Highwoods Properties Inc (HIW) 2021 Q4 法說會逐字稿

Good morning, and welcome to the Highwoods Properties Earnings Call. (Operator Instructions). As a reminder, this conference is being recorded, Wednesday, February 9, 2022.

It is now my pleasure to turn the conference over to Hannah True. Please go ahead, Ms. True.

Thank you, operator, and good morning, everyone. My name is Hannah True, and I work with Brendan on the Finance and Investor Relations team here at Highwoods.

Participating on the call this morning are Ted Klinck, our Chief Executive Officer; Brian Leary, our Chief Operating Officer; and Brendan Maiorana, our Chief Financial Officer.

For your convenience, today's prepared remarks have been posted on the web. If you have not received yesterday's earnings release or supplemental, they're both available on the Investors section of our website at highwoods.com.

On today's call, our review will include non-GAAP measures, such as FFO, NOI and EBITDAre. The release and supplemental include a reconciliation of these non-GAAP measures to the most directly comparable GAAP financial measures.

Forward-looking statements made during today's call are subject to risks and uncertainties, including the ongoing adverse effect of the COVID-19 pandemic on our financial condition and operating results. These risks and uncertainties are discussed at length in our press releases as well as our SEC filings. As you know, actual events and results can differ materially from these forward-looking statements, and the company does not undertake a duty to update any forward-looking statements.

With that, I'll now turn the call over to Ted.

Thanks, Hannah, and good morning, everyone. I'd like to start off by welcoming Hannah to our call today. It's great to have you with us.

Our fourth quarter was representative of our execution throughout all of 2021, as we delivered strong financial results, solid leasing metrics and strengthening cash flows, all while improving the quality, the resiliency of our portfolio, protecting our fortress balance sheet and laying the groundwork for additional long-term growth. Our simple and straightforward investment strategy is to generate attractive and sustainable returns over the long term by developing, acquiring and owning a portfolio of high-quality, differentiated office buildings in the Best Business Districts, which we call BBDs.

A core component of this strategy is to continuously strengthen the financial and operational performance, resiliency and long-term growth prospects of our portfolio, and recycle out of properties that no longer meet our criteria. To this end, 2021, we acquired $800 million of high-quality office buildings in Raleigh and Charlotte, completed $350 million of 92% leased office development, acquired approximately $100 million of land for future development in 3 BBDs and sold $385 million of noncore properties. In addition, since our last call, we've announced $174 million of development that is a combined 36% preleased, even before putting the first shovel in the ground.

Since the beginning of 2019, we have acquired 3.1 million square feet of best-in-class office assets for a total investment of $1.3 billion, delivered 1.4 million square feet of highly leased office development for a total investment of nearly $600 million and sold 6.7 million square feet of noncore properties for $1 billion.

Because of these continuous and meaningful improvements, our portfolio is even more resilient and better poised for long-term growth. Plus, our cash flows have continued to strengthen, as evidenced by 15% higher average in-place office rents and a meaningful reduction in our CapEx spend over these 3 years. During the same period, we've grown core FFO 9% and our dividend 8% while maintaining a strong balance sheet and investing in the building blocks for additional long-term growth.

Turning to our results. We delivered FFO of $1.06 per share in the fourth quarter, which includes $0.09 of land sale gains. Even when we exclude these land sale gains, our full year FFO was $3.77 per share, $0.01 above the high end of our revised outlook in October and $0.19 above the midpoint of our original outlook last February. In addition to FFO, our operations were also healthy. Same property cash NOI growth was solid at plus 3.2% for the quarter and plus 5.5% for the year. We leased 884,000 square feet of second gen space, including 284,000 square feet of new leases and 47,000 square feet of net expansions.

Rent spreads were a positive 3.2% on a cash basis and plus 11.6% on a GAAP basis. We also signed 158,000 square feet of first gen leases since our last call. Solid leasing activity helped drive year-end occupancy up to 91.2%. Similar to last quarter, utilization across our portfolio hovers around 40%. We anticipate more customers returning to the office later in the first quarter and during the spring months.

Utilization tends to be higher in our suburban buildings and among smaller customers. Despite overall utilization continuing to be significantly below pre-pandemic levels, we are encouraged by the strong customer and prospect interest we're seeing across our portfolio, which translated into healthy leasing in the fourth quarter.

Turning to investments. In the quarter, we sold 1 million square feet of noncore assets for $191 million that were a combined 77.5% occupied. These sales helped bring our debt-to-EBITDA ratio down to 5.4x. We have sold over $350 million of noncore properties since the middle of last year with another $150 million to $200 million to go to return our balance sheet to pre-PAC acquisition metrics.

On the acquisition front, competition for high-quality properties in our markets' BBDs has continued to increase since the beginning of the pandemic. Institutional investors, both foreign and domestic, recognize the excellent long-term value of assets located in the best submarkets across our footprint. We will continue to be disciplined with our capital allocation as we seek to acquire office assets that would further strengthen our performance, resiliency and long-term growth prospects.

Our $283 million development pipeline is 51% pre-leased. Leasing was healthy for our completed but not yet stabilized developments. As you may remember, we started both Virginia Springs II and Midtown West fully spec in 2019. At our Virginia Springs II project in Nashville's Brentwood BBD, we're now 90% leased and have healthy interest in the balance of the space. At Midtown West in Tampa, our 150,000 square foot, $71 million property is 65% leased and we have solid interest from additional prospects.

