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Presentation

Operator: Good morning and welcome to the Highwoods Properties Earning Call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. As a reminder, this conference is being recorded today, Wednesday, February 8, 2023. I would now like to turn the conference over to Hannah True. 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’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.

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 a strong end to a strong year for Highwoods. In the fourth quarter, we enjoyed solid leasing in terms of both volume and economics, acquired a best-in-class property in uptown Dallas, placed in-service our highly successful Midtown West development in Tampa, announced Midtown East, our second development in Midtown in Tampa and delivered strong FFO of $0.96 per share. Our healthy leasing during the fourth quarter is somewhat contradictory to the broader macro environment, with interest rates up sharply, limited capital availability and widespread concerns of a pending recession. We continue to believe that to be resilient, our portfolio must be diversified and not be overly reliant on any single customer, market, submarket, industry or lease size.

This diversification is a core component to our long-stated simple and straightforward goal to generate attractive and sustainable returns over the long term. Our largest market, Raleigh, is less than 22% of revenues. Our largest customer, Bank of America, is less than 4%. Our top 20 customers account for less than 30%. Our largest industry, the highly diversified professional, scientific and technical services category is less than 30%. And our average lease size is under 15,000 square feet. We believe this purposeful diversification, our high-quality portfolio and continued strong population and job growth across our markets has driven our strong leasing since the onset of the pandemic, including throughout last year. In 2022, we signed 1.5 million square feet of new leases, the most in any year since 2014.

We ended the year on a positive note with 337,000 square feet of new leasing and 924,000 square feet of total second-gen leasing. In the fourth quarter, we signed 28 expansions, nearly half of our renewal count, with expansions outpacing contractions by a ratio of 3.5:1 equating to 81,000 square feet of net expansions. In addition, we signed a 312,000 square foot renewal at a 50-50 JV property in Richmond. This renewal was for 100% of the customer’s prior space with a roll-up in cash rents and limited TIs. As a reminder, JV leasing is not included in our overall leasing statistics. As we move into 2023 our occupancy and same-property cash NOI will be negatively impacted by the 263,000 square foot move-out activity in the Cool Springs BBD of Nashville at the end of this month, a space that we have already substantially backfilled.

The backfill customers’ lease isn’t scheduled to commence until early 2024. As is our practice, we do not remove in-service buildings from our same property pool. In addition to our solid leasing efforts in 2022 we are also pleased with our investment activity during the year. We acquired $400 million of best-in-class assets in Charlotte and Dallas both with meaningful long-term growth potential. We placed in service roughly $100 million of 99% lease development. We announced over $400 million of development in Dallas, Atlanta, Tampa and Charlotte and we sold $133 million of non-core land and buildings. This volume of work combined with our high-quality office portfolio and the strongest BBDs throughout the Sunbelt gives us the building blocks we need to generate additional long-term growth.

Turning to our results. We delivered FFO of $0.96 per share in the fourth quarter. Our full year FFO was $4.03 per share including $0.13 of net land sale gains. Excluding land sale gains our full year FFO was $3.90 per share $0.06 above the midpoint of our initial 2022 outlook even with the unanticipated sharp rise in interest rates. Turning to investments. In the fourth quarter we expanded our presence in the dynamic Dallas market by once again partnering with local sharpshooter Granite properties, this time to acquire McKinney & Olive in Uptown Dallas and a 50-50 JV for a total investment of $197 million at our share. McKinney & Olive is a trophy mixed-use building with approximately 500,000 square feet of office and 50,000 square feet of retail.

The building is well-leased with growing customers and average rents estimated to be 35% below market. This investment priced below replacement cost provides a unique combination of an attractive going-in cash flow yield with the opportunities to earn development-like returns as we roll rents up to market. Further, this building is only four blocks from our 2023 Springs development providing ample opportunity for leasing and operating synergies and with what we believe will be the two of the best buildings in Uptown. During the quarter, we also announced the Midtown East development in a 50-50 JV. This project will encompass 143,000 square feet in a highly successful Midtown Tampa mixed-use development. The total cost is estimated at $83 million with our share being half of that.

This announcement follows our first office development in Midtown Tampa, Midtown West which we placed in service during the fourth quarter as originally scheduled at 97% leased. We started Midtown West on a fully specked basis in late 2019. And despite the pandemic, the project leased up successfully at rents at or above our original pro forma. Our 1.6 million square foot development pipeline now represents a total investment of $518 million at our share across five different markets it is a combined 21% pre-leased. Three of those developments representing nearly 800,000 square feet and $234 million of total investment at our share are scheduled to deliver in 2023, but are not projected to stabilize until 1Q 2025 through 1Q 2026. With rising interest rates and reduced debt availability, the investment sales market has slowed meaningfully over the past few quarters.

Fortunately, our balance sheet is in excellent shape, which allows us to be patient with our disposition efforts. Over the long run, we will continue our strategy of monetizing properties we believe have below average growth prospects, limited upside or our CapEx intensive, and we’ll use the proceeds to replenish our dry powder and ultimately recycle into higher-growth properties. As illustrated in our 2023 outlook, we expect to be a net seller this year, although, the volume of dispositions will depend upon the stabilization of the office investment sales market. Our plan is to sell up to $400 million of non-core assets this year, while we believe acquisitions are unlikely. Our initial 2023 FFO outlook is $3.66 to $3.82 per share. At the midpoint interest expense will be significantly higher due to rising rates and we also project higher same-property operating expenses.

