City Office REIT Inc (CIO) 2015 Q3 法說會逐字稿

Good morning and welcome to the City Office REIT Incorporated third quarter 2015 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).

It is now my pleasure to introduce to you Mr. Tony Maretic, the Company's Chief Financial Officer, Treasurer and Corporate Secretary. Thank you, Mr. Maretic, you may begin.

Good morning. Before we begin, I would like to direct you to our website at CityOfficeREIT.com where you can download our third quarter earnings press release and the supplemental information package. Certain statements made today that discuss the Company's expectations or are not based on historical fact may constitute forward-looking statements within the meaning of the federal securities laws. Although the Company believes that these expectations reflected in such forward-looking statements are based upon reasonable assumptions, we can give no assurance that these expectations will be achieved. Please see the forward-looking statements disclaimer in our third quarter earnings press release and the Company's filings with the SEC for factors that could cause material differences between forward-looking statements and actual results. The Company undertakes no duty to update any forward-looking statements that may be made in the course of this call. The earnings release and the 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.

Thanks, Tony. Before we review the results from the quarter, I would like to briefly discuss what we've accomplished over a relatively short period of time. When we made the decision to go public in April 2014, we had a vision of taking a relatively small base of quality assets and building upon it to create scale, diversification and exposure to a number of incredible markets that many investors were overlooking. We believed this would allow us to acquire well-located properties in markets with exceptional growth characteristics and create a company that would generate rising cash flow per share over the long term.

During the last year and a half, we've made great progress on implementing this plan. We have acquired properties in leading submarkets that are positioned favorably, increased the inherent value of our assets through specific policing initiatives and diversified our holdings across a number of markets and tenants. These results can be highlighted by reviewing a few key statistics. Over this time we purchased $250 million of property and increased our footprint from 1.85 million square feet to 3.3 million square feet today. we have significantly derisked our portfolio and we have completed or extended 680,000 square feet of new or renewal leases with our tenants, predominantly on a long-term basis.

The markets that we've chosen to target have performed very well and we are seeing rising rents in almost all cases. This has put us in the enviable position of having a strong portfolio with a high percentage of credit tenants, built-in annual rental rate step-ups and rising market rents. We expect that these characteristics will position us to continue to grow our net operating income at attractive rates over the long term.

As part of the growth of our company, earlier this week we announced that City Office has entered into definitive agreements to internalize management on February 1, 2016. We believe this will be a very important milestone for the Company. The transaction provides that our entire team will become City Office employees.

We are fortunate to have built such a strong team that possess energy, drive and optimism and this transaction will only enhance our capabilities. Overall we believe that the internalization will result in economies of scale as we grow and it creates a stronger alignment between management, our Board of Directors and shareholders. Furthermore, we have been mindful of mitigating our G&A costs and as part of the internalization we have entered into an administrative services contract that will result in City Office receiving $3.25 million of payments over the next three years. This helps us to maintain a strong team with offices in both Vancouver and Dallas but in an economical manner. You can find more details in our November 2 press release as well as the presentation that's posted on our website under the investor relations section.

Turning to our quarter's results, we are reporting our best quarter yet as a public company. Our per-share operating metrics and occupancy levels are the highest they've been since becoming a public company. As mentioned on our last call, our Q2 numbers had very little benefit from the acquisition that closed late in the quarter. During the third quarter, our results reflect a full quarter for both the Superior Pointe and Crossroads acquisitions. Furthermore, in September we closed upon our two most recent acquisitions, 190 Office Center and Intellicenter, which I'll speak to in a moment. Like the second quarter, we had less than 30 days of results from these two properties this quarter and will receive the full benefit in the fourth quarter. These purchases, in conjunction with strong operating performance across our portfolio, resulted in healthy dividend coverage for both core FFO as well as AFFO. Tony will elaborate further in a few minutes.

