Image source: The Motley Fool.
City Office REIT Inc (CIO -1.08%)
Q3Â 2019 Earnings Call
Nov 1, 2019, 11:00 a.m. ET
Contents:
- Prepared Remarks
- Questions and Answers
- Call Participants
Prepared Remarks:
Operator
Good day, and welcome to the City Office REIT, Inc. Third Quarter 2019 Earnings Call and Webcast. [Operator Instructions]
It is now my pleasure to introduce to you Mr. Anthony Maretic, the Company's Chief Financial Officer, Treasurer, and Corporate Secretary. Thank you, Mr. Maretic. You may begin, sir.
Anthony Maretic -- Chief Financial Officer, Secretary & Treasurer
Good morning. Before we begin, I would like to direct you to our website at cityofficereit.com, where you can download our third 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. Although the Company believes that these expectations 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 third 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.
James Farrar -- Chief Executive Officer and Director
Good morning. Since our last earnings call in August, we've been actively taking steps to position City Office for long-term success. During the quarter, we capitalized on strong equity and debt capital market conditions to significantly improve our balance sheet. We've also continued to source attractive acquisition opportunities, which will drive long-term performance. In addition, leasing momentum and healthy same-store results have continued across our portfolio. With my comments today, I'd like to speak to each of these major components of our results this quarter.
Starting with our recent capital raising activity, the combination of strong equity market conditions and outperformance of our common stock year-to-date allowed us to access equity capital at our highest pricing to-date. Between shares issued through our ATM program, during the third quarter, and a follow-on offering in early October, we raised just over $200 million at an average gross issuance price of $13.56 per share. This was an important step as it allowed us to secure capital for portfolio growth and diversification, but it also will reduce our fully deployed leverage level.
Separately, we took advantage of the drop in interest rates over the summer to renegotiate loan terms on approximately $88 million of property level debt. Tony will provide more details shortly, but these steps will generate meaningful savings over time.
Moving to our recent acquisitions and pipeline. We closed a $49 million acquisition in Denver, during the quarter called 7601 Tech. This six-story building is located in the Denver Tech Center submarket of Southeast Denver, adjacent to our existing property, 7595 Tech, which we previously called DTC Crossroads. We've combined the two properties into a 380,000 square foot amenitized campus that features a full suite of attractive and recently built-out amenities. This enhances the profile of both buildings and provides us leasing flexibility as tenants grow or contract within the two buildings.
In addition, we will be further amenitizing the properties and if consolidated the leasing execution with one of the best leasing teams in Denver. 7601 Tech was 95% leased at the time of acquisition with a weighted average lease term remaining of 7.5 years when including committed leases. The building has had strong recent leasing success and the tenancy is anchored by Jackson National Life Insurance Company and a well-capitalized public company.
Our third quarter occupancy for 7601 Tech shows as 80%, as one of the tenant signed a lease to expand into new space and they are expected to physically occupy the space late in the fourth quarter of 2019 or early 2020. We acquired the property at a 7.1% cap rate and expect it will produce solid long-term results.
Behind 7601 Tech, we continue to evaluate a broad pipeline in excess of $750 million. Given the typical timeline of a closing process, we don't expect to have any further acquisitions in 2019. We're focused on executing on the pipeline and are targeting between $320 million and $360 million of new acquisitions. On a related note, we have two smaller dispositions in process in Denver, one of which is a land parcel adjacent to our Circle Point property, and the other is our Logan Tower property. The buyers deposit on the Circle Point land parcel is non-refundable. We will provide further details on our next earnings call.
Turning to our operating performance during the quarter. We continued the trend of robust same-store cash NOI growth with 5.8% growth for the quarter year-over-year. This brings our year-to-date same-store cash NOI growth to an impressive 4.5%. Our occupancy decreased from 93.4% to 91.2% during the quarter, which is a little bit misleading as far as our actual performance. I mentioned earlier that our new acquisition, 7601 Tech, is 95% leased, but one significant tenant does not technically occupy the space yet. This brought down the reported occupancy at this property to 80% and lowered the combined portfolio occupancy by about 0.5% at quarter end, despite 7601 Tech being leased long-term.
