Cousins Properties Incorporated (NYSE:CUZ) Q4 2022 Earnings Call Transcript
Cousins Properties Incorporated (NYSE:CUZ) Q4 2022 Earnings Call Transcript February 10, 2023
Operator: Good morning, and welcome to the Cousins Properties Fourth Quarter 2022 Conference Call. All participants will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would like to turn the conference over to Pam Roper, General Counsel. Counsel, please go ahead.
Pam Roper: Thank you. Good morning, and welcome to Cousins Properties fourth quarter earnings conference call. With me today are Colin Connolly, our President and Chief Executive Officer; Richard Hickson, our Executive Vice President of Operations; and Gregg Adzema, our Chief Financial Officer. The press release and supplemental package were distributed yesterday afternoon, as well as furnished on Form 8-K. In the supplemental package, the company has reconciled all non-GAAP financial measures to the most directly comparable GAAP measures in accordance with Reg G requirements. If you did not receive a copy, these documents are available through the quarterly disclosures and supplemental SEC information links on the Investor Relations page of our website, cousins.com.
Please be aware that certain matters discussed today may constitute forward-looking statements within the meaning of federal securities laws, and actual results may differ materially from these statements due to a variety of risks, uncertainties and other factors, including the risk factors set forth in our annual report on Form 10-K and our other SEC filings. The company does not undertake any duty to update any forward-looking statements, whether as a result of new information, future events or otherwise. The full declaration regarding forward-looking statements is available in the supplemental package posted yesterday, and the detail special of potential risks is contained in our filings with the SEC. With that, I'll turn the call over to Colin Connolly.
Colin Connolly: Thank you, Pam, and good morning, everyone. We had a strong fourth quarter at Cousins to close out a productive 2022. On the earnings front, the team delivered $0.66 per share in FFO and same property net operating income increased 2.5% on a cash basis. Importantly, we leased 632,000 square feet during the quarter with a 7.3% cash rent roll-up. Excluding Houston, where we signed a strategic 328,000 square foot renewal and expansion with Apache, the cash rent roll-up was 27.7%. For the full-year of 2022, we executed approximately 2 million square feet of leases with a 9.5% cash rent roll out. These are terrific results. Before providing an update on our strategy at Cousins, I will share a few observations on the macro environment: First, despite inflation, the Federal Reserve and other central banks around the world have rapidly raised interest rates to slow economic growth.
Financial conditions have tightened. In response, companies are becoming more efficient. In some cases, this includes employing fewer people and reducing office space. Second, we are seeing an increase in office utilization. According to Castle, physical office occupancy averaged over 50% during the last week of January, the highest since the start of the pandemic. Austin, our second largest market led the survey at 68%. As the health crisis fades and financial pressures grow, CEOs are increasingly more focused on results and surveys. Rebuilding culture, collaboration and mentoring are now clearly priorities for innovative companies. Return to office mandates have accelerated, and this trend is likely to continue. Third, there is little to no leasing demand or capital available for older vintage, lower-quality office properties.
As a result, the values of these properties will likely reprice to facilitate a repurposing or even a teardown. This process will take time to play out. In the meantime, these types of buildings will likely stagnate and have a reduced impact on the overall office market. Lastly, the pipeline for speculative new development projects is shrinking. So what are the implications for office real estate. In the short-term, leasing demand is likely to soften, expanding office footprint is challenging amid shrinking headcounts. However, silver linings are taking shape. The office market has begun the process to rebalance. Our customers are returning in greater force. Accelerated obsolescence is reducing the existing inventory. New development is minimal.
And after companies right size and adapt to a more normalized world, they will grow again. Improving supply and demand fundamentals are not that far over the horizon for premier properties. The trend of growing companies distributing their workforces across attractive, affordable markets in the Sun Belt is still in the early innings. The flight to quality continues. Leasing demand is outsized for premium workplaces in amenitized locations. The is headed towards our Sun Belt trophy portfolio. Our conviction around our simple and compelling strategy to build the preeminent Sun belt REIT continues to grow. As I mentioned, market conditions will likely become more challenging in 2023. However, we built Cousins to thrive during all phases of the economic cycle.