Same-property cash NOI growth is projected to be flat at the midpoint below our historical average due to higher CapEx and lower average occupancy largely as a result of the activity move out. While a 2023 FFO outlook is below 2022 actual results, as a reminder we have grown normalized FFO per share each year for 12 consecutive years at a 4% compound average rate. Since the onset of COVID at the beginning of 2020, we have acquired 3.2 million square feet of best-in-class office assets for a total investment of $1.2 billion delivered 1.2 million square feet of highly leased office development for a total investment of nearly $500 million and sold 6.4 million square feet of non-core properties for $1 billion. All the while growing normalized FFO per share 11% and continuing to strengthen our cash flows.

With our ever-improving portfolio quality, we’re now even more resilient and better poised for long-term growth. In conclusion, while our high-growth BBDs and high-quality portfolio received most of the attention from our shareholders are humble, hard-working and talented teammates are the ones who drive our success. I would like to thank our entire Highwoods team for their continued commitment and tireless dedication to our company during the past year. It’s their effort that has positioned us for continued success for many years to come. Brian?

Brian Leary: Thanks Ted and good morning everyone. As Ted mentioned, strong fourth quarter capped off a strong 2022 and a strong three-year run through the pandemic that saw the team and portfolio meet every challenge and produce compelling results. We’ve leaned into our BBD strategy to upgrade markets and assets by taking a deliberate approach to diversify geographic reach across the Sunbelt high-growth markets, which include six of the top 10 and five of the top six US markets to watch for the most recent PwC, Urban Land Institute, Emerging Trends in Real Estate report. Within these markets our BBDs are both urban and suburban and have proved successful in meeting our customers where they prefer to be. Suburban workplaces have proven to be competitive options when Wayne and individuals and organizations flight to quality of life calculus as evidenced by the highest physical occupancy and leasing activity across our portfolio and a Sunbelt.

It is our belief that the greatest determining factor of a workplace being commute worthy is the magnitude of the commute burden, the worthiness has to overcome. Our urban and suburban BBD portfolio provides a variety of options and amenities with regard to commute worthiness and has attracted a customer base across a broad spectrum of industries and sizes. Small and medium-sized customers are bread and butter with an average customer size of less than 15,000 square feet, are disproportionately back in the office and expanding. This customer mix has allowed our portfolio to weather the ebbs and flows of previous cycles, a pandemic and evolutions in the so-called future of work. While concrete, steel and glass may not be the most flexible of materials, we are formalizing the variety of flexible work options we offer under our Highwoods Commons banner based on the success we’ve had to-date.

Whether it’s convening a town hall in our Spark conferencing hubs, taking occupancy on one of our dedicated full floor Spec Suite collections or booking one of our ultimate Zoom rooms, we call the CoLab, the Commons platform provides our customers scalable flexibility with regard to space and duration and can be tailored to their specific needs. It includes both formal and informal spaces, all conceived around collaboration and the platform enters 2023 having delivered over 100 such spaces with healthy net new rental income associated with it. This deliberate diversification across a variety of factors makes our portfolio more resilient, coupled with our approach to creating compelling and competitive workplace making experiences. We are confident that the Highwoods portfolio will continue to serve as a location of choice for the best and brightest individuals and organizations.

To that end, our team finished the year with solid financial and operating results for the fourth quarter, signing 924,000 square feet, including 28 expansions, the most net expansions we have signed since the beginning of 2018. As Ted mentioned, this does not include the 100% renewal of our 312,000 square foot JV owned property in Richmond through 2034. Net effective rents for the quarter were higher than our five-quarter average and our net effective rents for the year represent a record high. While there is often much focus on cash or GAAP rent spreads, we have long stated that our leasing focus is securing the best overall economics. For example, we may trade lower face rents for lower TIs or free rent if the overall net effective rents are attractive.

Our all-time high for net effective rents during the year is a strong endorsement of our Sunbelt, BBD and diversified portfolio strategy. Trimming down on our market activity, in Raleigh, we signed 263,000 square feet and end of the quarter 92% occupied and where market rents grew 5.1% year-over-year for CBRE. Our local team has seen healthy activity so far this year and we expect this to continue led by job growth in professional and financial service companies. Second, in terms of volume for the quarter, Nashville signed 225,000 square feet and is nearing the finish line on hybridizing almost 1 million square feet of assets in Brentwood and Cool Springs, the two BBDs that garner the majority of leasing activity for the entire national market in 2022.

Our signature reimagining and repositioning of these assets have been well-received leading to the substantial backfill of our portfolio’s largest 2023 lease roll in Tivity, five months prior to expiration. According to Cushman & Wakefield, the national market posted positive net absorption for the quarter and a 4.7% year-over-year increase in market rent. As Ted mentioned previously, occupancy will be lower in our natural portfolio in 2023 as Tivity vacates and our replacement customers lease doesn’t commence until the beginning of 2024. Moving further south to Tampa, which leads the state of Florida for net New York City resident relocations, we placed in service our 97% leased Midtown West joint venture development in the quarter and announced Midtown East a 143,000 square foot mixed-use development, which will offer the highest views in the Westshore BBD.

Midtown has established itself as an address of choice for blue-chip organizations who have placed a priority on recruiting, retaining, and returning talent. Our newest markets in Charlotte and Dallas are great examples of decisively leaning into our simple and straightforward strategy and executing successfully via the wide and deep relationships we’ve built over time. With the off-market acquisition of 650 South Trian and Charlotte, the Queen City now stands is Highwood’s fourth largest contributor to NOI. The December acquisition of McKinney and Olive, a 550,000 square foot 99% leased tower in the heart of Dallas’ uptown BBD, which was tops in the market for annual absorption and rental growth for 2022, we’re on track for Dallas to contribute 6% of pro forma NOI to our bottom-line, following the completion and stabilization of our two development projects.

