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City Office REIT Inc (NYSE:CIO)
Q1 2021 Earnings Call
May 7, 2021, 11:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning and welcome to the City Office REIT Incorporated First Quarter 2021 Earnings Conference Call [Operator Instructions]. As a reminder, this conference call is being recorded.

[Operator Instructions] 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.

Anthony Maretic -- Chief Financial Officer, Secretary & Treasurer

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. 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 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'll 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 & Director

Good morning. Thanks for joining today. I'm pleased to report that our results for the first quarter and our expectations for the balance of 2021 are trending positively. For the first quarter, we reported strong core FFO and AFFO growth. Our dividend was well covered by these metrics and we continue to expect to generate cash in excess of our dividend over the long term.

Our rent collections were solid, once again, with almost 100% collection. We've exceeded 99% collection of contractual base rents in every quarter since the start of the pandemic. Further, of the $331,000 of rent deferrals that we granted in 2020, we have been repaid 84% to-date and expect to receive the balance before the end of the third quarter. Bottom line, the health of our tenancy is strong and collections continue to be excellent.

We also achieved 5% same-store cash NOI growth compared to the first quarter last year. This was driven primarily by prior leasing at our Denver Tech property and the substantial mark to market renewal at one of our life science properties in San Diego.

Other highlights of the quarter include the sale of our Cherry Creek property in Denver, and the 93,000 square foot renewal and expansion at our Carillon Point property in Tampa. We announced both of these events on our last earnings call, but the execution is worth noting again. The $95 million sale of Cherry Creek represented a 5.8% cap rate, and generated a $47 million gain, the largest gain on sale in our Company's history.

The lease at Carillon Point was with Paychex, our largest tenant at the property that we secured an eight-year renewal on 78,000 square feet and a 15,000 square foot expansion commencing early in 2022. To touch on some other leasing metrics, over the last 12 months, we have achieved a healthy lease renewal rate of 77%. Of note, the first quarter of 2021 was also our strongest quarter for new leasing since the start of the pandemic.

We signed 72,000 square feet of new leases, including five expansions and three leases of over 10,000 square feet. We see this as a great start to the recovery. Overall, we are feeling increasingly more optimistic about the timing of a major return to the office. Based on our tenant discussions, the combination of vaccination levels and a full return to school for kids is giving us confidence that we will see higher utilization levels post Labor Day. We anticipate, this will further stimulate new leasing activity.

Further, we continue to believe that the strength of our Sunbelt cities will position us well over the long term. However, we do expect an element of tenant turnover as some companies will elect to reduce their space needs. As detailed in our press release, Toyota Motor Credit Corporation who lease 133,000 square foot building at our SanTan property in Phoenix accelerated their lease maturity by two years through August 31st, 2022.

Toyota will continue to pay full rent until then, and have paid a $3.8 million termination fee, representing approximately half of the rent that would have been due over the accelerated two-year period. While we had of course hoped that Toyota would remain a tenant long term, we are well positioned with over 16 months of lead time to secure a replacement tenant in a great city. Chandler is one of the most desirable submarkets of Phoenix, for large corporate and technology tenants due to the abundance of professionals that live there, the strong demographics, and the high quality of life.

Turning to acquisitions. Transaction volumes in our markets continues to be slow. However, core and stabilized buildings are still trading at strong valuations with a lot of private capital looking for investment opportunities. We are actively searching for potential acquisitions but the options for attractive entry points have been limited. However, we secured an off-market acquisition opportunity to purchase two properties adjacent to our existing Sorrento Mesa Holdings in San Diego for $43 million. We waived our due diligence conditions on this transaction and expect it to close later this month.

We're very excited about the incremental value that this purchase creates for our portfolio. To provide investors with a better perspective, we've included a slide in our May investor presentation on our website. That includes a map of our holdings. Effectively, we are buying two smaller office buildings, located on highly valuable infill development land contiguous with our own properties.

The combination with our properties produce two solid development sites that generate holding income as we progress strategic options. In total, these two sites including our own land are zoned for over 1 million square feet of life science development. Of note, when you look at the map in our presentation, you will see that both of these development sites have a fantastic location directly across the street from Qualcomm's world headquarters campus.

As we've mentioned in the past, the life science sector continues to be very attractive. San Diego is one of the top three life science markets across the United States and vacancy hit a record low of 4.3% at the end of the first quarter. At the same time, rents continue to grow to new highs. CBRE's 2020 data showed that San Diego's life science rental rates grew by 7% in 2020 and an impressive 96% over the last 10 years.

