Orion Office REIT Inc. (NYSE:ONL) Q2 2022 Earnings Conference Call August 4, 2022 10:00 AM ET
Company Participants
Paul Hughes – General Counsel
Paul McDowell – Chief Executive Officer
Gavin Brandon – Chief Financial Officer
Chris Day – Chief Operating Officer
Conference Call Participants
Jyoti Yadav – JMP Securities
Edward Reilly – EF Hutton
Operator
Greetings. Welcome to the Orion Office REIT’s Second Quarter 2022 Financial Results. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] Please note this conference is being recorded.
At this time, I’ll turn the conference over to Paul Hughes, General Counsel for Orion. Mr. Hughes, you may now begin.
Paul Hughes
Thank you, operator. Good morning, everyone. Yesterday, Orion released its financial results for the quarter ended June 30, 2022, filed its Form 10-Q with the Securities and Exchange Commission and posted its earnings supplement to its website. These documents are available in the Investors section of the company’s website at www.onlreit.com.
Forward-looking statements made during today’s call, such as the company’s guidance estimates for calendar year 2022, are subject to a number of risks and uncertainties that could cause actual results to differ materially from our expectations. These risks and uncertainties are discussed in our earnings release as well as in our Form 10-Q and other SEC filings. The company undertakes no duty to update any forward-looking statements that may be made during the course of today’s call.
Additionally, during the conference call today, we will be discussing certain non-GAAP financial measures, such as funds from operations or FFO, and core funds from operations or core FFO. The company’s earnings release and supplement include a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP measures.
Hosting the call today are Paul McDowell, the company’s Chief Executive Officer; Gavin Brandon the company’s Chief Financial Officer. And joining us for the Q&A session are Gary Landriau, our Chief Investment Officer; and Chris Day, our Chief Operating Officer.
With that, I am now going to turn the call over to Paul McDowell. Paul?
Paul McDowell
Good morning, everyone, and welcome to Orion Office REIT’s second quarter 2022 earnings call. On behalf of our team, I want to thank you all for joining us. On the call today, I will discuss our performance during the second quarter, which is only our second full quarter of operations, as well as highlight the progress we continue to make in optimizing Orion for future success. I will then turn the call over to Gavin to provide an update on our financial results and guidance.
As we have detailed, since November 2021, following our spin off from Realty Income, we inherited a portfolio that needed some intensive asset management and repositioning to address significant lease maturities and vacancies. While this process will take time and certainly consists of a variety of challenges along the way, we have made strong progress in the first half of the year.
We remain excited about the importance of suburban net lease office in the evolving landscape of office space and the workforces of tomorrow, and have strong conviction in our ability to ultimately grow Orion and maximize long-term value for our shareholders.
As a quick reminder, Orion is unique in that we are the only public net lease REIT, that is exclusively focused on owning a diversified portfolio of mission-critical and corporate headquarters office buildings, located in high-quality suburban markets throughout the United States. As a result, our business represents a specialized opportunity to invest in suburban net lease office.
At quarter end, the portfolio consisted of 91 properties and six unconsolidated joint venture properties, representing 10.5 million square feet that was 86.7% occupied. The properties are leased predominantly to creditworthy tenants, primarily on a net lease basis. As a percentage of annualized base rent as of June 30, 2022, there was 67.3% investment-grade tenancy across the portfolio and approximately 80% of our leases are either triple or double net.
Our assets are also diversified by tenant, tenant industry and geography. No tenant industry makes up more than 12.8% of annualized base rent and no single tenant makes up more than 12.4% of annualized base rent. Our largest markets by states are Texas and New Jersey, which represent 14.3% and 11.2% of annualized base rent respectively. And approximately 31.1% of our annualized base rent is derived from Sun Belt markets.
We are continuing to make progress in renewing leases in the portfolio with our current tenants. Last quarter, we secured 178,000 square feet of lease extensions and lease expansions in Texas and Georgia. And this quarter, we garnered another 206,000 square feet of lease extensions in Nebraska and Illinois, with a new weighted average lease term of 7.8 years.