We are exceptionally well positioned today. Let me highlight why. First, we own the leading Sun belt trophy office portfolio in the best submarkets in Atlanta, Austin, Charlotte, Tampa, Phoenix, Nashville and Dallas. Likely surprising to some, our customers are growing. During 2022, our renewing customers expanded by 162,000 square feet in total. Importantly, our lease expirations through 2024 averaged just 5.1% per year of annual contractual rent among the lowest in the office sector. This positions us favorably to grow occupancy despite a softer market. Next, our $428 million development pipeline with the office component 63% pre-leased is appropriately sized and positioned for the current climate. We will benefit from meaningful incremental NOI during 2023 and 2024, while having only modest speculative risk.
We approached 2022 with caution. While asset values were repricing, we intentionally and patiently prioritize our best-in-class balance sheet over new investments. Our net debt-to-EBITDA closed the year at 4.9 times. This compares to the Green Street sector average of 8.2 times. Importantly, we have no significant near-term loan maturities and approximately $950 million available on our $1 billion revolving credit facility. Simply put, we have significant liquidity and capacity to pursue compelling new investments in a dislocated market when many peers now lack capital to compete. In closing, we are mindful of the potential impacts of higher interest rates and a slowing economy. However, over the long-term, we are optimistic that premier workplaces will separate into its own asset class with improved sentiment.
Cousins is an exceptionally strong position. We are in the right Sun belt markets; we own a trophy portfolio; we have a fortress balance sheet and our talented and creative team is a differentiator. Before turning the call over to Richard, I want to thank all of our employees at Cousins who provide excellent service to our customers. Their dedication, resilience and hard work continue to propel us forward. Thank you. Richard?
Richard Hickson: Thanks, Colin, and good morning. Our operations team closed out 2022 with another solid quarter. I'm very proud of our team for finishing the year well in the midst of a complicated macro backdrop. We remain encouraged that the Sun Belt migration and flight to quality trends are intact. Additionally, we are pleased to see more influential companies in a number of industries calling for employees to spend more time together in the office. We expect this trend to continue. For the fourth quarter, our total office portfolio weighted average occupancy and end-of-period lease percentages were 87.1% and 91%, respectively. Those numbers include the addition of $100 million, and 92.3% leased and occupied new development in Phoenix into the operating portfolio.
Our weighted average occupancy was down 0.2% in the quarter, driven primarily by a couple of explorations at San Jacinto Center in Austin and Tippy Gateway and Phoenix, both of which have been partially backfilled. Our lease percentage increased almost a full percent from last quarter, largely driven by the recently announced 328,000 square foot lease for Apache Corporation's new global headquarters at Brier Lake Plaza in Houston. As Colin said, when we announced this lease, this highlights the importance of Premier workplaces and foster employee collaboration and enhancing company culture. Apache's employees will experience an engaging, state-of-the-art workplace when they arrive at BriarLake, and we are excited to be a part of. In the fourth quarter, we executed 39 office leases totaling 632,000 square feet with a weighted average lease term of 11.6 years.
Photo by Kara Eads on Unsplash
This was our highest quarterly square footage volume of 2022. And excluding new development, it was also the highest since the third quarter of 2019. Our total signed activity for the full-year was just under 2 million square feet, a fantastic year of leasing for Cousins. The Apache weeks was clearly a big contributor to our fourth quarter leasing volume. However, it also muted overall leasing economics given it was in the relatively weaker non-core Houston market, namely our recent concessions, defined as the sum of free rent and tenant improvements were elevated and weighed on net effective rents. I'm pleased to say that even with our outsized leasing activity in Houston, second-generation net rents for all activity increased 7.3% on a cash basis and in the fourth quarter and 9.5% for the full-year.
