Brandywine Realty Trust (BDN) 2020 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Brandywine Realty Trust Third Quarter 2020 Earnings Call. (Operator Instructions) Please be advised that today's conference is being recorded. (Operator Instructions)

I would now like to hand the conference over to your speaker today, Mr. Jerry Sweeney, President and CEO. Sir, you may begin.

Crystal, thank you very much. Good morning, everyone, and thank you for participating in our third quarter 2020 earnings call. On today's call with me, as always, are George Johnstone, our Executive Vice President of Operations; Dan Palazzo, our Vice President and Chief Accounting Officer; and Tom Wirth, our Executive Vice President and Chief Financial Officer.

Prior to beginning, certain information discussed during our call may constitute forward-looking statements within the meaning of the federal securities law. Although we believe estimates reflected in these statements are based on reasonable assumptions, we cannot give assurance that the anticipated results will be achieved. For further information on factors that could impact our anticipated results, please reference our press release as well as our most recent annual and quarterly reports that we filed with the SEC.

Look, first and foremost, all of us at Brandywine sincerely hope that you and yours continue to be safe, healthy and engaged. The pandemic continues to disrupt all of our lives and has resulted in a new landscape for everyone and certainly every business, and its duration, unfortunately, remains unclear. At the time of our Q2 earnings call in July, we did anticipate a return to the workplace commencing after Labor Day and into the fall. Given recent headlines, however, that time line for many of our tenants has been extended into 2021. And as we noted in our SIP, our portfolio is about 15% occupied, with variances between the different operations, but we can certainly provide more color on that during the Q&A.

Additional details on our approach to this crisis are outlined in our COVID-19 insert found on pages 1 to 4 of the supplemental package. During these prepared comments, we'll review third quarter results, an update to our 2020 business plan. Tom will then summarize our financial outlook and update you on our strong liquidity position. After that, Dan, George and Tom and I are certainly available to answer any questions.

So looking at the quarter, we continue to execute on every component of our business plan. We're certainly pleased that most of our 2020 objectives have been achieved. We are 100% complete on our speculative revenue target. And while the volume of executed leases was down a bit quarter-over-quarter, as you might expect during the summer, regardless of the pandemic, our overall pipeline increased by over 330,000 square feet. For the third quarter, we also posted very strong rental rate mark-to-market of 17.1% on a GAAP basis and 9% on a cash basis.

In addition, the core portfolio did generate positive absorption of 102,000 square feet, which includes 47,000 square feet of tenant expansions. Also included in those absorption numbers was the full building delivery of our 426 Lancaster Avenue redevelopment in Pennsylvania suburbs, that was 55,000 square feet, and 112,000 square feet of the occupancy backfill of the SHI space down in Austin, Texas.

We did experience during the quarter 58,000 square feet of COVID-related terminations. The primary one of that was a Philadelphia sports club in our Radnor complex of 42,000 square feet and a couple other small hospitality and medical offices.

Our full year 2020 same-store numbers are tracking in line with our revised business plan. For this quarter, the numbers were consistent with our business plan and were primarily driven, as you might expect, by the 9/30 2019 move out of KPMG at 183,000 square feet and the SHI move out on 3/31 '20.

Cash collection rates continue to be among the best in the sector. We've collected over 99% of our third quarter billings, and our October collection rate continues to track very, very well, with over 97% of office rents collected as of yesterday.

Also on capital. Our capital costs were in line with our targeted range as we continue to experience very good success in generating short-term lease extensions that require minimal capital outlay. Retention was 60% and slightly above our full year range, and based on fourth quarter scheduled lease commencements, we will be within our stated occupancy range. As Tom will articulate in more detail, we did post FFO of $0.35 per share, which is in line with consensus estimates.

In taking a broader look at our '20 business plan, as we mentioned on the last call, any crisis embodies a level of danger and opportunity. So our first plan of attack was to fully assess risk to our business, and we believe we have instituted plans to either mitigate or anticipate any adverse impacts. We do remain focused on growth, whether that's through our early lease renewal program, our margin-improving rebidding programs. We're continuing to work with institutional sources of equity to seek investments in opportunities where we can create earnings and value accretion.

But just looking at the risk factors that we face as part of the pandemic. First, and consistent with all applicable state, local and CDC guidelines, we did maintain a doors open, lights on approach to our buildings during the entire breadth of the pandemic thus far. While hard to fully quantify, we estimate that current occupancy levels of our buildings range from 8% in Austin, to around 15% in the Philadelphia CBD, to 18% in the PA suburbs, to 25% in DC. Now certainly for a variety of factors, primarily public policy, employer liability concerns, mass transit, virtual schooling and other safety concerns, most tenants in our portfolio, particularly the larger ones, anticipate a phased return after the new year. That certainly remains fluid, and we're tracking, but it seems like the larger tenants won't be phasing back in until next year.

Second, we focused on portfolio stability as a top priority with particular focus on these items. Rent collections, I already talked about, I think we're doing fairly well. Rent deferrals, we did frame that on Page 1 of our SIP. We had a total of $4.5 million of deferrals, with $4.1 million scheduled to repay those deferrals within the next 18 months. Now interestingly, to date, we've already collected 14% or $536,000 of those deferrals, including $100,000 of early prepayments. So we certainly think that we're making some good progress there.

