Highwoods Properties, Inc. (NYSE:HIW) Q1 2024 Earnings Call Transcript

Highwoods Properties, Inc. (NYSE:HIW) Q1 2024 Earnings Call Transcript April 24, 2024

Highwoods Properties, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Thank you all for joining. I would like to welcome you all to the Highwoods Properties Q1 2024 Earnings Call. My name is Brika and I will be your moderator for today. All lines are on mute for the presentation portion of the call with an opportunity for questions-and-answers at the end. [Operator Instructions] Thank you. And now I would like to pass the conference over to your host Hannah True, Manager of Corporate Finance and Strategy to begin. So, Hannah, please go ahead.

Hannah True: Thank you, operator, and good morning, everyone. Joining me 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 are 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.

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 turn the call over to Ted.

Ted Klinck: Thanks, Hannah, and good morning, everyone. We had an excellent quarter executing on our key priorities and delivering solid financial results. First, we signed 922,000 square feet of second gen leases, including over 400,000 square feet of new leases and 36,000 square feet of net expansions. This volume of work will benefit us in future periods as the new leases commence. Second, we signed 157,000 square feet of first gen leases in our development pipeline. We continue to see solid interest in these best-in-class projects, which will provide approximately $40 million of incremental NOI upon stabilization and be a significant growth driver for our cash flows. Third, we delivered Four Morrocroft, an 18,000 square foot, $12 million build-to-suit that we developed at our Morrocroft property in the South Park BBD of Charlotte.

As you may recall, this creative office development is situated on a surface parking lot with zero basis. While Four Morrocroft is one of our smaller developments, it demonstrates our resourcefulness in cultivating and generating attractive risk-adjusted returns for our shareholders. Finally, we sold nearly $80 million of non-core properties in Raleigh, including over $60 million that closed early in the second quarter. These sales improve our portfolio quality, increase our long-term cash flow growth and further strengthen our liquidity and already strong balance sheet. We expect our solid leasing momentum to continue as our markets generate outsized population and job growth given their high quality of life and business friendly environments.

Simply put, our markets and our BBDs are where people and companies want to live, work and play. This is why our portfolio has outperformed the national average, our markets and our submarkets, all because customers and prospects are attracted to our commute-worthy buildings. Plus, being a long-term landlord with a strong balance sheet that can fund tenant improvements and leasing commissions and care for our best-in-class properties is proving to be a clear competitive advantage for us. Contrary to popular opinion, we’re seeing strong demand across our portfolio, whether they be brand new trophy assets or well-located second gen properties and whether they be suburban or urban. We believe financially capable landlords who provide value to customers and prospects will see healthy demand across a wide variety of price points.

Turning to our quarterly results, we delivered FFO of $0.89 per share and same property cash NOI growth of positive 0.3%. As expected, our occupancy dipped modestly to 88.5%. Our 2024 FFO outlook is a penny and a half lower at the midpoint due to higher-than-expected interest rates and the dilutive impact of non-core asset sales already completed, neither of which were factored into our initial outlook. These items are partially offset by higher projected NOI. The strong leasing start to the year modestly helps 2024, but most of the new leasing will drive upside in 2025 and beyond. We’ve also had a successful start to the year with non-core asset sales, and we’re prepping additional properties for potential disposition. We now expect to sell up to an additional $150 million during the remainder of the year.

The volume and timing of dispositions will depend on how conditions are in the investment sales market, but we’ve been encouraged by the response we’ve seen in recent quarters to our marketing efforts and the modest improvement in the capital markets for prospective buyers. While we don’t have any acquisitions included in our 2024 outlook, we continue to build the foundation for future investment opportunities. Similar to the first few years coming out of the Global Financial Crisis, we believe compelling investment opportunities will arise, but these will take time to play out. We’re comfortable being patient as we continue to have conversations with owners and lenders of wish list properties in our markets. Our development pipeline is now $506 million following the delivery of the 100% leased Four Morrocroft building in Charlotte.

With 157,000 square feet of first gen leases signed during the quarter, our pipeline is now 41% leased. A big chunk of the activity was at our 642,000 square foot, $460 million, 23Springs project in Uptown Dallas that we are developing in a 50/50 joint venture with Granite. 23Springs is now 54% pre-leased a year prior to scheduled completion and four years before the estimated stabilization. The largest lease signed was a current law firm customer at our 98% occupied McKinney & Olive property just a couple of blocks away who needs to expand by nearly 50%. Given we couldn’t accommodate their growth at McKinney & Olive, we were able to accommodate their growth at 23Springs. We already have excellent activity to backfill their space at McKinney & Olive more than two years before their scheduled move to 23Springs.