Further, we had approximately 190,000 square feet of vacates during the quarter. These were known vacates that we mentioned on previous earnings calls or were necessary as part of our Camelback Square, repositioning at higher market rents. These move-outs in Q3 will be offset by the 114,000 square feet of new leases that are signed and committed, but not yet an occupancy. The vast majority of these committed leases are expected to commence in Q4, although the timing of the construction of tenant suites could straddle year-end.
Notably, during the quarter, we signed a 30,000 square foot lease at our 7595 Tech property, which is a significant step in leasing the attractive blocks of vacancy at that property. We therefore expect portfolio occupancy to pick back up in Q4, and we've provided updated guidance of over 92% at year-end.
In conclusion, the net effect of the transactions that I discussed and the impactful balance sheet enhancements that Tony will detail, have positioned City Office to take advantage of opportunities in our thriving markets. Management's focus continues to be on intelligently investing our capital, enhancing our balance sheet and driving NOI growth. We believe these steps will increase net asset value for our investors and increase our share price over the long-term.
And with that, I'll turn the call over to Tony to provide further details on our financial results.
Anthony Maretic -- Chief Financial Officer, Secretary & Treasurer
Thanks, Jamie. On a GAAP basis, our net operating income in the third quarter was $24.6 million, this represents a $2 million decrease relative to the $26.6 million reported in the second quarter. The decrease was primarily attributable to a $2.6 million one-time assignment fee income reported in the previous quarter. Without the one-time fee in the previous quarter, NOI would have increased by approximately $600,000, which was driven by the acquisition of 7601 Tech late in the third quarter and NOI growth from our same-store portfolio.
The gross assignment fee income received of $2.6 million was recorded within rental and other revenue in the second quarter. For accounting purposes, the outlays and expenses were classified in G&A as one-time costs. Those costs were approximately $1.1 million, resulting in a net $1.5 million benefit in the previous quarter. Overall, we reported core FFO of $12.4 million or $0.29 per share, which was $1.3 million lower than the second quarter. As I mentioned, the second quarter included a $1.5 million benefit from the net assignment fee income, with an offsetting increase attributable to the year-to-date acquisitions. G&A was also slightly higher in the quarter, partly due to higher costs related to our first year being subject to auditor attestation under Sarbanes-Oxley.
Our third quarter AFFO was $9.3 million or $0.22 per share. Excluding the impact of the higher share count from our capital raising activity, our AFFO would have been right on top of our $0.235 dividend. Our third quarter AFFO was affected by the tenant improvements and leasing commissions associated with our leasing activity in the quarter. Due to the relative size of our portfolio and the impact of significant leasing in any one quarter, our AFFO numbers will continue to move around some from quarter-to-quarter.
Our leasing activity and capital expenditures are provided on pages 17 and 19 of the supplemental package. Consistent with our definition of AFFO, we have excluded some first generation leasing costs, the largest of which relate to our recently acquired Canyon Park property. Further details are disclosed on Page 19 under non-reoccurring capital expenditures.
Our third quarter same-store cash NOI grew 5.8% year-over-year or 4.5% for the first nine months of the year as compared to the same period in the prior year. Orlando, Portland and San Diego were our best performing markets in the third quarter, each with double-digit same-store cash NOI growth, which was primarily driven by combination of occupancy gains in those markets, free rent burn off, and mark-to-market or step up in rents. With the slight decrease in occupancy we experienced at the end of Q3, we expect same-store growth to remain positive but moderate in the fourth quarter.
Moving on to our balance sheet. Our total debt, net of deferred financing costs, at September 30th was $652 million. Our net debt to enterprise value ratio was reported at 43.5%, but that figure does not include the additional 6.9 million shares issued in early October. Including the proceeds from that offering, net of underwriting discounts, our net debt to enterprise value is closer to 37% today.
