Cousins Properties Incorporated (NYSE:CUZ) Q3 2023 Earnings Call Transcript

Cousins Properties Incorporated (NYSE:CUZ) Q3 2023 Earnings Call Transcript October 27, 2023

Operator: Good morning, and welcome to the Cousins Properties Third Quarter 2023 Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please also note that this event is being recorded today. I would now like to turn the conference over to Pamela Roper, General Counsel. Please go ahead.

Pamela Roper: Thank you. Good morning, and welcome to Cousins Properties’ Third Quarter Earnings Conference Call. With me today are Colin Connolly, our President and Chief Executive Officer; Richard Hickson, our Executive Vice President of Operations; and Gregg Adzema, our Chief Financial Officer. The press release and supplemental package were distributed yesterday afternoon as well as furnished on Form 8-K. In the supplemental package, the company has reconciled all non-GAAP financial measures to the most directly comparable GAAP measures in accordance with Reg G requirements. If you did not receive a copy, these documents are available through the quarterly disclosures and supplemental SEC information links on the Investor Relations page of our website, Cousins.com.

Please be aware that certain matters discussed today may constitute forward-looking statements within the meaning of Federal Securities laws, and actual results may differ materially from these statements due to a variety of risks and uncertainties and other factors, including the risk factors set forth in our annual report on Form 10-K and our other SEC filings. The company does not undertake any duty to update any forward-looking statements, whether as a result of new information, future events, or otherwise. The full declaration regarding forward-looking statements is available in the supplemental package posted yesterday and a detailed discussion of some potential risk is contained in our filings with the SEC. With that, I’ll turn the call over to Colin Conolly.

Colin Connolly: Thank you, Pam and good morning everyone. We had a strong third quarter at Cousins. On the earnings front, the team delivered $0.65 per share in FFO and same-property net operating income increased 4.6% on a cash basis. We leased 548,000 square feet during the quarter with a 9.8% cash rent roll-up. New and expansion leases totaled 189,000 square feet. In addition, we executed key renewals in Atlanta and Tampa. These are terrific results in any market. I will start with a few observations on the macro environment. To tame inflation, the Federal Reserve has rapidly raised interest rates more than 500 basis points over the past 18 months. The impact of higher rates have been slow to materialize, but they are now upon us.

The economy is slowing and financial conditions have tightened. Real estate debt and equity are less available and significantly more expensive. As a result, a meaningful bid/ask spread has emerged and the investment sales market has temporarily frozen leading to few relevant data points for asset pricing. None of this should be a surprise. This is all typical behavior in a rate tightening cycle. The macro narrative for the office sector is likely to get worse before it gets better. Media will focus on rising vacancy rates and accelerating loan defaults. This reporting will not be wrong. However, it will be a significant over generalization. As I said last quarter, where and what you invest in matters. Over the last 12 years, Cousins has intentionally focused on investments in premier lifestyle office and mixed-use properties, located in vibrant and well-amenitized Sunbelt neighborhoods.

See also Jim Cramer’s 14 Best of Breed Stocks and Billionaire Ray Dalio’s 15 Best Stock Picks.

Q&A Session

This is an entirely different strategy than commodity office in older downtowns in nondescript suburban locations. Despite the challenging macro environment, we are seeing some positive trends in our portfolio. I’ll highlight a few. First, the return to work is gaining momentum. CEO sentiment around remote work has shifted. Company announcements mandating three, four, and in some cases, five days a week of in-person work are accelerating and finally require compliance. In-person activity has increased within our portfolio, and we are seeing patterns begin to normalize in many properties. As it turns out, lifestyle office properties are full of professionals who’s, lifestyle is set around working in the office, at least most of the time. Collaboration, mentoring and serendipity are key to advancing their careers.

Come visit one of our properties and you’ll see a very different story, than the next headline with Castle data, which as an aside, is proving to not be representative of Trophy properties. Second, the flight to quality is becoming more pronounced. Newer vintage product is commanding most of the demand. Over the last 12 months, according to JLL, Office properties built since 2010 have accounted for 114 million square feet of positive net absorption. Properties built before 2010, account for 346 million square feet of negative net absorption. This statistic clearly captures the story. Third, the flight to capital is increasingly more important. Historically, landlords evaluated the credit of prospective customers. Today, it goes both ways. Prospective customers and their brokers are now evaluating the credit of their landlords.

Sponsorship is more important than ever. Not surprising, owners like Cousins with sound capital structures are growing market share. Fourth, there is little to no capital availability for older vintage lower-quality office properties or for speculative new development. So what are the implications for the office sector? There’s a bifurcation in the market. It is not a one-size-fits-all answer. Many traditional offices are emptying and will stagnate until they are repurposed or torn down. At the same time, lifestyle office is filling up and will thrive over the long-term. As I have mentioned previously, the office is not debt, Obsolete offices is debt. Said another way, the office market is not oversupplied. Commodity office is under demolished.