We made modest leasing progress at Granite Park Six in Dallas and GlenLake III in Raleigh. Both of these developments delivered late last year and are projected to stabilize in 2026. These buildings are best-in-class in their respective BBDs and prospect activity is accelerating. We’re confident in the long-term outlook and expect these developments to drive solid cash flow growth for us in future years. Midtown East in Tampa, our 143,000 square foot, $83 million project that we are developing in a 50/50 joint venture with Bromley in the Westshore BBD, is seeing strong interest from prospects given we’re the only office project currently under construction in the entire market. We’re 16% pre-leased and are very encouraged by the strong interest more than two years before scheduled stabilization.

We don’t expect to announce any new development projects during the year. Obviously, this isn’t unique to Highwoods. It’s very difficult for new starts to pencil in the current environment. We’re not seeing meaningful reductions in hard costs and interest rates continue to be elevated. Plus, for other developers who are capital-constrained, securing capital for new office construction is very challenging. As a result, new starts have plummeted and with current development pipelines that will largely be delivered across our markets over the next few quarters, the lack of new supply in future periods will play to our advantage as users seek high-quality properties from landlords with strong financial resources. In conclusion, as we have for the past few years, we acknowledge the headwinds in the office sector, yet we’re bullish about the future for Highwoods.

First, our portfolio has never been better, and it will continue to improve as we sell additional non-core properties and deliver our $500 million development pipeline. Second, we have significant organic growth potential within our operating portfolio where we’ve already leased some of our existing vacancy and have solid interest on expected future vacancy. Third, our balance sheet is in excellent shape and will enable us to capitalize on future growth opportunities. And finally even with higher interest rates, our underlying cash flows remain strong, which allows us to keep investing Highwoodtizing capital to generate higher returns on our existing portfolio. Brian?

Brian Leary: Thank you, Ted, and good morning all. As we mentioned on last quarter’s call, our leasing teams got off to a strong start in 2024. We maintained our positive momentum through the end of the first quarter and signed 97 deals and exceeded our five quarter average with 922,000 square feet signed. New leasing volume of 422,000 square feet was the second highest quarterly total since 2014. Average term was also strong at nearly seven years, one year longer than our prior five quarter average. Tampa, Atlanta and Raleigh signed nearly three-fourths of this quarter’s total volume with average terms of 7.5 years. Expansions outpaced contractions two-to-one and while lease economics reflect a highly competitive market, we will prioritize occupancy as needed over pushing rental rates to lean on our strengths as a long-term owner while strengthening our long-term cash flows.

In addition, we are seeing strong activity across our $500 million development pipeline. As Ted mentioned, we signed 157,000 square feet of first gen leases, including 129,000 at 23Springs, our JV development in Uptown Dallas. The 129,000 square feet of preleasing at 23Springs follows the 105,000 square foot lease we announced last quarter. 23Springs is now 54% preleased, one year before completion and four years before our estimated stabilization in the first quarter of 2028. The quality of our portfolio, our sponsorship and the commute-worthy lifestyle office experience we provide our customers is giving us a clear edge in today’s leasing environment. We’re seeing strong demand at various price points across our portfolio. As demonstrated by strong leasing volume in our development pipeline, the top of the market is doing well, but we continue to see the most demand for our well located second gen assets.

This is because a large segment of customers and prospects prioritize a premier office experience at rents that are more affordable than a trophy price point. Moving to our markets, Tampa recorded the most volume in the quarter with 267,000 square feet signed. Our 16% pre-leased Midtown East development is the only Class A office development under construction in Tampa and is on-time and on-budget for a Q1 2025 delivery. Solid inbound interest continues as the building advances toward completion. According to Cushman & Wakefield, Midtown East’s Westshore BBD was the most active submarket in Tampa during the quarter capturing nearly one-third of all leasing activity. Further, CBRE is currently tracking several large users in the market and over 2.6 million square feet of demand.

We leased a lot of our vacancy earlier this year at Tampa Bay Park, and we’re now working to fill pockets of vacancy at Meridian where we have solid traction. Moving to Atlanta, the MSA recently passed Philadelphia and Washington, DC as the nation’s sixth largest and is the second largest metropolitan area on the East Coast per the latest population estimates from the US Census Bureau. Our Atlanta team signed 199,000 square feet for the quarter, of which 160,000 was new. This represents the greatest share of new leasing across the portfolio. Further north in Raleigh, which was recently ranked number two in the Milken Institute’s annual Best Performing Cities report, our team signed 201,000 square feet in the quarter. We averaged close to eight years of lease term and over half of this leasing activity was new.