In conclusion, each and every Highwoods teammate remains focused on making our diverse portfolio the most talent supportive and commute worthy it can be. We believe this approach will enable our customers and their teams to achieve together what they cannot apart and when we do this, we will create value for our customers and in turn our shareholders. I’ll now turn the call over to Brendan.

Brendan Maiorana: Thanks Brian. In the fourth quarter, we delivered net income of $27.6 million or $0.26 a share and FFO of $103.1 million or $0.96 a share. There were no significant unusual items in the quarter. For the year, our FFO was $4.03 per share came in at the midpoint of the upwardly revised outlook we provided in October. This was $0.19 above our original 2022 FFO outlook. Excluding $0.13 per share of land sale gains, net of impairments core FFO in 2022 was $3.90 a share or $0.06 above the midpoint of our original outlook. The upside in core FFO in 2022 compared to the midpoint of our initial outlook was due to the following: $0.08 of higher NOI, largely driven by lower than forecast OpEx and higher parking revenues $0.02 from less disposition activity than originally planned and $0.01 from acquisitions.

These items combined for $0.11 of upside, and were partially offset by $0.05 of higher interest expense attributable to higher than forecasted rates, on our variable rate debt. In addition, to strong FFO during the year, our cash flows continue to strengthen. Even with what we believe is an attractive current dividend yield of over 6.5%, we had strong coverage in 2022 with a CAD payout ratio under 75%, providing us meaningful retained cash flow to reinvest. We have been purposeful with our focus on strengthening cash flows. We’ve sold assets that were capital inefficient and recycled into acquisitions and development projects, with higher long-term cash flow yields. To quantify this, since 2019, our cash NOI is higher by 16% or $75 million and our capital spend leasing and maintenance CapEx, is down 8% or $12 million resulting in $87 million more cash generated from our portfolio, and a ratio of CapEx to NOI that has improved by 15%, without any meaningful increase in our equity base.

CapEx spend is often lumpy quarter-to-quarter or year-to-year. But regardless of the short-term fluctuations, the trend is clear. Our portfolio has become more efficient and our cash flows have continued to strengthen. Our balance sheet is in excellent shape. We ended the year with debt-to-EBITDA of 5.9 times, up from the third quarter due to the acquisition of McKinney & Olive and continued investment on our development pipeline, but still low overall. We have ample liquidity over $550 million between our line of credit and undrawn amounts on the construction loans, at our Dallas development JVs, which provide us plenty of room to fund the remaining $359 million to complete our development pipeline. We have purposely set up the balance sheet with ample flexibility, as we have over $900 million of debt that is pre-payable without penalty, and no consolidated debt maturities until the end of 2025.

This fits well with our investment plan for the year, where we expect to be a net seller. We expect to reduce our floating rate exposure as we move throughout the year, with planned disposition proceeds. We also have a solid pool of unencumbered assets and the financial flexibility to obtain the longer-term fixed rate debt. As Ted mentioned, our FFO outlook for 2023, is $3.66 to $3.82 per share. As you know, the largest headwind for 2023 is higher interest rates. Based on the current of SOFR curve, we expect to incur $0.25 to $0.30 per share of higher interest expense in 2023 compared to what the forward curve implied just 12 months ago. As I mentioned earlier, we purposely structured our balance sheet to provide us optionality to be able to repay debt without penalty.

While this means we expect higher projected interest expense in the short-term, given the forecasted peak in SOFR during 2023, and with no fixed great debt maturities until 2027, we are positioned to benefit from a downward trend in the interest rate curve after this year. In our release last night, we stated an anticipated headwind of $0.08 per share at the midpoint from higher OpEx, net of anticipated recoveries. The higher projected OpEx combined with lower average occupancy principally related to the Tivity move-out has negatively impacted our same-property cash NOI outlook in 2023. Year-over-year same-property comparisons are often helpful, but 2023 is somewhat distorted by the unusually low OpEx from the first half of 2022. Using our more normalized second half of 2022 as a comparison point, we expect positive cash NOI growth in our same-property pool in 2023.

Finally as you may have noticed, we made some routine SEC filings yesterday and this morning. Under SEC rules S-3 shelf registration statements sunset every three years. It has been three years since our last shelf filing. As a result, last evening, we filed a new S-3 with the SEC. This was a joint shelf filing by the REIT and the operating partnership that registers an indeterminate number of debt securities, preferred stock and common stock for future capital market transactions. With this new shelf in place, we also needed to refresh our longstanding ATM program which we filed via Form 424(b) this morning. As you know keeping an ATM program in place is one of the many arrows we like to keep in our capital-raising quiver. To be clear, the FFO per share outlook that we provided in last night’s release assumes no ATM issuances during 2023.

Operator, we are now ready for questions.

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Operator: Thank you Our first question is from the line of Camille Bonnel with Bank of America. Please go ahead.

Camille Bonnel: Good morning. Just a few questions on the same-store NOI outlook you provided. When we think about your occupancy guidance excluding the impact of the large move-out in Q1, what sort of retention ratio is embedded in your outlook?

Brendan Maiorana: Hey, Camilo, it’s Brendan. Thanks for the question. So our retention when we look at 2023, in terms of what’s remaining at year-end 2022 is below average. So with the Tivity move out that overall including that we’re probably around 40% of the 2023 expiration. So if we back that number out, that goes back up to we’re probably a little bit under 50% overall. I need to kind of just grab that right in front of me but that’s probably about where that number would be, which is roughly in line with average when we’re at this point in the year where you have just the forward four quarters. Over time, we do a lot of early renewals so that number tends to be higher. But 50%, as we roll into a new year for the forward four quarters is about average for us.