During the quarter, we also took advantage of a drop in interest rates to renegotiate loan agreements on four of our properties. The annual savings from those renegotiations will result in initial annualized interest expense savings of approximately $800,000, and this was achieved without incurring any prepayment penalties.
We also expanded our unsecured credit facility to $300 million by entering into a $50 million five-year term loan. Simultaneously, we entered into a $50 million five-year swap arrangement. The term loan is priced off of LIBOR, so the swap fixes a 30-day LIBOR component of the borrowing rate at 1.27% for the five-year term of the term loan. At quarter end, the LIBOR swap effectively fixed our term loan interest rate at 2.67%. Given the positive differential in rates, the unrealized gain from this hedge is reflected in our 10-Q in comprehensive income.
As a result of those balance sheet transactions, we lowered our overall weighted average interest rate on our total debt portfolio to 3.99% at quarter end versus 4.22% at the end of the prior quarter. At quarter end, and including the swap agreement I discussed, 93.4% of our debt was effectively fixed and had a weighted average maturity of 5.6 years.
Finally, in our third quarter earnings release, we provided updates to our previously issued 2019 guidance. The updated full-year guidance primarily reflects the higher share count from our share issuances and interest savings through to the end of the year. Based on these assumptions, we are anticipating core FFO between $1.17 and $1.19 per share for the full year ending December 31, 2019. Excluding the impact of share issuances, the updated range would have been between $1.24 and $1.26, which is at the higher end of our previous guidance. Further, we continue to expect same-store cash NOI growth between 4% and 5%. A full set of revised guidance estimates and underlying assumptions is provided in our third quarter press release.
That concludes our prepared remarks, and we will open up the line for questions. Operator?
Questions and Answers:
Operator
Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question today will come from Michael Carroll of RBC Capital Markets. Please go ahead.
Jason Idoine -- RBC Capital Markets -- Analyst
Hey guys, good morning. This is Jason on for Mike. I'm wondering about the 7601 Tech acquisition. Just curious what other type of capital is chasing that asset and also if that was a marketed deal?
James Farrar -- Chief Executive Officer and Director
Thanks for the question. Yes, it was a marketed deal. It was fairly competitive. I think we had a good advantage given that we own next door and clearly knew the market well and it was a pretty large private REIT that sold it, but it was a very competitive process.
Jason Idoine -- RBC Capital Markets -- Analyst
Got you. And then are you expecting any leasing synergies now that you guys have kind of built out a little cluster there?
James Farrar -- Chief Executive Officer and Director
As part of what we were doing, it really was helpful to put together in an amenitized campus. So we're taking a few steps there. One, the building we acquired had a great food offering. We have recently built out in our other building, fitness, shared amenities, conference. So combining them all provides a much better package. And so, as part of that, we've reawarded the leasing on that to the team that was leasing 7601, who's done a fabulous job. So we do think there's going to be some synergies and advantages there, particularly some of the tenants in that building are rapidly growing. It might be a good candidate to grow into our buildings.
Jason Idoine -- RBC Capital Markets -- Analyst
Okay, great. And then moving away from DTC. Could you provide an update on leasing FRP and Sorrento Mesa, and then any trends that you're seeing in those markets?
Anthony Maretic -- Chief Financial Officer, Secretary & Treasurer
Sure. So this is Tony here. So FRP Collection, we effectively have backfilled the space that was vacated by Meters [Phonetic] -- sometime ago in the [Indecipherable] were moving into occupancy. At quarter end, FRP Collection was effectively 89% and we have another tenant moving in in Q4.
James Farrar -- Chief Executive Officer and Director
In terms of Sorrento Mesa, we still do have one building, Life Sciences that is vacant. A few prospects looking at that. We've completed the majority of our cosmetic work. We've built that kind of a centralized amenity campus. So we're in good shape there. The market is extremely strong there as well as far as rents. So the value of the vacancy is very significant to us.
Jason Idoine -- RBC Capital Markets -- Analyst
Got it. Thank you, guys.
James Farrar -- Chief Executive Officer and Director
Thank you.
