lease at our FRP Collection property in Orlando, a 15,000 square foot expansion at our Circle Point property in Denver and three leases at our Park Tower property in Tampa.

Furthermore, during the quarter, we advanced our acquisition and capital recycling initiatives. We’ve been selectively pruning our portfolio to concentrate on properties with the best long-term risk adjusted returns.

In addition to the previously announced Denver sale, we entered into an agreement to sell one of the 10 buildings that comprise the San Diego portfolio that we acquired in September 2017. The sale of this 89,000 square foot building in the Sorrento Mesa sub-market was part of our acquisition business plan when we bought the portfolio.

The sale price is $16.5 million and the buyer has waived its due diligence conditions. We anticipate the sale will close later this month. We have also been successful in identifying attractive opportunities in our pipeline to deploy sale proceeds and the balance of our acquisition capital.

We closed the previously announced $63 million purchase of Canyon Park in Seattle in the first quarter, giving us high quality exposure to Seattle’s thriving technology and innovation industries. Further, we continue to make progress on the loan assumption for the previously announced $32.5 million pending Portland acquisition.

Provided the loan assumption is approved and other conditions to closing are met, we expect this transaction will close late in the second quarter and we’ll discuss it further on our next call. With the pending acquisition and sale activity, our net acquisitions for the year so far will be approximately $61 million.

Our 2019 net acquisition guidance is $78 million to $90 million, which leaves capacity for another small to mid-sized purchase. Beyond this, we continue to explore other accretive, capital recycling opportunities to fund our pipeline. Tony will go into further details shortly, but we’re optimistic about our prospects for the balance of 2019.

We believe that the occupancy gains we’ve achieved to-date will lead to higher same-store NOI growth for the balance of the year. Finally, relating to corporate initiatives, we’re excited to welcome Sabah Mirza to our Board, who we announced, joined as an independent director in March. Ms.

Mirza has over 20 years of legal, corporate governance and securities experience, most of which has been spent as in-house counsel across diverse industries. Her unique perspective and expertise will be a great addition to our Board. And with that I’ll turn the call over to Tony to provide further details on our financial results..

Thanks, Jamie. On a GAAP basis, our net operating income in the first quarter was $23.3 million. This represents a $2.4 million increase over the $20.9 million achieved in the fourth quarter of 2018.

The increase from the prior quarter was primarily attributable to the acquisitions of Greenwood Boulevard and Camelback Square late in the fourth quarter, and the acquisition of Canyon Park in the first quarter.

We reported core FFO of $11.8 million or $0.29 per share, which was $1.4 million higher than the fourth quarter and was similarly impacted by acquisitions, which straddled year-end.

In accordance with the updated lease accounting standards, effective January 1st of this year, we’ve included in expenses the straight-line effect of lessee operating leases, which are now being recognized on the balance sheet.

The impact to core FFO was less than $10,000 in Q1 and was added back when calculating AFFO under the renamed caption, net reoccurring straight-line rent and expense adjustment.

In accordance with the new lease accounting standards, we’ve also updated our presentation of revenues on the income statement and consolidated our historical reporting of revenue line items into a single line. Further disclosure on this leasing standard will be included in our 10-Q. Our first quarter AFFO was $8.3 million, or $0.21 per share.

Our first quarter AFFO was affected by the tenant improvements and leasing commissions associated with our leasing activity in the quarter, particularly at City Center and Logan Tower, which saw increases in occupancy during the quarter.

Do 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. 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 several of our properties, the largest of which relate to Park Tower repositioning, which was completed in the quarter in our recently acquired Canyon Park property.

Further details are disclosed on Page 19 under non-recurring capital expenditures. Our same-store cash NOI grew 1.8% year-over-year. Denver, Tampa and Orlando were our best performing markets, each with 9% same-store cash NOI growth.

With portfolio occupancy trending ahead of target and embedded contractual rent step-ups, we expect same store results will continue to accelerate throughout 2019. Moving onto our balance sheet. Our total debt, net of deferred financing costs, at March 31st was $695 million.

Our net debt to enterprise value ratio was reported as 53.8%, but that figure is based on our stock price at March 31st. Using that consensus analysts’ estimate of NAV at quarter end, our net debt to enterprise value ratio was 49%.

With the pending acquisition and disposition after quarter end that Jamie discussed, we expect our leverage will be approximately 50% using this same measure. At quarter-end, fixed rate debt represented 78% of our total debt, with a weighted average interest rate of 4.2% and a weighted average maturity of 5.7 years.