Another key focus for us is strategic tenant outreach. Information, as you may expect, is key right now, and we have an outstanding on-the-ground team of property and leasing professionals in all of our operations. Their top priority is being in close touch with our tenants, understanding their concerns, their transition plans and seeing where we can provide help. As such, we've reached out to our entire tenant base, with a particular focus on those tenants who spaces roll within the next 2 years. The results of those efforts are framed out on Page 2 of the SIP and have resulted in 82 active tenant renewal discussions totaling over 920,000 square feet that to date have resulted in 45 tenants totaling 300,000 square feet executing renewals. These leases had an average term of 24 months, with about a 2.6% cash mark-to-market and a sub-5% capital ratio. We certainly hope that as we get more clarity on the pandemic that over the next couple of months, we can convert some of those ongoing discussions to executed renewals.

From a construction standpoint, nothing really more to update from last quarter. We continue to have construction activity in all of our markets. We have not programmed any further construction delays in our numbers. And we are beginning to see, with the exception of lumber and pressure-treated wood, some downward pressure on construction costs as we're starting to see an overall shrinkage of forward construction pipelines.

And speaking of pipelines, our leasing pipeline stands at 1.6 million square feet, including approximately 400,000 square feet in advanced stages of lease negotiations. As I mentioned, the overall pipeline increased by 331,000 square feet. The expansion of pipeline was driven by over 444,000 square feet of tours during the quarter which, as we noted, is up 115% from last quarter. So size of the market, reawakening a bit.

From a liquidity and dividend standpoint, Tom will certainly talk about it in some more detail, but the company is in excellent shape from a liquidity and capital availability standpoint, as we've outlined on Page 3. After factoring in the full repayment of the Two Logan Square mortgage, we're still projecting to have about $530 million of our line of credit available by year-end. We are also anticipating paying off a small mortgage during the fourth quarter of $9 million. We have no maturities in '21 and no unsecured bond maturities until '23 and have a very good 3.75% weighted average interest rate. Dividend remains incredibly well covered with a 56% FFO and a 76% CAD ratio. And given those mortgage prepayments, we do anticipate that by the end of this year, we will have a completely unencumbered portfolio, with no wholly owned secured mortgages and no wholly owned mortgages going into '21.

Now to quickly look at our development investment opportunities. First of all, on the development front, all 4 of our production assets, that's Garza and Four Points in Austin, 650 Park Avenue and 155 in Pennsylvania, are all fully approved, fully documented, fully ready to go subject to preleasing. We are still actively marketing those. We have a good pipeline on those production assets. As you might expect, it's moving a bit slow. But tenants continue to look at new construction and upgrading their stock as part of their workplace return strategy.

405 Colorado remains on track for completion in Q2 of next year at a very attractive 8.5% cash-on-cash yield. We have a pipeline of almost 200,000 square feet on that project. Again, moving slow, but again, we're pleased with the breadth of that pipeline. But we really don't expect a lot of significant decision-making to occur until the -- we get more clarity on what's happening with the pandemic.

3000 Market, that's the 64,000 square foot life science conversion that we're doing within Schuylkill Yards. Construction is underway. That building will -- is fully leased to Spark Therapeutics on a 12-year lease, commencing later in the second half of 2021 at a development yield of 8.5%.

And looking at Broadmoor and Schuylkill Yards for just a moment. We are advancing block a, which is a mixed-use block consisting of a 350,000 square foot office building and 340 apartment units. That's going through final design and final approvals from the city of Austin. We expect all those to have to be accomplished by year-end.

Within Schuylkill Yards, we continue a very strong push to the life science space. As mentioned last quarter, and we've outlined in more detail in the supplemental package, the overall master plan for Schuylkill Yards is we can do at least 2.8 million square feet of life science space. So we have an excellent long-term opportunity to really create a scalable life science community. 3000 Market and The Bulletin Building were the first steps in their conversions to create a life science hub.

We are also well into the design, development and marketing process for a 500,000 square foot life science building located at 3151 Market Street. We have a leasing pipeline on that project totaling about 580,000 square feet, and our goal is to be able to start that by Q2 '21, assuming, of course, market conditions permit.

Our Schuylkill Yards West project, which is our life science office and residential towers, fully approved and ready to go, subject to finalizing our debt and equity structure. That project consists of 326 apartments and 100,000 square feet of life science and office space. We currently have an active pipeline of over 300,000 square feet for those with commercial uses. And based on this level of interest, we are contemplating starting that project without a prelease.

Similar to our approach on 3000, where we looked at existing assets, we have commenced the construction and conversion of 3 -- floors 3 through 9 within Cira Centre to accommodate life science uses. That will be done in 2 phases. We have 34,000 square feet already preleased, and we currently have a pipeline of about 125,000 square feet. Another interesting point on both Schuylkill Yards and Broadmoor that we can't lose sight of is that based on current approvals and the master plans in place, between those 2 sites, they can accommodate about 5,000 multifamily units.

On the equity financing front, we have an active ongoing dialogue with a broad cross-section of institutional investors and private equity firms. We continue to explore other asset level joint ventures and sales to both improve our return on invested capital, generate additional liquidity and provide growth capital for our development pipeline. And these discussions, as you might expect, encompass both Broadmoor and Schuylkill Yards, but also some of our existing assets.

Let me close on this one final point. As you know, our normal practice for many, many years was to provide next year guidance during our third quarter earnings call, but these are not normal times. And as we discussed on our July call, we are not providing '21 guidance at this time. Although our company's overall rent collections remain very strong, we have increasing visibility into our existing portfolio and our -- and even with the rent collections being the highest in the sector, we believe it's prudent to delay our 2021 earnings guidance and business plan until we have better visibility on the duration of the COVID-19 pandemic and its impact on the macro economy and in particular, our markets.