Operator
The next question today will come from Rob Stevenson of Janney. Please go ahead.
Robert Stevenson -- Janney Montgomery Scott -- Analyst
Good morning, guys. Jamie, how are you thinking about market concentrations these days when you're evaluating the $750 million of deals. Phoenix and Denver now over 20% of rent if you get Camelback in Denver Tech lease and Tampa isn't far behind. Is that about where you sort of want to keep things in those markets and maybe you trade-in and out of assets, you know are you comfortable going into 25% or even 30% exposure in the market these days?
James Farrar -- Chief Executive Officer and Director
It's a good question, Rob. So if you look at few of our markets, we've got a lower weighting toward Seattle and Portland, but generally we're very comfortable with what we have. We're just slightly over 20% in both Denver and Phoenix. Would we be comfortable going a little higher based on getting some great quality assets? Yes, but that's right around where we want to be long-term on the upper end. So our focus is continuing to find great acquisitions in some of our other markets. We continue to look at a couple of similar markets, we've discussed in the past as well, and build out product portfolio.
Robert Stevenson -- Janney Montgomery Scott -- Analyst
Okay. And any incremental known or likely move-outs that have come to like this quarter?
Anthony Maretic -- Chief Financial Officer, Secretary & Treasurer
Hey, Rob. It's Tony here. So in Q4, we do expect approximately another 50,000 of known vacates that will take place during the quarter. Now some of that actually already been backfilled, but there are 50,000 square feet of known vacates, Q4.
Robert Stevenson -- Janney Montgomery Scott -- Analyst
Okay. But it's a large -- is much -- is there -- looking into 2020, is there anybody who's like given you notification in the last 90 days or 100 days or so that of note?
Anthony Maretic -- Chief Financial Officer, Secretary & Treasurer
Yeah, no real change in the last 90 days, I'd actually say that. On previous calls, we've talked about, we have seven tenants that are greater 3,000 square feet that are rolling next year. And on previous calls, we talked about having high confidence in renewals on at least four of them. We would probably bump that number to five based on recent positive discussions. And then, we do have a couple of the known or expected vacates in 2020, they're both in the back half of the year, and both of them may be -- may do short-term extensions. So looking pretty good for 2020.
Robert Stevenson -- Janney Montgomery Scott -- Analyst
Okay. And then lastly, Tony, any known difference between NAREIT and core FFO in fourth quarter at this point?
Anthony Maretic -- Chief Financial Officer, Secretary & Treasurer
So known and NAREIT, so you're talking about our -- our only adjustment for FFO is, as you know, we use core FFO definition which backs out the stock-based compensation, which is a non-cash item. That's really the only adjustment we have. Did I understand your question, Robert?
Robert Stevenson -- Janney Montgomery Scott -- Analyst
Yeah, I just wanted to make sure that there wasn't anything either from some of the debt refinancings or anything else that's like a one-time thing that we need to be cognizant of -- that would be in core FFO -- that would be added back for core FFO, that wouldn't be for NAREIT.
Anthony Maretic -- Chief Financial Officer, Secretary & Treasurer
Fair question. It's actually a good point worth mentioning, because I did talk about the refinancings. We did manage to do all of those refinancings without actually incurring any prepayment penalties. So no prepayment penalties are expected.
Robert Stevenson -- Janney Montgomery Scott -- Analyst
Okay. Thanks guys. Appreciate it.
James Farrar -- Chief Executive Officer and Director
Thanks, Rob.
Operator
Our next question today will come from Bill Crow of Raymond James. Please go ahead.
Bill Crow -- Raymond James -- Analyst
Thanks and good morning. Hey guys, any updated thoughts toward co-working exposure and maybe your thoughts going forward on that sector?
James Farrar -- Chief Executive Officer and Director
It's something we've been looking a lot, Bill. So we have no exposure to rework. We do have a few regions, offices that are very well occupied. There's nothing really significant across our portfolio, then we have a couple smaller regional again when you look at the occupancy levels they have. They are high and the space build-out is great. So we have no concerns within our portfolio.