Similar to Merrill Lynch, who signed on for an 11-year extension at the end of last year, tenants have demonstrated a willingness to lock in multiple year extensions ahead of their current expirations. It is great to see this continued positive leasing activity. As we have highlighted on previous calls, however, tenant retention will ultimately continue to be volatile.
Specifically, we had two scheduled lease expirations during the quarter totaling about 157,000 square feet. We had 11 vacant assets as of June 30, 2022, though our occupancy held fairly steady. Additionally, our portfolio’s weighted average lease term remains 4.1 years.
A critical component of our near to intermediate-term asset management strategy is to sell vacant and identify non-core assets that do not fit our long-term investment objectives. The sale of these assets will allow us to both reduce carry costs, and avoid the uncertainty and significant capital expenditures associated with retenanting.
To-date we have closed on two dispositions totaling 210,000 square feet for net proceeds of $9.2 million avoiding near-term vacancies as the leases expire. More importantly, we have six additional properties totaling about 338,000 square feet, under contract for sale for an aggregate sale price of approximately $19 million. We have a further two properties totaling a bit more than 300,000 square feet, under LOI for an aggregate sale price of about $13.8 million.
Several of these properties are currently vacant, while the remainder have short lease terms where we know the tenant will not renew. We are also actively marketing a number of other assets for sale or lease that fall into the same bucket. We anticipate that several of these sales will occur in the very near term, while one or two will trail into next year allowing us to continue to harvest rent before the sale closes.
Addressing the portfolio’s vacancies and significant lease roll over the next several years has and will remain our priority until we reach stabilization and enhance our portfolio’s weighted average lease term. We will continue to dedicate our time, capital and resources to this initiative. Again, we highlight that this will take time and put continued pressure on our earnings performance over the coming quarters and years, but we are confident in our experience and expertise, the track record of these assets and the strength of many of the properties we already have in the portfolio. While we are hard at work on repositioning the portfolio, we remain excited about Orion’s growth prospects and opportunity set.
We have a good pipeline and continue to actively review a number of acquisitions for both the joint venture as well as Orion’s own balance sheet. However, given the macroeconomic environment, our current valuation and our capital allocation needs, we will remain highly disciplined and strategic when it comes to adding new properties to our core portfolio.
We recently paid our second dividend and our Board has just declared our third quarterly dividend. As we have previously cited, it is our objective over time to position the portfolio to a place where we can increase our current payout ratio. We are acutely aware of our capital allocation obligations and in conjunction with our Board, we carefully weigh where best to apply our operating cash flow, the proceeds from our property sales and borrowings under the revolver. While current market conditions are dynamic, our long-term plans remain firmly in place.
We have a strong portfolio of occupied assets, some of which will require significant capital outlays as we renew our tenants. We have several current or near-term vacancies, where we believe the quality and location of the properties merit holding these assets, repositioning them as necessary and retenanting them makes sense. These assets will also take significant amounts of capital to carry and then attract new occupants. Our belief is that rather than make Orion’s equity base smaller over time our shareholders’ best interests will be served by preserving and then growing our core portfolio.
Importantly, we are pleased with the engagement we are observing with tenants, the progress we have made in leasing the portfolio, and our ability to dispose of vacant and non-core assets. Despite market disruptions, we are continuing to make steady progress in 2022 on our key goals, and believe in our capabilities to actively manage, recycle capital and ultimately grow this portfolio. We remain enthusiastic about Orion’s future and are steadfast in our commitment to delivering value for our shareholders.
With that, I will now turn the call over to Gavin Brandon, our CFO, who will discuss our second quarter 2022 financial highlights, our balance sheet, dividend and outlook for the remainder of the year. Gavin?
Gavin Brandon
Thanks Paul. I will begin by discussing Orion’s GAAP results for the second quarter of 2022, which is our second full quarter operating as a public company. Orion generated total revenue for the second quarter of 2022 of $52.8 million and reported net loss attributable to common stockholders of $15.6 million, or a loss of $0.27 per share. Core funds from operations was $26.8 million, or $0.47 per share, and adjusted EBITDA was $34.7 million.