In terms of leasing, we have continued to achieve higher occupancy at our properties and we ended the quarter at a healthy 95.4% occupied, including signed leases not commenced. Of note, we have previously mentioned that our AmberGlen property has approximately 65,000 square feet leased to Cascade Microtech, which is currently not being used and we'll be getting back on December 31 of this year. During the quarter, we proactively completed a 10-year lease with Kaiser Foundation Health Plan, a strong credit profile tenant, for approximately half of the space starting on April 1, 2016 after the buildout is complete. The new rent is just over $23 a square foot on a gross basis, which is in line with the expiring rent.

Turning to acquisitions and dispositions, during the third quarter we closed the purchase of both the 190 Office Center acquisition in Dallas as well as the Intellicenter building in Tampa. Like all of our acquisitions, we have posted a summary presentation under the investor relations section of our website. These summary decks provide an overview of the asset as well as the rationale behind why we purchased them.

We discussed the 190 Office Center acquisition on our last call. It's a well-located, two-building property that is in the Richardson/Plano market, one of the most established in Dallas. The property combines a number of the attributes that we look for: a great location, quality tenancy with long-term leases, a discount to replacement costs, a strong in-place yield and below market rents that will enhance our cash flow over the long term. The purchase price is anticipated to generate a full-year cash net operating income yield of approximately 7.5% after adding back amounts that are being funded by the seller. Approximately $4 million in TI, LC and free rent credits were funded to us in cash by the seller and are held in an escrow account related to two lease renewals and extensions which were signed prior to us closing. Approximately $1.2 million of this cash relates to free rent credits, which will be released to us over the first and second quarter of 2016 as if we received rent directly. But from an accounting standpoint, they will not be recognized as revenue next year, creating a bit of an accounting anomaly, but they will be normalized in our AFFO adjustments.

We also acquired the Intellicenter building in Tampa, Florida during the third quarter. This 204,000 square-foot Class A property is 100% leased to a variety of strong tenants. Similar to the 190 Office Center, it possessed many of the same attributes. The property has great tenancy and the average remaining lease term at acquisition was over 10 years, with built-in annual rental rate increases. Intellicenter will benefit from very little capital required, below market rents and a healthy NOI yield that will escalate over time. This will be further amplified as we fixed our interest rate on the purchase debt for the next 10 years.

Our management team has also been proactive to consider disposition opportunities within our portfolio. As mentioned on our last earnings call, we positioned our Corporate Parkway property very well by completing a 10-year lease extension with the Dun & Bradstreet company. The property is desirable given its strong tributes. It's a Class A building in a premier office park with great retail amenities nearby. Corporate Parkway has a globally recognized investment-grade tenant and it's located at the interchange of an interstate highway approximately 90 minutes from New York City and 60 minutes from Philadelphia.

However, as previously mentioned, the location is not one of our target markets and the completion of the 10-year lease extension has encouraged us to consider options. To that end, in order to explore opportunities, we commenced the marketing of the property with CBRE last week. Over the next few months, we will determine our best course of action and should be in a position to provide greater visibility on our thinking in early 2016.

I will now turn the call over to Tony Maretic to discuss our financial results.

On a GAAP basis, our net operating income was $9.1 million this quarter versus $7.5 million in the second quarter. The $1.6 million increase is attributable to the acquisitions in June and September that Jamie mentioned. Superior Pointe and DTC Crossroads were acquired late in Q2 and we saw the full impact of those acquisitions in Q3 and approximately one month of operations from 190 Center and Intellicenter, which were both acquired on September 3. Our same-store sales NOI saw a marginal decrease due to the timing of expenses at these properties, but are still tracking to the updated guidance we provided last quarter.

We reported core FFO of $5.1 million or $0.33 per share. Our core FFO adjusts NAREIT-defined FFO for acquisition fees and expenses, change in the fair value of the earnout, cost of internalization and the amortization of stock-based compensation. Our FFO is tracking our budget and we ended the quarter $1 million higher than Q2 on a sequential basis, as the increase in NOI was offset by the increase in interest expense as a result of the aforementioned acquisitions.