Upon closing this purchase, we intend to operate the existing buildings to maximize cash flow and are holding income. We're considering all of our options, including participating in a phase development with an experienced partner. In the meantime, we are excited to further build one of the dominant holdings in Sorrento Mesa.

And lastly, for me, as we head into a busy spring and summer, management is focused on driving cash flow growth and completing strategic leasing across our portfolio. We have a number of exciting opportunities that we're working on and we look forward to providing updates in the future.

I'll now turn the call over to Tony to provide further detail on our financial results.

Anthony Maretic -- Chief Financial Officer, Secretary & Treasurer

Thanks, Jamie. I'll address the first quarter's results and then provide an update to our guidance for the balance of 2021. Our net operating income in the first quarter was $25.4 million, which was $200,000 higher than the $25.2 million we reported last quarter. The increase was the result of a combination of factors.

We had an increase in NOI at our Carillon Point property as a result of the straight line rent increase from the major lease we signed in the quarter, which Jamie described. We had lower operating expenses in the first quarter at a number of our properties and we recorded slightly higher termination fee income. In the aggregate, these positive variances more than offset the reduction in income from the Cherry Creek sale midway through the quarter.

As Jimmy discussed, Toyota paid us a termination fee of $3.8 million related to the SanTan property. We recorded just $57,000 of this amount during the first quarter. A total of $2 million will be recorded in the remaining three quarters of 2021 and $1.75 million will be recorded in 2022.

We reported core FFO of $14.5 million or $0.33 per share, which was $400,000 higher than in the fourth quarter for the same reasons that NOI was higher. Our first quarter AFFO was $11.2 million or $0.26 per share. The largest impact to AFFO was a $1.3 million leasing commission paid on the Paychex's eight year renewal and expansion at our Carillon Point property.

Our first quarter same-store cash NOI growth was a positive 5% as compared to the first quarter last year. The leases we signed in 2020 particularly those at Denver Tech property and our life sciences portfolio are the biggest drivers to these results combined slightly lower property operating expenses over the prior year. Our total debt at March 31st was $573 million, which was $104 million decrease over our year-end figure. That decrease was primarily a result of the repayment of an $83 million loan with the proceeds from the sale of Cherry Creek during the quarter.

Our net debt including restricted cash to EBITDA was a healthy 6.0 times. At quarter end, our total debt had a weighted average maturity of 4.7 years and 91% of our debt was effectively fixed. Our weighted average interest rate is now 3.7% and we have no property debt maturities until 2023.

Last, we have provided updated full-year 2021 guidance in our press release. The primary drivers of the guidance changes are the termination fee income, a reduction to our general provision due to strong rental collections, and the acceleration of our acquisition timing.

These operational updates positively impacted our forecasted net operating income, core FFO, and same store cash NOI growth. We refer you to the material assumptions and considerations set forth in our earnings press release.

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

Questions and Answers:

Operator

We'll now begin the question-and-answer session. [Operator Instructions] Our first question comes from Rob Stevenson with Janney. Please go ahead.

Rob Stevenson -- Janney Montgomery Scott LLC -- Analyst

Good morning, guys. Jamie, what's the plan for Sorrento Mesa post-closing of this acquisition? Do you lease up the current vacancy? Do you now, with the incremental development capability and the ability to put larger office there, do you market this to a large user with the build-to-suit element here and keep the vacancy and hold that back for somebody who is going to occupy 0.5 million square feet or something like that? How are you guys thinking about that at this point?

James Farrar -- Chief Executive Officer & Director

Sure, Rob. So, there is a couple of elements there. One in our existing portfolio, we have one building it's 59,000 square feet that's vacant and action on that, it's starting to pick up as far as prospects and we're feeling pretty good about that. So that's one. We want to get leased up. That's a pretty sizable increase in our overall cash flow by doing that.

When you look at the development land, we're early days, I'd say. We're looking at all of our options there. What we know is, by adding these two other properties, we've created two really solid development sites that have a lot of value and potential and kind of all options are on the table, including participating in a phased development with an experienced developer.

Rob Stevenson -- Janney Montgomery Scott LLC -- Analyst

Okay. And then, Tony, in terms of the comments earlier about potential downsizings et cetera, any incremental move-outs that are known at this point or downsizings of note that we should be aware of this year or early next?

Anthony Maretic -- Chief Financial Officer, Secretary & Treasurer

Yeah, hey Rob. To address that question, the first one to make note of is, in Q2 coming up here, we have 65,000 square feet that's coming up for renewal in Florida Research Park. We've talked about this on previous calls. We're expecting to sign a lease in very short order here for approximately half the space, which means we'll be getting back just over 30,000 square feet, that's an immediate space that's coming back to us in Q2.