G&A in the second quarter of 2022 was $3.3 million. CapEx with tenant and property improvements and leasing commissions this quarter were $2.4 million consistent with last quarter. As we have discussed, CapEx timing will be dependent on when leases are signed and work is completed on properties and likely will increase over time as our leases roll over.
Turning to the balance sheet. We ended the quarter with $628.3 million of outstanding debt, including Orion’s proportionate share of debt in the joint venture. During the quarter, we repaid $20 million outstanding on our revolving credit facility to bring the balance down to $71 million from $91 million.
As of June 30, 2022, we had total liquidity of $374 million consisting of $354 million of available capacity on our revolving credit facility and $20 million in cash and cash equivalents, including Orion’s proportionate share of cash in the joint venture. We have no debt maturities this year, and over 84% of our debt is fixed or swapped to fixed rate.
Our net debt to annualized adjusted EBITDA was 4.38 times at the quarter end. We also want to highlight that Orion’s Board of Directors has declared a quarterly dividend of $0.10 per share for the third quarter of 2022 to be paid on October 17, 2022 to stockholders of record, as of September 30 2022.
With our current liquidity, anticipated proceeds from dispositions and the cash flow the business is generating itself we believe we are in a strong financial position to weather the current and anticipated market volatility, while setting out to achieve our near- and longer-term objectives due primarily to the impact of a variety of accounting and onetime items such as the recent finalization of purchase price allocations, related to the spin-off from Realty Income, the timing of amortization of stock-based compensation under GAAP, and an additional one-year delay in the SEC requirement for an internal control audit, and a delay in hiring for a number of roles that are now filled we are updating our 2022 outlook.
That being said, these updated ranges should not be extrapolated to future years, given the impact of the lease expirations this year, coupled with the anticipated expirations in the portfolio over the next two years, and the associated expected decline in revenue due to a smaller portfolio size.
In addition, future years will also be affected by increased G&A related to the timing of certain expenses, as well as the end of the certain operating subsidies we have received from Realty Income as part of the spin-off.
Specifically, our G&A is now anticipated to range from $16 million to $16.5 million, down from $17 million to $18 million. Our core FFO is now expected to range from $1.74 to $1.78 per share up from $1.66 to $1.74 per share. Lastly, our net debt to adjusted EBITDA is now expected to range from 4.7 times to 5.0 times down from 4.7 times to 5.5 times.
With that, we’ll open the line up for questions. Operator?
Question-and-Answer Session
Operator
Thank you. We will now being conducting question-and-answer session. [Operator Instructions] Our first question comes from the line of Mitch Germain with JMP Securities. Please proceed with your question.
Jyoti Yadav
Hi. Good morning, everyone. This is Jyoti Yadav on for Mitch. So my first question is, Paul you mentioned in your opening remarks about asset dispositions. We’re hearing from a number of landlords that, they are slowing sales efforts due to pricing. So, just curious about your view on potential volume and timing of your sales?
Paul McDowell
Yeah. Well, we’re lucky. The assets that we’ve been looking to sell are sort of the assets that fall a little bit in the more specialized category versus typical institutional investment assets. So the market for – the markets in which we’re operating to sell our properties seem to be functioning pretty well. We’ve got very strong number of bids for the properties that we’ve been looking to sell. We’ve got as we said in the remarks, six properties under contract, and a couple of more under LOI.
And we see continued demand in the market for the types of properties that we’re selling. So we feel pretty good about our expectations for selling this noncore portfolio over the next couple of quarters.
Jyoti Yadav
Okay. Thank you. The second question that I have is, so your 2022 guidance midpoint is up from the first quarter that you gave us initially. But it kind of implies $0.40 per quarter going forward compared to $0.47 in the second quarter. So, how do you think what would cause this change? What are the key components there?
Paul McDowell
Well, I mean, I think – look we – our guidance is our guidance and we don’t give quarterly guidance. But I think that we will begin to see the impact of some of the lease expirations that we’ve had earlier this year on revenues, and that will impact revenues in the current quarter by that, I mean, the third quarter and then again in the fourth quarter and of course to some extent next year as well.