Camille Bonnel: Thank you. And really solid leasing last year. Looking forward though, and I understand it’s a very challenging time, but can you also talk to your expectations for new leasing volume this year?

Ted Klinck: Sure, Camilo. It’s Ted. Look, obviously, last year, we had a really good year. We signed 3.3 million square feet of leases, 1.5 million square feet of new — leasing new customers. Coming to Highwoods is roughly 180 new customers that came into our portfolio, which was a great number. I think that was most new leasing we had since 2014. And I think three of the fourth quarters, we had over 300,000 square feet of new leasing. So, we’ve been very pleased with leasing. And obviously, it’s quarter-to-quarter. But we’re off to a good start in first quarter. Our leasing pipeline is active in all of our markets. I will say, as we look at the pipeline, it’s a lot of smaller deals. I think we’ve all seen that and you’ve heard it from others, and that was a case for us really in 2022 as well.

Leasing activity, the large users sort of hit the pause button late in the year. But just — the demand we’re seeing right now plays to what our core portfolio is smaller and medium-sized customers where we continue to see demand. So first quarter, it’s continuing, but it is a lot of small customers, but the volume in tour activity is pretty good, maybe a little bit slower than second half of last year, but still pretty decent.

Brian Leary: Camilo, Brian Leary here. I might just add on for a little additional complexion into that momentum that Ted talked about the small or midsized, who are they law firms? So what’s interesting, I know there’s a theory that law firms just move around. But what we’re seeing in our markets are a number of law firms that are coming in from out of market, planting a flag and then growing. So we’ve seen that, say, in Charlotte, where we landed an inbound law firm from New York, open an office in one of our spec suites grew into the space next door and is now looking at growing further. Financial services — engineering, we’re seeing the engineering firms, I think, start to get the momentum with the infrastructure bill, starting to find its way down into the local markets as well, so just a little extra color.

Camille Bonnel: Appreciate the detail there. Thank you for taking my question.

Brian Leary: Thank you.

Operator: Next question is from the line of Michael Griffin with Citi. Please go ahead.

Unidentified Analyst: Good morning. This is Ari Tyres on for Michael Griffin. My first question is on the turn to office. How are you seeing return to office faring across your Sunbelt markets? Are there any markets or tenant types that are coming back stronger than others from a utilization perspective?

Ted Klinck: Hi Ari, it’s Ted. Look, as you know, the Sunbelt markets have probably come back quicker than a lot of the larger gateway markets. I think not necessarily types of tenants, really size of tenants. Our return to the office has really been the smaller customers, suburban customers, as well have been the first ones back. They’ve been back for a really long time. It’s the larger companies, a large public company as well, have been a little slower in terms of their returns. So, I think it’s more customer size than it has been a type of customer, type of industry.

Brian Leary: Hi Ari, Brian Leary to clip on there. The three days of the week, Tuesday, Wednesday, Thursday is absolutely when we’re seeing our occupancy. So financial services in Charlotte, the buildings are full, top level of the parking garage is getting parked on. And so, we’re even seeing the larger ones have implemented their hybrid work week. Three-two is what we hear a lot of. So Tuesday, Wednesday, Thursday is when we’re seeing the majority of folks in our buildings, driving restaurant sales, sundry sales, things like that.

Unidentified Analyst: Helpful. Thank you. My follow-up question is on the activity backfill. Wondering if you can comment on what the backfill rent is in 2024 relative to activity was paying?

Brendan Maiorana: Hey, Ari, it’s Brendan. Yes we had a modest roll up from a cash basis versus where Tivity was. And then a more normalized kind of GAAP roll-up in the double-digit range. So, we found that that was €“ we were very pleased with that execution given that Tivity was a build-to-suit done in 2007, 2008 and had healthy bumps that compounded over 15 years. So, I think we were pleased with the execution from a leasing standpoint to be able to roll that up on a cash and GAAP basis for the new customer.

Unidentified Analyst: Great. Thanks for the time.

Operator: Our next question is from the line of Blaine Heck, Wells Fargo. Please go ahead.

Blaine Heck: Great. Thanks. Good morning. You guys talked about the flexible work options you guys are providing within the portfolio. Can you just expand a little bit on that? Are there specific buildings or markets that those suites or flexible spaces work best in? And how much of your office space do you think could eventually be converted to more of a flexible use?

Brian Leary: Hey, Blaine, Brian Leary, good morning, thanks for the question. This is how much time does everyone have, because I’m obviously pretty passionate about this. So I’ll be honest with you, it started with the momentum that we garnered a few years ago with rolling out spec suite program. And as we started to realize that not all spec suites are the same or customers are the same, or BBDs are the same, or buildings are the same. We started to flush out a matrix that can be applied across markets and BBDs to custom Taylor for instance in Brentwood. We’ve been very successful in Nashville rolling out floor by floor of our common spec suites, where there’s a certain different complexion of the user that goes in there, what the rents are and that carries a certain amount of amenity base, where you look at a Buckhead collection, the type of customers that’s there, we’ll be able to demand and pay for something different.

And so what we’re doing is, we’re also realizing that folks want to collaborate and kind of get out of their own office. It’s not even just a potential of growing 110% occupancy, if you will. It’s just giving them a diversity of spaces. So I don’t think, I could give you an idea of what percent could be transformed over time. I think this is just now going to be embedded in the offerings that we provide. Yes, we’ve been fairly opportunistic, when vacancies presented itself to do this, and it’s been successful, but we really see this rolling up as kind of our flexible option that you get by having a kind of long-term relationship with Highwoods, and not necessarily have to engage at the more typical kind of co-working environments.