Beyond that, there really isn't anything too significant for the balance of this year. At the end of the year, on December 31st, we're expecting to get back 46,000 square feet also in the Florida Research Park. That's field ingenuity drive property that we refer to. We have some time yet to go there. But just as you recall that 125,000 square foot building we've signed a direct deal with a subtenant for 79,000 square feet. And 46,000 square feet is coming back to us on December 31.

Rob Stevenson -- Janney Montgomery Scott LLC -- Analyst

Okay. On the second quarter, give back, is the current tenant staying in? Is that a new tenant that's taking half the space? And is there any material improvements that we need to be aware of?

Anthony Maretic -- Chief Financial Officer, Secretary & Treasurer

Yes, so that's a -- it's a GSA tenant that's in there now and they are giving back half. So we're renewing the existing tenant on reasonable terms.

Rob Stevenson -- Janney Montgomery Scott LLC -- Analyst

Okay. And then last one for me. When you wind up closing the acquisition you've got the disposition proceeds. What does the capital position look like? I mean, how much capital do you have essentially to invest in the remainder of the year without going to the upper ends of your leverage levels, etc.?

James Farrar -- Chief Executive Officer & Director

So maybe I'll start on that one, Rob. So we've got another, call it, $57 million from our guidance of the top end at $100 million. We're still comfortable that we could go a bit above that. As far as timing, the way we've model internally was kind of mid Q4, as far as a follow-on acquisition. But there are a number of things we're looking at right now. It could be sooner it could be later. It's really hard to say. So I think as far as best guess on timing, I wouldn't change what we put there.

Rob Stevenson -- Janney Montgomery Scott LLC -- Analyst

Okay. Thanks, guys. Appreciate the time.

James Farrar -- Chief Executive Officer & Director

Yes. Thanks, Rob.

Operator

The next question comes from Jason Idoine with RBC. Please go ahead.

Jason Idoine -- RBC -- Analyst

Hey, guys. Just touching on the SanTan Toyota lease. So I guess my first question is why does the tenant looking to leave that space, if you have any idea around on that? And then could you tell us a little bit about the prospects for that space? I think you guys have two buildings there. So just wondering if there's anything creative there that you could do? Maybe you bring in one tenant to lease both of those buildings? Or are you planning on multi-tenant and the Toyota one or kind of what's the plan there?

James Farrar -- Chief Executive Officer & Director

Sure. So Jason, as far as the -- there's two buildings, you're correct. Toyota occupies one. They put a lot of money into their space. What we were advised by Toyota is they were taking three buildings they have across the country and shifting the bulk of those workers to remote. And so they moved in that direction on three different locations. One in Phoenix, two in other parts of the country.

So it was disappointing from our standpoint, it's early days. We still have a lot of time, almost 16 months here before we get the space back. And so we've fired up our leasing team. We're starting to spend time on looking at what we can do with that particular building as far as enhancing amenities. It could be we're thinking of multi-tenant building, but at the same time there are some large users in Chandler looking for space to follow. Intel are making a huge investment and commitment in the area. And there could be some ancillary benefit from that.

So we're feeling really good about the time we have and the prospects and the rate we're going to get, but obviously, we'd love to have kept Toyota but I think we're in a good spot there.

Jason Idoine -- RBC -- Analyst

Okay. And I guess, on the redevelopment opportunities in Sorrento Mesa. So I think that those are going to be conversions from traditional office to lab. Some of your other peers who are in the life science space have noted that it's exceptionally difficult to kind of bring some of those traditional office spaces up to spec for lab tenant users. So just kind of curious to hear your thoughts around that or I guess what the ultimate development plan is there?

James Farrar -- Chief Executive Officer & Director

So we're in a bit of a different position where the five buildings we have, four of them are already life science with lab. One of them is leased to Intel, is an R&D building with a lot of infrastructure that could be easily -- sorry, Qualcomm, which could be easily converted to lab.

So when you look at the two buildings that are on the sites that we're buying, our view there is we're going to maximize holding income. It's likely would be a phased development that would happen over time. So it's a number of years before those ones would be ultimately taken down and then wrapped into a larger overall development.

Jason Idoine -- RBC -- Analyst

Okay, got it. And then I guess my last one on the FRP GSA lease. I know, I think last quarter, it was you guys gave an update that you were confident on the one space and the second space, you guys are still working through some discussions, but I guess we just had those discussions and why did they end up deciding to give back the one space? And I guess what are the prospects of leasing the remaining 30,000 that's going to be vacant out?