Jyoti Yadav
Right. Okay. That makes sense. And then last one for me really is, is there some sort of guidance that you have on the capital expenditure, just considering your leasing strategy going forward?
Paul McDowell
We haven’t issued guidance on capital expenditures, but what we have said is that we see capital expenditures running anywhere between $5 and $10 per square foot per year for new and renewed leases.
Jyoti Yadav
Okay. Thank you so much. That’s all for me.
Paul McDowell
Thank you
Operator
[Operator Instructions] Your next question is from the line of Edward Reilly with EF Hutton. Please proceed with your question.
Edward Reilly
Good morning, gentlemen. A bunch of housekeeping. You had three properties under LOI for an aggregate sale price of $13.8 million?
Paul McDowell
I think we have two under LOI 13.9 – $13.8 million. I’m sorry, $13.8 million, Eddie.
Edward Reilly
Okay. And – so there’s eight properties in the queue right now to be sold. Could you tell us how many of these are currently vacant?
Paul McDowell
About half of them are vacant. And the remainder, as I mentioned in my prepared remarks have short lease terms, where we expect the tenant will not renew.
Edward Reilly
Okay. Got you. So – let’s see here. So there’s currently 11 vacant properties. So you expect there to be maybe seven vacant properties after sale of these. I was wondering what the carrying costs for those seven baking properties are?
Paul McDowell
I’m going to let Chris Day answer that.
Chris Day
I think the average roughly around $7 a square foot per year. Some are higher, some are lower. Your properties in the Chicago area typically have higher property taxes, et cetera versus a property in a smaller market. But on average they are around $7 a square foot.
Edward Reilly
Okay. Got you. And of these remaining seven, are they considered [Technical Difficulty]?
Paul McDowell
Well I would say more generally when we look at the remaining vacant properties we have, several of them we may in the future decide to sell. Several of them we think are good properties and we think deserve a very solid and strong effort to re-lease them. We’re prepared to spend money on updating those properties and we’re prepared to spend money to attract new tenants to those properties. And the expectation is that we will. But if for some reason we feel like leasing is stalled or we’re not seeing the momentum we hope to see, we recognize how expensive it is to carry these properties we’ll then take a hard look at them and we may sell those as well.
Edward Reilly
Okay. Got you. And I’m wondering what industries have the most lease expirations in 2023 and 2024?
Paul McDowell
I don’t think I have that data right in front of me Eddie. Let me just look that up and we’ll get it back to you.
Edward Reilly
Okay. I mean do you think the – there’s a strong probability of [Technical Difficulty] to some of the tenants that have [Technical Difficulty] 2023 and 2024?
Paul McDowell
Sorry, could you repeat that? You were sort of going in and out a little bit.
Edward Reilly
Sorry. No I was just wondering if there is a strong probability of re-leasing to the tenants that have lease expirations in 2023 and 2024.
Paul McDowell
Yes. We’ve got – I would say that – our – last quarter I think our recapture or – was about 55%, 56% of tenants; about half renewed half terminated. I think looking forward we don’t know exactly where that’s going to come out. But quarter-to-quarter will be very, very volatile. So we may have one quarter where we have very strong renewal because if you have two leases expire and they both renew you’re at 100% renewal. And then if you have two leases and they both don’t renew, you’re at 0%.
But we think over time, we’ll have strong renewal in the portfolio but there will be some volatility quarter-to-quarter. Next looking into the coming periods, the coming two quarters – remaining two quarters of this year and then looking into next year, it will be a mixed bag like it has been this year. We’ll have some very good renewals. We’ve got some good new leasing visibility on properties that are going vacant. And we’ll have some departures and additional vacancy.
Edward Reilly
Okay. Great. Thanks, guys. Appreciate it.
Operator
Thank you. [Operator Instructions] Thank you. We’ve reached the end of our question-and-answer session. I’ll now turn the floor back to Mr. McDowell for closing comments.
Paul McDowell
Okay. Thank you all for joining us today. We look forward to updating you on our next quarterly conference call. Have a good weekend.
Operator
This concludes today’s conference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.
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