Added back to core FFO are some costs associated with the internalization. You will see this line item described as "external advisor acquisition." These costs are comprised primarily of the legal and other advisor costs incurred to September 30. We expect a similar amount will be expensed in Q4 related to the work completed after September 30 and the purchase price will also be expensed in that same line item in Q1 next year after the closing date of February 1. Our third-quarter AFFO is $4.2 million or $0.26 per share. AFFO similarly benefited from these acquisitions, as we ended the quarter fully invested for the first time since the IPO. Our leasing activity and capital expenditures are clearly laid out on pages 17 and 19 of the supplemental package. Consistent with our definition of AFFO, we have excluded some first-generation leasing costs and the capital costs [put out] at acquisition for some of the most recently completed acquisitions. We have also excluded the costs associated with the major repositioning of Plaza 1 at Washington Group Plaza as we did in the prior quarter. Further details are disclosed on page 19 under non-reoccurring capital expenditures.

From a liquidity standpoint, we had cash of about $10.5 million at September 30 and approximately $25 million remaining undrawn and authorized under our current $75 million credit facility. Additionally, we have $17.4 million of restricted cash that is available to fund future TIs, LCs and capital projects. The restricted cash balance increased over the prior quarter, primarily as a result of the lender escrows set aside to fund future TIs, LCs, CapEx and free rents entered into by the seller for the 190 Office Center in Dallas, which Jamie described earlier.

Our total debt at September 30 was $344.9 million or $337.8 million when deducting the noncontrolling interest share of certain debts. Our net debt to enterprise value was 64% based on our share price at September 30. Any proceeds from the potential sale of Corporate Parkway will be used to first repay the term loan and other indebtedness, including our secured credit facility.

That concludes our prepared remarks and we will open the line for any questions. Operator?

(Operator Instructions). Rob Stevenson, Janney.

Good morning, guys. Beyond the Dun & Bradstreet building, is there any of the other assets at this point where you guys are contemplating marketing and seeing what you can get for it as such?

So we're very pleased with the other assets and the positioning so there's nothing contemplated today in our portfolio, aside from D&B.

Okay. Then, from right now, what are you guys seeing in terms of availability of potential acquisitions that would meet your underwriting criteria normally, if you had capital today? I mean, I guess the question said a different way is, if you had plenty of capital today, how abundant are the acquisition opportunities presented to you in your core markets or is it a situation where pricing has gotten a little bit robust and there's not as much opportunity today as there has been in the past.

Rob, we've still been very focused on building our pipeline. So today, looking in kind of the key markets that were focused on and in the ranges of what we're looking at in stabilized property, long-term leases, below market rents, ability to buy at a discount to replacement cost, there's still a very robust pipeline within the cap rate range. It is tighter than where it was before but we're still in that 7% to 8% cap range generally. The pipeline today is north of $400 million from that standpoint but we're being very cautious about not getting ahead of ourselves so we're keeping a warm pipeline but we certainly don't want to get to the point where we have to raise capital.

Then just lastly, what is the next big lease expiration in the portfolio?

If you move through -- we talked about the Cascade lease, which is at the end of this year at AmberGlen. We discussed that. So the next one really of size would be in Central Fairwinds, the Fairwinds Credit Union, which is in June. Correct me -- Tony, it's about 40,000 feet?

Correct.

So that's one we're focused on. From the grand scheme of our portfolio, it isn't huge. Fairwinds has great space. They've got incredible signage in downtown Orlando. So we are focused on moving that one out long-term but we still have a fair bit of time before that one is going to be addressed.

Okay, guys. Thank you.

Craig Kucera, Wunderlich.

