City Office REIT Inc (CIO) 2014 Q4 法說會逐字稿

Good morning and welcome to the City Office REIT Inc. fourth-quarter and full-year ended 2014 earnings conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions)

As a reminder, this conference call is being recorded. (Operator Instructions) It is now my pleasure to introduce you to Tony Maretic, CFO. Thank you, Mr. Maretic. You may begin.

Good morning. Before we begin, I would like to direct you to our website at cityofficereit.com, where you can download our fourth-quarter earnings press release and a supplemental information package. Certain statements made today that are not in the present tense or that discuss the Company's expectations are forward-looking statements within the meaning of the federal securities laws.

Although the Company believes that these expectations reflected in such forward-looking statements are based upon reasonable assumptions, we can give no assurance these expectations will be achieved. Please see the forward-looking statements disclaimer in our fourth-quarter earnings press release for factors that could cause material differences between forward-looking statements and actual results.

The earnings release and supplemental package both include a reconciliation of non-GAAP measures that will be discussed today to their most directly comparable GAAP financial measures. I will review our financial results after Jamie Farrar, our Chief Executive Officer, discusses some of the quarter's operational highlights. I will now turn the meeting over to Jamie.

Good morning and welcome to City Office REIT's fourth-quarter 2014 earnings call. With me today is Tony Maretic, our Chief Financial Officer; and Greg Tylee, our President and Chief Operating Officer.

I'd like to begin by stating that we are pleased with our fourth-quarter results and the progress that has been made on a number of important fronts. Our management team has been focused on executing specific initiatives that we believe will create significant value. These initiatives include sourcing attractive acquisition opportunities as well as various internal measures designed to unlock value at our existing properties.

Specific examples of these initiatives include extending lease maturities, increasing net operating income by leasing vacant space, and reducing operating costs by investing in our properties. Before I get into specifics concerning our performance during the quarter, I'd like to briefly touch upon what we are seeing in a number of our markets.

Overall, we continued to see strong underlying real estate fundamentals in our target markets and the increasing demand for office space from a variety of users. Boise, a market where we have a significant lease rollover event at the end of 2015, continues to be a strong performer. The downtown Boise submarket absorbed over 200,000 feet in 2014, and vacancy has steadily declined to 7.4% at quarter end.

Dallas, a market we acquired a property during the year, continues to be a leader in national employment growth. It achieved year-over-year job growth of approximately 3.7%. Dallas has now absorbed space for 18 consecutive quarters.

Denver, one of our key markets, has continued to achieve strong performance. Denver's economy is driven by a diverse set of industries, including aerospace; aviation; bioscience; broadcasting and telecommunications; energy; financial services; and information technology. Despite the presence of energy companies, the growth in other sectors has driven Denver's unemployment rate to approximately 4% at quarter end, and its leasing rates have increased for 13 consecutive quarters. Overall, leasing rates achieved a 4.3% year-over-year increase and are at $23.15 on a full-service gross equivalent.

Finally, Orlando is a market where we continue to have significant lease-up opportunity at our downtown Central Fairwinds property. Overall, Orlando's office market continues to lag many of our other markets, but it's slowly recovering. Its fourth-quarter leasing activity resulted in 160,000 square feet of positive net absorption, which pushed 2014 net absorption figures into positive territory.

However, employment growth continues to remain strong, with a year-over-year increase of 4.3%. We continue to see steady traffic at Central Fairwinds, and our in-place and committed occupancy has increased from 63% at the beginning of 2014 to 77% at December 31.

Overall, with the exception of Houston, we continue to believe that our target markets possess great long-term fundamentals for ownership of office properties. Given the recent volatility in the price of oil, we remain cautious concerning exposure to the energy industry, and we've consciously avoided the Houston market. I should also note that our direct exposure to tenants operating in the oil and gas industry is extremely limited. Less than 2% of our portfolio's annual gross rent is derived from oil and gas tenants.

I would now like to turn to City Office REIT's performance during the quarter. As mentioned earlier, we continue to concentrate on growth through property acquisitions as well as on internal initiatives that we believe will unlock value in our portfolio.