During the quarter, we announced the 218,000 square foot, $95 million, GlenLake III office and amenity retail project in Raleigh that is currently 15% pre-leased. We have just broken ground on this property, which will be LEED and Fitwel certified. We have 732,000 square feet of in-service product in GlenLake that are a combined 97% occupied. GlenLake III, which is scheduled to be completed in late 2023 and stabilized in early 2026, will provide growth opportunities for existing customers and new users.

After year-end, we announced the 135,000 square foot 2827 Peachtree office development in a 50-50 joint venture with Brand Properties. This $79 million boutique office development has a healthy mix of on-site and nearby amenities, which have helped drive strong activity. The development is already 62% pre-leased and talks with prospects continue.

Our land bank has never been more attractive. It can support $2.3 billion of future office and another almost $2 billion of adjacent mixed-use development via new apartments, shops, restaurants and hotels.

Now to our 2022 FFO outlook of $3.76 to $3.92 per share. We assume utilization of our portfolio will gradually increase throughout the rest of the year. At the midpoint of our per-share outlook, we project same-property operating expenses will be $0.10 higher than last year, while parking revenues will improve by only $0.01. As we have long foreshadowed, as usage increases, OpEx will recover faster than parking revenues, and this is incorporated in our 0% to 2% same-property cash NOI growth outlook for 2022.

As previously stated, we plan to sell $100 to -- $150 million to $200 million of noncore assets to return our balance sheet metrics to pre-PAC acquisition levels. We currently project the dilutive impact of these dispositions to be $0.04 to $0.08 per share. In addition, our outlook includes up to an additional $200 million of potential dispositions, the effect of which is not assumed in our 2022 FFO outlook. We have included a placeholder for acquisitions of $0 to $200 million.

We also continue to have conversations with build-to-suit and anchor customers for additional developments and project $100 million to $250 million of development announcements, inclusive of the $79 million 2827 Peachtree development.

Before I turn the call over to Brian, I would like to briefly recap 2021. During the year, we generated 5% growth in core FFO; increased our dividend 4%; delivered 5.5% same-property cash NOI growth; signed 194 new second gen leases, the most in any single year since 2006, totaling 1.1 million square feet; acquired $800 million of high-quality office assets in Raleigh and Charlotte; completed $356 million of 92% leased office development; acquired $100 million of development land; and maintained a strong balance sheet with year-end leverage of 39% and a debt-to-EBITDA ratio of 5.4x.

While we're pleased with our 2021 results, we're even more confident that we continue to have the building blocks in place to drive sustainable growth over the long term.

In conclusion, while our high-quality BBDs and buildings are the beneficiaries of a flight to quality, it is our humble, hard-working, talented teammates leasing, operating and maintaining our portfolio as a single team wearing the same Highwoods Jersey that are our true trophy assets.

I would like to take time to thank the entire Highwoods' team for their continued hard work and commitment throughout 2021. This type of dedication has put our company in a great position for years to come.

Brian?

Thank you, Ted, and good morning, everyone. The positive metrics we've posted for the quarter and throughout the global pandemic are a testament to the simple strategy we execute every day. This strategy has positioned Highwoods to be the beneficiary of a great migration to our markets, a great acceleration to our BBDs and a flight to quality buildings, all of which are both urban and suburban in nature. Most customers have plans to return to the office, are expanding more than they are contracting and now see the workplace as a vital part of their ability to retain and recruit but specifically return talent to their organization.

Companies that create value through collaboration and culture have come to a clear conclusion that they are simply better together. We believe a workplace that attracts people and allows them to achieve together what they cannot apart will be full and command attractive economics. We're seeing this now throughout our portfolio and is evidenced in the results our team is producing.

Occupancy increased 80 basis points from last quarter, ending the year at 91.2%. We expect occupancy to dip modestly in the first half of the year before increasing in the latter half. Our utilization currently remains below pre-pandemic levels. We project it will increase steadily throughout the year. We continue to see healthy tour and RFP activity, which is evident in the 884,000 square feet and 123 deals signed in the quarter, the highest quarterly deal count since 2016. Of these 123 deals, 54 were new, totaling 284,000 square feet. Emblematic of our balanced portfolio, no one market disproportionally carried the load, as 5 of our markets garnered 8 or more new deals. In addition, we signed 158,000 square feet of first-generation leases in the quarter for our developments in Nashville, Tampa, Raleigh and Atlanta.

Our markets are benefiting from what some have termed the great migration. It has accelerated since the onset of the pandemic, is generating economic prosperity and has started a flywheel of corporate expansions and relocations. These moves will have generational impacts as these talented individuals and organizations plant roots in our markets. As a result of this momentum, we continue to see strong fundamentals throughout our footprint. Atlanta, Raleigh, Nashville and Charlotte all posted positive net absorption for the quarter. Unemployment rates are returning to near-record lows and multiple markets have grown their office-using jobs since the start of the pandemic.

Raleigh has been a clear winner coming out of the pandemic, where tens of thousands of tech and life science jobs have been announced and where we signed 220,000 square feet of leases for the quarter, ending the year 92.8% occupied. Witnessing this demand firsthand and recognizing we had little room for growth at our 732,000 square foot and 97% occupied GlenLake mixed-use development, we started construction in November on a new 218,000 square foot office building and a curated collection of shops and restaurants. This will complete GlenLake's live-work-play master plan and serve as the latest product of our workplace making efforts. This $94.6 million investment is 15% preleased, will achieve LEED and Fitwel certifications upon completion and will be home to McKim & Creed, a national engineering and surveying firm.