We closed a Canyon Park loan during the quarter for approximately $41 million with a fixed interest rate of 4.3% for an 8 year term. Finally, in our first quarter earnings release, we reiterated our previously issued 2019 guidance.

If the strong first quarter trends continue, we believe we will end the year near the top end of our range for core FFO, same store cash NOI growth and year-end occupancy. That concludes our prepared remarks and we’ll open up the line for questions.

Operator?.

[Operator Instructions] And the first question comes from Craig Kucera with B. Riley FBR..

Hey. Good morning, guys. I noted that you didn’t take an impairment charge on Sorrento Mesa.

Do you plan on booking a gain there or is that going to be pretty flat?.

Hey, Craig, it’s Tony here. We will be recording a gain there. Think of -- it’s a small number, approximately about $1 million..

And as far as the sort of remaining capacity you have for acquisitions, have you soft circled any markets or particular assets that you might go down the path of -- find in the future?.

Hey. Good morning, Craig. It’s Jamie. So, we have the Portland acquisition we’re closing and then we’ve got room for another kind of small to mid-sized acquisition, which could potentially be a little larger, depending if we recycle out of some other assets as well. So we want to continue to concentrate and build up in the markets we’re in.

But we don’t have anything at the forefront right now to talk about it..

And one last one for me.

As far as your non-recurring CapEx in TI, do have a budget that you can give us or a sense of what the total amount would be for 2019?.

Hey, Craig. So, I mean, if you look at the largest number this quarter is really the last amounts related to the Park Tower repositioning. So, that was an elevated number. After the call I can make -- in terms of -- you’ll see that trend decrease. I don’t have the exact number for the balance of the year in front of me here..

Okay.

But somewhere south of $5 million, let’s say?.

Correct..

Thank you. And the next question comes from Michael Carroll with RBC Capital Markets..

This is Jason on for Mike..

Good morning..

Good morning. I was wondering if you could provide a little more color on the 10455 sale in Sorrento Mesa. Just curious what type of buyers are showing interest in that asset..

Sure. So, it was a value-add deal. So occupancy was under 50% since we bought it. And when we looked at the property and the amount of capital that went in, it wasn’t ideal from a restructure and so transaction hasn’t closed yet. They’re hard and non-refundable, but it’s really suited for a value-add profile..

And could you provide any details on the cap rate?.

Given that it’s less than 50% occupancy, the cap rate is low. So it’s in the 5% range..

And then, the leasing trends look good. There are so few large blocks available, it looks like, so we’re wondering is, where do you guys see the next biggest coming down or what the next big lease-up opportunity is..

So, really there’s three big blocks across our portfolio. So we have one full building in Sorrento Mesa, which if you recall, was a building that we got back early. We renegotiated, we let the tenant off. We got prepaid roughly 80% of future rent. And so we’ve made a major investment there, cleaning that particular building up.

We’ve done significant amenity in Sorrento Mesa, which really enhances that property. So there’s a number of prospects working on that. DTC Crossroads is the next same story. We put in full fitness facility, building amenities, upgraded the lobby. So we have a number of prospects there. That market has been a little slower.

We do have some good prospects, particularly post renovations, been really well received, when we brought the leasing teams through over the last couple of weeks. And then finally the last big block is Camelback Square in Scottsdale. That one’s about just over 80% leased. That’s one of our new acquisitions from December.

We didn’t assume that we would have any major leasing in the first year, although we do have some prospects that might accelerate that a little quicker than our own internal plans..

And then lastly, there was a small term fee in the quarter. I was wondering if that relates to anything in specific..

So, there was a couple of tenants that comprise that, the largest was at Central Fairwinds. We had a tenant that effectively paid through almost the full amount of its remaining rent to get out of a lease early. So it’s a combination of a couple of terms, the largest was Central Fairwinds..

Thank you. And the next question comes from Rob Stevenson with Janney..

Any known or likely tenant move-outs of size as of now of incremental nature?.

So, if you look at the balance of 2019, we have about 5% that’s rolling. We do have a couple of known vacates, but none are -- they’re all smaller than 15,000 square feet. So there’s -- we just got to continue to kind of block and tackle as we like to say, to kind of fill that.

So we do expect that occupancy could take a small dip, kind of in Q3, Q4, depending on the speed at which we lease some of those known vacates. But it’s not significant..

Anything in 2020 as of yet?.