First I would like to discuss our acquisition program, which continues to progress well. During the fourth quarter we completed the purchase of the Florida Research Park, a 124,500 square-foot property in Orlando, Florida. We discussed this acquisition on our last call, so I won't go into tremendous detail; but this is a well-located Class A property in Orlando, with market-leading attributes including a 7.1 per 1,000 parking ratio; high-end finishes; and contractual annual rent growth through December 2021.

Moving into 2015, we continue to build our acquisition pipeline. In early February we closed on our most recent purchase, Logan Tower, which is located in downtown Denver. While this is a small acquisition at $10.5 million, we really like the fundamentals of the real estate and Logan Tower's under-market rental rates. The property was extensively renovated recently, and it's well positioned within downtown Denver. It's situated in close proximity to the financial district, the state capitol building, mass transit stations, and quality restaurants and amenities.

Logan Tower's acquisition metrics were attractive. We purchased it for $150 per square foot, representing an 8% capitalization rate on year-one projected net operating income. This is especially favorable since the in-place rents are approximately $18 gross, which is $5.00 per square foot or 22% below current market rental rates. Over time we expect to achieve significantly higher net operating income from this property as its below-market leases roll over. More information can be found concerning each of these acquisitions on our website under the Investor Relations tab.

In terms of our future growth, our current transaction pipeline is over $200 million in a number of our key target markets -- including Austin, Dallas, Denver, Phoenix, San Antonio, and Tampa. These markets continue to lead the country in terms of job and population growth, and we believe they continue to offer an attractive buying dynamic.

Several of these deals are at the higher end of our typical deal size, and the acquisition in-place cap rates are trending in the 7% to 7.75% range. Given the quality of the real estate, strong tenant base, and favorable in-place rental rates, we believe this continues to offer good value and the ability to grow NOI postacquisition. The acquisition stage of each of these deals differs in terms of the status of their sale process as well as the level of work that we have completed to date.

For example, we currently are in best-and-final for a property that is well located in one of the hottest submarkets of our target cities. Another example in our pipeline includes a property that we recently had under contract, and our due diligence investigation was completed. During our review process, we discovered a few significant issues that required additional dialogue with the seller before we could proceed with the transaction. At this time we continue to work with the seller to address these issues and generally are well positioned to move forward, subject to reaching an agreement on valuation.

I would now like to provide an update on various internal value-enhancing opportunities. As I mentioned earlier, two of our top priorities have been leasing vacant space and extending lease maturities. Both of these initiatives are long-term by nature, and results take time to achieve.

Notwithstanding the limited time that we've been public, our initial progress has been promising. During the quarter we completed 42,000 square feet of new and renewal leases, of which an additional 8,000 square feet of new leases will commence subsequent to the end of the fourth quarter. At quarter end, our portfolio was 94.1% occupied, including signed leases that will commence subsequent to quarter end. This compares to 93.1% at September 30.

Excluding the impact of acquisitions that occurred during the fourth quarter, our occupancy increased by approximately 60 basis points over the prior quarter. During the fourth quarter we had a 99% tenant retention rate as we signed 29,000 square feet of expiring and early renewals at an average rent of $23.48. This was a 6% increase from the expiring rents.

In 2015 we will have approximately 320,000 square feet of lease expirations. However, close to 270,000 square feet of these expirations will occur in December. Given the fundamentals in our markets, we are optimistic on our ability to renew our existing leases, continue to push occupancy at our properties, and we are working with tenants to recapture underutilized space that we can lease-up at higher rates.

For example, at our Portland property, we have proactively sought the early extension of Planar's 72,000 square-foot building. Their lease expires on October 31, 2016, and subsequent to quarter end we secured an extension until January 31, 2022.

The terms of this extension included a 20% increase in base rental rates over the expiring rate of $12.45 triple net, with an additional 3% annual increase. The lease inducement allowance is $1.9 million, which is equivalent to $5.39 per year of additional term and will be reflected in our Q1 2015 AFFO calculation. I think this is a strong illustration of our results, which will materially benefit us in 2016 when the new lease terms take effect.

