Good morning, and welcome to the City Office REIT, Inc. Fourth Quarter 2023 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] As a reminder, this conference call is being recorded.

[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'd like to direct you to our website at cioreit.com, where you can view our fourth quarter earnings press release and supplemental information package.

The earnings release and supplemental package both included 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 fourth 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'll review our financial results after Jamie Farrar, our Chief Executive Officer, discusses some of the quarter's operational highlights. I’ll now turn the call over to Jamie..

Good morning and thanks for joining today. On this call, I'd like to touch on several topics. First, a look back at our performance in 2023. Then an overview on the state of the office market and last updates on our progress and focus areas for 2024. Overall, 2023 was in line with our expectations.

Our core FFO per share ended the year at $1.39, which was within the guidance range we set at the beginning of 2023. Our performance led to dividend coverage for the year with a total AFFO payout ratio of 66%. Operationally, we executed 599,000 square feet of new and renewal leasing throughout the year.

Our pipeline of leasing prospects gained considerable momentum as the year progressed. In the fourth quarter, we executed 109,000 square feet of new leases, which was the highest level of any quarter in 2023. The average term of those leases was a healthy eight years.

Our occupancy also ended the year approximately where we expected it to land, and we achieved 3% same-store cash NOI growth for 2023 as compared to the prior year. Last, during 2023, we renewed two property loans for five years, which was a success in an otherwise challenging financing market.

I'll use this as a transition to provide an update on the state of the office market. There continue to be headwinds in certain areas and promising green shoots in others.

On the challenging side, the investment sales market continues to be very slow, across the office market in 2023, sales volumes was down 57% year-on-year within the limited transactions that closed, many were aided by seller financing or assumable debt.

Debt capital also continues to be effectively frozen for new originations with lenders seeking to reduce their office sector exposure. We're closely monitoring these trends and remain in active dialogue with our own lending relationships.

On the side of positive trends, the corporate pressure on employees to return to the office continues to gather momentum. Major companies, including employers such as Google, Meta, Salesforce and Amazon, to name a few, have all shifted their policies towards more consistent in-office collaboration.

Having employees attending the office a minimum of three days a week, which appears to be a common current policy should bolster overall space needs and benefit high-quality office assets. We believe these trends will further strengthen throughout 2024. Another helpful change is the rapid slowdown in new construction.

Q4 2023 had the least amount of ground broken for new office buildings in over 20 years according to JLL. The projects that are breaking ground are generally build to suit or pre-leased with almost no new spec projects underway. This will help shift the supply demand balance, as obsolete buildings get removed from inventory without being replaced.

Subleasing is also moderating with Q4 starting to indicate an equilibrium or decrease of sublease availability across many office markets. Relating to leasing trends, the flight to quality trend continues, which benefits our portfolio. According to JLL Research, 60% of total vacancy is concentrated in just 10% of buildings.

Leasing demand continues to be highest for well-located premier buildings that have amenities and ready to lease space. That leads us to our update on our progress so far in 2024, the leasing momentum that we experienced in the fourth quarter carried over into 2024. Today, we're actively pursuing a leasing pipeline that exceeds 200,000 square feet.

Of note, last year, larger corporate user lease discussions were less frequent with most of last year's activity in the small to medium size sweet range. Within our current pipeline, we are in active lease negotiations with four companies that average over 40,000 square feet per lease.

The return of these larger corporate tenants has a positive development, which has the potential to reaccelerate leasing results. Our leasing pipeline is in part driven by our spec suite and renovation programs that we've been focused on for the last two years.

We currently have 84,000 square feet of built spec suites in our inventory with 19,000 square feet under construction or planned to commence in 2024, combined with renovations such as our Preston Center property in Phoenix, these investments are allowing us to compete for a larger share of leasing across our markets.

As a status update on WeWork, they continue to operate in bankruptcy. As a reminder, at year end, we had three WeWork leases at our newest and best properties. On our last call we highlighted that WeWork's Raleigh and Dallas operations in our buildings appear to be performing well from an occupancy standpoint.