Blaine Heck: Great. Thanks, Brian. That’s helpful. For my second question, can you just talk a little bit more about your capital needs this year? I know, Brendan you mentioned no ATM issuance was included in guidance, but should we expect you to issue any additional debt this year? And how should we expect leverage to trend as we progress throughout 2023?

Brian Leary: Yeah, Blaine, it’s a good question. So we do have a lot of flexibility within the capital stack. So, as I mentioned in the prepared remarks no scheduled debt maturities until really the end of 2025. So, we have no need to be in the capital markets. However, we do have a lot of freely pre-payable debt that is outstanding. So the two options there are, one, I mean, we would like to have some of the non-core disposition proceeds come in the door. As Ted mentioned, that’s highly dependent on the investment sales market in terms of how much proceeds we get in the door there but that would be used to help pay down some of that debt. And then, I think we also have options with respect to longer-term financing to reduce the floating rate exposure that we have.

And on that we would be opportunistic. But I do think, it’s probably reasonable to assume that at some point It — I would say, it’s more likely than not that we’ll do some form of financing to term out some of the floating rate exposure that we have during this year. It’s just we’ll be opportunistic as to when and what form that takes.

Blaine Heck: Great. Thank you.

Operator: Next question is from the line of Georgi Dinkov with Mizuho. Please go ahead.

Georgi Dinkov: Hi. Thank you for taking my questions. So could you please walk us through the occupancy trajectory through the year? And what gets you to the low versus the high-end of the guidance?

Brendan Maiorana: Hey George, this is Brendan. I’ll start with that and maybe Ted and Brian will add in some color. So yes, I mean, as we talked about we obviously have the headwind from Tivity the 263,000 square feet. That’s in the first quarter so that’s 100 basis points. So we ended the year at 91%. And then you expect that number to go down in Q1 with Tivity and the backfill customer doesn’t commence — is not scheduled to commence until the beginning of 2024. And then, we have some other expirations that are — some move outs that will occur as well. We had a government user that was in soft term that gave us back a sizable amount of square footage. So that also is impacting us. And then, we have some leases that are queued up to commence into occupancy later in the year.

So with all of that, that’s where we think when we mix all that stuff together, we think we’ll end 2023 about 100 basis points lower than where we ended 2022. But keep in mind we’ll also have then as we start 2024 we will have the backfill customer for Tivity that will be in a sizable amount of that space. They do leg into that space over time but they’ll take the majority of their space at the beginning of 2024.

Georgi Dinkov: Okay. Great. And what was the size of the space that was given back to you?

Ted Klinck: This is Ted. Really we had a couple as Brendan alluded to. One of the government customer, they were — again, just to reiterate they’re in the soft term so they had the ability to terminate their lease on a reasonably short notice. I think it was a 90-day notice but it’s a 116,000 square feet in Atlanta and then they gave that back I think they gave mid-January. So that’s another big one for the majority of the year. And then, I’ll just mention one other one. Those are the only two above Tivity and the government tenant above 100,000 feet. We had about 120,000 square foot customer that we went through a merger here in Raleigh. And they downsized to 46,000 feet. So they gave us back early as part of the renewal long-term renewal they gave us back about 77,000 square feet effective January one of 2023.

So that’s a hit on the occupancy as well. Now, the good part of that story is we’ve already released 55,000 of the 75,000 square feet and with customers that will be starting throughout this year. So really those are the three big ones.

Georgi Dinkov: Great. That was very helpful. And just my last question, Can you talk about the sublet market. How is that trending in your markets and specifically in your portfolio?

Brian Leary: And George, Brian Leary here to take that question. So we’ve talked about this before and we are very much focused on the sublet activity the growth of it, the complexion of it. It looks different in certain cases not all of it is the same. And so where we see it growing, Raleigh is probably a market with the greatest amount of sublet space as a proportion of available space that’s kind of the headline. As you dig into that you realize that almost 60% of all the sublease space in a market like Raleigh is in one single area called the Research Triangle Park, which we don’t have any exposure to and have none in our market. And then — so what — the big thing is who’s leasing, who’s the sub-lessor and what are their motivations to write a check to move someone in there or how much term do they have left?

And so if you look within our portfolio from a sublet standpoint, the average wealth of our sub-lessor is north of six years if you even take out one user who’s got 14-plus years, it’s over four years. So we feel pretty good about the visibility and exposure that’s within the high risk portfolio. And then if you look at the general markets, Nashville is actually going down and we are part of that with folks backfilling. But it’s out there. When it gets — the ratio of available sublet space gets over 25% we have seen that that starts to impact rents. And Raleigh’s the place where that shows up. But other than that, most of the sublet amount has stayed stable quarter-to-quarter. It’s definitely up year-over-year I mean nationally and within our markets.

But quarter-to-quarter we haven’t seen a lot move.

Georgi Dinkov: Great. Appreciate the color. Thank you so much for the time.

Operator: Next question is from the line of Rob Stevenson with Janney. Please go ahead.

Rob Stevenson: Good morning guys. Brian you guys had north of $135 million of combined building improvements and second-gen expenses in 2022 and just shy of $120 million in 2021, what are you expecting in 2023 at this point given Tivity retenanting and other known spending?

Brian Leary: Hey, Rob, yeah that number is — I mean, it’s bounces around a lot. What I would say is, I think the leasing that we did is probably — I mean, that’s the hardest one to figure out. And I would say that we probably think leasing is likely to be reasonably stable. It depends a little bit on the volume of leasing and the nature of that leasing and things like that. We committed a little bit more in terms of dollars to leases in 2022 than what we spent. So I think our expectation is those things probably normalize. And we probably won’t be pretty steady on the leasing CapEx. And then usually the maintenance CapEx numbers are fairly steady as well. So I would guess we — and we — this is what we project that it will be pretty consistent 2023 versus 2022, but that is a hard number to gauge.