Finally, I would like to touch upon the lease rollover at our Boise property. As I mentioned earlier, AECOM Technology Corporation currently occupies approximately 143,000 square feet, with a December 31, 2015 lease expiration. Securing a long-term lease with a high-quality tenant remains one of management's top priorities. At this time we are unable to provide any specific guidance due to the status of negotiations, which are at an advanced stage but not complete. If we are successful in executing a binding lease, we will press release specific details at that time.

I will now turn the call over to Tony Maretic, our Chief Financial Officer, to discuss our financial results.

For the fourth quarter we reported core FFO of $3.3 million or $0.26 per share. Our core FFO adjusts NAREIT-defined FFO for acquisition fees and expenses, change in the fair value of the earnout, and the amortization of stock-based compensation.

On a sequential basis core FFO was approximately $40,000 higher than Q3. Our results benefited from the impact of the Florida Research Park acquisition in mid-November and having a full quarter of operations for Lake Vista Pointe, which was acquired in July.

Offsetting these increases was lower income at Washington Group Plaza as a result of a $140,000 termination fee -- which we have previously disclosed we received in Q3, with no corresponding amount in Q4 -- along with a higher G&A cost due to year-end processes which were expected in Q4, as well as a higher base management fee as a result of our follow-on offering completed during the quarter.

Our fourth-quarter FFO is $2.9 million or $0.23 per share. I would like to note that as of December 31, 2014, we have modified our definition of AFFO to improve consistency with industry standards for the definition of AFFO. Specifically, we have excluded non-reoccurring capital expenditures. You will find details of our definitions on page 21 of our supplemental information package.

On page 19 we provide details on both our reoccurring and non-reoccurring CapEx. For the fourth quarter 100% of our non-reoccurring CapEx is attributable to first-generation tenant improvements and leasing commissions. Our reoccurring capital expenditures were elevated in the fourth quarter, and this explains the majority of the decline in our sequential AFFO.

Our reoccurring CapEx went up in the fourth quarter, largely due to $244,000 which was spent on the first phase of a chiller replacement project at Central Fairwinds. The full project cost is estimated to be $550,000. When the system is fully operational, we expect the savings in annual operating expenses to be approximately 8% of the full project cost.

From a liquidity standpoint, we had cash of about $34.9 million and an authorized undrawn credit facility of $30 million at December 31. Additionally, we have $11.1 million of restricted cash that is available to fund future TIs, LCs, and capital projects. Our total debt at December 31 was $189.9 million or $182.7 million when deducting the non-controlling interest share of certain debts.

Our net debt to enterprise value was 43%. Our conservative strategy of building a stable portfolio with predictable, growing cash flows extends to our capital structure. All of our debt is fixed rate, with a weighted average interest rate of 4.3% and a weighted average maturity of 6.2 years.

Lastly, we'd like to provide some guidance for 2015. For the nine properties we owned as of December 31, 2014, on a cash net operating income basis we are providing a 2015 outlook range of $27.7 million to $28.3 million. That translates to a GAAP NOI 2015 outlook range of $27.2 million to $27.8 million once you adjust for the expected straight-line rent and amortization of above- and below-market leases. There will be no further free rent funded by predecessor adjustments in 2015, as the last of those adjustments were recorded in Q4.

We are also reiterating our previous estimates for full-year G&A costs of $1.8 million. G&A costs will be slightly higher in Q4 and Q1 of each year due to the additional costs associated with that time period, which includes the cost of the year-end audit and additional regulatory filings. We'll also continue to provide expected full-year cash NOI yield with each acquisition announcement in 2015.

That concludes our prepared remarks, and we are now happy to open the line for any questions. Operator?

(Operator Instructions) Craig Kucera, Wunderlich.

You closed the year with $35 million of cash after the offering. You deployed $10.5 million into Logan Tower, which you didn't finance. Can you talk about how you anticipate investing your remaining $25 million, and the sort of when you think you'll have it fully deployed on a levered basis?

Sure, Craig. So if you look at what we think our buying power is with the leverage that we would typically assume, this is probably $100 million to $110 million of acquisitions. Based on our pipeline and kind of our expectations right now, it would be probably mid-Q2 by the time we would be having some additional closings on things we are working right now.

So we think that is going to take us probably into the beginning of Q3, if we hit our plan. Could be a little sooner, could be a little later, with those acquisitions occurring -- spread out through the second quarter.