Yes, hi. Good morning, guys. Yes, I appreciate the color on the Corporate Parkway marketing but as you think about pricing, is the expectation that that would still be in the low to mid 6% cap range or do you have a feel for where that might price out?

You know, it's very early in the sale process, Craig. We are not providing specific guidance on cap rates, obviously, as we are in the process of selling it. If you look at our cap rate of our portfolio, this asset would be, we think, at a significantly lower cap rate than our portfolio as a whole. If you look at comparable trades, I think the range you quoted probably is roughly in line. But it's early in our process before we assess where we're going to be.

Got it. No, I appreciate that. The reason I ask is, I mean, with your stock trading in maybe the mid to even high 8% cap rate range in our estimation and you can sell sort of these non-core assets, can you give us any thoughts on insider purchases and maybe why you guys haven't necessarily been stepping up to buy the stock?

Appreciate the question, Craig. So with the internalization discussions, they actually started at the very beginning of this calendar year so we have been in a blackout period, our insiders, since then. So this will actually be the first quarter where that's going to drop off after we release our results.

Got it. Finally, in the past I know you've discussed maybe in addition to this position possibly doing some joint ventures for capital. Is that still on the table or have you made any progress or thoughts in going that direction?

Good question. It's something we've been really focused on but our view, the market's been really choppy since the summer so as far as considering alternatives to raise capital, it has not been an ideal time. We think there are a lot of options that are available to us and now that the markets have settled down somewhat, it's something that we can explore further.

What our focus has been, and I think you'll see it in our results, is really focusing on our portfolio and the results from that are higher per-share operating metrics. We've increased our occupancy. We've gotten the internalization agreements done. So our focus has been trying to create value internally before having discussions where having a low stock price puts us at a disadvantage. There are, for sure, a number of opportunities that could be available if we wanted to choose them: convertible debt, preferred shares, JV equity. We've had a lot of inbound calls but we've been really focused one, internally and two, trying to keep our story pretty simple on the go-forward.

Got it. Thanks. Appreciate the color.

(Operator Instructions). Wilkes Graham, Compass Point.

Hey, good morning. Most of my questions were just asked by the previous two gentlemen. So maybe, Jamie, can you maybe talk about what markets that you are seeing better acquisition opportunities?

So if you kind of zero in on where we see attractive cap rates but really the fundamentals that are positioning to real estate well over the medium and long term, top of the list still Dallas, Tampa, Orlando, Phoenix, Portland. We're looking at a few things there as well. We actually are looking at a couple of transactions in Seattle that still fit, a very tough market to get into but we're finding a few interesting opportunities there. So that's the very top of the list, Wilkes. Again, Houston -- we don't want to cross it off our list, given the uncertainty with energy pricing, but it's certainly not one we're actively considering but remains on the list, because if opportunities in the market start turning, it could be very attractive. It's just not on the foreseeable horizon for us right now.

Okay. I apologize if I missed this but I heard you talking with Craig about the idea of maybe buying stock personally going forward. I'm curious -- even though you're interested in growing the market cap, if the stock price stays out of these levels, how interested are you as a company in buying back stock?

As a company I think we want to really try and preserve our liquidity right now. It's something that we haven't been actively considering. That could change but I would say in the new term, buying back stock hasn't been a priority. It's been trying to grow and build our portfolio and build our shareholder base. Individuals, directors and insiders are free to buy and I think generally the consensus is we see great value right now but we haven't been able to execute for the last nine months.

Well, I'll say congratulations on covering the dividend with AFFO -- I think the stock is not reflecting that currently -- and good luck in the coming months with the internalization. Hopefully the stock gets credit for that.

Appreciate it, Wilkes.

Thanks, Wilkes.

If there are no more questions, I will turn it back to Mr. Farrar to wrap up.

Thank you. We appreciate everybody joining today. Over the quarter we think we've made tremendous progress. We are continuing to take steps that will unlock value and create more value in our company for our shareholders. We look forward to updating you further in the coming quarters.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.