Tom will now provide an overview of our financial results.

Thank you, Jerry. Our third quarter net income totaled $274.4 million or $1.60 per diluted share, and FFO totaled $60 million or $0.35 per diluted share.

Some general observations regarding the third quarter results. The results were generally in line with our second quarter guidance with the following highlights. Core -- the property operating income, we estimated $74 million, it came in slightly above that at $74.4 million, which was a good result. Termination and other income, we expected that -- it ended up $1.3 million below projections primarily due to the timing of certain anticipated transactions that we believe will occur in the fourth quarter.

And then interest expense was also lower by $1.7 million over forecast primarily due to the interest expense reduction from the loan assumption and recapitalization of Two Logan Square, which resulted in a onetime noncash reduction in interest expense totaling $2 million. Our third quarter fixed charge and interest coverage ratios were 3.5 and 3.8, respectively. Most -- both metrics improved sequentially as compared to the second quarter primarily due to the Commerce Square joint venture. Both metrics exclude the onetime interest deduction -- reduction noted above. As expected, our third quarter annualized net debt-to-EBITDA started to decrease. The decrease to 6.7 was primarily due to the sequential EBITDA remaining similar to the second quarter and the reduced debt levels from the Commerce Square joint venture.

Two additional reporting items. As Jerry mentioned, cash collections were above 99%. Additionally, if we included third quarter deferrals, our core portfolio would have been very strong, 97%. Collections for October are currently 97%. However, one vendor payment anticipated to be received in the next day or so will bring us up to 95 -- 99%. Write-offs for the quarter were approximately half a penny and primarily due to retail-related tenants.

Same-store, as outlined on Page 1 of our supplemental, we have included $1.1 million and $3.8 million of rent deferrals in our third quarter and year-to-date results. While not billed during the quarter, we feel that presentation will more accurately represent our current same-store metrics, with normalized going-forward results not inflated by subsequent cash deferral, cash receipts, which as noted above, is already starting to be collected.

Looking at the fourth quarter guidance, we have the following general assumptions. Property level operating income will total about $74 million and will be sequentially lower by about $500,000. The decrease is primarily due to the Commerce Square being in our numbers for part of the third quarter, and they will not be in our numbers for the fourth quarter. That totals about $1.5 million. Offsetting that decrease is a sequential increase in the portfolio, which will improve NOI by $1 million.

FFO contribution from our unconsolidated joint ventures will total $7.5 million for the quarter, which is up $0.3 million from the third quarter, primarily due to the full quarter inclusion of Commerce Square, offset by reduced NOI at our MAP joint venture. For the full year 2020, the FFO contribution is estimated to be about $20 million. G&A will be about $7 million for the fourth quarter and full year, will be about $31 million.

Interest expense will be sequentially higher by $0.8 million compared to the third quarter and will total $17 million for the fourth quarter. Capitalized interest will be $1.1 million for the fourth quarter, and full year interest expense were approximately $74 million.

Of note, we repaid our mortgage at Two Logan during October. The mortgage payoff was approximately $79.8 million. That loan had an interest coupon of 3.98%. We anticipate an early prepayment of a wholly owned mortgage at Four Tower Bridge with an effective interest coupon of 4.5%. With those payoffs, we now have no maturities scheduled on our wholly owned books until 2023 -- 2022 for the term loan, I'm sorry.

Termination and other income, we anticipate that to be $4.5 million for the fourth quarter. That's up from $0.9 million in the third quarter. And net income, leasing and development fees. Quarterly NOI will be $2.6 million and will approximate $8.5 million for the year. There will be $0.5 million in the fourth quarter as it relates to land sales. While our $272 million gain represented 100% of the gain for reporting purposes, we only recognized 30% of that gain for tax purposes. And with some tax planning, we will not require a special dividend in 2020.

We have no anticipated ATM additional share buyback activity scheduled. For the investments guidance, no more incremental sales activity. With the acquisition of the land parcel being anticipated fourth quarter, we only have the building acquisition located at 250 King of Prussia Road for $20 million. It's scheduled to be acquired in the fourth quarter and held for redevelopment. No NOI will be generated in 2020.

Looking at our capital plan. As outlined, we have 2 development/redevelopment projects in our 2020 capital plan, with no additional plans scheduled for the balance of the year. Based on the above, our 2020 CAD will remain in a ratio of 71% to 76% as lower capital will offset deferred rent that is repaid beyond 2020.

Uses for the remainder of the year is $185,000, comprised of $25 million in development and redevelopment, $33 million of common dividends, $8 million of revenue maintained capital, $10 million of revenue create capital and the repayment of the mortgages at Two Logan and Four Tower Bridge as well as the acquisition of 250 King of Prussia Road. Primary sources will be cash flow after interest of $45 million, use of the line of $68 million, use of our current cash on hand at the end of the quarter of $62 million and $10 million in land sales. Based on the capital plan outlined above, our line of credit balance will be about $68 million. We also project that our net debt-to-EBITDA will remain in the range of 6.3 to 6.5. In addition, our net debt to GAV will approximate 38%, which is down sequentially from the 43% in the prior quarter, primarily due to the Commerce Square joint venture. In addition, we anticipate our fixed charge ratio will continue to approximate 3.9 on interest coverage and will be -- 3.9 on debt service, fixed charge, and 4.1 on interest coverage.

