Q4 2023 Office Properties Income Trust Earnings Call
Participants
Kevin Barry; Senior Director of IR; Office Properties Income Trust
Yael Duffy; President, Chief Operating Officer; Office Properties Income Trust
Brian Donley; Chief Financial Officer, Treasurer; Office Properties Income Trust
Bryan Maher; Analyst; B. Riley Securities
Ronald Kamdem; Analyst; Morgan Stanley
Presentation
Operator
Good day and welcome to the Office Properties Income Trust fourth quarter 2023 earnings conference call. (Operator Instructions) Please note, this event is being recorded. I would now like to turn the conference over to Kevin Barry, Senior Director of Investor Relations. Please go ahead.
Kevin Barry
you and good morning, everyone. Thanks for joining us today. With me on the call are OPI.'s President and Chief Operating Officer, Yael Duffy, Chief Financial Officer and Treasurer, Brian Donley. In just a moment, they will provide details about our business and our performance for the fourth quarter of 2023, followed by a question and answer session with sell-side analysts.
First I would like to note that the recording and retransmission of today's conference call is prohibited without the prior written consent of the Company. Also note that today's conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and other securities laws. These forward-looking statements are based on OPI's beliefs and expectations as of today, Friday, February 16th, 2024, and actual results may differ materially from those that we project.
The Company undertakes no obligation to revise or publicly release the results of any revision to the forward-looking statements made in today's conference call. Additional information concerning factors that could cause those differences is contained in our filings with the Securities and Exchange Commission or SEC, which can be accessed from our website, OPIRE. dot com or the SEC's website. Investors are cautioned not to place undue reliance upon any forward-looking statements. In addition, we will be discussing non-GAAP numbers during this call, including normalized funds from operations or normalized FFO, cash available for distribution or CAD and cash basis, net operating income or cash basis and why a reconciliation of these non-GAAP figures to net income are available in OPI.'s earnings release presentation that we issued last night, which can be found on our website and finally, we will be providing guidance on this call, including normalized FFO and cash basis NOI. We are not providing reconciliation of these non-GAAP measures as part of our guidance because certain information required for such reconciliation is not available without unreasonable efforts or at all such as gains and losses or impairment charges related to the disposition of real estate.
I will now turn the call over to Yael
Yael Duffy
Thank you, Kevin, and good morning. Before we begin, I would like to start by discussing the announcement last month regarding OPI. quarterly cash dividends. As market conditions in the office sector remain challenging, we felt it was prudent to reduce the dividend to increase our liquidity and financial flexibility. This will help us address future leasing costs, capital expenditures and our upcoming debt maturities. We recognize the value of the dividend to our investors, and this decision was not made lightly.
On today's call, I will review OPI.'s operating and leasing performance before providing an update on our goals heading into 2024.
From there, I will turn the call over to Brian to review our financial results. OPI. portfolio consists of 152 properties totaling approximately 20 million square feet with a weighted average remaining lease term of 6.5 years. Our portfolio is well diversified by industry and geography, with 64% of our revenues coming from investment grade rated tenants. During the fourth quarter, we executed 196,000 square feet of new and renewal leasing with an average lease term of seven years and a roll-up in rent of 60 basis points. We ended the quarter with same-property occupancy of 89.5% renewals drove most of our leasing activity this quarter, including an eight year renewal with an insurance company for 100,000 square feet in San Antonio, Texas in a six year renewal with an aerospace government contractor for 80,000 square feet in Chantilly, Virginia concessions and capital commitments declined 12% quarter over quarter and were 21% lower than our average for the year. We hope to see these trends continue as we head into 2024. In total, we signed 75 leases in 2023 for nearly 1.7 million square feet at a weighted average lease term of 8.5 years. New leasing accounted for 402,000 square feet or 24% of the activity.
