Brandywine Realty Trust (NYSE:BDN) Q4 2022 Earnings Call Transcript

Brandywine Realty Trust (NYSE:BDN) Q4 2022 Earnings Call Transcript February 2, 2023

Operator: Good day. And thank you for standing by. Welcome to the Brandywine Realty Trust Fourth Quarter 2022 Earnings Call. Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Jerry Sweeney, President and CEO. You may begin.

Jerry Sweeney: Catherine, thank you very much. Good morning, everyone and thank you for participating in our fourth quarter 2022 earnings call. On today’s call with me today are George Johnstone, our Executive Vice President of Operations; Dan Palazzo; our Vice President and Chief Accounting Officer and Tom Wirth, our Executive Vice President and Chief Financial Officer. Prior to beginning, certain information discussed during our call may constitute forward-looking statements within the meaning of the federal securities law. Although, we believe estimates reflected in these statements are based on reasonable assumptions, we cannot give assurance that the anticipated results will be achieved. For further information on factors that could impact our anticipated results, please reference our press release as well as our most recent annual and quarterly reports that we file with the SEC.

Well, first and foremost, we hope that you and your family had a wonderful holiday season and are looking forward to a successful 2023. During our prepared remarks this morning, we’ll briefly review fourth quarter results, provide color on recent transactions and outline our €˜23 business plan. Tom will then review our €˜22 results and frame out the key assumptions driving our €˜23 guidance. After that certainly Dan, George, Tom and I are available to answer any questions. So quickly reviewing our €˜22 results we posted fourth quarter FFO of $0.32 per share in line with consensus and full year FFO of $1.38 per share, which exceeded consensus estimates by $0.01 per share. During the fourth quarter of €˜22, we executed 226,000 square feet of leases, including 142,000 square feet of new leasing activity.

For 2022, we leased 1.8 million square feet of space, which compares favorably to both our volumes in 2021 and 2022. More specifically, looking at 2022, our new leases that we executed during the year exceeded our €˜21 new leasing activity by 11%, it was equal to pre pandemic levels that we experienced back in the fourth quarter of 2019. We also post a rental rate mark-to-market of 21% on a GAAP basis, and 12.5% on a cash basis. Our full year mark-to-market was just shy of 19% on a GAAP basis and just shy of 10% on a cash basis. Absorption for the quarter was negative by 123,000 square feet. Now half of this negative absorption was the result of a tenant default in Austin, while the other half were known tenant move outs, which resulted in a quarterly retention rate below our annual run rate.

So for the year we did post the retention above our business plan guidance at 64%. We did end the quarter at 89.8% occupied and 91% lease which were below our targets. And the previously mentioned tenant default accounted for about 50 basis points on each of those metrics. And occupancy was generally a little bit lower due to anticipated December move into split into January and the sale of our forward Tower Bridge property. From an occupancy and leasing standpoint, our DC portfolio continues to underperform. And as such, it’s worth noting that our Philadelphia, Pennsylvania suburbs and Austin portfolios, which comprise about 93% of our NOI are 91.7% occupied and 92.7% lease, spec revenue of $35.7 million exceeded the midpoint of our $34 million to $36 million range.

As we look at it, the portfolio is solid with a stable outlook. As we noted in the supplemental package, we have reduced our forward rollover exposure through €˜24 to an average of 6.2% and through €˜26 to an average of 7%. Physical tour volume has also been encouraging. Fourth quarter physical tours exceeded third quarter tours by 50% and was also ahead of our fourth quarter €˜21 tour buying by 12%. For the full year ’22, our tour volume was over 1.2 million square feet. We also continue to experience tenants taking advantage of opportunities to move up the quality curve. During 2022, over 600,000 square feet of leasing activity was the result of this flight to quality. In addition, looking at our portfolio tenant expansions continue to outweigh tenant contractions as a point of reference in 2022 expansions totaled 325,000 square feet, while contractions totaled 132,000 square feet.