Raleigh is joined by Nashville, Dallas and Charlotte in Milken’s top ten best performing cities list. In summary, our leasing pipeline is healthy and we are pleased by the flow of inbound proposal and tour requests across our portfolio. We believe this is emblematic of our simple and straightforward strategy of creating commute-worthy experiences in the SunBelt’s best business districts. Brendan?

Brendan Maiorana: Thanks, Brian. In the fourth quarter, we delivered net income of $26.1 million or $0.25 per share and FFO of $96 million or $0.89 per share. There were no unusual items in the quarter. We are pleased with the quarterly results, which demonstrate the resiliency of our operations and continued strong cash flows. Rolling forward from the fourth quarter and excluding the $0.08 per share of unusual items in Q4, FFO per share was $0.02 lower in the first quarter. Higher G&A, which we incur every year during the first quarter due to the expensing of equity grants for certain employees and the full quarter impact of November’s bond issuance reduced FFO by $0.04 per share. These headwinds were partially offset by $0.02 per share of higher NOI, which nets to the $0.02 sequential reduction.

Our balance sheet remains in excellent shape. At March 31st, we had $850 million of available liquidity, which has increased to $915 million following the non-core dispositions we closed in early April. We have a little over $200 million left to fund on our development pipeline and no consolidated debt maturities until May of 2026. We do have one mortgage that matures in the third quarter of this year at our unconsolidated McKinney & Olive joint venture. This is a low leverage loan and we’re reviewing financing options with Granite Properties, our partner. We may ultimately decide to jointly repay this loan upon maturity and seek longer term financing when the lending environment is more attractive. Given our ample liquidity, we have many options available.

This also demonstrates the strategic value of having such a financially capable joint venture partner in Granite. As Ted mentioned, we have updated our 2024 FFO outlook to $3.46 per share to $3.61 per share, which implies a $0.015 reduction at the mid-point. The reduction is driven by the $0.03 dilutive impact from the asset sales completed since our outlook was provided in February and higher than anticipated interest rates for the remainder of 2024, partially offset by $0.015 of higher anticipated NOI. It’s still early in the year and therefore our range remains wide with several variables, most around projected property tax savings which aren’t assured yet. We’re pleased with the non-core property sales completed thus far. While modestly dilutive to near-term FFO, as we have long stated, our capital recycling program has been accretive to our cash flows while also improving our long-term growth rate.

We’ve increased the midpoint of our same property cash NOI outlook and moved the high end of our total dispositions to $230 million including the $80 million we’ve closed so far. All other items in our outlook remain unchanged. As Ted and Brian mentioned, we had a strong leasing quarter, especially new leasing volume. Many of the new leases signed in the quarter won’t commence until late this year or next year, and therefore will not have a meaningful financial impact on 2024 results. This volume of work will obviously bolster our results in future years. As you know, we try to be as open and transparent as possible with our stakeholders and we’ve stated for quite some time that we expect occupancy will trough in the first half of next year.

We still expect this to be the case, but if we can continue to post strong leasing volumes, we believe our trough occupancy level will be higher than our original expectations and our recovery will be faster. You may have seen in our supplemental package that we have made some adjustments to how we present property-level operational information. Starting this quarter and going forward, we are now including in-service properties owned by consolidated and unconsolidated joint ventures at our share. We are doing the same thing with respect to the presentation of our same property operational results in the supplemental. For those of you who would rather see same property results on a consolidated basis only, all of the ingredients are itemized in the same property reconciliation table in the back of the earnings release.

These changes have a relatively modest impact on our property-level metrics this quarter as JVs today comprise less than 3% of our business but will increase to around 8% as our development properties are placed in service. To wrap up, we’re very encouraged about the future for Highwoods. Our high-quality SunBelt portfolio is located in the BBDs where talent wants to be, which is clearly demonstrated by our performance this quarter. We have strong embedded growth potential within our operating portfolio and approximately $40 million of future NOI as our development pipeline stabilizes. Our balance sheet is in excellent shape, and our cash flows continue to be resilient. Operator, we are now ready for questions.

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Q&A Session

Operator: Thank you. [Operator Instructions] We have our first question from the phone line from Camille Bonnel of Bank of America. Your line is open.

Camille Bonnel: Good morning. Great to see the pickup in leasing this quarter. I’d like to start with some questions around guidance. As you clearly laid out the puts and takes for bringing the top end of FFO down. Can you explain the drivers behind raising the low end of your same-store guide? And how confident are you in the bottom range here if there is a pullback in decision-making?