I will now turn it back over to Jerry.

Great. Thanks, Tom. So these are really not normal times as we all know. So let us close with a couple of key takeaways. First, our portfolio and operations are in solid shape, with really increasing visibility into our tenants, their thought process and what they're thinking about in terms of their return to the workplace.

Secondly, our deal pipeline continues to increase as those tenants begin to really think about their workplace return, and us staying in touch with those tenants is key. Outreaching to a lot of existing or new prospects is also very much a key part of our business plan. So we're happy to see our pipeline really increase during the pandemic and during the slow months of the summer.

Another observation, and we're hearing this directly from tenants, both large and small. Safety and health, both in design and execution, are rapidly becoming tenants' top priorities, and we believe that new development and our trophy quality stock will benefit from that trend. And we're seeing the beginnings of that in the existing pipeline.

Private equity and the debt markets have stabilized and are becoming increasingly competitive, and strong operating platforms like Brandywine are really gaining significant traction for project level investments. And then we'll end where we started, which is that we really do wish all of you and your families remain safe during these interesting times.

And with that, we'd be delighted to open up the floor for questions. (Operator Instructions) Crystal?

(Operator Instructions) And our first question comes from Anthony Paolone from JPMorgan.

Jerry, I think last quarter, you'd talked about rents and the market generally holding up and you hadn't seen much diminution, if any, at that point. Can you give a little bit of color on where that stands today as you're getting deeper into the discussions of renewals and such with your tenants?

Certainly. Look, we are continuing to see fairly good stability within our portfolio. And I think the harbinger of that or the look through the glass is really through the renewal program that we have. I mean we're not really seeing any concessions that needed to make kind of as a part of postpandemic concerns.

We're very much focused in terms of the pipeline increasing. The rental rates that we had in place prepandemic are still the ones we have in place today. Certainly, in a couple of markets, like in Austin, for example, I know there's a lot of concern about the increase in sublease space down there. We can certainly talk about that. We haven't really seen any real erosion of rent yet. Certainly, the overhang of the sublease space might create that trickly in CBD Austin, where there's more than 1 million square feet of sublease space available, and the announcement the other day of Parsley Energy's acquisition could have an impact as well.

But in that case, Tony, we've been saying that on a 4 or 5, we have targeted kind of a mid-8% return on cost free and clear there. We can reduce rents by more than 10% and still -- asking rents by 10% and still generate about an 8% return. But George, why don't you amplify anything you're seeing throughout the portfolio?

Yes. I think, Tony, the real evidence has been in the 45 early renewals that we've done. Even those deals, albeit short in terms of averaging 24 months of extension, you still had a 2.6% increase in the cash mark-to-market. So I think even as it relates to the new deals, as Jerry alluded to, the asking rents that we have, have been holding up. We haven't really seen that much pressure on that. I think tenants are a little bit more focused on what their TI dollars will get them in terms of building the space the way they want it to ensure that they've got proper capacity for workstation, turning radius within the space, et cetera.

Okay. And then my second question is maybe a 2-part on life science. I think it was last quarter you had mentioned converting 56,000 square feet of Cira, and I just couldn't tell if what you laid out in your comments is an expansion of that conversion or if that was the same amount of space.

And then the second part of that, I just would love to get some color on the nature of the tenants that would look at a converted space like that versus perhaps wanting to go into a new build or more specific life science-type building. Like are they okay working with lawyers and accountants and stuff like that? Or is there a crossover with the pipeline you talked about for the Schuylkill development with the same pipeline that would go into this converted space? So any color there would be helpful.

Sure. And Tony, you're right. I mean the first phase, that's why I mentioned 2 phases at Cira, the first phase is around that 56,000 square feet. That's the lower several floors. And then we're incorporating capacity due to the conversion for the other floors as we need to or see the market demand over the next couple of years.

The pipeline of transactions we're saying on that really have not indicated any concern about being and called it a mixed-use commercial project at all. In fact, any concern that might be there is really being more offset by the ability of us to deliver space fairly quickly. I mean a number of these companies are looking for space in the very near term, which is really one of the catalysts behind doing this conversion and doing it on an accelerated basis. And we actually do view over time that, that original building we did at Cira Centre will essentially be incorporated into the whole ecosystem we're creating at Cira Centre.

Our next question comes from Jamie Feldman from Bank of America.

Can you talk more about the incremental 300,000 square feet in the leasing pipeline? Where is that located? It sounds like maybe a lot of that's at Schuylkill Yards but just more color on where the incremental demand is.

Yes. Sure. This is George. Just so we're all clear, when we talk about the volume of the pipeline, that's always exclusive of our development and redevelopment projects. So Jerry did cover the Schuylkill Yards and 3151 Market Street pipelines in his commentary. But the increase in the -- just normal core portfolio, we had a very good quarter of touring activity, 444,000 square feet. And a lot of that really was in both Philadelphia CBD and in the Pennsylvania suburbs, where we saw the largest amount of pipeline contribution. And we're also continuing to now see, with the summer coming to an end, an elevated amount of touring activity at our 1676 International building in Tysons. So they probably had about 140,000 square feet of additions to the overall pipeline.

Okay. And then...