Bill Crow -- Raymond James -- Analyst
All right. And then, I guess home court advantage here. I saw that your -- your Tampa partner in the downtown building just acquired an office asset in Carillon, which you also own and I'm just wondering whether they reached out to you for potential partnership in that building?
James Farrar -- Chief Executive Officer and Director
That was on the table early on, given the vacancy in that particular building. It was not something that we wanted to partner and within CIO. So that was not something we explored.
Bill Crow -- Raymond James -- Analyst
Okay, great. Thank you.
James Farrar -- Chief Executive Officer and Director
Thanks, Bill.
Operator
Our next question today will come from Craig Kucera of B. Riley FBR. Please go ahead.
Craig Kucera -- B. Riley FBR -- Analyst
Hey, good morning guys. Given that you still have a handful of loans that are priced, kind of, in the mid 4%. Are there any other opportunities to maybe work on those as well to bring them down to what you achieved in the third quarter?
Anthony Maretic -- Chief Financial Officer, Secretary & Treasurer
That's a good question, Craig. Just to give you a little bit more color. So when interest rates kind of start to fall and there was that opportunity, we looked at our entire portfolio. We focused on and we had a couple of loan that had no prepayment penalty, and a couple of them were actually at the same bank that had some prepayment penalties. We managed to negotiate reductions and a waiver of those prepayment penalties.
The other loans within our portfolio that we have a little bit of higher rates have substantial prepayment penalties. We've made some inquiries but were unsuccessful and sort of moving the dial in that. So that's a long way of saying. I think we've taken advantage of the opportunity as best we can. And the remaining ones, the prepayment penalty is probably too prohibitive for us to make sense.
Craig Kucera -- B. Riley FBR -- Analyst
Got it. And just going back to your commentary on sort of your acquisition pipeline and what you're looking to do with the equity that was raised. Is it fair to say, are you guys going to shoot to do something on the order of $320 million to $360 million next year or is that sort of over time that's where you see putting that money to work?
James Farrar -- Chief Executive Officer and Director
Yeah, based on where we are, it's beginning of November, timing of transactions. We don't see anything meaningfully impact in Q4. So our own internal plan is to start taking advantage in closings early 2020 with full deployment on the back half of 2020.
Craig Kucera -- B. Riley FBR -- Analyst
Got it. And just as we think about leverage in general going forward, I guess, just sort of the back of the envelope math is about 40% leverage on this around the capital. Is that sort of how we should think about the company moving forward as far as sort of a target leverage on new acquisitions and sort of gradually bringing on leverage?
Anthony Maretic -- Chief Financial Officer, Secretary & Treasurer
Hey, Craig, I think you're about right. I've talked about that in the past. I've used the term low-40s. So as we're penciling it out, our own math was kind of between 40% and 45% on this acquisition capital. It will depend a little bit on the chunkiness of the acquisition. I can't time it or size it perfectly, and a little bit may be determined by the cap rates so that we are ensuring we're getting sufficient NOI. So low-40s, certainly, I would agree that's the right number to use.
Craig Kucera -- B. Riley FBR -- Analyst
Got it. And I think you mentioned this in your commentary, but it sounds like there was a lease that got picked up at 7595, what was that number and kind of where were the rents?
James Farrar -- Chief Executive Officer and Director
So 30,000 feet, so it's a full floor. Now there is a tenant that's about half of the floor that there that's going to roll, that Tony mentioned in the fourth quarter. So we backfilled that and taken up the rest of the space on that floor. The rate we negotiated was $2,650 [Phonetic] starting rental rate.
Craig Kucera -- B. Riley FBR -- Analyst
Okay. And I know that market for quite a while, it's been a little slow, and I think you even alluded to the Denver Tech Center being a little slow. Are you start seeing better activity there now and was that sort of what led you to maybe double down in that market?