So almost a 2.5 to 1 ratio of expansions over contractions. Our leasing pipeline of 3 million square feet is about 1.2 million on our operating portfolio, and 1.8 million on our development projects. On our operating portfolio which includes about 184,000 square feet in advanced stages of lease negotiations. Also 41% of that pipeline are prospects looking to move up the quality curve. And in fact, during the fourth quarter 58% of the new leases we executed were flight to quality tenants. Looking at some financial metrics, based on increased 2022 leasing activity and higher EBITDA, our fourth quarter net debt to EBITDA ratio decreased to 7.0x from the 7.2 in the third quarter. And as we’ve discussed, this ratio was transitionally higher due to our development spend and the debt attribution from our joint venture activity.

The more meaningful metric we track is our core net debt to EBITDA, which ended the year at the midpoint of our range of 6.2x and certainly in times of rate volatility and economic uncertainty, leasing and liquidity are our two key benchmarks. So since our last call, we’ve made significant progress on both the financing and capital recycling fronts by raising over $745 million of proceeds. As previously announced in December we completed a five-year $350 million unsecured bond offering at a 7.5% coupon. Those proceeds were essentially used to retire our February bond maturity. In January, we did complete a five-year $245 million secured financing with an 8.75% coupon that’s collateralized by seven wholly owned properties. The note has flexible release and prepayment provisions debt of about two years.

And it’s important to note, we took the secured route solely due to pricing differences between the secured and unsecured debt markets as we do plan to remain an investment grade unsecured borrower. Also during the fourth quarter, we get actually two sales generating $130 million of proceeds, the cap rates on those two sales were below 6%. The team also swapped our $250 million unsecured term loan towards June 27 maturity date at roughly 5%. So the results of all these combined transactions significantly improved our liquidity. Our consolidated debt is 96% fixed at essentially a 5% rate. We have no consolidated debt matures until our October 24 $350 million bond. We also now have full availability on our $600 million unsecured line of credit and approximately $30 million of unrestricted cash on hand.

As we noted on page 13 in our SIP, based on our full development spending projections, our 2023 business plan execution after fully funding our remaining development spend all TI leasing and capital costs, we expect to have about $590 million of available capacity at yearend €˜23. So based on our business plan, only $10 million of net usage during the year so very strong liquidity position. Turning quickly to 2023. We are providing €˜23 earnings guidance and FFO range of $1.12 to $1.20 per share for midpoint of $1.16 per share. At the midpoint the €˜23 FFO projection is $0.23 per share below our €˜22 FFO. The primary drivers are as follows. Our €˜23 NOI will exceed €˜22 levels by $20 million, or about $0.10 a share. Those improved operating results include contributions from 405 Colorado, 250 King of Prussia Road and 2340 Dulles as well as higher same store results.

This NOI growth though is offset by $33 million, or $0.19 per share due to increased interest expense on the recently completed financings. We also have about $0.08 per share decrease in our contribution from joint ventures, primarily due to higher interest rates, and initial projected losses from several development projects coming online and not being stabilized until after €˜23. We also anticipate about a $0.04 per share decline in other income as well as a $0.02 per share decrease in projected land gains over the activity in 2022. And Tom can certainly amplify those points in more detail. Our €˜23 plan is headlined by two key operating metrics. Our cash mark-to-market range is between 4% and 6% and GAAP mark-to-market is between 11% and 13%.

While these ranges are lower than our €˜22 levels, they certainly remain very strong, and it’s primarily driven by the composition of our projected €˜23 leasing activity. For example, during 2022 with much higher leasing revenue contributions from CBD, University City and the Pennsylvania suburbs. For ’23, higher leasing volumes have shifted to Austin Texas given a high level of occupancy in our core Pennsylvania and Philadelphia markets. Our mark-to-market in CBD and University City will perform above our business plan ranges while Austin given current market conditions in demand drivers are anticipated to perform below those ranges. Spec revenue will be between $17 million and $19 million with $10 million or 56% done at the midpoint. The occupancy levels will be between 90% and 91%.

