Title

Presentation

Operator: Good morning, and welcome to the City Office REIT, Inc. First Quarter 2023 Earnings Conference Call. At this time, all participants are in listen-only mode. A brief question-and-answer session will follow the formal presentation. . And as a reminder, this conference call is being recorded. . It is now my pleasure to introduce you to Tony Maretic, the company’s Chief Financial Officer, Treasurer and Corporate Secretary. Thank you. Mr. Maretic, you may begin.

Tony Maretic: Good morning. Before we begin, I would like to direct you to our website at cioreit.com where you can view our first quarter earnings press release and supplemental information package. The earnings release and supplemental package both include a reconciliation of non-GAAP measures that will be discussed today to their most directly comparable GAAP financial measures. Certain statements made today that discuss the company’s beliefs or expectations or that are not based on historical fact may constitute forward-looking statements within the meaning of the Federal Securities Laws. While the company believes that these expectations are 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 first 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 obligation to update any forward-looking statements that may be made in the course of this call. 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 call over to Jamie.

Jamie Farrar: Good morning, and thanks for joining today. Since our last earnings call at the end of February, we’ve continued to track our expectations in terms of operations and per share performance. With our results this quarter, we have reiterated all aspects of our guidance, including strong core FFO per share expectations and positive same-store cash NOI growth. Despite considerable volatility in the broader markets and the banking sector, our premium Sunbelt platform provides an enduring competitive advantage. On our last call, I highlighted our Pima Center property in Phoenix, which is benefiting from an adjacent new entertainment development. On this call, I want to focus on our City Center property in Downtown, St. Petersburg, Florida.

St. Petersburg continues to generate very strong population and economic growth metrics due to its vibrant lifestyle and its unique waterfront location. An influx of new restaurants and entertainment venues downtown, combined with limited available land has driven real estate values. From an office market perspective, the St. Pete CBD has among the lowest vacancy rates in the country at approximately 7%. In addition, year-over-year, in Q1, rents have increased by a healthy 8%. Our building City Center has direct water views and is situated near the waterfront and Marina various restaurants, shops, and mixed used developments. It is 92% occupied today when including signed and committed leases. Our parking garage also sits on a prime location, which may be suitable for future residential development.

While we’re at an early stage of unlocking that potential value, City Center is a great case study in the tailwinds associated with amenitized Sunbelt locations. Relating to the outperformance of our Sunbelt markets, next I would like to discuss space utilization across our portfolio, which continues to trend higher. At the end of March, approximately 60% of our portfolio-wide tenant offices or workstations were being utilized. Both Raleigh and Tampa exceeded 70%. Overall, these levels have increased dramatically from the low 30% utilization range at the same time last year. To highlight this, we’ve provided a new chart in our May Investor Presentation that shows utilization levels over time. It is noteworthy that these results are trending towards the approximately 85% utilization that we estimate occurred pre-pandemic when factoring in travel, vacation, and sick days.

Our expectation is that increasing utilization levels in our cities will translate to greater leasing activity over time. In terms of new leasing, newer and amenitized properties in the best locations are continuing to outperform. We’re also seeing prospective tenants start to scrutinize the financial position of building ownership when evaluating their leasing options. Across our industry, many of the buildings that we compete with are owned by higher leverage investors that are not as well capitalized. In today’s environment, a growing share of these owners don’t have the capability to fund required capital and tenant improvements. As the year progresses, we believe that our strong financial position will help to enhance occupancy levels.

Also, to further advance leasing activity and property level cash flow, we continue to execute renovations and spec suites across our portfolio. During the last 12 months, we signed 87,000 square feet of new leases for spec suites. We currently have only 14,000 square feet of built spec suites in our inventory, but we’re advancing over 100,000 square feet, which is either under construction or will be later this year. We’ve started the benefit from these investments in this program, but the full extent will be realized over time as suites are leased and initial free rent periods burn off. While we continue to take active steps to optimally position our portfolio for long-term success, we are also very mindful of broader market volatility and headwinds.

The combination of rising interest rates and the recent banking sector challenges has impacted debt availability across the commercial real estate industry, and in particular, the office sector. We anticipate that these challenging conditions will continue for smaller and regional banks that have been important capital providers to the commercial real estate industry. Given the backdrop of these conditions, we believe it’s particularly important to operate conservatively. To that end, we announced today that we’ve reduced our quarterly dividend to $0.10 per share for an annualized rate of $0.40 per share. As I mentioned on our last earnings call, our Board has been pragmatically reviewing the challenging operating conditions each quarter and assessing the appropriate direction.