I also want to share some of the metrics behind our fourth quarter leasing activity, excluding Houston, in order to provide better insight into our core markets. Excluding Houston activity, we executed 36 leases in the fourth quarter, totaling 296,000 square feet with a weighted average lease term of 8.1 years. New and expansion leases represented 49% of total leasing activity. 83% of our activity net of Houston was in Austin and Atlanta and activity was balanced in terms of industries. Leasing concessions, excluding Houston, were $5.88 this quarter, 19.7% below our weighted average for the first nine months of the year. Further, net effective risk this quarter were a company record $30.61, when excluding Houston. Lastly, when excluding Houston's second-generation net rents increased 27.7% on a cash basis in the fourth quarter.
From a broader market perspective, the flight to quality continues to bifurcate the market. According to JLL, assets built since 2015 saw 8.1 million square feet of positive net absorption last quarter and 33.8 million square feet in 2022. JLL Research also found that assets less than 10-years old captured 14.1% of gross leasing activity this past quarter, a 22.6% increase in share compared to the previous cycle. Even with the powerful flight to quality trend in our favor, we are seeing some slowing in our leasing pipeline as macroeconomic uncertainty persists and demand from large technology companies pauses. We expect that our total leasing activity is likely to moderate in 2023. In addition to the softening economy, we have modest lease expirations in 2023 at only 5.1% of our annual contractual rent.
Thus, we have fewer renewal opportunities during the year. With a smaller sample size of leasing activity, there could also be more volatility in our leasing statistics quarter-to-quarter. This may especially be the case with net rent growth, which is highly geared to the mix of lease size and geography. For instance, we are in lease negotiations to renew our largest 2023 expiry customer in about 120,000 square feet. They are not a traditional office user and their in-place rent has escalated for a decade. As a result, we expect their net rents to roll down modestly on renewal. Given the size and despite being a fantastic potential lease renewal for Cousins, it could have an outsized impact on leasing metrics in one of the next couple of quarters.
With this anticipated renewal of our largest 2023 expiration, minimal expirations otherwise and about 625,000 square feet of signed leases yet to commence in 2023, we see a reasonable path to maintaining occupancy and hopefully growing occupancy towards the end of the year. Moving to some market dynamics. The Atlanta Metro recorded 485,000 square feet of net absorption last quarter, bringing the 2022 total to over 1.1 million square feet, the most in seven years according to JLL. Class A rents in the market were up 5% year-over-year, continuing to be driven by highly amenitized, newer and recently redeveloped buildings. JLL also noted that Midtown posted annual rent growth greater than 10% for the year. We signed 92,000 square feet of leases across all of our submarkets in Atlanta this past quarter, rolling up cash net rents over 10% on average.
In Austin, JLL pegged market leasing activity last quarter just below the pre-pandemic average at 1.1 million square feet, with positive net absorption for the fourth quarter and the full-year. We signed 153,000 square feet of leases in Austin last quarter, rolling up cash net rents over 40% on average. Our activity included a 43,000 square foot renewal and expansion of Adobe, a technology customer of the domain. JLL Research also cited that 80% of Austin's leasing activity this quarter occurred in leases for less than 10,000 square feet, an indication that we see momentum could slow in Austin as larger requirements pause. Fortunately, our portfolio is 95% leased as in-place weighted average lease term of over six years and only 8.2% of our annual contractual rents in Austin expire through 2024, equally balanced between 23 and '24, including only one exploration larger than 50,000 square feet that is in the third quarter of 2024.