Brendan Maiorana: Camille. Hi. It’s Brendan. I’ll start. So I think in terms of the components of the driver of the higher NOI outlook that we talked about, both in terms of the same property growth and what we said is just overall better NOI with respect to the FFO outlook. I would say that it’s roughly evenly split between better revenue and some expense savings. So that better revenue is driven by probably what I would characterize as modestly higher average occupancy. We didn’t change the average occupancy range, but it is modestly higher overall. So it’s a combination of top line and expense savings. And then in terms of how much spec leasing is in the forecast, we still have spec leasing that is there. I think if things really slowed down in for the remainder of the year, it probably doesn’t have a very large impact in terms of the financial performance for 2024 as most of the spec leasing that we have slated to come in this year would be later in the year and therefore, not have a big impact on ’24 results.

But obviously that’s going to carry more impactful to 2025 and future years. But I think we feel good about kind of where our leasing activity has been through the first almost four months of the year and are optimistic that, that will continue as we go forward.

Camille Bonnel: To clarify, is the spec leasing the same as new leasing activity that you report?

Brendan Maiorana: We have — within our spec outlook for the business plan for the year, there’s a combination of that between both new and renewal. So it’s with both.

Camille Bonnel: Got it. Okay. Well, if we look back, it seems like you were able to improve your occupancy when new leasing volumes were above 1 million square feet. So are you able to expand a bit more on that specific assumption baked into guidance this year? And do you think you can sustain the pace of new leasing throughout the year? Or was the first quarter? How did that track compared to your budget?

Brendan Maiorana: Yes. Maybe I’ll start and then I’ll let Ted and Brian provide more color on specifics. But I think, certainly, new leasing volume of 423,000 square feet, we don’t expect that to continue. That was, I think, the second highest quarter that we’ve had over the past 10 years. So that’s certainly above expectations. And the volumes are going to bounce from quarter-to-quarter. But I think if we could average around 300,000 square feet of new per quarter for the year, so call it, 1.2 million square feet of new during the year. I think that would place us in a good position to kind of build occupancy as we get through some of the large known expirations. And what I mentioned in the prepared remarks, we certainly expect to trough occupancy early in 2025 and then build from there.

But I think if we’re able to sustain good new leasing volume and manage reasonable levels of renewals then I think that puts us in position to build kind of from the base. And as we stated earlier, trough at a higher level than what we previously expected and then recover faster.

Camille Bonnel: Just one final question. If we were to dive deeper into your portfolio, are you seeing any areas where vacancy has been concentrated, whether that be by location like suburban, urban, infill or lease size? Thank you.

Ted Klinck: Hey, Camille, it’s Ted. I don’t think so. I think we’ve seen pretty good demand across the portfolio. Our biggest vacancies as a company are the well-known Tivity move out. That building is still largely vacant, so that’s 260 or so thousand feet. And then the CDC vacated building in Atlanta and that is leased, but it’s vacant right now. So combine those two, that’s about 100, if I remember right, it’s about 130 basis points of occupancy. But other than those two big holes, it’s really not concentrated anywhere.

Camille Bonnel: Thanks for taking my question.

Operator: Your next question comes from Vikram Malhotra from Mizuho.

Georgi Dinkov: Hey, this is Georgi Dinkov on for Vikram. Can you just walk us through any known move-outs and the occupancy trajectory in 2024?

Ted Klinck: Yes. Maybe I’ll take the first part and Brendan can jump in on the trajectory on the occupancy. So look, the known move-outs, we’ve talked about these for several quarters. I’m going to hit it just at a high level. We’re seeing some good activity on the Novelis space in Atlanta. It’s 168,000 square feet. And so we’re seeing really good activity there. We’re seeing good activity actually in Pittsburgh. Now as we’re getting closer to the EQT expiration later this fall. As you know we — I think last quarter, we indicated we went direct with one customer and we’ve got strong prospects for another 50,000 feet and over 100,000 square feet of proposals that are out. So we feel good about the activity we’re getting there.

We’ll see where that goes. In Nashville, Bass, Berry moves out next February, and still a little bit early there, but we’re well on our way on Highwoodtizing plans for the project that will be getting underway really the day they move out. So we’re excited about our plans there. Activity is a little slower there just because we’re still 10 months away from them vacating. And then really the other big one is the Department of Revenue at the end of this year, 1800 Century Center. They’re the ones consolidating and downsizing to another one of our buildings in that same park. We’re still evaluating our plans for that building, whether it be office lease-up or potential residential conversion. So we’re well underway. We’ve been analyzing that for a while.