Office Properties Income Trust (NASDAQ:OPI) has announced its financial outcomes for the second quarter of 2024, highlighting a significant reduction in total debt and a stable property portfolio. The company successfully completed $1.3 billion in secured financing and reduced its debt by nearly $300 million. Despite facing challenges from known vacates and macroeconomic uncertainties, OPI exceeded the high end of its guidance range with a normalized Funds From Operations (FFO) of $33.2 million. However, the company anticipates a decrease in normalized FFO and same property cash basis Net Operating Income (NOI) in the upcoming third quarter.
Key Takeaways
- OPI reduced its total debt by approximately $300 million and completed $1.3 billion in secured financing.
- The portfolio comprises 151 properties, generating $483 million of annualized revenue.
- Known vacates will negatively impact future results, with 208,000 square feet of new and renewal leasing in Q2.
- OPI faces headwinds from work from home trends, macroeconomic and political uncertainty.
- The company plans to sell 12 unencumbered properties for $93.5 million.
- Normalized FFO for Q2 exceeded expectations at $33.2 million, but a decrease is expected in Q3.
- Same property cash basis NOI decreased by 7.7% compared to the same quarter last year.
- OPI has $160 million in total liquidity and $2.3 billion of outstanding debt with a weighted average interest rate of 7.1%.
- Strategies to address the next debt maturity of $499 million in February 2025 are being evaluated.
Company Outlook
- OPI expects a reduction in normalized FFO and same property cash basis NOI in the third quarter of 2024.
- The company is working with Moelis (NYSE:MC) & Company to address the upcoming maturity of $499 million of senior unsecured notes due in February 2025.
Bearish Highlights
- Known vacates in 2024 and 2025 will negatively impact results in the coming quarters.
- Upcoming lease expirations are challenged by the work from home trend and minimal tenants in the market.
Bullish Highlights
- The company reported a strong leasing activity, with renewals accounting for almost 90% of the activity.
- OPI has 12 unencumbered properties under agreement to sell, which is expected to improve liquidity.
Misses
- OPI reported an impairment charge to write down the value of 13 properties to their estimated fair value.
Q&A highlights
- All properties planned for sale or under agreement are unencumbered, which could affect the company's total revolver capacity.
- The company experienced lower expenses in Q2 due to successful tax appeals and deferred projects, but expenses are expected to rise in Q3.
- The valuation of life science development assets remains stable once stabilized, although comparisons to office properties are challenging.
Office Properties Income Trust, with a portfolio that includes a substantial number of properties and a strong leasing activity, is navigating through a period of financial restructuring and market challenges. The company's efforts to reduce debt and manage its portfolio in light of the evolving work environment and economic landscape will be closely monitored by investors and stakeholders in the coming quarters.
InvestingPro Insights
Amidst the financial restructuring and strategic maneuvers of Office Properties Income Trust (OPI), it's crucial for investors to consider the company's valuation and performance metrics. According to InvestingPro data, OPI is currently trading at a low Price/Book multiple of 0.09, which is indicative of the market valuing the company's assets at significantly less than their accounting value. This could suggest a potential undervaluation of the company's stock, especially considering the company's efforts to streamline operations and reduce debt.
Additionally, the company's P/E ratio stands at 8.76, which, when juxtaposed with its negative near-term earnings growth reflected in an adjusted P/E ratio of -2.58 for the last twelve months as of Q2 2024, suggests that the market has priced in the expected earnings decline. The PEG ratio of 0.29 for the same period also points to the stock potentially being undervalued relative to its earnings growth rate.
InvestingPro Tips highlight that, despite the challenges, OPI has maintained dividend payments for 16 consecutive years, which might appeal to income-focused investors. The company's liquid assets also exceed its short-term obligations, providing some financial cushion in the near term.
For those considering an investment in OPI or seeking to understand its current market position, additional insights are available. There are 14 more InvestingPro Tips listed on https://www.investing.com/pro/OPI, which can provide further depth into the company's financial health and market potential. These tips, coupled with real-time data, can help investors make more informed decisions in the context of Office Properties Income Trust's current market dynamics.
Full transcript - Government Properties Income Trust (OPI) Q2 2024:
Operator: Good morning, and welcome to the Office Properties Income Trust Second Quarter 2024 Earnings Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Kevin Berry, Senior Director of Investor Relations.