I guess, Jamie, on the development pipeline, I think the -- thanks, George, for that clarification for everyone. I mean we do have a pretty good pipeline on our Schuylkill Yards project. It has continued to grow. Pieces of that relate to a couple of the anchor institutions in University City. We're looking for some expansion. Despite, I think, some of the macro impact of the pandemic on some of those institutions, they're still looking forward to increasing their market share and expanding their research capacities.

And then we have a variety of life science companies who are looking at both Schuylkill Yards West and our 3151 project. And within our Schuylkill Yards West project, we have several life science companies certainly, but we also have a number of law firms and financial service firms that are also looking at Schuylkill Yards West as a new location.

Okay. And the 300,000, does that include renewals? Or that's all incremental demand?

It's all incremental, yes.

So [if it's not] that, it would actually increase occupancy?

Correct.

Okay. All right. And then secondly, can you just talk us through the largest vacancies in the portfolio? I know you've got Macquarie and Standard Reliance (sic) [Reliance Standard] to work on.

And then just thinking about the expiration schedule. You got some big law firm expirations over the next, I think, 16 months or so based on your schedule?

Yes. Sure. Look, the large existing vacancies in the wholly owned portfolio are really at 1676 International in Tysons. And as I mentioned previously, we are starting to see some increase in the pipeline there.

The Macquarie and Reliance vacancies at Commerce Square, which are now within the joint venture structure, no significant change obviously during this past quarter. We continue to do several spec suite builds on some of the lower floor space. We had leased part of 1 floor previously and have the balance of that floor now constructed for spec suite to have some hopefully accelerated quick-hitting occupancy. Reliance, still a little bit early in terms of a true pipeline there, but we're hopeful that, as the fall progresses and post election day, we start to see some increased activity over there.

The rollover schedule for 2021, really, there are kind of 4, kind of larger ones to talk about. We've talked about most, if not all, of these in the past. But Northrop Grumman at 2340 Dulles, our plan, when that lease expires on 12/31 of 2020, is to shift it into either a redevelopment mode, continue to market the property to potentially sell and/or JV it, and those plans are progressing. We've had some preliminary inquiry about the building from the brokerage community. And so we continue to vet that.

The second largest is IBM and 199,000 square feet at Broadmoor in Building 5. That will come back to us on March 31, and the plan is to then convert that building and its underlying land into the overall development planning at Broadmoor.

The third largest is Comcast, 4 floors over at Two Logan Square, 88,000 square feet. We have already backfilled one of those 4 floors. That was a kind of a deal that was a little bit of a quick-hitter for us. They're going to take occupancy. Actually, we're going to terminate Comcast a month early and immediately backfill it with this replacement tenant. And again, where that lease expired, we had close to a 30% mark-to-market on the cash rents, with only a 10% capital ratio on a 6-year deal. So again, I think that building being trophy-class and what tenants are looking for, we feel good about the prospects for the other 3 floors.

And then the last one is some of the space over at Cira Centre coming back to us, and one of those is a full floor in that lower stack, 27,000 square feet, and that is part of our life science conversion that Jerry just spoke to.

Okay. That's very helpful. So just to confirm, when does the Comcast expire?

Natural expiration is 2/28/21, and one of those 4 floors, we will terminate a month early.

Okay. And then do you have any updates on the Dechert, Blank Rome and Baker leases?

Continuing to negotiate with all 3 of them. Active dialogue, no pen-to-paper at this point, but expectation is that we should be able to retain a good portion of those tenancies. And again, those are all in our 2022 expiration time frame.

Our next question comes from Steve Sakwa from Evercore ISI.

Jerry, I noticed that many of your assumptions didn't change, obviously, for the year-end 2020. I guess the one that jumped out at me was the percent leased, I guess, on the core portfolio of 94% to 95%. If I'm doing the math right, that sort of implies 275,000 square feet of absorption from a lease perspective, not necessarily an occupancy perspective. And I think you mentioned that you did about $100,000 of absorption in Q3. So just kind of walk us through sort of how you're going to achieve that lease percentage just given the softness in the leasing environment.

Yes. Sure. Steve, this is George. Let me take the first crack at that. Again, I think part of the reason we still feel that, that range is attainable is kind of the strength of the pipeline. We also have a couple of fourth quarter '20 expirations where we're in advanced dialogue and actually have a couple of leases signed so that when those fourth quarter vacates occur, the backfill is there. But because it's not vacant today, it does not hit our prelease statistic. So again, I think, again, the pipeline at 1676, some of that looks promising. And we're hopeful that we have a productive remainder of the fourth quarter to get some of these deals across the finish line.

Yes. As George mentioned and it was in our comments, I mean, a good portion of that is coming out of the pipeline activity we have, which is we have a number of tenants who are advanced -- in advanced stages of negotiations as well. So when we kind of risk assessed, we thought we still had a pathway to get to that number.

Great. And then maybe, Jerry, just to kind of circle down on Austin and 405 Colorado, I realize it's still maybe 3 quarters out from completion. But maybe just talk a little bit about the 200,000 square foot pipeline. Is -- are those tenants really kind of all in the market with existing, kind of upcoming expirations? Is there anybody kind of new or expanding in the market to take that? And then you did mention kind of the increase in sublease space. I'm just curious the competitive nature of the sublease against new construction.