We did not take the decision to reduce the dividend lightly, and we continue to believe the dividend is an important component of total shareholder return. This adjustment is expected to result in the retention of $16 million of incremental cash annually, which we will use strategically to best position ourselves. This may include investments into our portfolio to enhance value, leverage reduction or share purchases. So in summary, we will continue to evaluate market conditions and operate in a cautious and strategic manner. Our initiatives will ensure we maintain a premium core Sunbelt portfolio, enhance our liquidity, and provide us with the flexibility to pursue opportunities as they arise. I look forward to providing future updates on our progress and I’ll hand the call over to Tony Maretic to discuss our results.

Tony Maretic: Thanks, Jamie. Our net operating income in the first quarter was $28.2 million, which is $600,000 higher than the amount we reported in the fourth quarter. This increase is primarily a result of the occupancy gains at our Block 23 and Block 83 properties, which are recently constructed and still undergoing first generation lease-up. We reported core FFO of $15 million or $0.37 per share, which was $400,000 lower than in the fourth quarter. The drivers of that decrease were primarily higher interest costs and higher G&A, which offset the net operating income increases. Our first quarter AFFO was $8.2 million or $0.20 per share. The largest impact to AFFO was continuing investment in ready-to-lease spec suites and vacancy conditioning, which is a key part of our business plan.

The total investment in spec suites and vacancy conditioning in the first quarter was $1.3 million or $0.03 per share. Moving on to some of our operational metrics. Our first quarter same-store cash NOI change was in line with our expectations at positive 3% or $700,000 higher as compared to the first quarter of 2022. Block 83, Block 23, and Park Tower have the largest year-over-year increases due to higher occupancy. Our portfolio occupancy ended the quarter at 84.9%, including 158,000 square feet of signed leases that have not yet commenced; our occupancy was 87.5% as of quarter end. Our total debt as of March 31 was $708 million. Our net debt including restricted cash to EBITDA was 6.5x. We had two smaller maturities in the fall of 2023 and both of these loans are secured by high quality properties at relatively low leverage levels.

With respect to the potential disposition of our 190 Office Center property that I mentioned on our last conference call, we continue to explore all of our options and are in discussions with the lender. We have non-recourse property level debt on the property, which is advantageous to us. In the event that we were to dispose of the property to the lender, we expect there would be an immediate positive impact on our financial position. We anticipate our total debt would decline by approximately $39 million and our net debt to EBITDA would improve modestly. As far as our liquidity, as of March 31, we had approximately $100 million of undrawn availability on our credit facility. We also had cash and restricted cash of $52 million as a quarter end, along with financeable unencumbered properties as an additional source of liquidity.

As we discussed in our last call during the first quarter, we executed two debt-related transactions, which enhance liquidity, reduce our exposure to rate fluctuations and give us better visibility into our future earnings. Following those credit facility expansion and interest rate swap transactions over 90% of our total debt was effectively fixed as of quarter end. Related to our capital structure, we also announced today that our Board approved a new $50 million share repurchase program subsequent to quarter end. We have not completed any repurchases to-date. Our intention is to continually evaluate market conditions and weigh any repurchases versus added liquidity or other uses of cash. Last, we continue to track the 2023 guidance ranges that we issued last quarter.

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

Operator: Thank you. . Our first question comes from Rob Stevenson of Janney. Rob, your line is open. Please go ahead.

Rob Stevenson: Good morning, guys. Jamie, how are you and the board thinking about share repurchases at this point you just put the new plan in place is $50 million sort of the upper end of where you think you can legitimately do given your size and liquidity? Is it more than that? Is it less than that? How should we be thinking about that and how are you guys thinking about that?

Jamie Farrar: Thanks for the question, Rob. So top of mind for us is shrinking our market cap overall. So we view this as a tool that we have and we’re going to keep it in mind as we’re making future decisions, but for us, first priority is building additional liquidity and then we’ll consider all of our options at that point.

Rob Stevenson: Okay. And I guess the question is besides the money that you’ve saved off the dividend and the potential of turning in keys on 190, I mean, are there other dispositions that you guys are thinking about at this point, given the fairly substantial spread between where you could probably sell some of your assets at versus where the implied cap rate is on your assets via the stock price?

Jamie Farrar: Top of mind for us, Rob, is the market right now is somewhat frozen on acquisitions and dispositions and that’s really driven primarily from the banking market being closed and an inability to get loans. So as far as we’re concerned it’s not an ideal time to be disposing of assets and so we’re positioning ourselves to keep those options open, but it’ll be down the road when market conditions are better.

Rob Stevenson: Okay. And then, Tony, where is the new dividend versus where you’re likely to be on taxable earnings? I mean just trying to figure out, I think that given the first quarter dividend you’ll be sort of $0.50 for 2023. Is that about where you’d have to be for your minimum payout for rate rules or is there additional room in there? How should we be thinking about that?