However, their Phoenix location at Block 23 had lower occupancy as it was still in a lease-up phase having been opened for just over a year. Block 23 is an incredible newly constructed building that is one of the top properties in Phoenix. We did not come to terms with WeWork on a lease restructuring and the Block 23 lease was rejected.

Effective February 7. City Office holds a $1 million letter of credit as additional security for this lease, which is being drawn and applied against our costs and lost income. As discussed on our last call, we've been working with other co-working operators to rebrand this location in the event of a WeWork departure.

We continue to keep all of our options open, but are in late-stage negotiations with another high-quality co-working operator. We are working at this location back so quickly and we will provide further details on our next call.

In terms of collection of rents from WeWork, they withheld January and February rent payments at Block 23 and the terraces as part of their lease negotiation tactics. In response, we immediately initiated litigation. Ultimately, WeWork have now agreed to repay these overdue amounts by the end of February in exchange for us dropping our litigation.

Bottom line, we remain very confident in our position. Our Block 83 terraces and Block 23 properties are three of the most desirable office assets in the entirety of Raleigh, Dallas and Phoenix. Irrespective of what happens with WeWork, these are incredible new buildings and are exactly what tenants want to lease today.

With that, I'll turn to our outlook for the balance of 2024. Tony will provide more detail, but in broad strokes, we have several focus areas. First, we remain focused on executing new leasing and driving occupancy. Related to that, we will further our spec suite and property renovation programs to optimally position our spaces for success.

We believe the timing of these enhancements aligns with market demands. Second, we continue to prioritize maintaining liquidity, protecting capital and addressing debt maturities in a prudent manner. And last, our DNA as a company has always been to uncover creative ways to unlock value at our properties.

And in 2024, we're looking to advance a few promising projects. While these initiatives remain at an earlier stage, we've been focused on finding ways to advance shareholder value. With that, I'll hand the call over to Tony to discuss our financial results and guidance in more detail..

Thanks, Jamie. Our net operating income in the fourth quarter was $26.9 million, which is $300,000 higher than the amount reported in the third quarter. Fourth quarter NOI was impacted by two offsetting accounting transactions.

First, we wrote off $1.4 million in straight-line rent receivables and above-market lease amortization related to the WeWork lease at Block 23.

Also during the quarter, the company recognized $1.5 million of income due to the reversal of an accrued liability for a tenant improvement reimbursement that was no longer owed as the claim period had expired. The net impact of these two transactions was an increase to NOI of $100,000.

We reported core FFO of $13.5 million or $0.33 per share for the fourth quarter. This was $200,000 lower than the third quarter as slightly higher G&A and interest costs offset higher NOI. Our fourth quarter AFFO was $9.3 million or $0.23 per share, which resulted in a well-covered dividend this quarter.

The largest impacts to AFFO were costs related to our, you're ready to lease spec suites and vacancy conditioning program, which are key parts of our business plan. The total investment in spec suites and vacancy conditioning in the fourth quarter was $900,000 or $0.02 per share. Moving on to some of our operational metrics.

Our fourth quarter same-store cash NOI change was negative 0.5% or $100,000 lower as compared to the fourth quarter of 2022. Same-store cash NOI grew by 3% for the year ended December 31, 2023 as compared to the prior year.

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.

Our retention rate in the quarter was 21%, which was significantly impacted by the 70,000 square feet of lease departures at our Portland properties alone during the quarter, consistent with JLL's market research that Jamie mentioned, the vacancy we have experienced in our portfolio is concentrated in a smaller subset of our properties.

Our portfolio occupancy ended the quarter at 84.5%, including 114,000 square feet of signed leases that have not yet commenced. Our occupancy was 86.5% as of quarter-end. Our total debt, as of December 31, was $670 million. Our net debt, including restricted cash to EBITDA was 6.6 times.

We had over $90 million of undrawn authorized on our credit facility. We also had cash and restricted cash of $43 million as of quarter-end. As far as our debt maturities in 2024, we had four scheduled maturities for a total of $102 million. The first, we have talked about on prior calls.