Looking ahead to 2024 and OPI.'s upcoming lease expirations, while we see evidence of large companies across corporate America, urging workers to return to the office, including in-person mandates. The office sector faces subdued demand driven by headwinds associated with macro economic uncertainty and the impact of work from home. Most markets experienced declines in asking rents and occupancy levels in 2023, and we expect this trend to continue into 2024. Additionally, competition among landlords has put further pressure on net effective rents in 2020 for 3 million square feet or 15.5% of OPI. annualized rental income is set to expire. Our leasing and asset management teams are proactively engaging in renewal discussions with our tenants to understand their space needs. Through these conversations, we have learned that approximately 1.9 million square feet representing 53.8 million of annualized rental income will not renew. Accordingly. We have engaged leasing brokers and launch marketing campaigns to address these vacancies. Our current leasing pipeline totaled 2.8 million square feet, of which 40% is attributable to new tenants.
Turning to our recent development projects are 427,000 square foot mixed-use development at 20 Mass Avenue in Washington, D.C. is 55% leased to finesse the international hotels, and we are actively marketing the remaining vacancy today we have toward over 20 tenants ranging in size from 15,000 to 150,000 square feet. However, as many of these tenants have requirements in 2025 and beyond, feedback has been slow in the first quarter of 2024, we expect to deliver the three property campus redevelopment located in Seattle, Washington, totaling approximately 300,000 square feet. Projects include the repositioning of two property from office to life science and maintaining the third property for office use. The project is 28% pre-leased to Sonoma biotherapeutics, and we are actively marketing the remaining vacancy with good activity. The project will be delivered with four move and renewed back last week, which we believe is a differentiator as tenants evaluate options in the market.
Turning to financing activities to begin the year, we have made significant progress addressing our upcoming debt maturities. At the end of last month, we recast our revolving credit facility that was scheduled to mature on January 31st with a new three year 425 million credit agreement. Additionally, last week, we completed a 5-year 300 million secured bond offering at a 9% coupon and announced the redemption of our $350 million senior notes maturing in May 2024. OPI. has $650 million of unsecured senior notes due in February of 2025, and we are assessing a range of options to address this maturity, including additional secured financing and asset sales to assist us in evaluating our potential financing strategies. We have engaged Moelis & Company as a financial adviser.
Turning to property dispositions. In 2023, we sold a non-core property, which generated 45 million in gross proceeds. Additionally, we have a 248,000 square foot property in Chicago, which Tyson Foods is vacating in January 2025 under agreement for sale. We anticipate this property will transact in the first quarter of 2024. Furthermore, we have identified and are in various stages of bringing additional properties to market. As we evaluate future sale, we will need to consider the impact that potential dispositions will have on our operating metrics and debt covenants.
Before I turn it over to Brian I would like to acknowledge that OPI., despite challenges facing the office sector accomplished many of its objectives in 2023 and to start the new year, we executed nearly 1.7 million square feet of leasing, substantially completed two major development projects in Washington, D.C. and Seattle sold non-core assets and successfully executed new financing in both the CMBS and bond markets. Our progress was greatly supported by the efforts and reach of our manager, the RMR Group with a deep bench of experienced real estate professionals and a banking relationship Looking ahead, we hope to continue to build on this momentum and further execute on our operational and financial priorities in 2024.
I will now turn the call over to Brian to review our financial results.
Brian Donley
Thank you, Yael, and good morning, everyone. We reported normalized FFO of $45.9 million or $0.95 per share for the quarter, which came in a penny below our guidance range due to higher operating expenses. This compares to normalized FFO of $49.4 million or $1.2 per share for the third quarter of 2023. The decrease on a sequential quarter basis was driven by higher interest expense and lower NOI. as a result of Q4 tenant vacates and operating cost increases. Same-property cash basis NOI decreased 12.5% compared to the fourth quarter of 2022 and was in line with our guidance range which was a decline of 11% to 13%. The decrease was mainly driven by elevated free rent concessions, vacancies and higher operating costs. We generated CAD of $0.18 per share during the fourth quarter and $1.51 per share on a rolling four-quarter basis. As John mentioned, based on the deterioration in market conditions, combined with OPI.'s near term cash priorities. Last month, we reduced our quarterly dividend to a penny per share. This equates to approximately 47 million of annual liquidity to support leasing capital and our refinancing initiatives.
Turning to our outlook for normalized FFO and same property cash basis NOI expectations in the first quarter of 2024, we expect normalized FFO to be between $0.79 and $0.81 per share decrease sequentially from Q4 is made up of several items, most notably increased interest expense related to our financing activity and lower rental income we expect same-property cash basis NOI to be down 14% to 16% as compared to the first quarter of 2023, driven by elevated free rent and tenant vacancies.