Yes. Steve, great question. And look, the pipeline, which is just shy about 200,000 square feet now, had a number of tenants that have been in the pipeline for the last couple of quarters, a couple of law firms and several financial service firms. We're talking to a couple of technology companies. And look, one of the things with 405, it's a fairly small floor plate building, very highly amenitized with one whole sky lobby floor and over 2.5 per parking on site, which is a rarity in the Austin CBD market. So we're very focused on getting some of those leases put away or some of those prospects translate to lease executions in the next couple of quarters. The curtain wall in the building is substantially done. Some of the interior finish work is starting. So while we're still doing hard hat tours, the hope would be by December, we'll be able to actually get people through -- in a more kind of finished way, and we think that will certainly generate some activity. So the leasing team is very encouraged by the increased level of activity that we're seeing there. Obviously, we're all frustrated with the pace of how that pipeline progresses.

And I think, Steve, as we looked at it, we're still -- our proposals are still out in the mid-40 range, rental rate range, with the same level of concession packages that we had programmed. And I think one of the things that -- we don't really necessarily see that there could be downward pricing pressure, what we're seeing now. But when we look ahead to the amount of sublease space and, frankly, the gap between sublease rates, existing building rates and the new building rates, we think there could be some downward pressure, which is why we we're certainly flexing our financial model that even if we end up reducing our pro forma rents by 10%, we're still able to deliver about an 8% yield.

But the major focus we have right now is, from a leasing standpoint, is let's get a few more of these leases signed and then cross the finish line. We think that will build some momentum as the Austin market continues to open back up.

And our next question comes from Manny Korchman from Citi.

Jerry, maybe just spending a little bit more time on life science. It's been a space that we've seen a lot of owners and developers talking about converting or building new space and yourself included. So just wondering, maybe specifically for Schuylkill, if you think about just the supply picture, where else might there be competitive supply that comes up in either existing or new product? And from the demand you're seeing, are those tenants that you think end up in that Greater Philadelphia market? Or are these tenants that might have national pursuits, and they're trying to figure out where they end up?

Yes. Thanks, Manny. I'll answer the best I can. We do view that the competitive set we have in Philadelphia for life science is the University City Science Center, which again is about 8 blocks west of where we are at FMC Tower. And there's also The Discovery Center in the Pennsylvania suburbs, which is a privately owned former GSK facility that's being converted to more up-to-date life science use. There is 1 building in the East Market Street, [Carter,] an older building that they are positioning some of their vacancy to be life science, and that building's in close proximity to Jefferson University health care system. So they had the basis for some demand drivers there.

We look at the competitive set, number one, I think they're all good and high-quality competitors. I think we can deliver is a better location and a very good, high-quality and efficient design. Most of the tenants that we are talking to, Manny, to go to your -- I think, your second question, I think the bias is they would always rather be a new build, and I think that's why we're seeing such a great upsurge in activity on both Schuylkill Yards West and our 3151 project. The challenge on that new build is that it takes 24 to 36 months to actually deliver the space, and a number of these tenants are facing nearer-term requirements that they need to fulfill rather than wait for that.

So one of our objectives, as really was with 3000 Market, was to kind of create some near-term space deliveries that would be attractive to other -- to some of those life science tenants in our pipeline. For better or for worse, we went up leasing that building in its entirety to Spark Therapeutics, who had a real near-term demand, and that's when we pivoted to Cira to take a look at that from an engineering design load, HVAC standpoint, to see what the conversion costs there would be in the lower [bank.] Fortunately, we've built in a lot of design flexibility when we built that building years ago so the costs aren't prohibited by any stretch. So we're able to present 30,000-foot floor plates to some of those tenants and be in a position to deliver that by the second half of 2021, which has a lot of value.

But I think we do view that the life science is one of the real green shoots in the Philadelphia region and not just being driven by the major anchor institutions as it has historically been. There are a number of tenants on our pipeline that are new entrants to the Philadelphia marketplace. I think the first-mover advantage that Philadelphia has generated in cell and gene therapy and the continued massive investment by University of Pennsylvania health care systems, Wistar, Children's Hospital of Philadelphia as well as the -- and augmented by the increase in NIH and venture capital funding, I think, has really created a solid springboard here for locations like Schuylkill Yards to really have the opportunity to create something that's scalable and attractive to these companies in terms of its creating an ecosystem with some durability.

That's great color. In the past, when we've spoken to life science developers, there's been some hesitation to do mixed-use, especially with residential. Have you seen that sentiment change? Are people willing to either live in a life science building? Or are life science tenants willing to be in a building that's partially residential?

Yes. It actually depends on the composition of what that life science company is doing in the building. So if it's a lot of level 1 work, it's not too concerning at all to the life science company. And in the case of like Schuylkill Yards West, Manny, to go to your point specifically, there, the -- there's separate lobbies for all of those uses. So there's a level of privacy and confidentiality that we built into the design of the building to make sure that there's not that concern about a resident walking into a lobby with white coats or by -- or a white coat walking into a building with someone walking their small dogs. So the -- I think you can design some of that segregation into the building, which we've done with Schuylkill Yards.

And there, again, the commercial component is only about 200,000 square feet. And we're only really anticipating about 100,000 of that to be combination of life science/research labs. The balance, we think, will be loft office space. And then certainly, in our dedicated life science building, we're dealing with larger tenancies there that are looking -- and larger floor plates that are looking for a dedicated life science component.

And then last one for me, Jerry. Can you talk about what you're seeing in terms of multifamily lines and demands in the Philly market?

Yes. Actually, they're holding in there very well. There really has not been a lot of downward pressure, particularly at the higher end of the curve. So we've -- we just completed our kind of monthly market survey, and the feedback across both existing stock projects under construction are still very much in line with what our pro forma assumptions are.