While our friends in Tampa may have sent the title town banner up Interstate 75 to Hot-lanta, where the Braves and Dawgs delivered a double dose of euphoria. Tampa has won Zillow’s #1 spot as the nation's top housing market for 2022, where the market's office rents increased 7% and our team signed 219,000 square feet of leases for the quarter. Our Midtown West development, above an REI and adjacent to a new Whole Foods, is now 64.5% leased and is busy with tours and inbound interest.

Speaking of Atlanta, the unemployment rate has dropped there below 2.5%, Cushman Wakefield has noted rents are at an all-time high and our team signed a 136,000 square feet of second generation leases in the quarter. Further, our $79 million 50-50 joint venture with Atlanta-based Brand Properties to develop 2827 Peachtree in Buckhead is 62% leased to multiple customers. This project will be completed in the third quarter of 2023 and is projected to stabilize in the first quarter of 2025.

Wrapping up in Nashville, where we ended the year 94.8% occupied, we made great progress on our Virginia Springs II development, which is now 90% leased, up from 59% last quarter. The most significant addition to our land inventory in 2021 was the acquisition of the remaining 77 acres of Ovation, in total, a 145-acre mixed-use development, already home to the Highwoods-developed Mars PetCare North American headquarters and which is currently entitled for an additional 1.2 million square feet of office, 480,000 square feet of shops and restaurants, 950 residential units and 450 hotel rooms. The opportunity inherent in Ovation is a perfect example of our workplace making efforts. Where appropriate, we'll utilize our mixed-use land bank to induce those vertical uses complementary to creating the best possible addresses to conduct business.

In conclusion, thank you to the amazing women and men of Highwoods Properties, who have put their customers first and allowed us to achieve great things together.

Now I'll hand it off to Brendan.

Thanks, Brian. In the fourth quarter, we delivered net income of $124.9 million, or $1.19 a share, and FFO of $113.5 million, or $1.06 a share. As Ted mentioned, the only significant unusual item in the fourth quarter were land sale gains of $0.09. Excluding the fourth quarter land sale gains, our 2021 FFO per share was $3.77, $0.01 above the high end of our revised outlook of $3.73 to $3.76. The better-than-expected FFO in the fourth quarter, which was primarily driven by higher occupancy and lower operating expenses, was consistent with the rest of the year, as our FFO of $3.77 a share was $0.19 higher than the original midpoint of the outlook we provided last February.

The upside for the full year was driven by $0.08 from operations due to lower anticipated OpEx, recovering parking revenues and higher occupancy; $0.05 from higher-than-anticipated NOI from development, the majority of which was from the early delivery of Asurion's headquarters, and; $0.06 from the net impact of the PAC acquisition partially offset by the acceleration of $353 million of noncore dispositions.

Our balance sheet is in excellent shape. We ended the year with debt-to-EBITDAre of 5.4x, down from 5.6x at the end of the third quarter. Last April when we announced the acquisition from PAC, we stated our plan was to return our balance sheet to pre-acquisition metrics by midyear 2022. We're on pace to meet this target with a plan to sell another $150 million to $200 million of noncore properties in the first half of this year.

We sold $353 million of noncore properties since the announcement of the PAC acquisition. These sales had an average in-place occupancy of 80% and had a projected cap rate of less than 6% on a GAAP basis and in the low 5s on a cash basis. The remaining $150 million to $200 million of dispositions are likely to have higher average cap rates, most likely in the low 7s on a GAAP and cash basis.

During the fourth quarter, we issued a modest amount of shares on our ATM program at an average price of $46.75 a share for net proceeds of $7.2 million, consistent with our ATM activity in the second and third quarters. ATM issuances remain one of the tools we believe are an efficient and measured way to fund incremental investments, particularly our development pipeline, on a leverage-neutral basis.

As Ted mentioned, our FFO (sic) [FFO outlook] for 2022 is $3.76 to $3.92 a share. As disclosed in last night's release, this includes $0.04 to $0.08 of dilution from planned dispositions and the anticipated headwind of $0.08 to $0.12 of higher OpEx net of anticipated recoveries. The higher projected OpEx has also reduced our outlook for same property cash NOI growth by 200 to 300 basis points. Excluding this impact, we would be in line with our long-term average.

Some of the major drivers of the year-to-year changes in our FFO growth outlook at the midpoint of the range are $0.10 of lower FFO due to higher OpEx, net of recoveries; $0.10 of higher revenue on the in-service portfolio; $0.06 of lower FFO due to first half 2022 planned dispositions; $0.04 of higher FFO due to the net impact of a full year of the PAC acquisition partially offset by a full year impact from 2021 dispositions; and $0.09 of higher FFO due to the full year impact of the $285 million Asurion build to suit.

These items add up to $0.07 per share of year-over-year growth, which equates to the midpoint of our 2022 FFO outlook.