Kevin Barry: Thank you, and good morning, everyone. Thanks for joining us today. With me on the call are OPI's President & Chief Operating Officer, Yael Duffy; and Chief Financial Officer & Treasurer, Brian Donley. In just a moment, they will provide details about our business and our performance for the second quarter of 2024, followed by a question-and-answer session with sell side analysts. I would like to note that the recording and retransmission of today's conference call is prohibited without the prior written consent of the company. Also note that today's conference call contains forward-looking statements within the meeting of the Private Securities Litigation Reform Act of 1995 and other securities laws. These forward-looking statements are based on OPI's beliefs and expectations as of today, Thursday, August 1, 2024, and actual results may differ materially from those that we project. The company undertakes no obligation to revise or publicly release the results of any revisions of the forward-looking statements made in today's conference call. Additional information concerning factors that could cause those differences is contained in our filings with the Securities and Exchange Commission or SEC, which can be accessed from our website, opireit.com or the SEC's website. Investors are cautioned not to place undue reliance upon any forward-looking statements. In addition, we'll be discussing non-GAAP numbers during this call, including normalized funds from operations or normalized FFO and cash basis net operating income or cash basis NLI. Our reconciliation of these non-GAAP figures to net income are available in OPI's earnings release presentation that we issued last night, which can be found on our website. And finally, we'll be providing guidance on this call including normalized FFO and cash basis NOI. We are not providing a reconciliation of these non-GAAP measures as part of our guidance because certain information required for such reconciliation is not available without unreasonable efforts or at all, such as gains and losses or impairment charges related to the disposition of real estate. I will now turn the call over to the Yael.
Yael Duffy: Thank you, Kevin, and good morning. I will start with an overview of our portfolio review second quarter leasing results and upcoming lease expiration before providing an update on our property dispositions. Before I begin, I would like to highlight that in the first half of the year, OPI completed $1.3 billion in secured financing. Most recently in June, we finalized a private debt exchange that reduced OPI's total debt by nearly $300 million while reducing our upcoming 2025 debt maturities from $650 million to $499 million, which Brian will discuss later on this call. Now turning to the quarter, OPI's portfolio consists of 151 properties totaling 20 million square feet with a weighted average remaining lease term of over 6.5 years. Our portfolio generates $483 million of annualized revenue and is diversified by industry and geography. With over 60% of our revenues coming from investment grade tenants or subsidiaries, we ended the quarter with same property occupancy of 89.9%. Through our secured financing initiatives, 62 properties, totaling 10 million square feet within our portfolio are encumbered under our debt agreements. On a consolidated basis encumbered assets account for $286 million of annualized revenue are 94% leased and have a remaining weighted average lease term of nearly 8 years. Our unencumbered assets portfolio consists of 89 properties totaling 10 million square feet, provides annualized revenue of approximately $197 million or 73% lease and have a weighted average lease term of 4.6 years. As we have shared previously, our known vacates in 2024 and 2025 are heavily concentrated within this portfolio of assets and will negatively impact our results in the coming quarters. In the second quarter, we executed 208,000 square feet of new and renewal leasing, which resulted in a weighted average lease term of 4 years. Renewals drove almost 90% of our leasing activity, including a short-term extension with an insurance provider in Washington DC for 62,000 square feet at a 3% roll up in rent in a 5-year renewal with the GSA in Phoenix, Arizona for 32,000 square feet at a 6% roll up in rent. Subsequent to quarter close, we renewed a 554,000 square foot lease with an investment grade single tenant user within our encumbered portfolio that was scheduled to expire in 2026. While we had previously forecasted that this renewal would happen, we are pleased that it has been finalized and the property will be long-term leased into 2037. Looking ahead to OPI's upcoming lease expirations, the office sector continues to face headwinds associated with the impacts of work from home as well as macroeconomic and political uncertainty. Throughout the country, we face pressure in our releasing efforts with minimal tenants in the market to absorb large blocks of vacant space. Most markets are experiencing negative net absorption, declines in asking rents and heightened competition. Washington DC where OPI has its largest concentration has a market vacancy rate of over 22%. The upcoming election creates additional volatility as government tenants are hesitant to engage in long-term space planning discussions, given the uncertainty surrounding return to work mandates. Our 20 mass of development, which sits in the capital health submarket has not been immune to these challenges. The office portion has seen limited leasing interest, especially in recent months, and we are evaluating next steps required to maximize value. However, despite an investment to date of nearly $300 million, we believe based on broker opinions of value that the property would trade for under a $100 million if we are to pursue a sale. In the second half of 2024, 1.8 million square feet is scheduled to expire with an additional 2 million square feet expiring in 2025, comprised predominantly of properties leased to single tenants and we have long telegraphed. 