I think we're also -- we are planning though, Manny -- there could be a slight slowdown in rental rate growth and maybe a marginal increase in concessions going in. So we have already built that into our Schuylkill Yards West pro forma. But right now, it seems like the fundamental demand drivers seem to be in pretty good shape.

Our next question comes from Michael Lewis from Truist.

So this morning, the Philadelphia Business Journal posted a story about rising vacancy in sublease space in Center City, sharply lower leasing activity. I was wondering your thoughts on -- 1/3 of your portfolio roughly is Philly suburbs. Do you think some of this may be movement from Center City to Philadelphia suburbs? Or do you think where we stand right now, this is just evidence of weak demand -- overall weak demand of where we are right now?

Yes. George and I will tackle this. Look, I think when we've looked at the sublease inventory in Philly, I have to be honest with you, we're pretty pleased with it. I mean the numbers are fairly low. I mean in the city, we're talking about CBD sublease space of -- in class A, about 320,000 square feet, which really hasn't moved all that much, with the largest block being 30,000 square feet. University City, less than 30,000 square feet of sublease space. The Pennsylvania suburbs have stayed around that 500,000 square foot mark, which really, given the size of the inventory base, is fairly small. And in none of those 3 markets have we really seen big uptick since the crisis began.

At one level, I think the world knows the office market's in a bit of a pause. And a pause can simply be a pause without being an Armageddon. I mean if you think about what's going on in the world, so many folks are focused on business or focused on things other than just their office platform right now. They're concerned about dissonance in public policy, mass transportation, the children getting back to school. So that's why I feel pretty optimistic that our leasing team and our regional heads -- I mean, they're -- we're talking to tenants, brokers, political leaders, community leaders on a daily basis to try and get as good a window into what's happening as possible. And I think, frankly, Philadelphia will prove out its resiliency in challenging times as we look out over the next couple of years. Whereas on the upside, we never grow as fast, we tend to be fairly stable when things get slower.

To go to your other question, we really haven't seen, and I'll defer to George, but we haven't seen any real significant movement, Michael, from CBD out to the suburbs or vice versa. But George, what do you think?

Yes. I think most tenants and companies are just evaluating any and all options but have been somewhat slow to pull the trigger on any. So I think the sublet prospect is one where it's -- should we test to see if there's some demand for some of our space and -- but again, we've got kind of the best of both worlds in that we've got the Center City and the suburban locations. And even within our own portfolio, we've yet to really see anybody say, "Hey, can I do something out in the suburbs, even on a short-term basis to maybe allow me to get more people into the office and not have to worry about mass transportation or other concerns they might have about longer commutes because of home schooling, et cetera?"

So look, I think the more visibility we get on the pandemic each and every day, I think you'll start to maybe see some companies start to make some of those decisions. And again, as I said, I think given our inventory locations, we've got an opportunity to kind of capture some of that, whether it's city flight out to the suburbs or vice versa.

Okay. And then my follow-up is kind of a big picture question as well. And maybe Jerry already answered it, but I'm going to ask it anyway because I think investors are less concerned about the next few quarters and the stocks are kind of pricing off of what people think the permanent impacts of this may be. So would you say -- do you think we have any more clarity on office demand, long term, versus a quarter ago or less? Because I hear you on the pipeline activity and the tours are up and we've had some passage of time. But on the other hand, we still have the low physical occupancy. Labor Day came and went. Now we'll see what happens next year.

What do you think about kind of the range of outcomes and the clarity we have into whether the office business is now, whatever, take the trajectory and now it's that trajectory, minus 10% or whatever it is? How do you kind of think about the long term?

Yes. It's a great question. And certainly, it's something we're spending a lot of time as a team and as a Board thinking about. Look, I think we still remain very optimistic. And I'll give you a couple of data points probably since the last quarter. I think the longer this has gone on, I think the more we are hearing consistently across our office base that they can't wait to return to the office. So to go to, Michael, your observation on kind of low level of occupancy, you can never dismiss the fact that public policy at this point is playing a fairly large role in what tenants want to do. That public policy has a couple of different elements to it. One is, like, for example, here in Philadelphia, the city public health guidelines are that if an employee can telework, it's feasible for them to telework, they must telework. So employers don't really have the public policy stamp of approval to be bringing people back into the office, except on a very voluntary and a very essential basis. And we're seeing that certainly with the distance in Texas between the state and the city governments. So that is a bit of a gating issue for people bringing their tenants back into town.

This question of employer liability is a big issue as well as well as the issue of mass trans. I think there are other factors besides people not wanting to come back to the office, enjoying working from home that is preventing these companies from ramping up their occupancies. So that is one point.

I think another point is that certainly, from what we're seeing, and again, it's early in the stage, but we are certainly seeing that while there could be a cyclical decline in office demand, we think the compensating factors there will be the replanning and redensification of space. I think one of the brokerage firms had it at a report. They were thinking, I think, about a 10% decline in office demand on a gross basis, but about 5% of that would be made back up through the redensification of space. We are going through a number of space planning exercises with some of our existing tenants, and topic 1 on their mind is how they create more work space area for each of their employees with greater circulation patterns. Whether that's a durable trend or it goes away when the vaccine comes along, we don't really know. But I think the signs are very encouraging that one of the downward pressures in office over the last decade has been this condensing of work space. I think that trend, which had been slowing anyway, is certainly going to go in the opposite direction for the foreseeable future.