I'd like to take a moment to recap the financial impact from the PAC acquisition and accelerated noncore dispositions. We stated we expected our plan to be approximately FFO neutral upon completion with growth over the long run. We now expect it will be modestly accretive to our pre-announcement FFO run rate. Our 2021 FFO benefited by a net $0.06 from the $683 million PAC acquisition and $353 million of dispositions, and we project this investment activity will add an additional $0.04 to our 2022 FFO for a total of $0.10 of accretion. Offsetting this will be the estimated $0.06 dilutive impact at the midpoint from our planned $150 million to $200 million of dispositions in 2022. All-in, on an annualized basis, we now expect the PAC acquisition and the corresponding noncore dispositions to be about $0.02 to $0.03 accretive to our pre-announcement FFO run rate with no change to the aforementioned improvement in our long-term growth rate.

Finally, as Ted mentioned, over the past 3 years, we have been very active on the capital recycling front, having sold $1 billion of noncore properties, acquiring $1.3 billion of high-quality, resilient properties with healthy long-term growth prospects, delivering $600 million of highly leased office developments and adding over $100 million of development land. Over the same time frame, we've increased average in-place office rents 15%, averaged 3.5% same property cash NOI growth, increased FFO 9% and our dividend 8%, all while maintaining a fortress balance sheet. Plus, as we have long highlighted, our cash flows continue to strengthen, increasing more than 30% over the last 3 years, resulting in higher dividend coverage on our growing distributions.

Our growth may not always be linear quarter-to-quarter or year-to-year, but regardless of the short-term impact, we will follow our investment strategy as we believe it will continue to improve the quality, resiliency and growth outlook of our portfolio over the long run.

Operator, we are now ready for questions.

(Operator Instructions). That first question comes from Blaine Heck of Wells Fargo.

Brendan, can you talk a little bit about the operating expense guidance and what's driving that increase this year and maybe also remind us of the proportion of leases outstanding that are in a net lease structure versus some variation of gross leases in which you're not getting fully reimbursed for those expenses?

Thanks for the question. So just first, the easy answer on the triple net versus full service. So we've got about 25% of the portfolio that has triple-net leases. The remainder is full-service gross leases. And the full-service gross is where there is movement in terms of operating expenses. So I'm going to try to be as concise on this sort of complicated and complex answer as I can.

So first, what we expect in terms of operating expenses is really to be in a pretty, let's call it, "normalized" OpEx environment for most of 2022, I think OpEx will probably be a little bit lower in the first quarter than normal, and then we'll be back to normal in the second, third and fourth quarters, with the thought being we expect the vast majority of customers to be back in their space by the second quarter. And while that may not be their full teams, it's difficult to heat and cool half a suite. So we think we'll be incurring a full load of OpEx for the vast majority of the portfolio over the majority of the year.

And operating expenses were low in 2020 and 2021, as utilization was low across the portfolio, and that benefited us. And so for a number of our leases, our operating expenses that were incurred were below the base year expense stop. And so that accrued to our benefit. As expenses return back to normal and increase, we don't receive recoveries until we get back to that base year expense stop. And so as expenses increase in '22, we think the vast majority of our leases will be at or above those expense stops, but we won't receive the recoveries until we get to those levels.

So we think that it will be an impact in terms of '22 because expenses will increase, and we won't receive recovery on all of those leases where we're below the base stop in '21. But as we get beyond '22, we don't think this is likely to be a major issue going forward. So I think if expenses continue to increase in '23, we ought to be protected there. And so it does hamper FFO growth for this year as we disclosed in last night's outlook by $0.08 to $0.12 and does, as I think I mentioned in the prepared remarks, impact same property growth as well by probably around 200 to 300 basis points to our projection for this year.

But I would say, outside of that, all the other major trends, I think, feel normal to us. And from a revenue standpoint, I think this year is pretty normal in terms of same property. So we do have a little bit of average occupancy growth that we expect in same property. So outside of absorbing higher OpEx in '22, I think our same property growth would be right in line with that long-term average of, call it, between 3% and 3.5%.

Okay. That's very helpful. And just to be clear, I guess, we're talking about you should be able to kind of phase out this added OpEx burden. As leases expire, this shouldn't be kind of a multiyear headwind for you all. It should kind of normalize next year as you explained. Is that correct?

Yes, that's right. I would say, as leases expire, so what I would pay attention to, to just determine whether or not there's any issue with respect to OpEx increases over time is probably looking at rent spreads. So when we calculate and provide rent spreads, which I think were, what, plus 3.2% this quarter, what we do is we take the operating expenses and if we're getting $2 of recovery, let's call it, in a lease, we add that to the expiring rent. So if the expiring rent on the base rent is $35 and we're getting $2 of recovery, we would say that the expiring rent is $37 and then we would compare the new rent to that.

So if we were absorbing anything in terms of higher OpEx, you would see that show up in the rent spreads. And as you can see, our rent spreads have held up reasonably well. So it hasn't been an issue thus far to the extent going forward. I think I would pay attention to those rent spreads to make sure that they're holding up in line with historical norms.

Got it. That's very helpful. Second question for you and then I'll turn it back over. Can you give us any color on your expectations for AFFO or FAD during the year in 2022? Is there any reason we should expect growth in AFFO or FAD to be materially different from FFO growth that you're expecting?

So I mean, cash flow is always more volatile than FFO. So I would say that, I mean, there always tends to be a little bit more variability from year to year. But in general, sort of the major movers between what's going to move cash flow versus what's going to move FFO are probably 2 main line items. So there's the level of noncash rent, and we disclosed that amount, and that ought to be relatively consistent, I think, between '21 and '22. And then there's the amount of CapEx, both leasing and building CapEx.