Rob Stevenson: Okay. And then given Ted’s commentary about the continued dislocation in the acquisition market are dispositions in 2023 likely to be back-end loaded? Do you have stuff teed up that could close in the first half of the year? How are you guys positioning that at this point?

Brian Leary: No I think you’re dead on. Obviously, we put a pretty wide range of zero to $400 million for our dispo range and it’s highly dependent on getting back to a stabilized fully functioning investment sales market. And I think we’re starting to see some green shoots that some encouraging signs, at least for other property types. I think office is going to trail that a little bit. I got a little bit more headwind, but we’re starting to see some positive things following maybe on the debt side so — which is good. So yeah, any dispose we do likely going to be back-end loaded. We’ve got a couple of buildings and a couple of land transactions that are in the market now that I’d say so far they’re going well. So that we may have a couple of things late this quarter — or late this first half of the year. And then anything else we do likely be heavily weighted towards the back half of the year.

Rob Stevenson: Okay. And then Ted, I mean any updated thoughts on the Pittsburgh portfolio and the potential sale now? Is that tabled for now? Is that more likely to be a 2024 transaction, or are you still thinking that that might wind up going to market this year?

Ted Klinck: Yeah. Look I think we can afford to be patient with Pittsburgh. There’s no real rush. And again until we get a fully functioning debt market and fully functioning investment sales market, I think it’s probably put on hold. We’ve hired the broker. We’re preparing it to market. We do want to sell. But in the meantime again, while we’re being patient, we’re seeing some really good leasing activity in Pittsburgh. So we’re going to try and take advantage of the holes we have there and button that up. But we’ll wait and see, but likely not going to be for a while.

Rob Stevenson: Okay. And then last one for me. Brian, you were talking about utilization before. Have you seen any change an uptick since the beginning of the year with more companies having a definitive plan with the date of January 1 coming back, or has it not been really noticeable and your markets?

Ted Klinck: No, I think it has Rob. That’s a great point and question. I think the big firms they’re not necessarily making decisions about moving or expanding. Some are putting stuff on the sublet market, if they’re contracting. They have a plan to get their people back in the office. They have their rhythm for the hybrid. And I think you all have seen a number of leaders, CEOs be pretty definitive on this. We’re a work-from-work company. It’s hard to manage by Hollywood squares things like that. And if you look at the again the makeup of our customer base, if you kind of go ahead and capture the small and medium customers, as I mentioned our bread and butter, which makes up a great majority, they have been back and they are back.

And then you look at the bigger users the corporates, the publicly traded, the folks in the financial services or what have you, they have their plan and we absolutely have seen it. I mean so much so as we’re working on how to exit the garages faster because now what we’ve done is we’ve been deliberately engaged with our customers, how do we kind of help them that Jerry Maguire scene help me help you, how do we help them with their return to work policy because they are committed that they are better together and they want to see their productivity increase. Their productivity increases when they’re in the building. So that’s kind of what we’re doing. We have kind of a campaign where we’re literally partnering with them specifically on recruiting and bringing their teammates back to the office.

Rob Stevenson: And where is utilization midweek for you across the portfolio these days?

Ted Klinck: Peers have been weak. I mean, I think those places that have the — you’ve heard the term commute worthiness that we talk about. And so those places that might have the higher commute burden to overcome, right? So interesting enough, while it’s considered itself the heart of the Sunbelt even Atlanta because of its greater commute times and distances is probably trailing the likes of Nashville. Pittsburgh, for sure, is a more traditional hub-and-spoke kind of commute model. But I would say, just Atlanta to some extent has kind of plateaued between 50% and 75%. Again, Monday — Tuesday, Wednesday, Thursday, we’ve absolutely noticed it. We look at the restaurant sales, the deli sales, the cafes; they’re much busier back to kind of pre-pandemic levels in terms of that activity.

Rob Stevenson: Okay. Thanks, guys. Appreciate the time.

Operator: Next question is from the line of Dave Rodgers with Baird. Please, go ahead.

Dave Rodgers: Yes. Good morning, everybody. Brian, I wanted to talk about rent a little bit and you talked about economic or effective rents earlier. Maybe they’re not where you’d love them to be, but they haven’t been terrible, but your average deal size has been about 10,000 square feet. So as you roll forward, is there any good evidence that you have now or that you’re starting to have negotiations on, were these bigger deals, say 50,000 to 100,000 or north of 100,000 square feet are getting done, where you’re seeing a substantially greater amount of pressure on rents or effective rents. It just feels like that comp could start to come out and maybe surprise us, but I’d love to know what you’re seeing on that front.

Brian Leary: Dave, haven’t really seen that yet. And I know, it probably — it just sounds like I’m just talking my book. But, I mean, our customers, even the bigger ones are, through a person, telling us that they want to get their people back. And they see the workplace experience as part of that. So right now, the rents are holding up. The free rent is absolutely there. I think, they’d like to finance their TI through higher rents. Again, not to go back like two years and first they’ve been listening to me for a while. I think I sound like a little bit like a broken record, but a lot of these organizations, while they are cost-focused for sure, 1% of what they spend every year is on utilities, 9% is on real estate, 90% is on people and they’re pretty focused on that 90%. And so, it obviously does have a connection to the 9%. So nothing yet to connect those days. Sorry for the long answer for fairly short yes or no. Ted, maybe a thought.