And there's more and more studies coming out for both small and large companies that continued remote work is having a significant adverse impact on productivity. And human nature being what it is, I mean, we're actually seeing now some of our tenants -- when the leadership of the company comes back to the office, the people that work for those leaders typically want to come back as well. So you have that whole social dynamic and team effort taking place.

So we still remain pragmatically optimistic that the office market will return to some level of stability as the pandemic starts to ease. And we also do think -- and we firmly believe this, is that there will be a greater emphasis on higher-quality, well-maintained stock owned by well-capitalized landlords. And I put our public company peers in that category with us. We tend to own the best space in the market. We tend to run it in a very, very professional proactive manner with great tenant outreach programs.

What used to be points about HVAC, et cetera, on Page 15 of an RFP, they're now on Page 1. And I think companies like Brandywine are really resonating quite nicely. Hope that answers your question. I apologize for going a little too long.

Our next question comes from Daniel Ismail from Green Street Advisors.

Just a follow up on your last point, Jerry. For those types of core office buildings, transaction volume has clearly fallen off. But I'm curious, in the conversations you're having, if there's been any noticeable differentiation between your markets and how office values are changing?

Look, we were really pleased to have been able to achieve the venture financing at Commerce Square. We thought that resonated very well from a -- us being in the market of a fairly large value-add transaction in Philadelphia. And I think we got some very good response to it, and I think we executed a very good deal.

I think as we're looking at other types of venture opportunities, whether it's on our development projects or on existing stock, I think while private equity and institutions are really coming back into the real estate market in some sectors much more aggressively, in the office sector, there still is a prevailing house view that most office investments are on hold until we get clarity post pandemic. So just the same question Michael asked and a lot of other folks asked about what's going to happen with the office. Until there's more clarity on that, I think the bidding pool for office assets will be a bit narrower than some of the other asset classes. I think projects that have shorter average weighted term lease renewals or a value-added component will face an even narrower set of investors.

But I think generally, on the office side, I think you've seen a couple of trades take place where there's long-duration, credit-backed lease structures that have been done at very low cap rates, where a lot of those investors are really looking at a credit stability situation compared to bond yields. And I think that will continue to create overall downward pressure or stability in office cap rates and, I think, where you'll see a bit of an increase in overall cost of capital on kind of the more value-add components temporarily. I think once the market has some visibility in terms of where the demand drivers are, that gap could close as well.

Great. And then last one for me. Going back to the leasing pipeline, don't believe you gave details regarding the composition of the pipeline in terms of industry base. And if you've noticed any more less activity from any specific industries outside of life science within that pipeline?

Yes. Again, the pipeline and the core portfolio, but for those couple of floors over at Cira Centre where we're doing the lab convert or life science conversion, everything else would be traditional office use. And yes, the composition of the pipeline really hasn't varied too much from kind of the existing composition of the portfolio. Still seeing law firms, professional services and the like. So I can't say that there's any one rising or declining industry at this point.

And our next question comes from Bill Crow from Raymond James.

I think of all the things you've talked about today, the most surprising to me was the 8% returns of office level in Austin. I don't think about Texas being more open than other markets. And you referred to kind of local policy issues. That's about half the rate of New York City and lower than San Francisco. And is there -- is it a tenant issue? Is it a portfolio issue? Is it a regulatory issue? And does it suggest that maybe there will be a more permanent impact in the Austin market than maybe some other markets?

Yes. I mean Bill, it's a great observation. And thanks for the prompt because I should have mentioned it during our comments. One of the reasons Austin is so low at 8% is that IBM, who is a major tenant of ours down there, is not coming back until after the 1st of the year. So if we excluded IBM and their square footage from that Austin calculation, we're back into the mid-teens. So I think the -- Austin, I think, wound up being one of those cities that had opened up early then had some other -- had some surge issues, reduced or kind of retracted back some of that progress and now is on the way back. So I don't think it's -- when I looked at the numbers with -- after factoring IBM -- and frankly, look, you think about some of our other large tenants like Comcast, like Lincoln Financial, those companies are being much slower to come back than the smaller companies. And our average tenant size is less than 10,000 square feet. The smaller companies are coming back much faster. But when you look at macro level stacks of square footage of occupancy, those big users are big users so they have a big impact.

But now yes, look, there's dissonance in every marketplace on public policy and what public health experts and political leaders and other folks are saying in terms of when it's safe to come back. You're seeing a different level of ramp-up of mass transit agencies that is having an impact on workforce return in these major urban areas. But thanks for raising that point on Austin because the 8% is really -- it does not reflect the composition of our portfolio down there.

And you wouldn't anticipate that IBM would be more inclined to make permanent changes than your typical tenant, it sounds like?

No, not at all. In fact, I think the larger tenants are the ones that are indicating they want to try and get back in even faster. They just, for a variety of issues they're dealing within their own employee base, are being slower to come back.

Thank you. And that does conclude our question-and-answer session for today's conference. I'd now like to turn the call back over to Jerry Sweeney for any closing remarks.

Great. Crystal, thank you, and thank all of you for participating in the call. Again, stay safe, stay well, stay engaged, and we look forward to updating you on our business plan on our year-end call. Thank you very much.

Ladies and gentlemen, this concludes today's conference. Thank you for your participation, and you may now disconnect. Everyone, have a wonderful day.