In '21, we probably had leasing CapEx that was a little bit lower than what it otherwise would be. And some of that, there tends to be a lag. So I think we reported $79 million of leasing CapEx that we spent during '21. And we committed $91 million of CapEx during the year. I would say, the amount of commitments in terms of that leasing CapEx is probably a better gauge of what we are likely to spend on a go-forward basis. So that means that maybe there's a little bit more leasing CapEx that we would incur, I'd say, on a normalized basis, but it is hard to tell kind of year-to-year.

But regardless of that, as Ted mentioned, our cash flow is up over 30% over the past few years. So even with a $10 million or $12 million increase in leasing CapEx, it still means that cash flow would be very healthy. And I think because of that strong cash flow, that was part of the reason why we increased the dividend a couple of quarters ago by over 4%.

The next question comes from Jamie Feldman, Bank of America.

Just a quick follow-up on the last question. So you talked about the $91 million committed in '21. I mean do you think there's a catch-up also that you'll have to spend in '22 that would take it above the $91 million?

Yes, it's a good question, Jamie. It is hard to -- I mean that's hard to -- I would say that, that's -- it's hard to predict. I don't -- I wouldn't say that it's particularly likely. It certainly could happen. I mean there's always a little bit of a backlog of leases that are committed to and then the spend comes later. I think we feel like the backlog is pretty stable. So I think from this point, if we continue to commit leasing capital that is in that range of, call it, $20 million or so a quarter, then I think that number will be pretty stable. But it is hard to kind of predict on a quarter-to-quarter or year-to-year basis, but I wouldn't think there's any major drivers that are going to cause it to be substantially higher than the commitment levels.

Okay. And then I know you gave core guidance, but then you also talked about potential dispositions, potential acquisitions. If you hit those ranges, how should we think about what that could do to the earnings? And then I know you had -- during the call, you guys talked about how your guidance has gone up from kind of initial guidance over the years. What are the upside and downside drivers to guidance here?

Yes, I'll take that and then maybe Ted or Brian will add in. So I think in terms of the acquisition, so we put the range in there for the $150 million to $200 million of the first half '22 dispositions that we project. And then the remaining acquisitions or dispositions we didn't put that effect into guidance. We put the $0.04 to $0.08 range in for the first half disposition. So if we were at $200 million of dispositions and they happened earlier in the first half of the year, then obviously, that's going to be -- probably be closer to the $0.08 of dilution. If we are at $150 million of those dispositions and they're, call it, towards the latter part of the second quarter, we'll probably be more in the 4% range.

On the remainder, I think that's just hard to tell, right? I mean that's just -- it depends on the cap rates that we sell. It depends on what we would buy. It depends on timing, all that kind of stuff. So I don't know, Ted, you might want to provide color in terms of what we're looking at.

Look, as Brendan mentioned, we left a placeholder of 0 to $200 million, both on additional dispositions on top of the remaining $150 million to $200 million and then 0 to $200 million on acquisitions as well. So it's just a matter of what hits, really. I mean we're looking at the acquisitions that are in the market. We're underwriting several things right now, but who knows if we're going to be successful or not. So I would think if we get -- if we're successful on an acquisition, we'll match that with a disposition or whatever. So the timing and if we're successful, it's just hard to tell at this point.

Okay. And then Brian had mentioned a pretty competitive acquisition market. Can you maybe talk about asset values in your markets and cap rates and maybe some movement to just kind of how they've moved just to give us a better sense of what the investment market looks like?

Sure. Anything high-quality asset with long-weighted average lease term, high credit and, certainly, the new buildings, the cap rates are pretty below pandemic levels with sub -- in that 5% range. We've had several trades in our markets in the 4s as well for some single tenant buildings. So incredibly competitive, both from domestic capital sources and international capital as well in our markets. So anything of high quality is going to be chased very hard.

On the value-add side, I think the pool is not quite as deep, but it's still there. It's still deep enough to make a market. And I think we've seen that on our own dispositions as well as value-add transactions that we're chasing in the market. I do think buyers are becoming more comfortable with the underlying fundamentals in the market. So they're able to underwrite vacancy, maybe a little bit more aggressive. So it's just competitive all the way around out there right now, Jamie.

Okay. And then last for me. Can you just talk about your thoughts on retention? I know you said that occupancy is going to be dipping early in the year and then recover. How are you thinking about the expiration schedule and the retention ratio?

Sure. I can start and either Brian or Brendan can jump in. I think from our expiration schedule, I do think our retention might be a little bit lower this year than historically. But the nice thing is we don't have a lot of large expirations this year. I think I've talked about on prior calls, really nothing above 100,000 square feet expiring this year. Our largest is 62,000 feet in December, then we've got 50,000 square feet in May. Both are known vacates, but we've got a strong prospect to backfill both of those with not a lot of downtime. Then after that, it's a 44,000 square foot expiration in Pittsburgh that we know the vacate. But we don't have any strong prospects at this point. So in general, just lower expiration schedule. I think our retention ratio is a little bit lower but not way off historical levels.

Yes. And Jamie, the only thing I would just add to that is, I mean, normally, we typically have a seasonal dip with respect to occupancy in the first quarter just because we have a lot of leases that expire at the end of the year and invariably, some of those are not going to renew. So we have a normal seasonal dip of typically 40 to 50 basis points in the first quarter or first half of the year and then tend to build back up in the back half of the year.

