Office Properties Income Trust (NASDAQ:OPI) Q1 2024 Earnings Call Transcript

Office Properties Income Trust (NASDAQ:OPI) Q1 2024 Earnings Call Transcript May 2, 2024

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Operator: Good morning and welcome to Office Properties Income Trust’s First Quarter 2024 Financial Results Conference Call. All participants will be in listen-only mode. [Operator Instructions] At this time, for opening remarks and introductions, I would like to turn the call over to Kevin Barry, Senior Director of Investor Relations. Please, go ahead.

Kevin Barry: Thank you, and good morning, everyone. Thanks for joining us today. With me on the call are OPI’s President and Chief Operating Officer, Yael Duffy; and Chief Financial Officer and Treasurer, Brian Donley. In just a moment, they will provide details about our business and our performance for the first quarter of 2024. I would like to note that the recording and retransmission of today’s conference call is prohibited without the prior written consent of the company. Also note that today’s conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and other securities laws. These forward-looking statements are based on OPI’s beliefs and expectations as of today, Thursday, May 2, 2024, and actual results may differ materially from those that we project.

The company undertakes no obligation to revise or publicly release the results of any revision to the forward-looking statements made in today’s conference call. Additional information concerning factors that could cause those differences is contained in our filings with the Securities and Exchange Commission or SEC, which can be accessed from our website, opireit.com or the SEC’s website. Investors are cautioned not to place undue reliance upon any forward-looking statements. In addition, we will be discussing non-GAAP numbers during this call, including normalized funds from operations, or normalized FFO, cash available for distribution or CAD, and cash basis net operating income or cash basis NOI. A reconciliation of these non-GAAP figures to net income are available in OPI’s earnings release presentation that we issued last night, which can be found on our website.

And finally, we will be providing guidance on this call, including normalized FFO and cash basis NOI. We are not providing a reconciliation of these non-GAAP measures as part of our guidance, because certain information required for such reconciliation is not available without unreasonable efforts or at all, such as gains and losses or impairment charges related to the disposition of real estate. I will now turn the call over to Yael.

Yael Duffy: Thank you, Kevin, and good morning. Last night OPI announced that it has commenced offers to exchange certain of its outstanding unsecured senior notes for up to $610 million of new senior secured notes subject to the terms and conditions set forth in an offering memorandum. Now that the offering period is open, today’s call will focus on OPI’s first quarter operating and financial results and we will not be taking any questions at the end of our prepared remarks. Before I begin I want to highlight the recent publication of the RMR Group’s annual sustainability report, which provides a comprehensive overview of our managers’ commitment to ESG goals. We are deeply committed to enhancing OPI’s corporate sustainability practices and continuing to advance initiatives that benefit our tenants and communities.

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Q&A Session

As a testament to our environmental stewardship, OPI was recently recognized as an Energy Star Partner of the Year for the 7th consecutive year and a sustained excellence honoree for the 5th year in a row. You can find links to the report and the tear sheet specific to OPI’s highlights on our website at opireit.com. Now turning to the quarter. I will begin with a recap of our recent activities then provide an overview of our portfolio, leasing performance, and the progress we made on key initiatives. From there I will turn the call over to Brian to discuss our financial results. The strength of OPI’s portfolio is its mix of credit quality tenants and its industry and geographic diversification. Since last fall, we have been focused on addressing our debt maturities, identifying assets for disposition, and leasing vacant space.

To accomplish our financing objectives in an extremely challenging lending market, especially for the office sector, we have utilized the properties with the strongest attributes to secure our recent deals, including the recast of our revolving credit facility into a new $425 million credit agreement and the refinancing of our 2024 debt maturity through a senior secured note issuance. The characteristics of the collateral pool securing these deals include high occupancy, strong remaining lease terms, and credit quality tenants. The note exchange offer we launched last evening includes additional senior secured notes backed by properties with similar attributes. However, beyond these portfolios, our unencumbered asset pool has its challenges, which I will discuss in further detail in a moment.

Turning to our portfolio as of quarter end, OPI’s portfolio consists of 151 properties totaling 20 million square feet with a weighted average remaining lease term of nearly seven years. Our portfolio is diversified by industry and geography with more than 60% of our revenues coming from investment-grade tenants or subsidiaries. We ended the quarter with consolidated occupancy of 85.6% and same property occupancy of 88.2%. Despite significant operational headwinds that continue to impact the office sector, we executed 488,000 square feet of new and renewal leasing. This activity resulted in an average lease term of 9.3 years and a roll-up in rent of 10.2%, reflecting our highest leasing spread since 2022. Leasing concessions and capital commitments continue to decline this quarter at $2.42 per square foot per lease year, which is less than half of OPI’s quarterly average in 2023.

Renewals drove over 90% of our leasing activity this quarter, including a 10-year renewal with the GSA for 352,000 square feet in Ellenwood, Georgia at a 24.7% roll-up in rent and a 10-year renewal with the State of Minnesota for 58,000 square feet in Roseville, Minnesota at a 30.7% roll-up in rent. The United States government is our largest tenant, representing 20% of annualized revenues across 43 leases for over 3.5 million square feet. We estimate that 12% of our annualized revenues are from leases at specialized building facilities that serve mission-critical needs for government agencies, such as the Federal Bureau of Investigation, Department of Homeland Security, and the Drug Enforcement Agency. The essential nature of the work these agencies are conducting and their need to physically occupy our properties has historically provided OPI with stable, predictable cash flows.

These historical trends were further reinforced this quarter. Conversely, the remainder of our U.S. government exposure or 8% of annualized revenues, are from leases for back office uses that are subject to the same remote work threat to building utilization as our private sector tenants. Over time, we expect the non-specialized portion of our government revenues to decline as the GSA seeks to consolidate office space into government-owned buildings, while reducing its reliance on lease properties. We plan to offset this pressure to OPI through releasing efforts and asset dispositions. Turning to OPI’s upcoming lease expiration, we have and will continue to face significant lease role over the next several years with nearly 30% of total annualized rental income expiring through 2026.

Lease expirations over the next 12 months total 2.5 million square feet or 15% of OPIs annualized rental income. As we discussed on our call last quarter, single tenant properties will drive most of our expirations and we expect approximately 2.2 million square feet representing $65.5 million of annualized rental income will not renew, which will negatively impact our results in the coming quarters. Furthermore, over 2 million square feet relate to properties not already encumbered in our existing debt agreements or part of the note exchange offer I referenced earlier. While we are proactively engaging in discussions with our tenants to address their space needs, tenant retention remains a significant challenge as hybrid work in an uncertain macroeconomic climate continues to negatively impact demand.

Releasing efforts are further impacted with minimal tenants in the market to absorb large blocks of space. Accordingly, it can take upwards of two years and significant capital to stabilize vacant properties. To that end, we are focused on selling vacant or soon-to-become vacant assets. We are in various stages of marketing more than 2 million square feet of properties for sale across OPI’s nationwide footprint, most of which were previously leased to single tenant users. In March, we closed on the sale of 400 South Jefferson in Chicago to an owner-user for a sales price of $38.5 million or $155 per square foot. We also received an additional $10.5 million in lease termination fees from Tyson Foods, our former tenant, as part of the deal. Turning to development activity.

We reached an important milestone with the substantial completion of Unison Elliott Bay, our 300,000 square foot life science and office redevelopment in Seattle, Washington. The property is 28% leased and we continue to aggressively market the project, including four move-in ready spec lab suites. No further development projects are underway. I will now turn the call over to Brian to review our financial results.