Tony Maretic: Yes. That’s a good question, Rob. For our 2023 estimates, the new dividend level is above where our minimum is. It’s just a little bit above. It gives us some cushion beyond there. So it’s not the absolute minimum. And we do have some ability to have additional accelerate depreciation to kind of lower that amount a little bit more in the future years if we need to if our net income continues to grow.

Operator: Thank you. Our next question comes from Barry Oxford of Colliers. Barry, your line is open. Please go ahead.

Barry Oxford: Hey guys, thanks for taking the question. Real quick, looking at the occupancy going from 4Q to 1Q is, a bit of a drop there down to 84.9%. And then in particular, just kind of matching up 4Q and 1Q, three buildings kind of came out to me, in particular that had drops, which would be Superior Pointe, Denver Tech and 590 North. Jamie, do you want to comment on maybe what’s going on in those three buildings?

Tony Maretic: Yes. Good morning, Barry, it’s Tony here. I can tackle that question and so — and so in this quarter —

Barry Oxford: Okay. Great, great, great, great.

Tony Maretic: Yes. The two largest vacates during the quarter were within the buildings that you mentioned. So there was a 49,000 square foot tenant at our 5090 building in Phoenix that departed during the quarter. This was a known vacate. We had talked about it on previous calls. And then the other was there’s a 30,000 square foot tenant at Denver Tech that also vacated during the quarter. So those two were the largest — were drivers of that decrease.

Barry Oxford: Right. What do you see over the next couple of quarters as far as known move-outs?

Jamie Farrar: Sure. So we’ve got a schedule on Page 15 of our deck that kind of breaks it down. And so we have roughly 733,000 square foot rolling over the next four quarters. If you put aside 190 Office Center, which we’ve talked about, which has vacates of approximately 174,000 square feet that leaves us at just five tenants that are greater than 30,000 square feet that are rolling. And of those five, two are actually known renewals. One is actually just signed in recent days. Two are known vacates and one is unknown at this point, which is a 2024 expiry. And of those two known vacates, the largest is a 49,000 square foot tenant at our Cascade Station property in Portland.

Barry Oxford: Okay. Great. Great. When you look at signing leases on — new leases on two fronts, one, have you noticed that that tenants are taking less space or they just kind of re-upping for their current space needs and then are TIs starting to creep more into the negotiations?

Jamie Farrar: So a couple different questions there, Barry, what we’re seeing with the smaller tenants is more consistency on renewals. What we’re seeing with much of the larger tenants, Corporate America is really assessing their options, downsizing where they can, in many cases, looking to move to higher quality properties, the flight to quality we’re seeing that. And so we’re positioned well with a number of our properties, but we also have a few that are very suburban that are 190 is the perfect case where you’re seeing a downsize overall. And so I think most of our portfolio are on the smaller size tenants. We have about 350 tenants in total. I think the average size is about 15,000 feet. The median’s about six. And so I think once we get through a few of these larger roles, we’re going to have much more stability.

But as we have larger roles in the near-term, we’re seeing a higher vacate and downsize. In terms of TIs, what’s leasing best right now is the highest quality space. And so TIs have been increasing costs have increased. What we’re seeing and what we’re factoring into our spec suite program is really building out very high quality space, because that’s what’s leasing and that’s what’s leasing at the best rates and there’s a healthy return on those. And so we’re trying to take advantage of that in properties where rents are much lower. It’s a little tougher on the economics, but for very high quality properties, the mask still is compelling.

Operator: Thank you. . Our next question comes from Craig Kucera of B. Riley. Craig, your line is open. Please go ahead.

Craig Kucera: Yes. Thanks, and good morning, guys. Tony, the specs suite spending in the first quarter was a little out of what we were anticipating. Are you still anticipating an incremental $10 million call up between that and vacancy reconditioning in 2022, or is that program slowing down at all?

Tony Maretic: Good morning, Craig. That’s a very good question and a good observation. And so there is no intention to slowdown the program, maybe a little bit on the margins, but effectively that’s still the number that we’re expecting to get to by the end of the year, subject to obviously there’s what happened to us in Q1 is a little bit of permitting and construction delays, which slowed down the pace of activity. But we are still committed to invest in our properties and invest in that program.

Craig Kucera: Okay. Great. And just one more for me, appreciate the color on the buyback, but is the Board also potentially looking at the preferred, I think it’s now trading the deal call it 10.5% to 11% obviously a lot more thinly traded, but is that also coming to the equation as well?

Jamie Farrar: So we have flexibility to purchase both common and preferred. And so what you’re saying has been observed and as we factor in decisions going forward, that is a potential as well.

Operator: Thank you. We currently have no further questions. I’ll hand back over to Jamie Farrar, CEO, for any closing remarks.

Jamie Farrar: Thanks for joining today. We look forward to updating you on our progress next quarter. Goodbye.

Operator: Ladies and gentlemen, this concludes today’s call. Thank you for joining. You may now disconnect your lines.