That is going -- our 2022 plan is consistent with that seasonal pattern or normal pattern. And we do expect occupancy by the end of '22 to be a little bit higher than where we ended '21. So we think all those trends are positive for us in terms of what's happening from a leasing perspective throughout the portfolio.

Jamie, Brian here. Just to follow on to both what Ted and Brendan just said. We're highly focused and arguably aggressive on retention looking into the future. So you may have noticed in the past quarters, term was a little shorter. We're actually talking to a number of customers that are renewing years in advance. Now it's only maybe a 3-year extension. So we're getting them -- picking up from '23, '24 and they're pushing out 3 or 4 years. And so that is pulling down that term, but we're being direct with them. A lot of them are excited about coming back into the space and want to reposition their space, want to upgrade their space as they bring people back. And they're seeing the space as an opportunity to recruit folks and return them. So that's also another kind of nuance that's coming out of some of our focus on renewals.

That's a good point. So did that show up in your 4Q leasing volume? I guess have you...

It does, primarily on that shorter term that you're seeing is being driven partly by that. It's not -- it was about 20% or so of that kind of approach, but it's something we're going to continue to do. We found some good success with it, and we're going to continue to maintain those conversations with our customers going forward. We're not going to apologize for kind of extending someone out years ahead and keeping them in the space. It's kind of a bad joke among the leasing team. When I have the leasing calls, I say to them, I feel much more confident about renewing someone who's in the portfolio than who's not. So we're taking that approach.

Okay. And then the Pittsburgh move out, when does that hit?

That is in September this year.

The next question comes from Rob Stevenson of Janney.

Can you talk to where parking revenues were in fourth quarter '21 versus '19? And then also how much additional expenses are there as that ramps back up? In other words, for each $1 million of incremental parking revenues that come in the door, how much incremental expenses do you have associated with that?

Rob, it's Brendan. So yes, I would say parking revenues were kind of running probably about $1 million a quarter below where we thought we would be at the onset of the pandemic on a same property basis. So it's certainly gotten better. We've improved from the depths of 2020 but not all the way back there. So there's probably another $4 million or so to go. And I think the vast majority of that revenue line is going to fall to the NOI line. So there's not a lot of incremental costs associated with additional revenue.

Okay. So you're basically down about $0.04 a share given your shares outstanding in rough numbers in terms of parking revenue still on an annual basis?

Yes. That's right.

Okay. And then how significant is the amount of your space that existing tenants are currently look to sublease at this point?

I got my finger stuck on the mute button. A couple of things. Just from a broad perspective, sublet space is down across our markets. There is one single user in Tampa, kind of a university -- medical university that has gone remote in the near term. And so that has kind of made the biggest move on our numbers, but it's still trending down. So I would say we're down probably across our total market about 4%. And then within Highwoods, it's just slightly ticked up.

So in terms of percent, Brendan, what is your kind of -- your number on that one? It's still a very small amount within the portfolio and holding steady. And we're seeing good movements. You see in Atlanta going down. You're seeing most of them across the board. Again, Tampa was the one spot where we had it.

Okay. So you wouldn't say that it's an overhang on your leasing existing vacancy at this point, of being competitive with tenants trying to sublease space at a lower -- possibly a lower rate than what you're offering space?

No, we're not.

Yes, Rob, I mean, it's in the -- I mean we're, call it, probably 5%, maybe a little bit less in terms of just kind of overall space that would be available for sublet. So it's a very small portion of the portfolio.

And Rob, just to jump in. A lot of the sublease space has pretty short term on it. So it's just not necessarily competitive with a lot of our vacant space. It's just hard for owners once you get below 2 years to sublease their space. So we do have some that have some longer term on it that would be competitive, and we've lost a couple of deals over the last couple of years, probably less than a handful. But most of the sublease space just isn't competitive to our vacant space.

And the last thing on that is, typically, you might have to write a check as kind of the lessor for sublease deal. And so a lot of the folks who were putting space on the market don't want to necessarily write a check to move someone in there either. So that's kind of one of the things we're seeing in the sublet market.

Okay. And then how much of the $150 million to $200 million of first half dispositions do you guys already either have under contract or letter of intent at this point? I mean what's the likelihood that, that is sort of more first quarter weighted than second quarter weighted in terms of the $0.04 to $0.08 of dilution?

Yes. So we don't have any of it under contract yet. We do have some out in the market, and we're talking with potential buyers on some of it. But none of it is under contract. But we do feel comfortable we're going to hit that $150 million to $200 million by mid-year. And we'll have probably just about everything out in the market in the next few weeks of what we plan to sell. So still feel comfortable we'll get it, but likely going to be towards the back half of the second quarter.

Yes. And just remember, Rob, I mean, we thought -- what we said for 2021 was $250 million to $300 million of dispositions that we expected there. We ended up doing $353 million. So we were at the midpoint $75 million, $80 million ahead of our '21 plan. So the 2022 plan was probably to have a fair portion of that $75 million to $80 million kind of occur in the middle to early part of the first quarter. We accelerated that into '21. And so the '22 stuff is naturally just going to hit a little bit later in the first half of the year.

Okay. And then one quick one. Are there any incremental marked retirement costs in 2022? Or was that all taken in 2021?

No. 0.

The next question is from Emmanuel Korchman of Citi.

Brian, maybe just a follow-up to your earlier comment. Just if we think about the differentiation of quality and the different demand from tenants for that difference in quality, how does that get defined in your markets? Is it location? Is it age of asset? Is it amenity? I assume you'll say all of that. So help us figure out like as we think about quality. How your tenants think about it?