James Farrar -- Chief Executive Officer and Director
Yeah, it was something we looked at a lot, Craig. So we think by having the campus, it really positions our building well, so high quality, food amenities, fitness, conference, large outdoor integrated space. If you look at who is winning a lot of the major leasing activity over the last little while, it was this particular building that we bought. And so they basically fully backfilled it and they did that by having really built-out space that was move in ready. So that's something we're probably going to explore going into next year as advancing the quality of the vacancy that we have, building some spec suites, bringing that same leasing team that had a lot of success, moving them over onto our property. And so, we think there's a lot of synergies there, but for sure that market has strengthened a lot.
Craig Kucera -- B. Riley FBR -- Analyst
Okay. Thanks.
James Farrar -- Chief Executive Officer and Director
Appreciate the question.
Operator
[Operator Instructions] Our next question today will come from Mitch Germain of JMP Securities. Please go ahead.
Mitchell Germain -- JMP Securities -- Analyst
Yeah. Hey guys. Portland 6%, Seattle 3%, when you talk about a deal pipeline of $750 million, is there a concerted effort to possibly grow further in some of those markets, where you have less scale?
James Farrar -- Chief Executive Officer and Director
Absolutely. The challenge we have at some of those markets is the valuations are just at a point where -- you're hitting a lower percentage. It's harder to buy well and make the math work. If you look at our pipeline, really it is a mixture of some smaller transactions, a couple larger, and then a couple of portfolio that our substantial size that would give us significant scale in some markets that we don't have exposure to or minimal exposure. So I think there is a way for us hopefully accelerate the growth in a few of those particular markets that we're feeling really good about.
Mitchell Germain -- JMP Securities -- Analyst
And then, Jamie, just on that point. When you talk about your pipeline and your underwriting, have you made any real shifts in the way that your underwriting to maybe account for, kind of, later cycle or anything that -- or is it really market-by-market that you're kind of looking at these assets?
James Farrar -- Chief Executive Officer and Director
We've made a lot of shifts over the last year or two, I would say, as far as how we underwrite assets. So generally we've been seeing a lot of growth in rents. And over long-term goals, we're not expecting that that's going to be there every year. That has been, but we're pricing accordingly that there are going to be setbacks, you are later in the cycle. There's going to be some pullback in rents and we're making sure we're pricing assets accordingly so that, if that happens, we're still hitting our business plan. And if it doesn't happen for a long time, we're going to exceed our business plan, but we want to make sure we're comfortable in any market for the types of underwriting that we're doing.
Mitchell Germain -- JMP Securities -- Analyst
Great. Last one from me. Tony, just to understand the leverage. I know you've talked about, I guess, it was debt to EV and what that is post equity raise? Is it just assuming kind of back of the envelope, post equity raise that your debt to -- net debt to EBITDA that gets achieved by about a full turn. Is that the way to think about it?
Anthony Maretic -- Chief Financial Officer, Secretary & Treasurer
I think somewhere between half a turn, full turn. So even before we are kind of high-7s. I'm now kind of guiding to low-7s in terms of the adjustment post deployment. But again, a lot of that will depend on the acquisitions and what the initial cap rates going into those acquisitions are. But it should move down significantly.
Mitchell Germain -- JMP Securities -- Analyst
Great. Thank you.
James Farrar -- Chief Executive Officer and Director
Thanks, Mitch.
Operator
Ladies and gentlemen, this will conclude our question-and-answer session. At this time, I'd like to turn the conference back over to Mr. Jaime Farrar for any closing remarks.
James Farrar -- Chief Executive Officer and Director
Thanks for joining us today. We look forward to updating you further on our next call. Good bye.
Operator
[Operator Closing Remarks].
Duration: 31 minutes
Call participants:
Anthony Maretic -- Chief Financial Officer, Secretary & Treasurer
James Farrar -- Chief Executive Officer and Director
Jason Idoine -- RBC Capital Markets -- Analyst
Robert Stevenson -- Janney Montgomery Scott -- Analyst
Bill Crow -- Raymond James -- Analyst
Craig Kucera -- B. Riley FBR -- Analyst
Mitchell Germain -- JMP Securities -- Analyst