The market and the media continue to under appreciate this. There is opportunity for investors who do. What does this mean for Cousins? Early green shoots are taking shape for our Sun Belt Trophy portfolio. Our customers are returning in greater force, accelerated obsolescence is reducing competition, the development pipeline is shrinking and demand remains firmly focused on the best lifestyle properties in the best submarkets. While it will take time, the market has begun the rebalancing process. Longer term, the office sector is likely to reshape. Financial constraints are already creating pressure on many real estate platforms. Thus, market players are likely to change. In addition, we believe that investors and the media will increasingly differentiate lifestyle office from commodity office.

The fundamentals are just too different to be aggregated together. And if capital remains constrained, private market pricing will need to converge with public market valuations to find liquidity. Similar public, private pricing resets have occurred in past cycles, such a scenario, would create a unique opportunity for a well-capitalized public REIT, like Cousins. In closing, we are realistic about the potential negative impacts of higher interest rates on the economy and our earnings. However, we built Cousins to thrive during all phases of the economic cycle. And today, we are in an advantageous position relative to many of our other office peers. We are in the right Sun Belt markets. We own a trophy lifestyle portfolio with modest near-term lease expirations.

We have a fortress balance sheet with minimal near-term debt maturities, and we have a well-covered dividend. I believe that we have unique optionality at Cousins and we’ll see compelling opportunities across our Sun Belt footprint. However, the downward repricing of assets in the private market is still playing out. Thus, we remain patient, disciplined and continue to prioritize driving cash flow and maintaining a strong balance sheet. We are watching closely, though, and we will be ready. Before turning the call over to Richard, I want to thank our entire team at Cousins, who provides excellent service to our customers. Their dedication, resilience and hard work continue to propel us forward. Thank you. Richard?

Richard Hickson: Thanks, Colin. Good morning, everyone. I’m pleased to report our operational results this quarter are solid across the board. We also continue to be encouraged by the growing number of companies, asking employees to return to the office for the majority of the work week. We believe this trend will continue, as companies increasingly focus on collaboration, employee productivity and overall efficiency. Before reviewing results, I want to talk about WeWork and SVB Financial Group. As you have probably heard, WeWork has stated that it is pursuing lease restructures with all of its landlords, including Cousins. We have four locations with WeWork, totaling 169,000 square feet and representing 1.1% of our annualized rent at share.

As of today, WeWork is one month past due on its rental payments to us at two Atlanta locations, 725 Ponce and 120 West Trinity. As a reminder, we are a 20% owner of 120 West Trinity. While it is no guarantee of the eventual outcome, WeWork is current on rent payments at the other two locations. Based on the late status of rental payments at the two locations, we anticipate those two leases will be rejected in the event of a WeWork bankruptcy. The 725 Ponce lease is 46,000 square feet and the 120 West Trinity lease is 33,000 square feet, of which our share is 6,600 square feet. Fortunately, we have meaningful letters of credit in place for both leases. We are confident that the high quality of those two underlying office properties would present us with a range of future alternatives for these patents.

725 Ponce is one of the most dynamic new office buildings in Atlanta is located directly on the Beltline in East Midtown and is currently 100% leased. Given that, we expect to have an opportunity to either backfill with traditional office users, lease the spaces to a different flexible office operator or even continue working with WeWork in an alternative structure. Regarding SVB Financial Group, our former 205,000 square foot customer at Hayden Ferry I in Phoenix. Consistent with our prior guidance, SVB paid rent through September 30 and vacated the property. Hayden Ferry I has since been taken out of operation as part of a broader redevelopment of the entire Hayden Ferry project. As I have stated before, we believe this redevelopment will redefine the standard of quality in the Tempe submarket and are excited about the opportunity to backfill Hayden Ferry I, especially given SVB’s average expiring rent was below market.

It’s early, but a number of interesting prospects of various sizes have already toured the space. We anticipate the construction component of this overall redevelopment project will wrap up by the end of 2024. Now for our operating results. Our total office portfolio weighted average occupancy and end-of-period lease percentage both increased 0.3% this quarter to 88% and 91.1%, respectively. These represent our highest occupancy and lease percentage levels since the end of 2021. Despite national office leasing volume declining amid continued economic uncertainty, our team was able to deliver our highest quarterly leasing volume of 2023. In the third quarter, we completed 32 office leasings, totaling 548,000 square feet with a weighted average lease term of 8.6 years.