In May, the $21 million non-recourse property loan at our Cascade Station property in Portland will mature. In December 2022, we recorded an impairment in that asset's value that effectively wrote off our equity value. We are in continued discussions with that lender.

Portland continues to be a challenging market and without some form of material loan modifications it is difficult to justify investing further equity into this asset today. At Central Fairwinds, we have a property loan with a $16 million principal balance that matures in June.

This is the same lender that we successfully renewed to property loans in mid-2023. At FRP and Genuity drive, there is a property loan with a balance of $16 million that matures at the end of the year in December. We are currently working on an early extension there.

Last, we have a $50 million corporate term loan with our line of credit banks that matures in September. Similarly, we have initiated discussions and expect to provide an update next quarter. Changing gears to guidance. We have introduced a new full year 2024 guidance in our fourth quarter press release. I'll walk through a few of the key points.

We have assumed no acquisitions for the year. And if we have included $21 million of dispositions. This $21 million reflects our Cascade Station property in Portland and our assumption unless we are able to achieve material loan modifications, that property would likely be a disposition to the lender.

Related to our industry assumptions for debt that is floating rate, we have assumed flat interest rates and have not baked in any potential reference rate decreases in 2024. Our G&A range is $14.5 million to $15.5 million for 2024. This is the same range we had for the prior year.

The result of our assumptions is a core FFO per share range of $1.18 to $1.22. Our projected 2024 core FFO is approximately $6 million lower than our 2023 actual core FFO.

We are expecting interest expense to increase by approximately $3 million year-over-year due to higher rates on property-level debt renewals and a higher average balance on our credit facility.

Cascade Station occupancy declines year-over-year and assume disposition lower leverage, but also result in a $2 million reduction to core FFO in 2024 as compared to 2023. Last, approximately $1 million of that reduction relates to the assumption on the former we workspace at our Block 23 property.

We have assumed no income in 2024 with this operation. But forecast to return to a similar monthly revenue stream beginning in 2025, if we complete the pending transaction with the replacement co-working operator. We will revisit these assumptions in the quarters ahead.

As the results solidify, we refer you to the material assumptions and considerations set forth in our earnings release for further details. That concludes our prepared remarks, and we will open up the line for questions.

Operator?.

[Operator Instructions] Our first question today comes from Upal Rana from KeyBanc Capital Markets. Your line is now open. Please go ahead with your question..

Great. Thank you. Good morning out there. Thanks for taking the question. Thanks for all the detail from the debt maturities and the assets that you have provided. I was just curious on Cascade Station.

How is the on marketability of the asset, any conversation you have with potential buyers? Or is this really like your probably give the asset back to a lender?.

Thanks for the question. So we did launch a marketing process kind of mid last year. And Portland has just been probably the most challenging market we have and one of the tougher in the entire country. So we did not have any prospects that were close to where the debt level is and that hasn't changed.

So I think absent any sort of material concessions from the lender that make it logical for us to put more money in that will be one that transitions back to the lender and we cancel the debt..

Okay, got it. And how is that going to be impacting your occupancy this year, just given the trajectory of when you expect occupancy to be somewhat up by the end of next year of this year and the I'm assuming that's going to have some sort of impact in driving a little bit of the occupancy on guidance..

It's a fairly small impact because the asset is really small to 128,000 feet. So it in our own forecasting, no, we think it will exit our results kind of mid this year. So at the end of the year, there would be a slight uptick from that. But that's not the real driver of the improvement. It really is from getting leasing done..

Okay, got it. And then from your same-store cash NOI, you expect to be flat this year compared to 3% last year. Can you walk us through some of the moving pieces that's impacting the growth..

Yes. So we're showing effectively flat for 2024. And so the drivers are – it's a – they are same-store number is a cash number. And so we are on cascade, we talked about there are some departures there. That will impact results in Q1 and Q2, until if we do transfer to the lender. So that will have a negative impact on results.

And then offsetting that would be the new leasing. We have 114,000 square foot of leases that haven't taken occupancy. They will take occupancy in 2024. Some of them have free rent periods so have no impact. But finally or parts of the year, it will start factoring into the numbers to offset the negatives to kind of end the year effectively flat..