And second to that, what happens to the not prime product in these markets? Is it just more capital is pumped in to make a prime product? Or is the conversion of use the more likely path?

Great question, and thanks for asking. First, I think that from a quality standpoint, right now, it's convenience and amenity, right? And so I do believe what we've heard in talking to customers is that they do -- they want to get back in the office. Now they're all coming back at different times. And depending on how big they are, multicity or multinational, they're a little more conservative because when they move, there's a ripple effect across there, but the small or medium size are back in. Those that believe in space, they all see it as a competitive advantage to bringing the talent in. So as I mentioned on -- in my remarks, we absolutely believe it's both urban and suburban.

And so you are seeing our suburban offices. As Ted noted, they're fuller than the high-rises in central business districts just because they're so much more convenient. They have access to fresh light and park space and things like that. So it is a little bit of all of the above, I hate to say that. Obviously, the buildings tell a story of health and wellness, LEED certification, Fitwel, is what we're doing on the new development. Food and beverage is a big driver. Making sure that's convenient and access to the outdoors is something that we're also focused on.

The last thing I'll add to the quality component is having a bit of flexibility built into either a building or a park or kind of adjacent from a portfolio standpoint. And so we've talked about our spec suite program before. We've talked about kind of co-working before. We do see users coming back and wanting to be able to flex in and out of their space, primarily for larger gatherings, town halls, things like that. And so we're seeing more requests for that as we bring people back.

Ted, do you have anything to add on that maybe?

The only thing I would add is I think we're also seeing a migration of quality owners, long-term owners, who are willing to reinvest in their assets, and they're not necessarily the quality, not necessarily the newest and shiniest assets either. It's -- buildings are in great locations. And I think we're -- the flight to quality is really playing out. We're seeing it in our portfolio. Manny, I think last quarter I mentioned it and summarized in my prepared remarks. Last quarter, we signed -- or last year, 2021, we signed 194 new leases, highest we've done since 2006. Then you add that -- add to that, we signed 18 -- in our development portfolio -- development projects, 18 leases as well and so 212 new customers to Highwoods that want to come into our portfolio. So I think we're benefiting from a flight to quality.

And then I'll remind you the second part of the question is what happens to the nonquality assets, whether it be the ones that get vacated or the ones that have been vacant?

Yes. Look, I think it's going to be a conversion in some cases. I think you've probably seen there's been a few big buildings that have sold and been converted to -- are going to be converted to industrial. I think you're going to see some multifamily conversions, maybe some hotel conversions over time as well. So I think it all depends on where the lower quality product is located and what the highest and best use is going forward.

One last little thing, Manny, on that is you're also seeing kind of a densification and addition of mix of uses around some of these assets. So in many cases, they're well located but might have either age or kind of the mousetrap is a little different than what you might build more recently. And so we're seeing surface parking lot converted into structured parking with multifamily, you're seeing retail added, and that seems to be kind of doubling down on place and location. Location is still a pretty strong amenity.

The next question comes from Dave Rodgers of Baird.

Ted and Brian, I think early on in the prepared comments, you said 40% utilization driven by smaller and suburban tenants. I was curious -- 2 questions. One, on the vacancy leasing, is that also being driven by CBD or suburban? Is there a clear distinction kind of between where the new leasing is happening? Or is it following really the utilization? And I guess the second question is on RFP and tour activity that you mentioned is up. How does that compare to pre-pandemic levels, Brian?

Great questions. First, on the urban, suburban. Now there's a little bit of a footnote on my answers that a good deal of the leasing activity has been suburban, actually, greatly so. But that's also where we had the ability to do that leasing. So a lot of our -- the urban was -- had a higher occupancy, too. So you have that kind of corporate occupancy in the urban locations that was a bit of a ballast, if you will, and we were able to do a good deal of suburban. So that's -- I think that's part of it.

Ted, do you want to kind of staple on to that?

No, I think that's it. I think we can only lease the space we have vacant. So it's been heavily suburban side in the past. We don't have as a company a lot of large vacancies either. So it has been a lot of small customers this past year, which obviously goes to the 194. A lot of those were smaller customers, but I think it pretty much covers it.

All right. That's fair. And then the RFP and tour activity maybe versus pre-pandemic levels on a like-for-like basis, how does that compare?

Sure. Absolutely. Thanks for the reminder. I knew there was a second part to that. So let's all go back to the first week of March of 2020. It felt like the economy was hitting on all cylinders and things were going well. So I think we had a good amount then. But at the same time, I feel like -- it sure feels like right now, the RFP and tours equal that. Let me tell you why. Because I think a lot of customers are now viewing their workplace that has to be a tool. It has to be part of their competitive advantage to not only retain and recruit talent but to return that talent. So they've made a decision that we have got to upgrade our workplace story and our workplace from an asset standpoint.

And so we're getting inbounds for folks that would probably lean in before they might have just wanted to be a tenant in someone else's building. They're leaning in to create a workplace. And what's interesting is that to build a new building today with escalations, inflation, podium parking, it is not inexpensive. And so what you're seeing is customers issuing RFPs, engaging in a process, [willing] it down with clear visibility in the rent premiums that are going to need to be paid to achieve this workplace.