Leasing levels between 91% and 92%. Retention rate will be between 49% and 51%. We do anticipate same store NOI growth will range from zero to 2% on a GAAP basis. And between 2.5% and 3.5% on a cash basis. Capital will run about 12% of revenues, which is lower than the 2022 results. And based on increased 2023 leasing activity and the continued development and redevelopment spend, we do project our net debt to EBITDA to be in the range of 7.0% to 7.3% with our core leverage between 6.2% and 6.5%. At the guidance midpoint our current dividend of $0.76 per share represents a 66% FFO payout ratio and 100% CAD payout ratio. Our business plan as we’ll talk in a few moments does project between $100 million and $125 million of sales activity that could generate additional gains.

And more importantly, with liquidity needs substantially addressed this targeted sale activity, we believe conservative underpinnings to our coverage ratios, we are keeping the dividend at current levels. Certainly as the business plan progresses, and we get more clarity on economic outlook, the board will as they always do continue to monitor both our coverages and the dividend payout levels. In addition to the financing activities that we already completed, we are actively engaged and planned to enter into a construction loan on our 155 King of Prussia Road project, which is fully leased and our 3151 Market Street project here Schuylkill Yards during the first half of the year. During 2023, we also have two joint ventures with non-recourse loans maturing.

We are already well underway with the refinancing discussions for these loans as well. The first one is a $20 million loan on our Commerce Square joint venture is a very low levered financing with a significant current debt yield. And we’re currently in the market to refinance that mortgage. We currently have over 15 lenders reviewing this financing opportunity. The second maturity is in August of €˜23. And refinancing efforts with our partners are underway there as well. As I touched on during the year, we are including a range in our business plan of between $100 million to $125 million at dispositions. We anticipate those occurring in the second half of the year. And we anticipate to generate those proceeds will have between $200 million to $300 million of properties in the market for price discovery.

In looking at development, we currently have $1.2 billion under active development, of that our wholly owned development aggregates $302 million and is 30% Life Science and 70% office. This portfolio is 83% leased with remaining funding requirements as we outlined in the SIP of $91 million. On the joint venture front, our development pipeline approximates $930 million, with a Brandywine share of $500 million. At full cost, this pipeline is 31% residential, 41% Life Science and 28% office. Brandywine’s remaining funding obligation in this entire pipeline is $4 million, with $68 million of equity remaining to be funded by our joint venture partners. Furthermore, as I mentioned in the last call, other than fully leased build a suit opportunities, our future development starts are on hold, pending more leasing on the existing joint venture pipeline, and more clarity on the cost of debt, capital and cap rates.

Looking ahead, though, we do plan to develop about 3 million square feet of life science space. And upon completion of the existing properties, we will have approximately 800,000 square feet of life science space in operation, representing about 8% of our portfolio. As we identified on page 6 in the SIP, our objective is to grow our life science platform to that 21% of our square footage. Just a quick review of specific projects. At 2340, our redevelopment project is now 92% leased with $45 million of remaining funding and a mid-year coming online at that lease — for those leases. 250 King of Prussia Road in our Radnor some market remains 53% leased with a strong pipeline of over 200,000 square feet. You will note in the SIP we had increased our costs on this project as our original pro forma assumed a 50:50 office and life science split.

The pipeline is now 100% life science which while requiring more capital is also generating longer term leases at a higher return on cost. And given the extended build that of the pipeline of several key prospects for life science base, we have also split the stabilization to Q1 of ’24. 3025 JFK, our life science residential tower is on time and on budget for delivery in the second half of the year. We currently have an active pipeline totaling 472,000 square feet, which is up about 75,000 square feet from last quarter. The project continued to see more activity as construction progresses. And the superstructure is now complete the window wall systems halfway up the building. We’ve done over 120 Hard Hat tours. We also expect to start delivery of the first block of residential units in the second half of this year, so all remains on schedule there.