Turning to our investing activities. During the fourth quarter, we sold two properties for $21.3 million and have one property under agreement for sale of 39 billion. That we expect will close in the first quarter. We spent 29.4 million on recurring capital and 19.4 million of redevelopment capital during the fourth quarter in 2024, we expect our recurring capital spend to be approximately $100 million, comprised of 25 million of building capital and $75 million of leasing capital. We also expect 20 million of redevelopment capital this year, which includes the remaining project cost to deliver our Seattle redevelopment and related tenant improvements.
Turning to financing activities, in January, we recast our revolving credit facility with a new 425 million credit agreement, consisting of a 325 million secured revolving credit facility and a 100 million secured term loan credit agreement has a three-year term and interest rate of sulphur plus a spread of 350 basis points. We have a one-year extension option for the $325 million credit facility. The agreement is secured by 19 office properties with a gross book value of 942 million, all of the 19 banks that providing lending commitments under our previous revolver. Supported this new agreement, we currently have 193 million of undrawn capacity on our credit facility last week, we issued 300 million of new 9% senior secured notes, which are backed by 17 office properties with a gross book value of 534 million proceeds of this offering of borrowings under our credit facility will be used next month to pay off our 350 million senior unsecured notes that are scheduled to mature in May for Q1 2020 for projecting interest expense of 36.4 million or $0.75 per share. Based on our recent financing activity, pro forma for the full impact of the new credit agreement, the secured notes issuance and our redemption of the May 24 notes. Our estimated quarterly interest expense run rate is projected to be 38.3 million or $0.79 per share. We were very pleased with the outcome of our recent financing. Given the challenges facing the office sector, we believe they demonstrate the quality of our assets as well as the value of the support from the RMR platform that help facilitate these transactions. However, our work on the balance sheet is not finished and challenges remain. Our next debt maturity is 650 million of 4.5% senior notes maturing in February 2025. We have over 3 billion of unencumbered assets based on book value that we can potentially utilize to raise future debt capital for asset dispositions to raise cash. We have also engaged small as a company to assist in evaluating various strategies as we navigate our upcoming debt maturities and beyond. We look forward to updating you on our progress.
That concludes our prepared remarks. Operator, we're ready to open up the call for questions.
Question and Answer Session
Operator
We will now begin the question-and-answer session. (Operator Instructions) Bryan Maher, B. Riley Securities.
Bryan Maher
Thank you, Tom, maybe just starting off with the commentary on the known vacates for 2024, I think you said 1.9 million square feet. And when we think about it. I mean, it seems like a big number for sure. But when we think about the fact that in 2023, you did $1.7 million of new and renewal leasing activity. What do you say that, you know that 1.9 is going to end up being significantly less actual vacates, and you'll be able to reoccupy a lot of that space when we sit here a year from now.
Yael Duffy
Morning, Bryan, it's a good question. I think some of the challenges we have with these vacancies is that these are generally single-tenant properties. And so it is hard to finalize a single tenant or a large block of time in this environment. So, you know, I think that is our hope as I mentioned, we are actively marketing these properties for lease, but we're also evaluating on disposition several properties, the known vacates on our potential disposition list and also evaluating if there's other our best other best, highest and best use for these properties. So I don't obviously our goal is to lease, but I just want to set expectations that I think it will take us a long time in some cases to lease these properties.
Bryan Maher
And is there any particular common denominator among the known vacates that you can share that type of business, et cetera?
Yael Duffy
Yes. So we have a home, a few of them are was previously leased to the GSA. And I think the common theme that we've been seeing at least in the properties that are vacating is that they've been moving to federally owned properties. And then a couple of others are corporate headquarters where what they were doing at those facilities has yes, the time of change that we have an instance where they were processing checks at the property and we know we all know we're not really using checks as much anymore so I think it's just become the from when they sign belief today, technology has changed and they found that they don't need this additional space.
Bryan Maher
And kind of moving on, I've been getting a lot of questions from the buy side regarding the collateral assets, backing the new credit facility and the $300 million of notes. And maybe for Brian, do you know when and if that those assets will be again known to investors?