Got it. And is that a cumulative number or an incremental number of acquisitions? I didn't see it.

So the $100 million to $110 million is in addition as of today that we expect.

Got it. And it sounds like some of these acquisitions are going to be a bit larger; there is a bit more competition, so they are not going to be in the recent cap rate range of sort of an 8% to 9%, even.

You know, there could be some opportunities that come in, based on what we are seeing right now and the deals we are looking at. A few of them are larger, as you said, which has higher competition, but also newer assets -- Class A. So the cap rates typically are a little bit lower.

We are very sensitive, though, about trying to buy well. And as we said in our conference call, we declined on one particular deal right now due to valuation and some discovery. So we are being very prudent about putting the money out well and buying assets that we know are well positioned that will increase over time.

Got it. And then finally, as you're looking to acquire these assets and getting quotes from lenders, what -- is the current sort of in the 4.25% kind of range for the term that you're looking at? Or has there been any movement upwards you've found much in financing rates?

You know, the rates are still very aggressive, both from traditional lifecos, CMBS. We are seeing on deals potentially getting three to five years of interest-only. And generally we have been quoting in the 5- to 10-year range. But I think your assumptions on current rates in the low 4% is probably accurate. Some deals we might be able to do a bit better than that, but I think that's a pretty good average.

Got it. Thanks. I'll jump back in the queue.

(Operator Instructions) Wilkes Graham, Compass Point.

Craig asked a lot of the questions that I had. But just to reiterate, you've got about $110 million of buying power left. You think you can do the majority of that, if not all of it, in the second quarter. And as Craig suggested, maybe that comes in 25 basis points or so lower than we might have previously thought? Is that fair?

Yes -- again, if you look at kind of the average, we said 7% to 7.75%. I'd be in probably the middle of that range based on what we're seeing today.

And as far as timing, again, until we ultimately move things through the process, it's really hard to predict. I mean, there are some that are at the higher end, closer to an 8%. But I think the blended average that we just discussed is about right.

Okay. And then can you just confirm the number of units that were redeemed with the cash from the last deal? I'm getting around 300,000, but I just wanted to confirm that.

The number of shares redeemed with the overallotment option?

Yes.

Yes. So the total overallotment option, I believe, was 512,000 shares.

Okay.

Just under 15% of the offering.

So all of it was used? All of the overallotment was used?

The entire balance of the overallotment was used to buy out the common units that were previously owned by the Second City group. Correct.

Okay, okay. And then, just as you spoke about recurring CapEx, and as I look at page 19 of the supplemental, is it sort of a fair run rate to use that number, at least on the existing portfolio, if we maybe exclude the chiller cost you referenced?

Yes. That is a fair assumption. That is why we tried to highlight it for you. It was a bit unusual amount, and so by excluding that, it gives you sort of a more accurate run rate. Correct.

Okay. Thank you.

(Operator Instructions) If there are no more questions, I will turn it back to Mr. Farrar to wrap up. But I do see that there is a follow-up question, so I'll connect Craig Kucera of Wunderlich for that follow-up. Please go ahead.

I had one final question on the Logan acquisition this quarter. Obviously you've got a big -- you're looking at $18 in place, $23 market. What are the -- what's sort of the lease expiration schedule on that? Is a lot of that going to roll over in the next year or two? Or is this sort of staggered over a longer period of time?

Actually, Craig, if you open up the presentation that we have on the website under Investor Relations tab, we do have a rollover schedule. It is pretty well scattered and staggered over the next four to five years. So there's no real major near-term roll. It's pretty well staggered.

So you will see it there. So I think it's going to take a few years to really get the benefit of that roll, but it's a good, stable asset.

Got it. Thanks.

Seeing that there are no other questions, I'll turn the call back to Mr. Farrar to wrap up the call.

Great. Thank you for joining. I'd like to conclude by stating that we remain very optimistic about our target markets and our ability to create value through both acquisitions and from the specific initiatives that I mentioned earlier.

We believe that we have a solid pipeline of acquisition opportunities and are positioned to create substantial value in 2015. Thank you for joining today, and we look forward to communicating our progress with you.

The conference has ended. You may disconnect your line at this time.