3151 Market, our 440,000 square foot dedicated life size building is also on schedule and on budget. We have a leasing pipeline totaling over 400,000 square feet, which again is up from Q3. And as I touched on during, we anticipate we will enter into a construction loan on this project in the second half of €˜23. Uptown ATX Block A, construction in Austin is also on time and on budget. On the office component, our leasing pipeline, there is 500,000 square feet. That pipeline is down from last quarter, primarily due to two larger users putting their requirements on hold. Our focus up to that — up to this point has really been on full building users. We’re now shifting to a multi-tenant marketing program. So expect that pipeline to build as the quarter progresses.

And to wrap up our commentary on the development pipeline. But the key phrase in our forward pipeline is timing flexibility. We have a low land basis and product diversity, of the 13 million square feet that we can build only about 25% required to the office. With the ability to do between 3 and 4 million square feet of life science and over 4,000 apartments. Our overlay approvals do give us flexibility to further adjust that next meet market demands. Our €˜23 business plan does include as I mentioned the $100 million to $120 million of property dispositions, we expect they’ll occur in the second half of the year. While not really including many in our plan for ’23, we do anticipate continuing to sell non-core land parcels and looking at our joint ventures $458 million of our debt levels or about 19% of our total debt is coming from our joint ventures with about $416 million of that coming from our operating JVs. Our 2023 plan anticipates recapitalizing several of those JVs. So our plan assumes we will reduce attributed debt from operating JVs by about $100 million or 24% by the end of the year.

Certainly a dollar is generated from these activities were used to improve our existing strong liquidity, fund our remaining development pipeline, reduce leverage and redeploy into higher growth opportunities, including as liquidity permits stock and debt buybacks on a leverage neutral basis. Tom will now provide an overview of our financial results.

Tom Wirth: Thank you, Jerry. Our fourth quarter net income totaled $29.5 million or $0.17 per diluted share, and FFO totaled $55.7 million or $0.32 per diluted share in line with consensus estimates. Some general observations report regarding the fourth quarter while our fourth quarter results were in line with consensus, we had a number of moving pieces and several variances compared to our third quarter call guidance. Our portfolio occupants, portfolio income was up by $900,000 above our third quarter guidance call primarily due to overall portfolio performance being better throughout the portfolio. Termination and other income totaled $2.7 million. It was $800,000 below our third quarter forecast, primarily due to budgeted other income items that will occur in 2023.

Interest expense totaled $20.5 million or $2 million below our third quarter guidance primarily due to the higher capitalized interest and our slower capital spend. So our line of credit balance at the end of the year was below where we thought to be x the bond deals transaction. G&A expense totaled $9.1 million or $1.1 million above our third quarter guidance. The increase was due to a $1.8 million onetime charge for the write off of acquisition pursuit costs partially offset by lower personnel costs. Before tested one land sale to generate 800,000 gains in the quarter which did not occur. We anticipate that transactions to occur in the first quarter. Our fourth quarter debt service and interest coverage ratios were 3.3 and 3.5 respectively.

And net debt to GAV was slightly below 40%. Our fourth quarter annualized net debt to EBITDA was 7.0 and 1/10 of a churn above our high end of our guidance, which was 6 to 6.9. As far as the portfolio changes, we expect this year, we do expect that we will have four or five, stabilize and become part of our core portfolio during 2023. On the financing activities Jerry outline since our last call, we have made significant progress on our financing and capital recycling fronts. In December ’22, we did complete the five-year $350 million unsecured bond offering at 7.55% coupon and in January completed a five-year $245 million secured financing at 5.875%. And it’s collateralized by seven wholly owned properties. Those two financings raised $595 million at a blended rate of 6.7%.

Prior to the securing secured financing, our wholly owned portfolio was completely unencumbered. And we anticipate that will remain as unsecured borrowing, we will remain an unsecured borrower on future financings. We also swapped our $250 million unsecured term loan through its June 27 maturity date, and our consolidated debt is now 96% fixed at just over 5% rate, only our floating line of — only our line of credit and trust preferred securities are floating rate on the balance sheet. Regarding joint venture debt, we are currently working on the 2023 maturities including active marketing of our Commerce Square property. We also are already working with our €˜24 maturities with our partners to possibly extend the current maturity dates with existing lenders.