Ted Klinck: Yes. The only thing I’d add is, Landmark, we did that — to what third quarter of last year, over 200,000 square feet and the rent was pretty high on that space as well. It’s been interesting just looking at our portfolio and it sort of goes to the question. Last year, we only did nine leases greater than about 50,000 square feet, which I thought was an interesting stat. It’s just a lot of the small and medium-sized users, which, again, plays right to our portfolio.

Brian Leary: And that’s out of 425 deals, right? So that gives you an idea.

Dave Rodgers: And then, some of the larger deals you have talked about the backfill of Tivity, or the deal that you did in Richmond. The larger transactions seemingly have focused on suburban markets. Is that not enough data to make that conclusion or leap, or are you seeing that definitely happening where the larger tenants aren’t gravitating to Buckhead, but maybe are gravitating towards Riverwood, or something similar across your markets?

Ted Klinck: I don’t think there’s really been any — enough data points to know and some of it is on renewals, right? You can only renew the ones you have and it’s where the holes you have as well in your portfolio. So, obviously, Tivity, we had a hole, so we’re able to go aggressively try and backfill it. And then, some of the other ones. So it sort of just depends. But I will say, a blanket statement. I think we’ve said this before that, during the pandemic, we have seen a disproportionate leasing out in suburbs versus urban, but I don’t think there’s enough data points to say if there’s any trend, one way or the other.

Brian Leary: I think just to clip on and this is decades in the making where people live is where they like to work. And so there’s a great continue migration of homeownership and home buying by the millennials to the suburbs. And so I think the concept it’s not — commodity suburbs is not something that we think just because of some of the suburbs is competitive by any stretch. And so if you think about what we’ve talked about the repositioning of our assets in Brentwood and Cools Springs — Cools Springs which said repositioning landed backfill of that building. It’s about amenitizing walkable mixed use a place to get a cup of coffee a place to walk and grab lunch a place to workout outside. And we’ve been a fitness center and have collaborative workspace. So it’s — you just can’t drop it down someplace in the suburbs or even in town and expect that to solve your problems, but that’s — it’s what we’ve seen.

Dave Rodgers: And then last for me on the dispositions. Ted you mentioned in your last comment maybe some land and maybe not Pittsburgh as kind of a full exit this here. So what do you anticipate being able to sell this year? And I guess maybe the point of the question really is if you’re selling $400 million how dilutive is that relative to the debt cost as you think about late 2023 into 2024?

Ted Klinck: Sure. I’ll take maybe the first part and Brendan can jump in. So the mix of assets it is it’s a couple of land deals. And then we’ve got a couple of single tenant transactions in the market, but it’s going to be a mix of typically what we’ve done in the last two or three large transactions where we go out and sell — go out and buy an asset like we did in McKinney & Olive flex up a little bit and then pay off bring the balance sheet back down over time. So it’s going to be a mix of single tenant some land some multi-tenant assets. Again assets that maybe have a lower growth profile going forward. So it’s not unlike other stuff we’ve seen. Pittsburgh, it may be in there. We’ll see but it is a large transaction and larger deals are harder to get done these days in terms of dilution. Brendan do you want to take that?

Brendan Maiorana: Sure, Dave. So what I would say is, I mean, I think the marginal cost of borrowing on what we would pay off if you look at our forecast for 2023 you’re probably in the mid to kind of upper 5s. So you can, kind of, apply the cap rates that you think versus those numbers. What I would say is from a cash flow perspective, which is where we have focused. Clearly there’s CapEx associated with — on going CapEx associated with the assets that we plan to sell. When we pay down the debt all of that interest savings falls to the bottom-line. There’s no CapEx associated with that obviously. So from a cash flow perspective it’s much less dilutive. And then when we staple on to that the development deliveries that come online that’s where we do think over time our cash flows will continue to get better even with the planned dispositions that we have.

Dave Rodgers: Right. Thank you.

Operator: Our next question comes from the line of Dylan Burzinski with Green Street. Please go ahead.

Dylan Burzinski: Hi, guys. Thanks for taking the question. Just curious, sort of, if you can kind of touch on the development leasing pipeline and where it stands today?

Ted Klinck: Sure, Dylan. Good morning. Yes, let me just walk — maybe walk through each of them. And maybe I’ll start in order of when they deliver. So the 2827 Peachtree just a reminder that’s now topped out. It delivers third quarter of this year. So it’s come together nicely. And we do have a stabilization date of first quarter 2025 and that. At the end of the year we were 75% leased and we’ve got a couple I’d say very strong prospects to get us somewhere in the mid-80s prior to delivery so we feel good about that one. GlenLake III here in Raleigh also delivers third quarter of this year stabilization as first quarter 2025. We did — if you remember we started that with 15% pre-leased we have not signed anyone else throughout so far.

But I will say in the last call it even 60 days late last year rolling into this year activity prospect as we’ve topped off the building. You can now see the shell of the retail that we’re adding as an amenity come together that our activity has picked up pretty good. So we’re encouraged by that. The third one that delivers this year is the Granite Park VI. That’s as a reminder in the Plano, Frisco submarket 50-50 joint venture with Granite Properties a local sharpshooter that we’re thrilled to be partners with that delivers in the fourth quarter so sort of towards the end of the year 12% pre-leased. And that one has been interesting in that, I’d say, mid last year the activity was just off the charts. A lot of larger users we are chasing, and we’re moving down making progress with or some sort of progress.