So 2020, I think we’ve talked about before on the call, BB&T have signage of our Park Tower building there in February 2020. We’re in discussions with them. And it’s been announced there in the mergers with SunTrust. So it’s a little bit up in the air.

Beyond them, we have an insurance company at Pima that rolls in August of 2020, that’s of significant size. Those are the only two large ones in 2020..

Yes, a little more color there. So that one is about 46,000 feet and expectation there is, likely there’s going to be a -- probably a short term extension, but we think we’ll get that space back. The bulk of the others, the seven leases over 30,000 feet, one we’re fairly confident is likely to vacate.

The other ones we think we’ve got a good shot at extending..

Okay.

And then where is occupancy on that portfolio -- on the Portland asset that you guys are buying?.

We believe it’s just under 100% or about 100%. Yes..

So, if I take out the Sorrento Mesa asset that you guys are selling, your occupancy in the portfolio’s is 93.4%, so that goes up a little bit because of the Portland acquisition and then comes back down a little bit because of some smaller vacates in the third and fourth quarter, is the way to think about that?.

That’s correct..

And then, have you guys come up with any definitive plans for the land parcel at Circle Point in Denver yet?.

So, we’ve been working very actively on that. We don’t have anything to disclose on this call, but it is a focus for us to basically separate the multi-family component, which is about half of the land, and then we would retain the office component, which is the other half.

We’re hoping we’ll be in a better position to talk about that on the next call..

Thank you. And the next question comes from Mitch Germain with JMP Securities..

Good morning guys.

Did you identify the rent spreads on leasing in the quarter?.

Again, small -- relatively small sample size, but it averaged about 4%..

And broader portfolio, kind of the differential between where current rents are versus market, is it still in the 5% to 10% area in your mind?.

That’s right Mitch..

Okay. I appreciate the color on same property results, specific to the markets that had some really robust trends.

I’m curious, what was the offset to those markets? Were there some challenges that kind of brought the rates down?.

Yes, sure. So, really it was San Diego. And San Diego was just added to our same store pool in Q4 of last year. So, it’s one we had 12 months where period was crossed. Within that property, last year we announced, shortly after we acquired the building, we had an early termination of one of our tenants who moved out.

That tenant moved out in February of last year. And if you recall, this tenant, Roca [ph] actually ended up paying 97% of its base rent for its remaining two-plus years that we can use to retenant the space.

So effectively, on a comparison of quarter-over-quarter, that rolls off this year, which has led to my commentary on accelerating same store results, because that headwind alone is going to be burning off..

[Operator Instructions] And the next question comes from Barry Oxford with D.A. Davidson..

Tony, just building on that same store, where might same store come out for the year in 2019?.

So, our guidance at the beginning of the year was 2% to 4%, and in my prepared remarks I indicated if the trends that we are seeing in Q1 continue, we’re expecting it to kind of go toward the top end of that range..

Okay.

Jamie, could you talk about some of the cap rates that are -- that you have in the current acquisitions? And then when you’re looking at the pipeline, maybe give us an idea of the type of cap rate you’re looking at?.

Sure. So generally, I’d say over the last 12 months, cap rates really haven’t changed much. I mean it’s been a very competitive environment on the buy side. So we have to be very selective. We’ve found we’re working on a lot more transactions versus the ones that actually close, just because there’s a lot of demand out there.

So cap rates really haven’t changed a lot. And if you look at the average of what we did last year, it was sub-7%. Typically we’ve been targeting 7%, 7.5% range. And so we still have a number of those in our pipeline. They may ultimately trade at a lower cap rate, higher valuation.

So for us it’s really focusing and being disciplined to work through that pipeline and bring as much forward as we can, so we can focus on what we see as the best opportunities..

And then when you look at your acquisitions and your need for capital, how would you view -- are you more inclined to kind of do dispositions and reposition the portfolio versus doing an equity offering? How are you viewing that at this juncture?.

Yes. Barry, when you look at where our share price is, we’re obviously not happy. We think we’ve done a very good job building out our portfolio. So raising equity today is not what our primary plan is. So it’s deploying the balance of the capital that we have.

We do think we’ve got a number of potential recycling opportunities where we can take assets at great valuations we have and redeploy them into other investments that we think have a higher long term return profile and better risk adjusted return. So we are exploring a number of those right now..

Thank you. And as there are no more questions, I would like to return the floor to James Farrar for any closing comments..

Thank you all for joining today. We appreciate your support and we look forward to discussing our future results with you..

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