1.7 million of the 1.8 million square feet expiring in 2024 will not renew and we currently expect an additional 1.3 million square feet will also vacate in 2025. In total known vacates over the next 18 months account for $70 million of annualized revenue or 14.5% of OPI's total annualized revenue. The U.S. government represents the highest percentage of these known vacates accounting for 32% of annualized rental income followed by the financial sector at 26% and the technology sector at 20%. Within the government sector, none of the properties being vacated are specialized building facilities or serve mission critical needs for government agencies. Over time, we expect the non-specialized portion of our government revenues will continue to decline as the GSA seeks to consolidate office space into government-owned buildings while reducing its reliance on lease properties. Our current leasing pipeline total 2.2 million square feet of which approximately 26% could result in positive net absorption. We plan to mitigate the impact to occupancy and associated carry costs through property disposition. While many of our single tenant properties that have become vacant could be converted to multi-tenant, the cost and downtime would be significant, which would put further burden on OPI liquidity. Office dispositions are challenging in this economic environment where property valuations have been negatively impacted since the pandemic and financing is not readily available to buyers. At OPI, we face additional obstacles given the properties we are marketing for sale are vacant or soon to be vacant, which further reduces the pool of potential buyers. Additionally, as we evaluate any sales, we must consider the impact the potential disposition will have on our operating metrics and debt covenants. Given these hurdles, we are pleased to report that we currently have 12 unencumbered properties totaling 1.4 million square feet under agreement to sell for an aggregate sales price of $93.5 million. This group of disposition assets has a total occupancy of 54% with a remaining lease term less than 3 years. We hope to close on these transactions by year end. While we have identified additional properties for disposition, our projection for disposition proceeds in 2024 remains at the a $100 million we referenced last quarter due to the challenges in the market I have described. As we look ahead, we remain focused on tenant retention, attracting new tenants to our properties, executing on our property dispositions and continuing to evaluate strategies to navigate OPI's upcoming debt maturities. With that, I'll now hand the call over to Brian to review our financial results.
Brian Donley: Thank Yael, and good morning everyone. Starting with our financial results for the second quarter, we reported normalized FFO of $33.2 million or $0.68 per share for the quarter, which exceeded the high end of our guidance range by $0.04 per share, largely due to lower-than-expected operating and general administrative expenses. This compares to normalized FFO of $38.3 million or $0.79 per share for the first quarter of 2024. The decrease on the sequential quarter basis was driven by higher interest expense and lower NOI. Same property cash basis NOI decreased 7.7% compared to the second quarter of 2023, which also came in better than our guidance range of a decline of 15% to 17% due to lower-than-expected operating costs and certain properties being classified as held for sale as of June 30. The year-over-year decrease was mainly driven by tenant vacancies. Turning to our outlook for normalized FFO and same property cash basis NOI expectations for the third quarter of 2024, we expect normalized FFO to be between $0.45 and $0.47 per share. The decrease sequentially from Q2 is primarily driven by lower rental income, higher seasonal operating expenses and increased interest expense related to our debt exchange transaction. Our current estimated quarterly interest expense run rate is approximately $43 million consisting of $41 million of cash interest expense and $2 million of non-cash amortization of financing costs. We expect same property cash basis NOI to be down 5% to 7% as compared to the third quarter of 2023 driven by tenant vacancies, elevated free rent specifically related to the lease renewal we executed in July that Yael referenced and increased operating expenses. This NOI guidance does not include any potential changes to our same store portfolio. Turning to our investing activities, we spent $30.1 million on recurring capital and $3.9 million on redevelopment capital during the second quarter. Our 2024 full year CapEx guidance remains unchanged with total capital spend expected to be approximately $100 million, comprised of $22 million of building capital and $78 million of leasing capital. We currently have 15 properties with a carrying value of $109 million classified as held for sale at quarter end. We took a $132 million impairment charge during the quarter to write down the caring value of 13 of these 15 properties to their estimated fair value. 12 of these properties are under agreement for sale for $93.5 million that we expect for transact by year end. We are continuously evaluating the portfolio for disposition opportunities that may improve our liquidity and financial metrics, and we are in various stages of the process to bring additional properties to market. Turning to the balance sheet, as of June 30, we have $160 million of total liquidity including $147 million of availability under our credit facility, which we expect to use to fund our operations and future leasing activity. We currently have $117 million of committed leasing related obligations. In mid-June, we completed a private debt exchange and eliminated almost $300 million of debt principle by exchanging $865 million of outstanding senior unsecured notes for $567 million of new 9% senior secured notes due 2029 and 1.5 million common shares. Our new 9% senior notes are secured by 19 properties with a gross book value of $716 million as well as second liens on the 19 properties that secure our credit agreement. We ended the quarter with $2.3 billion of outstanding debt with a weighted average interest rate of 7.1% and a weighted average maturity of 5.2 years. Our next maturity consists of $499 million of senior unsecured notes due in February of 2025. We are focused on evaluating all potential strategies to address this maturity and continue to work with our third-party advisor, Moelis & Company on evaluating the different options available to us as well as the impact each option would have on OPI's leverage, debt covenants and liquidity. We look forward to providing you with further updates on our as our plans progress. That concludes our prepared remarks. Operator, we are ready to open up the call for questions.