In the short-term, our portfolio is well insulated from softening fundamentals. Long-term, Austin remains one of the most desirable cities in the nation to live and work with strong demographic and job growth drivers. As the economy and the technology sector rebalances, we expect Austin to be poised for strong growth. In conclusion, our team had a strong finish to the year despite increasingly challenging macroeconomic headwinds. Looking ahead, we are optimistic that great companies will continue to seek high-quality, highly amenitized office space as they increasingly bring employees back into the office. Cousins is well positioned for the long term with a stable high-quality portfolio in the best Sunbelt markets. Before handing it off to Gregg, I want to thank our talented team at Cousins, whose hard work made 2022 a successful year.
We look forward to a productive 2023 together. Gregg?
Gregg Adzema: Thanks, Richard. Good morning, everyone. I'll begin my remarks by providing a brief overview of our results, as well as some detail on our same-property performance in parking revenues. Then I'll move on to our capital markets activity and our development pipeline, followed by a quick discussion of our balance sheet before closing my remarks with information on our initial outlook for 2023. Overall, as Colin stated upfront, fourth quarter numbers were really solid. Leasing velocity remained brisk, second-generation leasing spreads were up, and same property, the year-over-year cash NOI was positive. It was also a very clean quarter. There were no unusual fees, gains or other items that materially impacted our results.
That being said, interest expense was up significantly during the fourth quarter, driven by higher interest rates. Daily SOFR averaged 3.6% during the fourth quarter, compared to 2.1% during the third quarter and only 5 basis points in the fourth quarter of 2021. Focusing on same-property performance for a moment. Cash NOI during the fourth quarter increased 2.5% compared to last year. This continues a string of improvements during 2022, with the gains largely driven by our properties at Domain in Austin. Looking forward, we anticipate same-property NOI growth to be positive during 2023 on both a GAAP and a cash basis as our strong leasing over the past several quarters bears fruit. As Colin mentioned earlier, physical utilization has continued to increase, and our parking revenues have grown along with it.
Parking revenues during the fourth quarter were the highest they have been since the first quarter of 2020. And for all of 2022, parking revenues were up 10% year-over-year. Turning to our capital markets activity. During the fourth quarter, we closed on a new $400 million term loan with our existing bank syndicate that matures in 2025 and includes four six-month extensions. We used a portion of these proceeds to pay off our maturing Promina Tower and legacy Union mortgages. During the quarter, we also refinanced the existing mortgages on our two terminus properties in Atlanta with the current lender, extending it from January of 2023 to January 2031. Looking forward, we only have about 1% of our total debt maturing in 2023. Specifically, we have a mortgage tied to a medical office building adjacent to a hospital that is essentially 100% leased.
We own 50% of this Midtown Atlanta property through a joint venture with Emery University. We've initiated the refinancing process and anticipate a late spring closing. Turning to our development efforts. As Richard mentioned earlier, one asset, $100 million Phoenix was moved off our development schedule during the fourth quarter. Our current development pipeline is comprised of a 50% interest in Neuhoff in Nashville and 100% of Domain 9 in Austin. Our share of the remaining development costs is $172 million, $97 million of which will be funded by an in-place Neuhoff construction loan leaving just $75 million to be funded by our operating cash flow over the next two years as these projects are completed. Looking at our balance sheet, net debt to EBITDA is 4.9 times among the best of our office peers.
Our liquidity position remains strong with only $56 million drawn on our $1 billion credit facility and our dividend remains well covered with an FAD payout ratio of only 70% in 2022. Our financial position is rock solid as we navigate these challenging economic times. I'll close by providing our initial 2023 earnings guidance. We currently anticipate full year '23 FFO between $2.52 a share and $2.64 per share with a midpoint of $2.58. No property acquisitions, property dispositions or development starts are included in this guidance. If any transactions do take place, we will update our earnings guidance accordingly. While there are no risks within our guidance around speculative property transactions, interest rates remain a risk for all rates.
Whether through variable rate debt exposure or pending debt refinancings. As we have for many years, we used the sofer and treasury forward curves to forecast interest rates. To the extent these curves change, which they've been doing quite a bit lately, so of our interest expense. With that, I'll turn the call back over to the operator.
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