We’re also considering some asset sales to lower leverage. 2023 guidance, at the midpoint our net loss is $0.08 per share on a loss basis, and FFO will be $1.16 per diluted share. Based on the midpoint, FFO has decreased $0.22 per share. As Jerry mentioned, the primary drivers being GAAP and NOI being up. We do expect a small increase in management fees. But we do expect other income to be lower, interest incomes to be lower as a result of the sale of 1919 Market Street in Philadelphia and our JV. Interest expense is going to be up $23 million. Our land gains are down $5 million and the JV FFO is down 16.8 which is primarily interest expense that we anticipate happening due to higher rates but also some of our liability management in terms of caps and swaps that will burn off.

We do also anticipate some initial losses primarily on the opening of our residential project at Schuylkill Yards West. Our 2023 range was built on some of the following assumptions. GAAP NOI will be $3.4 million, an increase of $20 million. Most of that is due to 2340 and 405 Colorado, having incrementally higher NOI as we go through the year, we expect continued leasing of our life science development at 250 King of Prussia to be about $5 million. And we do expect about $3 million of net increase to the improvement on the same store portfolio. Our FFO contribution from joint ventures will total $8 million to $10 million. And that is primarily due to lower income due to the higher interest expense. G&A expense will be $34 million to $35 million and consistent with 2022.

As we talked about, total interest expense will be about $105 million. We do forecast some use of a line of credit throughout the year. But as we have the asset sales hit in the later part of the second half of the year. We do expect that to bring the line down but there will be incremental interest expense during that time. Capital interest — capitalized interest will increase it to 1$2 million as we continue our development and redevelopment projects. And we have $2 million to $4 million of land sales program for this year. We do anticipate further progress on selling non-core land parcels. And then those numbers can change as we go through the year as well. Termination and other income, $5 million to $6 million, which is below 2022 due to several anticipated onetime items and normal recurring activity in €˜22 that we don’t see happening in €˜23.

Net management fees will be between $15 million and $16 million. And we do have the property sales as Jerry mentioned at the second half of the year between $100 million and $125 million. There are no property acquisitions in our model. There’s no ATM or share buyback activity in the model and we anticipate a construction loan on 155 King of Prussia Road. Our share count will be approximately 174 million shares. As we look at the first quarter of the year, general assumptions are that we’ll have about $73 million of property NOI. The FFO contribution from our joint ventures will total $5.5 million, G&A will increase to $9.5 million. This is normal for the first half of the year as we have sequential increases due to our compensation expenses recognized and total interest expense will be $24.5 million.

Termination fee should be about $2 million. And we expect land gains to be about $1.5 million. From a capital plan perspective, our plan is about $465 million. Our CAD rage as Jerry mentioned between 95% and 105%. The main contributor to the higher range is primarily due to lower earnings, partially offset by reduced leasing costs. Those uses are going to be $105 million for development and redevelopment. The primary uses are going to be for 405 Colorado, 250 King of Prussia Road, 2340 Dulles and some work on Broadmoor infrastructure. Our common dividend is $132 million, revenue maintain should be about $34 million, $60 million of revenue create capital equity contributions to our joint ventures total. Some of that will be the development joint ventures but we also anticipate some capital contributions to our operating joint ventures including Commerce Square.

We had $54 million to retire the balance of our bonds in January. And the primary sources are going to be cash flow from operations of $175 million. The secure term loan which did close and generated $236 million of proceeds, $80 million of our cash on hand and about $120 million between the land sales as well as the program sales between $100 and $125 million. Based on that capital plan, our line of credit balance will decrease by approximately $84 million at the end of the year leaving almost full availability. We also projected our net debt to EBITDA will range between 7.0 and 7.3. And the increase is primarily due to the incremental spend on a development project, which will have minimal income by yearend. And our net debt to JV will be in the 40% to 42% range.