Operator: We will now begin the question-and-answer session. [Operator Instructions] Our first question is from Bryan Maher with B. Riley FBR.
Bryan Maher: As you move through the second half of 2024 and close on these dispositions and receive those proceeds, is there anything that precludes you from taking those proceeds and immediately starting to buyback 2025 notes at the meaningful discount that they currently trade at?
Brian Donley: That's something we're evaluating here now. We're looking at all different options to be able to pull in those notes whether it be via cash or exchanges or other options as we talk with our advisor, as I mentioned in the remarks, so that's our immediate focus. It's a large amount coming due in February and we're going to do everything we can to sort of get this in short order.
Bryan Maher: And then as we think about the debt exchange that you just completed, I think that there's like $46 million, I might be off a little bit balance that's still available for more exchanges. Are you seeing any traction from owners of your 2025 paper to possibly take you up on that sometime in the next couple, few months?
Brian Donley: Yes, that too is something we're looking at very closely and we're having discussions with various groups. But that is something that is definitely on the table as we try to utilize the maximum amount of notes that we had offered, the 610, which I think is around $43 million left of capacity, yes, we are looking to use those.
Bryan Maher: And then as it relates to your comments on 20 Mass Ave, I guess I'm a little perplexed there, the commentary that you would only get a $100 million. I mean, when we look at the recent transaction of Apple (NASDAQ:AAPL) Hospitality buying the ACDC as held just a few blocks away, a couple of months ago, I believe they paid like $500,000 per key. I think it was 218 keys there and have 220 Mass Avenues. It's a great hotel, large rooms, new, fresh, can't believe for a second, you probably couldn't get $600 a key for that if you sold it just as a hotel. Forget the office space that's empty, which would get you like $165 just for the hotel component. So where are the brokers coming up with this $100 million is just -- when you've just spent $300 million on it's pretty hard to get my head around that.
Yael Duffy: Trust me, if we could sell the property today for the valuations that you believe we would be thrilled. I think there's a couple factors that the brokers are taking into account. First, the hotel has been open less than a year, so it's still in its ramp up period. Additionally, the office component that that provides 45% vacancy on the whole site, and I think it's impairing the value of the property in whole because I think any potential buyer has a hard time underwriting what it would take to release that property or to lease that property as office given the challenges in DC for the office market, the specific market has vacancy of over 26%, so I think it's a long ramp up to lease the office component, and then if a potential buyer was to convert the whole property into more hotel rooms, there's significant cost associated with that. So I think the property you're referencing was a stabilized asset and this isn't today.
Bryan Maher: Yes, I understand that, but I mean, is that one of the options that you are considering? You made a comment about considering options for that space. Are you considering maybe converting those 3 floors to hotel given that there clearly is a market for hotel, forget for a second that it's only been open for 9 or 10 months. Is that something that you're thinking about doing to maximizing the value of that property?
Yael Duffy: We're trying to understand what the cost would be. I don't know that OPI would do that on itself right now given where we are, but it is something that we're evaluating to see what the cost would be and then also what the ramp up would be if we were to hold it as office and try to lease it.
Bryan Maher: And can you share with us who the tenant was who renewed the 554,000 square feet?
Yael Duffy: Yes, it was actually Bank of America (NYSE:BAC). They're one of our top 5 tenants.
Bryan Maher: And yes, maybe one last for me and I'll jump back in the queue. We get leasing activity reports and news from the greater DC area. It seems like a big law firm, Brown Rudnick just signed a new lease in DuPont (NYSE:DD) Circle. Just came across my desk this morning. Are you seeing any early shoots of improvement in demand in that market? And I think that when we look at the election forget who you're backing, the Democrats or the Republicans. I do believe I've heard Trump say that he's going to demand federal employees get back to the office if he's elected. Do you see any movement whatsoever that the federal employees will get back to that market sometime in the next year or 2?