And I know I'm going to be kind of labeled as a broken record, but it's bearing fruit in the whole kind of cliche of the 1%, 9%, 90%, right? Customers that don't build gigantic power plants or things like that, 1% of their annual revenues is on utilities, 9% is on real estate, 90% is on people, and they're realizing how important the 9% can be to bring back their 90% and make them collaborative and to continue that culture.

So we're seeing now -- we don't have any to announce, but we're seeing that, that price to pay the premium for a great workplace is something that these companies are bearing. So I'd say we're right on it right now. It feels very similar. Now are we getting exercised and what will happen by the end of the year? Time will tell. It'd be interesting to ask the same question at the end of the year and see which ones came to roost.

Thanks for that color, Brian. I really appreciate it. And then Ted, maybe just last for you on the disposition. It's been asked a couple of times, but I guess I wanted to get better color. Are you moving forward with the dispositions regardless? Or is it the acquisitions and the development that will drive the dispositions? I guess I heard it 2 different ways in the call, and I was just kind of curious on kind of what comes first in the order of magnitude for your investment strategy right now for the additional sales?

Yes. So obviously, we're definitely moving forward with the $150 million to $200 million. So that will get done just to finish up the vortex transaction to match fund that. The remaining 0 to $200 million, look, I think that will likely be dependent on if we find investment opportunities, whether it be development or acquisitions.

The next question comes from Ronald Kamdem of Morgan Stanley.

Just want to follow up on the expense question, maybe asking a little bit of a different way. Maybe a little bit more color on just what are the line items that are driving it? Is it like cleaning, utilities, like things like that? And then is there -- is it sort of spread out across the portfolio? Or is there certain markets maybe that have the lion's share of that? Would be helpful.

So it's really -- I mean I guess, I would put it into -- let's just put it into maybe 2 main buckets, right? So there's taxes, which are -- we're certainly seeing those increases across a number of our municipalities. So we're -- that's part of it. And then really, it's sort of just the building operating expenses, the day-to-day, right? And so most of the day-to-day stuff is increasing because our customers are coming back to the buildings. And so it's just sort of getting back to normal operations.

There is some -- certainly, inflation is higher now than it has been for a number of years. So there's a little bit of inflationary pressure that's on there. But the vast majority of the increase that we're absorbing, that we expect to absorb and not get recovery on is really just getting those OpEx -- those building operations kind of back to normalized levels.

Our final question comes from Daniel Ismail of Green Street.

Ted, I believe you stated previously that the net effect of rents across your markets are probably down around 5% to 10% from pre-COVID highs. I was curious your outlook for net effective rent growth as in '22. Are you anticipating a recovery to pre-COVID levels or is that still a '22 time frame?

Sure, Danny. You're right. I think we've said 5% to 10%. I think it's -- we're probably right at maybe the lower end of that now, right, mid-single digits down. Look, I do think it's going to come back, but it's going to take time. It's going to be varied by market. The market is competitive still, right? And there's still pressure on TIs, both from a competitive standpoint, but then it just costs more on top of that and then free rent as well. So I think it's going to come back maybe differently or different cadence by market.

Certainly, we're seeing already rent increases occurring in Nashville that does come with corresponding increases in TIs. But I would hope we've hit the bottom, and we're going to be starting our way back to get to prepandemic levels. But look, we're not there yet. And there's -- again, there's increased pressure on costs.

Great. And then can you remind us what contractual rent bumps are today in the portfolio? And then maybe what are you guys negotiating for contractual bumps for today's leases?

Yes, Danny. So we're in the mid-2s just kind of broadly across the portfolio. That's been very steady, I would say, throughout the pandemic. So it really didn't dip too much. And actually, this quarter, we were higher than that in terms of those leases signed. I think we were at 2.7%, so a little bit higher than the average. So we've been successful kind of increasing those annual bumps a little bit. But that has certainly been helpful in terms of those net effectives that we're able to keep capturing annual rent bumps across virtually all of our leases.

And then Brendan, maybe since I have you, I appreciate all the details on the operating expense side. Maybe just going back to the split between triple nets and full-service gross leases, is there any interest in pivoting more towards triple net leases? Or is this beholden to market convention that you guys are responding to?

Yes. I mean, it depends. I mean I think we do often push for triple net leases and do get those often. The one thing I'd like to just mention is full-service leases have actually been beneficial to us over time because, over time, we have typically been able to control expenses and often reduce expenses. And those reduced expense levels accrue to our benefit. So it's only been we -- and I think we received a lot of benefit from lower operating expenses in '20 and '21 as OpEx was low and building utilization was low. And that helped offset a lot of the decline in parking revenue in both '20 and '21.

Now as expenses kind of come back up, then we are absorbing that increase. But keep in mind, we got the benefit. So we're really just getting back to kind of normal. So over time, full-service leases have actually worked well for us because we've enjoyed the benefit of our control on OpEx. And I think if you look at our same property growth over time, typically, we have had same property NOI growth that has outpaced our same property revenue growth because we've been able to control those expenses. So we often -- I mean we will push for triple net leases where we feel like we can get them. But full-service leases for us, typically, are not problematic. And we are protected on increased expenses as long as those expenses are above the base year expense.

That was our final question. I'll turn the call back over for any closing remarks.

I just want to thank everybody for being on the call with us this morning, and thank you for your interest in Highwoods. If you have any follow-up questions, please feel free to reach out. Thank you.

Thank you. This does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines. Thank you, and have a good day.