So Tony, Jamie again. So the one thing and I can't stress enough is the leasing pipeline really has improved and our own views when you look at free rent and build out periods, there's not going to be much impact to our cash flow in 2024 from that. But we see that really establishing and pushing 2025 and beyond..

Okay. Got it. And then just one last one for me is you mentioned the, you're seeing some momentum on the leasing side. I wanted to -- I was curious, where is that really coming from into the size industry or location..

So it's a mixture one market that was quite slow last year was Phoenix. It's a great city. But on the leasing side, it really did slow down and any discussions we're having in 2023, we're really -- usually in the small suite size. That's changed in that, as I mentioned, kind of for discussions that we're having right now above 40,000 feet each.

Two of those are in Phoenix. We're in lease negotiations on both. And we're advancing. And so we feel pretty good about that. So it's really diverse. But I'd say your best markets, right of those four that were in negotiation, two are in Phoenix, ones in Orlando ones, ones in Raleigh. And so our top markets continue to perform really well..

Okay, guys, thanks for all of the answers..

Our pleasure..

Yeah. Thanks Upal..

[Operator Instructions] Our next question today comes from Barry Oxford from Colliers. Barry. Your line is now open. Please go ahead..

Great, thanks, guys. Jamie, on the Work space out in Phoenix, does it have to be another we worked like tenants, because of the way the specious is built out. But if somebody wanted the space or would it just costs too much money too. So we have it to a normal tenant..

So we've explored both Barry and again, we just got the space back a couple of weeks ago. If you ---.

Right. No, no. I get it. I get it..

…get it phenomenally. Yeah, it's phenomenally built out. So there's logic to transitioning that into a co-working operation, because the money's predominantly already been spent. But could you transition to a corporate tenant? Absolutely. We just think the logical thing to do in this particular case is to continue as it will co-working..

All right. Okay. That makes sense. That makes sense. And then from a big picture, Jamie, given that you guys are carrying some of that high-debt? Does it make sense or look, Barry, I can't make the math work selling into this environment to sell some assets reduce your leverage.

But are you just saying, look, I can't get the prices that I need to make that a viable game plan at this particular junction..

So we've had a lot of success, no recycling assets in the past. And I guess what I'd say is there are very few buyers and one of the toughest parts is, it's almost impossible to get new debt financing. So the transaction that you are seeing in the market right now, a percentage of them are lenders who are foreclosing and trying to get some recovery.

And the other is sellers who are able to carry vendor take-back financing at a low rate. And so if one of those two isn't there really, isn't a lot of buyers. So it's an option, Barry. And I guess, I'd say, in my prepared remarks, I made a comment about no we're trying to explore ways of creating value.

We do have a few conversations going on there very early stage with unique buyers, whether they're strategic buyers, owner users, who are going to owner-occupier. It's early stage. But if we can find something that works for everyone, we're absolutely open to that, but it's got to work for us. And so yes, I think that will flesh out.

We haven't assumed any of those in our guidance. This year, but it's not lost on us that that could be a good source of liquidity if values are compelling..

Right. And Jamie, I would imagine if somebody's going to assume the mortgage that has to be mortgage with term. If you don't have really enough term on it, then you get up they're going to recognize pretty quickly. You're transferring your problem to me..

I think that's fair. Yeah. And in all cases are mortgages assumable. So it just becomes very complex.

And I think that's why until the debt markets open up a bit more, you're going to see very muted activity, which means from our standpoint, where do we focus to drive value? We focus on getting leasing done, that's going to drive cash flow which enhances your ability to borrow against it and enhances your ability to drive your cash flow back to the mother ship..

Right, right. That makes sense. Okay, guys, appreciate the time..

Thanks Barry..

Yeah. Yeah..

That concludes the Q&A portion of today's call. I'll now hand the call back over to Jamie Farrar, for any final remarks..

Thanks for joining today. As always, please feel free to reach out. if you have any follow-up questions. Goodbye..

That concludes today's City Office Q4 2023 earnings conference call. You may now disconnect your lines..