Yael Duffy: Based on what we're seeing at our own properties that are especially the non-specialized portion where it's mostly office, we are not seeing employees back at work of even 50% capacity today.
Operator: [Operator Instructions] The next question is from Ronald Camden with Morgan Stanley (NYSE:MS).
Tamim Sarwary: This is Tamim for Ron. Just a question on the operating metrics by collateral pool page that you guys have in the supplemental. I found it really helpful. But if I add the remaining unsecured properties, there's about 10 million square feet and it looks like the occupancy for those assets blends to about 7 million square feet. And if I just take your disclosure about 2 million square feet expected to vacate, that brings you to about 50% occupancy on those buildings. Can you guys maybe just talk about where you expect NOI to trend on an annualized basis for that pool of assets assuming the 2 million square feet that you guys referenced on that page actually vacates?
Brian Donley: Yes, the properties that are held for sale, the 15 with about 2 million square feet, they were 53% occupied. As of quarter end, they generated about $20 million of annualized NOI for the trailing 4 quarters, only $4 million in Q2. And that's continuing to decline as some of these tenants have such a short walls that the NOI's going to be burning off. We're only projecting $2 million of revenue for Q3 and those properties will start generating losses, which is part of why we're disposing of them. So take those out of the equation, our occupancy is still tracking where it is today overall in the mid-to-high 80s.
Tamim Sarwary: Then just on the 2.2 million square foot pipeline, how much of that relates to properties currently unencumbered?
Yael Duffy: It's about half unencumbered.
Tamim Sarwary: And is most of that renewal or is it any new leasing as well?
Yael Duffy: It is. Of the 2.2 million in the total pipeline, about 1.4 million of it million is related to renewals.
Operator: Next question is a follow up from Bryan Maher with B. Riley FBR.
Bryan Maher: Given the commentary on asset sales, are any of the properties that you're considering selling to reduce debt or maybe address the 499, are any of those encumbered properties at all? And I'm assuming if you sell any of the encumbered properties, do all the proceeds from the asset sale have to go towards the debt it's encumbered on?
Yael Duffy: I'll start and Brian can add. So all of the properties we're looking to sell or are under agreement are all unencumbered.
Brian Donley: Yes. And as far as whether or not we decide to pursue sales on anything that's part of a debt transaction, yes, there are factors that that could impact such as if we were to sell something out of the credit agreement pool of properties, that could affect our availability of the total revolver capacity. So again, unencumbered assets are where we're focused. We just entered in a lot some of these debt transactions that are backing these. So it's unlikely we'll sell anything out of the encumbered pool.
Bryan Maher: And who are the buyers that you're talking to? Is it people that they're just looking for distressed properties, they're hoping for a market turnaround? Are they planning on doing office to residential conversions? I mean, who are these buyers?
Yael Duffy: So it's a mix, Bryan, it's a good question. We have some owner users and those are actually worthwhile when we have owner users because they pay a premium. And then we also have some value-add investors and some potential developers. So it does appear to be a mixed bag of buyers.
Bryan Maher: Maybe one last one for me for Brian. Look, the expense part of the income statement looked pretty solid. Expenses coming in fairly meaningfully below our expectations. Is there anything going on there per se that would continue that trend? Or was there any anomalies that we should be thinking about?
Brian Donley: It was a mixed bag, Bryan. Q2, we had some successful tax appeals that we had not projected at a handful of properties as we continue to evaluate and appeal taxes across the country as part of our normal process. So we were successful in a couple and that was about call it $1.6 million where we difference to our projections. We had some projects that I think were deferred from Q2 to Q3, so we'll see some increase in Q3. As I mentioned sequentially, we're expecting costs to be up, and we'll also see some increased utilities as the summer months are impacting Q3. So really it was a mixed bag. Some of its deferrals, some of it's one time and some of it's just savings.
Operator: The next question is a follow up from Ronald Camden with Morgan Stanley.
Tamim Sarwary: Just a follow up to that previous question. So the life science development those are encumbered assets but given some of the commentary on 20 Mass Ave and what you guys think that's worth. What are the broker conversations suggesting the life science development could be worth if you've had any conversations on those assets as well?
Yael Duffy: So I think given that those are life science properties, I think the valuation of what we've put them into the debt agreements is still holding true once stabilized. So it's a little hard to, it is very much apples and oranges given one is office and one is lab.
Operator: This concludes our question-and-answer session. I would like to turn the conference back over to the Yael Duffy for any closing remarks.
Yael Duffy: Thank you for joining us on the call today.
Operator: The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.
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