Our additional metric of core net debt to EBITDA will be 6.2 to 6.5 by the end of the year. That excludes our joint ventures and active development projects, but will include closed projects such as 405 Colorado. We believe this core metric better reflects the leverage of our core portfolio and eliminates our more highly leveraged joint ventures and our un-stabilized development and redevelopment projects. We believe these ratios are elevated. And due to growing development pipeline, and we believe that as these developments are stabilized, our leverage will decrease back towards the core leverage ratios. We anticipate our fixed charging interest coverage ratios will approximate 2.7x, which represents a sequential decrease in those coverage ratios primarily due to the capital spend, but also the higher interest rates.

I will now turn the call back over to Jerry.

Jerry Sweeney: Tom ,Thank you very much. So key takeaways or we believe the portfolio is in solid shape from an operation standpoint, our average annual rollover exposure through €˜26 is only 7%. With strong mark-to-market, manageable capital spends and stable and accelerating leasing velocity. Since last quarter, we have fully covered all of our wholly near-term liquidity needs, we finance our €˜23 bonds, as Tom mentioned, I mentioned only reduced our line of credit to zero, and presented a baseline business plan that continues to improve all liquidity while fully covering our dividend and keeps our operating portfolio in very solid footing with strong forward growth prospects. As usual end where we start and that we really do wish you and your families well. And with that we’d be delighted to open up the floor for questions. We do ask that in the interest of time you limit yourself to one question and a follow up. Catherine.

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Q&A Session

Operator: Our first question comes from Steve Sakwa from Evercore ISI.

Steve Sakwa: Yes, thanks. Good morning, Jerry and Tom. I guess I just wanted to start on the operating portfolio and some of the outlooks for lease and core occupancy. I know those numbers came in at the end of the year, kind of below your original forecasts. And some of those numbers are expected to be flat or even up in €˜22. And but you’ve got a lower retention ratio. So just trying to sort of square up your confidence level, in kind of the new leasing pipeline to kind of hit your leasing and occupancy numbers that seem to fall short last year.

Jerry Sweeney: Sure, Steve, George, why don’t you take that one?

George Johnstone: Yes, sure. Glad to and good morning, look on fourth quarter occupancy, we did, in fact, come up short the tenant default in Austin was 51 basis points, we had another 42,000 square feet or about 330 basis points of occupancy that did occur in January, but substantial completion, and the actual moving process did not occur in December. So all-in-all we thought we’d probably be closer to 90.7, which would have been about 34,000 square feet off of our 91% bottom end the outlook for €˜22 is probably again, close to a 90% average occupancy, that really being driven twofold, in Pennsylvania and CBD Philadelphia, we’re going to average about a 93% occupancy levels for the year, but in Austin in DC, only an 82%. And as Jerry mentioned in his commentary, that’s really the some of the dynamic that is occurring with CBD at 96% occupied for the year, the contribution levels that we will require and anticipate out of Austin, have risen.

They were roughly 16% of our square footage contribution in €˜22, and are now projected to be about 32% of our square footage contribution in €˜23. The pipeline is relatively consistent with what we’ve seen in the past. As it relates to Austin, in particular, since a lot of our focus is there, we have seen some good levels of tour activity, we do have a lease out currently on about 12,000 square feet of that space that was defaulted and given back in December. So we’re starting to see activity levels already in that building. So we remain positive, we still believe in the growth characteristics of Austin, a lot of our suburban properties are somewhat insulated from the big tech companies. And we see a lot more of financial service and just professional service prospects in that pipeline.

Hope that answers —

Steve Sakwa: Okay, and then maybe just quickly, yes, so thank you, I just wanted to touch quickly. Jerry, you talked about the 1.8 square feet on the development pipeline, and I know you’ve kind of walked through 3025, 3051, it sounded like Austin maybe was a bit slower. But can you just give us a little more color on the tenants that you’re talking to the timelines? Like how many of these are new to Philadelphia for the life science assets? And are the Austin tenants kind of new to Austin or they expanding tenants in Austin and obviously that mark is feeling some pressure with the tech slowdown which you mentioned, but just case any flavor on kind of in-house tenants or in market tenants versus new to the market?