And all of a sudden late last year or the third quarter the big users like we’ve all heard they sort of just press the pause button. So there’s still smaller activity. But again, incredibly well-located building and we’re encouraged by again by the looks how the building is coming together. And then the other two are 23Springs also with Granite that doesn’t get completed until first quarter 2025 stabilizes in 2028. And activity has been very, very strong there even though the delivery is a couple of years out. So we feel great about that. And then the fifth one just Midtown East, obviously, we’re just — we put the silt fence around it and we’ll be breaking ground in the next week or two with that one doesn’t deliver until 2025. And we’ve actually had — since we’ve had the fence go up we’ve had some inquiries on that, which I didn’t really expect.

Tampa is really not a pre-lease market. So we’ll see those are very early and haven’t even responded to some of the RFPs, but we’re getting some activity there. So, again, we feel good. We got a couple of years until we get that one done. Did that answer your question?

Dylan Burzinski : Yes. That was perfect. I appreciate the color on that. And then I guess just you mentioned Granite Park just a follow-up on Granite Park VI. Have you guys underwritten or underwriting expectations changed given sort of the drop-off in leasing activity, or just kind of how should we be thinking about that?

Ted Klinck: Not at all. Not at all. I think we feel very good about the underwriting. Again, we don’t stabilize that until I think first quarter 2026. So again, we’ve got plenty of time. There’s no rush here. We didn’t have a lot of pre-leasing coming in before the building was done. So we think we are pretty conservative. The proposals we’re putting out are well in line with our underwriting. So no we still feel very good about it.

Dylan Burzinski : Thanks.

Ted Klinck: Thank you.

Operator: Next question from the line of Peter Abramowitz with Jefferies. Please go ahead.

Peter Abramowitz: Yes. Thank you. I just want to ask what’s kind of built into your guidance in terms of the mark-to-market that you’re expecting for the year?

Brendan Maiorana: Hey, Peter, it’s Brendan. I would say, I mean, it’s on a cash basis we’ve been roughly kind of around flat for the pack really almost since the onset of COVID. So that’s probably a good marker and in the low double digits on a GAAP basis. So those are probably good markers. Again, a little bit difficult to forecast just given the mix of expirations and new lease signings and things like that. But I think if you use those guideposts that probably gets you to kind of where €“ that probably ought to be in line with what we’ve got included in our outlook.

Peter Abramowitz: Okay. Got it. And then I guess a slightly different way of asking something that was asked earlier, but a lot of your coastal competitors have talked about a pickup in activity pretty meaningfully since the New Year. Are you seeing any signs of that in your markets and €“ or generally kind of any signs of an inflection in terms of business confidence and business leaders being more willing to make decisions, or is it still kind of the same that they’ve been for the past year or so?

Brian Leary: Hey, Peter. Brian here. So a couple of things to that kind of comparison. Our markets, our submarkets or BBDs are buildings we’re already ahead of that curve. So that’s kind of the first thing. But €“ so again, our smaller and medium-sized and particularly suburban were first back then they came back kind of across the board. Now the start of this year, I do think the bigger corporates, the ones that you’ve read about their CEOs saying that they want to get their folks back. We have absolutely seen that. Now what the great thing I think and we hope that this is the case, the issues around the pandemic, which still were hovering a year ago just as a potential back, those are really kind of abated in terms of the reason why folks are not coming back.

So I think that’s a good thing. Hopefully, that’s in the rearview mirror. We have been a fairly consistent, ahead of the curve, that curves continue to go up, peak occupancy is Tuesday, Wednesday, Thursday for sure, Fridays are quiet, you’re seeing more on Mondays than you did at the end of last year. But I do believe that to a company there is a plan now that folks are back in the office three days a week.

Peter Abramowitz: All right. That’s it for me. Thank you.

Operator: We have a follow-up from Camille Bonnel, Bank of America. Please go ahead.

Camille Bonnel: Hi. I just have one follow-up. Given the big debate on whether the weakness of CBD urban office is temporary or not, can you remind us of the breakdown of the urban versus suburban in your portfolio? And within that are you seeing any clear distinction between the operating performance between the two, whether it would be leasing activity, occupancy or rents?

Brendan Maiorana: Hey Camille, it’s Brendan. So, yes, I mean I would say I mean from a CBD — we kind of classify it in three different ways. So, CBD, infill, and suburban. So, suburban, they’re not quite evenly distributed. You might have a little bit maybe suburban is about a quarter infill is — and then evenly split between infill and CBD. So, that’s kind of the portfolio breakdown in terms of maybe in terms of performance. I’ll let that over to Brian or Ted to answer that.

Brian Leary: Camille just to add on. And our CBDs are fundamentally different from a CBD of the gateways. So, our customers and their teammates who are commuting to our CBDs on the whole are not spending an hour on the train each way. So, our CBDs have a different kind of complex. I keep using that term. Now, as I mentioned earlier those regions that do look more like a gateway in terms of longer commutes and kind of that hub-and-spoke from the burbs and then back out again, they are looking more like kind of the coastal gateways in terms of the return. But to Brendan’s point the CBD, infill, and suburban kind of nature of how we break out our markets; infill, that’s basically a Buckhead in Atlanta if you know that. It has a solid residential base with incredible incomes and educational attainment.

Then what happened is they added the shops and restaurants for that high net worth population to service. And then because they already live there and they played there, they wanted to work there. And so that’s Buckhead, that’s South Park Charlotte, that’s North Hills here in Raleigh. So, that is a little bit of a nuance between the CBD, within the Highwoods Sunbelt portfolio and a CBD analog to the gateways of coastals.

Camille Bonnel: Thank you.

Operator: Thank you. We have no further questions on the phone line.

Ted Klinck: Well, thanks everybody for joining the call today. We appreciate your interest in Highwoods and we look forward to talking to you all again soon. Thank you.

Operator: That concludes today’s call. We thank you for your participation and ask you to please disconnect your lines.