Brian Donley
That's a great question, Bryan. As you know, we don't typically just list out every asset that part of our financings. I will just describe the portfolio in each instance under the revolver. As you know, high quality with the properties with long-term walls tenants that are sticky, if you will, and have utilization of the properties, as you can imagine, to finance an office asset in this environment? The credit metrics have to all be there, but we haven't really disclosed the list per se of every address.
Bryan Maher
And I guess maybe one more for me, and I'll hop back in the queue. When you think and maybe for both of you when you think about how 2024 plays out between the asset sales that you're contemplating, potential, CMBS financing, et cetera, you know, is that just kind of a quarterly slow drip until we get to the back half of this year where you start to think about something more holistic to deal with the $650 million, just kind of how are you thinking about 2024 as it relates to next year's maturity?
Brian Donley
Yes. I mean, we've been laser focused on the balance sheet. Obviously, the revolver was our first step in dealing with the main maturities, which are now behind us, and we're looking at the six 50, but also what the impact will be beyond as we continue to look at secured debt as a as an option for us today, we have to be mindful of various debt covenants, our liquidity position and our operating metrics. What we know about our properties and what could be happening as you all talked about with leases on potentially tenants vacating, and we've hired more as an advisor to help us sort through all this now with the six 50. We have a large portfolio of unencumbered assets. We're going to utilize it to get something done. But holistically, we have to also look beyond that and figure out how to deal with the maturities behind the six 50 at the same time to keep our metrics in check. And so I think over the summer, I think you'll find we'll be more further along in our plans and evaluating different different options we might have.
Bryan Maher
Okay, thanks. I'll hop back in the queue.
Operator
Ronald Kamdem, Morgan Stanley.
Ronald Kamdem
Hey, just a couple of quick ones. I guess, you know, number one is just if you could talk a little bit more about sort of the occupancy cadence and that you're sort of expecting for next year. I know you sort of mentioned the known exploration are the normal without the now move outs, I should say and the expirations, but how do you guys sort of putting it all together? How do you expect occupancy to trend on the routes or the 2024? And where where do you think we'll have? Where do you see that sort Bye?
Yael Duffy
So look, I mean, I think the good news of the 1.9 million square feet that we know is going to vacate. It is pretty equal across each quarter. So no, it's around 400,000, give or take on each quarter. So that's about assuming we don't do any other new leasing, which I don't anticipate it would be about somewhere around 2% a quarter of decline in occupancy, but again, as I mentioned, we are several of the properties that are on the known vacate list are also properties worth considering for disposition. So if we're able to exercise on those dispositions, then our occupancy will it be better.
Ronald Kamdem
And then just sort of on the right, you know, the Moa, the oil is higher as you guys have obviously been contemplating further this maturity schedule. Was there ever an opportunity to just refinance everything in '24 and '25? Just curious that if that was our scenario where and you could take over the '24 and '25 at the same time? And if not, you know, what's sort of the thinking in Moelis and what sort of value kind of strategies would they explore?
Brian Donley
It's a great question. And to answer the first part of the question, yes, we did contemplate a much bigger deal than to take out the 20 fours 20 fives deal, we were evaluating whether that could have been a similar execution in the secured senior note market. And so we had to look at our options on the table as far as getting a revolver, which it gives us liquidity and more flexibility. And that's where we ended up leaving on doing the revolver versus not doing revolver and potentially doing a bigger bond deal of those. Those are sort of the two biggest things in front of us. We're also looking at individual assets, mortgage financing, the CMBS market cooling properties. So we've been looking at a lot of different options. The model as we've actually we actually engage them in the early part of the fourth quarter, and that helped us along the way as far as sifting through our options, you're bringing new ideas, bringing different capital alternatives to the table. So they've been very helpful guiding us and helping us navigate some of this stuff and they'll continue to do that in the future.
Ronald Kamdem
Great. That's it for me. Thanks so much.
Operator
This concludes our question-and-answer session. I would like to turn the conference back over to Jan Duffy for any closing remarks.
Yael Duffy
Thank you for joining us on the call today. Have a nice weekend.
Operator
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.