James Farrar -- Chief Executive Officer & Director

Yes. So in terms of the discussion, so the discussions were revolving around whether another department could utilize the space. Ultimately what they decided to do and is that they needed one floor and the second floor at the end of the day, we weren't able to come to terms with another department to take it over. Ultimately, we're going to do a very short term extension for two months on half of the space and then they'll vacate.

In terms of prospects for that space, again, this is just a reminder for Florida Research Park is around the military base there. There is a number of contractors and so demand has remained steady. And we feel good about our prospects. They'll be downtime probably through the balance of this year and then hopefully to have a replacement tenant paying rent in the new year.

Jason Idoine -- RBC -- Analyst

Okay. Thanks.

Operator

Your next question comes from Craig Kucera with B. Riley Securities. Please go ahead.

Craig Kucera -- B. Riley Securities -- Analyst

Hey. Good morning, guys. We're hearing more from Office REIT this earnings season about leasing and traffic coming back to pre-pandemic levels. You clearly sound optimistic, but I'd be curious as to any color on which markets you're seeing which are maybe showing greater strength versus those that might be lagging in that regard?

James Farrar -- Chief Executive Officer & Director

So Craig, I think that's a fair comment. So when you look at actual starting with utilization, it's picked up a little bit, but it's still kind of in the mid 20%. But where we are feeling a lot more optimistic is hearing directly from tenants as far as their plans on coming back and the timing, which is starting to circle around summer, fall, Labor Day. And so we're feeling good about that.

And then when you translate into tour activity, it's come up a lot, and really the markets like Phoenix, Dallas, Tampa, Orlando, I would say are kind of at the forefront. San Diego on life sciences is absolutely white hot. So those would be kind of the leaders across our portfolio.

The other thing we're spending some time on is looking at a few of our larger blocks of space where utilization hasn't been as high or in the case of merger or something spaces being used. And we're getting some good action around bringing in replacement tenants that could potentially really extend the overall lease terms that we have in those assets. And so that activity is picking up as well. And that would be in space that we couldn't otherwise accommodate in our vacancy.

So we're feeling pretty good about what we're seeing. I think it's going to be back end of the year before that really starts translating to seeing leases done in a meaningful way.

Craig Kucera -- B. Riley Securities -- Analyst

Okay, I appreciate that. Tony, will the remainder of the Toyota motor credit lease termination fee be recognized ratably until they vacate? Or is there any sort of lumpiness in there?

Anthony Maretic -- Chief Financial Officer, Secretary & Treasurer

No, it's really straight line between now and the end of August 2022. They signed. We got information notice really at the end of March, which is why you only see 57,000 recognized in Q1, but it'll be a straightline until the departure.

Craig Kucera -- B. Riley Securities -- Analyst

Okay, great. And one more for me. Jamie, you mentioned that you really have to find any attractive entry points in the acquisition market. Is that because there's just not a lot of product to evaluate now or are you actually seeing cap rate compression relative to maybe we were year to year and a half ago?

James Farrar -- Chief Executive Officer & Director

There's both Craig. There is just not a lot of transactions that really fit. And the ones that we are interested in, there's been a lot of competitors and pricing has moved and some of the cases of transactions we're working on move well beyond what they were initially asking. And so I think there is a lot of capital on the sidelines for good quality assets. And that's making it a little bit more difficult.

And then we kind of known that and that's why we timed in our own acquisition model the back end of the year and so we're going to be disciplined and make sure what we buy and where we put our capital they're going to be good value for us.

Craig Kucera -- B. Riley Securities -- Analyst

Okay, great. Thanks.

James Farrar -- Chief Executive Officer & Director

Thanks, Craig.

Operator

[Operator Instructions] As there are no additional questions, I would like to turn the conference back over to Mr. Farrar for any closing remarks.

James Farrar -- Chief Executive Officer & Director

Thanks for joining the call today. Please don't hesitate to reach out to us at any time if you have any further questions. Goodbye.

Operator

[Operator Closing Remarks]

Duration: 26 minutes

Call participants:

Anthony Maretic -- Chief Financial Officer, Secretary & Treasurer

James Farrar -- Chief Executive Officer & Director

Rob Stevenson -- Janney Montgomery Scott LLC -- Analyst

Jason Idoine -- RBC -- Analyst

Craig Kucera -- B. Riley Securities -- Analyst

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